GameStop Corp (GME) 2005 Q2 法說會逐字稿

Good morning.

Welcome to the GameStop Corporation's second-quarter 2005 earnings results conference call.

Today's call is being recorded.

At the conclusion of the announcement, a question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS).

I would like to remind you that this call is covered by the Safe Harbor disclosure contained in GameStop's public documents, and is property of GameStop.

It is not for rebroadcast or use by any other party without prior written consent of GameStop.

At this time, I would like to turn the call over to Mr. Dick Fontaine, Chairman and Chief Executive Officer of GameStop Corporation.

Please go ahead, sir.

Thank you, and thank you all for joining us today.

I am Dick Fontaine, the Chairman and CEO of GameStop.

With me today are Dan DeMatteo, our Vice Chairman and Chief Operating Officer, and David Carlson, our Chief Financial Officer.

This morning, we announced a very good second quarter.

I am particularly happy with this quarter due to the fact that we both managed to execute our business plan extremely well, and we were able to do this in the midst of some very exciting news pertaining to our merger with Electronics Boutique.

Sometimes in these situations, it is difficult to keep your mind on the business at hand.

But we did keep our focus, we did drive our business during the quarter and made significant progress at the same time in beginning to craft an integration plan for the future merger of the two companies.

We are going to discuss the integration update a little bit later in the call.

But without further ado, I want to turn this over to David Carlson, who will take you through some of the numbers.

David?

Good morning.

Before the market opened today, we released our sales and earnings results for the second quarter of fiscal 2005.

GameStop's sales for the second quarter increased 20.3% over the prior year to 415.9 million.

Comparable store sales increased 6.2% on continued strength of hardware sellthrough, particularly the Sony PlayStation Portable.

In addition, videogame software sales remained solid, with 16% growth, led by such titles as NCAA Football, Star Wars Episode III -- Revenge of the Sith, and Pokemon Emerald.

For the second quarter, we reported net earnings of 7.9 million, or $0.14 per diluted share.

During the quarter, we wrote off approximately 1.1 million of our used Grand Theft Auto: San Andreas inventory due to the re-rating of the game as Adults Only by the ERSB and the pulling of the product from our shelves.

Gross margin rates improved by 10 basis points during the second quarter in spite of a 40% increase in hardware sales.

This was accomplished through improved freight efficiencies and increased margins on video game software.

SG&A expenses were slightly higher than the prior year as a percentage of sales, due primarily to expenses related to the relocation of our general office and warehouse to our new facilities, including duplicate occupancy costs for both the old and new facilities.

Our balance sheet remains very strong, with nearly 100 million in cash at the end of the quarter.

Inventory on a store-by-store basis increased by 19% from the prior-year quarter.

This was primarily due to increased video game hardware levels after experiencing shortages in the prior year.

We also issued guidance for the third quarter and reiterated our earnings guidance for the full year.

Based on current hardware sellthrough expectations and video game software releases, third-quarter diluted earnings per share are expected to range from $0.18 to $0.20, with corresponding comparable store sales decreasing in the minus 8 to minus 10% range.

This guidance excludes the anticipated merger with Electronics Boutique.

However, we are planning to update guidance for the combined Company after the merger closes.

With that, I will turn it back over to Dick.

Thanks, David.

Strong sales, strong margin, strong comps, excellent new store performance, and a strong balance sheet -- in short, another very solid quarter, and in combination, gives GameStop an excellent first half.

During the quarter, we open 76 new stores, bringing our total for the first half of the year to 171 additional stores.

We ended the quarter with 1980 total stores.

Since announcing our merger with EB, we obviously have been reassessing our real estate pipeline, and will now be forecasting that we will be opening between 320 and 335 new GameStop stores this year, a slight decrease from the number that we previously discussed, which was closer to the 350 range.

I want to take a minute to comment on an expense element of the quarter.

And as you know, we pay very close attention to all of our expenses, namely a slight rise in our SG&A.

A major portion of that increase was due to a decision we made to overlap our old distribution and general office facility with our move into a new building, which has now for the most part been completed.

We made a conscious decision to absorb some incremental overhead to give us a safety net in the event that there were any unanticipated moving problems, particularly pertaining to the systems facility and the distribution center.

