百思買 (BBY) 2003 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Best Buy first quarter earnings conference call for fiscal 2003. At this time, participants are in a listen-only mode. Later, we will conduct a question-and-answer session. If you have a question, you will press 1 and 4 on your touchtone phone. As a reminder, this call is being recorded for playback and will be available by 12 p.m. eastern time today. If you need assistance on the call, please press * zero and an operator will assist you. I would like to turn the call over to Mrs. Jennifer Driscoll, vice president of investor relations.

Thank you for joining us today. With me are Richard Schulze our Founder, Chairman and C.E.O., who will provide an overview of our performance and product category; Allen Lenzmeier, president and chief operating officer, who will report on the stores; and Darren Jackson, executive vice president and C.F.O. who will provide our outlook for the second quarter. Kevin Laden, president of our Canadian operations is on the call from the road in Toronto. Also available are Kevin Freeland, president of Musicland stores; Michael Lundon, executive vice president of general merchandising; Susan Hoff, senior vice president of (inaudible); and Bruce Vankle, vp of performance and planning management. As always, comments made by me or others representing Best Buy may contain forward-looking statements, which are subject to risks and uncertainties. Filings contain information about factor that is could cause actual results to differ from management's expectation. I would like to remind (inaudible) listen-only mode. Also, in the and (inaudible) replay instructions. Simply dial 973-341-3080 and then enter the personal identification number of 3328297. With that, I will turn it over to Mr. Schulze who will begin our prepared remarks.

Good morning, everyone. I am pleased to report the company's earnings for the first quarter of fiscal 2003 rose 27 percent to $70 million or 22 cents per diluted share, adjusted for our three-for-two stock split. That compares favorably with the earn accident guidance provided in early April of 20 to 21 cents per diluted share. Our revenues for first quarter as reported on June sixth, rose 24 percent, to 4.58 billion. Revenue increase included the impact of new stores opened in the past 12 months, addition of Future Shop revenues and a company comparable store gain of 5.7 percent. We view this increase as quite healthy, particularly in light of the current economic environment. Many of you have asked about the progression of comparable store sales as a barometer of consumer behavior. We saw the strongest comp gains in March, which included an earlier Easter, followed by somewhat less robust sales in April. In May, however, sales picked up again, due in part to a slightly more promotional environment. As you can see, our margins held up well as a result of our strength in both mixed and balance. We will talk about the quarter's business highlights and then comment on our product categories. Afterward, I will turn over to Al for a discussion of results by each business segment. Finally, Darren will give us the financial highlights, as well as an elaboration on our outlook for the next quarter. The business highlights of the quarter were as follows: First, we continued to grow by opening more new stores. In fact, we opened 12 Best Buy stores this past quarter, as well as two Future Shop stores and three Magnolia Hi-Fi stores in the San Francisco market. Our grand opening schedule was heavier than usual, for the first quarter. We also closed a net of 6 mall-based Sam Goody stores that were not meeting our profitability targets. Secondly, we increased comp store sales by 5.7 percent, well ahead of our origin expectations. During the environment that was of course, generally weak for most all of retail. I attribute the increase to the incredible strong product cycle we continue to enjoy. It is truly exciting to see product innovations that extend so far beyond a single product category. Many people, seeing some products for the first time, literally stop and stare because of the difference that is so visually compelling, particularly in the case of digital television, DVD and flat-screen T.V. Thirdly, as a result of new stores in a solid comparable store sales, we believe we continue to gain an overall market share, specifically we believe we achieved share gains in computers, television, as well as many other digital products. We remain North America's top retailer of consumer electronics computers for the home, movies and music. Fourth, we continue to increase the gross margin rate on top of the large gains we made last year, reflecting lower interest rates, which reduce the overall costs that are associated with consumer financing offers. I would like to talk briefly about our product categories. Consumer electronic sales remained our largest product category in the first quarter and add comparable store sales gains in the high single digits. Sales of video products remain very strong, including double digit increases in digital television, digital cameras, as well as DVD hardware. Lower price points are driving the digital television business, which now comprises approximately fully one-third of our overall T.V. revenue at Best Buy stores. DVD players continue very strong, as lower price points and feature products continue to boost household penetration. Advanced features continue to enable us to sell higher-priced digital cameras, while lower priced models fuel the increasing demand. Sales of audio equipment were nearly flat on a comp store basis and declined in home components, speakers and portable products were mostly offset by continued growth in our home theater in a box category. Our home office category grew in the mix, reflecting comp store sales gains in the mid- singles, as well as the inclusion of sales from the Future Shop stores, which have a higher proportion of home office sales, sales of notebook computer grew double digits, reflecting second-time users requirement for portability. Sales of desktop PCs improved, as well, reflecting aggressive pricing in the category. We are modestly optimistic for the desktop computers in the coming quarters. The first quarter included the successful launch of our new private label PCs called VPR matrix. We will continue to use the platform to compliment our brand name assortment. Sales of peripherals also perform very well, particularly networking, hard drives, memory and MP-3 players. Cellular sales were very strong and the growing pre-paid sales have not taken away from our traditional eight plan offers. The third largest category is entertainment software. It had comp store sales gains in mid-single digits. We enjoyed strong sale of video hardware, software and a wide variety of accessories, as well as increased sales in DVD movies. The video gaming category benefited from significant price reductions on Sony and Microsoft hardware, although sales softened somewhat ahead of the anticipated price drops. New releases, strong catalog movies and more affordable prices contributed to strong sales of DVD movies. Sales of pre- recorded music declined, partly due to digital downloading, file sharing, lack of content, lack of recognized artists and a reduction in radio play. Computer software, particularly productivity software performed very well, despite the comp store sales gains in this category, entertainment software declined in the company's overall mix because of the inclusion of Future Shop sales, which have a lower proportion of entertainment software. We had comp store sales declined in the mid-single digits for appliances amid a competitive environment. In the next three quarters, the focus at Best Buy's appliance departments is going to be on improving the in-store experience, having the right products in the right store at the right time, and increasing closed ratio of appliance shoppers. We continue to believe in the long-term future of this business for Best Buy, as well as, of course, Future Shop. Each day more homes are connected to broadband and reengineering this business in the United States will enable us to leverage our relationships with the higher income, technology-oriented consumers that frequently visit our stores. Digital products which tend to carry higher margins, comp prized 19 percent of total sales in the quarter, up from 15 percent in the first quarter of fiscal 2002. We continue to anticipate the sales of digital products will grow to 25 percent of our overall sales by the fourth quarter of this year. Some of you have expressed concern about the promotional environment. In the past quarter, the environment was hotter than it was expected, driven by lower prices on mostly Chinese-produced goods and lower costs in some other categories. Secondly, consumer electronics is now the fashion component of the retail business and more and more competitors are participating in this space. Third, financing is being used as promotional lever. These factors contribute to overall promotional environment that is perhaps more challenging. However, these trends also are allowing us to bring more value to the consumer, which helps support strong comparable store sales gains as we experienced in the first quarter. Remember, we have developed four strong segments and achieved meaningful balance in our overall mix. With that, I would like to turn the conference call over to Al Lenzmeier, our president and chief operating officer. Allen.

