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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended 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. Unless otherwise noted, transactions and other factors significantly impacting our financial condition, results of operations and liquidity are discussed in order of magnitude. Our MD&A is presented in the following sections:
| • | Overview |
| • | Business Strategy |
| • | Results of Operations |
| • | Liquidity and Capital Resources |
| • | Critical Accounting Estimates |
| • | New Accounting Pronouncements |
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.
Overview
We are a leading provider of technology products, services and solutions. We offer these products and services to customers who visit our stores, engage with Geek Squad agents or use our websites or mobile applications. We have operations in the U.S., Canada and Mexico. We operate two reportable segments: Domestic and International. The Domestic segment is comprised of the operations in all states, districts and territories of the U.S. The International segment is comprised of all operations in Canada and Mexico.
Our fiscal year ends on the Saturday nearest the end of January. Fiscal 2018 included 53 weeks with the additional week included in the fourth quarter. Fiscal 2017 and 2016 each included 52 weeks. Our business, like that of many retailers, is seasonal. A higher proportion of our revenue and earnings is generated in the fiscal fourth quarter, which includes the majority of the holiday shopping season in the U.S., Canada and Mexico ("Holiday").
Throughout this MD&A, we refer to comparable sales. Our comparable sales calculation compares revenue from stores, websites and call centers operating for at least 14 full months, as well as revenue related to certain other comparable sales
channels for a particular period to the corresponding period in the prior year. Relocated stores, as well as remodeled, expanded and downsized stores closed more than 14 days, are excluded from the comparable sales calculation until at least 14 full months after reopening. Acquisitions are included in the comparable sales calculation beginning with the first full quarter following the first anniversary of the date of the acquisition. The calculation of comparable sales excludes the impact of revenue from discontinued operations, the effect of fluctuations in foreign currency exchange rates (applicable to our International segment only) and the impact of the extra week in fiscal 2018. The method of calculating comparable sales varies across the retail industry. As a result, our method of calculating comparable sales may not be the same as other retailers' methods.
The Canadian brand consolidation, which included the permanent closure of 66 Future Shop stores, the conversion of 65 Future Shop stores to Best Buy stores and the elimination of the Future Shop website, had a material impact on a year-over-year basis on the remaining Canadian retail stores and the website. As such, from the first quarter of fiscal 2016 through the third quarter of fiscal 2017, all Canadian store and website revenue was removed from the comparable sales base and the International segment no longer had a comparable metric. Therefore, Consolidated comparable sales equaled the Domestic segment comparable sales. Beginning in the fourth quarter of fiscal 2017, we resumed reporting International comparable sales as revenue in the International segment was once again deemed to be comparable and, as such, Consolidated comparable sales are once again equal to the aggregation of Domestic and International comparable sales. However, we have not provided International comparable sales for fiscal 2017 as the calculation would only include comparable revenue from the fourth quarter of fiscal 2017 and may be misleading in future periods when used for comparison purposes.
Non-GAAP Financial Measures
This MD&A includes financial information prepared in accordance with accounting principles generally accepted in the United States ("GAAP"), as well as certain adjusted or non-GAAP financial measures such as constant currency, non-GAAP operating income, non-GAAP effective tax rate, non-GAAP net earnings from continuing operations, non-GAAP diluted earnings per share ("EPS") from continuing operations and non-GAAP debt to earnings before interest, income taxes, depreciation, amortization and rent ("EBITDAR") ratio. We believe that non-GAAP financial measures, when reviewed in conjunction with GAAP financial measures, can provide more information to assist investors in evaluating current period performance and in assessing future performance. For these reasons, our internal management reporting also includes non-GAAP financial measures. Generally, our non-GAAP financial measures include adjustments for items such as restructuring charges, goodwill impairments and gains or losses on investments. In addition, certain other items may be excluded from non-GAAP financial measures when we believe this provides greater clarity to management and our investors. These non-GAAP financial measures should be considered in addition to, and not superior to or as a substitute for, GAAP financial measures. We strongly encourage investors and shareholders to review our financial statements and publicly-filed reports in their entirety and not to rely on any single financial measure. Non-GAAP financial measures as presented herein may not be comparable to similarly titled measures used by other companies.
In our discussions of the operating results of our Consolidated business and our International segment, we sometimes refer to the impact of changes in foreign currency exchange rates or the impact of foreign currency exchange rate fluctuations, which are references to the differences between the foreign currency exchange rates we use to convert the International segment’s operating results from local currencies into U.S. dollars for reporting purposes. We also use the term "constant currency," which represents results adjusted to exclude foreign currency impacts. We calculate those impacts as the difference between the current period results translated using the current period currency exchange rates and using the comparable prior period currency exchange rates. We believe the disclosure of revenue changes in constant currency can provide useful supplementary information to investors in light of significant fluctuations in currency rates and our inability to report comparable store sales for the International segment from the first quarter of fiscal 2016 through the third quarter of fiscal 2017 as a result of the Canadian brand consolidation.
Beginning in the first quarter of fiscal 2018, we no longer exclude non-restructuring property and equipment impairment charges from our non-GAAP financial metrics. When we began to execute our Renew Blue transformation in the fourth quarter of fiscal 2013, we adopted a change to non-GAAP reporting to exclude non-restructuring property and equipment impairment charges from our non-GAAP results. From that point, through the fourth quarter of fiscal 2017, we believed that reporting non-GAAP results that excluded these charges provided a supplemental view of our ongoing performance that was useful and relevant to our investors. Now that Renew Blue has ended and Best Buy 2020: Building The New Blue has officially launched, we believe it is no longer necessary to adjust for non-restructuring property and equipment impairments in our non-GAAP reporting. We believe that future such impairments will predominantly be immaterial and incurred in the ordinary scope of ongoing operations. Accordingly, commencing in the first quarter of fiscal 2018, we no longer adjust for non-restructuring property and equipment impairments. Impacted prior period non-GAAP financial measures have been recast to conform with this presentation.
Refer to the Non-GAAP Financial Measures section below for the detailed reconciliation of items that impacted the non-GAAP operating income, non-GAAP effective tax rate, non-GAAP net earnings from continuing operations and non-GAAP diluted EPS from continuing operations in the presented periods.
Refer to the Other Financial Measures section below for the detailed reconciliation of items that impacted the non-GAAP debt to EBITDAR ratio. Management believes this ratio is an important indicator of our creditworthiness. Furthermore, we believe that our non-GAAP debt to EBITDAR ratio is important for understanding our financial position and provides meaningful additional information about our ability to service our long-term debt and other fixed obligations and to fund our future growth. We also believe our non-GAAP debt to EBITDAR ratio is relevant because it enables investors to compare our indebtedness to that of retailers who own, rather than lease, their stores. Our decision to own or lease real estate is based on an assessment of our financial liquidity, our capital structure, our desire to own or to lease the location, the owner’s desire to own or to lease the location and the alternative that results in the highest return to our shareholders.
Business Strategy
In November 2012, we introduced our transformation strategy called Renew Blue. Since then we have stabilized comparable sales and increased our profitability. In fiscal 2018, we declared Renew Blue complete and unveiled a new strategy: Best Buy 2020: Building the New Blue.
Customers are at the core of Best Buy 2020. Technology continues to evolve, opening an increasing range of possibilities for our customers. It is also creating more complexity and we believe many of our customers need our help. The purpose of our strategy is to help our customers enrich their lives through technology. We believe we can do this by focusing on customers’ underlying needs, such as entertainment, communications, security and health. We continue to believe we have a material opportunity to grow the company. Technology innovations continue to be vibrant and exciting and we believe our market offers room for differentiation.
Against this backdrop, we intend to fulfill our purpose and grow the company by expanding what we sell, evolving how we sell and building key enablers, all while continuing to reduce costs. To these ends, in fiscal 2018, we expanded our In-Home Advisor program, introduced our Total Tech Support offering, continued to enhance associate proficiency, and continued to improve and simplify the online buying process for our customers. We invested in enterprise customer relationship management capabilities and continued to develop our services platform. We also began investing in the transformation of our supply chain, while continuing to make progress on our productivity goals. Based on early results, as outlined in the Results of Operations section below, we believe our strategy is working.
Results of Operations
In order to align our fiscal reporting periods and comply with statutory filing requirements, we consolidate the financial results of our Mexico operations on a one-month lag. Consistent with such consolidation, the financial and non-financial information presented in our MD&A relative to these operations is also presented on a lag. Our policy is to accelerate the recording of events occurring in the lag period that significantly affect our consolidated financial statements. No such events were identified for the periods presented.
The results of Jiangsu Five Star Appliance Co., Limited ("Five Star"), in our International segment, are presented as discontinued operations on our Consolidated Statements of Earnings. Unless otherwise stated, financial results discussed herein refer to continuing operations.
Fiscal 2018 included 53 weeks, and fiscal 2017 and 2016 included 52 weeks.