That move is going very smoothly, and is somewhat ahead of schedule, but nevertheless, we felt that this was worthwhile insurance to make sure that there was no support interruption to the business during the second half of the year, and I am sure you would all agree with that decision.

Now we need to spend some time to bring you up to speed on the progress towards completing the merger, and a little bit later, the progress on our integration.

As you know, on April 18, we announced a merger with the Electronics Boutique.

Since that time, the Hart-Scott-Rodino FTC waiting period expired, which was a very favorable event for the transaction moving forward.

We are now into addressing some purely technical issues with the SEC, which is, to be truthful, taking somewhat longer than we would have hoped.

But the issues will be addressed, and we plan to close the merger by late September or early October.

All of our top executives, along with the key management team at EB, are making real progress on the integration plan.

Our effort is being spearheaded by Joe DePinto, the President of GameStop, who would have been on the call today but, as we speak, is in EB's headquarters continuing to do work with the team there.

I do, however, want to clarify that we are still separate companies.

And as such, we have to move forward somewhat cautiously with legal counsel being fully involved every step of the way.

We want to make absolutely sure that while we are planning for a smooth and professional integration of the companies, we are doing so very consistent with applicable laws.

That being said, and before I turn it over to Dan, who will be commenting on our product future, and also be giving you some additional insights into the integration process, I do want to say that I am very impressed with the EB executives that I have met and the way they are working to make the integration as efficiently as possible.

It is very, very encouraging to work with a new team that absolutely speaks our language.

And I think all members of our team have not only been impressed with our partners in Pennsylvania, but have been very impressed with their cooperation in making this work.

And with that, I will turn it over to Dan.

Thanks, Dick, and good morning.

I want to take a moment to put our third-quarter forecast in perspective from a product point of view.

Last year's third-quarter comps were 12%, driven by the combination of Grand Theft Auto: San Andreas, Fable, Pokemon and Star Ocean -- truly exceptional titles, many of these released early in the quarter in advance of the earthquake caused by Grand Theft Auto and Halo 2, which released early November.

This year, we have a more normal release schedule, with titles releasing late October and early November.

This does not mean that we don't have exciting products in the third quarter this year.

It is just that the comp lineup we're going against was an all-time record.

In fact, we are very excited about them, and some of the expected bestsellers for the quarter will be Madden, all formats;

SOCOM III for the PS2;

Soul Caliber III for PS2;

Grand Theft Auto -- Liberty City for the PSP -- hopefully it doesn't get recalled;

Nintendogs for the Nintendo DS; and NBA live, all formats.

In addition, as Dave mentioned, sales of hardware have been strong in the second quarter, and we expect hardware sales to be strong this quarter, led by sales of Sony's PSP handheld system and console sales led by the PS2.

We expect consumer demand to continue to be strong for these Sony SKUs in the quarter, and believe supplies will match demand.

And if you remember last year, we had very short supply of consoles.

Also in the news this week, Nintendo announced a price drop on its new handheld system, the DS, and this price move, coupled with the new hardware/software bundle later in the quarter, should improve sales of it.

And when we look into the future, we see the beginnings of the next console cycle, led by the Xbox 360 in November.

As they just announced, there will be a premium SKU for the early adopter at 399, and a 299 SKU also.

And I am sure many of you saw in this morning's Wall Street Journal an article whereby Robbie Bach committed that they would have this product out in November this year.

The title lineup for this console is lining up nicely, and we expect 15 to 20 titles at launch.

And wild less is known about the PS3, we are expecting it sometime next year in North America.

So we have a runaway success and our first Christmas coming the new PSP handheld, a new price point on Nintendo's latest handheld, better sales than last year with Sony's PS2, due to supply and consumer demand, and new console launches just around the corner.

And on top of this, our merger with EB will make us the largest retailer of video games in the world.

Now, some comments on the integration planning that Dick mentioned.

First, the cornerstone of the successful integration is the standardization of systems.

We have selected the best systems from each organization, and our IT staffs are busy working to ensure that they integrate and work well together.

Next, we have teams in each functional area from both companies resolving the issues resulting from these system decisions and reviewing each other's best practices.

It is interesting when we look at EB and their personnel, it is almost like looking in a mirror.

We both speak the same language, have similar cultures, and have both been intensely focused on the same business for a long time.

