Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

GameStop (NYSE:GME)

F1Q08 Earnings Call

May 22, 2008 11:00 am ET

Executives

Dick Fontaine - Chairman, Chief Executive Officer

David Carlson - Chief Financial Officer

Dan DeMatteo - Vice Chairman, Chief Operating Officer

Analysts

Colin Sebastian – Lazard Capital Markets

Gary Balter – Credit Suisse

Tony Gikas – Piper Jaffray

Analyst for David Magee – Suntrust Robinson Humphrey

Tony Wible – Citigroup

Arvind Bhatia – Sterne, Agee

Mike Hickey – Janco Partners

Bill Armstrong – C.L. King & Associates

Operator

Welcome to the GameStop Corporation’s Q1 2008 earnings conference call. Today’s call is being recorded. (Operator instructions)

I would also like to remind you that this call is covered by the Safe Harbor disclosure contained in GameStop's public documents and the property of GameStop. It is not for rebroadcast or use by any other party without the prior written consent of GameStop. Now at this time I would like to turn the conference over to Dick Fontaine, Chairman and Chief Executive Officer of GameStop Corporation. Mr. Fontaine, please go ahead.

Dick Fontaine

Thank you and welcome to GameStop’s first quarter conference call, I am Dick Fontaine, Chairman and CEO. With me today are David Carlson our CFO and Dan DeMatteo, our Vice Chairman and COO.

This morning we released our numbers for the first quarter which were again outstanding and by any traditional retail growth metrics, almost unprecedented. With total sales increasing 42%, comps increasing by 27% and net income increasing by 151% while first quarter earnings per share doubling over last year.

I’d make the point that the unique GameStop new and used model coupled with the continued growth of GameStop stores in both existing and emerging markets and a business with a record console and portable growth, expanding demographic reach, new applications and emerging genre combined make GameStop a truly distinctive retail specialist and a preeminent growth investment.

In previous quarters we’ve made the case that many of the metrics tied to the analysis of the business on a predictive cycle model have changed and we’re backing that believe with our cap ex investments and our investments in the future. We stated in the past that we believe that this business will be deeper, wider and longer than at any time in the past, any cycle in the past and the evidence keeps growing that that’s the case.

Deeper in that the power and the pull of the games is continuing to attract an increasing number of core and avid gamers purchasing games like Super Smash Bros. Brawl, GTA IV, Army of Two and purchasing these titles in record numbers.

As the average age of the gamer has surpassed 30, it’s very obvious that great games to continue to attract long time gamers. The cycle is also going to be much longer. Last week three of our top 20 titles were for PlayStation 2, a console now in its eighth year and I fully expect given the computing power of the PlayStation 3 and the 360, we’ll be seeing a longer life as developers use the horsepower of these systems in more creative applications into the future.

Wider in that we’re seeing expanding demographics, particularly with more females and families discovering the entertainment value of gaming, emerging genres as we’ve discussed, Guitar Hero, Rock Band and releasing yesterday by the way Wii Fit which is blowing off the shelves and a wide variety of systems from which to choose.

In short, more products, more customer choices and the need for more informed sales associates all play into GameStop’s model and GameStop’s strength. In fact given the innumerable product choices with an ever increasing number of add on and accessory items, GameStop currently stocks over 4,500 SKUs.

There’s no doubt in my mind that the roll of the specialist with the largest selection of products in the industry staffed by knowledgeable video game specialists located in very convenient locations with a unique value proposition turning used products into a form of cash is a winning long term strategy and a very difficult strategy to copy.

We continue to improve our operating metrics as our stores are becoming more productive than ever. Sales per square foot increased by over 27%, SG&A has been reduced by 200 basis points and our inventory productivity in both new and used products has never been better.

We’re very focused on not only the growth of the company but making our existing portfolio of stores more efficient and we continue to invest in system enhancements, distribution improvements, merchandising refinements and more customer centered scheduling for our store personnel.

We have a long history of consistent performance and we also have an underlying drive to improve all areas of our business with a special focus on the continued development of this very unique used model. We’re well aware that the macroeconomics are making this a very challenging time for many retailers and while GameStop is dramatically running counter to that trend, I want to assure you that we don’t have our head in the sand and don’t take our strong sales and profits for granted.

