GameStop Corp (GME) 2006 Q2 法說會逐字稿

Good morning and welcome to Gamestop Corporation's second-quarter 2006 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 the property of Gamestop.

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

And at this time I'd like to turn the call over to Dick Fontaine, Chairman and Chief Executive Officer of Gamestop Corp.

Please go ahead, sir.

Thank you.

Good morning and welcome to Gamestop's second-quarter conference call.

With me this morning are Dan DeMatteo, our Vice Chairman and COO;

Steve Morgan, our President; and David Carlson, our Executive Vice President and Chief Financial Officer.

David will be taking you through the numbers in just a moment, Steve will follow-up and will be commenting on the completed integration of our merger, and Dan is going to be discussing the drivers and the potential for the third quarter and the second half of the year, and then as usual we'll wrap the session up by taking questions.

This morning we released our second-quarter numbers which were superb and combined with the strong first-quarter performance has gotten us off to a great first half in what's going to be a very strong year for Gamestop.

During the quarter all aspects of the business were solid -- and I really want to stress that, all aspects of the business were solid.

We exceeded our sales goals, surpassed our comp store forecast, increased our gross margin, reduced the SG&A expense, were more efficient in our inventory control and improved our cash on hand position at the end of the quarter.

That's about as close to a grand slam as I think you could imagine in any given quarter.

I want to come back to margin for just a second.

For those of you who have been following us for some time you know how significant the margin increase is in a quarter where we had such robust hardware.

As a matter of fact gross margin increased not only for hardware but for software and used products as well.

Almost as important as the numbers is that -- the fact that during the quarter we completed the internal integration of Gamestop and EB.

As all of you know, a great deal can go wrong when two very large companies attempt to combine and run as a single entity.

Yet the early work done to bring these two companies together under a best practices single culture got off to such a great start that over the last six months as each of these milestones have been met, many of them exceeded.

I've been telling the management team that we are well on our way to completing perhaps the most professional merger ever.

I believe we've accomplished that goal and it has put us in a position to maximize all the potential that we originally envisioned.

The shear number of people have had a very meaningful effect on accomplishing this integration is testimony not only to be very deep management that we have at Gamestop, but to the work ethic, flexibility and dedication of our team.

I couldn't be more proud of how well everyone has come together and how well everyone has worked together to accomplish this goal.

There's no question in my mind that the merger with EB has already proven to be very successful and will prove to be even more so as we roll through the second half of the year and on into a very bright future.

Along with the work on the integration, one of the key accomplishments of the second quarter was to take a complete and total assessment of our real estate portfolio, literally store-by-store, all stores in all countries.

That has proven to be very, very successful.

But during the quarter as a result of this very meticulous review by at least Gamestop's standards, we opened only 54 stores in the second half while closing 27.

I want to stress that of the 27 stores that we closed, that does not mean that we walked away from the volume in all of those stores.

There are about half of those stores where we fully expect to see transfer sales into existing stores.

I want to tell the group at this point in time while the 54 stores during the quarter, again, is relatively modest by Gamestop standards, I have absolutely no doubt that we will be achieving our goal of opening 400 stores worldwide by the end of the year -- certainly are through this process and we'll be getting into Gamestop speed as we move into the third and the fourth quarters as far as new stores opened.

There are opportunities out there, our real estate people are on top of them and we will be achieving this goal.

But again, I want to come back and remind the group that our goal is not simply to get numbers but to get quality new stores.

And again, during the second quarter that quality has gotten better and better and we fully that that will continue through the rest of the year.

In short our second quarter was solid, our first half was solid, we're in a great position to capitalize on the great product releases of the second half that Dan will be addressing in just a minute.

But before we do that and hear from Steve I want to turn it over to David for a review of the numbers.

David?

Thanks, Dick.

Good morning.

Before the market opened today we released our sales and earnings results for the second quarter of fiscal 2006.

Gamestop's sales for the second quarter increased 132% over the prior year quarter to $963 million.

Comparable store sales increased 3.9% for the quarter with strong sells through of the new Nintendo DS Lite handheld system and in-stock positions of Xbox 360 hardware spurring the growth.

In addition, new videogame software increased 8% with New Super Mario Bros. and NCAA Football 2007 topping the bestseller list.

Net earnings for the quarter were $3.2 million including merger-related expenses of $1.6 million.

Diluted earnings per share for the quarter were $0.04 including $0.02 per diluted share for merger-related expenses.

These results exceeded the high end of our previously released guidance and stemmed from better-than-expected sales performance of new videogame hardware and software.

Gross margins improved year-over-year in the quarter due primarily to higher hardware margins from Gamestop's warranty program and improved used videogame margins.

