Home » GameStop’s (GME) CEO Paul Raines on Q2 2014 Results – Earnings Call Transcript

GameStop’s (GME) CEO Paul Raines on Q2 2014 Results – Earnings Call Transcript

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Source: Seeking Alpha

GameStop (NYSE:GME)

Q2 2014 Results Earnings Conference Call

August 20, 2014, 4:30 p.m. ET

Executives

Tony Bartel – President

Robert Lloyd – EVP and CFO

Mike Mauler – EVP of International

Mike Hogan – EVP of Strategic Business and Brand Development

Matt Hodges – VP of Public and Investor Relations

Analysts

Tony Wible – Janney Capital Markets

David MaGee – Suntrust

Curtis Nagle – Bank of America

Brian Nagel – Oppenheimer

Arvind Bhatia – Sterne Agee

Edward Williams – BMO Capital

Sean McGowan – Needham & Company

Operator

Good day, and welcome to GameStop Corporation’s second quarter 2014 earnings conference call. 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.

At this time, I would like to turn the call over to Tony Bartel.

Tony Bartel – President

Thank you, operator. Good afternoon everyone, and welcome to GameStop’s second quarter earnings call. As always, we would like to start by expressing our gratitude to our associates around the world for their performance and dedication to customers again this quarter. Whether they are in EB Games, Micromania, Spring Mobile, Game Informer, Kongregate, Simply Mac, GameStop, or Cricket, they are truly professionals at what they do, and the secret to GameStop’s success.

Joining me today on the call are members of one of the most tenured management teams in all of consumer electronics retail. Rob Lloyd, chief financial officer; Mike Mauler, executive vice president of international; Mike Hogan, executive vice president of strategic business; and Matt Hodges, our vice president of public and investor relations.

Paul Raines is not joining us as he is recovering from his recent medical procedure. He is in good spirits as he continues his recovery, and, as we’ve previously communicated, the prognosis is very positive for a full recovery. We all wish him well, and look forward to having him back in the office in a few weeks.

We are executing against our vision of a family of specialty retail brands that makes your favorite technology affordable and simple. And today, we are going to share with color around how all of our segments, physical gaming, multichannel, digital, and technology brands are working together to drive solid and diversified profit growth and return to our shareholders.

The second quarter exceeded our expectations, with earnings per share beating the high end of our guidance by $0.02. The new console cycle is gaining momentum, driving positive 21.9% comp sales and total sales growth of 25%, driven by 125% growth in new hardware and 16% growth in new software. We have now had four consecutive quarters of positive comps, and we expect that trend to continue for the foreseeable future.

Our international business also had a strong quarter, which Mike Mauler will elaborate on further. Another major contributor to the earnings beat came from our technology brand segment, which contributed $70.1 million of sales and $7.1 million of operating profit, representing 19% of our operating profit for the quarter.

This highlights the importance of evolving our business into mobile and consumer technology by leveraging the core strength of our vibrant PowerUp rewards community, our unique buy-sell-trade model, our real estate expertise, and our human and capital strength. We are aggressively expanding this part of our business as we added 49 stores during the quarter through acquisition and development, bringing our total store count to 319, a 46% increase since the beginning of the year.

It is hard to believe that it has been less than a year since we announced our initial investment in Simply Mac, our first foray into technology brands. We have learned much, and our relationships with AT&T and Apple are strong and are leading to significant growth opportunities. We have proven our ability to operate at high service levels and provide relevant customer solutions, and this is resulting in an ever-expanding growth relationship.

We have a robust pipeline of additional acquisitions and development opportunities in the tech brand space. Rob will have more comments on the positive impact that these businesses have on our financial performance.

For the quarter, our digital receipts rose 18%, with console digital increasing 13% and PC digital increasing 24%. On a year to date basis, we have grown our digital receipts by 13%, which is essentially in line with the mid-teens digital growth rates of our top four publishers.

