GameStop Corp (GME) 2008 Q2 法說會逐字稿

Good morning.

Welcome to GameStop Corporation's Q2 2008 earnings 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 would like to turn the call over to Dan DeMatteo, Vice Chairman and Chief Operating Officer.

Please go ahead, sir.

Good morning and welcome to GameStop second quarter conference call.

I am Dan DeMatteo, GameStop's Vice Chairman and Chief Operating Officer; Dick Fontaine, our Chairman and CEO could not be with us this morning as he is recovering at home from minor surgery from this past weekend; with me today is David Carlson, our Executive Vice President and Chief Financial Officer.

This morning, we released our financial results for our second quarter 2008 and gave guidance for the remainder of the year.

Given the economic environment we are operating in, our performance could only be described as spectacular.

Clearly the consumers accepted the great entertainment value that video games provide.

With sales increasing 35%, comps increasing 20%, and earnings increasing 162%, we could not be more pleased with our results.

These results were achieved through great leveraging of our SG&A expenses on strong comp sales.

David will give you more details of the specifics for the quarter financially.

Once again, our model which creates value for the old games consumers are no longer playing did well with the budget stretched consumer.

As a matter of fact, we had five of our Top 10 trade weeks of all-time in this second quarter and our June trades set a new monthly record.

Also, our Nintendo Wii trades which some people were concerned about grew five times faster than the average as we focused on converting this new consumer to our trade model through our marketing activities and sales associates.

You may have seen our TV ad this summer promoting our trade in message.

As a result of all this trade activity, our used sales grew 32% and we expect continued great sales growth over the rest of the year in the used category.

If we analyze US video game sales in the quarter as reported by NPD, the growth has been driven by ever growing installed base of next generation consoles and handheld systems and new genres, and the installed base growth continued in the quarter with these systems growing 44% on top of 55% last year led by growth of the PS3, Wii, and X-box 360.

Also, handheld systems performed well with 32% growth in the category during the quarter.

Clearly, the installed base this year will grow over last year.

The year in which many predicted was the peak.

Again, we believe this cycle will be broader and longer than any cycle of the past as video games are truly becoming mass entertainment for consumers of all ages.

As we all remember, last year had the release of Halo 3 in the third quarter, GameStops best selling title of all-time which resulted in 46% comps.

This year we see a much broader line-up of titles that will drive sales in the third and fourth quarter and along with growth in our used sales has allowed us to increase our back half sales and earnings guidance and again, David will discuss this further.

The title line-up for the back half includes--Fable 2 for the X-box 360, Call of Duty, World at War for the X-box 360 and PS3, Years of War for the 360, Animal Crossing for the Wii, World of Warcraft again for the PC, Guitar Hero World Tour All platforms, Rock Band 2 all platforms, and Kirby Superstar for the Nintendo DS and many others so you can see the breadth of titles we have across all these new platforms.

Now I'd like to discuss our new store growth.

First, we do not add new stores solely for store count and we try to avoid cannibalization of sales in our existing stores.

The goal of our new store program is the expansion of the market by growing our used sales, capitalize on growth from the industry and take business from our competitors.

Our new stores that opened this year as a group are performing as well as the year before group and the year before that.

In other words, our new store selection process and financial performance continues to succeed our model as it has in the past.

In the quarter we added 125 new stores, 68 in the US, 28 in Europe, 25 in Australia, New Zealand and four in Canada.

As we have said in the past, the specialist model which includes the buy-sell trade, largest assortment of games and best-in-class sales support continues to be accepted around the world in all areas we operate.

As a matter of fact we believe we now have number one market share of game sales in the US, Canada, Australia, Italy, Ireland, Scandinavia and are closing in on it on the Germanic countries.

Therefore, we believe we have many opportunities for expansion in all countries we operate and continue to look at new countries to expand into.

In our release we stated that we believe our earnings will continue to grow extremely well next year by at least 25%.