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 | 2018 | 2017 | 2016 | ||||||||
| Revenue | $ | 42,151 | $ | 39,403 | $ | 39,528 | |||||
| Revenue % gain (decline) | 7.0 | % | (0.3 | )% | (2.0 | )% | |||||
| Comparable sales % gain (1) | 5.6 | % | 0.3 | % | 0.5 | % | |||||
| Comparable sales % decline, excluding estimated impact of installment billing(1)(2) | n/a | n/a | (0.1 | )% | |||||||
| Restructuring charges - cost of goods sold | $ | — | $ | — | $ | 3 | |||||
| Gross profit | $ | 9,876 | $ | 9,440 | $ | 9,191 | |||||
| Gross profit as a % of revenue(3) | 23.4 | % | 24.0 | % | 23.3 | % | |||||
| SG&A | $ | 8,023 | $ | 7,547 | $ | 7,618 | |||||
| SG&A as a % of revenue | 19.0 | % | 19.2 | % | 19.3 | % | |||||
| Restructuring charges | $ | 10 | $ | 39 | $ | 198 | |||||
| Operating income | $ | 1,843 | $ | 1,854 | $ | 1,375 | |||||
| Operating income as a % of revenue | 4.4 | % | 4.7 | % | 3.5 | % | |||||
| Net earnings from continuing operations | $ | 999 | $ | 1,207 | $ | 807 | |||||
| Gain from discontinued operations(4) | $ | 1 | $ | 21 | $ | 90 | |||||
| Net earnings | $ | 1,000 | $ | 1,228 | $ | 897 | |||||
| Diluted earnings per share from continuing operations | $ | 3.26 | $ | 3.74 | $ | 2.30 | |||||
| Diluted earnings per share | $ | 3.26 | $ | 3.81 | $ | 2.56 |
| (1) | The Canadian brand consolidation that was initiated in the first quarter of fiscal 2016 had a material impact on a year-over-year basis on the Canadian retail stores and website. As such, beginning in the first quarter of fiscal 2016 through the third quarter of fiscal 2017, all store and website revenue was removed from the comparable sales base, and an International segment (comprised of Canada and Mexico) comparable sales metric has not been provided. Therefore, Consolidated comparable sales for fiscal 2017 include revenue from continuing operations in the Domestic segment for the full year and the International segment for the fourth quarter only, and Consolidated comparable sales for fiscal 2016 equal the Domestic segment comparable sales. Comparable sales also exclude the impact of the extra week in fiscal 2018. |
| (2) | Represents comparable sales, excluding the estimated revenue benefit from installment billing. In fiscal 2015, we began selling installment billing plans offered by mobile carriers to our customers to complement the more traditional two-year plans. While the two types of contracts have broadly similar overall economics, installment billing plans typically generate higher revenues due to higher proceeds for devices and higher cost of sales due to lower device subsidies. As we increased our mix of installment billing plans, we had an associated increase in revenue and cost of goods sold and a decrease in gross profit rate, with gross profit dollars relatively unaffected. This change in plan offer did not impact our International segment. Beginning in fiscal 2017, we no longer reported comparable sales, excluding the estimated revenue benefit from installment billing, as the mix of installment billing plans became comparable on a year-over-year basis. |
| (3) | Because retailers vary in how they 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 other retailers' corresponding rates. 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, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. |
| (4) | Includes both gain from discontinued operations and net earnings from discontinued operations. |
Fiscal 2018 Results Compared With Fiscal 2017
Consolidated revenue of $42.2 billion in fiscal 2018 increased 7.0% compared to fiscal 2017. Fiscal 2018 includes approximately $760 million of revenue from the extra week. The components of the 7.0% revenue increase in fiscal 2018 were as follows:
| Comparable sales impact | 5.3 | % |
| Non-comparable sales(1) | 1.5 | % |
| Impact of foreign currency exchange rate fluctuations | 0.2 | % |
| Total revenue increase | 7.0 | % |
| (1) | Non-comparable sales reflects the impact of net store opening and closing activity, the impact of the extra week in fiscal 2018, as well as the impact of revenue streams not included within our comparable sales calculation, such as profit-share revenue, certain credit card revenue, gift card breakage and sales of merchandise to wholesalers and dealers, as applicable. |
Our gross profit rate decreased by 0.6% of revenue in fiscal 2018. Our Domestic segment contributed a rate decrease of 0.4% of revenue, while our International segment contributed a rate decrease of 0.2%. For further discussion of each segment's gross profit rate changes, see Segment Performance Summary, below.
The SG&A rate decreased by 0.2% of revenue in fiscal 2018. Our Domestic and International segments both contributed a rate decrease of 0.1% of revenue. For further discussion of each segment's SG&A rate changes, see Segment Performance Summary, below.
Restructuring charges decreased from $39 million in fiscal 2017 to $10 million in fiscal 2018. The fiscal 2018 and fiscal 2017 activity primarily related to our Domestic segment. For further discussion of each segment's restructuring charges, see Segment Performance Summary, below.
Our operating income decreased $11 million and our operating income as a percent of revenue decreased to 4.4% of revenue in fiscal 2018, compared to operating income of 4.7% of revenue in fiscal 2017. The decrease in our operating income was primarily due to a decrease in our gross profit rate and an increase in SG&A.
Fiscal 2017 Results Compared With Fiscal 2016
Consolidated revenue of $39.4 billion in fiscal 2017 decreased 0.3% compared to fiscal 2016. The components of the 0.3% revenue decrease in fiscal 2017 were as follows:
| Comparable sales impact | 0.2 | % |
| Impact of foreign currency exchange rate fluctuations | (0.2 | )% |
| Non-comparable sales(1) | (0.3 | )% |
| Total revenue decrease | (0.3 | )% |
| (1) | Non-comparable sales reflects the impact of revenue in our International segment for the first through third quarters of fiscal 2017, net store opening and closing activity, as well as the impact of revenue streams not included within our comparable sales calculation, such as profit share revenue, certain credit card revenue, gift card breakage and sales of merchandise to wholesalers and dealers, as applicable. |
Our gross profit rate increased 0.7% of revenue in fiscal 2017. Our Domestic segment contributed a rate increase of 0.5% of revenue, while our International segment contributed 0.2%. For further discussion of each segment's gross profit rate changes, see Segment Performance Summary, below.
The SG&A rate remained flat on a year-over-year basis with both Domestic and International segments contributing flat year-over-year SG&A as a percentage of revenue. For further discussion of each segment's SG&A rate changes, see Segment Performance Summary, below.
Restructuring charges decreased from $198 million in fiscal 2016 to $39 million in fiscal 2017. The fiscal 2017 activity primarily related to our Domestic segment, while our fiscal 2016 activity was driven by our International segment. For further discussion of each segment’s restructuring charges, see Segment Performance Summary, below.
Our operating income increased $479 million and our operating income as a percent of revenue increased to 4.7% of revenue in fiscal 2017, compared to operating income of 3.5% of revenue in fiscal 2016. The increase in our operating income was primarily due to an increase in our gross profit rate and a decrease in our restructuring activity.
Segment Performance Summary
Domestic Segment
The following table presents selected financial data for our Domestic segment for each of the past three fiscal years ($ in millions):
| Domestic Segment Performance Summary | 2018 | 2017 | 2016 | ||||||||
| Revenue | $ | 38,662 | $ | 36,248 | $ | 36,365 | |||||
| Revenue % gain (decline) | 6.7 | % | (0.3 | )% | 0.9 | % | |||||
| Comparable sales % gain(1) | 5.6 | % | 0.2 | % | 0.5 | % | |||||
| Comparable sales % decline, excluding the estimated impact of installment billing(1)(2) | n/a | n/a | (0.1 | )% | |||||||
| Gross profit | $ | 9,065 | $ | 8,650 | $ | 8,484 | |||||
| Gross profit as % of revenue | 23.4 | % | 23.9 | % | 23.3 | % | |||||
| SG&A | $ | 7,304 | $ | 6,855 | $ | 6,897 | |||||
| SG&A as % of revenue | 18.9 | % | 18.9 | % | 19.0 | % | |||||
| Restructuring charges | $ | 9 | $ | 31 | $ | 2 | |||||
| Operating income | $ | 1,752 | $ | 1,764 | $ | 1,585 | |||||
| Operating income as % of revenue | 4.5 | % | 4.9 | % | 4.4 | % | |||||
| Selected Online Revenue Data | |||||||||||
| Online revenue as a % of total segment revenue | 15.5 | % | 13.4 | % | 11.0 | % | |||||
| Comparable online sales % gain(1) | 21.8 | % | 20.8 | % | 13.5 | % |
| (1) | Comparable online sales gain is included in the total comparable sales gain. Comparable sales also exclude the impact of the extra week in fiscal 2018. |
| (2) | Represents comparable sales, excluding the estimated revenue benefit from installment billing. In fiscal 2015, we began selling installment billing plans offered by mobile carriers to our customers to complement the more traditional two-year plans. While the two types of contracts have broadly similar overall economics, installment billing plans typically generate higher revenues due to higher proceeds for devices and higher cost of sales due to lower device subsidies. As we increased our mix of installment billing plans, we had an associated increase in revenue and cost of goods sold and a decrease in gross profit rate, with gross profit dollars relatively unaffected. Beginning in fiscal 2017, we no longer reported comparable sales, excluding the estimated revenue benefit from installment billing, as the mix of installment billing plans became comparable on a year-over-year basis. |
The following table reconciles our Domestic segment stores open at the end of each of the last three fiscal years:
| Fiscal 2016 | Fiscal 2017 | Fiscal 2018 | ||||||||||||||||||
| Total Stores at End of Fiscal Year | Stores Opened | Stores Closed | Total Stores at End of Fiscal Year | Stores Opened | Stores Closed | Total Stores at End of Fiscal Year | ||||||||||||||
| Best Buy | 1,037 | — | (11 | ) | 1,026 | — | (18 | ) | 1,008 | |||||||||||
| Best Buy Mobile stand-alone | 350 | — | (41 | ) | 309 | — | (52 | ) | 257 | |||||||||||
| Pacific Sales | 28 | — | — | 28 | — | — | 28 | |||||||||||||
| Total Domestic segment stores | 1,415 | — | (52 | ) | 1,363 | — | (70 | ) | 1,293 |
We continuously monitor store performance. As we approach the expiration date of our stores leases, we evaluate various options for each location, including whether a store should remain open. On March 1, 2018, we announced our intent to close all of our 257 remaining Best Buy Mobile stand-alone stores in the U.S. Refer to Note 4, Restructuring Charges, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for further information about our restructuring activities.
Fiscal 2018 Results Compared With Fiscal 2017
Domestic segment revenue of $38.7 billion in fiscal 2018 increased 6.7% compared to the prior year and includes approximately $715 million of revenue from the extra week. The components of the 6.7% revenue increase in the Domestic segment in fiscal 2018 were as follows:
| Comparable sales impact | 5.3 | % |
| Non-comparable sales(1) | 1.4 | % |
| Total revenue increase | 6.7 | % |
| (1) | Non-comparable sales reflects the impact of the extra week in fiscal 2018, as well as the impact of revenue streams not included within our comparable sales calculation, such as profit-share revenue, credit card revenue, gift card breakage, commercial sales and sales of merchandise to wholesalers and dealers. Non-comparable sales also reflects the impact of net store opening and closing activity of (0.7)% in fiscal 2018. |
The profit-share revenue included in our non-comparable sales relates to our extended warranty protection plans that are managed by a third-party underwriter. We may be eligible to receive profit-sharing payments, depending on the performance of the portfolio. When performance of the portfolio is strong and the claims cost to the third-party underwriter declines, we are entitled to share in the excess premiums. In fiscal 2018, we recognized $59 million of such profit-share revenue, with an equal impact to gross profit and operating income. In fiscal 2017, we recognized $110 million of such profit-share revenue. The fiscal 2018 profit-share revenue decrease from fiscal 2017 reflects reductions to the premiums that we pay to the third-party underwriter. In light of the continued impact of these lower premiums, we expect the profit-share payments to continue to decrease in future periods.