We are pleased with our digital market share, which we estimate is in line with our overall market share. Our knowledgeable associates, our proprietary digital delivery system, and our unique buy-sell-trade process gives us a dominant share of digital retail sales by driving discovery and affordability. Mike Hogan will provide more commentary about how Kongregate is helping bring new developers to a crowded games market.

Although no credible market share source exists for digital receipts, a couple of external sources have recently validated our importance in driving this high-growth segment. Microsoft recently announced that over 40% of their digital receipts are sold at retail, and we believe that we sell the dominant portion of that revenue. Likewise, Ubisoft recently announced that 70% of their DLC sales from their Watchdogs title came from retail locations. Again, we are dominant, especially at launch, at selling digital content.

As Mike Hogan will share with you in his remarks, we expect to see continued double digit digital category growth in the foreseeable future, and maintain our market share. Looking ahead to the second half of the year in video gaming, we are excited about the unprecedented lineup of high-quality games this fall and holiday season.

Even with titles like Battlefield Hardline, Evolve, and Batman Arkham Knight moving out of our year, we have 24 high-quality games launching this season, including Activision’s Destiny, Call of Duty: Advanced Warfare, and Skylanders Trap Team; Take-Two’s GTA V, NBA 2K15, and Borderlands: The Pre-Sequel; Ubisoft’s Assassin’s Creed Unity and Far Cry 4; EA’s Madden NFL 15, FIFA 15, and Dragon Age: Inquisition; and Nintendo’s Super Smash Brothers, amiibo, and Pokémon Alpha Sapphire Omega Ruby.

Our hardware and software market share continues to expand and is now at an all-time high as we go into the critical holiday season. We continue to sell over one half of all PS4 and Xbox One titles. We face a challenging third quarter as we roll over the Grand Theft Auto IV launch, but expect to see significant software growth in the fourth quarter.

Our pre-owned business grew 5.5% and a 47% margin. Our value initiative, which provides us with in-demand inventory from existing relationships, helped drive our growth as we brought in over $30 million of product to replace out of stock value items.

Earlier this week, we rolled out a simplified trade-in pricing policy to help customers better understand the value that they get for their games and electronic devices. It should be noted that this policy will not impact our overall pre-owned margins. This move simply creates better visibility to the true value that customers receive using our trade center on the GameStop mobile app, GameStop.com, and in our stores. We continue to see little if any impact from other big box competition in the pre-owned game business.

In just two weeks, we will have over 5,000 of our managers from all of our brands and all of our countries in Anaheim, California to experience a week of immersion in the great slate of new games that we will be launching over the next few quarters. There is no doubt that we will again have the most knowledgeable sales force in the entire videogame category. In addition, we’ll also be hosting thousands of gaming fans through our gaming expo and hosting our first annual developers conference.

We will continue to drive a high rate of internal change to keep GameStop ahead of the curve. We will continue to provide best-in-class customer service in videogames, multichannel, digital, and technology brands and we remain committed to returning free cash flow to shareholders.

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I will now turn the call over to Rob.

Robert Lloyd – EVP and CFO

Thanks, Tony. Hello, everyone. I’d like to begin by reviewing our second quarter results including highlights of 25% revenue growth and EPS growth of 144%, up to $0.22 per share. GameStop’s consolidated global sales were $1.73 billion, up over 25% from $1.38 billion in the prior year quarter.

Our comps were up 21.9%, up 19.7% in the U.S., and up 26.2% internationally. For the last four quarters, our comp was 12.3%, demonstrating the power of the console cycle and compelling titles like GTA IV and Watchdogs. Our same-store sales for the quarter exceeded the high end of that range we outlined in last quarter’s call, due to strong next-gen hardware sales. We outperformed the U.S. market, leading to a hardware share gain of 360 basis points.

There were a few major releases in the quarter, but the success of Watchdogs, Mario Kart 8, and The Last of Us for PlayStation 4 helped drive our new software sales up 15.6%, compared to an 8.5% increase in the U.S. market. Overall, we gained 240 basis points of new software market share in the quarter.

