Edgar Filing: BEST BUY CO INC

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended August 26, 2006

OR

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

For the transition period from to

Commission File Number: 1-9595

BEST BUY CO., INC.

(Exact name of registrant as specified in its charter)

Minnesota		41-0907483
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

7601 Penn Avenue South
Richfield, Minnesota		55423
(Address of principal executive offices)		(Zip Code)

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

N/A
(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No o

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

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes o No o

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. Common Stock, $.10 Par Value — 480,250,000 shares outstanding as of August 26, 2006.

BEST BUY CO., INC.

FORM 10-Q FOR THE QUARTER ENDED AUGUST 26, 2006

INDEX

Part I —	Financial Information			3

	Item 1.		Consolidated Financial Statements (unaudited):	3

		a)	Consolidated condensed balance sheets as of August 26, 2006; February 25, 2006; and August 27, 2005	3

		b)	Consolidated statements of earnings for the three and six months ended August 26, 2006, and August 27, 2005	5

		c)	Consolidated statement of changes in shareholders’ equity for the six months ended August 26, 2006	6

		d)	Consolidated statements of cash flows for the six months ended August 26, 2006, and August 27, 2005	7

		e)	Notes to consolidated condensed financial statements	8

	Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	26

	Item 3.		Quantitative and Qualitative Disclosures About Market Risk	39

	Item 4.		Controls and Procedures	39

Part II —	Other Information			40

	Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds	40

	Item 4.		Submission of Matters to a Vote of Security Holders	41

	Item 6.		Exhibits	41

Signatures				42

PART I —		FINANCIAL INFORMATION

ITEM 1.		CONSOLIDATED FINANCIAL STATEMENTS

BEST BUY CO., INC.

CONSOLIDATED CONDENSED BALANCE SHEETS

ASSETS

($ in millions, except per share amounts)

(Unaudited)

	August 26, 2006		February 25, 2006		August 27, 2005
CURRENT ASSETS
Cash and cash equivalents	$	1,104	$	748	$	614
Short-term investments	1,564		3,051		2,211
Receivables	483		439		389
Merchandise inventories	4,049		3,338		3,250
Other current assets	687		409		378
Total current assets	7,887		7,985		6,842

PROPERTY AND EQUIPMENT
Property and equipment	5,151		4,836		4,436
Less accumulated depreciation	2,364		2,124		1,913
Net property and equipment	2,787		2,712		2,523

GOODWILL	1,010		557		529

OTHER INTANGIBLE ASSETS	83		44		42

LONG-TERM INVESTMENTS	277		218		122

OTHER ASSETS	363		348		201

TOTAL ASSETS	$	12,407	$	11,864	$	10,259

NOTE: The consolidated balance sheet as of February 25, 2006, has been condensed from the audited financial statements.

See Notes to Consolidated Condensed Financial Statements.

BEST BUY CO., INC.

CONSOLIDATED CONDENSED BALANCE SHEETS

LIABILITIES AND SHAREHOLDERS’ EQUITY

($ in millions, except per share amounts)

(Unaudited)

	August 26, 2006		February 25, 2006		August 27, 2005
CURRENT LIABILITIES
Accounts payable	$	3,858	$	3,234	$	2,760
Unredeemed gift card liabilities	392		469		358
Accrued compensation and related expenses	263		354		216
Accrued liabilities	958		878		916
Accrued income taxes	399		703		254
Current portion of long-term debt	496		418		12
Total current liabilities	6,366		6,056		4,516

LONG-TERM LIABILITIES	392		373		380

LONG-TERM DEBT	184		178		540

MINORITY INTERESTS	31		—		—

SHAREHOLDERS’ EQUITY
Preferred stock, $1.00 par value: Authorized — 400,000 shares; Issued and outstanding – none	—		—		—
Common stock, $.10 par value: Authorized — 1.5 billion shares; Issued and outstanding — 480,250,000, 485,098,000 and 492,444,000 shares, respectively	48		49		49
Additional paid-in capital	389		643		973
Retained earnings	4,690		4,304		3,600
Accumulated other comprehensive income	307		261		201
Total shareholders’ equity	5,434		5,257		4,823

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	12,407	$	11,864	$	10,259

NOTE: The consolidated balance sheet as of February 25, 2006, has been condensed from the audited financial statements.

See Notes to Consolidated Condensed Financial Statements.

BEST BUY CO., INC.

