GameStop Corp (GME) 2002 Q1 法說會逐字稿

Good afternoon, everyone, and welcome to today's Electronics Boutique's first quarter results for fiscal 2003 conference call. You should have all received a copy of the press release issued after the close of the market today. If you did not, please contact Electronics Boutique and we will send you to confirm in your name on the e-mail list.

With us today from management are Mr. Jeff Griffiths, President and Chief Executive Officer; Jim Smith, Chief Financial Officer; and other members of the senior management. Before we begin the call, I'd just like to remind everyone that certain statements contained in today's press release, and on this conference call, are forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected.

For a more detailed discussion of some of the ongoing risks and uncertainties of the company's business, I refer you to the press release in the company's recent filings with the Securities and Exchange Commission. Some of the material presented this evening may become outdated, and EB undertakes no obligation to revise or update the information provided during the conference call.

A telephone playback of the conference call will be available from 8:00 PM today, through June 5th at 11:59 PM Eastern Time. The conference call will also be archived on EB's Web site, www.ebholdings.com, for two weeks.

Now, I would like to turn the call over to Mr. Griffiths.

Good afternoon, and thank you for joining us today.

As I stated in the release issued this afternoon, our results for the first quarter of fiscal 2003 reflect improved gross margins on strong video game software sales. In fact, we were pleased by our video game software performance with year-over-year sales better than the total market, or a 60.3 percent increase, compared to a 31 percent increase for the industry. Given this solid performance, and our recently announced decision to focus exclusively on gaming, we decided now would be a good time to capitalize on our unique industry position, and EB's name recognition. Hence our decision announced today to embrace the single worldwide name of EB Games for the company's entire chain.

The adoption of a master brand will allow the company to leverage its marketing programs across its multiple retail formats and bridge awareness between our strip center and mall locations, while building upon the established EB identity developed over the past 25 years.

Our plan is to rebrand approximately 30 percent of our total chain this year, with a goal of completing the rebranding initiative by the end of 2004.

As you know, we just returned from the E3 show in Los Angeles. By all accounts the show was a tremendous success. This certainly is the most exciting period in gaming history, and we're gaining momentum every day as software sales drive the industry.

Avid gamers and mainstream consumers in diverse demographics are all enjoying this unique form of entertainment, and EB stands at the forefront.

I might also add that while 2001 was the year of hardware, and we still expect sales to be brisk in the second quarter given the recent hardware price drops, the focus for the second half of the year will clearly shift to software.

Nonetheless, let me share with you some hardware sales data for the sales period immediately before and after the price drop, as well as the impact on software sales.

For PlayStation 2 we've experienced sales an increase of 6.8 times sales prior to the drop, Xbox 6.6 times and GameCube 3.6 times.

In software our PlayStation 2 software sales are 23 percent ahead of what they were the period prior to the price drop. Xbox sales are 165 percent ahead, and GameCube sales are 19 percent ahead.

I would like to note, the Xbox number is significantly higher because of the timely release of Hunter from Vivande and World Series Baseball from Sega, which both came out right around the time of the price drop.

Given the expanding installed base of Sony's PlayStation 2, Nintendo's Game Boy Advance, GameCube and Microsoft Xbox, and the recent price drops, we have raised our second quarter earnings guidance, which Jim will discuss in a few minutes.

Our breakdown of sales by category for Q1 this year as compared to Q1 last year, as a percent of total sales, was: video game software, 50 percent compared with 37 percent; video game hardware, 15 percent compared with 23 percent; PC software, 16 percent compared with 18 percent; accessories, 13 percent versus 15 percent; and other, six percent versus seven percent.

Our hardware-to-software buy ratios for the first quarter were 10.3 to one for Xbox and 1.8 to one for accessories, 10.2 to one for GameCube, and 2.5 to one for accessories, 19.4 to one for PlayStation 2, and 3.5 to one for accessories, and five to one for Game Boy Advance, and two to one for accessories.

Top titles for the first quarter included Grand Theft Auto III for PlayStation 2 from K2 Interactive, State of Emergency for PlayStation 2 from K2 Interactive, the multi-formatted Spiderman from Activision, WWF RAW is WAR for Xbox from THQ, Resident Evil for GameCube from CAPCOM, Super Mario World for the Game Boy Advance from Nintendo, and Dungeon Siege for the PC from Microsoft.

To summarize, following our few points to support the positive outlook for our business, in North America the install base for PS2 will grow from approximately nine million units today -- nine million units of hardware today -- to 16 to 17 million by the end of the year. But the Xbox and GameCube are enjoying tremendous consumer acceptance with expectations that four to five million units each will be sold in the U.S. this year. Additionally, over 55 million units of software are expected to be sold this year for PS2, 24 million for Xbox, and 19 and-a-half million units for GameCube. The recent reduction in the price of Xbox, and the successful launch of GameCube in Europe on May 3rd, will help to accelerate our business, giving us confidence in strong performance and support our growing presence overseas, with 30 new stores planned for Europe this year.

In addition, Xbox and GameCube recently launched in Australia. Sales have exceeded our expectations. We plan to open 10 new stores in that market. Anticipated top titles for the second quarter will add to consumer demand. These include Medal of Honor Frontline for the PS2 from Electronic Arts, NCAA Football for PS2 and Xbox from Electronic Arts, Morrowind for Xbox from Bethesda, WWE Wrestle Mania for GameCube from THQ,

for Game Boy Advanced from

, War Craft III for the PC from Vivende -- this will be the largest PC game of the year, perhaps the largest PC game of all time -- Neverwinter Nights for the PC from

. With the introduction of significant new software titles, the pre-own market, which I might add was a strong performer for the first quarter, will continue to be an important component of our growth strategy.

