GameStop - Earnings Call - Q3 2011

Transcript

Speaker 4

Good morning. Welcome to GameStop Corporation's third quarter 2011 earnings call. Today's call is being recorded. At the conclusion of the announcement, a question and answer session will be conducted electronically. Anyone wishing to ask a question may signal us by pressing the star key followed by the digit one. If you find your question has been answered, you may remove yourself by pressing star two. I'd like to remind you that this call is being covered by the safe harbor disclosures contained in GameStop's public documents and the property of GameStop. It is not to be rebroadcast or used by any other party without prior written consent of GameStop. At this time, I'd like to turn the call over to Mr. Paul Raines, CEO of GameStop Corporation. Please go ahead, sir.

Speaker 0

Thank you and good morning. Welcome to GameStop's third quarter earnings call. Thank you for joining us. Before we get started, I want to thank our team of over 50,000 associates worldwide for another quarter of giving power to the players. GameStop associates, true to our values and with a passion for gaming, delight customers in 17 countries around the world with the absolute best service, assortment, value, and digital offering. The third quarter continues the transformation of GameStop into a hybrid retailer of physical and digital gaming and electronics products. Our strategic plan developed over the last three years is on track and providing tangible results, and our investments in digital businesses continue in a disciplined way.

As you read in our release, we achieved our earnings forecast, although the quarter presented some challenges in top line due to a cash-strapped consumer that could not afford all the good titles released during the quarter. Comps in the U.S. were slightly positive and -2.2% in our international market. Globally, new software grew 4.8%, driven by three titles that sold over a million units in the first week of their release. Meanwhile, our digital businesses are significantly contributing to our gross margin expansion. Given the amount of strong titles available in holiday 2011, it is clear to us that consumers will make choices on which titles to purchase among the unprecedented quality of offering. At the same time, hardware was flat year over year, reflecting some strength in Sony and continued weakness in handheld.

As we get through a strong launch schedule and into the holiday shopping season, we believe that our ability to place currency in consumers' hands through our buy-sell-trade model is the most effective way to support consumers. If you are a PowerUp Rewards member, you know already the types of innovative promotions we are using to help you fund your holiday game shopping through the trade-in of your pre-owned video games, consoles, and electronics. The pre-owned business grew at 3%. While we saw double-digit growth in the first two quarters of this year, the third quarter grew slower due to the investment gamers made in new titles. As we have seen in prior cycles, strong new title releases tend to attract dollars from pre-owned buyers into the new category.

We are excited, however, about the work we were able to do on building inventory in the quarter through innovative use of the PowerUp Rewards program to drive trades and bring inventory into our stores in preparation for holiday. Our margin rate in the pre-owned business during the quarter reflects some investment in trade promotions, and we are pleased to say we achieved record trade volume at GameStop during the third quarter. This trade volume sets us up for the holiday shopping season, where we will use PowerUp Rewards to promote and merchandise our pre-owned assortment of high-quality games, consoles, and electronics. On a competitive note, we continue to watch competitor experimentation in pre-owned closely, and the data indicates no impact in our domestic store base from those competitors' efforts.

As we continue evolving our strategic plan, we launched an extension of our buy-sell-trade ecosystem in pre-owned iDevices nationally during the third quarter. We now accept the trades of those products in all domestic stores and are currently selling them on our website and in 260 stores. The early read on consumers is that, as we expected, the trading of pre-owned electronics at GameStop feels natural and is convenient to consumers. While it is early on in this new business model, we estimate that the re-commerce market in North America is approximately a $700 to $800 million market and growing very fast in the mobile handset, MP3 player, and tablet categories. The market is highly fragmented and without a clear leader, and retail stores are the best channel to acquire inventory. We also estimate that there are over $7 billion of used iDevices in homes in the United States.

Our investment in refurbishment technology and efficient in-store trade processes is paying off in a rapidly growing emerging category. GameStop is uniquely qualified to integrate these new categories into our buy-sell-trade ecosystem, and the same competitive moats that apply to video games apply in the consumer electronics segment. We also recently launched a gaming tablet assortment in over 200 stores. Once again, GameStop has created an innovative business model by focusing on gamers and thinking outside the box. Our GameStop-certified Android tablets work with the Android operating system, come with preloaded games, and have a proprietary Bluetooth controller available for console-like gameplay on Cool Game. Tablet manufacturers and game publishers are excited by the possibilities we have brought to the market and are meeting with GameStop teams weekly to create innovative products for launch in the upcoming year.

By the way, the tablets we carry are eligible for trade-in at our stores as newer technology tablets become available. We are only beginning to do some work on a market model of what the upgrade cycle on tablets might look like and how we can merchandise and launch immersive tablet games in-store and online, and how big a refurbished tablet business could be. On the digital front, our progress is energizing the organization. Downloadable content is proving to be the killer app our managers told us it would be, as gamers love the idea of getting more content on the games they love at launch. Kongregate and GameStop PC download platform are on target, and we are spending lots of time playing the Spawn streaming beta and getting ready for a market launch.