Likewise, SG&A leverage improved from the prior year quarter by 120 basis points on a pro forma basis.

This leverage came primarily from the closing of the EB Westchester general office and the Coatesville distribution center.

Based on these strong results operating earnings doubled on both a GAAP and a pro forma basis.

We also issued guidance for both the third quarter of fiscal 2006 and the full year.

We are expecting third-quarter comps to range from plus 4% to plus 6% with diluted earnings per share of between $0.20 and $0.22.

For the full fiscal year of 2006 we continue to believe sales will grow 15 to 17% on a pro forma basis with comparable store sales increasing between plus 7% and plus 9%.

Diluted earnings per share are now expected to range from $1.94 to $2.04.

Our balance sheet remains strong with over $200 million in cash at the end of the quarter and inventory levels decreasing on a store-by-store basis from the prior year quarter.

In May we announced Board approval of a $100 million note repurchase program to be used from time to time as market conditions warrant.

Through the second quarter we repurchased approximately $7 million of notes.

We have continued to repurchase debt in the third quarter and have completed total repurchases of over $22 million of notes through yesterday.

In addition to the bond buybacks we also completed the sale of the Coatesville distribution center during the quarter and paid off its mortgage of approximately $9 million.

With that I'll turn it over to Steve for an integration update.

Thanks, David and good morning, everyone.

I thought I'd take just a moment to recap some of the milestone events that have taken place over the past six months leading up to the successful completion of our Gamestop integration.

Back in February the entire field organization was successfully blended into one operations team utilizing one reporting structure thereby setting the stage for consistent communication ensuring the smooth balance of the rest of the integration.

In March all of the EB stores were connected to the Gamestop inventory management system and tonight I'm happy to announce the last Gamestop store will be converted to the EB POS system allowing the entire company to operate on a single replenishment system from a single buying office from two very well-positioned distribution centers.

This past April all payroll system conversions took place followed by an entirely new benefit package which was enacted on July 1st.

Lastly, the functional integration of the Louisville distribution center which began last November has recently been completed and is fully up and running and now handles our top 500 SKUs as well as most shipping for EBGames.com and Gamestop.com.

As a result of the recent enhancements to the centers stores can now get daily replenishment if needed with reduced in-transit time and freight costs due to its location and proximity to the UPS hub.

It is also being used as our primary breakpoint for new titles thus saving third-party logistic costs.

Freight costs on all categories have been reduced and the management headcount is the same as it was prior to the integration while supporting twice the number of stores.

These completed tasks essentially end the integration of Gamestop and EB Games.

What now remains is the fine tuning, enhancement and the physical rebranding of our stores.

But this organization is now officially on one system run by one field organization as one great company thanks to the resolve and hard work of all our associates here at Gamestop.

Thank you.

Now I'd like to pass it on to Dan to talk about what lies ahead.

Thanks, Steve; good morning.

This morning I'd like you talk about what we see as drivers for the third and fourth quarter of this year.

Besides all of the excitement for the new platforms we have some great titles for the existing platforms starting with Madden which launches next week on all systems.

Our reservations are expected to be at an all-time high and we expect sales to set Madden records.

Following Madden we have a new IP from THQ -- Saints Row for the 360 which is reserving extremely well.

And last week Deadrising for the 360 from Capcom hit store shelves and once again we see the tremendous pent up demand for 360 titles.

We expect the supply of 360's this back half will meet the anticipated high demand.

And I'm sure you've been following the tremendous sell through of the Nintendo DS Lite this summer.

We expect it to be at the top of many holiday lists for the handheld gamer.

So before we discuss the new platforms, here are some of the best-selling titles we see -- in August Madden, all platforms from EA, as I just mentioned;

Final Fantasy VII for PS/2 from SquareSoft; and Deadrising for Xbox 360 from Capcom.

In September things really begin to heat up here.

We have a great September especially compared to what we were comping over LY -- MBA live, all formats from EA;

Saints Row, as I just mentioned, for Xbox from THQ -- yes, that's THQ with an M-rated game;

The Godfather for the Xbox from EA;

Pokemon Mystery Dungeon for the Nintendo DS from Nintendo; and LEGO Star Wars Trilogy for the PS/2 from Lucas; and many, many others.

We expect, as I said before, a very big September compared to LY.

And then in October we have Scarface for the PS/2 and Xbox from Vivendi;

Grand Theft Auto - Vice City Stories for the DSP from Take2;

Tiger Woods Golf, all formats from Electronic Arts;

Mortal Kombat for PS/2 from Midway; and Splinter Cell for Xbox 360 from Ubisoft.