We remain confident that the

issues for PlayStation II, Game Boy Advanced, GameCube and Xbox will continue to grow as the install base expands, which will continue to drive higher margin sales.

I would now like to have Jim Smith take a moment and review our financial performance for the first quarter, and then open the session for Q&A.

Thank you, Jeff.

Total revenues for the first quarter increased 21 percent to 217.7 million from 179.9 million reported for the same quarter last year. Net income was 627,000, or two cents per diluted share, compared with a net loss of 1.4 million, or six cents per diluted share a year earlier. On a pro forma basis, which excludes the results of operation and related expenses associated with our EB Kids and BC Sports Collectibles businesses, in both the current and prior year periods, as well as goodwill amortization recorded last year, revenues for the quarter were 211.5, compared with the 174.3 million a year ago. And net income of 1.6 million this year, or six cents per diluted share, compared with a net loss of 546,000, or two cents per share last year.

We are very pleased with this performance, which exceeded the guidance we issued earlier in the quarter of one to three cents per share. Comparable store sales increased by 4.3 percent in the quarter, driven by strong software sales, both new and pre-owned. I'd like to comment on our pre-owned activity. As you know, we report the trade-in of pre-owned games as a reduction in revenue, which had a negative impact on comparable sales in the quarter, due to a significant increase in this activity. Without this reduction, we would have reported a comparable sales increase of approximately eight percent.

We are currently reviewing a change in our revenue reporting policy regarding trading activity to not reduce revenue, which will report results more consistent with the overall retail community. This change may be implemented in the second quarter.

Pro forma, selling and general administrative expenses were $48.5 million in the current quarter compared with $37.2 million for the prior-year period. This increase reflects costs associated with the larger store base, as well as expenses associated with the company's expansion into the European market in fiscal 2002.

As noted in today's press release, during the quarter we opened 26 new stores and closed 27 EB Kids stores, of which 12 were converted to the Electronics Boutique format, and ended the quarter with 948 stores compared with 763 last year.

To update you on the progress of our previously announced restructuring program, we successfully completed store closing sales to liquidate inventory, and all of the EB Kids stores, and have resolved our lease obligations for these stores.

At the end of the quarter we had converted 12 of these stores to the EB format, and another six stores will be converted in the second quarter. As a result of these actions, we reversed $508,000 of charges accrued at year-end for this restructuring activity.

As for BC Sports Collectibles, we are marketing the business and expect to locate a buyer in the second quarter.

We expect earnings for the second quarter of fiscal 2003 to be in the range of three to four cents per diluted share, again, excluding the results of operations from EB Kids and BC Sports Collectibles businesses.

This estimate is based on achieving a comparable stores sales increase of approximately eight percent in the quarter.

We would now like to open up the call for questions.

If you would like to ask a question during this time, please press star, then the number one on your telephone keypad.

We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Melissa Williams.

Hey, guys. Wondering if you could comment a little bit about your full-year outlook, given the performance that you had in the first quarter, are you comfortable with consensus estimates? And what do you think the full-year comp looks like?

At this time, we'll reserve giving any change to our current guidance. We gave a range in the first - at the end-of-year results of $1.52 to $1.58. And we're still comfortable with that guidance for the year.

We'd like to reserve making any changes to that until the end of the second quarter when we have more visibility for the back half of the year.

We're still comfortable with our comp range of 10 to 15 percent for the year, also, though.

OK. So the $1.52 to $1.58 excluded BC and EB Kids?

Yes. That would be on a pro forma expectation. And I believe the consensus for the Street is around $1.57 at this point. So, we're comfortable with our annual outlook at this point.

OK. Great. And could you comment a little bit about the new store rollout plans for the second quarter and how you think the year shapes up to get to 200 by the end of the year?

And also, what you're seeing out of the strip store performance, if it's consistent with what you saw in the fourth quarter in terms of opening, and then a stronger second year for ...

We're looking at somewhere between 50 and 60 stores for the second quarter. And we are still very confident with the 200 number for the year.

The strip center performance is consistent with what we saw in the fourth quarter of that. The stores ramp up slower than the mall stores do, but then tend to be comping higher in their first - once they hit their first full year.

So, we're still seeing that. We're very pleased with the performance of the strip center stores.

OK. And then lastly, could I ask this software percentage increase that you gave, how does that treat pre-owned sales?

Pre-owned is included in that number. If pre-owneds backed out of that number, we still are seeing an increase significantly higher than the overall market.

OK, great. Thank you.

Thank you.

Your next question comes from

.

Hey, guys, congratulations on the quarter.

Thank you.

Thanks,

.

When you back out the trade-ins and you come up with an Op of eight percent, I know you don't give any comparisons as far as malls versus strip, but could you try to reconcile that with your competitor at

? They reported a 28 percent increase. There's still a disparity there. I was wondering if there was any focus you could -- you know, any guidance you could give us

on that?

Sure, sure. We think that there are a couple of reasons for that. First one is somewhat unique to this past quarter. In the first quarter of last year, -- or the first quarter this year compared to first quarter last year -- we experienced a significant decline in PS2 hardware sales. We have a disproportionate share of that product in the first quarter last year, and that really went back to what happened at the launch in the fourth quarter of 2000. We had a very large pre-sell number at launch, and because of the shortage problem and the production problem that Sony had with PlayStation around the launch, and during the first few months of its availability. It took us the entire fourth quarter of 2000 just to fill the demand of our pre-sell. So we were never able to put any product out on the shelf.

In the first quarter of last year, in working very closely with Sony, they thought it was very important that that product was made available to the hardcore gamer, who is so important to help support the introduction of a new platform. And we believe that we received a disproportionate share of PS2 hardware in the first quarter last year. Our comp decline just in that one skew was about 32 percent this year, because we think that our sales this year were more natural with where our normal marketshare should be. So we think that that was the significant difference between the two comp numbers. And, that that difference goes away in the second quarter.