Thanks and good morning, everyone. This quarter we began reporting in two segments, domestic and international. I will address the two of them in order during my portion of the call. Our domestic segment now includes Best Buy, Magnolia Hi-Fi and Musicland stores. The comparable store sales gain of 6.6 percent was above planned at Best Buy, which accounts for the largest percentage of the sales. Musicland comp declined 1.2 percent and was in line with our expectations. Magnolia Hi-Fi's comp decline of approximately 10 percent was below our expectations. For the combined group, the comps of 5.7 percent was ahead of our expectations. The profitability of these segments was essentially on plan. The gross profit margin rate rose by 20 basis points reflecting a higher proportion of digital product sales and lower costs associated with consumer financing offers. The selling, general and administrative expense rate declined by 10 basis points, reflecting leverage from strong comp store sales gains. The operating income rate improved by 40 basis points. Our international segment includes Future Shop stores in Canada, but will expand to include our first Canadian Best Buy stores in the first quarter in Toronto. We are pleased to report this segment continues to report above-average growth. Comps at Future Shop were above planned at 9.6 percent. Operating results were ahead of plan, as well, including investments made to boost the future profitability of Future Shop stores and to prepare for the launch of Best Buy stores in Canada in Toronto. The 50-basis point decline in gross profit rate was due to higher levels of clearance markdowns and product mix shift. As we expected, the SG and A rate rose by 140 basis points, as we increased use of outside consultants to promote our process to profits initiative, similar to the initiative we completed at Best Buy stores a few years ago. We expect the benefit of these investments to begin to accrue in the latter part of the year, as we demonstrated at Best Buy stores. Another factor in the SG and A rate was investments and systems and processes to prepare for the launch of the Best Buy stores in Canada. We previously have stated we would incur start-up costs in the first and second quarters related to the launch. Combined these initiatives result indeed 190-basis point decline for international segments. We had expected a loss from international segment of approximately one and a half cents per diluted share, which is where we finished. Recent milestones in domestic business include the following: first, last week we opened our first downtown store in Manhattan. Our new Chelsea location features 35,000 square feet on two floors and illustrates the versatility of our Hi-Fi format. We are optimistic about the store's potential and the New York metropolitan area stores led the country in comp store sales gains again in the first quarter. Second, in the first quarter, we successfully launched the VPR matrix computer line. VPR matrix computers fill gaps in our product line. In July, we will introduce a unique new design created by Porsche or VPR matrix. We tested a change to Best Buy's computer department and it incorporates computer technicians directly in the retail selling space. The change boosted sales in test stores and profitability and will be rolled out to approximately 120 Best Buy stores this year. In addition, we successfully tested in-home pc networking in two markets and are prepare tog start rolling that out this summer. We feel these initiatives will further strengthen our lead in the retail channel and support our customers. Third, during the first quarter, Future Shop opened a fully automated distribution store in Meskuse, Quebec and Courtney, British Columbia. We are on track for eight new Best Buy stores and nine new Future Shop stores in Canada in the current fiscal year. Later this year, we plan to test a 20,000 square foot form at of the Best Buy store in several markets. This new store design is expected to include all four of our product categories and utilize aspects of the Hi-Fi design. We can reach markets with the population of less than 120,000 and would provide the company with yet another avenue for growth. We believe this store size could give us a opportunity to open up an additional 150 locations. At Musicland, we continue to refine our product assortments. For example, we are preparing to rename our small market On Cue stores of Sam Goody and to remerchandise the stores with an expanded assortment of DVD movies and video gaming. We will expand our assortments in these two categories at approximately 250 of our mall-based Sam Goody stores. Our Suncoast stores are enjoying strong store gains due to the popularity of DVD movies. Next, Darren Jackson will provide our outlook for the second quarter.