We are also seeing that the console and PC digital businesses are accelerating internationally as our teams work together with publishers around the world to grow the digital business. Tony Bartel will provide additional color in his remarks. PowerUp Rewards continues its extraordinary ride as the most compelling CRM program in retail. Membership now stands at 14.5 million. The game library includes 218 million games, and renewals continue ahead of plan. Our promotional offerings, digital and paper Game Informer magazine, Epic Rewards, and personalized discounts continue to delight consumers. Publishers tell us they want to use the data asset we have built in more ways, and our team continues to scramble to keep up with the growth of the program. This program represents over 60% of our transactions, and Pro members who have been in the program for a year shop us every 21 days.

PowerUp Rewards, more than print or electronic media, will be our primary weapon in the competitive marketplace during this holiday season. I hope you are a member. On the real estate front, we continue to make great progress using our PowerUp data to consolidate store volume on closing, and in fact, we'll see a net decline in our square footage in the U.S. The program is ahead of the targets we have previously outlined, and we are modeling several scenarios for 2012, both in the U.S. and around the world that we will share with you in the first quarter. Creating value from the real estate portfolio as it consolidates is becoming meaningful to us. Rob Lloyd will give you some color on that in his remarks. In the international business, we continue our work around transferring best practices, and the cost reductions in challenged markets continue.

We saw stronger performance in our European markets, reflecting in particular our market share dominance in France, Italy, and the Nordic region. We believe we are gaining share in most European countries. As a very strong highlight on best practices, I would like to call out our launch of the Australia version of PowerUp Rewards, known locally as the EB World program. This program launched in September and already has over 100,000 members in Australia. In addition, both our Australia and France businesses accept trades of iDevices, with Australia piloting sale of new Apple products and Red Bull phone service. Mike Mauler, our EVP of International, is with us on the call and can provide color on our international performance. In conclusion, we would like to point out that GameStop is a very different company from those competitors that may imitate our strategies.

In the last three years, we have grown new software market share consistently. We invented in-store DLC while making efficient acquisitions in a casual game platform, a PC download engine, and a game streaming technology. We have built a dominant loyalty program that represents over 30% of all video game consumption in the United States, and all of this has been accomplished while buying back close to $1 billion of our shares and debt. We have demonstrated a unique ability to drive change in an evolving market. Our early read on the fourth quarter is strong, and we expect a good holiday. I will now turn the call over to Rob.

Speaker 1

Thank you, Paul. Good morning, everyone. I'd like to begin my remarks today with an update on our capital allocation program. During the third quarter, we repurchased 1,925,000 shares of GameStop stock at an average price of $22.09 for a total of $42.5 million. We also retired $125 million of our senior notes. We ended the quarter with $442 million in cash, up $260 million from last year. As we indicated in the earnings release, our board of directors authorized a new $500 million stock and debt buyback plan. This new authorization replaces the $180 million remaining on the previous authorizations and allows us to continue to buy back our shares over the next 12 months. In addition, we have called the remaining $125 million in senior notes, and when they are retired in December, GameStop will be debt-free.

As Paul mentioned, since January 2010, our stock and debt buybacks have totaled just under $1 billion. This represents approximately 86% of our free cash flow in the last 24 months. Now, I'll recap our third quarter financial results. Total sales were $1.95 billion, an increase of 2.5% compared to the third quarter of 2010. There were a number of very strong new titles released in the quarter. We had three titles sell in excess of 1 million units domestically, and software sales grew 4.8% during the quarter. However, a few of the new releases fell short of our expectations, and as a result, total company comparable store sales were down 0.6%, with +0.2% in the U.S. and -2.2% internationally. Given concerns about Europe involving economic turmoil and competitor results, I want to take a moment to point out that our year-to-date comps in Europe are slightly positive.

Pre-owned sales during the quarter grew 3.1%. As we expected, consumer dollars shifted from pre-owned to new software during the strong title slate. Our efforts this year to improve awareness of the buy-sell-trade ecosystem have paid off as pre-owned sales increased 8.3% compared to the same 39-week period last year. Our digital business increased 59% over the third quarter of last year, with strong growth in both console digital and PC digital. GameStop's fiscal 2011 digital sales year-to-date have now matched the digital revenue from all of fiscal 2010. Digital gross profit grew more than 50%, contributing approximately one-third of the increase in gross profit over last year. Tony will provide you with more details on our digital strategies. Net earnings were $53.9 million, and diluted earnings per share for the quarter were $0.39, in line with our guidance range.

During the quarter, we continued to spend on our strategic initiatives, including expenses to support our PC download platform and the Spawn beta test. These expenses amounted to approximately $0.03 per share. Gross margins for the quarter were 29.4%, up 60 basis points from last year, with the increase driven primarily by digital growth. In Q4, we expect to see similar improvement over the fourth quarter of 2010. The margin rate on pre-owned during this quarter declined slightly from 2010. We were more promotional in an effort to provide PowerUp Rewards members with additional trade credits to buy the multitude of titles released during the quarter. As a result, we had record trades for the third quarter and built inventory for the holidays. The margin rate on the other category grew 710 basis points from last year.