We continue to evaluate our business at the micro level to determine if there is any underlying weakness affecting GameStop and we do so in a number of ways: evaluating key title sales or any of the key titles not quite living up to expectations. All are achieving or surpassing our expectations.

The tertiary story impact are the smaller stores generally with a wider trade area being hammered by $4.00 gas resulting in a cutback on driving to these generally Target, Super Wal-Mart or major grocery store anchored shopping centers. Not that we can see. In fact our tertiaries are some of the best performers year to date.

How about average transaction, our average transaction size has increased and our customer count is up as well for the quarter. Trades in used, while strong, they grew by 27%, are relatively in balance with this tremendous growth and are achieving and slightly exceeding our expectations, yet there’s no current evidence of any massive trading down.

Significant market variations, we review our store performance at the market as well as the macro level and our comps in every market are strong. We’re focusing somewhat on Southern California and South Florida as areas, two regions where we may be seeing some slight affect though it’s very minor at this time.

And finally our new stores are opening strong and staying strong. Speaking of new stores, during the quarter we opened 210 stores, a record number of openings with the previous first quarter record being 103. We opened 87 stores in Europe, 86 in the US and yes this is the first time Europe has turned in the largest amount of new stores in the quarter, slightly exceeding the US which I would say is not in any manner, shape or form believe that there’s any slowdown in the US.

We opened 25 in Canada and 12 in Australia. The new stores continue to perform exceptionally well. In fact the first quarter performance over our hurdle rate has never been higher. Last quarter we forecasted we would open between 550 or 600 stores worldwide and with these first quarter openings, we’re now much more confident that it will be closer to 600.

Finally I want to address on element of the somewhat dated cycle model that still does hold water, namely that software sales follow hardware growth, the razor and razorblade effect if you will. In 2005 and 2006, the industry and this is according to NPD data and US data only, added almost 44 million consoles to the total installed base, at that time a combined two year record.

Yet in 2007 alone that number was over 31 million and we are forecasting 2008 console and handheld numbers to be over 32 million industry-wide. In short we are in the middle of an explosive growth cycle where console and portable game units will exceed 63 million new units over the two year period.

That’s a 44% increase over the prior two year high water mark and again I would stress that we fully believe that these platforms will have extended life, extended application and extended development of great new games.

In short, over the four year period, 106 million hardware units have been sold and that’s in the US only. What a great springboard for continued GameStop success filled with additional opportunities. We’re very excited about our business, very bullish on the future and backing that confidence with tremendous growth of building the GameStop business. And with that I’ll turn it over to David.

David Carlson

Good morning, before the market opened today we released our sales and earnings results for the first quarter of 2008. GameStop sales for the first quarter increased 42% to $1.8 billion as compared to $1.3 billion in the prior fiscal year. Comparable store sales for the first quarter increased 27% with North American comps exceeding 30% and Australian and European comps in the low double digits as they comped against the launch of PS3 in the prior year quarter.

These results were driven by exceptional results across all categories. New hardware sales grew 21% with all platforms meeting or exceeding our expectations. New video game software grew 72% driven by such blockbuster titles as Grand Theft Auto IV, with only five days of sales in the quarter, Super Smash Bros. Brawl and Rainbow Six Vegas II.

This compares to NPD software growth of 59%, showing we gained significant market share during the quarter. This astounding growth in new video game software was the primary driver in our exceeding previously released guidance.

Used video game sales also grew by over 27%, accelerating from the 25% growth experienced last quarter. The current economic environment and great new titles stimulated trade ins and budget conscious customers continued to discover the value pricing of our used mix.

Net earnings for the quarter were $62.1 million, increasing 151% over the prior year quarter’s net earnings of $24.7 million. Diluted earnings per share for the quarter were $0.37, including debt retirement costs of $0.01 per share. These results were $0.05 per share higher than the high end of previously released guidance.

Gross margins decreased about 120 basis points due primarily to product mix. SG&A expenses were leveraged by 200 basis points due to strong sales comps, cost controls and international growth leverage. This allowed operating margins to increase 140 basis points to 6.1% in comparison to the prior year quarter.

Our balance sheet remains exceptionally strong with over $625 million in cash at the end of the quarter. And inventories grew only 25% on a 42% sales growth rate. In the first quarter we retired $30 million of debt in accordance with the debt buyback program approved by the Board of Directors in early February.