OK.

And the second piece of it is the -- as Jim mentioned -- the way we account for the pre-owned.

OK. And just to follow-up a little bit on that, I mean, without quantifying, could you talk about the comps in the strip versus the mall? Were they consistent, was one stronger than the other? Blah, blah, blah.

Well, we're working off such a small base in the strips. We only had 20 strip stores that were actual comping. There wasn't that significant a difference at this point.

OK. And just back to your guidance. For Q-2 to Q-4, could you give us what the impact was that EB Kids had and BC Collectibles, so we know what the numbers were to back out, so to speak?

I don't have the full year in front of me, but in the second quarter last year it was, on a net income basis, just under $800,000.

OK.

I just don't have the Q-3 and Q-4 with me right now.

OK. Will we be able to get the revenue numbers from you, too, Jim?

The revenue was about 5.9 million.

OK. And the back half of the year, you don't have that with you right now?

No, I don't. We can get that to you later.

OK, great. And just one final question. What are your thoughts on not only the hardware -- you know, you both talked about the hardware price drops, which I think everyone anticipated.

What are your thoughts regarding, you know, Sony's software drop, you know, and, you know, how - I know most publishers say they're not going to follow with A titles. Is that how you've budgeted for the rest of the year? And is that incorporated in your numbers?

Yes, it is. We had assumed that the average selling price for software would decline from last year, because of addition of classics products at 19.99, of closeouts of older titles, 29 and 39.

And we did feel that we'd start to see some B and C titles being introduced into the market at 39.

So first of all, we did assume a decline in the average selling price for software. Our assumption was that frontline software would stay at 49.99 this year, and that it would go to 39 at some point in time next year, which if you look at historical patterns in previous cycles, that's about the time it normally would happen.

We do not believe that the other publishers will follow Sony's price drop to the 39 price point on their A titles. Sony has relatively low market share. It's under 10 percent.

The feeling is that none of their titles are really going to be impact titles in the market. So, you know, we believe that you're going to see the triple A titles stay at 49 through Christmas.

OK. Great. Thanks, Jeff.

Sure.

Your next question comes from

.

Yeah, hi. Can you just repeat a little bit in terms of before the price cut and after the price cut for the PS2 and the Xbox?

And could you just talk about the availability that you guys see for both those devices if, you know, the increase in sales - if you'll have any trouble getting ...

Sure.

... hardware going forward?

The PlayStation 2 was six - increased by a factor of 6.8 times, Xbox 6.6 times and GameCube 3.6 times.

And what we did was we took - I think it was about two weeks' worth of business for PS2 and Xbox, and we compared it to the two weeks prior to the price drop. And that's how we came up with that increase.

As far as availability, Xbox is, and GameCube both seem to be readily available. There's adequate amount of inventory.

PlayStation, we had a pretty substantial inventory going into the price drop. There were some stores that ran out of product last weekend. We did get additional inventory from Sony this week, and we've had pretty strong indications from Sony that it's going to be somewhat tight the next two to four weeks, but that we will receive shipments on a weekly basis.

And our feeling is that, you know, Sony's looking very closely at sell-through, and they will direct the product to the retailers who are getting the best sell-through.

So we feel like we're in a very good position to get adequate supply of PS2.

And I know we're early on in terms of this price cut, but from your previous experience with PS1 and some of the other hardware platforms, what is the

start to look like. I mean if we ...

This increase was significantly more dramatic than anything we've ever seen in the past. And, you know, I think it just is one more sign that points to how much bigger this cycle is than any previous cycles.

You know, there's a statistic that, just to share with you. The PlayStation I was introduced in September of 1995 at 299, and in May of 1996, they lowered the price to $199. In that timeframe of eight months, they sold about 1.3 million units at the 299 introductory price point. The PlayStation II, which was launched in October of 200, and then the

, which was launched last year, both sold at the introductory price of 299 in the U.S. approximately 13 million units. So ten times the amount of units were sold at the introductory price point, as there were sold in the last cycle.

And I think that's just one more sign to show how much bigger the cycle is. So that I think every event that happens in this cycle just seems to compound the business. And the reaction to this price drop is just one more point to that. So we expect that the acceleration in sales that we saw will start to level off somewhat. But that we're still going to sell a lot more units in the second quarter than we sold in the second quarter last year, which is just healthy for the industry, because of the add-on software and accessory sales that come with it, and the additional pre-owned opportunities that come along with it. So it's a very positive sign.

OK, and just one final, and I know it's not a complete apples-to-apples. But when you look at this current quarter, versus the last quarter, on the unit basis because of where the price cuts occurred, I mean, is it going to be that significant? Like, going to be five times for PS2, five times for Xbox? Or, do you think you sustain for like the next three or four months these types of levels?

It's probably not going to stay that high. I mean, our assumption was that it -- we'd probably see double the unit sales, but it's started out higher than that. So it's hard to say. But five seems pretty high.

You were assuming double the unit sales over like a six month timeframe with the $100 price drop? Is that what ...

Yes, yes.

Thank you.

Your next question comes from

.

Hi, guys, I've just got one question. The cash account was -- it declined $50 million in the quarter, and income was roughly flat. I was wondering if you could detail the major uses of cash in the quarter? Thanks.

Actually, I don't have that information available in front of me right now,

. Can I do a follow-up with you on that?

Yes, I'll call you guys back. Thanks.

I just don't have the information in front of me right now.

Your next question comes from

.

Congratulations, guys.

Thank you.

I have a few questions for you. First one, Jim, you'd mentioned that there was a reversal of 500,000 from your reserves?