Over 60% of this increase resulted from digital growth, with the remainder attributed to margins earned on the PowerUp Rewards Pro membership and a shift in sales mix away from boxed PC software. SG&A expenses as a percentage of sales increased from 21.5% of sales in the third quarter of 2010 to 22.8% of sales. This reflects our planned investment in digital initiatives, deleveraging from negative same-store sales and swings in currency exchange rates. We demonstrated expense control in light of sales trends, as SG&A, excluding the impact of foreign exchange rates, was less than budgeted. The profit contributed by our store closing sales transfer process, driven by PowerUp Rewards data, continues to increase each quarter. We continue to refine the data from this program to help shape our future store portfolio strategy.

The tax rate this quarter was 30.1% due to accounting for uncertain tax positions and was comparable to the third quarter last year. Total company inventory decreased 8.5% as we continue to focus on disciplined purchasing and inventory management. Inventory turnover was comparable to the third quarter of last year. We ended the quarter with 6,627 stores. We added 20 net new stores in the U.S. after opening 51 and closing 31. Year-to-date, we've opened 126 stores in the U.S. and closed or divested 202. We no longer expect to open 200 stores in the U.S. this year. We will have a decline in net square footage in the U.S. for this fiscal year, and our early plans are for fewer openings next year. Internationally, we added 25 net new stores, opening in better-performing markets such as Italy and France.

We expect to open approximately 50 net new stores internationally for this year. Now for the fourth quarter outlook. We forecast same-store sales to range from flat to plus 2%. During this quarter, we are overlapping the Kinect launch and selling Wii and PS3 at lower price points than last year. We expect fully diluted earnings per share to range from $1.66 to $1.76. This compares to $1.56 per share in the fourth quarter of 2010. During the quarter, we will continue to invest in our strategic initiatives with the impact expected to be approximately $0.03 per share. As we've told you in the past, the payoff for these investments is beginning to come now and will come in future years. We'll continue to prepare Spawn for a service offering in 2012 and continue our other digital and PowerUp improvement.

We expect that the tax rates for the fourth quarter will be approximately 100 basis points higher than last year. We are reiterating our previously announced full-year 2011 earnings per share guidance of a range from $2.82 to $2.92, representing an EPS growth rate of 6% to 10% based on 2010's EPS of $2.65. We are revising our full-year comparable store sales guidance to range from down 1% to flat, and our full-year revenue guidance to range from plus 2% to plus 3%. This change reflects the top-line results of the third quarter and the uncertainty surrounding the consumer in today's economy. Earnings guidance does not include the effect of additional buybacks. Now, I'll turn it over to Tony for his comment. Thanks, Rob, and good morning, everyone. As mentioned earlier, we had expectations for stronger sales due to the great title lineup and record reservations.

We found that consumers were unable to fund the products that they wanted as these strong titles rolled out week after week. As we head into the fourth quarter, we are pleased with the performance of Activision's Call of Duty: Modern Warfare 3, Bethesda's Elder Scrolls V: Skyrim, Ubisoft's Assassin's Creed: Revelations, THQ's Saints Row 3, and Microsoft's Halo Combat Evolved Anniversary, all of which met our very high expectations. Recent launches are strong, and we are not seeing new titles falling off. We are outpacing market growth on each of these launches and have driven over one-half of the total U.S. growth that these titles have experienced. We have equally high expectations for several strong titles yet to release, including EA's Star Wars: The Old Republic and Nintendo's Mario Kart 7 and The Legend of Zelda: Skyward Sword.

From a digital perspective, we exceeded our expectations as we continued fast-paced growth in all of our digital initiatives. Total digital revenue grew 59% in the third quarter, with console digital growing 63% and PC digital growing 51%. We have grown digital revenue 61% year-to-date and are on schedule to exceed our $450 million annual digital revenue goal. With the strength of 14.5 million PowerUp Rewards members, the support of our publishing partners, making digital content available as a simple gifting solution, and the multi-channel integration of our digital strategy, we are very excited to see the growth that we will garner during the holiday season. By integrating downloadable content into our pre-sale programs on major title launches, we are driving significant incremental purchase of downloadable content. We are averaging double-digit attach of the sale of downloadable content with recent major releases.

In the case of Call of Duty: Modern Warfare 3, we work closely with Activision, Sony, and Microsoft to pre-order and deliver nearly 600,000 instances of the Modern Warfare 3 Elite DLC to date. This places the launch of Elite as one of our top 10 launches of the year so far. We have found that consumer demand for downloadable content is very strong at the point of launch, and our ability to pre-sell and deliver in real time to a PowerUp Rewards member's digital locker gives us a unique competitive advantage. Based on our research, we know that one-half of the DLC that we sell is to customers that have never purchased DLC before. We are driving strong incrementality by helping people discover and fund this add-on content.

Customers note the ability to earn PowerUp Rewards points, the knowledge of our associates, and the fact that they can use non-credit card sources of currency as the top reasons that they purchase from GameStop. As mentioned last quarter, we continue to see that over 70% of the currency used to purchase digital assets is non-credit card. Our cloud gaming subsidiaries, Spawn Labs, completed a successful private beta, proving the viability of our technology in a data center environment. As previously announced, we plan on scaling our model by launching a nationwide private beta before the end of the year that will take place in six data centers located throughout the U.S. We continue to see this as a great way for gamers to experience and trial actual gameplay to drive additional sales of console games and digital add-ons.