In fiscal 2018, Domestic segment online revenue of $6.0 billion increased 21.8% on a comparable basis, primarily due to higher conversion rates and increased traffic. As a percentage of total Domestic revenue, online revenue increased to 15.5% versus 13.4% last year.
The following table presents the Domestic segment's revenue mix percentages and comparable sales percentage changes by revenue category in fiscal 2018 and 2017:
| Revenue Mix Summary | Comparable Sales Summary | ||||||||||
| Year Ended | Year Ended | ||||||||||
| February 3, 2018 | January 28, 2017 | February 3, 2018 | January 28, 2017 | ||||||||
| Consumer Electronics | 33 | % | 34 | % | 3.1 | % | 5.0 | % | |||
| Computing and Mobile Phones | 45 | % | 45 | % | 5.3 | % | (1.8 | )% | |||
| Entertainment | 8 | % | 7 | % | 12.6 | % | (13.8 | )% | |||
| Appliances | 10 | % | 9 | % | 11.4 | % | 7.8 | % | |||
| Services | 4 | % | 5 | % | 4.0 | % | (3.3 | )% | |||
| Total | 100 | % | 100 | % | 5.6 | % | 0.2 | % |
We believe the strong execution of our business strategy, combined with better product availability, a continued healthy consumer confidence, positive macro conditions and a favorable competitive environment contributed to our Domestic comparable sales growth across most of our categories. The following is a description of the notable comparable sales changes in our Domestic segment by revenue category:
| • | Consumer Electronics: The 3.1% comparable sales gain was driven primarily by smart home, home theater, headphones and voice assistants, partially offset by declines in health and fitness. |
| • | Computing and Mobile Phones: The 5.3% comparable sales gain was driven primarily by computing, mobile phones and wearables, partially offset by declines in tablets. |
| • | Entertainment: The 12.6% comparable sales gain was driven primarily by gaming hardware. |
| • | Appliances: The 11.4% comparable sales gain was driven primarily by large and small appliances. |
| • | Services: The 4.0% comparable sales gain was primarily driven by continued growth in our warranty business, and higher installation and delivery services. |
Our Domestic segment experienced a decrease in gross profit rate to 23.4% in fiscal 2018 from 23.9% in fiscal 2017. This rate decrease was primarily due to the $183 million of cathode ray tube ("CRT") settlement proceeds recorded in the first quarter of fiscal 2017 and a decrease in our periodic profit-share revenue as described above, partially offset by improved margin rates across multiple categories.
Our Domestic segment SG&A rate remained flat at 18.9% of revenue in fiscal 2018 compared to the prior year. SG&A increased in fiscal 2018 due to (1) higher incentive compensation for store and corporate employees, (2) investments in growth initiatives, (3) the impact of the extra week, (4) one-time expenses related to tax reform, which included $75 million related to employee bonus expense and a $20 million charitable donation to the Best Buy Foundation, and (5) higher variable costs due to
increased revenue. These increases were offset by cost reductions and $22 million in CRT settlement legal fees incurred in the first quarter of fiscal 2017 that did not recur in fiscal 2018.
Our Domestic segment incurred $9 million of restructuring charges in fiscal 2018 and $31 million of restructuring charges in fiscal 2017. The restructuring charges in fiscal 2018 related to the Best Buy Mobile plan that began in the fourth quarter of fiscal 2018, whereas the charges in fiscal 2017 related primarily to the Renew Blue Phase 2 plan that began in the first quarter of fiscal 2017. Refer to Note 4, Restructuring Charges, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for further information about our restructuring activities.
Our Domestic segment’s operating income decreased $12 million in fiscal 2018 compared to fiscal 2017. In addition, the operating income rate decreased to 4.5% of revenue in fiscal 2018 compared to 4.9% of revenue in the prior year. The decrease was primarily driven by the gross profit rate decline and increase in SG&A described above.
Fiscal 2017 Results Compared With Fiscal 2016
Domestic segment revenue of $36.2 billion in fiscal 2017 decreased 0.3% compared to the prior year. The components of the 0.3% revenue decrease in the Domestic segment in fiscal 2017 were as follows:
| Comparable sales impact | 0.2 | % |
| Non-comparable sales(1) | (0.5 | )% |
| Total revenue decrease | (0.3 | )% |
| (1) | Non-comparable sales reflects the impact of net store opening and closing activity, as well as the impact of revenue streams not included within our comparable sales calculation, such as profit share revenue, credit card revenue, gift card breakage, commercial sales and sales of merchandise to wholesalers and dealers. |
The net store changes did not have a material impact on our revenue in fiscal 2017, as the majority of closures related to our small-format Best Buy Mobile stand-alone stores. The closing of small-format Best Buy Mobile stores have a significantly smaller impact given their smaller size and limited category focus compared to our large-format stores.
The profit-share revenue included in our non-comparable sales relates to our extended warranty protection plans that are managed by a third-party underwriter. We may be eligible to receive profit-sharing payments, depending on the performance of the portfolio. When performance of the portfolio is strong and the claims cost to the third-party underwriter declines, we are entitled to share in the excess premiums. In fiscal 2017, we recognized $110 million of such profit-share revenue, with an equal impact to gross profit and operating income. In fiscal 2016, we recognized $148 million of such profit-share revenue. The fiscal 2017 profit-share revenue decrease from fiscal 2016 reflects reductions to the premiums that we pay to the third-party underwriter. In light of the continued impact of these lower premiums, we expect the profit-share payments to continue to decrease in future periods.
In fiscal 2017, Domestic segment online revenue of $4.8 billion increased 20.8% on a comparable basis, primarily due to higher conversion rates and increased traffic. As a percentage of total Domestic revenue, online revenue increased to 13.4% versus 11.0% in fiscal 2016.
The following table presents the Domestic segment's revenue mix percentages and comparable sales percentage changes by revenue category in fiscal 2017 and 2016:
| Revenue Mix Summary | Comparable Sales Summary | ||||||||||
| Year Ended | Year Ended | ||||||||||
| January 28, 2017 | January 30, 2016 | January 28, 2017 | January 30, 2016 | ||||||||
| Consumer Electronics | 34 | % | 32 | % | 5.0 | % | 4.7 | % | |||
| Computing and Mobile Phones | 45 | % | 46 | % | (1.8 | )% | (2.6 | )% | |||
| Entertainment | 7 | % | 8 | % | (13.8 | )% | (3.6 | )% | |||
| Appliances | 9 | % | 8 | % | 7.8 | % | 15.4 | % | |||
| Services | 5 | % | 5 | % | (3.3 | )% | (11.6 | )% | |||
| Other | — | % | 1 | % | n/a | n/a | |||||
| Total | 100 | % | 100 | % | 0.2 | % | 0.5 | % |
The following is a description of the notable comparable sales changes in our Domestic segment by revenue category:
| • | Consumer Electronics: The 5.0% comparable sales increase was primarily due to an increase in the sales of connected home products, streaming devices and large screen televisions. |
| • | Computing and Mobile Phones: The 1.8% comparable sales decline was primarily due to continued industry declines in tablets and product constraints in, and to a lesser effect, lower sales of mobile phones. This decline was partially offset by an increase in the sale of computers. |
| • | Entertainment: The 13.8% comparable sales decline was driven by declines in gaming, music and movies due to continued industry declines. |
| • | Appliances: The 7.8% comparable sales gain was a result of continued growth in both large and small appliance sales. |
| • | Services: The 3.3% comparable sales decline was primarily due to lower reimbursement revenue from our third-party underwriter on extended protection plan claims. This trend, which primarily related to mobile phones, was a reflection of changes to the design of our extended protection plans in fiscal 2016, improvements to our repair and fulfillment operations and industry trends. |
Our Domestic segment experienced an increase in gross profit rate to 23.9% in fiscal 2017 from 23.3% in fiscal 2016. This rate increase was primarily due to (1) rate improvements in computing hardware, and (2) an increase in CRT legal settlements, partially offset by (1) lower margins from mobile phones due to changes in device mix, and (2) a decrease in our periodic profit-share revenue as described above.
Our Domestic segment SG&A rate slightly decreased to 18.9% of revenue in fiscal 2017 compared to 19.0% of revenue in the prior year. The decrease in rate was primarily driven by cost reductions and lower incentive compensation, partially offset by investments in growth initiatives.
Our Domestic segment recorded $31 million of restructuring charges in fiscal 2017 and incurred $2 million of restructuring charges in fiscal 2016. The restructuring charges in fiscal 2017 related to the Renew Blue Phase 2 plan that began in the first quarter of fiscal 2017. Refer to Note 4, Restructuring Charges, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for further information about our restructuring activities.
Our Domestic segment’s operating income increased $179 million in fiscal 2017 compared to fiscal 2016. In addition, the operating income rate increased to 4.9% of revenue in fiscal 2017 compared to 4.4% of revenue in the prior year. The increase was driven by the revenue, gross profit rate and SG&A rate improvements described above.
International Segment
During the first quarter of fiscal 2016, we consolidated the Future Shop and Best Buy stores and websites in Canada under the Best Buy brand. This resulted in the permanent closure of 66 Future Shop stores and the conversion of the remaining 65 Future Shop stores to the Best Buy brand. The costs of implementing these changes primarily consisted of lease exit costs, a tradename impairment, property and equipment impairments, employee termination benefits and inventory write-downs.