CONSOLIDATED STATEMENTS OF EARNINGS

($ in millions, except per share amounts)

(Unaudited)

	Three Months Ended				Six Months Ended
	August 26, 2006		August 27, 2005		August 26, 2006		August 27, 2005
Revenue	$	7,603	$	6,702	$	14,562	$	12,820
Cost of goods sold	5,701		4,991		10,895		9,551
Gross profit	1,902		1,711		3,667		3,269
Selling, general and administrative expenses	1,572		1,450		3,000		2,769
Operating income	330		261		667		500
Net interest income	21		18		44		31

Earnings before income tax expense and minority interests	351		279		711		531
Income tax expense	121		91		247		173
Minority interests	—		—		—		—

Net earnings	$	230	$	188	$	464	$	358

Basic earnings per share	$	0.48	$	0.38	$	0.96	$	0.73
Diluted earnings per share	$	0.47	$	0.37	$	0.94	$	0.71

Dividends declared per common share	$	0.08	$	0.07	$	0.16	$	0.15

Basic weighted average common shares outstanding (in millions)	482.0		491.2		483.3		491.2

Diluted weighted average common shares outstanding (in millions)	496.5		509.1		498.4		507.5

See Notes to Consolidated Condensed Financial Statements.

BEST BUY CO., INC.

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE SIX MONTHS ENDED AUGUST 26, 2006

($ and shares in millions)

(Unaudited)

	Common Shares		Common Stock			Additional Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive Income			Total
Balances at February 25, 2006	485		$	49		$	643		$	4,304		$	261		$	5,257

Net earnings, six months ended August 26, 2006	—		—			—			464			—			464
Other comprehensive income, net of tax:
Foreign currency translation adjustments	—		—			—			—			51			51
Other	—		—			—			—			(5		)	(5		)
Total comprehensive income															510

Stock options exercised	4		—			94			—			—			94
Stock-based compensation	—		—			59			—			—			59
Tax benefits from stock options exercised and employee stock purchase plan	—		—			31			—			—			31
Issuance of common stock under employee stock purchase plan	—		—			23			—			—			23
Repurchase of common stock	(9	)	(1		)	(461		)	—			—			(462		)
Common stock dividend, $0.16 per share	—		—			—			(78		)	—			(78		)
Balances at August 26, 2006	480		$	48		$	389		$	4,690		$	307		$	5,434

See Notes to Consolidated Condensed Financial Statements.

BEST BUY CO., INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

($ in millions)

(Unaudited)

	Six Months Ended
	August 26, 2006			August 27, 2005
OPERATING ACTIVITIES
Net earnings	$	464		$	358
Adjustments to reconcile net earnings to total cash used in operating activities:
Depreciation	246			222
Asset impairment charges	21			—
Stock-based compensation	59			62
Deferred income taxes	(28		)	(31		)
Excess tax benefits from stock-based compensation	(22		)	(21		)
Other	14			(1		)
Changes in operating assets and liabilities, net of acquired assets and liabilities:
Receivables	(15		)	(13		)
Merchandise inventories	(548		)	(385		)
Other assets	(5		)	(21		)
Accounts payable	231			(75		)
Other liabilities	(185		)	(19		)
Accrued income taxes	(263		)	(273		)
Total cash used in operating activities	(31		)	(197		)

INVESTING ACTIVITIES
Additions to property and equipment, net of $23 non-cash capital expenditures in the six months ended August 27, 2005	(299		)	(280		)
Acquisition of businesses, net of cash acquired	(421		)	—
Purchases of available-for-sale securities	(1,635		)	(995		)
Sales of available-for-sale securities	3,060			1,805
Proceeds from property dispositions	—			42
Changes in restricted assets	(16		)	12
Other, net	12			10
Total cash provided by investing activities	701			594

FINANCING ACTIVITIES
Repurchase of common stock	(462		)	(262		)
Issuance of common stock under employee stock purchase plan and for the exercise of stock options	117			187
Dividends paid	(78		)	(73		)
Long-term debt payments	(7		)	(66		)
Proceeds from issuance of long-term debt	38			7
Excess tax benefits from stock-based compensation	22			21
Other, net	37			37
Total cash used in financing activities	(333		)	(149		)

EFFECT OF EXCHANGE RATE CHANGES ON CASH	19			12

INCREASE IN CASH AND CASH EQUIVALENTS	356			260

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD	748			354

CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	1,104		$	614

See Notes to Consolidated Condensed Financial Statements.

BEST BUY CO., INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation:

In the opinion of management, the accompanying financial statements contain all adjustments necessary for a fair presentation as prescribed by accounting principles generally accepted in the United States. All adjustments were comprised of normal recurring adjustments, except as noted in the Notes to Consolidated Condensed Financial Statements. Due to the seasonal nature of our business, interim results are not necessarily indicative of results for the entire fiscal year. Our revenue and earnings are typically greater during our fiscal fourth quarter, which includes the majority of the holiday selling season. These interim financial statements and the related notes should be read in conjunction with the financial statements and notes included in our Annual Report on Form 10-K for the fiscal year ended February 25, 2006.

To maintain consistency and comparability, we reclassified certain prior-year amounts to conform to the current year presentation as described in Note 1, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended February 25, 2006. In addition, to be consistent with our accounting policies, we reclassified selected balances from receivables to cash and cash equivalents in our February 25, 2006, consolidated condensed balance sheet. These reclassifications had no effect on previously reported operating income, net earnings or shareholders’ equity.

