GameStop Corp. (GME) Q4 2014 Earnings Report, Transcript and Summary

Good day and welcome to the GameStop Corporation’s Fourth Quarter and Full Year 2014 Earnings Conference Call. A supplemental slide presentation is available at investor.gamestop.com. 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 Paul Raines, Chief Executive Officer of GameStop Corporation. Please go ahead, sir.

Thank you, operator and welcome to the year ending earnings call for GameStop. As we begin our call, I as always want to thank our global team for delivering outstanding customer service in 2014. Joining me today on our call are Rob Lloyd, Chief Financial Officer; Tony Bartel, Chief Operating Officer; Mike Mauler, President of International; Mike Hogan, our EVP of Strategic Business and Brand Development; and Matt Hodges, our Vice President of Investor Relations. In 2014, we saw many aspects of our strategic plan come to fruition and I am very proud of the dedication and execution of our entire team. One of our goals is to maximize our brick-and-mortar stores and our next-gen videogame hardware and software launches were dominant as we delivered all-time high market share of 28% on hardware and 46% on software. All the investment in PowerUp rewards the unique content. Execution and customer service paid off with this generation. We expect that to continue. Non-GAAP digital receipts climbed 31% year-over-year and digital is a solid growth story for us. We delivered this year $948 million of digital revenues. If you go back and look at our 2010 Investor Day, we forecast $1.5 billion by 2015. And though we will not reach that target, our growth is comparable or ahead of most publishers. Rob will discuss our digital market share and our progress in that business with you. Pre-owned showed growth of 2.6% in a declining software market and maintained healthy margins. You will recall that last year we introduced the value category as our strategy to gain share in new games sold below $20 as well as growing our pre-owned category. I am pleased to report that our market share in this category grew by 2% indicating that our buying took inventory out of the market and away from our competitors. Let me state once again that competitors who have entered the pre-owned market have not heard our market leading position, but have helped create greater awareness among consumers. Technology brands had a spectacular year. On this strategy, I am pleased to report that we have exceeded our initial commitments laid out last year. After only 2 years, our technology brand strategy is producing real results and we now expect that business to contribute over $1.4 billion in sales and $170 million in operating earnings by 2019. Our internal rate of return on acquisitions and new real estate exceeds our internal targets and we believe we are the most productive dealer for both AT&T and Apple. Our partnership with AT&T is particularly productive. After only 2 years, we are their second largest and fastest growing dealer and we have done multiple acquisitions in the past year. Our Cricket stores are also growing although not as fast. Even our GameStop Technology Institute in Austin is partnered with AT&T on high-speed fiber connections as you may have read about in the AT&T annual report Apple is also a great partner. And with the three acquisitions we have made, we are now their largest independent dealer. We believe there is a solid business model to place Simply Mac stores in secondary markets that do not have Apple retail and take share from existing big boxes. The end result of all this activity is a record high gross margin rate of 29.9%. In the last 7 years, we have increased our gross margin rate from 25.8% to 29.9%. As many of you know, we recently completed our third investor survey in the last 5 years. One of the points of feedback that we got in that survey is that we need to set achievable financial targets. Rob will cover our guidance with you, but I wanted to point out in that spirit that given the way this console cycle has played out, modeling software growth has been challenging. For 2015 we have looked at every model available from analysts, software publishers and industry sources. Analyzing all of this information and comparing it with our internal data, our team has forecasted our new software growth for 2015 at 4% to 6%, a number we believe to be realistic for our business. The final pillar of our strategic plan is disciplined capital allocation. Outside of any investment opportunities that are more accretive than buybacks, we intend to return our free cash to shareholders. During 2014, we have repurchased $333 million of stock and paid out $149 million in dividends. We currently have an authorization of $500 million on our share repurchase plan and we recently increased our dividend by 9% to $1.44 per share. As we look ahead to the future, we are excited. Our videogame business has a solid growth rate and we have been successful in building our market share, loyalty programs and reputation which will serve as a springboard for our future growth. Our digital and tech brands initiatives give us great growth vehicles and our pre-owned business will always be a strong foundation. Before I turn it over to the team I want to make one important point. At GameStop only one thing remains constant, our focus on the ongoing transformation of the company, at the heart of GameStop’s evolution is the story of driving commitment to change, the relentless pursuit of innovation and a deep understanding of the consumer marketplace. One good example of our ongoing transformation is that non-physical gaming products will represent 20% of our revenues this year. Mike Hogan has been running our business development process for several years and we have asked him to discuss this topic later in the call. Thank you for your support at GameStop and I will pass the call on to Rob.