The following table presents selected financial data for our International segment for each of the past three fiscal years ($ in millions):
| International Segment Performance Summary | 2018 | 2017 | 2016 | ||||||||
| Revenue | $ | 3,489 | $ | 3,155 | $ | 3,163 | |||||
| Revenue gain (decline) % | 10.6 | % | (0.3 | )% | (26.2 | )% | |||||
| Comparable sales % gain(1) | 6.3 | % | n/a | n/a | |||||||
| Restructuring charges - cost of goods sold | $ | — | $ | — | $ | 3 | |||||
| Gross profit | $ | 811 | $ | 790 | $ | 707 | |||||
| Gross profit as % of revenue | 23.2 | % | 25.0 | % | 22.4 | % | |||||
| SG&A | $ | 719 | $ | 692 | $ | 721 | |||||
| SG&A as % of revenue | 20.6 | % | 21.9 | % | 22.8 | % | |||||
| Restructuring charges | $ | 1 | $ | 8 | $ | 196 | |||||
| Operating income (loss) | $ | 91 | $ | 90 | $ | (210 | ) | ||||
| Operating income (loss) as % of revenue | 2.6 | % | 2.9 | % | (6.6 | )% |
| (1) | The Canadian brand consolidation had a material impact on a year-over-year basis on the Canadian retail stores and the website. As such, beginning in the first quarter of fiscal 2016 through the third quarter of fiscal 2017, all store and website revenue was removed from the comparable sales base, and an International segment (comprised of Canada and Mexico) comparable sales metric for the full year has not been provided. Beginning in the fourth quarter of fiscal 2017, we resumed reporting International comparable sales as revenue in the International segment was once again determined to be comparable. International comparable sales for the fourth quarter of fiscal 2017 was 0.9%. Comparable sales also exclude the impact of the extra week in fiscal 2018. |
The following table reconciles our International segment stores open at the end of each of the last three fiscal years:
| Fiscal 2016 | Fiscal 2017 | Fiscal 2018 | ||||||||||||||||||
| Total Stores at End of Fiscal Year | Stores Opened | Stores Closed | Total Stores at End of Fiscal Year | Stores Opened | Stores Closed | Total Stores at End of Fiscal Year | ||||||||||||||
| Canada | ||||||||||||||||||||
| Best Buy | 136 | — | (2 | ) | 134 | — | — | 134 | ||||||||||||
| Best Buy Mobile | 56 | 1 | (4 | ) | 53 | — | (2 | ) | 51 | |||||||||||
| Mexico | ||||||||||||||||||||
| Best Buy | 18 | 2 | — | 20 | 5 | — | 25 | |||||||||||||
| Express | 6 | — | (1 | ) | 5 | 1 | — | 6 | ||||||||||||
| Total International segment stores | 216 | 3 | (7 | ) | 212 | 6 | (2 | ) | 216 |
Fiscal 2018 Results Compared With Fiscal 2017
International segment revenue of $3.5 billion in fiscal 2018 increased 10.6% compared to the prior year and includes approximately $45 million of revenue from the extra week. The components of the 10.6% revenue increase in the International segment in fiscal 2018 were as follows:
| Comparable sales impact | 6.1 | % |
| Impact of foreign currency exchange rate fluctuations | 2.7 | % |
| Non-comparable sales(1) | 1.8 | % |
| Total revenue increase | 10.6 | % |
| (1) | Non-comparable sales reflects the impact of net store opening and closing activity, including the Canadian brand consolidation activity in the first three quarters of fiscal 2017, the impact of the extra week in fiscal 2018, as well as the impact of revenue streams not included within our comparable sales calculation, such as certain credit card revenue, gift card breakage and sales of merchandise to wholesalers and dealers, as applicable. |
The following table presents the International segment's revenue mix percentages and comparable sales percentage changes by revenue category in fiscal 2018 and 2017:
| Revenue Mix Summary | Comparable Sales Summary | |||||||||
| Year Ended | Year Ended | |||||||||
| February 3, 2018 | January 28, 2017 | February 3, 2018 | January 28, 2017 | |||||||
| Consumer Electronics | 32 | % | 31 | % | 7.1 | % | n/a | |||
| Computing and Mobile Phones | 46 | % | 48 | % | 2.0 | % | n/a | |||
| Entertainment | 7 | % | 7 | % | 9.3 | % | n/a | |||
| Appliances | 8 | % | 6 | % | 41.3 | % | n/a | |||
| Services | 5 | % | 7 | % | (5.1 | )% | n/a | |||
| Other | 2 | % | 1 | % | 15.4 | % | n/a | |||
| Total | 100 | % | 100 | % | 6.3 | % | n/a |
As noted above, comparable sales information has not been provided for the International segment for fiscal 2017 due to the Canadian brand consolidation. As such, it is also impractical to provide such information on a revenue category basis. Beginning in the fourth quarter of fiscal 2017, we resumed reporting International comparable sales as revenue in the International segment was once again determined to be comparable.
The following is a description of the notable comparable sales changes in our International segment by revenue category in fiscal 2018:
| • | Consumer Electronics: The 7.1% comparable sales gain was driven primarily by smart home, home theater, headphones and voice assistants, partially offset by declines in digital imaging and health and fitness. |
| • | Computing and Mobile Phones: The 2.0% comparable sales gain was driven by primarily by computing, mobile phones and wearables, partially offset by declines in tablets. |
| • | Entertainment: The 9.3% comparable sales gain was driven primarily by gaming hardware. |
| • | Appliances: The 41.3% comparable sales gain was driven primarily by large and small appliances due to the addition of an appliance department within all of our stores in Canada. |
| • | Services: The 5.1% comparable sales decline was driven primarily by technical support and repair, partially offset by gains in installation. |
| • | Other: The 15.4% comparable sales gain was driven primarily by other product offerings, including baby and sporting goods. |
Our International segment experienced a gross profit increase of $21 million, or 2.7%, in fiscal 2018 compared to fiscal 2017, primarily related to foreign currency exchange rate fluctuations. Excluding the impact of foreign currency exchange rate fluctuations, the increase in gross profit was $3 million. However, the gross profit rate decreased to 23.2% in fiscal 2018 from 25.0% of revenue in fiscal 2017. This decrease in rate was primarily due to lower year-over-year periodic profit-share revenue and lower sales in the higher-margin services category in Canada. This was primarily driven by the launch of our Total Tech Support offer, an ongoing service revenue model that carries a higher sales-attach rate, but a lower gross profit rate.
Our International segment's SG&A increased $27 million, or 3.9%, in fiscal 2018 compared to the prior year. Excluding the impact of foreign currency exchange rate fluctuations, the increase in SG&A was $12 million. However, the SG&A rate decreased to 20.6% in fiscal 2018 from 21.9% of revenue in fiscal 2017. The increase in SG&A was primarily driven by the impact of the extra week and a one-time employee bonus expense related to tax reform, partially offset by lower payroll and benefits and administrative costs.
Our International segment recorded $1 million of restructuring charges in fiscal 2018 and $8 million of restructuring charges in fiscal 2017. Restructuring charges in both years relate to adjustments to our vacant space liabilities outstanding as a result of the Canadian brand consolidation and the Renew Blue plans. The adjustments were due to changes in estimates related to sublease income. Refer to Note 4, Restructuring Charges, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for further information about our restructuring activities.
Our International segment operating income was $91 million in fiscal 2018 compared to $90 million in the prior-year period. The slight improvement in operating income was primarily driven by increased gross profit and lower restructuring costs, offset by increased SG&A.
Fiscal 2017 Results Compared With Fiscal 2016
International segment revenue of $3.2 billion in fiscal 2017 decreased 0.3% compared to the prior year. The components of the 0.3% revenue decrease in the International segment in fiscal 2017 were as follows:
| Non-comparable sales(1) | 1.8 | % |
| Comparable sales impact | 0.3 | % |
| Impact of foreign currency exchange rate fluctuations | (2.4 | )% |
| Total revenue decrease | (0.3 | )% |
| (1) | Non-comparable sales reflects the impact of net store opening and closing activity, including the Canadian brand consolidation activity, as well as the impact of revenue streams not included within our comparable sales calculation, such as certain credit card revenue, gift card breakage and sales of merchandise to wholesalers and dealers, as applicable. |
The following table presents the International segment's revenue mix percentages by revenue category in fiscal 2017 and 2016:
| Revenue Mix Summary | |||||
| Year Ended | |||||
| January 28, 2017 | January 30, 2016 | ||||
| Consumer Electronics | 31 | % | 31 | % | |
| Computing and Mobile Phones | 48 | % | 48 | % | |
| Entertainment | 7 | % | 9 | % | |
| Appliances | 6 | % | 5 | % | |
| Services | 7 | % | 6 | % | |
| Other | 1 | % | 1 | % | |
| Total | 100 | % | 100 | % |
As noted above, comparable sales information has not been provided for the International segment for fiscal 2017 or 2016 due to the Canadian brand consolidation. As such, it is also impractical to provide such information on a revenue category basis. However, as noted above, the revenue mix by category did not change significantly from fiscal 2016.
Our International segment experienced a gross profit increase of $83 million, or 11.7%, in fiscal 2017 compared to fiscal 2016. Excluding the impact of foreign currency exchange rate fluctuations, the increase in gross profit was $98 million. The gross profit rate increased to 25.0% in fiscal 2017 from 22.4% of revenue in fiscal 2016. This increase was primarily due to the increased promotional activity in fiscal 2016 as a result of the Canada brand consolidation which did not reoccur and to a lesser extent rate growth in computing and home theater.
Our International segment's SG&A decreased $29 million, or 4.0%, in fiscal 2017 compared to the prior year. Excluding the impact of foreign currency exchange rate fluctuations, the decrease in SG&A was $9 million. The SG&A rate decreased to 21.9% in fiscal 2017 from 22.8% of revenue in fiscal 2016. The decrease in SG&A rate was driven by year-over-year sales leverage.
Our International segment recorded $8 million of restructuring charges in fiscal 2017 and incurred $199 million of restructuring charges in fiscal 2016. The fiscal 2017 restructuring charges related to adjustments to our vacant space liabilities outstanding as a result of the Canadian brand consolidation and the Renew Blue plans. The adjustments were due to changes in estimates related to sublease income. The fiscal 2016 restructuring charges primarily related to the Canadian brand consolidation and consisted of facility closure costs, a tradename impairment, property and equipment impairments and employee termination benefits. Refer to Note 4, Restructuring Charges, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for further information about our restructuring activities.
Our International segment operating income was $90 million in fiscal 2017 compared to a loss of $210 million in the prior-year period. The improvement in operating income was primarily driven by lower restructuring costs and gross profit and SG&A rate improvements.