We are targeting a launch of our trial service in the first half of next year. As a reminder, our business model is a pro-publisher model that requires no additional build or additional investment to use our cloud gaming service. On PC downloads, we rebranded our Impulse client to the GameStop PC app and are now selling digital PC content in our stores alongside our physical PC offerings. We're also using the Impulse platform to download PC titles from GameStop.com and are awarding PowerUp Rewards points for PC downloads. As with DLC, the use of trade credits and gift cards is fueling the growth of this digital content. The GameStop retail engine is working to drive both traffic increases through our download engine as well as additional installs of our client on gamers' computers.

Fueled by strong titles such as EA's Battlefield 3, we saw 158% revenue growth in PC digital downloads during the quarter. Kongregate continues its rapid growth in the quarter as well, increasing revenue by 181% over last year. Our focus on adding free-to-play games to our site, along with in-store promotion, is working and is accelerating our growth. Our Game Informer magazine, in addition to being the fourth largest magazine in the U.S. with over 7 million paper subscribers, continues to grow its digital offering with more than 800,000 digital subscribers, adding over 330,000 digital subscribers during the quarter. Finally, as Paul mentioned earlier, we recently launched three gaming-certified tablets at over 200 GameStop stores in the U.S. We worked closely with OEMs to find tablets that would satisfy gamers' high standards and chose the Acer 7-inch Iconia, the 10-inch ASUS Eee Pad Transformer, and the Samsung 10-inch Galaxy Tab.

These tablets all run on the Android operating system and come pre-installed with seven free games: Kongregate Arcade, Digital Game Informer, and a GameStop web app that provides relevant product advice, as well as a curated list of immersive games that can be purchased through the Android Marketplace. In addition, we also offer a proprietary Bluetooth controller that allows for a more immersive gaming experience. Four of the seven preloaded games that we offer support the new wireless controller, and we have additional controller-enabled games listed in our GameStop web app. We also announced this quarter that we are accepting iDevices as trade currency, and this has been a key accelerator of tablet sales in our pilot stores. Finally, we will also be a launch partner for the new ASUS E-Pad Transformer Prime, which runs on the new NVIDIA Tegra 3 Quad-Core chipset.

To date, we've been very pleased with our tablet sales and are executing our second replenishment order. We believe that we can drive the adoption of Android tablets as a great gaming device and are excited about the opportunity to participate in a non-e-reader U.S. Android tablet market that Gartner estimates at over $1.5 billion in 2012. With that, I'll turn it over to the moderator.

Speaker 4

Thank you. At this time, if you'd like to ask a question, again, you may do so by pressing star one on your touch-tone telephone. Please make sure that your mute function is turned off to allow your signal to reach our equipment. We'll go ahead and pause for just a moment to give everybody an opportunity to signal. We'll take our first question today from Bill Armstrong with C.L. King and Associates.

Speaker 2

Good morning, gentlemen. The other category, gross margin up 700 basis points. You mentioned, is digital just in the other category? Do you have certain digital revenues in the software category as well? How should we think about that?

Speaker 1

This is Rob. Digital is just in the other category.

Speaker 2

Are we looking at the 100% margin where you're basically getting a commission on these sales? Is that how we should think about that?

Speaker 1

That is a component of what's in that other category. You know, there are a lot of things going on in the digital margin world. We have various digital offerings, and the margin characteristics of them are somewhat different. Some of them are the 100% that you described.

Speaker 2

Okay. If digital sales were obviously up very strongly, but the overall other category actually was down 4%, what was the offset there? What declined in the other categories?

Speaker 1

It was principally boxed PC product. There were a couple of strong titles in the third quarter of last year selling PC.

Speaker 2

Okay. Used game margins down 140 bps. Was that just your efforts to acquire more product?

Speaker 0

Yeah, Bill, this is Paul. We are using the PowerUp Rewards program pretty extensively in the pre-owned business in two ways. One is to market and sell pre-owned games, as we've described before. The other is to bring in inventory and maximize trades. A lot of our activity in the quarter was in anticipation of holiday, in unique promotions to consumers, sort of individualized promotions to drive trades on popular games in stores. Fair to say, Rob, you want to add anything to that?

Speaker 1

I think that covers it well.

Speaker 2

Okay. One last question on your iDevice program. Obviously, you've got a very rapid product cycle on iDevices. I guess the question is, who are you going to sell, you know, three or four-year-old iDevices to? You know, what and how do you address the risk of product obsolescence?

Speaker 0

Great question, Bill. You know, it's interesting, as we've gotten into this, there is tremendous consumer demand. If you look at video game consoles, one of the things GameStop has learned through the years is the pre-owned business is not a substitute for the new business. It actually is a market-expanding business because if you look at our pre-owned consoles, we are hitting newer price points and lower price points than on the new. If you flip this around to iDevices, there's a large segment of consumers who don't have access to a new iDevice. The people who are buying them, to answer your first piece of your question, the people who are buying those older devices are the aspirational consumer who is looking for something, maybe can't afford a new phone, etc., or wants to replace another branded phone with an iDevice. That's one point.

The other point is our velocity, thanks to our refurbishment center and our ability to understand how fast these devices can turn, we feel pretty confident around the velocity we can turn this product. Of course, we're looking forward around upgrade cycles and everything else that we hear about in BREED, but you'll see that our ability to marry these upgrade cycles to new tablets, new consoles, new software launches will become more and more efficient. We don't have a lot of heartburn around that.