Thank you, Paul. Good afternoon. Today I would like to take you through four major points. First, I will very briefly recap our growth for fiscal 2014. Next I would like to discuss our 2015 guidance focusing on software growth. Third, I will provide some information about digital from both the market and a GameStop perspective. And lastly I will provide additional color and metrics on our technology brands segment. So let’s begin with the 2014 recap on Slide 2. Overall results were in line with our expectations. Sales decreased 5.6% in the fourth quarter, but increased 2.8% for the year. Excluding FX, sales decreased 2.8% in the fourth quarter and increased 4.3% for the year. Comparable store sales declined 1.8% for the quarter, but increased 3.4% for the year. Gross margins expanded 50 basis points for the year resulting in a 29.9% margin rate, which is our highest annual gross margin rate and the highest gross profit dollars we have achieved in our history. Operating earnings increased 7.7% for the quarter and increased 7.8% for the year. Non-GAAP net income increased 5.9% for the quarter and 10.2% for the year. Non-GAAP EPS increased 13.2% for the quarter despite a $0.05 negative impact from FX rates and increased 15.3% for the year despite $0.08 negative impact from FX. SG&A as a percentage of sales was 21.6% for the year, up from 21% the prior year period due to the growth of tech brands which carries higher SG&A rate. Now let’s look at sales for some of the categories on Slide 3. As expected hardware declined 30.2% in the quarter with a tough comp given the console launches in the same period last year. But hardware grew 17.3% for the year. Software grew 6.1% in the fourth quarter, but was down 11.3% for the year. We are now seeing next-gen software consistently exceed prior gen on a monthly basis. And it’s great to note that we ended the year with our highest market share ever in hardware and software. Pre-owned revenue was down 1.7% in the quarter, but increased 1% excluding currency. Pre-owned revenue grew 2.6% for the year despite the decline in new software and the effect of currency headwinds. Pre-owned margin rates for the quarter were comparable to the prior year and the full year we are up 100 basis points from 2013. As we close the fiscal year we made an adjustment to GAAP digital revenues to convert Kongregate’s kred and mobile revenue from a broader to a commission basis with an impact of approximately $15 million. We closed a net of 251 videogame stores around the world. We acquired or opened 266 technology brand stores. In 2014, we repurchased 333 million in stock or 8.4 million shares at an average price of $39.50 and we paid out a $149 million in dividend. We generated free cash flow of $334 million, which was below our guidance range due primarily to the timing of payments associated with income taxes and other liabilities of approximately $60 million when comparing fiscal 2014 to fiscal 2013. We also had increases in accounts receivable associated with the tech brands business of approximately $20 million. The last thing I would like to cover on 2014 is how the market performed relative to industry projections. As you can see on Slide 4, in 2014 the North American physical and digital console market was expected to total approximately $16.7 billion, implying about 13% growth over 2013. Hardware exceeded expectations by about $500 million due to strong net-gen sales. Physical software fell short of expectations by about $800 million, which as you can see is entirely due to the fall off the old-gen. And digital fell a little short of growth expectations. In total the console market grew 9% to $16 billion versus the 13% increase that had been predicted. What’s important to note here is that the shortfall in physical software was caused by the falloff in old-gen software sales, but was not caused by a greater than expected shift to digital, which came in below industry expectations. Now, I will move on to 2015 guidance. As stated in our earnings release, we are guiding the EPS ranging from $3.60 to $3.80 per share for 2015, an increase of between 3% and 10%. Full year revenues are forecasted to range between down 1% and positive 4% with same store sales ranging from positive 1% to 6%. We anticipate a foreign currency exchange impact of approximately $300 million to $400 million in sales and between $0.06 and $0.09 per share for fiscal 2015. Looking at the first quarter of 2015, we expect total revenues to range from negative 2% to positive 1%. And same store sales of positive 2.5% to 5.5%. We expect earnings per share to be in the range between $0.53 and $0.60 per share. For purposes of your models, the average number of shares outstanding we used in our guidance is 109 million shares for the first quarter and the full year as we do not assume any share buyback in our guidance. This is 2 million shares more than the consensus models and that has an impact of approximately $0.07 per share for the year. We project free cash flow for fiscal 2015 to range between $400 million and $500 million with the largest variable being the number of technology brand stores and the CapEx and receivables to support that. The next slide shows you the major puts and takes of sales in 2015. Foreign currency exchange impacts could essentially wipe out all of our comp store sales gains expected for the year. Let me go off the slide for a minute, we have compared our revenue expectations by category for 2015 to the average of the analysts models. We are fairly consistent with the exception of new software growth. We are estimating new software growth in 2015 to be between 4% and 6% based on our current visibility into the title lineup. The consensus estimate for new software growth is over 11% which we believe is overly optimistic. Last year we shared with you our projection of the console market would grow 10% to 15% in 2015. The decline in old-gen software in 2014 occurred faster than we or the market expected. And following those results, we project decline in old-gen hardware and software of more than 50% in 2015. We see moderate growth in new-gen hardware, over 50% growth in new-gen software and growth in digital of more than 10%. Moving on to some greater depth on digital, based on all of the sources we had used over the last couple of years to build the market model, we believe DFC Intelligence is the leading third-party resource in the console digital space. This spring DFC will be publishing some insightful data on what happened in the digital market in 2014. We have some of that data that we can reveal today. The number one digital component to address is the adoption rate of full game downloads. Slide 7 shows some key statistics based on DFC data which analyzes the AAA games sold in 2014. You can see that DFC estimates that of the total number of AAA videogames sold last year 12% were downloaded and 88% were physical. Of the 12% downloaded, it is estimated that 60% were given away in hardware bundles, that means about 5% of AAA titles were downloads, but were actually paid for by consumers. DFC estimates that full game downloads of AAA titles paid for by consumers made up only 2% of the total physical and digital software market. DFC also provided us some data on their estimates of the DLC market for 2014. Overlaying our DLC sales onto DFC’s estimate of market sales, we calculate that we had approximately 42% of the market, in line with our overall software share. Hopefully, on our next call we can take DFC’s published data and our data and provide even greater clarity. Now, let’s move on to a discussion about technology brands. Slide 8 shows our performance in technology brands for fiscal ’14. As you can see revenues totaled $329 million, operating earnings were $33 million with an operating margin of 10%. Tech brands added $0.19 to earnings per share. We believe this was an incredibly successful first full year with 5% of our consolidated operating margin coming from a new segment. The next slide shows the average internal rate of return target for the tech brand stores we opened or acquired in 2014. As you can see we acquired 16 dealers with a combined targeted IRR of 23%. We opened 123 whitespace stores with a combined IRR of 27%. Between acquisitions and new stores our aggregate targeted IRR is 24%. As we seek new whitespace stores or new acquisitions, the minimum targeted hurdle rate is 20%. Keep in mind, our weighted average cost of capital is 10.6%. As I have said in the past our targeted IRR is far in excess of our weighted average cost of capital. The potential RadioShack stores which we are negotiating have a pro forma IRR of 25%. The performance of our new and acquired tech brand stores in 2014 was very strong as they outperformed their performance by 114%. This is due to our ability to drive productivity and customer conversions particularly in stores we acquire from other resellers. We are projecting growth of 350 to 550 technology brand stores in 2015 to include whitespace stores, acquisitions and conversions of GameStop stores. The last slide provides updated guidance on where we see the tech brands business growing in the next 5 years. As you can see and as Paul mentioned, we believe we can grow this business to over $1.4 billion in revenues by the end of 2019 and almost $170 million in operating earnings. The CAGRs demonstrate robust growth for several years. I will now turn it over to Tony for his comments.

