GameStop Corp (GME) 2005 Q4 法說會逐字稿

Good morning.

Welcome to GameStop Corporation's 2005 fourth-quarter and fiscal year-end 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 being covered by the Safe Harbor disclosure contained in GameStop's public documents and is the property of GameStop.

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

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

Please go ahead, sir.

Thank you and welcome to GameStop's 2005 year-end conference call.

We're pleased to have you with us today.

With me is Dan DeMatteo, GameStop's Vice Chairman and Chief Operating Officer, and David Carlson, our Executive VP and Chief Financial Officer.

This morning we released our year-end numbers, which were very satisfying and a reflection of a great deal of hard work on the part of our management team.

Fiscal 2005 was clearly a huge win for GameStop and all of our shareholders.

The completion in October of our merger with EB Games was obviously a major milestone.

It not only has tactically been almost instantly beneficial, but has put us in a superb strategic position to capture more of a growing market worldwide.

For the year, we achieved record sales, increased our gross margins, even though very low margin hardware sales grew by almost 5% as a percentage of sales, and kept our expenses well under control, even as we added new stores at a record pace.

Our operating margins grew to 6.2%, 6.6 without onetime merger-related expenses, and net earnings for the year surpassed $100 million.

Our balance sheet remains strong.

At year-end we had over $400 million in cash and operating cash flows for the year came in at approximately $283 million.

During the year, we opened 792 new stores, 450 in the U.S. and 342 internationally.

We will continue to define ourselves as a rapid growth company in the future.

In 2006, we will be opening approximately 400 new stores, slowing slightly only to assure that our field organization has time to digest the many changes of the integration process.

GameStop's marketshare has now grown to the point that 21% of all new videogame products sold in the U.S. comes through our over 3600 stores across the country.

In addition, with the completed merger, we are now doing business in 14 countries outside the U.S. with 866 international stores and are now well poised to reap the benefits of worldwide growth in the videogame category.

The integration is on schedule and has already begun to yield many synergies.

When we brought the two companies together, we did so under the banner of "better together," and that has proven to be much more than a slogan.

While there are many areas where best practices have been applied to improve the business, nowhere is it more evident than in refining our new and used interrelationship.

By applying the GameStop algorithms when setting the buy and sell price for used products to all EB stores, we have not only increased margins, we have improved our new title reservations, which are often reserved by trading used goods, and have given our customers continued great value.

Our management team is not only experienced, but we are very deep.

It takes a great many people working together, holding themselves accountable, making deadlines, and constantly exhibiting a high sense of urgency to move as fast as we have as successfully as we have.

I will now turn the call over to David, who will take you through the numbers in more depth.

David?

Thanks, Dick, and good morning.

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

Earnings for the fourth quarter of fiscal 2005 were $85 million, or $1.10 per diluted share, including merger expenses of approximately $1.4 million, or $0.02 per diluted share.

These earnings exceeded our previously released guidance by $0.04 per diluted share on the strength of January sales mix, January gross margins, and better-than-anticipated expense controls in December.

Sales for the fourth quarter were $1.67 billion, with comparable store sales decreasing 0.3% during the quarter, in line with expectations.

Earnings for fiscal 2005 were $100.8 million, or $1.61 per diluted share.

This included merger expenses of approximately $13.3 million, or $0.21 per diluted share.

Sales for fiscal 2005 amounted to $3.1 billion, with comparable store sales increasing 1.4% for the full fiscal year.

This morning we also provided initial guidance for fiscal 2006.

We are expecting diluted earnings per share for fiscal 2006 to range from $1.83 to $1.93.

As we are adopting SFAS 123 this fiscal year, included in this EPS guidance is approximately $0.17 per share of stock-based compensation.

Excluding this stock-based compensation, diluted earnings per share would range from $2.00 to $2.10.

In addition, we expect comparable store sales for the fiscal year to increase between 6 and 9%, with total sales on a pro forma basis increasing between 14 and 17%.

Embedded in our guidance we are assuming U.S. videogame software growth of between flat and plus 3% for the year.

We are also assuming that the Sony PS/3 and Nintendo Revolution launch worldwide in November.

However, we are modeling conservative quantities for these launches due to our prior experiences with November hardware launches.

We currently expect to open 400 new stores in fiscal 2006 with capital expenditures of approximately $110,000 for the fiscal year -- $110 million for the fiscal year -- excuse me.

Merger synergies are on track, and we now expect savings of between 70 and $80 million in fiscal 2006.