This left $100 million in the buyback program. This morning we also issued initial guidance for the second quarter of 2008 and updated guidance for the full fiscal year. For the second quarter of 2008 we are expecting comparable store sales between 12-14% with diluted earnings per share ranging from $0.26 to $0.28, over double that of the prior year.

Based on the stronger than expected first quarter results, we are raising our diluted EPS guidance for the full year of 2008 to a range from $2.30 to $2.39. We continue to expect full year comparable store sales to increase between 10-12% and that US industry video game software sales will increase between 15-20%.

Finally, based on these strong industry trends, our expanding worldwide footprint and our excellent cash generation, we continue to expect that GameStop will achieve at least 25% EPS growth in fiscal 2009. With that I’ll turn it over to Dan.

Dan DeMatteo

Thanks Dave and good morning. The first quarter was even better than expected and the growth can be attributed to a great new title lineup, new sales driven by used trades and record setting hardware sales. As a matter of fact in the US next gen hardware sales grew 25% year over year in the quarter.

This growth includes handhelds which are becoming an important segment of the business, expanding the video game audience. As we predicted and as Dick mentioned, hardware sales in 2008 will beat 2007’s record setting levels and this should create unprecedented demand for games in 2008, 2009 and beyond.

As we saw in the first quarter, game sales for the rest of the year will be propelled by a broad genre of titles for an ever expanding gamer group. As a case in point, when I reviewed last week’s top selling 25 games, they were across seven platforms and included everything form a PC title to four titles for the seven year old PS2.

And we expect game sales to continue to grow for the year across many platforms such as Guitar Hero Aerosmith for all platforms. As Dick mentioned, Wii Fit for the Wii again an application for the Wii that is expanding video gaming. Metal Gear Solid for the PS3, Gears of War II for the Xbox 360 and our reservations are running exceedingly well on that title. Madden for all platforms, Guitar Hero On Tour for the Nintendo DS handheld, the first version of Guitar Hero on a handheld.

[Same] Pro II for the Xbox 360 and PS3, Ghostbusters all platforms, a Warcraft expansion pack coming in the fall for the PC, Guitar Hero IV for all platforms and many, many more. Based on the insight we now have, it appears that titles releasing in the back half of the year will be much more numerous than last year as publishers avoided the Halo 3 launch.

And when you factor in the fact that publishers now have better development techniques for these new platforms as well as they now are developing more games for the third-party Wii, this places GameStop in an exceptional position.

As we stated in the end of the year conference call, we believe and Dick just mentioned it again that the cycles of the past are not applicable and this cycle will be longer due to the new genres and easier to use systems that are attracting a much larger audience than in the past.

And again as Dick mentioned, we are aggressively opening new stores as our model has been accepted across the US and all countries that we have expanded into. And as expected, the new stores are performing extremely well. We are investing in our people and existing stores as we continuously strive to improve the customer experience. Our investments in proprietary systems and refurbishment operations are significant as we increase the used video game business and its profitability.

In the quarter we converted to a new internet ecommerce site that had been in development for several years that is easier to use, provides more game content and will soon allow customers to reserve online and pickup in store. Our Game Informer Magazine is the largest of its kind in the world with now over 3.4 million subscribers and we just launched an Italian version two months ago.

So in summary, we are well positioned with our stores and our investments to continue to grow and gain market share in this fastest growing entertainment business. Thank you and with that I’ll turn it over to the moderator for a question and answer session.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Colin Sebastian – Lazard Capital Markets.

Colin Sebastian – Lazard Capital Markets

I’d like to drill down a little bit into the mix between hardware and software in used, specifically in the 2Q guidance and hopefully for the full year if you could provide some additional color there. And related to that, it doesn’t sound like there’s been any change to your forecast for Q2 or the linearity of the year but just wanted to clarify that given you didn’t increase the full year comp store growth outlook.

David Carlson

On the second quarter margin mix, I guess what we’re looking at is having a fairly flat margin for the second quarter over the prior year. It will increase some from the first quarter as the hardware mix was very strong in the first quarter and typically is very strong in the first quarter. So that’s the second quarter.