Thanks. Good morning, everyone. Now that we have covered the first quarter results, I would like to give you our outlook for the second quarter. Our assumptions for the second quarter include total sales growth of 23 to 24 percent, including the impact of new stores of comparable store gain of 4 to 5 percent and the addition of Future Shop sales. We are projecting comp gain of 5 percent at Best Buy stores. Essentially flat comps at Musicland and 8 percent gains at Future Shop for the second quarter. We expect our gross margin rate for the enterprise to decline by 30 basis points, reflecting continued strength in the digital products offset by mixed changes at Musicland stores, principally the increase in DVD and video gaming. We also expect to increase our penetration in the lower margin computer business in the second quarter. We anticipate the SG and A rate being essentially flat with the prior year. That brings me to our international guidance for the second quarter. This level of performance would bring us to estimated EPS of 30 to 32 cents per diluted share and average increase of 21 percent, which is in line with projected growth rate for the year and higher than we originally budgeted. This estimate includes approximately 4 cents per share of dilution, related to our investments in remerchandising in Sam Goody stores, launching Best Buy in Canada and (inaudible, background noise) initiatives in Future Shop stores. This investment is equivalent to the 4 cents invested in the first quarter in the same initiatives. Today, we will reiterate the full-year guidance, which included growth of 17 to 20 percent and earnings growth of 18 to 21 percent. We feel very confident about that guidance in this current environment. With that, I will return the call to Dick.

Thank you. As you know, at the end of this month, I will step aside as the C.E.O. of Best Buy to focus on my new role as Founder and chairman of the board. Brad Anderson will be C.E.O. As many of you know, and he will lead our future earnings conference calls. This was a great deal of confidence I turn over the helm to Brad, who has been my colleague for three full decades. Together, we have built one of the nation's top retailers and it is a gratifying scene and scenario to me that I can place the future of this company in the hands of a truly talented management team. Now, I would like the operator to open up the floor to questions from our investor audience.

Thank you. To ask a question, press 1, followed by 4 on your touchtone phone at this time. Our first question is from Bill Julian of Salomon Smith Barney.

Thank you. Good morning. With respect to the four cents of dilution, which you are referring to in the second quarter here. As you probably know, consensus estimates sit at 33 cents and you are guiding to 30 or 32 cents. Are we to read into this there is nothing new about guidance here and this 4 cents was always planned? Have you changed the timing of cost? Can you give me color on that?

That is Darren. We have not changed the timing. Our practice has been to guide during these conference calls on the next quarter. We have never given guidance in terms of a point estimate in the second quarter. So, from our vantage point, nothing has really changed. If you go back to our last call, we had said in the first two quarters of this year, historically Future Shop is break even to losing a little money. We talked on the last call about making investments, particularly in the Sam Goody change. So, from our perspective, things have not changed. That is why when you look at the full-year number you see it inched up a little bit as a result of our first quarter performance. It is a timing event versus any change in guidance. I would say we feel every bit as confident about the year today as we did when we started the year.