These synergies represent both cost savings and gross margin enhancements realized from applying best practices from both companies, including the elimination of duplicate general office and warehousing expenses, advertising efficiencies, freight reductions, benefits from applying GameStop merchandising algorithms to EB's used videogame category, and other fixed cost savings.

Please note that the elimination of the duplicate general office and warehousing expenses should occur in the last three quarters of the fiscal year, as the West Chester general office and the Coatesville distribution center are phased out.

For the first quarter of fiscal 2006, we are expecting comparable store sales will decline between 7% and 9%, due primarily to the launch of Sony PSP in the prior-year quarter.

Diluted earnings per share are expected to range from $0.04 to $0.05 per share, including stock-based compensation of approximately $0.04 per share.

Excluding stock-based compensation, diluted earnings per share would range from $0.08 to $0.09.

Finally we are extremely positive about GameStop's future.

With strong industry fundamentals on the horizon, continued work to extract synergies from the merger with Electronics Boutique, and the strong cash flow we are experiencing, we believe we can achieve a long-term EPS growth rate of 25%.

Now I will turn it over to Dan for his comments.

Good morning.

This morning, I'd like to share with you some of our assumptions that went into our sales planning for '06, give a brief update on the integration activities with Electronics Boutique, and then we will turn it over to the moderator for a Q&A session.

First, the sales planning assumptions. 2006 has a lot of moving parts, but at the end of the day, we believe the industry will transition nicely and it will be a positive year in sales for both videogame hardware and videogame software.

We expect that the flow of Microsoft Xbox 360s will meet demand very shortly and you will begin to see retail 360 ads for the first time, as Microsoft will definitely want to take advantage of its head start over Sony and capitalize on the PS/3 announced delay.

We have planned a fourth quarter PS/3 launch, with limited total market U.S. quantities in the 1 million to 1.2 million range.

And we are assuming a launch of Nintendo's Revolution system in the fourth quarter, with again limited U.S. total market quantities in the 750,000 range.

Our hardware sales plan also assumes a price cut on the PS/2 that will drive sales to the 5 million range, similar to last year.

And with the introduction of a new core unit PSP at $199, we expect full-year PSP hardware sales to be in the $5 million range also.

Lastly on the hardware front, we really like what we are seeing in creative software development for the Nintendo DS with the Wi-Fi-enabled games and the new brain fitness games that will appeal to an entirely new demographic and help drive DS hardware sales to record levels this year.

Our software sales planning efforts look at trends as well as expected title releases.

The PS/2 software sales category will be down in the 20% range due to fewer unit sales and an average retail price decline.

We are expecting, though, some record sales of PS/2 titles that will really appeal to our core gamer, like Kingdom Hearts 2 from Squaresoft, due next week, and Final Fantasy XII, also from Squaresoft, due this fall.

Sales of GameCube games are planned to be down significantly this year also, but we will benefit from a new Legend of Zelda game expected this fall, which our marketshare might well be over 50%.

Also, sales of both PSP and Nintendo DS games, the handheld systems, are expected to almost double over the prior year.

And we have been very pleased with sales of recently released Xbox 360 games like Fight Night: Round 3 from EA and Ghost Recon from Ubisoft, which have exceeded expectations.

And our reservations on Elder Scrolls IV from Take 2, due out today, are well above plan.

So while visibility at this time of the year is obviously limited, we are seeing some major title releases from non-U.S. publishers like Nintendo, Sony, Squaresoft, and Ubisoft that drive sales, especially in the core gamer segment, which we dominate.

Customers are trading in their old games for these new games and systems in record numbers.

Remember, the trade-in program gives our customers a source of currency that drives our new business and supplies us the inventory for the budget-oriented customer that cannot afford the price of the newest games.

This new/used model has allowed GameStop to increase new game marketshare each quarter for the past eight years, and once again, in February, we gained almost a full marketshare point over the prior year.

As Dick mentioned, the integration has gone remarkably well and we have already reached some major milestones that will provide the company with the promised merger synergies in '06 and beyond.

Also, we have been implementing best practices across all stores that will improve in-store merchandising, used business practices, and store operating efficiencies, to name a few.

We will begin rebranding in the U.S. later this year, but within several months from now, stores' merchandising practices and systems will be standardized such that the customer experience will be exactly the same in both store formats.

Now, we will turn it over to the moderator for a Q&A session.

(OPERATOR INSTRUCTIONS) David Magee, SunTrust Robinson Humphrey.

Great quarter.

Just a question regarding what you are seeing with your newer stores on the international front.

As you look over the next couple of years, more and more of your new stores will be there.

What are you learning as far as the economics and experience of opening stores there?

Well, the economics, David, are generally like the U.S.