Thanks Rob. Good afternoon. It’s very exciting time for GameStop. At this stage of the console cycle, as we continue to dominate the videogame market around the world grow our differentiated position in market share and brands into exciting areas that leverage our retail and digital expertise. The focus of my comments today will be on the current console software environment, our plans to continue growth in our digital business and the expansion of technology brands. To-date, this has been a strong launch and GameStop has gained on every front as compared to the last launch. The PS4, Xbox One category hardware unit sales are 56% higher than PS3 Xbox 360 over the same period of time following launch. GameStop has gained significant hardware share with our unit sales up 145%. In software, we have a commanding 46% market share of PS4 Xbox One software with unit sales of 92% over the last launch cycle. And so far in 2015, we continue to dominate the new generation of software with our Xbox One and PS4 software market share at 52%, up 440 basis points over the same timeframe in 2014. We believe that new software sales were impacted in the latter part of 2014 as many games were given away at subsidized marketing incentives in next-generation hardware bundles. According to NPD, these free digital games reduced the total physical next-generation software market by $250 million. We also believe based on our discussions with publishers and platform holders that these pack-in programs will be significantly reduced in 2015. We are excited about the innovation that is coming to the new consoles in 2015. Key titles include the just launched Battlefield Hardline from Electronic Arts, the soon to be launched Mortal Kombat X and Batman: Arkham Knight from Warner Bros, Madden, FIFA, and Star Wars: Battlefront from Electronic Arts, Halo 5 from Microsoft, and Call of Duty’s next installment from Activision. We leverage our close relationships with the publishers to drive differentiation. For instance, two weeks ago, we had a very successful launch of Battlefield Hardline. Working closely with EA, we provide an each U.S. associate with the opportunity to play actual game four days prior to its launch. They were able to share their experience through both social media and with our customers during the weekend and during the crucial midnight opening. Clearly, we had the most informed associates on the night of the launch. In terms of our pre-owned business, it returned to growth in 2014 and we expect it to accelerate in 2015 driven by new software growth. As the next-gen cycle takes hold, we are seeing more of our pre-owned sales shift in the PS4 and Xbox One. Additionally, as publishers continue to transition from legacy to new, it positions GameStop as the destination location for older games and systems. In addition, we continue to drive new forms of payment to make GameStop the most simple and affordable place for gamers’ favorite technology. In addition to the Powerup Rewards credit card, which has generated over $225 million of credit supply, we have also added Apple Pay and a gift card exchange program to provide customers with even more ways to afford the technology that they want. Turning to our digital business, we matched the growth of our publishing partners by generating $948 million of digital receipts at a growth rate of 31%. Key digital drivers continue to be our dominant share of downloadable content, digital sales of full game downloads our sale of subscriptions and point cards, digital Game Informer and our fast-growing Steam PC download business. Our important enrollment in digital value chain is the discovery and affordability of digital content. And we have spoken often of our success in driving digital adoption with our customers. As Rob mentioned, based on data from DFC Intelligence, we had a 42% market share in 2014 of all of the downloadable add-on content sold. We accomplished this because our knowledgeable associates, many of whom have actually placed a downloadable add-on content help customers discover and purchase this great content. We expect to provide a similar benefit for full game downloads both for AAA games and for indie games. We are a key player in the digital value chain and we have plans in place to be full participants in all facets of digital gaming similar to what we have done in add-on downloadable content. And in mobile, our Kongregate service continues to publish profitable mobile games. We expect to publish 15 to 20 games this year and grow our mobile revenue by 80%. It’s important to note that two of our most important digital initiatives are mobile and PC publishing and our digital magazine, Game Informer are led by two of the most influential women in gaming, Emily Greer, the Co-Founder of Kongregate and Cathy Preston, the Publisher of Game Informer. Finally, as Rob shared, we are very pleased with the returns that we are getting on our technology brands businesses. We have closed exclusive relationships with AT&T and Apple that allow us to participate in consumer-friendly offering such as the next program in our Spring Mobile stores and iPhone warranty replacement in our Simply Mac stores. These partners also offset a portion of our construction costs. The growth of 350 to 550 stores that Rob talked about will come from four main sources. First, wide space development, working with AT&T and Apple, we have identified sites that will support a new AT&T, Cricket or Simply Mac stores and we are leveraging our real estate expertise to identify and procure the best real estate available. Second, mergers and acquisitions, working closely with our partners we continue to look at opportunities to acquire new stores. On average, we see at least a 30% increase in productivity in acquired stores through stronger execution. Third, GameStop real estate conversions, as we continue to rationalize the GameStop asset base, we are identifying locations where we can convert GameStop real estate into AT&T, Cricket or Simply Mac locations. We target stores that we can transfer significant sales to nearby GameStop locations. This is our most profitable asset move and we plan on executing 70 to 100 of these conversions this year. Finally, RadioShack conversions, we procured 163 leases from the RadioShack Bankruptcy Trust and we are currently in the process of converting most of these leases into AT&T stores. We were very selective in picking the top stores that had great lease terms, strong visibility and were consistent with our partners’ needs. With that, I will turn it over to Mike Hogan for his comments.