So we have a great slate of games for the existing platforms.

We are working with both Nintendo and Sony on respective launches of the Wii and PS3 and expect to relay our stores with introductory PS3 and Wii sections in September.

Our first combined company annual managers' conference will be held in several weeks so we can prepare our associates for what we believe will be a record back half.

As Steve mentioned, the integration work is all behind us now and has been totally successful.

The back half of this year is loaded with product for all types of gamers and we believe we are well-positioned to capitalize on this dynamic and growing entertainment industry.

Now I'll turn it over to the moderator for a question and answer session.

(OPERATOR INSTRUCTIONS).

Elizabeth Osur.

Congratulations on a great quarter.

I just have two questions.

First, can you talk about the DS Lite hardware supply and whether or not you feel comfortable with the quantities you have in your stores now or when you might see better quantities?

That's a good question.

It has been in relatively short supply.

We're being replenished every week, Liz, but basically we probably are running with only a couple weeks of inventory.

Nintendo is doing all they can to increase the supply.

I can't give you a definitive answer if we will be in full supply at the holiday or not.

Right now it has been in short supply though.

Thanks.

And just a second question.

Can you give us an idea of how to think about used software sales growth in the back half of the year and whether or not there should be some lag between used and new or vice versa as the new consoles come out?

Thanks.

That's a good question.

As we see in this quarter the new used Gamestop software followed the new game software.

And generally that is the case, but mostly when we get into the third and the fourth quarter especially there will be a lag as the new game software becomes a more dominant piece of the mix.

So yes, generally in the first and second quarter they follow pretty close, but with all the new releases in the third and fourth the used will have a lag over the new.

Okay, thanks a lot.

David McGee, SunTrust Robinson Humphrey.

Good quarter.

A couple questions.

One is, if you ex out the electronic boutique stores in the quarter, how did the used business do year-over-year?

David?

The used business on a pro forma basis grew at a little over 9% which is very, very close to the 8% growth we saw on the new software.

So slightly better than new software, but very close.

And do you all have a -- what are your thoughts now on unit expansion for 2007?

New stores, David, is that what you're talking about?

Yes.

We're consistent with what we talked about early in the year.

We're forecasting 600 stores.

And again, as you can imagine, we've already got a number of those teed up, so we feel confident that that will be achieved.

And then lastly, the recent news from Microsoft offering software to gamers who develop their own games, is that something we should see as kind of a niche business going forward?

I don't think that's probably much of a niche in total.

I don't know how to answer that -- I don't think any of that stuff will get probably published in box form.

I don't think so, I don't think it will be a niche for a for us, but I don't think it's going to be much of a business in total at all.

I don't think it's going to have a significant or even a nominal effect on our business per se.

But having said that, from a personal standpoint I think it's a good idea.

I think certainly anything that can be done to continue to stimulate the interest and unique creativity out there -- something we sometimes call garage publishing -- with individuals with an idea that they want to follow and if this makes the programming somewhat easier -- should something emerge that would be outstanding.

I think it's probably a healthy thing for the industry and my guess is that some of this is probably going to be incorporated into some of the graduate programs in a number of the universities.

So I like it but, as Dan said, I just don't think it has any significant impact on the business.

Thanks and good luck in the second half year.

Mike Wallace, UBS.

A couple questions.

As far as the launch quantities go, what sort of numbers are you putting into your budget for the Wii and the PS3?

I know the companies have said about $4 million worldwide by the end of the year.

So assume that's $2 million for the U.S.

Most people are cutting the Sony numbers in half.

Could you talk about what your thinking is for both of those platforms and what your thinking is for allocations and when you're going to start taking pre orders for both?

In our assumptions for the platform launches, that hasn't changed since we first talked about it.

We're looking at around 1 million units of PS3 in the U.S. which is somewhere around half or less of what Sony has said.

And with the Wii we are looking at about 750,000 in the U.S.

We believe that's probably at this point could be a light number.

So it's hard to say, though.

We remain conservative until they actually show up at our warehouse.

Mike, we're not going to take pre orders until we have some more clearer information from both Nintendo and Sony in terms of likely launch quantities for Gamestop.

We don't want to do what we did last year which was take way too many on the 360 and then under deliver.

So we want to get closer to keeping a promise with the consumer.

So we want to know more what our quantities are going to be before we begin doing that.

I assume you'll know by over the next couple of weeks I would hope they're going to start talking about that to you guys?

Yes, well -- Nintendo has said it would be some time in August and then next week there's a meeting in San Francisco with Sony to prepare for the PS3 launch.

And I don't know if numbers will come out of that or not -- they haven't said and my guess is not.

My guess is not.