There probably are slight differences country by country, but for the most part, it is not a totally new business formula.

It is more a variety of the existing business formula that we have fine-tuned in the U.S.

Just some of them that I might hit is that in Spain, we are obviously adopting -- we have a new business in Spain we're adopting to some very unique business hours.

They are open only 39 hours during the course of the week.

That will be somewhat different for us.

In Germany, we are expanding very rapidly.

There, we have potential for very high sales per square foot, but commensurately somewhat higher rental costs, particularly in the malls, which is where most of our expansion is taking place.

And in all countries, they probably are two steps behind where we are in the U.S. in terms of developing the nuances of their new and used business model.

They certainly are in that business, but they probably are where we were perhaps two plus years ago.

So we think we will move them much more aggressively into that category, not only increasing the used sales, but as I indicated before, driving more [new] sales and giving customers better values as well.

Thank you.

Elizabeth Osur, Citigroup.

Thanks.

I just had two questions.

One, could you just specify -- obviously, we're supposed to see the synergy number for this year, but you're still expecting an incremental $20 million in SG&A synergies in the following year?

Yes, we're looking at some additional synergies in the following year because of the timing of the closing of the general office and distribution center.

Obviously, we feel we will get a pretty significant piece this year, but it will be closed for the entire year in 2007, obviously, so we will pick up some additional synergies, yes.

Okay, thanks.

And then second, could you just kind of comment on your bigger picture goal of saying that you felt that there were the potential for 7000 specialty videogame stores in the U.S. and essentially the same number in Europe.

As you spend time going through the EB portfolio, does that still seem like a reasonable number to you?

Are you worried about cannibalization at any point?

Well, we have continued -- because we have grown so fast over the last few years, we've kept a very close eye on cannibalization, or to be precise, cannibalization that does not make financial sense.

We have in many instances put stores within markets where we felt that there was going to be a 5, 10% cannibalization, but net-net, the investment still made sense.

That will continue to be the case.

We have not changed our opinion as to the growth of the market with the merger of Electronics Boutique.

We probably have refined our criteria somewhat in terms of new stores because we have such a larger base now to analyze.

But fundamentally, there isn't anything that would cause us to back off our growth projections based on the mergers of the two companies.

And indeed, given that we are beginning to be more knowledgeable about the opportunities and the potential internationally, if anything, there may be more opportunities there than we originally thought.

Thanks.

If I could just ask one more, can someone kind of speak to the software comps you expect in the first quarter and how you're thinking about some of the top titles over the next few months?

Overall comps, Liz, I think, as David said, will be slightly negative in the first quarter, primarily because of the PSP launch.

But earnings will increase nicely in the first quarter, primarily because of shifting mix to more software sales.

And we have some great titles that have already released in the quarter, and I think I mentioned one that is due out today, Ghost Recon -- or Elder Scrolls -- Ghost Recon came out a couple weeks ago -- we expect it to be very well.

So we're really pleased with sales of games that are released so far in the first quarter.

We have not had disappointments in game releases.

And as a matter of fact, it has been more the opposite.

We have been pleasantly surprised with the strength of some of these titles that have come out.

That's great.

Thanks a lot.

Edward Williams, Harris Nesbitt.

A couple questions for you.

First of all, you alluded to it in your remarks, but we are hearing that there is a significant supply of Xbox 360 hardware coming into the channel in the next few weeks.

Could you kind of give us some color as to this compares to what your original launch quantities were?

I don't know, Ed, if I can compare to my original launch quantities that quickly.

I can tell you that, as I mentioned, you will begin seeing ads for 360s, which imply pretty much widespread supply.

And I think there was an announcement by Microsoft just this morning that talked about -- what -- a two to three times the number weekly than they had been supplying the channel.

But that channel supply has been lumpy.

Some weeks it has been good and some weeks not so good.

So with this two to three times, which week?

I can't answer that.

But from everything we are getting from Microsoft, we have turned a corner, and that supply seems to be -- we're expecting supply commensurate with demand any day now, within the next several weeks.

Okay.

Then looking into calendar '06, what are your capital expenditure plans, given the 400 store builds?

And should we model those stores similar to historical patterns or what is the rate that we should be adding them to your model?

As I mentioned, we're looking at about 110 million of capital expenditures for the year, and they should be fairly evenly distributed over the four quarters.

Right now, it's looking like about [100] per quarter.

Okay.

And are these stores primarily going to be in Europe or can you give us some geographic or --?

We have said in the past that we think about half of the new store openings will be U.S. and half of them will be international.

Okay.