Pre-owned and value sales grew 5.5% compared to the prior year quarter. The U.S. was up 5.3%, and international was up 11%. Our GAAP digital sales totaled $52.3 million, a 5.9% increase over the second quarter of last year, with growth coming in PC digital. Our digital receipts, or non-GAAP revenue, totaled $179.2 million, a 17.6% increase over Q2 last year, with growth in both console and PC digital.

Our mobile revenues grew 85% to $112.1 million, from $60.6 million in the second quarter of last year. The technology brands business continues to grow rapidly, with revenues of $70.1 million, and operating profit of $7.1 million during the second quarter.

Technology brands represented about 40% of the operating profit growth for the quarter. [Life] to date, the store contribution from the tech brands acquisitions and new stores is far ahead of our aggressive pro formas. We are well on our way to adding the 300 to 400 new tech brand stores we outlined earlier this year, and are aggressively seeking additional growth.

Consolidated global net earnings were $24.6 million, up 134% from $10.5 million a year ago. Diluted earnings per share for the quarter of $0.22 exceeded our guidance range and grew 144% from $0.09 per share earned in the second quarter of last year.

Gross margins for the quarter were 31.8%, which are down 300 basis points from Q2 last year, driven by the growth of console hardware as a percentage of total sales. Gross margins in new hardware decreased 100 basis points due to selling more next-gen consoles. New software margins increased slightly when compared to the second quarter of 2013.

Gross margins on pre-owned and value were 47.0%, comparable to the same quarter of last year. As Tony said, we are not seeing an impact from competitors in the pre-owned business. Based on what we learned from the simplified trade price program that we use in Australia, we implemented the new trade pricing policy in the U.S. This will simplify pricing for our customers and our associates, and will not impact margins going forward.

The digital gross margin rate was 65%, and the gross profit was $34 million, with slight declines compared to the prior year quarter due to the mix of underlying products. The gross margin in the mobile and consumer electronics category was 36.1%, with gross profit of $40.5 million, up from $16.3 million in the second quarter of last year. This growth was primarily driven by the Spring Mobile and Simply Mac acquisitions and store growth.

Total SG&A expense dollars increased $53.8 million, due primarily to the addition of Technology Brands, which accounted for $26.1 million of the increase. SG&A decreased as a percentage of sales from 30.5% in the second quarter of 2013 to 27.5% this quarter, evidencing that we leveraged the increase in sales in the videogame brands segments.

Depreciation and amortization was also about 5% less than the prior year quarter. We ended the quarter with 6,698 stores, 4,197 U.S. videogame stores, 2,182 international videogame stores, and 319 Technology Brand stores. We opened six videogame stores and closed 24 in the U.S. and opened four and closed 17 internationally.

We added 26 Tech Brands stores through acquisitions and opened 23 more. At the end of the second quarter, we had short term debt of $214 million, with the increase over the prior year balance due to M&A activity and additional cash returned to shareholders in the form of buybacks and dividends.

As we indicated in the earnings release, our board of directors authorized a dividend of $0.33 per share for this quarter to be paid on September 16. We repurchased 1.9 million shares in the second quarter at an average price of $39.67, for a total of $75.5 million.

Year to date, we’ve repurchased 127.7 million, well on our way to the annual guidance we gave of 250 to 300 million. Life to date, we’ve now bought back over 1.5 billion of our shares, at an average price of $23.51. We have approximately $323 million remaining on our current buyback authorization.

Now I’ll turn to the third quarter outlook. We are forecasting same-store sales to increase ranging from plus 1% to plus 5%, once again driven by next-gen hardware sales. The third quarter title lineup is exciting, as Tony outlined. However, new software comparisons for the third quarter will be difficult with the overlap of Grand Theft Auto IV. We sold well over 6 million units of GTAIV in the third quarter of last year.

We expect diluted EPS to range from $0.58 to $0.64, representing flat to an increase of 10% when compared to $0.58 for the third quarter of last year. We’re using weighted average fully diluted shares outstanding of 114 million, following buyback through the second quarter.