Thanks, Tony and good afternoon everyone. Paul asked me to comment briefly on our business development process in the areas in which we continue to explore new growth opportunities. We initiated a robust business development process a number of years ago to facilitate our diversification efforts. We are constantly exploring new prospects that could leverage core GameStop capabilities to drive future growth in value. GameStop has been the unquestioned leader in gaming for many years, but we are successfully expanding our influence to become a family of specialty retail brands that makes the most popular technologies affordable and simple. Our early efforts were primarily focused on expansion into digital gaining and produced opportunities such as the acquisition of Kongregate, which continues to perform very well for us. Since our acquisition in 2010, Kongregate revenue has grown at a 75% compound annual growth rate. Kongregate has launched a number of successful mobile games, such as Tyrant, Game of Thrones and Adventure Capitalist and PowerUp Rewards has proven instrumental in driving awareness and customer acquisition. This is in addition to our internally developed opportunities such as the sale of downloadable content in our stores and on gamestop.com. As Tony mentioned, GameStop now has an estimated 42% share for downloadable content sales. In recent years, we have expanded our focus to include a broader array of adjacent categories in which we believe our core competencies of real estate, consumer relationships, retail execution, buy/sell trade, and disciplined capital allocation can be brought to bear. Our biggest recent success was the formation and expansion of our technology brands business unit, which includes our AT&T Wireless, Cricket and Simply Mac stores. These businesses leverage core GameStop competencies and return – and in return have given us new leadership such as Jason Ellis and Steve Bain and category expertise in Wireless and in Apple retail. As we have discussed, this business unit is projected to reach $1.5 billion of sales by 2019. We remain focused on exploring and exploiting new opportunities with significant total addressable markets that provide growth and leverage our strengths. For example, the wireless category roughly $185 billion in the U.S., we are now one of the AT&T’s largest and most productive dealers. The Apple products ecosystem which exceeds $50 billion in U.S., we are now the number one Apple specialist retailer. And most recently the market for videogame, movie and pop culture licensed merchandise which is estimated to be over $20 billion worldwide. We see it as a great opportunity to offer a wider array of attractive products to our PowerUp members both in-store and online. We expect to quickly become the market leader here as well as we utilize our brand, store footprint, multi-channel selling capabilities and PowerUp rewards. We will provide updates on this initiative throughout the year. Our efforts to-date have delivered significant new diversified growth platforms for GameStop. It is worth noting that in 2014 our business outside physical videogames totaled $1.6 billion or approximately 16% of total revenue and we expect it to grow to at least $2 billion or more than 20% of revenue in 2015. We are very pleased with the progress to-date and are investing in these platforms to drive continued growth. But we are actively seeking additional growth platforms as well. We are exploring acquisition and partnership opportunities that leverage GameStop’s core competencies and provide great value and growth for our shareholders both in the U.S. and in our international markets. Finally, a few quick thoughts on PowerUp rewards, PowerUp membership grew 13% in 2014 and is now over 30 million members in the U.S., international membership grew 30% and is now 10.7 million members. PowerUp represents 74% of total spend and on average members spend three times more than non-members. Average annual spend per member grew 5% to $323 per year in 2014. We continue to expand and innovate to enhance the appeal of our members. One example is our PowerUp rewards credit card which is launched last fall. To-date we have been able to grant over $225 million of new credit to our members, which will support new purchases such as the growth of next-generation hardware and software. I will now turn it back over to Paul.