Okay. Perhaps you can give us just a feeling for what is expected in the third and fourth quarter. Consensus now sits at 32 cents for the third quarter, which implies stronger growth, much stronger than consensus implies in the fourth. Should we look at the timing of profitability in the back half of the year maybe shifting that from the third to the fourth quarter?

The short answer is for the year, we still plan on doing the two 10 to 2 17. Look at performance last year, we had a strong fourth quarter. I would suggest to you that our third quarter performance in all retail expected this and felt this last year result of September 11th. When we look to the back half of the year, the third quarter would be a place that I think we have a little bit of opportunity. In the fourth quarter, based on our initiatives and store openings, we feel good about that. The third quarter, in relation to where the consensus is seems to be in place where we would look to outperform a little bit.

Okay. Thank you very much.

Thank you. Our next question is coming from Peter Caruso of Merrill Lynch.

Thank you. Good morning. First, Dick, good luck in your new role as Chairman of Best Buy. I hope it is as success employ as your C.E.O. role was. I would like to ask you first, your perspective. You have been through many promotional cycles in this business. This is not the first time we have such a highly consolidated market share where Best Buy circuit, Sears, (inaudible) dominant players and increasingly have to eat each other's lunch to gain market share. Are you committed to remaining the promotional leader no matter what it entails in terms of gross margin over the next year if the market continues to heat up? Who would you name as one or two major competitors you have seen heat the market up the most?

I suggest you are correct that with the consolidation that has occurred in the framework of the last five or six years in particular, the balance of market share has shifted to a small, but very powerful group of retailers. We have a strong franchise with American consumers. We believe that we have emerged through the process clearly as the branded choice, the preferred retailer for the sale of three of the four categories that are major components for our growing business. I would say that it is incumbent on us to always maintain a balance between the level of promotional activity or the type of representation we will have to be in the game with any and all players that would attempt to try to ratchet market share. We have, however, learned that you don't have to overload the assortment with that type of product. In fact, you are better off by sharpening your offerings, making sure they are competitive, turning them effectively and strategizing for much of the shift that you have seen has taken place in digital products. This is where we feel we have a huge leg up over most of all our competitors, certainly for sure, the discount channel in the purest form, meaning wholesale clubs and mass retailers. The other specialty retailers certainly have similar plans. We just think that the next element of differentiation falls to execution. So, the simple answer is we are definitely going to be in the game, matching off on any and all pricing from wherever it comes to ensure the fact that we are always priced right for our consumers on literally any and all products offered by the mass channel. But, you will see a stave evolution, to higher better quality brand names and technology offerings on our floor, as we continue to move more toward that early adaptor techno file consumer. We think the way we merchandise, display, interact, demonstrate, train, and promote, that we will continue to get more share of footsteps into our stores than any of our direct competitors trying to emulate the same strategy. This got us here and we are fortunate right now because of the market share we occupy and the preference that our stores have shown against any and all competitors that many more suppliers, each and every year, are opting to introduce products on our floor. I feel confident we are well positioned a minimum two-and- a-half to one over the next consumer preference and meaningful share advantage over everybody. So, the one key obvious factor that the rest of the world needs to be aware of, the consolidation that has literally driven a high level of that threshold level type product is now in the hands of the Wal-Mart, Target, K-mart strategy and because of sheer magnitude of the volume of retail stores in the marketplace, they are just bound to do a tremendous amount of business in those categories. It is why they have been so formidable. But, we think that the complexity and the technology of the new digital products will ensure the fact those consumers will stay in our stores.

Do you see anyone other than Circuit City racking up the promotional environment?

I would ask Michael who is here. Mike, have you seen anybody other than Circuit? They have had aggressive activity on the PC world in the last quarter. Has there been anybody else doing anything?

Everybody is behaving as they have in the past. I think one thing that is important as we think about this is that we are just really in the beginning of the digital cycle. I think a lot of us are close to the product and live it everyday. When you go out and talk to consumers and talk about satellite, radio, digital T.V., we are just beginning. As Dick eluded to, the parts of more complex. More and more parts are working together. I think we have the opportunity to offer a wide variety of products of digital cameras, for example, are extremely popular. Take a look at our circular this week. We have prices from 999 to 279. There are a tremendous amount of offering to the consumer as they embrace new digital technology. Even DVD, household saturation is really just beginning.

The best way to look at it with this promotionality in the most recent quarter, our margins were up, which would suggest we have a great mix and a strong balance and we know how to get to the better quality more profitable products.

