Best Buy sued over price plunge: two shareholders allege execs overhyped stock - Best Buy Company Inc

Discount Store News, Jan 2, 1995

EDEN PRAIRIE, MINN. -- Best Buy has been sued by two stockholders after news of lower-than-projected earnings coupled with Whirlpool's decision to pull its appliances out of the chain's stores sent the electronics retailer's stock into a tailspin. The stock plunged 26%, or $11.25 a share, immediately after the news hit, and continued to slide into the next week.

The two stockholders alleged that Best Buy knew that it wouldn't make projected third quarter numbers, and that its chief financial executives, chairman Richard Schulze and cfo Allen Lenzmeier, continued to hype the stock anyway. Specifically, Best Buy knew that stiffer industry competition, the cost of rapid expansion, growing inventory levels and heavy industrywide promotions combined to cut into profitability and that the company "continually attempted to disparage any negative comment and to emphasize that the company's earnings momentum would be in line with analysts' growth expectations," the lawsuit alleged.

Nonsense, retorted Best Buy. "We feel the complaint is wholly without merit and will vigorously defend against it," corporate communications director Susan Hoff responded.

Industry analysts generally blame the lower profit picture on computer prices plummeting faster than projected (particularly in the Pentium category), higher-than-expected costs of entering the Los Angeles market, and according to Johnson Rice analyst David Childe, disappointing results after the grand opening. Stores are now projected to gross only about $40 million each per year (against Best Buy's overall average of $25 million to $30 million) compared to optimistic projections of $50 million or more.

Childe expects the L.A. stores to perform better next year, but projects a loss for fiscal 1995, where Best Buy had projected break-even. He also expects computer margins to stabilize in 1995, as manufacuturers get better prices on materials and lower wholesale costs, but not necessarily list prices.

Best Buy president Brad Anderson noted at the L.A. openings that computer margins were in trouble. Traditionally, higher-priced competitors like CompUSA swung into the market with ultra-low prices (reportedly operating on markups of 8% or even less) to retain market share. That forced Best Buy to lower prices just when it needed a profit kick the most.

The chain reported its third quarter results shortly before Christmas; earnings rose 59% compared to the same period a year ago, to $17.7 million, or 41 cents per share. Analysts had hoped for 45 cents to 47 cents per share.

The gross profit margin slipped slightly to 13.6% from 15% a year ago and about 14% for the first two quarters of this fiscal year. Chairman Dick Schulze noted that the decline in margin "is mainly due to promotional activity associated with the grand opening of the 34 stores (opened during the period) and the 18 stores that were relocated/remodeled, combined with a more competitive environment in November."

"As an emerging national retailer, we achieved strategic positioning during the quarter with our coast-to-coast expansion," he added.

Sales for the quarter increased 67% to $1.35 billion, and 73% for the first nine months of fiscal 1995 to $3.13 billion. Same store sales rose 20% during the quarter and SG&A expenses as a percentage of sales hit an all-time low of 10.8%, compared to 12.4% a year ago.