Great. Thank you, Mike. I guess at this point we will now open it up for question-and-answer. Operator?

Thank you. [Operator Instructions] We will take our first question from Brian Nagel with Oppenheimer.

Hi, good afternoon.

Hi Brian.

Hi Brian.

Nice quarter, I have a couple of things I wanted with the recall of questions. First off on the pre-owned or used business, I have recognized the currency was a factor there and how it was reported, but it’s still somewhat sluggish, but as you look at 2015 and kind of the trajectory I know you weighed up pretty explicitly your thoughts about new software sales, how should we be thinking about your pre-owned business going through the course of this year relative to the new software business?

Sure Brian, Rob you want to take that.

Sure, remember that in the fourth quarter pre-owned is typically not the hot item that the gift giver wants to give to their family, so fourth quarter is never our highest growth period for pre-owned. But as we look forward as I mentioned in my comments when we compared our estimates of where the analyst models were on the category by category basis for our business, we were comparable in most of the categories, pre-owned was one of those. So digging into that data you would see that we are forecasting growth for pre-owned.

Got it. Then the second question I want to ask is regarding the first quarter guidance here we are I think almost two-thirds away through the quarter now and the guidance especially with sales and it’s a relatively wide range, can you make some comment as to how we are tracking right now?

You want to take that one?

Well, we put out the range that we put out based upon the information that we have to-date. And one of the aspects of our business that we have seen historically is a sort of a pre-Easter and post-Easter phenomenon. And so that remains a little bit of a wildcard for us.

Easter this year Rob is several weeks…

April 5.

Yes. We also have foreign exchange impacts that as any of you that are following those markets know have been pretty substantial and impactful to international businesses.

Okay, thank you very much.

Okay.

We will take our next question from Seth Sigman with Credit Suisse.

Thanks. Good afternoon and hey guys. Thanks for all the color today.

Thanks, Seth.

I had a question about capital allocation, so when you look at the $150 million to $170 million CapEx you are guiding to, second year in a row where you have had a stepped up CapEx. How much of that is tech brands, what are you embedding in there? And then secondly, how does that affect your ability to buyback stock at this point, how much cash do you feel comfortable with pertaining on the balance sheet? Is there more room to lever up potentially like you did in 2014, just trying to think through those things? Thanks.

Sure. If you think, Seth, back a couple of years in terms of what our rate had been on CapEx, it was in the roughly $130 million range. The difference between that and what you saw in 2014 and what we will see in ‘15 is technology brands. And the reason that we have arranged it which we haven’t done I think in a while is because of the wildcard associated with the RadioShack stores and our ability to negotiate for those leases that Tony talked about. I think as we look at the ability to buyback shares, we are pretty confident that we can continue to do share buybacks in excess of $200 million, it would be the minimum for the year and that still allow ourselves to do what we want to do in terms of acquisitions and capital dedicated to technology brands.

Seth, one thing too to remember is that there was a time here years ago, where it was uncomfortable with lots of things, debt, buybacks and everything else, but our board today is very progressive and I think is very comfortable with our capital allocation, disciplined capital allocation the way it’s been and the way it’s going to go forward. So, that’s not a barrier either.

Okay. And then a question on tech brands specifically, I just wonder if you could discuss the EBIT margin performance for that business line in the fourth quarter, if you just kind of back into it from the annual numbers you gave, it seems to imply a pretty big drop in the margins versus the third quarter. And at the same time, when you look at the mobile and CE category, it also seems to imply a big drop off in the gross margin versus prior quarters, any more color there? Thanks.