Full year we haven’t really changed our guidance, I believe I said we were looking at 20 basis points of increase in gross margins for the full year and that really hasn’t changed since the guidance we gave in March.

Colin Sebastian – Lazard Capital Markets

And related to the comp store growth outlook and not increasing that given the upside in Q1?

David Carlson

Right the first quarter upside of about 2 points has only marginally changed the full year numbers so we still believe we’re looking at about a 10-12% comp for the year.

Colin Sebastian – Lazard Capital Markets

Secondly in your hardware unit assumptions, are you still expecting $50.00 price cuts on the PS3 and the 360 by the end of the year?

Dick Fontaine

One of the things that you may have noticed is that [Kasa Rye] about two weeks ago indicated that at this time they were not planning any price cuts on the PS3. But that certainly doesn’t mean that as market conditions evolve that they may not change that and the truth of the matter is is that we have been sufficiently happy with the rate of sale on the PS3 at its current price points that assuming it continues at that rate I think we’d be just fine with holding the price.

If it shows any sign of weakening or if they make a move to decide they want more market share, I still think that option is open. But right now we’re okay with that announcement.

Operator

Your next question comes from Gary Balter – Credit Suisse.

Gary Balter – Credit Suisse

One of the comments that we get from people and we talked about it in the past but just as you’re starting to see the Wii grow and you’re starting to get the used games is the argument that well they’re not going to, a used business in that environment won’t be strong because it’s a different type of game. What are you seeing as you’re another quarter into the Wii?

Dick Fontaine

We’re very happy with the growth of our used video games in the Wii category and in the first quarter we put together several promotions to attract the new Wii customer and convince them to trade in their games and they worked extremely well and we’re very pleased with the growth in our used video games in the Wii category, so we don’t have a concern there.

Gary Balter – Credit Suisse

This is actually Seth here too, just a quick question on some of your category margins, can you guys just provide a little bit of additional color on some of the fluctuations we saw this quarter and maybe what are your expectations going forward?

David Carlson

The hardware margin was down slightly from the prior year. That was mostly due to our exit from the Microsoft Zune category and to some extent our de-emphasis of warranties related to Microsoft’s manufacturing issue they had with the Xbox 360 which really began in the second quarter of last year.

We think these manufacturing issues are behind Microsoft and with that we’re confident we can start to re-emphasis warranties in our stores probably in the second half of this year. So we’re looking at probably this to be the bottom of the hardware margin and it should go up from here. The new software margins were pretty much flat with prior year. Used product margins decreased slightly from the prior year but improved from the last three sequential quarters.

As refurbishment costs really increased with the surging production and that is maximizing gross margin dollars and keeping to our target of used product margins between 48-50%. And the other category was up slightly, that had to do with a lot of video game accessories that went out the door during the first quarter.

Operator

Your next question comes from Tony Gikas – Piper Jaffray.

Tony Gikas – Piper Jaffray

I want to go back to the used business a little bit and is it picking up to your expectations or do you think that it’s maybe a little bit behind the curve and when does that business start to hit the sweet spot and do you get some gross margin improvement as you move through that sweet spot? Is this a better late cycle business or is it performing as well today as you expect it to be performing two years from today?

Dan DeMatteo

Our used video game business exceeded our plan in the first quarter, so it is performing as we expected. As we always have said is that it will trail new video games but over a long period of time, five or six quarters, it will grew like new video games growth. So we expect that to continue to happen and when you have a quarter of course where new video games grew 60-70%, used will not keep up with that.

But, our trades are doing extremely well this year, as a matter of fact as the economy has weakened, our trades have actually strengthened as consumers need more currency to buy the video games that they want to buy, buy the new video games that they want to buy.

On the margin rate, we’re optimizing for margin dollars, not necessarily margin rate and the range will probably stay in that 48-50% and some quarters will have more refurbishment costs as we attract back games that need to be fixed before we sell them and some quarters maybe a little bit less and that’s one of the biggest variables that changes the margin rate in the used category.

Dick Fontaine

I would also point out Tony that if you’re looking further out and your question began to address 2009 and at what point we have the sweet spot, there’s a very important factor that is emerging here in terms of the mix of our stores.