While we do not have visibility to many releases next year, we expect the continued growth in the next generation installed base and historical tie ratios as well as growth in our used games to drive top line sales in earnings.

Now before I turn it over to Dave this morning, this morning we have had some questions about the apparent loss of share in the quarter.

First, comparing our total software growth to US NPD data will not give an accurate picture as over 27% of our sales are international, and in the second quarter, their release schedule was not as robust as the US.

As far as we know, there isn't a comparable data source outside the US like NPD.

Next, the mix of titles sold in the quarter will have an affect on our market share like last year in the third quarter where we way overindexed with Halo 3 and lastly, we have the used category which other retailers don't, growing at the rapid rate of 32% in the quarter.

We are making investments in our infrastructure to support our growth.

We continuously make improvements in our used model to drive more trades and manage this inventory.

Our Game Informer magazine just broke the 3.5 million subscriber barrier and we even have an Italian version of it.

We are hosting our annual store managers conference in a few weeks that will be attended by all of our field management and 56 of our suppliers.

We feel that we are ready for the back half of the year both US and internationally and are well positioned to continue to grow in this fast growing industry.

With that, I'll turn it over to Dave for a more in depth financial review.

Good morning.

Before the market opened today, we released our sales and earnings results for the second quarter of fiscal 2008.

GameStop sales for the second quarter increased 35% to $1.8 billion as compared to $1.3 billion in the prior fiscal year.

Comparable store sales for the second quarter increased 20%, significantly exceeding our prior expectations of 12 to 14% comps.

These results were driven by exceptional performances across all categories.

New hardware sales grew 29%, again exceeding our expectations and building a massive installed base for future growth.

New video games software sales grew 43% with the US game release schedule far exceeding the more modest European and Australian releases for the quarter.

Used video game sales grew an astonishing 32% with the current economic environment continuing to stimulate trade-ins.

As we've explained previously, used video game growth lags new game growth by 6 to 12 months and this is playing out as expected.

Net earnings for the quarter were $57.2 million increasing 162% over prior year quarters net earnings of $21.8 million.

Diluted earnings per share for the quarter were $0.34 beating the high end of previously released guidance by $0.06 per share.

Please note the acquisition of Free Record Shops in Norway and Finland reduced operating earnings by approximately $2 million during the second quarter and will show up as a reduction to European segment operating earnings when our 10-Q is filed later this month.

Gross margin rate decreased by 20 basis points due primarily to product mix and the stronger than expected sales of hardware during the quarter.

Used video game margins were especially strong increasing 120 basis points from the prior year quarter, as fewer promotional active its were needed to drive the business.

SG&A expenses were leveraged by 150 basis points due to strong sales comps and cost controls particularly in the US segment.

This allowed operating earnings to nearly double and operating margins to increase 170 basis points to 5.5%.

Our balance sheet remains strong with $540 million in cash at the end of the quarter, and inventories growing ratably to the sales increase during the quarter.

This morning we also issued initial guidance for the third and fourth quarters of 2008 and updated guidance for the full fiscal year.

Based on the strong results of the first half and increased confidence in the second half title release schedule, we are increasing various components of our guidance.

First, we had previously expected US video game software sales to grow between 15 and 20% for 2008, and now we're expecting that growth will exceed 20% for the year.

For the third quarter of 2008 we are expecting diluted earnings per share to range from $0.36 to $0.38 with comparable store sales ranging from flat to plus 2%.

As you may recall the amazingly successful release of Halo 3 and the related hardware sales in the prior year quarter resulted in 46% comps with no similar title being released in the current quarter.

For the fourth quarter of 2008 we are expecting diluted earnings per share to range from $1.37 to $1.40 representing EPS growth of 23% at the high end.

Comparable store sales growth should range from 8%to 10% for the fourth quarter with strong results expected across all product categories.

We are raising our diluted EPS guidance for the full year of 2008 to range from $2.45 to $2.50.

We now expect full year comparable store sales to grow between 12% and 14% and total sales to grow between 23 and 25%.

Operating margin is expected to be 7.8% at the mid point of guidance, with gross margins improving 20 basis points from the prior year and SG&A leverage improving by 40 basis points.

Store openings are on Target to hit the high end of our 550 to 600 new store range with new stores performing above expectation even in this current economic environment.

With that, I will turn it over to the moderator for questions.

Thank you.

(OPERATOR INSTRUCTIONS) Our first question is from Bill Armstrong from C.L.

King & Associates.

Good morning.

Great quarter.

Dave, if we look at inventory on a per store basis going into the third quarter it's up about 21% by my calculation, and you're looking for roughly flat comps.

Are there any concerns about your inventory position maybe being a little too high at this point?

No.

We're not concerned about it at all.

We obviously had inventory for the significant increase in the second quarter.

Sales growth in the second quarter yes we're looking at comp s of 2% but we're looking at obviously total growth higher than that.

So we've been building our used inventory.

We want to be building our used inventory for both the third and the fourth quarter, so we're actually very happy with where our inventory levels are at the at the end of the second quarter.

You mentioned the less promotional activity on the used game side during the quarter.

Was wondering if you could flesh that out a little bit and maybe talk about your thinking behind that?

Yes, because of the economic conditions, we didn't have to be as promotional on the buy side of games because it just seemed like we were naturally getting consumers trading them in, so that's why we are, our margins are slightly better than they were in the second quarter last year.

And typically, you always feel like you wish you had more used inventory.

How do you feel right now with your used inventory position?

Well, I feel very good about it just because it's much higher than it was at this time last year and Bill, you're right.

We always say that we can't have used inventory too high going into the back half of the year, so we feel very good about it as I said, we expect used sales to be very strong in the third and fourth quarter because of that inventory.

Got it.

Okay, thank you.

Moving on our next question comes from Edward Williams from BMO Capital Markets.

Good morning.

A couple quick questions for you guys.

First of all can you give us an idea as to what sales were like in the European market, what you think the market growth was like in the European market?

And if you can, some profitability and sales break down on an international basis?

And then looking at your store count, how many stores did you close and what's the end number that you have at quarter end and what's your expectation at this point for the balance of the year and how will those stores split international versus US?

On the European sales level, we won't give a whole lot of detail because you'll get more details when the 10-Q is filed but the comparable store sales in Europe were slightly lower than they were in the US just because of the title line-up basically as we had mentioned earlier.

The title line-up in the US was much more robust than it was in Europe so the comparable store sales in Europe were slightly lower than they were in the US?

And then what was the second?

The second question was related to store closing.

Store closing, store count at quarter end.

And end of year store count.

Sure.

We had 5557 total stores at the end of the quarter.

We opened 125 stores during the quarter and we closed 21 stores during the quarter.

Okay, and then what's your expectation for new store adds for the balance of the year and how will those split?

Yes, we're looking at the high end of our guidance for about 600 new stores for the full year and again, we believe, I believe we said earlier we thought that was about half in the US and half internationally and that looks like that should be about right.

Okay, and just to clarify the point, if I can for a moment or just to touch upon it again, the 43% software growth that you reported which obviously includes international markets and 49% market growth at NPD shows for US, if we were to look at your US number how does it compare to NPD?

For the first half and for the first and second quarters, it compares much more favorably to the NPD number.

Okay.

Thank you.

Moving on, we'll hear from Mike Hickey from Janco Partners.

Congrats on the quarter guys, great job.

I was curious somebody just announced a new PS3 skew with a larger hard drive and I was curious if you could talk about digital distribution and how you expect that will impact your business today and into the future?

I think the primary reason why Sony has introduced that 160 mg hard drive is they want consumers to use that as the hub of their media system with both movies and music.

We do not expect publishers, we do expect publishers will develop some revenue stream by adding on digitally distributed content on selected games but the forecast for this in total is pretty insignificant.

We do know, we don't expect full distribution of new games to be a threat due to the game size and distribution speed so again, we're looking at this as Sony's introduction of a system to act as a media hub.

Okay, and then on your store count, are you still thinking 50/50 US and international or are you over indexing in one geography versus the other and then do you expect that you might ramp up your store count in Q3 versus Q4 to try to hit the holiday period?

Well, as Dave mentioned we still expect about 600, the high end of our range and we still expect that to be about 300 international and 300 US based so it's pretty much even split, and so that's where we'll be at the end of the year and I guess I'd have to add what we did in the first quarter I know we did the acquisition of Norway stores in the first quarter so first quarter was pretty high.

Second quarter was about average, at 125 and the next two quarters will be probably whatever the difference between that is.

Okay.

All right, thanks guys.

Our next question comes from Tony Wible from Citi.

Congratulations guys on the quarter, the market isn't recognizing it but I think you did a great job in a tough environment.

First question David, really deals with the Wii and I'm curious, what kind of inventory outlook do you see for the Wii and do you anticipate any new Wii titles coming out between now and year-end that might fit into being bigger sellers aside from Animal Crossing?

Well, I'll take, Animal Crossing I think is for the DS, is that right or is that for the Wii?

It's for the Wii.

That's for the Wii, okay, I'll take the first one, Tony.

On the Wii allocation, Nintendo told us that allocations will be higher than they have been compared to last year and indeed we have seen that but we still expect shortages on the Wii allocation.

The Wii Fit though will probably actually be the most at least what we see now the most highly allocated of the Wii products.

It's in very short supply, even more short supply than the Wii but at a $90 ring and we didn't have it last year, it's a big plus over LY when it didn't exist.

Some of the other big Wii titles that we see will be Wii music, that's from Nintendo, Rock Band, Guitar Hero, and Ray Man.

Do you believe that there could be another title announced between now and year-end?

I would not have any color on that, it would just be a guess.

I don't have any color on that.

We will have our managers conference as I said in three weeks and Reggie will be there as well as the other executives and I'll be meeting with them privately and maybe they will give me something then but I don't know right now.

Last two questions, I was hoping you could provide qualitative commentary on just how we should think about the hardware margin rate?

I guess it's flat sequentially and running a little bit under what it's been the last year.

Was there anything in the second quarter that caused it to be at the 6% level?

I know in the first quarter you had some impairments but is there anything in the second quarter that caused it to be there?

No.

Other than mix and our warranty program, we've reduced a little bit of our warranty program from the prior year and we think that going forward we should be looking at the 6% margin rate in hardware pretty much consistently as we go forward.

Okay and what are your thoughts on the use of cash with I guess interest rates where they're at and the stock at its current level.

Do you guys have any bias towards buying back stock?

At this point, we actually as we said before, we first cover our capital expenditures then we look at potential acquisitions.

As you know, we've done a couple acquisitions this year, Norway, Finland and in New Zealand and after that, after we've done the appropriate due diligence on whatever acquisitions we may be looking at, then we, the Board I'm sure will be looking at whether we should do debt and/or stock buyback.

Great.

Thank you.

Moving on we'll take our next question from Arvind Bhatia from Sterne Agee.

Thank you, good morning guys.

Good morning.

Just one question on the margins again.

David I think on the other margin category, I noticed that was also down slightly.

I know that's primarily PC and I think strategy guide, et cetera.

Was there anything unique there this quarter that impacted that and kind offer what you expect that category going forward, and then housekeeping question, what was stock based comp during the quarter?

Sure.

The other category, as you know, has video accessories and PC software and some other things in it as well, but I believe the PC software piece of the category was very strong in the second quarter.

The title is escaping me, I think it was Age of Conan was very very strong and that obviously brought the margins down in the other category slightly.

Stock based compensation, give me one second.

Stock based compensation was approximately $8.4 million during the quarter.

Got it.

And final question is as we look at next year and look at kind of the margin improvement with a change in mix, can you give some broad idea of how you're expecting margins to trend next year, gross margins in particular?

We believe that gross margins will increase next year as the mix of new and used software increase and the mix of hardware decreases slightly, but we are probably not going to be giving any guidance on that at this point.

Great job guys.

Thanks.

Thank you.

It appears we have time for one more question and that question will come from Ben Schachter from UBS.

Hi guys.

Congratulations on a really exceptional job of executing.

A few questions.

One with Wii could you talk about what you're seeing over the last month?

Is there any change in terms of demand?

And then secondly I just want to go through the music genre a bit and just understand how important this is for the holiday and for the year and do you expect it really to be driven by the higher ASPs or units or both?

And then how can you, can you talk a little bit about how you're doing in the used with the music genre?

Are people trading in hardware and the software?

Is it more software, just some qualitative thoughts around the music genre.

Let me take the first one on the Wii demand, the Wii demand is still extremely strong.

I mean, probably three months ago, whatever we got into our stores would sell in two days.

Now it's three or four days, but it's still extremely strong compared to I mean for a system that's been out for what's it been a year and a half now, the demand continues, it's really very strong and as I said before, I think it's going to continue and I think there will still be shortages throughout the year.

The music genre has been important.

It's been important to the Wii sales, it's been important to PS3 sales, it's been important to 360 sales, even DS sales you have the Rock Band on the DS, you saw 32% increase in handheld and those handheld systems are fairly old in the second quarter and I think some of that demand has been driven by the music genre and I think the music genre is becoming an important genre to the business and to the category, and yes, people are trading it in as a matter of fact.

I was just going through some comments from my store associates, what issues they want me to address at the managers conference and they said what the hell are we going to do with all of these used guitars that we got traded in as people upgrade to the different guitar?

So they're filling up my store.

So, they're big and so yes, we are getting trades in the music genre and as I mentioned earlier and specifically, we really targeted the Wii customer and the DS customer with our marketing this Summer both TV and in store and in store promotions especially targeted to those people and we really were pleased with our overall Wii trades and DS trades and the Wii trades as I said grew five times faster than the average grew and so by definition, since music is a big piece of the Wii, we had to have gotten, while I didn't dig into the detail, I'd have to think that Wii music, we had a lot of Wii music traded in for that to have occurred.

And just one final last question.

Does your guidance assume a hardware price cut any time for the second half of the year?

Our guidance continues to assume the hardware price cut we talked about at the very beginning of the year.

Assuming there is about a $50 price cut on both the X-box and PS3 going into the holiday season.

Great.

Thank you.

Okay, well thank you very much for attending this morning.

As you can see we are extremely excited about our past performance and the first half of this year but equally excited about the back half performance and the performance we see next year.

The installed base growth as we predicted, well, as a matter of fact we didn't predict it would be this high but we did predict it would grow over last year continues to grow and that is setting up a very good 20009.

I would not expect that hardware sales in 2009 actually to decrease that much because most likely what will happen is the manufacturers will begin lowering the price to keep the velocity going.

So, this cycle, we have reached a 31 million or 32 million unit a year in hardware sales compared to the last cycle of a 20 million to 21 million so almost 50% higher and we expect that to continue and it's going to continue to broaden the market and it's going to continue to therefore create demand for both new and used software.

And lastly, in this economic environment that we are operating in, we are really pleased with the trade program as I mentioned before, five of our top 10 all-time weeks occurred this Summer when we didn't have a blockbuster blockbuster like Halo 3 and one of them of course was last year with Halo 3, but our trades are up significantly and that's driving our sales and we think that the new/used model in these economic times really is a differentiator between GameStop and other people that sell video games that will allow us to continue to grow and open new stores.

So thank you very much for attending and we look forward to a great back half.

That does conclude our conference call today.

Thank you all for your participation.