I am sorry. Could you repeat the last part of the question there?

So, within your mobile category when you breakout the gross margins, it seems to imply a big drop in the gross margin in Q4 relative to Q3?

Yes, Tony, you want to talk about that? There is one of the things about the cellular business is you have various promotions and holiday things coming and going. So, Tony, you want to take that?

Absolutely. That’s one of the things that takes place there is that you do have shifts between sales and gross margin rates. And that’s one of the things that did take place during the fourth quarter as we had a shift. Based on the compensation programs that we have with AT&T, which is our exclusive partner, you will sometimes get shifts, so you will see gross margin rates fluctuate, that you will see gross margin dollars being more consistent.

Is there a way to think about the annual gross margin rate for that category going forward?

Rob, you want to take that?

Yes, I would say probably and then – so, what we saw in 2014, if you think about the mobile and consumer electronics category as we categorize sales, the margin rates if I remember correctly were between 35% and 40%. And I would say think about that business, that category in that range and of course that contains technology branch.

As an example, Seth, you will have promotions on a particular SKU, where you won’t have the inventory in the store. You will sell the product, but you will not bring the retail of the hardware of the handset that you will get all the gross margin. And those promotions come and go with various carriers and so that’s what makes this a little bit more complex than the videogame business.

Okay, thanks guys. Good luck.

We will take our next question from Chris Merwin with Barclays.

Alright, great. Thank you. So, I just had a couple of questions. The first one is can you talk a bit about what the DLC attach rate is at your retail stores and how that compares to the last cycle? Are you seeing some stability in the mix shift of DLC being sold at the retail stores versus on consoles? And then secondly in terms of the impact that the digital download business is having on physical sales for new-gen, have you found that some genres like shooters are doing better where maybe the resale value is a bit higher for the customer or is it pretty consistent across all the genres of titles that you sell in and do you see that changing over time? Thank you.

Sure. And welcome Chris to the call. Tony, that sounds like one of your products…

Sure, yes. But on the DFC shift, it’s a little hard to talk about the launch over launch because there really was no deal to see back when the 360 and PS3 launch. So it’s a business that’s really we have created and then created since then, and quite honestly it’s been accelerated since GameStop got into that business. So when we look at attach rates we will typically attach about 30% to 40% of add-on downloadable content to a title when it launches and it tends to be fairly consistent regardless of genre. There are obviously some price point differences, so if you have downloadable content is a higher-priced to get a slightly lower attach rate, but essentially it’s a very strong attach rate. And again that really is our associates who are selling that at the time of launch that drives our 42% market share.

What about the – Tony you want to make any comment on the trade-in business on genres, with any genres you get more trade?

Yes on the trade-in business we have seen a very consistent across genres and very consistent really across AAA titles. I think some that have a little stronger downloadable content will actually the trade-ins will be a little bit delayed, but the percent of trades that we get are generally very strong and they typically come in from 45 days to 90 days after the game is launched.

And then tailing on Chris’ question, this is Amir Rozwadowski the telecom analyst at Barclays. I was wondering if I could touch upon some of the increased efforts you folks have had been placing on additional product distribution capabilities and opportunities, specifically it seems that phone distribution has picked up momentum largely due to your partnership with AT&T including the cricket brand. I was wondering if you can provide some additional color on the piece of the business, the specific drivers for growth. For example, are you seeing an opportunity to work with AT&T and consolidating their distribution strategy tapping additional markets where they may not have an active footprint and where are you to seek contribution from or where do you expect to see contribution from this segment over the mid to longer term. And then as a second question, AT&T seems to be on the verge of closing a pretty large transaction with DirecTV, should that deal happen hypothetically what type of additional opportunities could you see with the new product segment given your partnership with the carrier? Thanks a lot.

Thank you, Amir. Welcome to the call. Tony before I get started – before you get started, I would just say two things that are important from our Analyst Day last spring one of which was how highly fragmented the AT&T dealer base is. It’s extremely fragmented and you are talking thousands of stores in the hands of hundreds of dealers. So one of our roles here is to consolidate and improve the execution of those dealers. The second part is the whitespace where they don’t have distribution we are trying to play a role in that. Tony, you want to talk about the rest of this.

Sure. In terms of pacing, it’s been a very aggressive pace and it’s been a great partnership with AT&T and the exclusive relationship has really allowed us to drive this speed. Since September 2013, when we first engaged with Spring Mobile and AT&T we have expanded the store, the door count from 90 to 361, so it’s really the hyper-growth pace. And we are very productive either for AT&T and they see us that way. Not only are we one of the largest and the fastest growing but we are also one of the most productive and consistently score as one of the highest if not the highest in customer service ranking. So that’s allowed us to have an opportunity to help them consolidate the market. As we have mentioned earlier we did 16 acquisitions. And on average when we do an acquisition, we see a 30% increase in the business which is obviously good for us and good for AT&T. And I think you asked about markets where we were helping AT&T and are into where they may not be. And we have opened 123 stores and really through whitespace areas like metro locations and secondary markets. And then from a long-term growth perspective I think Rob you mentioned that we are going from $33 million of operating earnings to $170 million in 2019. So it’s a very, very relevant part of our business and will become an increasingly larger part of our earnings.