As a result, these teams are getting along extremely well, and we are proud of the success they have made in such a short time, led by Joe DePinto, our President.

As a result, once the merger is completed, we can share the remaining information to complete the studies and get on with the actual integration.

We feel we are on track to get the synergies we communicated to you earlier.

Now, I would like to turn it over to the moderator for a Q&A session.

(OPERATOR INSTRUCTIONS).

Elizabeth Osur, Citigroup.

I had a couple of different questions.

First, I was hoping you could comment on the pace of integration as it is expected, and whether or not those costs will be broken out on the income statement so that we will be able to take them out of the regular operating results?

Yes, Liz, definitely, we are going to be keeping track of those expenses, and we will list them as a separate line item on the income statement.

And the pace of the integration -- is there an expected completion date for all of the systems to be fully integrated in all the stores?

We expect to run both companies under separate infrastructures, which includes systems and distribution, through Christmas of this year.

We expect to begin the integration right after that, and end that integration hopefully around June of next year.

Okay, thanks.

And then just one final question.

When we think about the gross margin opportunities in the used business -- I know you have commented in the past that you've felt that your margins in that business might be higher than Electronics Boutique.

Is there any way to kind of talk about either the different pricing strategies that you have had, or what the opportunity might be there, or whether the opportunity is in your ability to buy in at a better price or to sell out at a better price -- can you give us some picture of where that might be?

We really don't have any information on that.

And again, it goes back to what I mentioned -- it is almost, I guess, our definition of a Miranda warning.

We have been very, very cautious and very careful about what we can do together and what we cannot do together.

And there are some areas that, for antitrust reasons, are real hotspots.

And we have really stayed away from doing pretty much anything in terms of pricing or policies or market development funds or advertising.

So there are certain segments of the business that, until we close, we just consciously have not really spend any time on those.

After we close, of course, we will look at everything and have a better insight to that.

But right now, we don't.

Thanks.

And if I could ask just one final question.

On the advertising spend, would you expect that in the fourth quarter, we would begin to see the benefits of the merger in the sense that you could cut down local ad spend?

I don't think in the sense of cutting down.

We will have to look at the plans.

And again, we have just begun to do some discussion about what we can do on the advertising and marketing.

And if there is any synergies, it will probably be that in certain inserts, we may overlap the stores.

But again, I wouldn't look for anything significant this year in that area.

Arvind Bhatia, Southwest Securities.

Actually, Craig Bell for Arvind.

I had a few questions for you on the new and used software.

Have you seen a change in the mix -- or a material change in the mix relative to last year?

No, there really hasn't been a change in the mix between the new and used software.

Typically in the second quarter, obviously, we have said this before, the used business is stronger as the kids are out of school.

But the actual shift in the mix really hasn't -- there hasn't been a significant shift in the mix, no.

Okay.

And then earlier, you said that you had seen improvements in gross margin on the software side.

Was that for new or used, or was it that a combination of both?

It is really a combination of both, but I think it was somewhat more driven by the used side of the business.

And that of course in part is somewhat driven by the continued expansion of the new stores.

The 76 stores that we opened were virtually all strips; as you know, they tend to have a higher percentage of used and new, so we continue to get the advantage from that.

Okay.

And then did you have any store closings during the quarter?

Yes, we closed four stores during the quarter.

And then last question -- do you have the breakdown of the store count by strip and mall location?

Actually, we have the breakdown by U.S. and international.

There are 1953 U.S. domestic stores and 27 international stores for a total of 1980 stores.

And at this point, we are not going to be breaking down mall and strip any longer.

(OPERATOR INSTRUCTIONS).

Dave Magee, SunTrust Robinson Humphrey.

Good morning.

It is Frank sitting in for David.

He is on another call.

Was the Nintendo price decrease already in guidance in terms of the positive impact that that should happen on sales trends in 3Q?

I imagine you are speaking about the DS price decline.

And no, I don't think we factor that into the third quarter.

But I don't think it is going to have a significant impact.

Okay.

And you addressed the software margins being higher because of the higher mix of the used.

Is there anything -- if we could look at the software margins for new product and year-over-year, how those margin trended?

They were just slightly up from last year.

Okay.

And just the last thing -- is there a way to quantify what the incremental expense would be from the overlap of that DC and the facility there, keeping two of them running at the same time?