Yes.

Was that -- where did that show up? Does that show up in your pro forma number?

No, it was in the GAP, but that was backed out of the pro forma as well as the operating results.

OK. Second question, can you compare the performance of your U.S. stores and your international stores on a comparable store basis? In other words, was there a drag on your sales from the international stores on a comp basis?

The international stores actually had a very strong performance in the quarter. So no, they were not a drag on the comp performance.

OK. And Jeff, a follow-up on your comments with respect to the allocation of PS2s last year. Is it your belief that

did not receive a similar type of allocation?

We believe we had a significantly higher allocation in the first quarter last year.

OK. Next question. Jim, you mentioned that you raised your guidance for the second quarter. What was that from?

We had not announced - I guess it was a misstatement in the script. We didn't give our internal guidance on the last call.

But does that represent an increase from ...

It's an increase from what we had internally been forecasting.

Can you tell us how much?

I believe it was about two to three cents.

OK. And last question is, is the eight percent

of guidance for comps in the second quarter based on the trend that you're running now? Or what you think you're going to be running at the end of the quarter?

It's a blend of what we'll run for the whole quarter. Certainly, we got a nice jump at the beginning with the hardware sales, but the eight percent target is for the whole quarter.

Thank you very much.

Your next question comes from Bill Armstrong.

Good afternoon. A couple of questions. With the - I'm wondering if this works. When Sony and Microsoft lower their price, when they announce effective immediately, the inventories of those goods that you have on hand, do they give you a refund for the difference?

And a related question would be, did you anticipate these price cuts? And were you able to adjust your offering prices for used hardware in anticipation of that?

Sure. First of all, they issue a credit for our existing inventory. So we will own all the existing inventory at the new cost and be able to sell it at the new retail, and maintain the same margin.

And that's in the form of a credit, you know, towards future purchases.

We - when we saw the slowdown in hardware sales in the first quarter, we started to believe that there would be a price drop at E3. And our assumption going into the year was that there would be a price drop at some point in time between E3 and, say, September.

But as we started to see the decline in hardware sales, and we started to believe that the price drop would happen sooner or later, we managed our buy and sell on the pre-owned hardware, so that when the price drop was announced, we owned the pre-owned at a competitive price.

And that's the way we manage the pre-owned business. And usually, you can get visibility on price drops usually before they happen.

OK. The eight percent comp guidance that you have for the second quarter, is that assuming the current accounting practice for used game sales? Or the perspective change?

That's the current.

That's current. What - if you were to change to, you know, the more conventional method, what would that - what would those comps be? What would that eight percent translate to, in other words?

We picked up an increase of over 3.6 percent in the first quarter. I would expect it to be in that same range, 3.5 or so. So it would imply about 11.5 range.

OK. And just a housekeeping question, and that is, could you break out by concept in the U.S., and then by country, your store base at the end of the first quarter?

The store base by country ...

We had 729 in the U.S., 100 in Canada.

One hundred in Canada?

Yes. Eighty-one combined New Zealand/ Australia, and the balance in Europe.

OK.

To get to the 948.

OK. And then, of those -- of the 729 in the U.S., how many were strip center?

Eighty-eight.

Eighty-eight?

Yes.

Thank you.

Your next question comes from

.

Hi. I got a couple questions, too. The mix of revenue switched in favor of software, given the new price in the lift that you've gotten, which is much more dramatic on hardware than software, could you give us a sense of what you think your mix is going to look like in the second quarter?

I think hardware will probably increase a little bit as a percentage to total, but not that much. It's not going to be that significant of a change.

Off of first quarter levels?

It was 15 percent in the first quarter.

Right, should we use that as the base, or are you talking about off of last year's second quarter?

I'd say off of the first quarter.

OK, so a little bit there, OK. So in other words, you're still expecting it sounds like reasonably good gross margin, because the mix isn't going to shift too much in favor of hardware?

Yes, right.

OK. And then, you cited the data point about the adoption rate being much faster here. I guess I have two questions. One is do you think your lift on PS2, or on the PS2 and Xbox is about what other retailers are seeing? Or are you hearing anything anecdotal as it relates to that? Are you higher or lower?

And the second part of the question is do you think that this year is going to be the year -- is going to be the sweet spot really for the kids market? Or in other words, down-market from your core customer? Or, is 2003 more likely to be that year?

The first part of the question, I think our bump was probably a bit higher than what the average market bump was. And the second part of your question, no, we believe that the demographics of the console purchaser are still running much, much older than they were in the last generation. So I don't think this is a year where you see it shift significantly to a younger consumer.

Yes, OK. And last year you had two things that really drove revenue. You had GBA introduction, and then you had of course Gran Tourismo on PS2. Other than the hardware price cut, is there anything that you expect to be a real business driver in Q-2?

WarCraft.

OK.

Yes, it's a PC game with at a $70 -- 70, $80 retail. There's a collector's edition, and then the regular one. And we're looking at unit sales on that to possible exceed what we did in Gran Tourismo last year.

Oh, really, just that one thing?

Yes.

So OK, so your PC software could go up as a percentage of revenue as well?

I would assume so, yes.

Yes, so total software really probably doesn't change that much from Q-1?

Right.

Yes, OK, all right. Thank you.

Sure.

Your next question comes from

.

Hi, guys.

Hey.

Congratulations on a good quarter.

Thank you.

A couple quick ones. First of all, I presume that the comps that you gave, those are on a pro forma basis.

Yes.

OK. So I need to go back and change the first quarter revenues to kind of see how the new stores are doing?

Yes. There was a, basically a push transaction from the Kids and the BC.

OK. So - I apologize. I don't know Game Stop's accounting that well. So you guys are the only ones that treat trade-ins as an offset to revenues?