The other thing Amir, when you talk to our team Jason Ellis runs technology brands, Steve Bain runs Simply Mac, Brett Bradshaw runs Spring Mobile and Tommy Oakey runs cricket. When you talk to them about DirecTV they get excited about it, but we are already selling U-verse and we are selling digital live, I think in the half to two-thirds of our stores. So, we know how that process works. So, we look forward to the DirecTV sales. We look forward to the Mexico integration as well. So, it’s – I think that side of the business is very healthy.

Thank you very much for the incremental color.

Thank you.

We will take our next question from Colin Sebastian with Robert Baird.

Great, thanks. I think it’s first off in terms of the guidance, the margins look like they are in line within expectation and so looking at the difference between EPS and consensus versus guidance, I think there is roughly $0.15, Rob, maybe you pointed out from the facts and from the higher share counts. Just trying to keep together the other portion is that mostly the lower software sales number that you have versus consensus or is it more of the tax and the store closures, maybe you can clarify that? That’s the first question.

Within the models, there is a lot of things that move around, but when we boiled it down to what were the biggest impacts, it was FX, it was the share count, but the single biggest difference, which is why we addressed it in the way that we did was the projected software growth.

Okay. So, that’s the single biggest impact to the year versus consensus?

Yes.

Okay. I guess secondly as a follow-up on the capital allocation question, you have mentioned M&A a couple of times, so I just wanted to clarify how that might impact or any change to the way you think that might impact capital allocation for returning capital to shareholders?

Well, again, we are pretty confident that we can do everything we want to do from a tech brands expansion standpoint, a buyback standpoint and pay the dividend at $1.44 a share during the course of the year. Should something come across our plate that we believe drives the kind of returns that we are looking for, we would certainly discuss that at that time.

And the past year we have done what did you say, Rob, 16 transactions?

Right.

Those were highly accretive. And I think those are opportunistic in nature, we frequently will get a call from one of our partners, AT&T or Apple and they will guide us to someone who is looking to exit their business. So, those are the opportunities we got to take when we can. I think shareholders would want us to do that if the returns are higher than – significantly higher than our hurdle rates. So, otherwise they are going to be buying back and paying dividends.

Okay, thanks, Paul. And then lastly just another clarification on attach rates with and without digital, obviously a lot of us should know of where attach rates will be moving to over the course of the cycle. Can you maybe qualitatively talk about looking ahead where you would expect attach rates to move obviously a key where we can model your sales and your margins going forward? Thanks.

Tony, you want to talk about that where attach rates would go. I mean, one question there Tony might be how many titles actually have DLC versus we used to talk about which titles have DLC and which don’t.

Yes, just for clarification, Colin, you are talking about attach rate for console?

That’s correct, yes.

So, right now, GameStop has nearly 6 whereas the industry is at 4, so we are significantly outpacing the industry and that’s really what’s driven our share gains. So, I think what we have seen very quickly as we talked about earlier, we have seen a very quick acceleration of the installed base over 30 million units already are installed. So, it’s an incredibly quick progression. What we are seeing is when the new innovation comes out we are actually seeing a very strong pickup on that. So we expect to see an acceleration and I would anticipate that we would close that gap somewhat, you have talked about a gap and then it’s a little less than one unit per console and that’s when you add in digital are basically flat. So, I would anticipate that on the physical side we will close some of that gap versus the prior launch as the software actually catches up with the strength of the hardware launch.

Okay, great. Thanks a lot.

We will now take our next question from Mike Olson with Piper Jaffray.

Hey, good afternoon. Did you say that what you expect specifically next-gen software sales growth for the company will be in 2015 and then what you think your share of next-gen software sales will be in the year?

Well, what we said was we believe that there will be over 50%. Obviously, ranges imply different levels, but at the bottom end we see next-gen sales of software growing over 50%. And I am sorry, tell me the second part…

The market share.

The market share, our goal in everything that we do is to be dominant in the videogame category. So what we have seen thus far is software share hovering around one out of every two games that gets sold for a next-gen console. And our teams across the globe are focused on continuing to drive our market share.

Okay. And then gross margin was very positive in the year, what do you expect for gross margin in ’15, I guess what you are expecting for new software versus kind of what you are expecting on the tech brands side, should it continue to improve or will legacy gen weakness for new software potentially bring gross margins down year-over-year?