Effective June 8, 2006, we acquired a 75% interest in Jiangsu Five Star Appliance Co., Ltd. (Five Star). Consistent with China’s statutory requirements, Five Star’s fiscal year ends on December 31. Therefore, we have decided to consolidate Five Star’s financial results on a two-month lag. There were no significant intervening events which would have materially affected our consolidated financial statements had they been recorded during the quarter. See Note 2, Acquisitions, for further details regarding this transaction.

The following table illustrates the primary costs classified in each major expense category (the classification of which varies across the retail industry):

Cost of Goods Sold

Selling, General & Administrative Expenses (SG&A)

· Total cost of products sold including:

— Freight expenses associated with moving merchandise inventories from our vendors to our distribution centers;

— Vendor allowances that are not a reimbursement of specific, incremental and identifiable costs to promote a vendor’s products;

— Cash discounts on payments to vendors;

· Cost of services provided including:

— Payroll and benefits costs for services employees;

— Cost of replacement parts and related freight expenses;

· Physical inventory losses;

· Markdowns;

· Customer shipping and handling expenses;

· Costs associated with operating our distribution network, including payroll and benefit costs, occupancy costs, and depreciation;

· Freight expenses associated with moving merchandise inventories from our distribution centers to our retail stores; and

· Promotional financing costs.

· Payroll and benefit costs for retail and corporate employees;

· Occupancy costs of retail, services and corporate facilities;

· Depreciation related to retail, services and corporate assets;

· Advertising;

· Vendor allowances that are a reimbursement of specific, incremental and identifiable costs to promote a vendor’s products;

· Charitable contributions;

· Outside service fees;

· Long-lived asset impairment charges; and

· Other administrative costs, such as credit card service fees, supplies, and travel and lodging.

Vendor allowances included in revenue for reimbursement of vendor-provided sales incentives were $6 million and $24 million, for the three months ended August 26, 2006, and August 27, 2005, respectively, and $12 million and $41 million, for the six months ended August 26, 2006, and August 27, 2005, respectively. Vendor allowances included in SG&A were $38 million and $35 million for the three months ended August 26, 2006, and August 27, 2005, respectively, and $67 million and $55 million for the six months ended August 26, 2006, and August 27, 2005, respectively. All remaining vendor allowances are initially deferred and recorded as a reduction of merchandise inventories. The deferred amounts are then included as a reduction of cost of goods sold when the related product is sold.

2. Acquisitions:

Pacific Sales Kitchen and Bath Centers, Inc.

Effective March 7, 2006, we acquired all of the common stock of Pacific Sales Kitchen and Bath Centers, Inc. (Pacific Sales) for $411 million, or $408 million, net of cash acquired, including transaction costs. We acquired Pacific Sales, a high-end home-improvement and appliance retailer, to enhance our ability to grow with an attractive customer base and premium brands using a proven and successful showroom format. Utilizing the existing store format, we expect to expand the number of stores in order to capitalize on the rapidly growing high-end segment of the U.S. appliance market. The acquisition was accounted for using the purchase method in accordance with Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations. Accordingly, we recorded the net assets at their estimated fair values, and included operating results in our Domestic segment from the date of acquisition. We allocated the purchase price on a preliminary basis using information currently available. The allocation of the purchase price to the assets and liabilities acquired will be finalized no later than the first quarter of fiscal 2008, as we obtain more information regarding asset valuations, liabilities assumed and revisions of preliminary estimates of fair values made at the date of purchase. All goodwill is deductible for tax purposes.

The preliminary purchase price allocation, net of cash acquired, was as follows ($ in millions):

Merchandise inventories	$	41
Property and equipment	2
Other assets(1)	14
Tradename	17
Goodwill	377
Current liabilities	(43		)
	$	408

(1) Includes $7 million related to the acquired customer backlog.

Jiangsu Five Star Appliance Co., Ltd.

Effective June 8, 2006, we acquired a 75% interest in Five Star for $184 million, including a working capital injection of $122 million and transaction costs. Five Star is one of China’s largest appliance and consumer electronics retailers with 131 stores located in eight of China’s 34 provinces. We made the investment in Five Star to further our international growth plans, increase our knowledge of Chinese customers and obtain an immediate retail presence in China. The acquisition was accounted for using the purchase method in accordance with SFAS No. 141, Business Combinations. Accordingly, we recorded the net assets at their estimated fair values, and included operating results in our International segment from the date of acquisition. We allocated the purchase price on a

preliminary basis using information currently available. The allocation of the purchase price to the assets and liabilities acquired will be finalized no later than the second quarter of fiscal 2008, as we obtain more information regarding asset valuations, liabilities assumed and revisions of preliminary estimates of fair values made at the date of purchase. The resulting goodwill is not deductible for tax purposes.