And what was your approximate store breakdown, if we were to look at it on a geographic basis at the end of the year?

At the end of the year, we had 3624 stores in the U.S., 261 stores in Canada, 177 stores in Australia/New Zealand, and 428 stores in Europe, for a total of 4490.

Dave, if you could just talk for a moment about comps for the year.

Are there other -- how should we look at comps in the second through fourth quarters?

It sounds to me like the fourth quarter should be fairly substantial, obviously, given the two new hardware systems comping against 360 and then significant supplies of 360.

Sure.

Although we have not given guidance yet, I think we can say that based on our full year number, the second, third, and fourth quarters at this point, at least, look to be positive comps versus the negative comps we were looking at in the first quarter.

And the primary issue in the first quarter is just the launch of PSP in March of last year?

Definitely.

That is the significant issue, yes.

Okay.

Then what was the timing that you're hoping to have the EB headquarters close down by?

I said it has -- many functions have already closed, but mostly it will be entirely closed about the 1st of April.

Okay, so looking at your second quarter, is that when we begin to get significant realization?

So the synergies that you are alluding to from the EB merger, will those primarily be coming in the second through fourth quarters?

As I mentioned in my comments, the distribution center and general office synergies should be coming in the last three quarters of the year, yes.

Great.

Thank you, guys.

(OPERATOR INSTRUCTIONS) Arvind Bhatia, Sterne, Agee.

Great quarter.

Quick question on the used business side.

Can you update us on the competition that you might be seeing there?

Then I have a follow-up.

I don't think is any new competition particularly, and certainly not on any massive scale that hasn't been out there before.

I'm sure, Arvind, you have heard or rumors or saw some minimal press release that Best Buy is testing the concept.

We of course are keeping an eye on that.

That appears to be in very, very few stores, with somewhat of a start-and-stop approach at the moment; so that is extremely limited.

The other two major competitors that are in the category, obviously, are Game Crazy and GameRush.

Because of the issues that are facing them, predominantly on the movie side, they are clearly not as focused on this category, nor are they as aggressive.

So I would say that it is a particularly good time for us in that none of the competitors that we have out there are moving forward tremendously aggressively and there really have been no new competitors on any significant scale.

Great.

A question on the marketshare increase that you talked about in February, 1%.

Can we look at the year-end numbers, January '06 and January '05 pro forma, 21% compares to -- what -- is it a couple percent share gain, more than that, less than that?

It was about a 3/4 percent share gain.

3/4, okay.

And last, Dave, clarification.

You had talked about $30 million in synergies this year and 50 next year.

And of course that was timing -- or 50 was the run rate.

Now 70 to 80 million is the actual synergies that you expect this year?

That is correct, yes.

Okay.

Just want to be sure.

That's all I have.

Thank you, guys.

Tony Gikas, Piper Jaffray.

A couple questions.

Have you experienced any changes to the margins to the used videogame business as a result of the transition or the merger with Electronics Boutique?

Has there been any opportunity to maybe improve those margins?

Second question, with the strength in the used business and this now being I guess potentially about a $1.5 billion industry in the U.S., have you been approached by any of the videogame publishers regarding the impact to their business?

Is there any -- could that business be compromised in any way?

And who sets the license agreements?

Is that Sony and Microsoft, etc.?

I guess I can answer those questions.

The first question is had we seen any margin improvement.

I think as Dick mentioned, by utilizing the best practices primarily of GameStop's pricing model, yes, we have seen some improvement in margins in the used videogame business.

And that is part of the synergies that they have alluded to in the $70 million to $80 million range that we will receive this year.

We're not breaking out exactly what that piece is, but that is part of it.

As it relates to the used videogame business, I think we had been very successful in explaining to the software publishers how the used videogame business benefits the new videogame business.

It drives it because it provides the customer with currency that they did not have and allows them to purchase new videogames.

Indeed, 80% of our trade-ins last year, in the year 2005, went towards the purchase of new videogames.

In other words, only 20% went used-to-used and 80% went used-to-new.

So we provided hundreds of millions of dollars of currency with which people, consumers bought new videogames.

It does not cannibalize the sales of new front-line videogames.

We have also proven that, in that consumers do not trade in games until long after they have played them, and usually it takes over a year or so before they trade them in.

So it drives the new game business.

We have had many discussions with the publishers and we think they all understand that.

Who sets those licensing agreements?

Is it the publishers or is that a Sony, Microsoft --?

It depends on intellectual property, but it is probably mostly the publishers who are setting the agreements.

Okay.

A couple quick follow-ups.

What is your price expectation for the PS/2 and Xbox when it gets cut here?