I think we'll know Nintendo's before we know Sony's.

As far as the number of titles what are you thinking for PS3 and for Wii?

For Wii the number I keep hearing is about 25 titles.

For PS3 I think, again, next week's planning is going to announce that in San Francisco.

Although if my memory serves me right, when we had dinner with Larry Probst at EA a couple weeks ago and I thought he said EA was going to have four titles that launch on the PS3.

Yes, they said four to five on their call.

At any rate, Mike, one of the things that is quickly coming upon us and certainly the publisher partners are well aware of this, as Steve alluded to, is that we will be having our all store manager conference in the third week of September.

That's an opportunity for our publishers to come before literally every one of our store managers.

Over the years that has proven to be a great event that is not only giving the publishers great feedback but really gets our people focused on our objectives and goals relative to these titles and hardware units.

So I would certainly hope that the publishers are moving towards more definitive information before that meeting.

So along with what Dan said I think the other milestone would be to see what we get going into our store manager conference.

Okay.

And for the Wii launch, traditionally they've kind of skewed more towards Wal-Mart and toys than now that you're a much bigger piece of the market you're assuming that you're going to get a little more on the launch?

I would assume that definitely.

Our market share on the Nintendo DS Lite, although I won't get specific with it, I believe it's number one in the country.

So we have been working extremely well with Nintendo.

We have helped develop that Nintendo market.

We have hundreds of thousands of reservations already on the Legend of Zelda that goes along with the Wii.

So I think that we've been great partners together in really developing the Nintendo market.

The other thing that I would say is because this is using some radical new approaches to video gaming and the interaction of the controller as well, I think Nintendo is well aware of the fact that it isn't just introducing another iteration of a machine but a totally new approach to interacting with the games.

And I think they're well focused on the fact that it's extremely important that they convince all of our store managers that this is an emerging technology and not a gimmick.

So I think along with the fact that we've been performing better and better in the Nintendo category, I think convincing our store managers that this is very cool and is here to stay is definitely within their focus.

So I think to launch this new approach they're going to be more dependent upon the true core gamers than perhaps we might think.

And lastly, Mike, on this too is I might want to say as it relates to the DS and probably will be the same for the Wii -- our trade-in model works extremely well here.

We're getting a tremendous amount of trade ins of older handheld systems as people trade up to the Nintendo DS and because its currency in their pocket.

And I think this trade-in model will hold up extremely well when that Wii comes out people trading in GameCubes and N64s, etc., on the Wii.

Okay.

And then just one more question.

Everybody's nervous about what Sony is going to actually have compared to what they've talked about.

For you guys if it's not 1 million, if it's 500,000 or 700,000 what kind of scenarios do you see playing out?

Microsoft, they usually do a bundle -- you think they do a 360 bundle and they kind of ramp up marketing.

So if Sony comes up short do you think people will buy another system or do you think it will sort of freeze the market?

What are your feelings there?

Well, I think last year as we saw the 360 in short supply had an effect of freezing the market.

But if you look at it there wasn't anything new.

There weren't any other new platforms out there so the 360 was the newest thing in the last four or five years.

So this year there will be a Wii and there will be a 360 so no matter what I can't believe it could have the same kind of impact as the 360 shortage had LY.

And do you think -- is Microsoft planning another bundle?

I have not heard of a Microsoft and 360 bundle, no.

I could be out of the loop, but I haven't heard of one.

All right.

Thanks, guys.

(OPERATOR INSTRUCTIONS).

Arvind Bhatia, Sterne Agee.

A couple questions.

First on the European side of your business, I wondered if you have any comments in particular as they relate to the Jump acquisition now that you've had it for a while; what you're seeing there as the potential.

Any comments on the inventory situation?

And then last question on your -- in the past of course you've guided for 25% EPS growth, any updates to that?

In terms of the Spanish acquisition, that certainly was part of what I alluded to as touching all of our portfolio.

We now have in fact gone over and visited every one of those stores and made an individual market assessment of each one of those stores.

I think what you will see is that we will probably from the existing 120 portfolio -- and this is relatively consistent with what our assumptions were going it -- we will close probably another 15 stores as not being productive for us.

Those will probably close in the third quarter.

Again, this is not a surprise to us.

The remaining stores -- we probably have at this time another 20 stores that we could say might be on the bubble.

They look like they have some potential.

To put it into perspective, during the quarter we just completed the installation of the new POS and inventory control system and have gotten the stores pretty much fully completed from the electronics business to the videogame business.

So in the very real sense we're just now really beginning to be truly Gamestop in Spain.

But that's kind of how it looks at the moment and it's relatively consistent with what our expectations were when the package was purchased.