Speaker 2

Okay. I think you said before you're going to be selling these, you're now selling them in about 200 stores. When will you roll it out to the entire chain?

Speaker 0

We are in 260 stores and we are on our website. The governor on that is inventory. If you look at other players in this industry, it is all about the inventory. As that builds, you will see us move to more stores. We are learning a lot about, you know, where, fair to say, Tony, where people shop. We have certain tourist markets, for example, where we get a lot of international tourists who have tremendous appetite for these devices. We are learning a lot about where, but you will see us expanding the footprint very soon.

Speaker 1

This is also a very strong seller on GameStop.com.

Speaker 0

It's very strong on GameStop.com. That's right.

Speaker 2

Okay, great. Thanks very much.

Speaker 4

Thank you for your question. As a reminder, please try to limit yourself to one question so everybody in queue has a chance to ask a question. We'll go next to Gary Balter with Credit Suisse.

Speaker 3

Hey guys, it's Seth and Gary. A couple of quick questions. First, a question on the holiday. We're starting to see some aggressive discounts out there on some new titles and some console bundles. How are you thinking about the promotional environment this year? What are some of the things you're doing to leverage PowerUp to get that traffic this holiday?

Speaker 0

Hi Seth. A couple of things I would point out. I'll start it off and then Tony has probably some thoughts on it as well. The first point we would make is if you look at last year, one of the things we learned was we faced an extreme discount environment, but we were able to gain share through the holiday. If you recall, it was the first holiday we had gained share in multiple years. I don't remember if it was six or seven. Usually, we gain share through the year and then in holiday when other players jump in and discount, we tended to lose share. Last year, we gained share. What we learned last year was that our strategy around leveraging buy-sell-trade with PowerUp is a pretty powerful tool.

We will, of course, be in the market with print, FSIs, and we'll do some electronic media, but more and more we see the effectiveness of our marketing around individualized offers to PowerUp. This year, last year, I think, guys, we were in the market with four to five million PowerUp members, I think, at holiday. This year, we are at 14.5 million and counting. The first point, Seth, is the power of the program is significantly enhanced through greater membership. Many of those already have a year under their belt. The second point is that the types of things you'll see us do is identifying individual consumers' buying behaviors. If you bought X game, there's DLC available or add-on for it, or if you have Y game, there's a similar sports genre title you may like. You'll see us doing individual offers around that.

You'll also see us do some things around exclusivity of certain times and places when you can shop. All of that's going to be happening on an individualized, personalized basis for competitive reasons. What we're finding is consumers react far more favorably. Tony, maybe you want to talk about how you're going to use this on new software and console.

Speaker 1

Yeah, absolutely. I think, Seth, what we're going to see is that there will be some deep discounts. Obviously, most of the FSIs are already out there, so you can see what takes place. We do believe that just like last year, these will be very deep for a very short amount of time, and then they'll be pulled back. We believe that the consumer is looking for ways to fund a lot of great product. To be quite honest, we believe that this great product is worth a tremendous value. We think that our trade program, buy-sell-trade program, is one of the best things that we can execute during the holiday season. Now you add iDevices to that mix.

You can think about ways that we are going to be using PowerUp Rewards to offer some very strong incentives to our PowerUp Rewards members, including the use of trading in their iDevices to purchase a lot of these games. To us, it's all about giving the consumer a way to be able to fund the games that they want to buy. We believe there are some great titles out there that are worth the amount of money that folks are, the price that they're offered at. You can also see on our FSI that we have some very strong discounts for Black Friday as well. Our main emphasis is going to be making sure that the consumers have the funds available so that they can buy the games that they want.

Speaker 0

This is Gary. Can I just follow up on, you know, you have a competitor in Europe, and you mentioned that your European business is positive, who said that one of the bigger problems they're facing right now is that after the title release, the drop-off is much greater. Could you talk about what you're seeing? If you're seeing, is that similar trends? You mentioned some of the new titles in November and how strong they are, but has it been strong initially and then a quicker drop-off, or are you seeing some continuity in it?

Speaker 5

Hey Gary, there's a lot there. I would say a couple of things, and I'll let Rob comment on the numbers and what he's seeing. We don't agree with that view. We have seen titles sell sustainably well that have launched in the third quarter through the fourth. We do not share that point of view around the drop-off. Remember also, when you have this many titles hitting all at once, there is going to be some consumers who can't buy them all on the first day, and they're going to come back and shop. The other side is we have a very strong trade system that drives currency for people. I mean, our value proposition is unrivaled by any competitor anywhere. I mean, last year we put over $1 billion of trade credits in people's hands. We think that's what's sustaining us.

Rob, any color you want to give on individual sort of sales rates or?

Speaker 0

Yeah, I guess I would say that our experience was in the third quarter with the title launches, the initial sell-through did not meet our expectation. That is not the case with the fourth quarter titles. As Tony has said, they have met our very high expectations.

Speaker 5

As Seth mentioned, we're starting to see these ads that are discounting some of these titles significantly. Are they able to do that under the MAP rules?