Sounds that way, yeah.

OK. And it also sounds like, going forward, Jeff, after this quarter, you feel like your business and performance can be somewhat more closely lined up with Game Stop's and ...

We shouldn't - we should start to narrow the gap in this quarter, yes.

OK. And then, on the guidance, I just want to get a little bit of clarification there.

Obviously, you know, relative to analysts' expectations, you certainly beat this quarter. And your guidance for the second quarter is four or five cents above what people are looking for in the second quarter. So, if you combine the two, it's, you know, approaching 10 cents.

And the year - I'm just trying to understand, would you expect to take a dime out of the second half of the year? Or are you just basically saying, we haven't, you know, gone through an updated, you know, expectations, and so therefore, we're just sticking with what we've previously said?

statement. And we really want to see at the end of the second quarter what the true outlook for third and fourth quarter is, you know, how - are all the titles we've seen at E3, the timeframe when they've talked about them being announced, in fact, are still on that time schedule and nothing starts flipping into 2003.

I mean, just last week we heard at one time

was going to be a, you know, 2002 calendar year title, and now that's announced for February 2003. So, you know, a couple of big titles could start having an impact if things slip.

We saw an awful lot of software that's announced and in the pipeline to be released this year. Additionally, I think we want to continue to see the hardware sell through, and see what the installed base grows to by the second half, which will give us a lot more confidence in how much software multiples we expect to get on that base in the second half of the year.

So it - again, just for clarification - it doesn't sound like you heard or saw anything specifically at E3 that would make you more cautious on the second half?

No. No. We're ...

Or it's just a law of numbers and a lot going out, and therefore ...

Yeah, yeah. I mean, it's - we've been involved in this business long enough that you don't, you don't want to make too many assumptions about too far out.

But overall, this is - this, you know, this is going to be the best year the industry ever had. The software that we saw out there for, you know, for the third and fourth quarter is by far the strongest lineup that we have ever seen.

So, you know, we feel - we're very excited about the prospects for the second half of the year.

OK. So qualitatively, that software that you saw on the back half of the year, were you, you know, pleasantly surprised? Or was it just kind of what you were expecting?

I know it's great, but ...

You know, it was wow!

OK.

Yeah.

And then, the gross margin - I may have missed it. It was obviously up a ton in the first quarter. I didn't - I haven't had a chance to calculate all the different mix things. It sounds like software was a lot higher and hardware was a lot further down.

How much of it was mix versus, you know, just kind of rates within the categories? And so, therefore, you know, the obvious question is, it sounds like Q2's mix is going to be relatively similar on a year-over-year basis.

So trying to get a sense of what we're really talking about on a gross margin.

First quarter was more impacted by the shift in the hardware percentage from, I think we

talked about 23, down to about 15. But it was also positively impacted by the increase in pre-owned sales. We had a nice contribution to margin, and that's over 40 percent margin product. The second quarter hardware this year versus last year, it's going to be a lot closer on a percentage of the mix basis. So you won't see the dramatic improvement in the gross margins, but we still continue to expect to get the benefit of the growth in the pre-owned, year-over-year.

So is there any way of quantifying just how much of the 330 or basis points that you improved in gross margin came from the pre-owned business?

Not here on the call right now. I don't have details to crank through the calculations.

OK, great. Thanks a lot, guys. Look forward to talking again.

Thanks.

Your next question comes from

.

Thank you very much, just a couple of quick questions.

First, I just want to go back to the earlier questions about the pickup that you've seen after the hardware price cuts. Asking another way, is the 6.8 time increase, you talked about that, versus the two weeks prior to the price cuts. Assume that the message was getting out on the channel; that may have impacted customer behavior a bit prior to the price cuts. Can you normalize those numbers a bit? And talk about the level of volume you've seen grown off a more normal base, let's say in March? Or, do you think there's something else explaining that?

The average weekly sales for the two weeks prior to the drop were not that much different from what we were seeing in April. I mean, March it was higher because I think that was Easter.

Yes.

No, we felt pretty confident, but I mean there were some rumors about price drop, but it wasn't that general knowledge.

OK. And then, the eight percent comp number you gave for the second quarter -- and I guess it's 11 percent if we adjust for pre-owned. Do you break that out between software and hardware?

No.

Normally we don't, no.

OK. And then lastly, obviously a lot of great software out of E-3, just any color in terms of how you allocate your shelf space as you head into the key holiday season? How you think about allocating enough room for the best looking titles would be helpful?

Thank you.

Sure, I mean, we do our planning based upon starting off with the numbers that we gave earlier with how many units of PS2 hardware are going to be sold this year, how many units of software are going to be sold. And then, we look at what our marketshare should be within that category, and then we look down at what percentage of shelf space that category should get, based upon that. And then, we take it down to the title-by-title level. So it's more of a overall macro view of the business is how we start the planning. So I think if you look at the stores, you'll see that PS2 gets the most shelf space of any of the consoles, because it's the biggest marketshare.

Sure, but on a genre basis, if you -- going back to your comment about an older demographic for this holiday. Would that be reflected in your allocation for titles for that?

Oh, absolutely.

OK.

Absolutely. I mean, we're --

is going to get a lot more space than Britney Spears.

OK, great. Thank you.

Your next question comes from

.

Hi, I was hoping you could explain a little bit further how the used games hurt comps as much as they did? And how exactly are you changing the revenue recognition, and why are you electing to do that now? The trade-in games?

I know. Our increased emphasis on pre-owned, both in the malls and because of our extended presence in the strip center stores, which do predominantly more business than pre-owned. But even in the malls we're doing significantly more sales and trade-ins of pre-owned, almost to the point of doubling last year's business.