The preliminary purchase price allocation, net of cash acquired, was as follows ($ in millions):

Restricted cash	$	204
Merchandise inventories	107
Property and equipment	37
Other assets	81
Tradename	21
Goodwill	69
Accounts payable	(363		)
Other current liabilities	(47		)
Debt, due 2006 to 2007, interest rates ranging from 1.9% to 6.8%	(64		)
Long-term liabilities	(1		)
Minority interests (1)	(31		)
	$	13

(1) The minority interests’ proportionate ownership of assets and liabilities were recorded at historical carrying values.

The minority interests’ share of net earnings included in the three and six months ended August 26, 2006, was less than $1 million.

3. Gift Cards:

We sell gift cards to our customers in our retail stores, through our Web sites and through selected third parties. Our gift cards do not have an expiration date. We recognize income from gift cards when: (i) the gift card is redeemed by the customer; or (ii) the likelihood of the gift card being redeemed by the customer is remote (gift card breakage) and we determine that we do not have a legal obligation to remit the value of unredeemed gift cards to the relevant jurisdictions. We determine our gift card breakage rate based upon historical redemption patterns. Based on our historical information, the likelihood of a gift card remaining unredeemed can be determined 24 months after the gift card is issued. At that time, we recognize breakage income for those cards for which the likelihood of redemption is deemed to be remote if we do not have a legal obligation to remit the value of such unredeemed gift cards to the relevant jurisdictions. Gift card breakage income is included in revenue in our consolidated statements of earnings.

Gift card breakage income recognized for the three and six months ended August 26, 2006 was not significant (less than $0.01 per diluted share). There was no gift card breakage income recognized for the three and six months ended August 27, 2005.

4. Net Interest Income:

Net interest income was comprised of the following ($ in millions):

	Three Months Ended						Six Months Ended
	August 26, 2006			August 27, 2005			August 26, 2006			August 27, 2005
Interest income	$	29		$	21		$	60		$	42
Dividend income	—			4			—			4
Interest expense	(8		)	(7		)	(16		)	(15		)
Net interest income	$	21		$	18		$	44		$	31

5. Earnings per Share:

Basic earnings per share is computed based on the weighted-average number of common shares outstanding. Diluted earnings per share is computed based on the weighted-average number of common shares outstanding adjusted by the number of additional shares that would have been outstanding had the potentially dilutive common shares been issued. Potentially dilutive shares of common stock include non-qualified stock options, nonvested share awards and shares issuable under our employee stock purchase plan (ESPP), as well as common shares that would have resulted from the assumed conversion of our convertible debentures. Since the potentially dilutive shares related to the convertible debentures are included in the calculation, the related interest expense, net of tax, is added back to net earnings, as the interest would not have been paid if the convertible debentures were converted to common stock. Nonvested market-based awards and nonvested performance-based awards are included in the average diluted shares outstanding each period if established market or performance criteria have been met.

The following table presents a reconciliation of the numerators and denominators of basic and diluted earnings per share ($ and shares in millions, except per share amounts):

	Three Months Ended				Six Months Ended
	August 26, 2006		August 27, 2005		August 26, 2006		August 27, 2005
Numerator:
Net earnings, basic	$	230	$	188	$	464	$	358
Adjustment for assumed dilution:
Interest on convertible debentures, net of tax	1		1		3		3
Net earnings, diluted	$	231	$	189	$	467	$	361

Denominator:
Weighted-average common shares outstanding	482.0		491.2		483.3		491.2
Effect of potentially dilutive securities:
Shares from assumed conversion of convertible debentures	8.8		8.8		8.8		8.8
Stock options and other	5.7		9.1		6.3		7.5
Weighted-average common shares outstanding, assuming dilution	496.5		509.1		498.4		507.5

Basic earnings per share	$	0.48	$	0.38	$	0.96	$	0.73
Diluted earnings per share	$	0.47	$	0.37	$	0.94	$	0.71

The computation of average dilutive shares outstanding excluded non-qualified options to purchase 0.4 million shares of common stock for the three months ended August 26, 2006, and 0.4 million and 0.2 million shares of common stock for the six months ended August 26, 2006, and August 27, 2005, respectively. These amounts were excluded as the options’ exercise prices were greater than the average market price of our common stock for the periods presented and, therefore, the effect would be antidilutive (i.e., including such options would result in higher earnings per share). There were no options excluded from the computation of dilutive shares outstanding for the three months ended August 27, 2005.

6. Stock-Based Compensation:

Stock-based compensation expense was $31 million for both the three months ended August 26, 2006, and August 27, 2005, and $59 million and $62 million for the six months ended August 26, 2006, and August 27, 2005, respectively. The year-to-date decline was due to an increase in our participant forfeiture rate resulting from recent workforce reductions. Stock-based compensation expense for the six months ended August 26, 2006, may not be indicative of the expense for the entire fiscal year.