We are reaffirming our full year comparable store sales guidance of plus 6% to plus 12%, and our previous full year 2014 earnings per share guidance of $3.40 to $3.70, using weighted average fully diluted shares outstanding of 114.7 million, following buybacks through the second quarter. Earnings guidance does not include the effect of additional buybacks.

Now, I’ll turn it over to Mike Mauler for his comments.

Mike Mauler – EVP of International

Thanks, Rob. Good afternoon everyone. GameStop’s international businesses had a very strong second quarter, exceeding expectations with a 26.2% same-store sales increase and a significant improvement in operating results over 2013.

Triple digit hardware growth drove strong same-store sales as the installed base of the next generation of consoles continued to increase faster than the previous cycle. During Q3, we also experienced a solid increase in new software sales, driven by new titles such as Ubisoft’s Watchdogs, Sony’s The Last of Us Remastered, and Nintendo’s Mario Kart 8, which also helped drive a more than threefold increase in Wii U hardware sales versus Q2 2013.

Investments in our multichannel strategy continue to pay off as our international ecommerce business entered into its fourth consecutive year of double-digit growth, increasing by more than 46% versus prior year. This growth was driven by an expanded product selection and an ever-increasing number of customers utilizing cross-channel purchasing features such as web in store and pick up in store.

The international sales of digital products accelerated during the quarter, growing at 53% versus 2013, primarily driven by strong DLC attach rate on new titles and significant growth in Steam Wallet and POSA cards, such as League of Legends, Minecraft, and Blizzard.

GameStop’s buy-sell-trade model continued to provide tremendous value to customers as they upgraded to the next generation of consoles. This transition drove an increase in trades, resulting in healthier pre-owned inventory. GameStop’s improved pre-owned inventory position, the expansion of our international loyalty programs, and the more efficient use of our CRM tools to engage customers drove a pre-owned sales increase of 11.2% versus 2013, led by Australia’s growth of 23%.

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In addition to the over 28 million PowerUp reward members in the United States, international loyalty programs topped 10 million members during the quarter across 15 countries. Improvements in our CRM capabilities to communicate with our vast membership base played a key role in the sales growth of digital, multichannel, pre-owned, and our expanding franchise marketing efforts on key titles.

Video gaming and entertainment collectables continued to grow at a fast pace during the quarter as we increased our product offerings to meet the needs of our passionate customers. As we have discussed on prior calls, we continue to test new concepts and product lines in different markets around the world. Over the last six months, in Italy, we have been piloting a partnership with Wind Telecommunications in some GameStop stores, under which we are selling Wind’s phone products and prepaid and postpaid services.

During this pilot, we have seen synergies with our existing customer base and an overall increase in store traffic in the test stores. We have been pleased with the results and our partnership with Wind and will be expanding Wind’s offerings to approximately 70 GameStop stores in the third quarter.

As we enter the second half of 2014, we are excited by the slate of new releases and the strong growth we are seeing in next-generation consoles. GameStop’s investments and subsequent progress in expanding multichannel businesses, growing our worldwide loyalty membership, and the diversification into associated products and services positions us to fully leverage the profitability of this new console cycle and to also grow our business in exciting new areas of adjacent technology.

And now, I will turn it over to Mike Hogan for his comments.

Mike Hogan – EVP of Strategic Business and Brand Development

Thanks, Mike. I will cover three topics this afternoon. First, an update on the overall videogames market, including both physical and digital videogames. Second, an update on the pre-owned business and our expanding presence in the value subcategory. And third, GameStop’s multichannel business and its contribution to overall company growth.

From a total videogames category perspective, we continue to see very strong growth, driven primarily by hardware. Sales of the new consoles continue to meet or exceed our initial estimates, further reinforcing our market model projections for physical category growth in 2014 and in 2015.

The attach rate is still building, as publishers release more new titles. GameStop’s attach rate is now above four, which is 75% higher than the rest of the industry. In the nine months since launch, category-wide sales of next-generation hardware are 70% higher than the same period following the PS3 and Xbox 360 launch, and GameStop’s sales are plus 140%. During the same timeframe, category-wide next-gen software sales are plus 26% versus the prior generation launch and GameStop’s are plus 103%.