We now have about 25% of our stores internationally and generally speaking and this is general, the growth of used has many of these markets, particularly in Europe have been more immature, have lagged the US number. But the growth that we can see in our international used sales is growing very, very rapidly. As a matter of fact, the growth in used on the comp store basis was higher internationally than it was in the US last quarter.

So as we continue to grow and diversify our business around the world, we’re going to get a lagging growth effect off of this used model which has been relatively new compared to the US in Europe and to some degree in Australia and New Zealand as well. So again with 25% of the business and that growing, that’s going to have a very positive long term impact.

Tony Gikas – Piper Jaffray

Could you share your preliminary comp expectations for Q3 and Q4 and then you said you’re taking share domestically at least, who do you think you’re taking share from and then last question on fiscal 09 you’re pointing towards 25% EPS growth, what’s the driver of that, is it sales growth or op margin expansion?

Dick Fontaine

On the third and fourth quarter comps, the only thing we’ve said thus far and we said it on the last conference call is that in the third quarter we do believe they will be positive comps, albeit they will not be enormous comps because we are against a very, very difficult Halo 3 launch in the third quarter of last year.

That being said, we’re seeing an amazing amount of titles that are going to be launched in September and October this year when we think last year publishers really stayed away from Halo 3. And although our initial expectations are to have pretty low single digit comps, the lineup is really starting to strengthen. We’re not ready to give guidance on that, but that being said, there is definitely some positive developments there.

Dan DeMatteo

On our market share gains, who are we taking it from, I wouldn’t know who we’re taking it from, the only thing I guess we do know is that the consumer acceptance of our model which is convenient location, large assortment, knowledgeable sales help and of course the buy, sell, trade model has been accepted in every market that we go into.

Tony Gikas – Piper Jaffray

And then fiscal 09, any primary drivers on that 25% EPS growth?

Dick Fontaine

The first thing I would say is that it clearly is an effect of this incredible install base growing over this four year period let along over this two year period that I discussed in my opening remarks. The developers that clearly are seeing those numbers and the investments that they’re making in the products, let alone the breakthrough products that we fully expect to see and Wii is just an early indication of that.

While we don’t have the specifics, basically what we’re banking on and feel very confident about is that the hardware numbers will tell a very strong story about the software numbers in 2009.

So it’s unusual perhaps particular in this economic condition that the country finds itself in that anybody would go out and begin to try to forecast 2009 but it comes from that very strong confidence in software following hardware that we have and believe that that 25% is very doable.

Operator

Your next question comes from David Magee – Suntrust Robinson Humphrey.

Analyst for David Magee – Suntrust Robinson Humphrey

This is [Kris Rapple Jay] on the call for David. I just wanted to clarify what you said about the margin on the used business, you mentioned some increased refurbishment costs and I was just wondering if that was within the realm of regular variation or if there’s any systemic [sir] change in the type of games you’re refurbishing or that process?

Dan DeMatteo

No I think its business as usual and it’s variable. We encourage our stores to buyback damaged games from consumers because we know it’s a good source of product and we can repair them at the 99% level and we need those refurbished games to open our new stores with.

So it will vary depending upon the quarter what we get back. But again we’re trying to optimize for gross margin dollars and this supply that comes through our refurbishment department is very important for us in our new store opening supply.

Dick Fontaine

What may be outside the realm of normal business is that we’ve made significant investments snuggling into the second year in technology, techniques, staffing, space, we have put a great deal of emphasis on the sophistication, there’s really no other term for it on this giant manufacturing process in the middle of our business. And indeed it is becoming more and more efficient literally every quarter.

A major factor in terms of margin, price, maximizing dollars is not only to be able to take in used products but to move that used products through a refurb factory and get it back and get it out on sale very, very quickly. And this has been important for many, many reasons, but not the least of which is as I’ve mentioned in the past, given the tremendous amount of new stores that we are open, when we open a new store, we can’t go out and order the opening inventory from the third-party.

We’ve got to provide it ourselves and given the amount of new stores that we’re putting on, that refurb facility gives us an opportunity to open these stores with an unprecedented amount of software. So we’re going to continue to invest in pushing that aspect of our business. The downstream benefits for our customers are absolutely fantastic, so that I would say over the two year period is probably definitely moving a little bit outside the norm but we think of it as an absolutely outstanding investment.