7. Comprehensive Income:

Comprehensive income is computed as net earnings plus certain other items that are recorded directly to shareholders’ equity. The significant components of comprehensive income include foreign currency translation adjustments and unrealized gains/losses net of tax on available-for-sale marketable equity securities. Foreign currency translation adjustments do not include a provision for income tax expense because earnings from foreign operations are considered to be indefinitely reinvested outside the United States. Comprehensive income was $222 million and $253 million for the three months ended August 26, 2006, and August 27, 2005, respectively, and $510 million and $410 million for the six months ended August 26, 2006, and August 27, 2005, respectively.

8. Segments:

We operate two reportable segments: Domestic and International. The Domestic segment is comprised of all U.S. store and online operations, including Best Buy, Geek Squad, Pacific Sales and Magnolia Audio Video. The International segment is comprised of all Canadian store and online operations, including Future Shop, Best Buy and Geek Squad, as well as our Five Star store and online operations in China. Our segments are evaluated on an operating income basis, and a stand-alone tax provision is not calculated for each segment. The other accounting policies of the segments are the same as those described in Note 1, Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended February 25, 2006.

Revenue by reportable segment was as follows ($ in millions):

	Three Months Ended				Six Months Ended
	August 26, 2006		August 27, 2005		August 26, 2006		August 27, 2005
Domestic	$	6,621	$	5,997	$	12,783	$	11,489
International	982		705		1,779		1,331
Total revenue	$	7,603	$	6,702	$	14,562	$	12,820

Operating income by reportable segment and the reconciliation to earnings before income tax expense and minority interests were as follows ($ in millions):

	Three Months Ended				Six Months Ended
	August 26, 2006		August 27, 2005		August 26, 2006		August 27, 2005
Domestic	$	328	$	255	$	661	$	497
International	2		6		6		3
Total operating income	330		261		667		500
Net interest income	21		18		44		31
Earnings before income tax expense and minority interests	$	351	$	279	$	711	$	531

Assets by reportable segment were as follows ($ in millions):

	August 26, 2006		February 25, 2006		August 27, 2005
Domestic	$	9,315	$	9,722	$	8,316
International	3,092		2,142		1,943
Total assets	$	12,407	$	11,864	$	10,259

Goodwill by reportable segment was as follows ($ in millions):

	August 26, 2006		February 25, 2006		August 27, 2005
Domestic	$	383	$	6	$	3
International	627		551		526
Total goodwill	$	1,010	$	557	$	529

The change in the Domestic goodwill balance since February 25, 2006, was the result of the acquisition of Pacific Sales. The change in the International goodwill balance since February 25, 2006, and August 27, 2005, was due primarily to the acquisition of Five Star totaling $69 million, with the remainder due primarily to fluctuations in foreign currency exchange rates.

Other intangible assets included in our balance sheets were comprised primarily of indefinite-lived intangible tradename assets related to Pacific Sales, which is included in the Domestic segment, and Future Shop and Five Star, which are included in the International segment. Other intangible assets by reportable segment were as follows ($ in millions):

	August 26, 2006		February 25, 2006		August 27, 2005
Domestic	$	17	$	—	$	—
International	66		44		42
Total other intangible assets	$	83	$	44	$	42

9. Investments:

Debt Securities

Short-term and long-term investments are comprised of municipal and United States government debt securities, as well as auction-rate securities. In accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and based on our ability to market and sell these instruments, we classify auction-rate securities, variable-rate demand notes and other investments in debt securities as available-for-sale and carry them at amortized cost, which approximates fair value. Auction-rate securities and variable-rate demand notes are similar to short-term debt instruments because their interest rates are reset periodically. Investments in these securities can be sold for cash on the auction date. We classify auction-rate securities and variable-rate demand notes as short-term or long-term investments based on the reset dates.

In accordance with our investment policy, we place our investments in debt securities with issuers who have high-quality credit and limit the amount of investment exposure to any one issuer. We seek to preserve principal and minimize exposure to interest-rate fluctuations by limiting default risk, market risk and reinvestment risk.

During the third quarter of fiscal 2006, we reclassified variable-rate demand notes from cash and cash equivalents to short-term investments for all periods presented. The amortized cost of the securities reclassified was $184 million at August 27, 2005.

We also revised the presentation in the consolidated statement of cash flows for the six months ended August 27, 2005, to reflect the gross purchases and sales of variable-rate demand notes as investing activities rather than as a component of cash and cash equivalents, which is consistent with the presentation for the six months ended August 26, 2006. The amount reclassified from cash and cash equivalents to investing activities was $68 million for the six months ended August 27, 2005.

The carrying amount of our investments in debt securities approximated fair value at August 26, 2006; February 25, 2006; and August 27, 2005, due to the rapid turnover of our portfolio and the highly liquid nature of these investments. Therefore, there were no significant unrealized holding gains or losses.