Speaker 1

Yes, they are able to do that under the MAP rules on the games so far that we've seen in the FSIs. We have seen that. Gary, one other thing that I might add that is also extending the gameplay, given our extensive focus on selling downloadable content in our stores, I think we've mentioned earlier that over half of the sales of DLC that take place in our store actually have a physical game attached to it. What we're seeing is as DLC is coming out on a monthly basis or on a quarterly basis on these games, that's actually prolonging and extending the tail on new games because people are coming in excited about the DLC and they're actually buying the game when they hear about the DLC.

Speaker 0

The other point, Gary, as you know, on the discount side, what we've learned in previous cycles of this, particularly on software, is there's frequently a lot of media buy that goes into this, but there's not as frequently depth of inventory. Of course, we have to be deep on inventory and we are deep. We've seen a lot of these promotions will be very short-lived as consumers flock, take all the markdowns, and then they're out of stock and we're right back into the environment we're in. We are looking hard at both what the markdown activity is, but also how much inventory are people buying in.

Speaker 1

Okay, thank you.

Speaker 4

Thank you. We'll take our next question from David McGee with Centro Robinson Humphrey.

Speaker 3

Yeah, hey, good morning guys.

Speaker 5

Good morning.

Speaker 3

A couple of questions. One is, when you talk about the title release schedule being almost too concentrated and too good in the third quarter and having some impact in terms of what people could afford, but then in November it seems to be better in that regard. Could you sort of tell us why that's maybe gotten better here in recent weeks with more recent titles than it was last quarter?

Speaker 0

Hey David, I think a couple of things we look hard at is the % of trade credits applied to new games, etc. We're doing a lot of analysis. Are some games getting more trades against them than others? There is some built-up expectation around certain key titles where we think some consumers, you know, we do a lot of consumer work. Some consumers were waiting on a title or a B title. We also, of course, know there's varying degrees of quality of titles out there, and some genres and some specific titles have more demand than others. I think it's early yet, right guys, to tell, Tony?

Speaker 1

Yes, I think it is. I'm not exactly sure why things have opened up. We've had strong reservation performance. I don't think it's ironic that we did really ramp up our iDevice program, which has accelerated very quickly and thrown more currency into the equation as well. I do think that there were great partnerships, great marketing campaigns driven on the launches that have taken place recently. We had high expectations for many titles and they have met those in the November launches.

Speaker 0

Yeah, the real analysis now is for us, as we look forward through holiday, you know, you have a bunch of great quality content out there, and how many consumers are going to come back and look for those as maybe gift items versus buying them at launch, which is what we traditionally see. That's where a lot of the work we're doing, trying to understand these early strength signals we're seeing in November.

Speaker 3

Thank you. Just to follow up, in the past, it seems like there's been a lot of strength in November around Black Friday, and then maybe it softens a bit in the first half of December. You mentioned that you can keep the PowerUp Rewards members more engaged this year just by the sheer numbers and doing what you did last year. Is there a way you can keep the sort of non-loyalty members also engaged in the first half of next month than maybe in the past?

Speaker 0

I think what we're learning, and if you listen to most retailers, what we're learning is Black Friday is a big event, brings people in, then .com becomes a very significant channel through the next two to three weeks. We had huge growth last year. If you recall, we comped over 100% in .com. We have built out significant capacity there and expect .com to be strong again. It gives us a real good gauge around traffic. You'll see us do some very interesting things around PowerUp in those gaps where we know folks are starting to build their Christmas shopping lists and so forth. PowerUp member, by the way, is very much a multi-channel shopper. They'll shop us in-store, online. They'll hold online, pick up in-store. They'll do a variety of ways and we'll see their traffic in multiple channels.

Speaker 3

Great, thank you. Thanks, David.

Speaker 4

Thank you. We'll take our next question from Marc Summey with Goldman Sachs.

Speaker 5

Hi guys, thank you for taking my question. First one was about the drivers of the international acceleration. If you could give us a little bit of detail, it seemed that year to date at Q2, Europe was trending down quite a bit and now it's up. That means that last quarter really accelerated a lot. I was wondering if you could give us some color on the drivers.

Speaker 0

Yeah, maybe Mike, you want to start that? Mike Mauler's here as well.

Speaker 5

Sure. Obviously, there is some economic headwind in Europe, and we've really been focused in two areas, and it goes back to 2010. We already decided really to focus on the basics, improving inventory management, optimizing our buy-sell-trade model, driving reservations, and rolling out best practices. That, combined with our activities in 2011 where we've been focused on cost control, we've closed 38 underperforming stores, we've completed headcount reductions in several markets, and we're in the process of consolidating some operations. I think we put those two things together, and what we've seen is some revenue growth in Europe, a decrease in expenses, and we've really done a good job, I think, at taking market share in most markets.

Speaker 0

Yeah, Marc-André, you know, Mike and I were in June in France and Italy, and Rob and Tony have recently been in Europe with Mike. I think if you look at our French, Italian, Nordic, Irish businesses where we have pretty dominant share, our ability to bring all of those things you've heard us talk about, RSV, loyalty programs, DLC, all those things we think are starting to come to bear and make us very different in those markets. That's, we believe, what's translating into share gains. Like everyone else, we watch the macro closely, plenty of headlines, etc., but our activity there, I think, fair to say, Mike, is reflecting a little bit of what we've been able to do with share growth in the U.S.

