Best Buy FY 2002 Annual Report

Management Discussion & Analysis pg 1 2 3 4 5 6 7 8 9 10 11 12 13 14

Consolidated Results
Net Interest (Expense) Income
Net interest expense was $1 million in fiscal 2002, compared with net interest income of $37 million last fiscal year. Fiscal 2002 included an $8 million pre-tax charge from the early retirement of debt acquired as part of the Musicland acquisition. The balance of the change in net interest resulted primarily from lower yields on short-term investments as the average interest rate declined by more than 2% compared with last fiscal year. The impact of lower short-term investment yields was partially offset by higher average cash balances resulting from strong operating cash flows and net proceeds from the issuance of convertible debentures.

Net interest income increased to $37 million in fiscal 2001 compared with $24 million in fiscal 2000. The increase was due to higher cash balances compared with the prior fiscal year. The higher cash balances were the result of cash flows generated from operations, including improved inventory management and a $200 million investment in Best Buy common stock by Microsoft Corporation as part of a strategic alliance. Interest expense on Musicland debt and lost interest income on the cash used to acquire Musicland and Magnolia Hi-Fi reduced net interest income by approximately $4 million.

Effective Income Tax Rate
Our effective income tax rate increased to 39.1%, up from 38.3% last fiscal year. The increase in the effective income tax rate was primarily due to the nondeductibility of goodwill amortization expense resulting from our acquisitions in the fourth quarter of fiscal 2001.

Our effective income tax rate in fiscal 2001 was 38.3%, unchanged from fiscal 2000. Historically, our effective tax rate has been impacted primarily by the taxability of investment income and state income taxes.

Liquidity and Capital Resources
Summary
We improved our financial position in fiscal 2002 while continuing to make significant investments in new growth initiatives, including the $377 million, or $368 million net of cash acquired, acquisition of Future Shop. Cash and cash equivalents increased to $1.9 billion at the end of fiscal 2002, compared with $747 million at the end of fiscal 2001. Working capital, the excess of current assets over current liabilities, increased to $881 million at the end of fiscal 2002, compared with $214 million at the end of fiscal 2001. In fiscal 2002, strong operating cash flows and net proceeds from the issuance of convertible debentures strengthened our liquidity position; however, our long-term debt-to-capitalization ratio increased to 24% at the end of fiscal 2002, compared with 9% at the end of fiscal 2001.

Cash Flows
Cash provided by operating activities was $1.6 billion in fiscal 2002, compared with $808 million in fiscal 2001 and $776 million in fiscal 2000. The increase in operating cash flows in fiscal 2002, compared with the prior fiscal year, was driven by increased net earnings and cash generated from changes in net operating assets and liabilities. The changes were related to increased accounts payable balances due to higher business volume and timing of invoice payments, as well as increased accrued income taxes. In addition, other liabilities increased due to business growth, advances received under vendor alliances, increased gift card liabilities and higher accrued performance-based compensation expenses resulting from our improvement in net earnings. The changes were partially offset by increased ending inventory, which resulted from the operations of 62 new Best Buy stores and improved in-stock levels.