Electronics retailer Best Buy (BBY) announced weak third quarter results. Revenue dipped 3.5% year-over-year to $10.8 billion, roughly in-line with consensus estimates. Earnings, adjusted to reflect continuing operations, dropped 94% year-over-year to $0.03 per share, which was worse than consensus expectations. We had previously highlighted why Best Buy's dividend is currently sound in this article here, but we think it may make more sense for the company to proactively cut it.
Perhaps the most encouraging parts of the report came from the headline and CEO Hubert Joly's remarks. The company showed its sense of frankness with the headline, "Best Buy Confirms Significant Decline in Fiscal Third Quarter 2013 earnings." Further, Joly stated:
"In line with trends experienced over the last three years, Best Buy's third quarter financial performance was clearly unsatisfactory. On November 13, we shared our candid assessment of Best Buy's situation and unveiled Renew Blue, a set of priorities to begin re-invigorating the companys performance and rejuvenating Best Buy. The results we are reporting today only strengthen our sense of urgency and purpose," said Hubert Joly, Best Buy president and CEO."
Unlike the eternal optimism we've seen practiced by struggling companies like JC Penney (JCP) and, to a lesser extent, Kohl's (KSS), we appreciate Best Buy's honesty. It would be easy for Best Buy to blame the litany of outside factors-a weak economy, lack of tech innovation, Amazon's (AMZN) sales tax advantage, or Apple's direct-to-consumer business; instead, management has taken accountability for the 4.3% decline in same-store sales. Honesty with respect to the business is a positive, in our view, because it likely means the Renew Blue initiative will be implemented quickly, testing its effectiveness. Nevertheless, Best Buy continues to face an uphill battle.
Gross margins continue to weaken, falling 160 basis points year-over-year to 24%. Results were slightly better in the domestic business, where gross margins tallied 24.2%, down 100 basis points year-over-year. Internationally, gross margins fell 280 basis points to 23.7% as economic conditions in Europe negatively impacted product mix. We saw a similar divergence with same-store sales, which fell 4% in the US and 5.2% internationally. Mobile phones were strong in the US, increasing 32% on a comparable basis. Internationally, Europe posted positive comparisons, but China weighed heavily on results.
We weren't too pleased to see SG&A increase nearly 3% on an absolute basis to $2.5 billion. While we like management's intent on retraining staff and giving the sales team a value-added function, we would have liked to see other cuts to offset this investment. We'll be interested to see if the training on Microsoft's Windows 8 (MSFT) yields improved results for either firm in the fourth quarter.
Cash flow was negative during the quarter, though the company makes a substantial amount of its cash during the fourth quarter, so this is of little concern at this time. Management anticipates slower margin declines in the fourth quarter to result in full-year free cash flow of $850 million to $1.05 billion, which is down substantially from its previous forecast of $1.25 billion to $1.5 billion, reflecting the poor third quarter results. We don't anticipate much upside to management's forecast.
Overall, we agree with management that the company's third quarter performance was bad. In addition to the number of factors we mentioned earlier, the company has to handle a shift to digital media consumption and now has thousands of stores with fewer products to sell in them. We think the holiday season will be challenging, especially if consumers capitalize on the price-match feature. As we've seen from Amazon, it's hard to make a profit when you sell goods at razor-thin gross margins. We see some potential upside in fiscal year 2014 related to housing and a possible boost in appliance sales if the market continues its recovery. Comparable appliance sales were up 10.8% during the quarter, but still only represent 7% of sales in the US.
Due to the various competitive and cultural forces hurting Best Buy, we aren't interested in shares at this time. We'd like to see a company in transition cut its dividend, something RadioShack (RSH) failed to do in a timely fashion. Investors looking to bet on stocks to fall as a result of a dividend cut should take a read of our Dividend Cushion here. We would much rather see management spare precious cash than return it to shareholders. Though a private equity deal may eventually materialize, founder and PE leader Richard Schulze will wait until after the holiday season to make deal-meaning if things get ugly, we wouldn't expect much of a premium.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: MSFT is included in our Dividend Growth portfolio.