Speaker 5

I think that's true. Yeah.

Speaker 3

Great, thanks so much. One more, in terms of share gains, when you look at new software, you clearly gain a lot of share in the third quarter. I was just wondering, are you seeing any impact from your competitors as they're ramping up pre-orders, something they have not really done before, or is that something in the same way that you're looking at what they're doing in use? Maybe you can talk about what you're seeing in terms of what they're doing on pre-orders?

Speaker 0

You know, we see that. We see lots of competitor initiatives around pre-orders. We see the tremendous media buys that go on. We also hear the volumes of what's happening on pre-order, and I think what's often lost is the scale of what we do. If you recall, was it the first quarter, Rob, we gave out our number on trades. You know, we did 30 million trades in the first quarter. Our competitor is trying to do a million and some for the year as a target. The scale of what we do is often lost. Yeah, we see competitors driving reserves. It's interesting, but what I think we are able to do uniquely is people don't understand what really drives reserves, which is the complete ecosystem of unique content, differentiated midnight launches, PowerUp points, trade credits against reserves. All of that, Mark, we monitor and do channel checks.

We don't see great execution in competitors on that.

Speaker 1

I would say that their attempt to drive reservations is not a recent attempt. They've been doing this for years. I don't think there's been a whole lot of change in their approach in the last few years.

Speaker 0

Yeah.

Speaker 3

Okay, and if I may, just one last one, a quick one on use. As we go into the fourth, as we're in the fourth quarter, just wondering if you could talk about, in the past, you had talked about recovering all of the margin hit from last fourth quarter. I'm just wondering now with the investment in the trade, are we supposed to expect the same thing or should we think more as maybe margins doesn't recover all of what it's lost last year and maybe sales pick up because of the inventory that you got this quarter? That'd be great. Thank you.

Speaker 1

I think you can expect the used margins for the fourth quarter to get back into that normal 46% to 49% range that we typically have, last year fourth quarter being an anomaly.

Speaker 0

We know that pre-owned games are a great gifting item. I mean, that's been proven several times. Given the quality of the release cycle, we know there'll be lots of pre-owned games under trees this year.

Speaker 3

Got it. Thanks so much.

Speaker 4

Thank you. We'll take our next question from Anthony Chukumba with BB&T Capital Markets.

Speaker 3

Good morning. I had a question, and maybe this is getting a little bit ahead of ourselves, given the fact that we do have a crucial holiday sign season coming up. I just wanted to get your initial thoughts on 2012. Obviously, we'll have the Wii U come out, the Sony Vita. It looks like Grand Theft Auto V will finally come out next year. I just wanted to get kind of your high-level initial thoughts on 2012.

Speaker 0

Anthony, I'll let Rob give you maybe sort of his thinking around. We're spending a lot of time modeling right now. We've got a pretty rich market model. There's lots of things going on there. We are excited about the Wii U, although we know Nintendo will not really be promoting that until we get through holiday because we've got to focus on this year. Wii U is going to be, we believe, a very exciting product from what we've seen. Vita looks dynamite in the demos, and we're eager to see how that product plays out in the handheld market that, as you know, has been under pressure. We're also doing quite a bit of market modeling around tablets and iDevices.

Those are very large pools of, on one hand, pre-owned inventory in homes, and on the other hand, emerging electronic categories that gaming will be a huge piece of. That's another part of it. Rob, maybe you want to share some of your thoughts around the new software and console side.

Speaker 1

There is not much to add there. I would just say that it's certainly early for us to talk about what GameStop sees for itself in 2012. Frankly, we need to see how this holiday comes in for the video game business before we talk about where we see the market in 2012.

Speaker 0

If you recall, we've said previously in our market model, of course, we see flat-ish physical console business extending through 2014 with significant double-digit growth around console DLC. I would say that with a lot of confidence, we think DLC continues to grow. Every publisher, fair to say, Tony, has big progressive plans around DLC.

Speaker 1

Right, we do see DLC as a continued very, very strong growth vehicle.

Speaker 0

DLC is an interesting one because our retail share of DLC is extremely dominant. We don't have perfect data on that, but the data we do have says we have a very unique, defensible mechanism through the digital locker of PowerUp Rewards members. Our modeling around DLC is a really important one, and it's one that publishers really like the profit characteristics of for themselves, fair to say, Tony.

Speaker 1

Absolutely.

Speaker 0

DLC is a great product for them and a great product for us.

Speaker 1

They like the discovery and the ability to fund it with unique currency in our store. All of those are working together.

Speaker 0

We will be spending a lot of time on that piece of the model.

Speaker 5

Okay, that's helpful. Thank you.

Speaker 4

Thank you. Ladies and gentlemen, due to the time constraints, we'll take two further questions. We'll go first to James Hardiman with Longbow Research.

Speaker 5

Hi, thanks for taking my call. I wanted to follow up on a question earlier in the call surrounding the other category. It seems to be a pretty big X factor here. You mentioned that all the digital numbers are in there. Obviously, you're seeing exponential growth in digital, but I think you said that it was PC games that are in there that were down pretty dramatically year over year. I guess as I look forward, and maybe if that's the case, maybe it was lapping the StarCraft release from last year, which would actually make some sense. If I look forward, how should I think about that other business? Obviously, digital should continue to grow. Do the comparisons in the other piece of other get any easier here in the fourth quarter in terms of what you're selling?