David Carlson

One thing to add there, we really started ramping up our refurbishment almost a year ago in the second quarter of 2007 and if you look at the margin rate on the used product for the second, third and fourth quarters of last year, they were around 48-48.5%. And you can really see the affect of doing that on the growth rates in the used category over the last three quarters as well.

Dick Fontaine

One of the other things that we should take some time to talk about this is that the fact of the matter is is that we tend to give ranges, 48-50% in terms of our gross margins and we do that on purpose because one of the really great things about the sophistication of this model is the price elasticity across different product and platform lines.

And we stay in a very flexible position to deliver more value if indeed a certain market or a certain segment or indeed a certain area of the country wants to or needs to get very, very promotional, either because of competition or because of marketing softening conditions. So the elasticity with the used area properly managed with everything working is a tremendous, tremendous advantage and a tremendous advantage for the consumer as well.

Analyst for David Magee – Suntrust Robinson Humphrey

With regard to your European stores, I was wondering if you could give just a little more color on performance there. It sounds like the used business is starting to gain traction and just the number of stores you opened was significant, I’m wondering if there’s any new thoughts on the opportunity there on accelerating it.

Dick Fontaine

We continue to believe in growing in every one of the countries and indeed with one exception, we didn’t add any stores in the quarter in Portugal, but every other country of the 16 countries we do business added stores. The overall performance for the quarter of our international operation was very, very strong.

As I indicated on a comp basis, the used comp was actually higher than the US and in fact on a software growth basis it was somewhat higher than the US if you take the international contingent as a whole. So those divisions are performing very, very well.

As we mentioned on our yearend conference call, we fully expect that in the 550 now approaching 600 store range that we fully expect about half of those will end up being international. So our management there, our field teams continue to find additional areas to grow and we’re very bullish on all of the markets.

Operator

Your next question comes from Tony Wible – Citigroup.

Tony Wible – Citigroup

I wanted to start off on the PC side, doesn’t get a lot of attention but you have a great lineup between World of Warcraft IV, Starcraft II and I just wanted to get your thoughts on how meaningful will the ramp up on the PC side be and similarly, accessories as the music genre grows, you can see the different Wii products rolling out, how big could accessories and the PC side be for you?

Dan DeMatteo

This will be a very good PC year with those three titles that you mentioned in the back half of the year and we do have that into our forecast. And PC sales run anywhere on a year basis from 5-7% of total sales and this year will probably be at the high end because of those three titles that you mentioned.

In terms of accessories, I think one of the things about the expansion of the videogame systems and their uses like with the Wii Fit etc, I think that accessories will continue to grow as the use for these systems continue to grow into different things like fitness etc. etc.

So right now we have some accessories for the Wii Fit like a pad that goes under it so if you’re on a hardwood floor it won’t slip, a carrying case with it as well as a rechargeable pack for it. So there’s three new accessories that just came out this week for the Wii Fit along. So while I don’t have a number right in front of me that says what we expect accessories to grow to, clearly it is a growth category.

Dick Fontaine

The other thing I’d mentioned and you’re 100% right, PC to some degree because of the blinding growth of the consoles and handhelds tends to get a little bit overlooked. But again, putting GameStop in the perspective of beginning to analyze it much more on a worldwide basis, we’ve got a number of countries where these strong PC titles that you referred to are going to have disproportionate importance.

Our German, Austrian, Switzerland operations still have PC sales as a whole that are definitely double plus over the average that we’re running in the US. And the Nordic countries in general are much, much stronger in PCs. So you’re right, PC has got some great titles coming and will benefit disproportionately in a number of these worldwide countries.

Tony Wible – Citigroup

With the cash that you have on the balance sheet I guess you could use it to pay down debt or pursue M&A or do other things with it, what are your thoughts and how do you weight those in light of the current interest rate environment and also with the potential for depreciation in the Euro.

Dick Fontaine

Let me address the first one and as we’ve said before, there’s certainly no problem with cash in macroeconomic times that are dicey. Having said that, we are a very aggressive growth oriented company and if you look at the history of our use of cash, not only investing in infrastructure but making acquisitions where they make sense, pushing the continued growth of our new stores, continuing to upgrade our stores with remodels, all of those continued to be on the table.