The following table presents the amortized principal amounts, related weighted-average interest rates (taxable equivalent), maturities and major security types for our investments in debt securities ($ in millions):

	August 26, 2006				February 25, 2006				August 27, 2005
	Amortized Principal Amount		Weighted- Average Interest Rate		Amortized Principal Amount		Weighted- Average Interest Rate		Amortized Principal Amount		Weighted- Average Interest Rate
Short-term investments (less than one year)	$	1,564	5.62	%	$	3,051	4.76	%	$	2,211	3.95	%
Long-term investments (one to three years)	277		5.74	%	218		4.95	%	122		3.95	%
Total	$	1,841			$	3,269			$	2,333

Municipal debt securities	$	1,736			$	3,153			$	2,209
Auction-rate and asset-backed securities	105				109				117
Debt securities issued by U.S. Treasury and other U.S. government entities	—				7				7
Total	$	1,841			$	3,269			$	2,333

Equity Securities

We also hold investments in equity securities. We classify all marketable equity securities as available-for-sale. Investments in marketable equity securities are included in other assets in our consolidated balance sheets and reported at fair value, based on quoted market prices when available. All unrealized holding gains or losses are reflected net of tax in accumulated other comprehensive income in shareholders’ equity.

The carrying value of our investments in equity securities at August 26, 2006; February 25, 2006; and August 27, 2005, was $29 million, $28 million and $28 million, respectively. Net unrealized gains, net of tax, included in accumulated other comprehensive income were $7 million, $12 million and $12 million at August 26, 2006; February 25, 2006; and August 27, 2005, respectively.

10. Restricted Assets:

Restricted cash and investments in debt securities, which are included in other current assets, totaled $398 million, $178 million and $146 million as of August 26, 2006; February 25, 2006; and August 27, 2005, respectively. Such balances are pledged as collateral or restricted to use for general liability insurance, workers’ compensation insurance, warranty programs and vendor payables. The increase in restricted cash and investments in debt securities compared with February 25, 2006, and August 27, 2005, was due primarily to restricted cash assumed in connection with the acquisition of Five Star.

11. Impairment of Long-Lived Assets:

We recorded pre-tax long-lived asset impairment charges of $9 million and $21 million for the three and six months ended August 26, 2006, respectively. Long-lived asset impairment charges for the three and six months ended August 25, 2005 were not significant. The long-lived asset impairment charges in fiscal 2007 related to assets that were taken out of service based on changes in our business. Long-lived asset impairment charges recorded in SG&A within our Domestic segment during the second quarter and first six months of fiscal 2007 were $7 million and $19 million, respectively. Long-lived asset impairment charges recorded in SG&A within our International segment during both the second quarter and first six months of fiscal 2007 were $2 million.

12. Commitments and Contingencies:

On December 8, 2005, a purported class action lawsuit captioned, “Jasmen Holloway, et al. v. Best Buy Co., Inc.,” was filed against us in the U.S. District Court for the Northern District of California. This federal court action alleges that we discriminate against women and minority individuals on the basis of gender, race,

color and/or national origin in our stores with respect to recruitment, hiring, job assignments, transfers, promotions, compensation, allocation of weekly hours and other terms and conditions of employment. The plaintiffs seek an end to discriminatory policies and practices, an award of back and front pay, punitive damages and injunctive relief, including rightful place relief for all class members. We believe the allegations are without merit and intend to defend this action vigorously.

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

13. Common Stock Repurchases:

Our Board of Directors (Board) authorized a $1.5 billion share repurchase program in June 2006. The program, which was announced on June 21, 2006, terminated and replaced a $1.5 billion share repurchase program authorized by our Board in April 2005. The April 2005 share repurchase program terminated and replaced a $500 million share repurchase program authorized by our Board in June 2004. There is no expiration date governing the period over which we can make our share repurchases under the June 2006 share repurchase program.

For the three months ended August 26, 2006, we purchased and retired 2.8 million shares at a cost of $130 million under our June 2006 share repurchase program. For the three and six months ended August 26, 2006, we also purchased and retired 1.8 million and 6.2 million shares, respectively, at a cost of $94 million and $332 million under our April 2005 share repurchase program.

For the three and six months ended August 27, 2005, we purchased and retired 1.1 million and 5.3 million shares, respectively, at a cost of $54 million and $200 million under our April 2005 share repurchase program, and 1.8 million shares at a cost of $61 million under our $500 million share repurchase program during the period from February 27, 2005, through April 26, 2005.

14. New Accounting Pronouncements

In October 2005, the Financial Accounting Standards Board (FASB) issued Staff Position (FSP) No. FAS 13-1, Accounting for Rental Costs Incurred During a Construction Period. FSP No. FAS 13-1 requires companies to expense rent payments for building or ground leases incurred during the construction period. FSP No. FAS 13-1 is effective for all interim and annual reporting periods beginning after December 15, 2005. Retrospective application is permitted, but not required. We adopted FSP No. FAS 13-1 on a prospective basis in the first quarter of fiscal 2007. The adoption of FSP No. FAS 13-1 did not have a significant effect on our operating income or net earnings.