Well, we didn’t give specific guidance on where we see the gross margin rates, but directionally we would expect that we will have a shift during the next year from hardware into software on the videogames side of things, so that is beneficial to margin. And then we will continue as we have talked about to aggressively grow tech brands and we know that that is margin accretive. So we think we will see a good margin a year ahead.

Alright. Thanks very much.

A record gross margin year end. Thanks mike

Our next question comes from Arvind Bhatia with Sterne Agee.

Thank you, guys. Couple of questions here, first one is on the next-gen and the downloads that we are seeing you provided a nice slide there, just wondering what your learnings are from the PC download market that you are going to apply to downloads on consoles. Second question is wondering what your model assumes for hardware units for next year and in 2015 versus 2014. And then last question is on not tech brands, wondering if your 2016 targets that you provided we should still look at that as well as we look at the long-term targets? Thank you.

Well, that’s an interesting question. Let’s see, Tony you want to start on the next-gen downloads?

Sure. I mean on the next-gen downloads as we talked about, when you look at the actual amount of paid downloads it’s still 2%. So I think we have always said that there will be an increase in the amount of digital and that’s been very clearly stated in our market model, so we anticipate that we will see that. As per learnings from the PC digital side that you asked about you will and we see right now – as we see an incredible increase taking place in the PC side as people are coming into the business. I think it’s important to remember that on the PC side of the business historically there has always been DRM limitations that have a significant restriction on pre-owned. And so you really didn’t have the residual value that you do in the console side of the business. So I think that that’s one important thing that you have to realize about the console side of the business is that that $20 residual is in the mind of the customer is really important piece of the business. Rob over to you?

Yes. In terms of the hardware units, the comment that I made in the script was that we see growth, slight growth in next-gen hardware. I was speaking in terms of dollars and you may think about it that we have to overcome the price point on the Xbox One for the entire year relative to where it’s not in November I think of last year and pretty much held there through the fourth quarter. So that would imply a slightly larger increase in units for that. And again, we don’t forecast any sort of price declines on hardware until we absolutely know something and we don’t know anything right now. So you asked about 2016 tech brands target, and what I would say to you is at the beginning of last year when we laid out our 2016 goals for tech brands with respect to revenue we were in very early days of the next program. And as we have discussed in the past the next program as Paul just mentioned it a few minutes ago changes the dynamic of how we recognize revenue. So, I would think in terms more of what we talked about today on a long-term basis such that almost $1.5 billion in revenue by the end of ‘19. And I would say to you that, that is formed based upon how the programs work today and they move around. For us, what we are more focused on is the operating profit. And we will see that growth as we go from the $33 million that we did this year, up to the target that we laid out for you for ‘19. I would rather not specifically say how that might have changed the target we have previously laid out for ‘16. Candidly, I don’t have that information in front of me.

Okay, that’s very helpful. Thank you, guys.

Thank you.

At this time, we have time for one final question. Our final question today comes from Tony Wible with Janney Capital Markets.

Thanks guys. I was wondering how much of the digital that you are now selling happens in-store versus online. And if I am reading this correctly the 42% share that you guys referenced that’s just DLC, so I was wondering if you had that for full game downloads in addition to DLC?

Tony?

95% of what we sell Tony is sold in the store, both online. And in terms of the market share, that’s what Rob was talking about earlier, we do not have market share information on information beyond the downloadable content to add on downloadable content. That’s what Rob was talking about. We hope to share more information as it becomes available from DFC Intelligence for the future.

But Tony, one thing on that DLC, the reason – or digital generally the reason it’s so important to understand it’s sold and historically that’s the place that we discover, provide guidance to the customer etcetera. It’s not because we happen to have a lot of stores, because we could put all kinds of things online and they won’t get sold, because the customers have a hard time in this category discovering that product. So, that’s one of the reasons why we have so much store activity, yes.

Okay. And you guys are expecting to ramp a huge amount of tech stores this year, I was wondering if you can just give us a little bit of a sense on timing for that? Are you expecting kind of a smooth build-out in kind of conversion as you get to the RadioShack stores and other stores or should we expect some lumpiness with that? And then also I presume on the closings we might have some lumpiness and seeing maybe more closings in the first part of the year versus later?

Yes, I think that’s – Tony, you want to start with that?

Sure. Tony, what I would say is that with a wide space stores and obviously you know about the RadioShack stores and we have – we are obviously working those as Rob said feverishly right now to get those opened for those you understand and that may frontload actually – private frontload the amount of stores from a wide space and a RadioShack perspective. I would say the conversions will happen pro rata throughout the year and acquisitions will be probably the lumpiest part of that equation as those come from our partners at AT&T and then we are able to negotiate those.

Got it. Great, thank you.

Thank you, Tony.

Great, thank you Tony and thanks to everyone. Thank you for your support at GameStop. And we look forward to seeing everyone on the next call. Take care.