Okay. Thank you and good luck in the next quarter.

Thank you. Next question.

Thank you. Our next question comes from Matt Fassler of Goldman Sachs.

Thanks a lot. Good morning. Dick best wishes to you going forward. A couple of questions. I want to focus on Canada and you spoke about bringing the process to profits efforts to the Future Shop operation. That was obviously very successful for you to say the least, in the United States. Can you comment on where that business is right now? What kind of changes you think you need to make? What the timeframe is to get that operation to targeted profit levels?

Maybe I might ask Allen and Kevin, who is on the phone from Toronto, to comment directly. Obviously Allen is spearheading the process as we know it here. Kevin is on the firing line in Canada. Maybe Allen, give Matt an overview and ask Kevin to fill in the blanks.

Matt, that probably was the process at Best Buy in terms of process to profits. I will probably compress it to probably two-year process with respect we are doing to Future Shop up in Canada. We are starting off the areas that we are starting off are advertising effectiveness, as well as assortment management and we are working on that now. We think we can start accruing benefits from that in the latter part of the year. Kevin, expand on that a little bit or -

You are correct on the fact we are basically taking on the two-year initiative component of what Best Buy did for process to profit. The biggest benefit actually comes in year two and then our ability to execute beyond that is on the table for us to continue. Certainly from the standpoint of what we are doing now, we are working on advertising effectiveness, number one. Number two is assortment management and number three is inventory in-stock, which Best Buy does a phenomenal job of advertisement as well as regular in-stock. The opportunity of Future Shop in the Canadian marketplace to improve that is substantial. We are in the low 80s as far as in-stock on some regular promotional goods. The ability to take that into the 90s like Best Buy has an upside opportunity for us and the assortment of life cycle management, which we believe will improve operating margin substantially.

Great. I could follow up on the domestic business, gross margin domestically relied the promotional intensity that you spoke about. We have seen some of the 18-month and 24-month no interest financing that has been rocked. At what point would this start to weigh on grosses and how - obviously, no interest financing is cheaper for you, is this something that has no cost at this point? We shouldn't focus on historical paradox for promotional extremes?

I think the financing vehicle is probably one of many vehicles that we use, Matt, in terms of the promotional strategy. Obviously, with interest rates down, it probably in the past quarter, anyway, we have used it more extensively. Again, it may vary by month, depending on the promotional climate out there in terms of the vehicle we use for financing and rebates and pricing, whichever is the most effective vehicle, we will use that vehicle.

Do you have sense this is a lever likely to be used for protractive period of time? That is what Matt wants to get his hands around. Is there extended use of it?

Go back to what Al said. This is a lever we use. We understand what happens to levers frequently and it is just a technique for us to go to market when appropriate.

Another thing that is important for you to know like follow to Peter's question. We are not going to withdraw from the use of any of the levers we feel is important and appropriate to make sure we are in the game on each and every sale. So, we are not letting anybody slide in anywhere with anything that we are not willing to respond to or ready to respond to.

Got you. Thank you very much.

Thank you. Our next question is from Allen Rifkin of Lehman Brothers.

My congratulations and best of luck, dick in future endeavors. Taking your comments with respect to Peter's question together with Darren's comments on the gross margin drivers. Darren did not mention in his comments that increased promotional would have a detrimental affect on margins in the second quarter. Do you think the near-term outlook with respect to promotional activity may actually subside as compared to Q1?

The best way to go at that is generally to suggest that it is only when promotional activity does not carry with it appropriate financial benefit or performance from those using it that they go back to the toolbox to look for new and different ways. That is why it was such an important question is if disproportionate gains were made from extraordinary offers and unresponsive, you can bet they will continue. The very fact our margins continue to strengthen certainly has a lot to do with the mix of product that we sell. It also suggests we know how to get to the category of product. This is, of course, digital offerings. That is something we have that the purest discount channel does not offer and the ability to connect it up and integrate it with existing products, it continues to be a competitive advantage for a store like ours. Our sense is that if others need to stimulate the market, disproportionately in the face of whatever their activity might be, it is incumbent on us to make sure we are in step with what happens in the market to make sure we hang on to customers and remain the preferred store.

I think we have enough tools in the tool kit to have the flexibility to move around here and if it does get promotional, I think we have proven in the past, we are pretty successful at if margins are impacted, we are able to offset that with increased revenue so the bottom line impact is pretty negligible. If it is promotional, we are confident we can drive more revenue to offset whatever margin dilution there may be.