Buying back shares, buying back debt, all of those are on the table to be discussed with the Board. My personal preference is that we spend the majority of our time however trying to employ that cash with opportunities to growth this business. As we’ve said in our introduction, we think this is a long term strong growth business.

We want to continue our position, open new countries where this makes sense and I’m much more favorable to at this point in time challenging management to look for additional areas to growth other than necessarily buying down our debt or even buying back shares. But you know that’s subject to change and the Board’s input.

Tony Wible – Citigroup

So with that said, looking to reinvest for growth, would that be more domestic or international and does that potential for decline in the Euro change your views on allocating more to Europe?

Dick Fontaine

No I don’t think so. I think our approach, we’ve been very, very good to date, our hedging positions vis-à-vis in particular the Euro, tried to keep that hedge at neutral. So what we end up doing is taking a look at what we believe the growth opportunities are within the countries and try to get ahead of that. So we try not to let currency fluctuations in a short term unduly drive what we believe are good long term investments.

Operator

Your next question comes from Arvind Bhatia – Sterne, Agee.

Arvind Bhatia – Sterne, Agee

In the first quarter you opened more stores than we had expected and I wonder if there was any extra cost built into the first quarter as a result of that. My second question is on cap ex, if you could refresh on what you’re modeling there.

I think your previous guidance was $175. And the last question is on tie ratios, as you are looking at 2009 and you’re looking at tie ratios etc, what’s your thinking there, are you building historical tie ratios. It looks like tie ratios have been stronger but just would like to get your thinking there.

Dick Fontaine

The first thing I would point out in terms of the 210 stores, that included which we’re very happy about, an acquisition of 49 stores from Free Record Shop in Norway. So that added significantly to that first quarter growth rate and obviously the European growth rate. But even that aside, we still would have grown at a record amount of stores over the first quarter, something like 160 without that acquisition on the top of 103.

David Carlson

And there were some costs related to that acquisition of running the stores and converting them to video game stores. So yes there was a little bit of a drag on SG&A because of that.

Dick Fontaine

And that’s part of our go forward business model, particularly as we look at opportunities to grow. Our predominant growth has been over the years a lot of de novo growth but we’ve also been very, very successful making both small acquisitions and helping them grow and some very large mergers and acquisitions with EB.

So we’ll continue to be very opportunistic and look at which markets we feel need to be better served or how we can pick up real estate to continue the growth. And obviously when we look at Europe in particular the EU with something like 450 million people, we do want to continue to evaluate the opportunities to move in to new countries that we’re not in.

David Carlson

And on your cap ex question, we are still looking at approximately $175 million of cap ex for the fiscal year. I think in our thought process that when we say that we think we’ll have double digit software growth in 2009 we are not looking at overly aggressive tie ratios.

We’re looking at more historical tie ratios. And you’re right, tie ratios are running ahead of historical rates. And yet even with the more conservative historical rates, we’re looking at some very, very strong software growth in 2009.

Operator

Your next question comes from Mike Hickey – Janco Partners.

Mike Hickey – Janco Partners

Obviously we’ve been struggling with the impact of a weak domestic economy for a while now. We have some near term stimulus, this tax refund program. Are you seeing any impact on your business today from that refund process?

Dick Fontaine

The truth of the matter is I would answer is I can’t point to a specific impact. I don’t have any metrics that indicate that that is the reason for the purchases. I would assume that as more of these rebates come into the market that a certain percentage of them will be spent on entertainment and I would guess that we will get probably more than our fair share. But I can’t point to anything specifically identifying that or at least not so far in the first quarter.

Mike Hickey – Janco Partners

Anecdotally at least the release of GTA IV was moving hardware although on the most recent NPD numbers that didn’t really show up, are you guys seeing increased sales of PS3 and 360 because of GTA IV or is it just kind of business as normal?

Dan DeMatteo

In the week of Grant Theft Auto launch we saw a significant increase week to week in the sell through of both Xbox 360 and PS3. Somewhere in the near doubling week to week, so there was a significant increase. Now people have to realize there’s been a lot of talk of the April numbers weren’t as good as the March. People forget there were five weeks in March and four weeks in April.