Additional Consolidated Results
Other Income (Expense)
In fiscal 2018, our gain on sale of investments was $1 million compared to $3 million and $2 million in fiscal 2017 and fiscal 2016, respectively. These gains were due to the sale of cost-based investments.
In fiscal 2018, our investment income and other was $48 million, compared to $31 million and $13 million in fiscal 2017 and fiscal 2016, respectively. The increases were primarily due to higher interest rates in the U.S. as well as an increase in investments throughout the year in fiscal 2018.
Interest expense was $75 million, $72 million and $80 million in fiscal 2018, 2017 and 2016, respectively. Interest expense remained relatively flat in fiscal 2018 but decreased in fiscal 2017 primarily due to a lower debt balance for a majority of the year caused by the March 2016 payment of our $350 million principal amount notes. Refer to Note 6, Derivative Instruments, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for additional information.
Income Tax Expense
On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act ("tax reform" or “Tax Act”), which among other things, lowered the U.S. statutory tax rate from 35% to 21% effective January 1, 2018. Consequently, we applied a blended U.S. statutory federal income tax rate of 33.7 % for fiscal 2018. In addition, the Tax Act imposed a one-time deemed repatriation tax on net unremitted earnings of foreign subsidiaries not previously subject to U.S. income tax, which is payable over a period of eight years. In response to the Tax Act, the Securities and Exchange Commission (“SEC”) staff issued a Staff Accounting Bulletin No. 118 (“SAB 118”) that provides guidance on accounting for the impact of the Tax Act. SAB 118 allows companies to record provisional amounts while the accounting impact of the Tax Act is still under analysis, not to extend beyond the measurement period of one year from the enactment of the Tax Act.
As a result of the Tax Act, we recorded provisional tax expense in fiscal 2018 of $283 million. The $283 million included a $209 million charge associated with the deemed repatriation tax and a $74 million charge primarily related to the revaluation of deferred tax assets and liabilities to reflect the new tax rate. The actual impact of the Tax Act may differ materially from our provisional amounts due to further refinement of our calculations as allowed by SAB 118, changes in interpretations and assumptions we have made, or actions we may take as a result of the Tax Act. The provisional amounts will be finalized within the one-year measurement period as we gather and analyze the additional documentation necessary for the calculations. Refer to Note 10, Income Taxes, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for additional information.
Income tax expense increased to $818 million in fiscal 2018, compared to $609 million in fiscal 2017, primarily as a result of the $283 million of tax expense associated with the Tax Act, partially offset by the impacts from the recognition of excess tax benefits related to stock-based compensation, the lower blended U.S. statutory tax rate of 33.7% and a higher mix of pre-tax income from foreign operations in the current year. Our effective income tax rate (“ETR”) for fiscal 2018 was 45.0%, compared to a rate of 33.5% in fiscal 2017. The increase in the ETR was primarily due to the impact of the Tax Act, partially offset by the recognition of excess tax benefits related to stock-based compensation and a higher mix of pre-tax income from foreign operations in the current year.
Income tax expense increased to $609 million in fiscal 2017, compared to $503 million in fiscal 2016, primarily as a result of an increase in pre-tax earnings, partially offset by a higher mix of pre-tax income from foreign operations and the resolution of certain tax matters in fiscal 2017. Our ETR for fiscal 2017 was 33.5%, compared to a rate of 38.4% in fiscal 2016. The decrease in the ETR was primarily due to a higher mix of pre-tax income from foreign operations and the resolution of certain tax matters in fiscal 2017.
Our consolidated ETR is impacted by the statutory income tax rates applicable to each of the jurisdictions in which we operate. As our foreign earnings are generally taxed at a lower statutory rate than the current 33.7% U.S. statutory rate, changes in the proportion of our consolidated taxable earnings originating in foreign jurisdictions impact our consolidated effective rate. With the lower U.S. statutory tax rate enacted by the Tax Act, we expect our fiscal 2019 effective tax rate to be lower.
Discontinued Operations
Discontinued operations reflect activity within our International segment. Gain from discontinued operations in fiscal 2018 was $1 million, primarily related to the proceeds attributed to a non-compete clause from the sale of Best Buy Europe to Carphone Warehouse plc. Gain from discontinued operations in fiscal 2017 of $21 million was primarily related to the sale of the remaining Five Star property assets that were held for sale as of January 30, 2016. The $90 million gain from discontinued operations in fiscal 2016 was primarily related to the gain recognized on the sale of Five Star.
Non-GAAP Financial Measures
The following table reconciles operating income, income tax expense, effective tax rate, net earnings from continuing operations and diluted earnings per share from continuing operations (GAAP financial measures) for the periods presented to non-GAAP operating income, non-GAAP income tax expense, non-GAAP effective tax rate, non-GAAP net earnings from continuing operations and non-GAAP diluted earnings per share from continuing operations (non-GAAP financial measures) for the periods presented ($ in millions, except per share amounts):
| Fiscal Year | |||||||||||
| 2018 | 2017(1) | 2016(1) | |||||||||
| Operating income | $ | 1,843 | $ | 1,854 | $ | 1,375 | |||||
| Tax reform-related item - employee bonus(2) | 80 | — | — | ||||||||
| Tax reform-related item - charitable contribution(2) | 20 | — | — | ||||||||
| Restructuring charges(3) | 10 | 39 | 198 | ||||||||
| Net CRT/LCD settlements(4) | — | (161 | ) | (77 | ) | ||||||
| Other Canada brand consolidation charges - SG&A(5) | — | 1 | 6 | ||||||||
| Restructuring charges - COGS(3) | — | — | 3 | ||||||||
| Non-GAAP operating income | $ | 1,953 | $ | 1,733 | $ | 1,505 | |||||
| Income tax expense | $ | 818 | $ | 609 | $ | 503 | |||||
| Effective tax rate | 45.0 | % | 33.5 | % | 38.4 | % | |||||
| Tax reform - repatriation tax(2) | (209 | ) | — | — | |||||||
| Tax reform - deferred tax rate change(2) | (74 | ) | — | — | |||||||
| Income tax impact of non-GAAP adjustments(6) | 41 | (48 | ) | 7 | |||||||
| Non-GAAP income tax expense | $ | 576 | $ | 561 | $ | 510 | |||||
| Non-GAAP effective tax rate | 29.8 | % | 33.1 | % | 35.3 | % | |||||
| Net earnings from continuing operations | $ | 999 | $ | 1,207 | $ | 807 | |||||
| Tax reform-related item - employee bonus(2) | 80 | — | — | ||||||||
| Tax reform-related item - charitable contribution(2) | 20 | — | — | ||||||||
| Restructuring charges(3) | 10 | 39 | 198 | ||||||||
| (Gain) loss on sale of investments, net(7) | 6 | (2 | ) | 5 | |||||||
| Net CRT/LCD settlements(4) | — | (161 | ) | (77 | ) | ||||||
| Other Canada brand consolidation charges - SG&A(5) | — | 1 | 6 | ||||||||
| Restructuring charges - COGS(3) | — | — | 3 | ||||||||
| Tax reform - repatriation tax(2) | 209 | — | — | ||||||||
| Tax reform - deferred tax rate change(2) | 74 | — | — | ||||||||
| Income tax impact of non-GAAP adjustments(6) | (41 | ) | 48 | (7 | ) | ||||||
| Non-GAAP net earnings from continuing operations | $ | 1,357 | $ | 1,132 | $ | 935 | |||||
| Diluted earnings per share from continuing operations | $ | 3.26 | $ | 3.74 | $ | 2.30 | |||||
| Tax reform-related item - employee bonus(2) | 0.26 | — | — | ||||||||
| Tax reform-related item - charitable contribution(2) | 0.07 | — | — | ||||||||
| Restructuring charges(3) | 0.03 | 0.12 | 0.58 | ||||||||
| (Gain) loss on sale of investments, net(7) | 0.02 | (0.01 | ) | 0.01 | |||||||
| Net CRT/LCD settlements(4) | — | (0.50 | ) | (0.22 | ) | ||||||
| Other Canada brand consolidation charges - SG&A(5) | — | 0.01 | 0.02 | ||||||||
| Restructuring charges - COGS(3) | — | — | 0.01 | ||||||||
| Tax reform - repatriation tax(2) | 0.68 | — | — | ||||||||
| Tax reform - deferred tax rate change(2) | 0.24 | — | — | ||||||||
| Income tax impact of non-GAAP adjustments(6) | (0.14 | ) | 0.15 | (0.03 | ) | ||||||
| Non-GAAP diluted earnings per share from continuing operations | $ | 4.42 | $ | 3.51 | $ | 2.67 |
| (1) | Beginning in the first quarter of fiscal 2018, we no longer exclude non-restructuring property and equipment impairment charges from our non-GAAP financial measures. To ensure our financial results are comparable, we have recast the prior period balances to conform to this presentation. Refer to the Overview section within this MD&A for more information. |
| (2) | Represents charges resulting from the Tax Act enacted into law in the fourth quarter of fiscal 2018, including charges associated with a deemed repatriation tax and the revaluation of deferred tax assets and liabilities, as well as tax reform-related items we announced in response to future tax savings created by tax reform, including a one-time bonus for certain employees and a one-time contribution to the Best Buy Foundation. |
| (3) | Refer to Note 4, Restructuring Charges, in the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for additional information regarding the nature of these charges. For the fiscal year ended February 3, 2018, $9 million related to the U.S. and $1 million related to Canada. For the fiscal year ended January 28, 2017, $31 million related to the U.S. and $8 million related to Canada. For the fiscal year ended January 30, 2016, $2 million related to the U.S. and $199 million related to Canada. |
| (4) | Represents CRT and LCD litigation settlements reached, net of related legal fees and costs. Settlements related to products purchased and sold in prior fiscal years. For the fiscal year ended January 28, 2017, the full balance related to the U.S. For the fiscal year ended January 30, 2016, $75 million related to the U.S. and $2 million related to Canada. Refer to Note 12, Contingencies and Commitments, in the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for further information. |
| (5) | Represents charges related to the Canadian brand consolidation initiated in the first quarter of fiscal 2016, primarily due to retention bonuses and other store-related costs that were a direct result of the consolidation but did not qualify as restructuring charges. |
| (6) | Income tax impact of non-GAAP adjustments is the summation of the calculated income tax charge related to each non-GAAP non-income tax adjustment. The non-GAAP adjustments relate primarily to adjustments in the U.S. and Canada. As such, the income tax charge is calculated using the statutory tax rates for the U.S. (36.7% for the fiscal year ended February 3, 2018, and 38.0% for the fiscal year ended January 28, 2017) and Canada (26.6% for the fiscal years ended February 3, 2018, and January 28, 2017, respectively), applied to the non-GAAP adjustments of each country. |
| (7) | Represents (gain) loss on sale of investments and investment impairments included in Investment income and other on our Consolidated Statements of Earnings. |
Non-GAAP operating income for fiscal 2018 increased $220 million compared to fiscal 2017, and non-GAAP operating income as a percent of revenue increased to 4.6%. The increase was driven primarily by strong revenue performance in both our Domestic and International segments in nearly all product categories and the impact of the extra week, offset by increases in SG&A primarily due to higher incentive compensation for store and corporate employees. The increase in non-GAAP operating income resulted in a year-over-year increase in non-GAAP net earnings from continuing operations and non-GAAP diluted earnings per share from continuing operations in fiscal 2018 compared to fiscal 2017.