Okay. One follow-up, if I may. Now that I have had a short period with the impact of reductions in the hardware prices on the part of Sony and Microsoft, what is your take on the net benefits to the business with respect to tirades and traffic and what-not? One more question, if I may. Do you care to quantify the diluted effects of Musicland the same way you did Future Shop in Q1?

Mike, take the first part relative to pricing on the video gaming hardware and (inaudible) respond to the second.

The video games of today are extensive features and solutions for customers. We have seen not only just the international shopping consumer demand, but continually increase consumer demand after the price drops. What is driving, we see people buying more software and accessories. This bows well for the upcoming season. We are excited about it. It has injected life into it. We have seen a lot of third-party software people talking about it and bringing to market a new software releases, which encourage people to buy more and more product.

As to the second question, the way I would answer it is in my comments, I said we expect a 4-cent diluted impact on Future Shop process to profits launch in Canada,s well as investments to convert some of the rural On Cue to Sam Goody and making remerchandising adjustments in the second quarter collectively that is 4 cents. If you recall, I think Al quantified the Future Shop impact as one and a half cents in this first quarter. So, you are good with math. I think the difference between the two is 2-and-a-half cents. I want to make sure I characterize. That would be the investments to go with it, including moving the lever mix to a fully assorted DVD gaming offer.

All right.

Next question, please.

Our next question from Colin McGranahan of Sanford Bernstein.

Good morning. Question is inventory levels. The levels were overall just a little bit higher than expected. It looks like sales exceeded our expectations and exceeded your plan. Can you comment on the quarter ending first quarter inventory levels and how you feel about the inventory situation going forward in the second quarter?

Absolutely. That is a great question. So, average store inventories grew a little over 10 percent in the first quarter. At first glance, that might appear concerning. What you should be aware of is right at the end of the first quarter, we had done a system conversion to our new retech management system. What we did in anticipation of that is to make sure that we brought in some extra inventory in the event and others have had challenges with ARP conversions in the past. I am glad to report, as we sit here today, we don't see those challenges. We put inventories in the store in the event there were challenges. So, we are comfortable that even though the inventory grows, we will work through the inventory through the June-July time period and be back on plan. Essentially, our trailing turns are still at 7.4, which is where we wanted to be.

Thank you. Secondly, doing my math I think I came up with 2-and-a-half cents that is 13 million from Musicland dilution in the second quarter. Was that a similar amount in the first quarter and overall for the year, you had said you would make a $30 million investment in Musicland? Are you on track there? If it was 2 and a half cents, that is 26 million so far first and second quarter, is the timing being moved into the first half of the year?

The math is not not far off. We have not changed our expectations to the overall 40 million dollars of incremental year over year investment in the business.

Sufficed to say, in the Musicland and Future Shop initiative, there does exist a miss-balance in the seasonality of the profitability generated through both chains not dissimilar from Best Buy in our earlier days before we were able to land our process to profits initiative. Clearly, we are working side by side with both management teams to put the kind of competency and processes in place to balance out what happens throughout the course of the year. Obviously, reduce the losses that occur more traditionally in the first part of the year and in large, the profitability that occurs in the back half of the year. That is the nature of the business. We have found ways to get at that meaningfully and we think given a bit of time, and obviously understanding from the leadership of both groups, that we are clearly going to land solidly on our feet there, as well.

Great. Thank you very much.

Next question, please.

Thank you. Our next question comes from Susan Quilty from Morgan Stanley.

If I could clarify the last point. When you look at the full year guidance, you are talking about 40 million in incremental investment on Musicland. I know you said you expected the contribution to be 40 million less this year. Is that all investment (inaudible) at Musicland?

Yeah, the short answer is it is the combination of the evolution of the mix. When we quantified 40, we said we would lose profitability as we intensify DVD and video game offer in the Musicland business. We should be essentially cycled on that at the end of the second quarter, maybe a little bit as we go into the first half of the third quarter. The second piece is going to include the investments that are - we are going to make in remerchandising, continuing to transform 250 Sam Goody mall locations and then the On Cue locations, making the investments to convert those from On Cue to Sam Goody rural locations.

When you are giving 4 cent dilution you talked about in the first and second quarter, that is also including the mix-related shift in addition to the remerchandising expenses and the actual start-up expenses you talked about in Canada?

That is correct.

If we look at the full year and you are factoring in a total of 40 million dilutions from Musicland, what would be the similar number for Future Shop? From an investment perspective?

We have not quantified that at this point. We have not shared that publicly. As we get - move through the year in terms of the Future Shop business, and finish scoping some of the process to profit work, as well as the benefits that go with it, we will finalize those estimates.

Okay. Is it renal to assume the recent trends would be not dramatically out of line with those kinds of numbers going forward?

That is correct.