On a comp basis - when I take a trade-in from a consumer, I reduce my revenue by the value I give them for them game. So if they buy a $50 new game and I give them $20 for their old game, I would record a $30 net sale, as opposed to a $50 sale and then treat the $20 credit that I gave the consumer as a purchase of inventory transaction.

So, because I'm significantly increasing my pre-owned sales and trade-ins, just as an increase in sales year-over-year would increase my comps, an increase of that negative impact is having a pull-back on my comps.

OK. I'm just wondering ...

Now, to explain why we're changing - because I'm sitting here explaining to you this concept of the trade-in and the revenue, and coming - it's been an issue coming up for probably about a year now, and comparing our results to other retailers and other competitors.

And it's just been more complicated - from the gross profit line down on our P&L, there's no impact. It's just a reclassification between cost of goods sold and revenue.

But if I - if my reclassification is - adds back $10 million to revenue, I'll have a corresponding increase in cost of goods sold of $10 million, and the gross profit dollars don't change.

But we just thought at this time that we would make the change so that the investment community could better analyze our performance against the other retailers in general and understand our performance.

OK. Fair enough. Thanks.

Your next question comes from

.

Hi. Also a question on the revenues, and maybe it relates to this issue. But we had you modeled at closer to $225 million, and the Street was closer to 225 and 230 in revenues for the quarter, and you came in at 217 - a little light.

Is that a mix issue? Or is there something else that I'm missing? Is it related to this trade-in issue? Can you just expound on that a bit, please?

I think it's a combination of the comp guidance. I think the Street was modeling in around 10 percent comps, and we reported, with the trade-ins involved, a 4.3 percent. So that six percent swing is probably a big chunk of that difference.

And then the increased trade-in activity is having a small impact.

And just to clarify it even further, when somebody trades in an old game, you reduce your revenues from a prior period?

No. In - the same day the transaction happens. They come into the store, they buy new games, they trade in an old game. I record the net sale that day, of the $50 minus the $20 credit to get the $30 net sale on that day.

So it has no prior period impact, no reclassifications or, you know, restatements of earnings.

OK. Thank you.

Your next question comes from

.

Hi, guys. Just to get a better understanding of the accounting on the pre-owned games.

So if you're netting the purchase of the pre-owned game against revenues, does that mean when you resell that pre-owned game, there's no cost associated with it?

No. I

at the price that I gave the consumer. If I, again, back to that $20 example, I own that game at $20. So when I sell it for 30 or 40 two weeks later, I'll record a $40 revenue sale, and I'll have a $20 cost of goods sold, which is the credit value I gave the previous consumer that traded it in.

But how do you record a cost of goods sale when you - if you - if you sold a $50 game, and he - and basically give him a $20 credit for that game ...

Right. That's on the retail side. On the cost of goods sold side, I relieved my inventory for the - say the cost on that original game was $40.

Right.

So I relieved cost of goods sold by an inventory by $40 for the new game they walked out the door with.

Oh, OK.

And then I add back to inventory $20, and impact cost of goods sold for the $20 credit that I gave them. So now I own their old game at the $20 cost.

OK, I got it.

That's why we want to change the accounting, because it's a big part of discussions when we're out marketing to the company, and trying to explain the concept. It's time to move on.

All right, thanks.

Your next question comes from

.

Hey, guys.

Hey.

Jeff, I was just wondering if you could give us a sense of your mindset of your thought process on the industry from let's say 12 months ago to six months ago to today, in terms of your confidence in the outlook going forward?

Sure. I mean, 12 months ago was like high anticipation, nervous anticipation, just going through a difficult PlayStation II launch. But then, seeing the PlayStation II really starting to take off in the second quarter last year. And then, being excited about the Xbox and GameCube, but at the same time, being nervous about them. Are they going to have similar problems that Sony had? So it was somewhat guarded last year. And then, as we got into the fourth quarter six months ago, and we saw the successful launches, and we saw the strong tie ratios in software last year, we had a lot of confidence in the business going into this year.

And then, with the recent price drops on the hardware and the immediate reaction in terms of the increased sales, and you couple that with the strong line-up of software that we just saw at the show, we feel very bullish about the business going forward. I mean, I've been in this business 26 years, and I'll say that the software lineup this year is probably the strongest I've ever seen. Now, will every single title ship on time? Will every single title meet expectations? And that's why we want to be somewhat cautious about predicting the year, but it sure looks good from here at this point in time.

OK. And could you also give us a sense in terms of where you think margins can go long term? Can they go above prior peak levels?

We believe that margins can go above prior peak levels, because of the increased pre-owned business. That's playing a much bigger role than it did in the last cycle. And I think we've barely scratched the surface with the potential of this category.

OK, so five and-a-half, six percent is more than achievable in terms of operating margins?

We believe so.

OK, thanks.

Your next question comes from

.

A couple of follow-ups. Jim, you said that the pre-owned business nearly doubled. I'd like to give you the opportunity to qualify that statement.

In what sense?

Did the pre-owned business nearly double?

The pre-owned business on the sales level more than doubled. How's that?

OK, can you give us some perspective on what percent of either sales or gross profit that was, relative to last year?

No, we're not going to discuss that for competitive reasons.

OK. Second question. Your SG&A went up as a percent of sales, even though you did have positive comps. Can you talk about whether there were any mitigating factors, or why your expenses went up as a percent of sales?

Most of the increase can be accounted for, the increase in store base in the year-over-year. But as I mentioned in the press release and in our commentary - or maybe it wasn't in my script commentary - but our European expansion has had an impact on the SG&A year-over-year.

With the light comps, there wasn't enough lift in the sales to get additional leverage in the SG&A expense, and the European overhead. You know, we acquired a group of businesses last year, and we've put some additional costs and infrastructure in place to prepare ourselves for expanding in that market.