Non-GAAP operating income for fiscal 2017 increased $228 million compared to fiscal 2016, and non-GAAP operating income as a percent of revenue increased to 4.4%. The increase was driven by the increased consolidated gross profit rate and continued SG&A cost reductions in both segments primarily due to the realization of our Renew Blue Phase 2 cost reduction initiatives and tighter expense management. The increase in non-GAAP operating income resulted in a year-over-year increase in non-GAAP net earnings from continuing operations and non-GAAP diluted earnings per share from continuing operations in fiscal 2017 compared to fiscal 2016.
Liquidity and Capital Resources
Summary
We closely manage our liquidity and capital resources. Our liquidity requirements depend on key variables, including the level of investment required to support our business strategies, the performance of our business, capital expenditures, credit facilities and short-term borrowing arrangements and working capital management. Capital expenditures and share repurchases are a component of our cash flow and capital management strategy which, to a large extent, we can adjust in response to economic and other changes in our business environment. We have a disciplined approach to capital allocation, which focuses on investing in key priorities that support our Best Buy 2020: Building the New Blue strategy.
The following table summarizes our cash and cash equivalents and short-term investments at February 3, 2018, and January 28, 2017 ($ in millions):
| February 3, 2018 | January 28, 2017 | ||||||
| Cash and cash equivalents | $ | 1,101 | $ | 2,240 | |||
| Short-term investments | 2,032 | 1,681 | |||||
| Total cash and cash equivalents and short-term investments | $ | 3,133 | $ | 3,921 |
Existing cash and cash equivalents and short-term investments as well as cash generated from operations were sufficient to fund share repurchases, capital expenditures and dividends in fiscal 2018 without the need to utilize our credit facilities or other debt arrangements.
Cash Flows
The following table summarizes our cash flows from operating, investing and financing activities for each of the past three fiscal years ($ in millions):
| 2018 | 2017(1) | 2016(1) | |||||||||
| Total cash provided by (used in): | |||||||||||
| Operating activities | $ | 2,141 | $ | 2,557 | $ | 1,343 | |||||
| Investing activities | (1,002 | ) | (877 | ) | (526 | ) | |||||
| Financing activities | (2,297 | ) | (1,418 | ) | (1,536 | ) | |||||
| Effect of exchange rate changes on cash | 25 | 10 | (38 | ) | |||||||
| Increase (decrease) in cash and cash equivalents | $ | (1,133 | ) | $ | 272 | $ | (757 | ) |
| (1) | Fiscal 2017 and 2016 have been recast to reflect our retrospective adoption of Accounting Standards Update ("ASU") 2016-09, Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting, ASU 2016-15, Statement of Cash Flows: Classifications of Certain Cash Receipts and Cash Payments and ASU 2016-18, Statement of Cash Flows: Restricted Cash. Refer to Note 1, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for further information about our credit facilities. |
Operating Activities
The decrease in cash provided by operating activities in fiscal 2018 compared to fiscal 2017 was primarily due to the timing of inventory purchasing and payments and advertising payments. During fiscal 2018, we purchased greater amounts of inventory with shorter payment terms than in the prior year, causing more payments to be made prior to fiscal year-end. This was partially offset by the timing of receivable collections and income tax payments.
The increase in cash provided by operating activities in fiscal 2017 compared to fiscal 2016 was primarily due to the timing of inventory purchasing and payments and increased earnings. During fiscal 2017, we purchased and paid for inventory later in the Holiday season than in the prior year, positively impacting operating cash flows. This was partially offset by the timing of collection of receivables.
Investing Activities
The increase in cash used in investing activities in fiscal 2018 compared to fiscal 2017 was primarily due to an increase in capital spending to support our strategic growth initiatives and cash received in fiscal 2017 for the Five Star asset held-for-sale. This was partially offset by a decrease in the net investment in short-term investments during fiscal 2018.
The increase in cash used in investing activities in fiscal 2017 compared to fiscal 2016 was primarily due to an increase in the net investment in short-term investments in fiscal 2017.
Financing Activities
The increase in cash used in financing activities in fiscal 2018 compared to fiscal 2017 was primarily due to increased share repurchases, driven by an increase in our share price and the number of shares repurchased, and an increase in our regular quarterly dividend rate from $0.28 per share in fiscal 2017 to $0.34 per share in fiscal 2018. These increases were partially offset by the repayment of our 2016 notes due March 15, 2016 (the "2016 Notes"), in fiscal 2017 and a special dividend payment in fiscal 2017.
The decrease in cash used in financing activities in fiscal 2017 compared to fiscal 2016 was primarily due to a decline in the number of shares repurchased, which was substantially offset by the repayment of our $350 million principal amount of our 2016 Notes.
Sources of Liquidity
Funds generated by operating activities, available cash and cash equivalents, short-term investments, our credit facilities and other debt arrangements are our most significant sources of liquidity. We believe our sources of liquidity will be sufficient to fund operations and anticipated capital expenditures, strategic initiatives, share repurchases and dividends. However, in the event our liquidity is insufficient, we may be required to limit our spending. There can be no assurance that we will continue to
generate cash flows at or above current levels or that we will be able to maintain our ability to borrow under our existing credit facilities or obtain additional financing, if necessary, on favorable terms.
We have a $1.25 billion five-year senior unsecured revolving credit facility (the "Five-Year Facility Agreement") with a syndicate of banks that expires in June 2021. At February 3, 2018, and January 28, 2017, we had no borrowings outstanding under the Five-Year Facility Agreement. Refer to Note 5, Debt, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for further information about our credit facility.
Our ability to access our revolving credit facility under the Five-Year Facility Agreement is subject to our compliance with the terms and conditions of the facility, including financial covenants. The financial covenants require us to maintain certain financial ratios. At February 3, 2018, we were in compliance with all such financial covenants. If an event of default were to occur with respect to any of our other debt, it would likely constitute an event of default under our facilities as well.
An interest coverage ratio represents the ratio of pre-tax earnings before fixed charges (interest expense and the interest portion of rent expense) to fixed charges. Our interest coverage ratio, calculated as reported in Exhibit No. 12.1 of this Annual Report on Form 10-K, was 6.86 and 6.97 in fiscal 2018 and fiscal 2017, respectively.
Our credit ratings and outlooks at March 29, 2018, are summarized below. In fiscal 2018, Fitch Ratings Limited affirmed its long-term credit rating of BBB- and changed its outlook from Stable to Positive. In fiscal 2019, Standard & Poor's Rating Services upgraded its long-term credit rating of BBB- to BBB and changed its outlook from Positive to Stable, and Moody's Investors Service, Inc. affirmed its long-term credit rating of Baa1 with a Stable outlook.
| Rating Agency | Rating | Outlook | |
| Standard & Poor's | BBB | Stable | |
| Moody's | Baa1 | Stable | |
| Fitch | BBB- | Positive |
Credit rating agencies review their ratings periodically and, therefore, the credit rating assigned to us by each agency may be subject to revision at any time. Accordingly, we are not able to predict whether our current credit ratings will remain as disclosed above. Factors that can affect our credit ratings include changes in our operating performance, the economic environment, conditions in the retail and consumer electronics industries, our financial position and changes in our business strategy. If further changes in our credit ratings were to occur, they could impact, among other things, interest costs for certain of our credit facilities, our future borrowing costs, access to capital markets, vendor financing terms and future new-store leasing costs.
Restricted Cash
Our liquidity is also affected by restricted cash balances that are pledged as collateral or restricted to use for general liability insurance and workers' compensation insurance. Restricted cash and cash equivalents related to our continuing operations, which are included in Other current assets on our Consolidated Balance Sheets, remained relatively flat at $199 million and $193 million at February 3, 2018, and January 28, 2017, respectively.
Capital Expenditures
Our capital expenditures typically include investments in our stores, distribution capabilities and information technology enhancements (including e-commerce). During fiscal 2018, we invested $688 million in property and equipment, primarily related to upgrading our information technology systems and capabilities and store-related projects.
The following table presents our capital expenditures for each of the past three fiscal years ($ in millions):
| 2018 | 2017 | 2016 | |||||||||
| New stores | $ | 5 | $ | 3 | $ | 5 | |||||
| Store-related projects(1) | 192 | 190 | 241 | ||||||||
| E-commerce and information technology | 425 | 347 | 356 | ||||||||
| Supply chain | 66 | 40 | 47 | ||||||||
| Total capital expenditures(2) | $ | 688 | $ | 580 | $ | 649 |
| (1) | Includes store remodels and various merchandising projects. |
| (2) | Total capital expenditures exclude non-cash capital expenditures of $123 million, $48 million and $92 million for fiscal 2018, 2017 and 2016, respectively. Non-cash capital expenditures are comprised of capitalized leases, as well as additions to property and equipment included in accounts payable. |
In fiscal 2019, we estimate cash capital expenditures of approximately $850 million to $900 million, with the focus on supply chain, retail store, e-commerce and information technology projects.
Debt and Capital
As of February 3, 2018, we had $500 million principal amount of notes due August 1, 2018 (the "2018 Notes") and $650 million principal amount of notes due March 15, 2021 (the "2021 Notes") outstanding. Refer to Note 5, Debt, in the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for further information about our 2018 Notes and 2021 Notes.