On your question on inventory, as I had said in my comments, our inventory on a store-by-store basis is actually down 6% year-over-year.

Part of that is due to the closing of one of the distribution centers and part of it is just very tight inventory control.

We're very happy of how the merchants and the distribution people have really taken care of the situation.

And on your 25% EPS growth question -- yes, we haven't changed our thoughts on our long-term growth rate for 2007 and 2008 being at least 25%.

Got it.

Thanks, guys.

Edward Williams, BMO Capital Markets.

Good afternoon.

It's Tom [Andrews] standing in for Edward.

Just a couple questions.

On the debt repurchase, can we expect that run rate to kind of continue for the foreseeable future?

And also, can we just get a store breakdown by territory?

And also, can you just touch on what percent of your new stores that you expect to open for the rest of this year and for next year would be in international markets?

Let me give you the store breakdown first.

At the end of the quarter we had 3,684 stores in the U.S., we had 261 stores in Canada, we had 197 stores in Australia/New Zealand and 450 stores in Europe for a total of 4,592 stores.

On the debt repurchase, we're not going to say exactly what our repurchase plans are.

We will use it from time to time as market conditions warrant and that's all we're going to say at this point.

On the go forwards with the stores, and this is somewhat inexact at this time, but of the 600 stores that we're forecasting for the next year I'd say a rough estimation would be approximately 350 domestic and 250 international.

Okay, great.

Thank you very much.

Tony Gikas, Piper Jaffray.

A couple questions.

I've been getting a number of questions from investors about the used business and I think you guys indicated last quarter that you're still chasing used product.

The gross margin in the quarter was really very strong; do you continue to be in short supply of used hardware and software?

If so, does that mean you're paying more for that product at all?

And then I have a follow-up.

As we've always said, we can sell everything we can buy back.

So we are always chasing used product and have been for the last five years.

Now in the second quarter, because there are fewer new releases and we've always said that used videogames are traded in to purchase new videogames.

So we do get more promotional in the second quarter and I think you saw about a 100 basis point drop in margin rate from the first quarter to the second quarter because of that.

But still, it was up over LY about 300 basis points.

So always are chasing used videogames.

Sometimes we get more promotional in order to buy them back.

When the new games are in short supply and therefore the trades are in short supply.

Okay.

And then your view of pricing risk -- we're looking at some new hardware platforms and software products that have some pretty high price points.

What's your view on that risk looking to the next year or so?

And then last question would be what's the biggest risk factor that you see in the market over the next couple of years?

Let me take maybe the highest price point that is out there, the PS3, the $600 level which is breaking new ground.

We have said internally and we continue to say internally that during the early release period we will sell every unit that we can get our hands on.

The real question is to the $600 price point is as the unit begins to be more in full supply how will the next level of user beyond the early adopter, the core gamer, adapt to stepping up and paying those price points?

And it's perhaps a little early to tell.

Again to reinforce, we have no concern about the first tranche and the early and the core gamer, but (indiscernible) market that's a possibility.

On the existing front I think, Dan, you would agree with me on this, that the acceptance -- that's an appropriate word -- of the 360 of the new price points has been very encouraging that for quality product the market is there.

I guess the biggest risk is when we I guess addressed or somebody asked about earlier which was the PS3 launch.

Given the lack of details I guess at this point right now and the fact that Sony is still claiming to attempt a three continent launch simultaneously I would have to put that in as a risk.

But as we've already stated, it's not a risk we don't believe to our financials this year because we've been very conservative, but long-term a failed PS3 launch would be obviously an issue for the industry.

But again, I would go back and say I'm bidding with Sony and I think we all are.

They've got an inordinate amount riding on the PS3, the Blueray technology being adopted.

We think that the demographic that shops at Gamestop is the absolute target opinion makers for adopting Blueray if they do that by entry into the videogame business all the better.

So at the top end we feel very good.

At the existing end we see Microsoft coming on very strong, doing better and better.

Supply is getting better.

And as we've said before and what is very encouraging, the revitalization of Nintendo having an opportunity to broaden the market and bring new gamers in is very, very strong.

So I think we would say while there are some concerns that we've identified we like the existing strong market.

We're optimistic about the upper end in the near-term.

And we absolutely like the entry-level products by Nintendo.

So we feel we're in great shape and are going to be absolutely super strong over the remainder of the year and into next year.

Okay, thanks, guys.

Great job.

Thank you all for joining us today.

A great quarter.

We're all looking forward to the third quarter in the second half and talking to you again in a few months.

Thanks for joining us.

Once again that does conclude today's call.

We appreciate your participation.

You may now disconnect.