Okay. One last question, if I have time. In the digital T.V. category, you talked about it being a third of overall T.V. revenue and price points being important. Can you give us a sense of where the average retails are in the category and where they will be at Christmas this year and then what you think the entry level price could be at Christmas this year? That is it for me.

Michael, can you give that end?

On the digital T.V. and it may be hard to quantify the average price. We have seen digital move down into smaller screen sizes and flat T.V.s move into smaller sizes. We see changes in prices and projection T.V.s. It is in the neighborhood of 10 to 15 percent if you compare year over year. We do see many more offerings with many more features. We have a phenomena of people walking into the store and looking at the picture availability. They are excited about home theater being in homes. We see an increase in average selling price in the television area.

Any sense, Mike, for the holiday season?

I think the holiday season will be relatively stable. The new models are coming out now. We are seeing price drops for new models coming out. We think prices will stay about the same as where they are now and where we are entering new products.

Is average retail for digital T.V.s are above $2000 or below that?

Below that, now.

As much as screen-sized?

Screen size plays a lot of it. They are up to $1700. The $2000 barrier has been broken with a number of offerings from multiple vendors.

Thanks.

Thank you. Our next question is from Mark Rowan of Prudential Securities.

Thanks and good morning. Couple of questions. First, on performance service plans, Darren, what percentage of revenues came from PSPs in this quarter? Do you expect any change from a mixed shift or anything that you are doing in-store as far as initiatives going forward for the rest of the year? Second, on expansion, if you could update us on your thinking on that, how many stores as far as Future Shop? How many stores Best Buy do you think you can grow to in Canada? You are thinking on Europe, what would you be thinking being doing there? Thank you.

We don't give out those numbers. What I can tell anecdotally, when products like digital cameras and digital televisions have the growth rates we have been experiencing and given the complex nature of those benefits products, there is benefits in the PSP arena we are seeing in the numbers today. So, the growth in the digital products certainly is benefiting the PSP business.

It is also effective add-on to include the fact that we have developed the process and sharpened the focus so effectively in our retail sop platforms that literally, new stores come onboard, the new styles assembled to launch these stores, literally get up to speed on the point of time in which we open. So, the ratio relationship of our sale on many of these accessory service warrants, extended service or connection- type opportunities literally hit the ground at about the same rate that of an up-and-running store. It is in the culture and into our process. We, of course, draw immediate gain and benefit from its impact. As far as the international activity or Canadian activity. The overall target for Best Buy over time is to open somewhere between 65 and 75 Best Buy stores across the country. At the same time, we would expect Future Shop to grow probably another 15 to 20 stores in total. Some of that will actually be the expansion of smaller stores into a larger footprint. Others will be just newly introduced stores in markets where they have not gained fully the kind of saturation that is necessary. So, it probably is going to lead us somewhere around 120 stores in Canada and 65 to 75 Best Buy stores in Canada. With respect to the international marketplace beyond the Canadian opportunity, we have really just begun to look seriously at each of a wide variety of new market opportunities. We are drawing down information about the European marketplace. We are exploring the same kind of information relative to competition market potential in Asia, as well as South America. This is the process we are just underway with. We need to learn more about the consumer attitudes and behaviors market by market, versus what we have known and become accustomed to in North America. We have made an initiative to appoint a special director, who has joined our board, and actually lives in Europe and knows a considerable amount about the business, the retail business in general, not just consumer electronics, a wide variety of countries. He is engaging in the development of a lot of facts and information to help us and guide our thinking about what this market opportunity may or may not be. Our sense is we have so much work ahead of us here in North America, not only the ability to land the Best Buy strategy in Canada, as Allen pointed out, but to continue to refine and enhance the Future Shop initiative to get the operating margins more closely aligned to what goes on at Best Buy. We have this entire magnolia strategy, which is only appearing in some increased form in San Francisco and ultimately we expect California. Allen mentioned the new 20,000 foot prototype we are going to be launching later this year for the expressed purpose to try to determine how many additional smaller communities might we bring all four of our offerings. We still have several hundred Best Buy stores to be launched throughout the United States. So, we have a full plate right now of new stores to open, new business to create and so, we are taking it a step at a time. Our commitment to our employees, as well as to our shareholders was to maximize the returns on the capital we have deployed and the investments we have made. That is what we have learned to do reasonably well and our intent is to stay after that barometer in a meaningful way.

Thanks. One other question, if I could on the music business. It has been a tough business for everybody and everyone has just kind of throwing up their hands and saying it is digital downloading and there is not a lot of good acts. What is your thinking going forward on that? Do you have contingency plans if the business does not pick up in the next 12 months, would you devote more floor space to you? Are you already doing that?