Share Repurchases and Dividends
We repurchase our common stock and pay dividends pursuant to programs approved by our Board of Directors ("Board"). Our long-term capital allocation strategy is to first fund operations and investments in growth and then return excess cash over time to shareholders through dividends and share repurchases while maintaining investment grade credit metrics.
In February 2017, our Board authorized a new $5.0 billion share repurchase program that superseded the previous $5.0 billion authorization from June 2011, which had $2.2 billion remaining as of January 28, 2017. There is no expiration date governing the period over which we can repurchase shares under the February 2017 authorization. On March 1, 2018, we announced our intent to repurchase $1.5 billion of shares in fiscal 2019, which reflects an updated two-year plan of $3.5 billion compared to the original $3.0 billion two-year plan announced on March 1, 2017. Between the end of fiscal 2018 and March 29, 2018, we repurchased an incremental 3.5 million shares of our common stock at a cost of $249 million. Repurchased shares are retired and constitute authorized but unissued shares.
The following table presents our share repurchase history for each of the past three fiscal years (in millions, except per share amounts):
| 2018 | 2017 | 2016(1) | |||||||||
| Total cost of shares repurchased | $ | 2,009 | $ | 751 | $ | 1,000 | |||||
| Average price per share | $ | 57.16 | $ | 35.54 | $ | 30.53 | |||||
| Number of shares repurchased | 35.1 | 21.1 | 32.8 |
| (1) | Share repurchases included the use of an accelerated share repurchase contract. Refer to Note 7, Shareholders' Equity, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for further information. |
In fiscal 2004, our Board initiated the payment of a regular quarterly cash dividend on common stock. A quarterly cash dividend has been paid in each subsequent quarter. The payment of cash dividends is subject to customary legal and contractual restrictions. The following table presents our dividend activity for each of the past three fiscal years ($ in millions, except per share amounts):
| 2018 | 2017 | 2016 | |||||||||
| Regular quarterly cash dividends per share | $ | 1.36 | $ | 1.12 | $ | 0.92 | |||||
| Special cash dividends per share(1) | — | 0.45 | 0.51 | ||||||||
| Total cash dividends per share | $ | 1.36 | $ | 1.57 | $ | 1.43 | |||||
| Cash dividends declared and paid | $ | 409 | $ | 505 | $ | 499 |
| (1) | Special cash dividends are authorized by our Board and issued upon their discretion. Dividends paid in fiscal 2017 are related to the net after-tax proceeds from certain legal settlements and asset disposals, while the dividends paid in fiscal 2016 are related to the net after-tax proceeds from LCD-related legal settlements. |
Dividends declared and paid in fiscal 2018 decreased from fiscal 2017 primarily due to the absence of a special cash dividend in the current year, partially offset by an increase in the regular quarterly dividend per share from $0.28 in fiscal 2017 to $0.34 in fiscal 2018. Dividends declared and paid in fiscal 2017 were relatively unchanged from fiscal 2016, noting that the quarterly dividend per share increased from $0.23 in fiscal 2016 to $0.28 in fiscal 2017. The increase in the regular dividend rate was
substantially offset by fewer common shares, due to a return of capital to shareholders through share repurchases and a smaller special dividend.
On March 1, 2018, we announced a 32% increase in the regular quarterly dividend to $0.45 per share.
Other Financial Measures
Our current ratio, calculated as current assets divided by current liabilities, was 1.3 as of February 3, 2018, compared to 1.5 as of January 28, 2017. The lower current ratio in fiscal 2018 was driven by a decrease in cash and cash equivalents, primarily from increased share repurchases, and an increase in the current portion of long-term debt related to our 2018 Notes.
Our debt to earnings ratio was 1.4 as of February 3, 2018, compared to 1.1 as of January 28, 2017, primarily due to lower earnings in the current year driven by an increase in tax expense associated with the Tax Act. Our non-GAAP debt to EBITDAR ratio remained unchanged at 1.6 as of February 3, 2018, and January 28, 2017, respectively.
Our non-GAAP debt to EBITDAR ratio is calculated as follows:
| Non-GAAP debt to EBITDAR = | Non-GAAP debt | |
| Non-GAAP EBITDAR |
The most directly comparable GAAP financial measure to our non-GAAP debt to EBITDAR ratio is our debt to net earnings ratio, which excludes capitalized operating lease obligations from debt in the numerator of the calculation and does not adjust net earnings in the denominator of the calculation.
The following table presents a reconciliation of our debt to net earnings ratio to our non-GAAP debt to EBITDAR ratio for continuing operations ($ in millions):
| 2018(1) | 2017(1) | ||||||
| Debt (including current portion) | $ | 1,355 | $ | 1,365 | |||
| Capitalized operating lease obligations (5 times rental expense)(2) | 3,914 | 3,872 | |||||
| Non-GAAP debt | $ | 5,269 | $ | 5,237 | |||
| Net earnings from continuing operations | $ | 999 | $ | 1,207 | |||
| Other income (including interest expense, net) | 26 | 38 | |||||
| Income tax expense | 818 | 609 | |||||
| Depreciation and amortization expense | 683 | 654 | |||||
| Rental expense | 782 | 774 | |||||
| Restructuring charges(3)(4) | 10 | 39 | |||||
| Non-GAAP EBITDAR | $ | 3,318 | $ | 3,321 | |||
| Debt to net earnings ratio | 1.4 | 1.1 | |||||
| Non-GAAP debt to EBITDAR ratio | 1.6 | 1.6 |
| (1) | Debt is reflected as of the balance sheet dates for each of the respective fiscal periods, while rental expense and the other components of non-GAAP EBITDAR represent activity for the 12 months ended February 3, 2018, and January 28, 2017. |
| (2) | The multiple of five times annual rental expense in the calculation of our capitalized operating lease obligations is the multiple used for the retail sector by one of the nationally recognized credit rating agencies that rate our creditworthiness, and we consider it to be an appropriate multiple for our lease portfolio. |
| (3) | Refer to Note 4, Restructuring Charges, in the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for additional information regarding the nature of these charges. |
| (4) | Beginning in the first quarter of fiscal 2018, we no longer exclude non-restructuring property and equipment impairment charges from our non-GAAP financial measures. To ensure our financial results are comparable, we have recast the prior period balance to conform to this presentation. Refer to the Overview section within this MD&A for more information. |
Off-Balance-Sheet Arrangements and Contractual Obligations
Other than operating leases, we do not have any off-balance-sheet financing. A summary of our operating lease obligations by fiscal year is included in the "Contractual Obligations" table below. Additional information regarding our operating leases is available in Item 2, Properties, and Note 8, 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.
The following table presents information regarding our contractual obligations as of February 3, 2018, with payments due by period ($ in millions):
| Payments Due by Period | |||||||||||||||||||
| Contractual Obligations | Total | Less Than 1 Year | 1-3 Years | 3-5 Years | More Than 5 Years | ||||||||||||||
| Long-term debt obligations(1) | $ | 1,150 | $ | 500 | $ | 650 | $ | — | $ | — | |||||||||
| Capital lease obligations | 27 | 7 | 7 | 4 | 9 | ||||||||||||||
| Financing lease obligations | 219 | 47 | 79 | 46 | 47 | ||||||||||||||
| Interest payments(2) | 147 | 51 | 77 | 19 | — | ||||||||||||||
| Operating lease obligations(3) | 3,046 | 791 | 1,202 | 653 | 400 | ||||||||||||||
| Purchase obligations(4) | 2,197 | 2,093 | 96 | 8 | — | ||||||||||||||
| Unrecognized tax benefits(5) | 279 | ||||||||||||||||||
| Deferred compensation(6) | 27 | ||||||||||||||||||
| Total | $ | 7,092 | $ | 3,489 | $ | 2,111 | $ | 730 | $ | 456 |
Note: For additional information refer to Note 5, Debt; Note 8, Leases; Note 10, Income Taxes; and Note 12, Contingencies and Commitments, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
| (1) | Represents principal amounts only and excludes interest rate swap valuation adjustments. |
| (2) | Interest payments related to our 2018 Notes and 2021 Notes include the variable interest rate payments included in our interest rate swap. For additional information refer to Note 6, Derivative Instruments, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. |
| (3) | Operating lease obligations do not include payments to landlords covering real estate taxes and common area maintenance. These charges, if included, would increase total operating lease obligations by $900 million at February 3, 2018. |
| (4) | Purchase obligations include agreements to purchase goods or services that are enforceable, are legally binding and specify all significant terms, including fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Purchase obligations do not include agreements that are cancelable without penalty. Additionally, although they do not contain legally binding purchase commitments, we included open purchase orders in the table above. Substantially all open purchase orders are fulfilled within 30 days. |
| (5) | Unrecognized tax benefits relate to uncertain tax positions. As we are not able to reasonably estimate the timing of the payments or the amount by which the liability will increase or decrease over time, the related balances have not been reflected in the "Payments Due by Period" section of the table. |
| (6) | Included in Long-term liabilities on our Consolidated Balance Sheet at February 3, 2018, was a $27 million obligation for deferred compensation. As the specific payment dates for deferred compensation are unknown, the related balances have not been reflected in the "Payments Due by Period" section of the table. |
Additionally, we have $1.25 billion in undrawn capacity on our credit facility at February 3, 2018, which if drawn upon, would be included as short-term debt on our Consolidated Balance Sheets.
Critical Accounting Estimates
The preparation of our financial statements requires us to make assumptions and estimates about future events and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors believed to be relevant at the time our consolidated financial statements are prepared. Because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.
Our significant accounting policies are discussed in Note 1, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. We believe that the following accounting estimates are the most critical to aid in fully understanding and evaluating our reported financial results. These estimates require our most difficult, subjective or complex judgments because they relate to matters that are inherently uncertain.
Except where noted, we have not made any material changes during the past three fiscal years, nor do we believe there is a reasonable likelihood of a material future change to the accounting methodologies for the areas described below.
Inventory
Description
Our merchandise inventories were $5.2 billion at February 3, 2018. We value our inventory at the lower of cost or net realizable value through the establishment of inventory markdown adjustments. Markdown adjustments reflect the excess of cost over the net recovery we expect to realize from the ultimate sale or other disposal of inventory and establish a new cost basis.