And that's having a higher than average cost on its sales level at this point.

At what point would you expect those businesses to cease being a drag?

They may not for the remainder of this year, but as the year goes on, and the overall volume increases, it'll be to a much smaller extent.

It's going to have a larger impact in the early part of the year.

I mean, would that - would that indicate that maybe this time around, because you'll be getting some efficiencies from those overseas operations, that you ought to see additional leverage in future years that you might not otherwise have seen?

On a comparative basis, yes, we will see improvements in the future years.

OK. Another follow-up. You said that you had looked for eight percent comps in the second quarter, yet you're still comfortable with 10 to 15 percent comps for the year, even though the fourth quarter would seem like an insurmountable comparison for you.

Can you just give us some perspective on what you're building into your third and fourth quarter expectations that would get you to 10 to 15 percent comps?

Well, the third quarter is going to be a significant increase over last year.

I mean, you know, if you look at the third quarter last year, we had negative comps in the quarter. We had, you know, declining mall traffic after the terrorist attacks. We had a lot of software titles delayed.

We had the anticipation for the launch of Xbox and GameCube, so there were a lot of negative factors impacting the business last year.

This year, there's an incredibly strong lineup of software in the third quarter. So we really see huge, huge increases in the third quarter.

The fourth quarter will be smaller increases, but nevertheless, it will be an increase. You know, we're looking at a hardware base, you know, by the fourth quarter the hardware base is going to be significantly larger than it was last year.

You think you can do double-digit comp in the fourth quarter?

We're not going to make any predictions on that yet.

OK. And then, just the last question. You've indicated that, you know, you're very excited about the software lineup and the outlook for the rest of the year.

Yet, you know, at the same time, you've kind of taken the positive surprise in the first quarter and the increase in guidance in the second quarter, and so to speak, put that in your pocket just to make sure all of the titles come out in the second half of the year, and that, you know, that you build some degree of conservatism into your forecast.

If somebody wanted to just look at the increase in hardware, that's been - and the optimism that comes out of E3 and shows to put out a higher estimate, would you have any objection to that?

Someone to

that's higher than that is out there right now?

Yes. I mean, that took into account the roughly, the nickel that you will have added in terms of the first quarter and the second quarter - understanding that ...

No comment,

.

Thank you.

Your next question comes from Melissa Williams.

Hi. I just want to follow up. On the rebranding, could you talk about what the plans are there in terms of, you know, expenses or anything else we need to model in there?

We actually don't see any significant operating expenses. We're planning at this point to convert about 120 stores, primarily strip, that are currently branded. All the Game World stores in the short run, and then a handful of the mall stores will be re-branded within the next two months, hopefully by the end of July is what we're targeting. That'll cost us about maybe $800,000 in cap ex for the new signage on the stores. So that'll be capitalized.

As far as the remainder of the stores, all new stores will be branded under the new name. Any stores that their leases are expiring, that are scheduled for remodeling, will be rebranded under the new name under just normal cap ex of remodeling a store at the end of their lease. Over the next two years, there will be a number of stores that we'll consciously rebrand sooner. That could cost us -- most of those will be mall-based. And for what it's worth, the mall-based signs are cheaper than the strip center signs. It's a much smaller sign. We estimate between $1 and $1 and-a-half per year in capital expense for the mall-based rebrandings. The remainder of the stores should fall out through the normal remodeling -- and the lease expirations and remodels. So we believe by the end of 2004 we'll have the entire company converted.

As far as actual expense, we're not planning any substantial marketing-type promotional campaign around this thing that would cause us to incur any heavy expense, as far as operating supplies and so forth, because we're going with a gradual transition. We'll buy supplies for those new stores, and the remaining stores will continue to use existing supplies.

OK. And can you just review cap ex in the quarter, and for the year?

For the first quarter it was about five and-a-half million. We're still leaning toward 30 to 35 for the year. I can actually get the follow-up to that question was asked earlier on the call about the cash, and where it went. Of the change in cash of about 48 million from the end of the year, five million -- five and-a-half million -- was towards cap ex, and about 42 million was just paying down current liabilities, primarily accounts payable.

Good. And then lastly, could you talk about the hardware in-stock position again? Just kind of review where you are with PS2, and are there any issues that you see coming up with the Xbox?

Xbox and GameCube, as I said, are in adequate supply. All the indications we've received from Nintendo and Microsoft is that they will have enough inventory to support the business. PlayStation II we had a substantial inventory at the time of the announcement, and we had a strong sell-through. We had some stores run out of product over the weekend. We did receive a shipment this week. We believe that we will receive weekly shipments going forward. We've have gotten some indication from Sony that there might be some tightness of product the next two to four weeks, but in our opinion if we continue to show strong sell-through, that we'll be able to get an adequate amount of inventory to support the business.

Thank you.

Your next question comes from

.

Just a couple follow-ups. On the quarter expectation of I think you have three to four cents, did you say before that your original internal expectation was two to three cents? Or is it two to three cents lower than your ...

Two to three cents lower.

Oh, OK. All right. And then, I was wondering if you could just talk about the current competitive situation? You know, we're hearing a lot about a lot of other retailers increasing their exposure to video games. And I guess the one I hear about more than any other, or the one that seems to strike fear in the hearts of a lot of investment managers is Blockbuster.

I was wondering if you could just kind of comment on that, and how you see them positioning yourselves - themselves - and how you see yourself positioned against new competitive incursions?

Sure. Well, I mean, first of all, let's keep in mind that the games business has more than doubled in the last five years.

We're looking at annual growth the next few years probably in the area of 20 percent.

You know, this is probably the biggest

category in consumer products. So, you know, every retailer is going to be looking for an opportunity to either get into the business, or, you know, get their fair share of the pie.