Were some of the add-ons in terms of Kinect and Move last year, was that all on the hardware side, or does that show up as a difficult comparison for other in the fourth quarter? Thanks.

Speaker 1

Let me first start by saying with respect to the PC software side of things, a year ago, we were not extensively in the PC download business. What we sold in terms of PC was box product. We had a World of Warcraft launch in December. I think that you'll see comparisons to that when the numbers come out at the end of the fourth quarter, and that will drive some of the movement in the other category. The Move accessories were in the other category last year and are still this year. The Kinect hardware, however, was in hardware for GameStop.

Speaker 5

Okay, that's very helpful. Just real quick, I was wondering if you could comment. You talked about some games did really well for you in the third quarter. Some games fell short of expectations. Can you give us any color on what games sort of did great and which games were maybe a little bit short of your expectations? Thanks.

Speaker 0

Probably early, James, to do that. We like to let the publishers make their own commentary, but I think you would say that, you know, the ones that we call out as million unit sellers, those are big blockbuster titles. I think we'll, fair to say, Tony, we'll leave that to the publishers.

Speaker 1

Fair to say. I think, yes, I'd rather address that comment after the publishers have had a chance.

Speaker 0

We like to let them, you know, brag on their intellectual property before we do. Certainly, I think it is fair to say, I mean, for the bear case that says the console business is disappearing, you can't help but look at what's happening out there right now with these big blockbuster titles and go, wow, you know, there's a tremendous market for high quality, big name properties.

Speaker 5

Great, thanks guys.

Speaker 4

Thank you. Our last question today will be from Mike Hickey with National Alliance.

Speaker 1

Hey guys, thank you for taking my questions and congratulations on the build of your PowerUp Rewards program. I've been a member now for over a year and you talked about lapping into this holiday with a much larger base of members. Can you talk about what you've seen in terms of member behavior, those of us that have been around for more than a year? Are you seeing more trade-ins? Are you seeing more buys? Just curious if you can provide any thoughts there.

Speaker 0

Absolutely. Hey Mike, thank you for being a member. I've got to go back and ask the team, we got to send Mike some special promotional activity. I didn't know that. As I shared on the remarks earlier, there are some very interesting numbers that are coming out. As I said, members who overlap into a one year, we now have measurement and visibility to their share of wallet, their spend, their frequency of visit. I mentioned earlier that a Pro member who's been with us a year shops us once every 21 days, which is becoming a very meaningful metric. Your frequency of shop for us is becoming a big deal because we know if we can inspire one more visit through a midnight launch, through an early visit, etc., it could be very interesting.

We also know that member pre-owned penetration is higher for members than non-members, and in fact, it's three points higher and getting higher. We've also shared with you before, member trade penetration is significantly higher than non-member. I think other than that, for competitive reasons, we've got to be careful with how much we talk about it, but I think you can expect that in future calls, and particularly in the new year, we'll be talking a lot about spend and share of wallets. The whole goal of this program, I will remind everyone, is to drive share of wallet in a MAP-priced category where everyone has the same retail price.

Speaker 1

Okay, thank you. On the PC download, it looks like, you know, when you think about the build in 2014 and your $1.5 billion guidance, it looks like PC download is kind of the critical inflection point in your growth medium term to get to that goal. Steam seems to have this stranglehold in terms of market share, and I realize that you guys have integrated Impulse into your GameStop.com e-commerce site, and it looks phenomenal. I'm just curious if you could share with us kind of the key drivers to breaking down the market share stranglehold that Steam has.

I think the key for our digital strategy is that that's one part of it, and I think we have a comprehensive digital strategy that we're going to build a platform like we've talked about in the past where when gamers want the game and on whatever platform they want the game, we're going to lead them there. This is just one part of our digital strategy to get us there, along with downloadable content, along with plays we've made in the mobile space, in the casual browser space. We've made several plays there, so this was one of them. If you look at how we've leveraged PowerUp Rewards, how we've leveraged our relationships with the publishing community, I think you can begin to get a grasp of how we plan on leveraging our new asset and really growing Impulse so that it's a very strong competitor in this space.

It's part of a broader digital strategy that we have. It is, like you say, a very important part, and as we talked about, we do plan on continuing to roll out improvements to it, some as early as first half of next year. I think that you'll see those plans evolve, and it's just a broader part of a larger digital strategy to allow people to game anytime, anywhere, and on any device.

Speaker 0

There's a lot of appetite when we meet with publishers. There's a lot of appetite for broadening the channels for distribution of PC download. If you can add trade credits and PowerUp Rewards points to that, we get a lot of welcome reception on that with publishers. You'll see more from us on that.

Speaker 1

Okay, thanks guys.

Speaker 0

Thanks, Mike. With that, we will wrap up the call. We want to thank all of you for listening in on the earnings call and look forward to talking to you again in the new year. We are looking forward to a tremendous holiday season. I hope that all of you are PowerUp Rewards members, so I can invite you in personally with unique promotions tailored to your taste level and hope everyone has a great Thanksgiving next week. Thank you very much.

Speaker 4

Thank you for your participation. This will conclude today's conference call.