Judgments and uncertainties involved in the estimate
Markdown adjustments involve uncertainty because the calculations require management to make assumptions and to apply judgment regarding factors such as the products to include in our analysis, the product’s condition, forecasted consumer demand, the promotional environment, the expected sales channel of ultimate disposition and technological obsolescence. We also apply judgment in the assumptions about net realizable value, including direct vendor allowances and selling and supply chain costs.
Effect if actual results differ from assumptions
A 10% change in our markdown adjustment at February 3, 2018, would have affected net earnings by approximately $8 million in fiscal 2018.
Vendor Allowances
Description
We receive funds from our merchandise vendors through a variety of programs and arrangements, principally as a result of purchase volumes, sales price protections or the promotion of a vendor’s product in our stores or through various advertising mediums. For the most part, these vendor funds do not represent the reimbursement of specific, incremental and identifiable costs that we incur to sell the vendor’s products. Therefore, we calculate and accrue for these funds as a reduction in the cost of inventory as the amounts are mutually agreed-upon with the vendor and recognize these funds as a reduction of cost of sales when the inventory is sold. Funds that are determined to be a reimbursement of specific, incremental and identifiable costs incurred to sell a vendor's products are recorded as an offset to the related expense.
Judgments and uncertainties involved in the estimate
Due to the quantity of and diverse nature of individual vendor agreements, a deferral estimate is required for vendor allowances received on inventory purchases. This estimate requires a detailed analysis of factors, such as (1) product and vendor mix, (2) the nature and period the negotiated funding relates to in order to determine the allowances to defer, and (3) analysis and judgment regarding when the inventory is sold.
Effect if actual results differ from assumptions
A 10% changee in our vendor funding deferral at February 3, 2018, would have affected net earnings by approximately $24 million in fiscal 2018.
Property and Equipment Impairments
Description
Property and equipment assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. When evaluating property and equipment assets with impairment indicators for potential impairment, we first compare the carrying value of the asset to its estimated undiscounted future cash flows. If the sum of the estimated undiscounted future cash flows is less than the carrying value of the asset, we calculate an impairment loss. The impairment loss calculation compares the carrying value of the asset to its estimated fair value, which is typically based on estimated discounted future cash flows. We recognize an impairment loss if the amount of the asset's carrying value exceeds the asset's estimated fair value.
We evaluate locations for triggering events on a quarterly basis to determine when a location’s asset carrying values may not be recoverable. For store locations, our primary indicator that asset carrying values may not be recoverable is negative operating income for the most recent 12-month period. We also monitor other factors when evaluating store locations for impairment, including significant changes in the manner of use or expected life of the assets or significant changes in our business strategies.
Judgments and uncertainties involved in the estimate
Our impairment evaluations require us to apply judgment in determining whether a triggering event has occurred. Our impairment loss calculations require us to make assumptions and to apply judgment in order to estimate future cash flows, including estimated sales, margin and expenses, as well as estimating lease lives and growth rates. We also apply judgment in forecasting useful lives of the assets and selecting a discount rate that reflects the risk inherent in future cash flows.
Effect if actual results differ from assumptions
A 10% change in our non-restructuring property and equipment impairments would have affected net earnings by approximately $1 million in fiscal 2018.
Tax Contingencies
Description
Our income tax returns are periodically audited by U.S. federal, state and local and foreign tax authorities. Tax authorities audit our tax filing positions, including the timing and amount of income and deductions and the allocation of income among various tax jurisdictions. At any one time, multiple tax years are subject to audit by the various tax authorities. In evaluating the exposures associated with our various tax filing positions, we may record a liability for such exposures. A number of years may elapse before a particular matter, for which we have established a liability, is audited and fully resolved or clarified. We adjust our liability for unrecognized tax benefits and income tax provisions in the period in which an uncertain tax position is effectively settled, the statute of limitations expires for the relevant taxing authority to examine the tax position or when more information becomes available.
Our effective income tax rate is also affected by changes in tax law, the tax jurisdiction of new stores or business ventures, the level of earnings and the results of tax audits.
Judgments and uncertainties involved in the estimate
Our liability for unrecognized tax benefits contains uncertainties because management is required to make assumptions and apply judgment to estimate the exposures associated with our various tax filing positions. Such assumptions can include complex and uncertain external factors, such as changes in tax law, interpretations of tax law and the timing of such changes, and uncertain internal factors such as taxable earnings by jurisdiction, the magnitude and timing of certain transactions and capital spending.
Effect if actual results differ from assumptions
Although we believe that the judgments and estimates discussed herein are reasonable, actual results could differ, and we may be exposed to losses or gains that could be material.
To the extent we prevail in matters for which a liability has been established or are required to pay amounts in excess of our established liability, our effective income tax rate in a given financial statement period could be materially affected. An unfavorable tax settlement generally would require use of our cash and may result in an increase in our effective income tax rate in the period of resolution. A favorable tax settlement may reduce our effective income tax rate in the period of resolution.
Tax Reform
Description
On December 22, 2017, the U.S. enacted the Tax Act which significantly changes U.S. tax law. Among other things, the Tax Act lowered the U.S. statutory tax rate from 35% to 21% effective January 1, 2018, broadened the base to which U.S. income tax applies, imposed a one-time, deemed repatriation tax on net unremitted earnings of foreign subsidiaries not previously subject to U.S. income tax and effectively created a new minimum tax on certain future foreign earnings.
Judgments and uncertainties involved in the estimate
The SEC staff issued SAB 118 that provides guidance on accounting for the impact of the Tax Act. SAB 118 allows companies to record provisional amounts to the extent that they are reasonably estimable and adjust them over time as more information becomes available, not to extend beyond the measurement period of one year from the enactment of the Tax Act.
As a result of the Tax Act, we recorded provisional tax expense in fiscal 2018 of $283 million. The $283 million included a $209 million charge associated with the deemed repatriation tax and a $74 million charge primarily related to the revaluation of deferred tax assets and liabilities to reflect the new tax rate.
Effect if actual results differ from assumptions
Although we believe that the judgments and estimates discussed herein are reasonable, the ultimate impact of the Tax Act may differ materially from our provisional amounts due to further refinement of our calculations as allowed by SAB 118, changes in interpretations and assumptions we have made, or actions we may take as a result of the Tax Act. The provisional amounts will be finalized within the one-year measurement period as we gather and analyze the additional documentation necessary for the calculations. Refer to Note 10, Income Taxes, of the Notes to Consolidated Financial Statements, included in item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for additional information.
Gift Card Breakage
Description
We sell gift cards to customers in our retail stores, through our websites and through select third parties. A liability is initially established for the value of the gift card when it is sold. We do not charge administrative fees on unused gift cards and our gift cards do not expire. We recognize revenue from gift cards when the card is redeemed by the customer. For unredeemed gift cards, we recognize breakage when the likelihood of the gift card being redeemed by the customer is deemed remote, and we determine that we do not have a legal obligation to remit the value of the unredeemed gift cards to a relevant jurisdiction. We determine the breakage rate based on historical redemption patterns and record projected breakage 24 months after card issuance.
Judgments and uncertainties involved in the estimate
There is inherent judgment in estimating gift card redemption patterns as they are susceptible to factors outside of our influence. However, we have extensive history of breakage patterns. In general, uncertainty reduces significantly within a short time frame, as the majority of our gift card redemptions occur within the first year.
Effect if actual results differ from assumptions
A 10% change in our cumulative gift card breakage estimate at February 3, 2018, would have affected net earnings by approximately $37 million in fiscal 2018.
Customer Loyalty Programs
Description
We have customer loyalty programs which allow members to earn points for each purchase completed with us or when using our co-branded credit cards. Points earned enable members to receive a certificate that may be redeemed on future purchases at our Best Buy branded stores. The value of points earned by our loyalty program members is included in Accrued liabilities on our Consolidated Balance Sheets and recorded as a reduction in revenue at the time the points are earned, based on the value of points that are projected to be redeemed.
Judgments and uncertainties involved in the estimate
There is inherent judgment in estimating the value of our customer loyalty programs as they are susceptible to factors outside of our influence, particularly customer redemption activity. However, we have significant experience in estimating the amount and timing of redemptions of certificates, based primarily on historical data.
Effect if actual results differ from assumptions
A 10% change in our customer redemption rates at February 3, 2018, would have affected net earnings by approximately $15 million in fiscal 2018.
Service Revenue
Description
We sell customers support plans as part of a bundled service offer which may include items such as technical support, extended warranty, anti-virus software and one-time service repairs. We allocate revenue to all deliverables based on their relative fair value. Revenue for our technical support plans is recognized over the contract term based on a straight-line or usage basis.
Judgments and uncertainties involved in the estimate
Our process for determining the fair value allocation of revenue to deliverables requires judgment as a portion of our deliverables require our best estimate of fair value. For revenue recognized on a usage basis, there is judgment inherent in our determination of the usage basis and related pattern of revenue. These judgment areas are also subject to change based on changes to our service offerings, including the types of support covered by the plan, products covered by plans, level of service required by customers, contract length, number of devices eligible for service and frequency and timing of customer support.
Effect if actual results differ from assumptions
A 10% change in the amount of services membership deferred revenue as of February 3, 2018, would have affected net earnings by approximately $10 million in fiscal 2018.
Self-Insurance
Description
We are self-insured for certain losses related to health, workers' compensation and general liability claims; however, we obtain third-party insurance coverage to limit our exposure to certain claims. Liabilities associated with these losses include estimates of both claims filed and losses incurred but not yet reported. When estimating our self-insured liabilities, we consider a number of factors, including historical claims experience, demographic factors, severity factors and valuations provided by independent third-party actuaries.
Judgments and uncertainties involved in the estimate
Our self-insured liabilities require us to apply judgment and make assumptions to estimate the ultimate cost to settle reported claims and claims incurred but not reported as of the balance sheet date. These estimates include a variety of inputs, including projected exposures, actual versus expected results, number of open claims, frequency of claims, severity of claims and historical loss development patterns of claims.
Effect if actual results differ from assumptions
A 10% change in our self-insured liabilities as of February 3, 2018, would have affected net earnings by approximately $9 million in fiscal 2018.
New Accounting Pronouncements
For a description of new applicable accounting pronouncements, see Note 1, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
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