In July 2006, the FASB issued Financial Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109. FIN No. 48 provides guidance regarding the recognition, measurement, presentation and disclosure in the financial statements of tax positions taken or expected to be taken on a tax return, including the decision whether to file or not file in a particular jurisdiction. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. We will adopt FIN No. 48 beginning in the first quarter of fiscal 2008. We are currently evaluating the impact, if any, the adoption of FIN No. 48 will have on our operating income or net earnings. The cumulative effect, if any, of applying the provisions of FIN No. 48 will be reported as an adjustment to retained earnings as of the beginning of fiscal 2008.

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, which provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB No. 108 is effective for fiscal years ending after November 15, 2006. Early application is encouraged, but not required. We are required to adopt SAB No. 108 for our fiscal year ending March 3, 2007. We are currently assessing the impact, if any, the adoption of SAB No. 108 will have on our operating income or net earnings. The cumulative effect, if any, of applying the provisions of SAB No. 108 will be reported as an adjustment to beginning-of-year retained earnings.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after December 15, 2007. We plan to adopt SFAS No. 157 beginning in the first quarter of fiscal 2009. We are currently evaluating the impact, if any, the adoption of SFAS No. 157 will have on our operating income or net earnings.

15. Condensed Consolidating Financial Information:

Our convertible debentures, due in 2022, are guaranteed by our wholly owned indirect subsidiary Best Buy Stores, L.P. Investments in subsidiaries of Best Buy Stores, L.P., which have not guaranteed the convertible debentures, are accounted for under the equity method. Certain prior-year amounts were reclassified as described in Note 1, Basis of Presentation, in this Quarterly Report on Form 10-Q. The aggregate principal balance and carrying amount of our convertible debentures is $402 million.

The debentures may be converted into shares of our common stock if certain criteria are met as described in Note 4, Debt, of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended February 25, 2006. During a portion of the six months ended August 26, 2006, our closing stock price exceeded the specified stock price for more than 20 trading days in a 30-trading-day period. Therefore, debenture holders had the option to convert their debentures into shares of our common stock. However, no debentures were so converted. Due to changes in the price of our common stock, the debentures were no longer convertible as of August 26, 2006, and through October 5, 2006.

We file a consolidated U.S. federal income tax return. Income taxes are allocated in accordance with our tax allocation agreement. U.S. affiliates receive no tax benefit for taxable losses, but are allocated taxes at the required effective income tax rate if they have taxable income.

The following tables present condensed consolidating balance sheets as of August 26, 2006; February 25, 2006; and August 27, 2005; condensed consolidating statements of earnings for the three and six months ended August 26, 2006, and August 27, 2005; and condensed consolidating statements of cash flows for the six months ended August 26, 2006, and August 27, 2005:

Condensed Consolidating Balance Sheets
As of August 26, 2006
(Unaudited)
$ in millions

	Best Buy Co., Inc.		Guarantor Subsidiary		Non- Guarantor Subsidiaries		Eliminations			Consolidated
Assets
Current Assets
Cash and cash equivalents	$	181	$	67	$	856	$	—		$	1,104
Short-term investments	1,527		—		37		—			1,564
Receivables	19		336		128		—			483
Merchandise inventories	—		3,355		935		(241		)	4,049
Other current assets	18		135		556		(22		)	687
Intercompany receivable	—		—		3,710		(3,710		)	—
Intercompany note receivable	500		—		—		(500		)	—
Total current assets	2,245		3,893		6,222		(4,473		)	7,887

Net Property and Equipment	241		1,786		763		(3		)	2,787

Goodwill	—		6		1,004		—			1,010

Other Intangible Assets	—		—		83		—			83

Long-Term Investments	277		—		—		—			277

Other Assets	99		260		158		(154		)	363

Investments in Subsidiaries	5,240		163		1,335		(6,738		)	—

Total Assets	$	8,102	$	6,108	$	9,565	$	(11,368	)	$	12,407

Liabilities and Shareholders’ Equity
Current Liabilities
Accounts payable	$	—	$	—	$	3,858	$	—		$	3,858
Unredeemed gift card liabilities	—		358		34		—			392
Accrued compensation and related expenses	—		164		99		—			263
Accrued liabilities	8		457		512		(19		)	958
Accrued income taxes	394		5		—		—			399
Current portion of long-term debt	404		10		82		—			496
Intercompany payable	1,348		2,362		—		(3,710		)	—
Intercompany note payable	—		500		—		(500		)	—
Total current liabilities	2,154		3,856		4,585		(4,229		)	6,366

Long-Term Liabilities	235		795		47		(685		)	392

Long-Term Debt	6		122		56		—			184

Minority Interests	—		—		31		—			31

Shareholders’ Equity	5,707		1,335		4,846		(6,454		)	5,434

Total Liabilities and Shareholders’ Equity	$	8,102	$	6,108	$	9,565	$	(11,368	)	$	12,407