We are clearly driving the growth of the next-generation console cycle. Our PowerUp rewards consumer research continues to show very strong purchase interest in the next-generation consoles. In our latest polls, 55% of PowerUp members surveyed indicate they are planning to purchase a next-generation console, but have not done so yet. This suggests significant ongoing demand for the new consoles and it also suggests a coming wave of trades as these consumers upgrade to a new generation of hardware and software.

As Tony noted, we are seeing strong growth in console digital, and our model continues to project double digit growth for the foreseeable future. Our internal numbers show that GameStop digital is keeping pace with this growth in the overall category.

In addition to console and PC digital, the category is experiencing big growth in the mobile gaming segment. As you may recall, GameStop entered this growing market in 2013 with Kongregate mobile publishing. We are seeing extremely strong results today.

In the second quarter, Kongregate, our mobile and casual games platform, hosted very strong results, growing plus 123% over the prior year. We currently have 12 games active on the IOS App Store and Google Play Store, with a total of 20 games expected to be launched by year end. We have multiple games running above a $10 million annual rate, and expect Kongregate to be a top-10 third-party mobile games publisher this year.

Through our efforts in the mobile publishing arena, we have learned a great deal about the needs of the development community. Kongregate is providing a value-added platform for mobile game developers, which to date has met with broad acceptance.

In addition to customer acquisition, monetization, and analytics, Kongregate’s $10 million mobile development fund provides much-needed resources for developers to deliver high-quality games. We will continue to focus on serving consumers by helping developers bring great new content into an increasingly crowded mobile games market.

Pre-owned sales grew plus 5.5% for the quarter. This has been an 11-point improvement versus the same quarter last year. This reflects the strength of the new console cycle and consumer demand for preowned. It also reflects the early success of our value strategy, which we first outlined back in the spring.

[unintelligible]’s pre-owned is clearly benefitting from the new console launches. Roughly 30% of our next-generation hardware and software to date has been purchased with the help of trade credits. Consumers continue to see trades as a great way to get the new technology they want.

Now, a word on the broader value opportunity and the results today. We are leveraging our core competencies and category knowledge, customer relationships, buy-sell-trade expertise, and refurbishment to capture a broader sales opportunity in pre-owned games, as well as an expanded set of technology products.

The results to date are very encouraging. We have seen significant interest from publishers and others in driving incremental sales from a select list of high-demand older games, accessories, and technology. In the second quarter, we sourced over $30 million worth of value inventory, and this value inventory has contributed significantly to our positive growth for the quarter.

Multichannel has a very significant impact on GameStop’s total business, with over 60% of our customers going to GameStop on the web or mobile prior to making a purchase in our stores. Multichannel continues to be a driver of total company performance in Q2, posting plus 49% growth for the quarter.

Leading that growth was our pickup of store business. Consumers can find the product they want online and guarantee availability when they pick up at a store, usually the same day. This also provides an excellent opportunity for the customer to bring additional trades into the store. Pickup in store grew plus 141% for the quarter. This reinforces consumers’ desire for the convenience of web shopping, combined with the GameStop in-store experience.

We continue to invest heavily in mobile and we launched an updated mobile app this summer. We upgraded the entire customer experience and added new functionality such as the trade center, where members can go to learn about trades, look up values, and see current promotions. This addresses the number one customer request for mobile functionality.

The GameStop mobile app has become a key driver of our multichannel business. We now have over 4.4 million installs and average daily users are up 60% over prior year. Our mobile app users spent 81% more, trade 53% more, and buy 79% more pre-owned than the average PowerUp pro member. These are clearly our most engaged customers.

I will now turn it back over to Tony.

Tony Bartel – President

Thanks, Mike. We look forward to seeing all of our passionate managers in a couple of weeks for a full dose of gaming immersion. As their enthusiasm will attest, the gaming business is healthy and growing. Technology Brands is providing relevant sales and profit growth, and we are excited about the growth path in front of us.

We will now open the call up for questions.

Question-and-Answer Session

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