And that, you know, we're used to that. We've been faced with competing like that for the 20-some years that we've been in the business.

Blockbuster's been a participant in this category for over 10 years. They do a great job in the rental business. And, you know, they're going to share in the growth, just like the rest of us will.

Will they take share away from the specialty stores? We don't believe so.

You know, we have a very unique environment for shopping for games. We're constantly changing the way we run our business to meet changes in the market and challenges in the market.

We're always going to be closer to the business than they are. We're always going to have a larger inventory commitment across a larger range of titles. We believe we'll always offer better service. We'll always have more focus on the category.

The trade-in is a unique feature that, you know, really helps differentiate us, you know, from just about all of our major competitors.

So, you know, we believe that we will be able to meet all comers. I mean, last year, you know, we were challenged with the Best Buy purchase of MusicLand and Sam Goody going into the malls. And, you know, we were able to successfully grow our market share, even with them getting into the business.

So, you know, we feel that, you know, they're a worthy competitor. Like I said, they do a great job in the rental. You know, sell-through will be a challenge for them, just like it is for everyone else who gets - becomes new in the category.

But we're confident that we can meet any challenge.

Thank you. And for the record, I think it's a great idea if you do change your accounting on the used-game sales.

Thank you.

Your next question comes from Richard Zimmerman.

Hey, guys. Just was wondering if you could comment on your earnings guidance for the year. To what extent is there a contribution from the international business?

There's not any planned this year.

OK. Is it a negative impact? How much of a negative impact? Is it material?

No, it's not.

OK, and ...

I'm sorry. You're talking just Europe, I presume. I'm sorry.

Our existing international operations in Australia, New Zealand and Canada have been and will continue to be very profitable. It's just the new market in the European area.

Can you comment, then, on the overall - outside of the domestic U.S. business, what kind of contribution you expect?

I don't have that available to discuss right now.

OK. Also, with the name change, is any of that related to the lawsuit - and maybe you can give us an update on the lawsuit in Europe?

The ...

The U.K.?

First of all, it has nothing to do with the lawsuit.

The - as far as back, as we expect the trial on the matter sometime in the fall. We remain very confident in our legal posture, and we're - intend to defend it vigorously.

Prefer not to comment on the particulars of the various legal issues, which are complex and involved, other than to say, we believe our interpretation of the services agreement with EB U.K. is correct.

OK. And just on follow-up to the question on the SG&A, do you expect you would get any SG&A leverage? And if so, at what comp would you need to achieve to get the leverage going forward?

In Q-2?

Well, for the rest of the year? Where do you expect that you'd start to see some leverage?

We expect to see the leverage in Q-2 with the comp guidance we've given. And we should continue to see it Q-3. And I'm not sure about Q-4, depending on what the

, and we're

But certainly for Q-2 and Q-3, we should see SG&A leverage.

OK. And just from a competitive standpoint, I'm wondering if you could just comment on the allocation of hardware, as well as also how you're doing as far as software? Has that changed at all, up, down?

Allocations have increased, as our business has increased. So it's gotten better.

OK, could you actually comment on what your marketshare of the total market was for the first quarter, versus what it was a year ago?

Based upon the tryst numbers for the February, March, and April, we think we're probably about 8.3 percent of the market, versus about eight percent last year.

OK, great. So your maintaining what your marketshare is, and actually some improving?

Yes.

OK, thank you.

Thank you.

Your next question comes from

.

Hi, just a follow-up on some of the comments you made on Blockbuster. If you could just further elaborate on your targeted customer, versus what you believe to be Blockbuster's targeted customer? And what you believe to be their willingness to commit inventory, versus yours, and they're likely -- you know, how that kind of all plays out?

We believe our target customer is older than theirs. You know, we believe that the typical customer who rents a video game is a family who rents a game for their children, because they don't want to make the investment purchasing that game. We believe once the child is old enough, and has their own disposable income, then their preference is to buy a game. So we believe that they skew more towards the younger consumer than we do. And I'm sorry, the second part of your question was the inventory investment?

Right, their willingness to have an inventory commitment.

Right, OK. Yes, I think we have to see how that plays out. I mean, in my opinion, the most difficult part of running this business is managing the inventory. And I'm saying that from 20 some years experience with it. That you know, it's a risk, and the retailer really takes on most of the risk. And this product has a relatively short shelf-life. It becomes obsolete very quickly. It has a sharp sales curve, where it declines in value rapidly.

And you know, if a retailer's going to be successful in this category for an extended period of time, you really to have to know how to buy the product. You've got to make good decisions on what you buy, yet you have to be able to make commitments to buy large quantities of the titles that ultimately become the best sellers, if you're going to be an impact player in the business. And I don't know, first of all, if they're going to be willing to make that kind of investment. I don't know if they're going to be able to get the kind of support from the publishers that they might be looking for, or what they've been able to receive from the movie studios.

And, you know, it - after you've been buying this product for a year, no matter how good you are, you're always going to have inventory issues to deal with.

And, you know, if you make a couple of mistakes, they tend to be big mistakes. And, you know, it - you know, after being in the business for a year or two, sometimes it doesn't look as good as it was when you first got into it.

So, I, you know, I think that there are some major challenges for them going forward, if they're going to purchase larger quantities of product for sell-through.

You know, we've - we have a lot of experience with it. We've invested a lot in our education and in our infrastructure and our systems, to enable us to make better decisions in how we manage the inventory.

You just don't get that experience overnight.

OK. Thanks.

Thank you.

At this time, there are no other further questions.

OK. Thank you. We appreciate your time this afternoon, as well as your support and confidence in EB Games.

We look forward to talking with all of you again in August, when we announce our first, second - our fiscal second quarter results.

Thank you.

Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect.