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Here’s the entire text of the Q&A from GameStop’s (ticker: GME) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.

Questions and Answers

Operator

Question by Edward Williams, Harris Nesbitt.

Q - Edward Williams

A couple of questions for you. Can you talk about the supply of Xbox 360 hardware in North America relative to Europe and also can give us some color as to how the PlayStation 2 and Xbox software perform and then I've got a couple of others after that?

A - Dan Dematteo

Sure. This is Dan. I can tell you what I know and what I know is we have given a flow of hardware in the United States through the month of December. So we have visibility through December. We do not have visibility right now in January. We do know that Microsoft plans on shifting from air to water freight somewhere around the first of January and that may signal or should signal some slowdown in supply for the first parts of January. As for Europe, Dick, maybe you have a better idea on Europe.

A - Dick Fontaine

Europe, as you know, releases on December 2nd and we have gotten our allocation by country and while we would like more, in most of the countries proportionately, we have actually done somewhat better than we have in the US. Again, it is not significantly so but it looks like with most of the countries it is a reasonable allocation per store. What we do not have yet or I have not received it yet is perhaps as much visibility post launch for the rest of December for Europe. I think that is maybe more dynamic than the information that they've given to Dan and our buyers here domestically.

A - Dan Dematteo

I think your second question was how are PS2 and Xbox titles selling. As we mentioned, most of the new titles that released the first three weeks of November did not meet our expectations. If there was a trend among those titles it was that the edgier titles seemed to have a harder time than the non-edgy titles because a couple of titles that just pop in my mind that did meet expectations were like Star Wars and WWE Smackdown and those titles did meet expectations. So it pretty much lined up with what you would have expected, to have the hard core gamer titles because that gamer was conserving his cash, his or her cash for this big purchase.

A - Dick Fontaine

I think that's an important point as well. It certainly does not appear to be a reflection on the quality of those games but as we know and perhaps to a slight degree underestimated is that the core gamer has a very high incident of overlap. They own both the PlayStation 2 and the Xbox. Clearly the core gamers moved very rapidly to the Xbox 360. The overwhelming majority of those moved to the higher priced units. So clearly they were very taxed from the standpoint of having expendable income. There is an expectation or at least an expectation on my part that as the season rolls on, some of these titles that may have sold faster earlier will begin to sell a bit better downstream as we get a little bit further away from the initial euphoria of the 360 with the core gamers. We will have to wait and see if that plays out but we think that is the case and that is a far better scenario than the fact that the games themselves are disappointing. I don't think that is the case.

Q - Edward Williams

And then looking at the 360 for a moment, you mentioned that the tie ratio is, relative to your expectations, is much better than expected. Can you give us any color as to how it is right now and what you were thinking it would be and then also looking at trade-ins? Can you give us any indications as to how significant trade-ins are to those who are buying the 360 from GameStop?

A - Dan Dematteo

Well the tie ratio on the Xbox 360 for software, like we said, it has broken records from any other launch. So obviously it is better than the PS2 and the Xbox launches from what we have seen and it is fairly significantly better. But other than that, we don't want to quantify it at this point.

A - Dick Fontaine

And I mentioned that our used inventory was at an all-time high and that is clearly due to the trade-ins. And on a per store basis, it is up double digits. So we won't quantify that but it is significantly higher than we were at this point in time last year.

Q - Edward Williams

And then one last question if I could. How is the PlayStation Portable performing? Obviously your hardware dollars dropped dramatically in the October quarter. How much of that is PlayStation Portable related versus actually having supplies of the current generation consoles and in general, how is the PSP looking going into this holiday season?

A - Dick Fontaine

I think the PSP may be one of those situations where it is suffering a little bit downstream from the Xbox 360 mania and maybe a little bit more from the hunt and hope. While we have sold a fair amount of units, I think the truth is, Ed, is that at this point we would have expected it to have more momentum than it has. As we look at the future promotion for PSP and as I think we get a little bit further away from the 360 hunt and hope, we expect it to pick up. It is an outstanding machine, as you know. It has been featured in virtually every article I have seen on the best electronic gifts for the year. So as long as it has that type of exposure and is a quality unit, we expect that it should close fast. But the truth of the matter is, it has started somewhat slower than we had anticipated.

Q - Edward Williams

One final question if I could. If you could just give us an idea as the trends that you have seen in the first three weeks in November on new software sales, you are expecting those trends to persist through January. I just want to clarify that point to make sure that is what is implied in your guidance.

A - Dan Dematteo

I don't know that we expect the exact same trends to apply. No. We believe that some of the weakness was due to core gamers waiting for the Xbox 360 to launch. Now that it has launched and they've spent their money, we don't necessarily see that continuing. As well from Thanksgiving until Christmas obviously there is a different consumer in our stores, the gift giver versus as much the core gamer. So no, we don't anticipate some of those trends to continue through January.

Operator

Question by Elizabeth Osur, Citigroup.

Q - Elizabeth Osur

I had a couple of questions. Just getting back to the question of tie ratios, can you give us any sense of tie ratios in terms of accessories on the 360? Or just how to think about it in terms of prior launches?

A - Dick Fontaine

I think you can look at it as almost a 2X over prior launches, close to a 2X. So that, extremely pleased with the tie ratios there.

Q - Elizabeth Osur

Thanks. And then just any comments about the holiday weekend, any takeaways from the competitive environment in terms of pricing trends that you're seeing from your competitors or just specific consumer spending patterns, things like gift card trends maybe where people are giving gift cards to help people by a 360 when it actually becomes available?

A - Dick Fontaine

The second question first, Elizabeth. There's no question that the trend continues with gift cards and they are very strong and they are significantly up from last year and that is a trend that we anticipate is going to continue throughout the year. Secondly, just in terms of broad comment, I think it is generally assumed and I think I would agree with that, that this was a more promotional Christmas on the price front with all categories, particularly with Wal-Mart leading out early and others following. We took a position, whether right or wrong, we think it is the right straddle position that that would probably be the case but that we would not go out and burn down gross margin in an attempt to end up with empty sales. We would begin to use the natural values that we have in the lower price points with our used product and then do some promotion in that category as well against these promotions. But net net, it seemed to be a more promotional kickoff. Certainly the huge specials kicking off earlier, the two, three hour specials are getting more and more aggressive and I think we would probably take a closer look at how we want to get a bigger part of that action next year.

Q - Elizabeth Osur

Thanks. I appreciate that.

Operator

Question by Mike Wallace, UBS.

Q - Michael Wallace

Could you comment about software pricing, looking at the PS2 market, I think overall a little weaker than people expected at this point? Do you think prices are going to come down quicker this Christmas, are you beginning to see some of the publishers give you some more promo dollars and maybe get more aggressive on price cuts before Christmas or do you think that's an '06 event? And that being said, do you think '06 could be weak from a pricing standpoint or is what's going on now at Christmas not a concern and do you think '06 will be the way you thought it would be?

A - Dan Dematteo

I have not had any discussions directly with any publishers since Thanksgiving weekend I guess as it relates to pricing. There will always be some publishers who will take down some titles prior to Christmas because they are not performing according to expectation. But I don't see a wholesale markdown of PS2, Xbox I titles prior to Christmas. As it relates to next year, I think as we would always have planned that there will be an average retail price decline of probably at least 10% into next year. That is what we will carry forward into our forecast. Again, I don't see a wholesale markdown this fourth quarter but generally we will definitely see a decline next year.

Q - Michael Wallace

Do you think the $50 prices on PSP titles have held that market back a little bit, do you need to see the prices on PSP games drop next year?

A - Dan Dematteo

I personally do. I have had that discussion with several publishers. I e-mailed them about three or four weeks ago that concern. But I think the $50 price point is too high and it should be $39.99. I can say that we have some people in agreement, some people not in agreement. I do think we will see that price point come down.

Operator

Question by Arvind Bhatia, Southwest Securities.

Q - Arvind Bhatia

My question is when we talk about the change in the same-store sales guidance for the fourth quarter, can we look at that as how much of that was Xbox 360 shortages and how much of that was the third generation software? If you could quantify that a little bit, maybe break it down? And then the second question is on the Xbox shortages, how much of that do you think was just supply and how much of that do you think was potentially some allocation if any?

A - David Carlson

I think the comp store guidance that we decreased slightly or I guess a little more than slightly for the fourth quarter, most of that related to the Xbox 360 shortages that we're anticipating at this point. I would say probably two-thirds of it. I haven't quantified it exactly and then probably one-third due to the slow PS2 and Xbox titles in the first three weeks of November.

A - Dick Fontaine

On your question on supply versus allocation, I guess there's probably not a retailer in the country that is happy with their allocation. And not knowing the total allocation for the U.S. market, I can't really answer the question on whether my allocation was fair or not fair. Microsoft tells me it was fair so I have to believe at this point that it was.

Q - Arvind Bhatia

Another question on the 360 attach rate. How much of that attach rate is being higher than you expected, could be related to the fact that people bought software ahead of the launch and never got the hardware and so that maybe artificially inflated that? Is that a possibility or you're saying that is not the case but in fact the attach rate is actually higher than historical averages?

A - Dan Dematteo

I would have no way of knowing and clearly, as usual, people do buy the games ahead of getting the hardware because on midnight when we opened or when anybody opens, they want to just run in, grab it and have their games to play. I can't imagine much of that would have been bought by people who didn't get a 360. It just wouldn't compute to me. There would be some, but I can't imagine there would be a huge proportion of that would be that. I think the attach rate, our high attach rate speaks more to the fact that since the last time we had a console launch four years ago or whatever, our trade-in business and our focus on the trade-in has been significantly intensified and we have a lot of people who are used to that model and again this is a big-ticket purchase and it's backward compatible and on and on. So hey they can trade games that they are no playing, etc. and trade those in and their out-of-pocket cash on the games, the new games, are less. And that is what I attribute our high attach rate to.

Q - Arvind Bhatia

Sure. Last question if I could. Used products gross margin up versus last year. Is it a trend that we should expect directionally again in the fourth quarter you think?

A - David Carlson

I would say directionally in the fourth quarter, the margin on the used games should be similar to the third. So if you're looking at a trend, yes, that should continue most likely.

A - Dan Dematteo

Primarily I would say that is a positive that it holds because we will use used videogames more promotionally in the fourth quarter compared to what we did in the third quarter. If you saw the front page of our flier this past weekend, it was buy two used games, get one free.

Operator

Operator Instructions Question by Bill Armstrong, C.L. King & Associates.

Q - Bill Armstrong

I have got a couple of questions. As far as Xbox 360, what is your degree of confidence that Microsoft, you said you have got some good visibility through December. What is your degree of confidence that Microsoft will actually supply you with the quantities that they have told you and have you yet received any replenishment shipments since the launch of a week ago?

A - Dick Fontaine

Well let me jump in with the first one. As long as we have been in the business, I think we continue to be trained, if you will, to be cautious and conservative. So I would have to say that I am not counting any chickens before they hatch or any units before they hit the dock. The total launch in the U.S., while it was exciting and fantastic, is at numbers that are much lower than I would have expected across the board and across the U.S. So from my standpoint, I am holding my breath to see what continues to happen downstream. Clearly, it is in Microsoft's best interest to do everything they can to maintain the momentum and doubly so to make absolutely sure that they maintain the momentum with the core and the casual gamer, which is the lion's share of our post Christmas sales. So I am anticipating they are highly focused on us but I think we are just going to be very conservative.

Q - Bill Armstrong

And have you yet received any replenishment shipments since the November 22nd launch?

A - Dick Fontaine

No, we haven't.

A - Dan Dematteo

No. I think it's next week we get some.

Q - Bill Armstrong

Next week.

A - Dan Dematteo

Planned.

Q - Bill Armstrong

Second question. It looks like the gross margins in all your non-used categories; hardware, software and accessories, were up pretty significantly. I was wondering what was behind that and I was especially surprised to see a 10.7% growth margin on hardware.

A - David Carlson

As you are aware, the co-op advertising funds, the majority of those now are classified in gross margin and as we said earlier, our co-op advertising funds for the quarter were very significant because of the title lineup from this year's adds that the vendor supported very heavily. So that is the reason for the increase. I wouldn't expect that to continue necessarily in other quarters other than the third quarter. So that is the main reason for the increase in the new video game margin.

A - Dick Fontaine

Proportionally as well is that it is very strong in that last year at this time, most of the vendors were pulling back on their promotional market development funds because they were in the face of Halo and Grand Theft Auto and they chose, and I think wisely, not to spend into that momentum. This year, the title base is broader. There isn't a killer title out there and we are seeing much better support on the marketing and the co-op end.

Q - Bill Armstrong

And then finally just on the store base, what was the store count at the end of the quarter? How many were opened and closed and how many do you plan to open and close in the fourth quarter?

A - David Carlson

At the end of the quarter, we had 4416 stores. We had opened on a pro forma basis, assuming we had EB for the whole quarter, we opened 174 stores between the two companies and closed 18 stores. Let me give you the breakout by division. We had 3603 U.S. stores, 240 Canadian stores, 171 Australia/New Zealand stores and 402 stores in Europe. And then in the fourth quarter I believe we anticipate opening somewhere between 80 and 90 stores.

Operator

We have time for two more questions. Tony Gikas, Piper Jaffray.

Q - Tony Gikas

Good morning, guys. A couple of questions. Going back to the tie ratios. You kindly asked your customers to purchase these bundles and do you think that that drove the tie ratios in accessories and softwares higher? If you exclude the impact from the bundling, do you think it was still materially higher than previous cycles? Second question, you talked about the PSP price points being too high and when do you think, we are sitting here and talking about $59.99 being too high on 360 and PlayStation 2 software? Is that a year down the road or is that more 18 months down the road? I can't imagine that that price point is going to hold exclusively either. And then I have a follow-up.

A - Dan Dematteo

On the tie ratios, this is Dan, I did the math on that as a matter of fact given the allocation we gave to the Internet. We only bundled on the Internet okay and the Internet was a very small portion of our total sales. So I did the math personally and it is insignificant to the increase in the tie ratio. On the PSP price point, I think your question was on PSP price point or was it, and how it relates to the Xbox 360 $59.99. It seems that $59.99 price point on console games is much more sustainable in my mind than $49.99 on handheld games. Handheld games typically are single player games obviously. Some aren't, but most are. Single player games meant to idle away your time, not as intense as a console game where you are in front of a big screen TV with your friends. So there's just more entertainment value in a console game in my mind than a PSP or a handheld game. So typically handheld games have been $29.99 to $34.99, sometimes $39.99. It seems to be that $39.99 is where the market wants that price point for a handheld game. On the $59.99, I can see it holding through 2006 for the most part and then 2007, I will have to redecide that given what we see in 2006 but I think mostly through six we can see that.

Q - Tony Gikas

Okay. And then what is your view of industry sales in 2006? Do you expect that the industry will experience growth during calendar '06 and then last question in terms of used inventory as the trade-in business picks up, any concerns that there could be some excess inventory in that regard?

A - David Carlson

First of all on the 2006 forecast, first we usually comment on that when we give guidance in January or February. Most analysts are anywhere between flat and plus 10 and we haven't come down on where we think that is at this point. So other than that, I don't think we're going to comment until we give guidance.

A - Dan Dematteo

And then your second question was because of our used inventory, is that going to cause a problem on the new inventory markdowns and the answer is absolutely not. The used inventory is not competition for new front-line titles. We have proven that time and time again. What the used inventory is it is inventory and it is products for a value-oriented consumer. So as such, it may have some competition in the new area with the $19.99 product. But the $19.99 budget product is, as you know, is republished product, is published just-in-time, delivered just-in-time because it doesn't need to be published or manufactured well ahead of time. There is no need to take a risk because these are titles that have sold record numbers, have been marked down to this $19.99, enjoy special licensing fees from Sony and Microsoft and Nintendo, etc. So, no, I don't ever see our increase in use causing a markdown issue in new video games.

Q - Tony Gikas

I guess part of the question then was as the trade-in business picks up and the current generation software sales start to slow over the course of the next year or two do you see, I mean, are you being very cautious with the amount of inventory risk that you're taking on that used?

A - Dan Dematteo

Oh, yes. I think that we have had much, we have had a lot of experience at this and we continuously monitor supply and demand. So we have not seen margin erosion in the used video game category since inception and I don't see it starting now. We know how to manage this.

A - Dick Fontaine

I also want to add what we have said before and a lot of people miss is that because of the source of all of our used game coming basically from the customers and not from a third party, in reality we have been chasing supply in this business for about five or six years. And as Dan says, the pricing models, both the systems algorithms and the individual talent of the buyers, we have never taken a hit to margin and indeed, while our inventory levels going into the holiday season now are high relative to historic norms, they need to be to drive the continued demand and the sales. So if there is an area of our overall assets and inventory that we need to be concerned about it would be evaluation of our used inventory.

Q - Tony Gikas

Good job. Thanks guys.

Operator

Question by Gary Cooper, Banc of America Securities.

Q - Gary Cooper

A couple of questions. Dan, first on the PSP I don't know if you addressed this. You talked about software. Do you think that the hardware price needs to come down as well? That's the first question. Second question is what does the new lineup in January look like? Are there any big games to be released there? And I guess maybe you could just extrapolate that into the first half to the extent you have any knowledge of what the lineup looks like in the first half. And then I've got one follow-up. Thanks.

A - Dan Dematteo

On your first question on the $299 handheld price point. Is it too high? I think if you go back in history, excluding Nintendo handhelds, there have been other handhelds at $299. I'm going to forget exactly. Wasn't one something from NEC and wasn't one an EOGO and something else? Now this machine delivers great value. Everything from movie play to game play to downloading of music. So is it too high at $299? Eventually, yes. Eventually, yes. You reach a point with certain level of adopter where you can sell it at $299 and then you'll reach another point where this thing will have to be $199. I don't know what that point in time is yet but it will come. I don't know if it is now or if we're there or if it is six months from now or nine months from now. I don't know the answer to that.

A - David Carlson

And on your question for 2006 basically title releases, although we didn't really put this together before the call, we have a quick list here. The first quarter looks pretty strong with Kingdom Hearts 2 and Legend of Zelda and Splinter Cell and I believe Elder Scrolls for the Xbox 360 as well. So that is just a real brief listing but the first quarter does look like it could be fairly strong.

A - Dick Fontaine

It's a brief listing but those first two titles are absolute powerhouses.

A - David Carlson

Exactly.

Q - Gary Cooper

Okay. Last question for Dick. So a lot of retailers have gone to Europe over the years from the U.S. and not done particularly well. You've got a little bit of head start here with 200, 250 stores. But could you detail the reason why you think the specialty videogame retailer works in Europe and maybe specifically why you think the used game business is going to work in Europe? Thanks.

A - Dick Fontaine

Well first of all let me say, as we said before, we are not coming from our side of the desk with a tremendous amount of history or experience. But I have spent some considerable time over there since we have made this acquisition and visited all the countries and I think I can answer you in two levels. One, pretty much the long-term forecast for the growth of the video game business through almost every country in Europe is very, very strong. Secondly, the market seems to be, to some degree, in terms of its growth and its broadening of its base, maybe a year, maybe even two years behind the growth of the US. We have got a very good foothold in all of the European countries with marketshare that is, for this very early stage of the growth, quite significant. We also have and I am ecstatic to see that some very good people over their heading up the managing directors of the country are very in tune with the business. The last point I would make is the last two days I was over there I attended the MAPIC real estate convention. We took a look at our growth opportunities, both in terms of what are called neighborhood stores, maybe roughly equivalent to our strips and new mall growth throughout Europe. While the strip store growth is not as robust as we are going to continue to experience in the U.S., there is plenty of opportunities. And the amount of new malls being built throughout Europe was much stronger than I had anticipated. And finally that does not include the amount of expansion in real estate with major investments that are going on in emerging countries like Poland and Czechoslovakia. And while we are not there and we are only going to jump there if we feel the market is ready, you really have to look at Europe as a market that is not only expanding but new countries coming into that, almost the equivalent of major new states coming into our mix in the U.S. So net, I think if you would go and look at some industry figures I think forecast for growth of videogames across the world, I believe you would find that in years three, four, and five it is expected that Europe could grow faster than the U.S. market.

Q - Gary Cooper

Okay. Thanks.

Operator

That does conclude our question-and-answer session and our conference. We thank you for your participation and you may disconnect at this time.

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