And when specifically -- is that a midyear cut and the specific price point?

I believe we have it planned at an E3 timeframe, and I believe it is about $129.

Okay.

Final question.

Can you comment on your used inventory levels?

Do you have enough supply of product right now?

Some of our checks have been showing you guys appear to be a little on the light side in terms of used.

Let me jump in, because we have addressed this on many occasions and I would say your last comment is correct.

It's a category where we continue to chase product, and at this point in time, I would say that we are somewhat light.

I think we will do a better job of getting those light stores into stock with some stock balancing within markets that will take place a little bit later as we complete the integration of our systems.

But the truth of the matter is that this is a category for the most part where we are chasing inventory and your observation is correct.

We are somewhat light at the moment.

Good job.

Thanks, guys.

Evan Wilson, Pacific Crest Securities.

Thanks for taking the question.

I wonder if you could drill down a little bit more on the cost of goods, both from the new hardware and new software side.

We saw a pretty big variance in Q4 relative to Q3 and also to Q4 last year.

Could you explain exactly what the drivers are there and how we should model that going forward?

Sure.

The margin on the new videogame hardware was up quite a bit from last year, which really had to do with the warranty programs that Electronics Boutique had in place that we have adopted for both companies.

So the entire increase has to do with that.

On the new videogame software, as we had talked about in the third quarter, co-op advertising will be very strong in the third and fourth quarters of this year, and that does get allocated into the margin.

So last year, when Halo and Grand Theft Auto came out, the co-op was fairly light in the third and fourth quarter; but this year, it was much better and back to the normal rates really.

So how would you expect that continue through 2006 and where would you expect it to finish the year?

I would expect it to have similar rates to what we experienced in the fourth quarter of 2005.

And what is the difference in terms of the Other line, the 500 basis point change in Q4 over Q3?

There are so many categories in there.

Off the top of my head, I'm not going to be able to give you a good answer there.

What are you guys forecasting for a tax rate in 2006?

We're looking at somewhere between 37 and 37.5%

Bill Armstrong, C.L.

King & Associates.

Great quarter.

On the $70 million to $80 million in costs synergies or synergies, my recollection was that you had been talking about $50 million.

I was wondering what the delta was there to increase that -- where that came from.

It was a couple things.

One was the freight savings that we were able to get from putting the two companies together, which we had never quantified.

Second, it was the benefits from putting the EB used videogame category through the buying and selling algorithms that GameStop has implemented.

Okay.

So that means it is not all going to hit the SG&A.

Some of it will show up in gross profit.

Definitely some of if will shop up in gross profit.

Okay.

Just a clarification on your longer-term 25% earnings growth projections.

Does that mean in the three years after '06 -- in other words '07, '08, and '09, you are looking for about 25% growth in each of those three years?

Actually, the way it's stated is that we expect for the three years 2006, 2007, and 2008 to have at least 25% growth rate, with 2006 obviously being higher, based on the guidance that we gave.

But what we were really trying to do there is to signal a long-term EPS growth rate.

Okay.

So it's not like a compounded rate where you get the 81% in '06 and then some single digit number in '07 and '08?

No, we were not.

Okay, just wanted to clarify that.

Finally, I guess you kind of answered this -- obviously, looking for negative comps in the first quarter and then positive beyond that.

I assume that you are assuming the biggest comp number would be in the fourth quarter with the two big launches?

That is pretty much correct.

We are looking at probably the largest comp in the fourth quarter when the PS/3 and Nintendo Revolution launch.

Do you feel that your unit assumptions of 1.0 million to 1.2 million for PS/3 -- first of all, I just want clarify -- is that North American?

Yes, that is the U.S.-based number.

Do you feel that that is a conservative number or --?

I don't know what I feel in terms of hardware launches anymore.

We don't really believe, though, that it is that significant, wherever that comes in at.

It could be higher than that; it could be less than that, and it's not going to have much significance at all to our fourth-quarter earnings.

Did the delay from the official spring target to November by Sony, did that come as a surprise to you guys?

No.

As a matter of fact, I think Dan mentioned this, is from the very get-go, we have had this forecast in our models as a November launch.

And with the discussions that have taken place leading up to this, we would have been pleasantly surprised had this come out, but it didn't change our numbers or our forecasts at all.

Great.

That's all I had.

All right.

Thank you very much for joining us.

Obviously, an outstanding year for GameStop.

We are extremely enthused about the year ahead and we really appreciate your support.

Thanks for joining us today.

Again, ladies and gentlemen, this does conclude today's conference.

Thank you for your participation.

At this time, you may now disconnect.