We are going the other way. This is a wonderful business. It is theater for our strategy. I would like to maybe ask Kevin Freeland to take a couple of minutes to tell you about the way Musicland has worked through for improved traction in the mall operation. I can tell you we are taking a tremendous amount of direction from their lead in determining the importance of getting our departments in our stores right. Even though there is erosion in the business from certainly a couple of different areas of opportunity, there is plenty of business to be done at retail. We fully intend to capture an increasing amount. Kevin, add color to what we are doing.

The combined companies have been working over the last several months looking at the music business, what we sell traditionally within our stores, the businesses we are doing on-line, both physical product and the paid down mode business on-line, as well as looking at the broader music business, including other channels of profitability, like live venues, concert venues, and the like. At this stage, the combined teams, the retail division teams, see an opportunity that when there is a significant change in the business, like what is going on in the music business today, that puts an opportunity out for a growth in our position. So, we, as a team, are committed to that business. It reminds us quite a bit of where we were in PCs a number of years back and by staying committed to a business that at times look troubled. Best Buy emerged as dominant leader in retail. So, we are at this point, looking at what strengths we have, what new competencies we need to build and we intend to hold our lead market share position. We intend to grow it.

Thank you.

Thank you. Our next question is coming from Dana Telsey of Bear Stearns.

Good morning and congratulations. Can you comment more on the private label computer area? How big do you expect it to be? How many skews have you added? Are there other categories where you would add private label to? Comment on the appliance categories. I was in the New York store this weekend, it was packed and the sales were terrific.

Let me ask Mike London, who rides over the top of merchandising efforts to give you initial thoughts around the VPR matrix and appliance business.

As far as VPR matrix goes, it is a limited selection of SKUs. We use it to fill in some spots where we think it is appropriate and we can offer value. I think we have always said we expect it to compliment branded name products and provides appropriate niches we can fill. We are learning the process as we go along and trying to understand it, it is complicated. We are building competency around developing an understanding of how you bring a product like this to market. We are excited about our back to school offer. I think we have just been in the business a short period of time. I think the VPR matrix brand, as you see today, is limited to the PC area. As far as the appliance business goes, we talk body our results. I would tell you, we are working extremely hard to satisfy our customers in the in-store experience and converting customers as quickly as possible and making the appropriate invests to do that. Coming back from the kitchen and bath show last April, having business in the business a number of years, there is probably more new product at that show, than the last 10 shows together. We are excited about the future of appliances as they become so-called smart. We think this is a great opportunity for Best Buy and an area where customers will look for us to be in a leadership position.

Thank you.

Thank you. I think we are running out of time here. With that, I would like to thank each and every of you who has so faithfully participated in our quarterly conference calls and attended the various conferences that we participate in around the country. I would like to leave you with some thoughts. I honestly, truly and genuinely believe we are at the top of our game in a wide variety of key areas. Our commitment to our shareholders, as well as our employees, is that we are going to continue to leverage many of the core competencies we have developed as a company over the last several decades, not the least of which is the yield in our process to profits initiatives. Of course, our standard operating process of procedure that is take place at retail stores. We turn these structural capital and we think one of the key differentiating benefits we have really is our ability to create best in class processes. This is obviously what we are attempting to land solidly in the new acquisitions we have made over the last year. We are also really strategically more strongly linked with our key suppliers in building partnerships of strategic importance going forward. You are going to see and hear about new exciting initiatives as the year rolls along, with many suppliers who are helping us get to market quickly at the right price and with the right offer. We are continuing to invest in new development. A special team of people are essentially dedicated to creating new solutions that can be packaged and sold on the floor of our stores with continuing improvement and profitability. Our strategic planning teams solidly focus on providing for us stimulating new ideas on how to think about our business over the next five years and up to 10 years. So, we are all about market share. We are about building customer preference. We are about improving execution. And, as I hand the mantel of responsibility as the C.E.O. over to Brad, I have never been more confident in the wonderful talents that a team has been assembled and the passion that each and every member of this team has for building us to another level of standard performance. Thanks again for all of your support and all of your commitment to what we are trying to do here. We feel good about it. I am confident over time that you will also continue to share in that same confidence. Thank you very much.

Thank you for participating in this morning's call. Again, this call will be available for replay by dialing 973-341-3080 and entering the pin of 3328297. You also can hear replace www.bestbuy.com by clicking on investor relations and presentations. If you have additional questions please call me, Jennifer Driscoll at 952-947-2350. That concludes our call.

Thank you. That concludes today's teleconference. You may disconnect your line at this time and have a great day.