Yes, we haven't quantified exactly; it's somewhere between 1.5 million and $2 million.

Okay, great -- thank you very much.

Nice quarter.

Thank you.

And I would also add to that in terms of this is that that is not a continuous overlap expense going forward.

That literally will decline somewhat month by month.

We'll still have the occupancy through the end of this year, but certain other related expenses will decline pretty much every month as usage in that facility declines.

Bill Armstrong, CL King & Associates.

A couple of questions.

Could you talk about current Xbox supplies -- hardware supplies, that is?

Has there been any improvement there?

Yes.

This is Dan.

The Xbox supply seems to be meeting demand.

So we are in stock with the Xbox, and as you would expect, demand will continuously decline as we get closer to the new Xbox 360.

But the Xbox has been in stock, yes.

The quarter was very good in-stock quarter as for all hardware platforms.

Okay.

Any additional word on the Xbox 360?

I saw the Wall Street Journal article.

Are you still -- I think you have previously said that you were expecting about 1 million units at launch and something like 2 million by Christmas.

Have you gotten any indication from Microsoft in terms of quantities?

No, we have not.

And it's several -- I think it's weeks away before we will know quantities.

But no, we do not.

There is a lot of speculation on the range here.

And I hear most people are believing about 1 million at launch, and numbers from 1.3 million to 2 million, I guess, by Christmas.

So we won't know for several weeks, though.

Okay.

Are those quantities that you have previously talked about in your own expectations -- is that what is built in to your full-year earnings guidance?

Actually, we have probably the lower end of that range built into the earnings guidance.

Okay.

Any word from Take 2 on the re-release of San Andreas?

I think we have a date on the Xbox, and I think that is next week, if I remember correctly -- yes, next week.

But we do not have the date, last time I checked, on the PS2 yet.

Okay.

And then for your third-quarter guidance, what sort of gross margin assumptions are you building into that?

We are looking at an increase in gross margin of anywhere between 25 and 75 basis points over the prior year.

And that is in spite of strong hardware anticipated sales -- is that once again a function of the used/new software mix?

It definitely is.

Last year, the new software mix was significantly stronger than it will be this year.

Right.

And I remember last year that that actually impacted your gross margins negatively.

That is correct.

Okay, so we will get the reverse this time.

Yes.

Tony Gikas, Piper Jaffray.

A few questions.

I will start out with the Grand Theft Auto.

Maybe you could just elaborate on why you've pulled the game and didn't continue to sell it?

And will this be a policy going forward that you are not going to sell AO-rated games?

The game you are about to start selling isn't going to be any different than the one you were selling a few weeks ago.

So curious on that.

Second question -- your thoughts on the success of the PlayStation Portable.

Sales sequentially have been falling off a little bit here recently, and wanted your thoughts on that.

And then two questions related to the merger with Electronics Boutique.

Will the pace of new store openings once consolidated be meaningfully slower than we are expecting on a separate basis?

And the second part of that -- once merged, do you see an opportunity to take used software pricing a little bit higher since there will be, obviously, less competition in the market?

Well, that's a lot of questions.

Let me address probably the first one, the Grand Theft Auto issue, and Dan can handle the PSP.

And then we will kind of ham-and-egg the other questions you had.

While it was a very difficult decision for us, it was a very clear decision.

As soon as this title was re-rated by the software board, we have historically not carried adult titles, and to be consistent, we were not going to make an exception for Grand Theft Auto.

Truthfully, and somewhat personally, we did not like the way that this came down at all.

And while this was something we would not have hoped for, and we are certainly not happy about the write-down we took, the fact of the matter is that this has occurred, and the industry is now aware of it and the creators of the product are now aware of it.

And I think we've got a much higher confidence that rogue code or hidden code is not likely, given the magnanimous amount of investment that goes into these products, is likely to pop its head up again.

At least, I certainly hope not.

So we took that decision.

And while we are not happy, it was not a difficult decision.

And as to going forward in terms of adult titles, we do not intend to sell adult titles.

And in addition to that, we have consistently stood behind the ratings, if you will, and used them as our guideline, and believed that it is an absolutely effective manner for this business to indicate what is appropriate for various users.

We have incorporated those ratings into our cash register prompts.

And, among other things, we have no cash register prompt for adult titles.