So there’s a lot of extenuating circumstances. Also, last time Grand Theft Auto came out we were in October going into the largest selling season in the industry and so you saw holiday type of numbers. We were actually very happy with the number of Xbox 360s and PS3s that tied along with the Grand Theft Auto and we continued to see some strength in May. So we actually saw some upside and we’re happy with it.

Mike Hickey – Janco Partners

And then what products are you currently out of? I’m guessing the Wii Fit is in short supply, do you have GTA or is there any kind of general sellouts on the product side?

Dan DeMatteo

Most products are in stock, we’re in good position. Wii Fit of course is a sell out as we expected. The Wii hardware continues to be a sell out as things come in and Mario Kart is somewhat in short supply, we’re getting re-supplied. But for the most part the area in the first quarter, we had a lot of hardware shortages with the DS and the 360 and the PS3, those have abated and the Wii remains the singular largest hardware shortage thing that we have.

Dick Fontaine

Speaking of software driving hardware or new units driving hardware, I feel pretty damn strongly that the Wii Fit itself is probably going to be the most significant addition that will drive new hardware sales. I think as more and more people begin to see this and they obviously need to Wii machine to play the Wii Fit, I think it’s going to drive even more demand for the Wii.

While we’ve been selling out everything that we get, I think this is going to add even more stimulus for demand of that product that’s going to run through the year. So in one sense again I give credit to Nintendo, it’s kind of a brilliant time to add on another accessory that really attracts a large number of new users that I believe are going to be motivated because of this unit to get the hardware units. So this looks like it’s win-win all the way around as long as we can begin to get the supply we need.

Mike Hickey – Janco Partners

And it looks like supply has been somewhat elevated over the last couple months, is that accurate and do you see that higher level of supply continuing?

Dan DeMatteo

Yes I think it went up about 15% a month ago, the production numbers went up and yes we have seen that supply go up. But as I mentioned, still, supply has not caught up with demand as they can sell through in roughly two days when we get them into our stores.

Dick Fontaine

I might mention again and it’s kind of been a recurring theme is you begin to look at GameStop and begin to think of it more as a worldwide company. Xbox 360 had a price break throughout Europe and that price break was in March, so we didn’t get the full quarter.

But it significantly accelerated sales in all of the European markets. And assuming again they keep up with supply, it may very well be a harbinger of what they may want to do in other markets downstream from Europe.

Operator

Your final question comes from Bill Armstrong – C.L. King & Associates.

Bill Armstrong – C.L. King & Associates

Are you seeing any competitive impact on your business from Blockbuster’s move into video games or any other competitors out there?

Dan DeMatteo

We looked at that, Blockbuster made an announcement that they were getting back into video games. We have not seen any impact based on their efforts to date and we’ve not gotten any feedback from our field personnel that they’re having competitive issues due to whatever efforts they are now putting forward.

Bill Armstrong – C.L. King & Associates

Is there any way for GameStop to capture some of these downloadable micro transactions that we’re seeing the publishers putting more emphasis on?

Dan DeMatteo

We do do downloads on our website to the PC games, with PC games. In addition, we sell time cards for the Xbox Live and Nintendo so that we do share, because we sell the time cards and often times these consumers would rather use the time cards than a credit card to make the purchases with.

So we do share in the revenue that way. So we do share in it and we expect that to grow and continue as publishers find ways to add on content as they will do to make the games more exciting for their customers. But we don’t see it as a negative for our business.

Bill Armstrong – C.L. King & Associates

Does it make sense for the publishers to bring in retailers to help broaden the distribution of this downloadable content?

Dan DeMatteo

Absolutely and I would think that as it continues to grow they would want us to begin to market that with them and help promote their downloadable content and I see that we would be in a position to do that. I might add that if you talk to most analysts about downloadable add on content for this year on a $10 billion game industry, it’s expect to be no more than $100 million.

Dick Fontaine

Thank you for joining us today. I frankly say we have never been more confident of our business and we’re in a position where all segments of our business seem to be running extremely well but if you’ve been following GameStop for quite some time you know we’re not resting on our laurels.

We look to improve and we think the opportunities that we have are not only worldwide but also within all of our divisions, the dot-com division as well as Game Informer. So thanks for your support, another great quarter and we’re looking forward to even more in the second.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: GameStop F1Q08 (Qtr End 05/03/08) Earnings Call Transcript
This Transcript
All Transcripts