Condensed Consolidating Balance Sheets
As of February 25, 2006
(Unaudited)
$ in millions

	Best Buy Co., Inc.		Guarantor Subsidiary		Non- Guarantor Subsidiaries		Eliminations			Consolidated
Assets
Current Assets
Cash and cash equivalents	$	10	$	79	$	659	$	—		$	748
Short-term investments	2,884		—		167		—			3,051
Receivables	27		319		93		—			439
Merchandise inventories	—		3,173		636		(471		)	3,338
Other current assets	20		211		265		(87		)	409
Intercompany receivable	—		—		3,757		(3,757		)	—
Intercompany note receivable	500		—		—		(500		)	—
Total current assets	3,441		3,782		5,577		(4,815		)	7,985

Net Property and Equipment	244		1,733		737		(2		)	2,712

Goodwill	—		6		551		—			557

Other Intangible Assets	—		—		44		—			44

Long-Term Investments	218		—		—		—			218

Other Assets	108		266		131		(157		)	348

Investments in Subsidiaries	4,813		—		1,124		(5,937		)	—

Total Assets	$	8,824	$	5,787	$	8,164	$	(10,911	)	$	11,864

Liabilities and Shareholders’ Equity
Current Liabilities
Accounts payable	$	—	$	—	$	3,234	$	—		$	3,234
Unredeemed gift card liabilities	—		430		39		—			469
Accrued compensation and related expenses	3		225		126		—			354
Accrued liabilities	7		518		392		(39		)	878
Accrued income taxes	670		—		76		(43		)	703
Current portion of long-term debt	404		9		5		—			418
Intercompany payable	1,717		2,134		—		(3,851		)	—
Intercompany note payable	—		500		—		(500		)	—
Total current liabilities	2,801		3,816		3,872		(4,433		)	6,056

Long-Term Liabilities	257		732		31		(647		)	373

Long-Term Debt	7		115		56		—			178

Shareholders’ Equity	5,759		1,124		4,205		(5,831		)	5,257

Total Liabilities and Shareholders’ Equity	$	8,824	$	5,787	$	8,164	$	(10,911	)	$	11,864

Condensed Consolidating Balance Sheets
As of August 27, 2005
(Unaudited)
$ in millions

	Best Buy Co., Inc.		Guarantor Subsidiary		Non- Guarantor Subsidiaries		Eliminations			Consolidated
Assets
Current Assets
Cash and cash equivalents	$	106	$	69	$	439	$	—		$	614
Short-term investments	2,071		—		140		—			2,211
Receivables	18		319		52		—			389
Merchandise inventories	—		2,876		624		(250		)	3,250
Other current assets	20		137		265		(44		)	378
Intercompany receivable	—		—		2,696		(2,696		)	—
Intercompany note receivable	500		—		—		(500		)	—
Total current assets	2,715		3,401		4,216		(3,490		)	6,842

Net Property and Equipment	247		1,581		698		(3		)	2,523

Goodwill	—		3		526		—			529

Other Intangible Assets	—		—		42		—			42

Long-Term Investments	122		—		—		—			122

Other Assets	120		163		92		(174		)	201

Investments in Subsidiaries	3,762		—		1,133		(4,895		)	—

Total Assets	$	6,966	$	5,148	$	6,707	$	(8,562	)	$	10,259

Liabilities and Shareholders’ Equity
Current Liabilities
Accounts payable	$	—	$	—	$	2,760	$	—		$	2,760
Unredeemed gift card liabilities	—		342		16		—			358
Accrued compensation and related expenses	1		147		68		—			216
Accrued liabilities	9		500		430		(23		)	916
Accrued income taxes	206		—		69		(21		)	254
Current portion of long-term debt	2		6		4		—			12
Intercompany payable	1,001		1,728		—		(2,729		)	—
Intercompany note payable	—		500		—		(500		)	—
Total current liabilities	1,219		3,223		3,347		(3,273		)	4,516

Long-Term Liabilities	239		711		60		(630		)	380

Long-Term Debt	410		81		49		—			540

Shareholders’ Equity	5,098		1,133		3,251		(4,659		)	4,823

Total Liabilities and Shareholders’ Equity	$	6,966	$	5,148	$	6,707	$	(8,562	)	$	10,259

Condensed Consolidating Statements of Earnings
For the Three Months Ended August 26, 2006
(Unaudited)
$ in millions

	Best Buy Co., Inc.		Guarantor Subsidiary		Non- Guarantor Subsidiaries		Eliminations			Consolidated
Revenue	$	5	$	6,254	$	6,878	$	(5,534	)	$	7,603

Cost of goods sold	—		5,099		6,215		(5,613		)	5,701

Gross profit	5		1,155		663		79			1,902

Selling, general and administrative expenses	37