So another technical reason for keeping this on the -- on sale, and violating that check and balance just made no sense to us.

So not happy about it, but it was pretty clear from our standpoint what we should do.

Dan, you may want to comment on the PSP?

Yes, the PSP, certainly sales have slowed down since it was initially launched back in March.

But the sales are still very strong.

You would expect them to slow down as we get to the end of the summer and we move away from launch.

However, we are expecting a great Christmas with PSP.

Again, as I mentioned, it will be the first Christmas for this new handheld system, and I think that it's going to be on a lot of kids' Christmas lists.

The used pricing that you mentioned there, we have an opportunity.

I think there's some natural check and balances on pricing given consumers.

We have tested independently various price issues, elasticity, et cetera.

And probably I would imagine Electronics Boutique has, too, although we haven't been able to share these formulas, et cetera.

So I don't know that there is upside there.

I would doubt it.

I would doubt it.

I think there's a price elasticity issue with the consumer that is at play here in both of our methods.

You don't think there is an opportunity to pay the consumer less for the used game or sell it at a slightly higher -- either side of that trade, do you know what I mean?

No.

We still have Blockbuster out there buying back games.

We have Game Rush out there buying back games.

We -- and Game Crazy, I'm sorry, buying back games.

So there is competition in the game market.

And the truth of the matter is that in a very real sense, and particularly with some of the platforms, we are chasing supply all the time.

It actually would be counterproductive for us to be drastically reducing what we pay for products and having less product coming in because in a very real sense, particularly in certain categories, we would always like more inventory than we are buying back.

We keep getting better at that, but it continues to be a challenge.

And I am in agreement with Dan, I don't think there is going to be on the sell side a higher price potential because of competition.

I think there is plenty of competition out there.

Price elasticity may come in as we see some of these platforms becoming older and older, simply because there are fewer and fewer people that may choose to carry those platforms or carry them in the depth that we do.

And in that range, there may be some elasticity that could be very positive for us.

But we will have to see how that develops.

And the last one was on the store count.

Yes, you last one is on the meaningful reduction of store expansion for the companies combined going forward.

And I would say no, I don't expect meaningful reduction.

What I do think you will see is a more balanced expansion going forward -- that is to say, we will probably be expanding internationally very close to the recent rates that Electronics Boutique has been expanding, and somewhat cautiously backing off on the U.S.

Net-net, it is still going to be, by anyone's standards, a very aggressive growth company, although we may look at that a little bit more in terms of a worldwide perspective than simply a U.S. perspective.

Good job this morning.

Evan Wilson, Pacific Crest.

First, on your Q4 conference call, you levied some initial guidance for the year -- 15 to 20% revenue growth and flat to 5% up comps.

I was hoping you would touch on that again and if there was any changes to that.

No, when we reiterate our full-year guidance and give the earnings per share, we typically just assume the same for the sales.

But yes, we are still looking at the same sales and comp guidance that we gave at the beginning of the year.

Great.

And in terms of the inventory position, it was up sequentially; even though sales were off, it was up about 16%, I think, per square foot, according to my calculations.

Anything going on there, and could you touch on whether or not that had any impact on the comp guidance?

Right, as I mentioned earlier, on a store-by-store basis, it was up about 18 or 19% from the prior year.

But the reason for that is the hardware shortages that we experienced last year.

We had very little hardware in stock of PS2 or Xbox at the end of July last year, and obviously, we do this year.

So that was the major reason for the increase.

And as well, we obviously had an increase in our comparable store sales, as well.

And finally, there have been two high-profile games and some others have been pushed out to Christmas -- Zelda, the Godfather stick out most notably.

Does that change the way you guys have looked at Christmas at all, and how can you quantify the impact of the big game or two big games like that being pushed out?

Well, obviously, we are disappointed by the delay of Zelda.

We do not believe that that is going to impact our quarter.

We think there will be other titles.

There are plenty of new titles in all formats coming out for each platform.

So other titles will just take their place on consumers' Christmas lists.

Okay.

Thank you very much for being with us today.

And I hope you share the enthusiasm that we all have with this business going forward, and our new model, combining the best of GameStop and the best of Electronics Boutique.

We really believe that we are building an exciting company here.

And thank you very much for following us.

And this does conclude today's conference.

Thank you for your participation.

You may disconnect at this time.