Paul Raines - CEO Tony Bartel - COO Robert Lloyd - CFO Mike Hogan - EVP, Strategy & Business Development Mike Mauler - President, International

Michael Olson - Piper Jaffray Daniel Farrell - Oppenheimer Colin Sebastian - Robert Baird Raymond Stochel - Consumer Edge Research Curtis Nagle - Bank of America

Good day and welcome to the GameStop Corporation's First Quarter 2016 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 party without the prior written consent of GameStop. At this time, I'd like to turn the call over to Paul Raines, Chief Executive Officer. Please go ahead sir.

Good afternoon and welcome to the GameStop's earnings call. I want to thank our worldwide team for another great effort in the first quarter in delivering outstanding customer service. Joining me on our call today are Tony Bartel, our Chief Operating Officer; Rob Lloyd, our Chief Financial Officer; Mike Hogan, our Executive Vice President of Strategy & Business Development; Mike Mauler, our President of International and Matt Hodges, our Vice President of Investor and Public relations. We thank those of you who joined us at our recent Investor Day and believed that our results played out along the lines we described. We introduced some new terms at that day, so if you weren't there, I will give you a primer on our new vernacular. First, we have introduced the concept of our GameStop branded stores to distinguish from our technology brand as well as our ThinkGeek stores. Second, we have introduced a reference to GameStop, the Incorporation as GME to distinguish the store brand and from our overall corporate identity. Third, we introduced some new school metrics like gross profit comps and traffic comps to distinguish our new businesses from the old school metrics in our GameStop branded stores. And fourth, we established some new targets for our digital collectibles and tech brand businesses. Now let me start by giving you a few highlights from the quarter; our technology brand business has 500 plus operating earnings growth on 62% sales growth. Traffic comps were 1% and gross profit comps were 7%. We are pleased with the performance in the tech brand segment and currently expect to close the two previously announced AT&T authorized resellers by the end of the second quarter. When completed, these two additional deals will bring our technology brands portfolio store count to approximately 1500 stores in the AT&T, Simply Mac and Cricket formats. Global comps in our video games business came in at negative 6.2% overlapping a positive 8.6% comps from last year in the first quarter in our video game business. As we described in the press release we overlap significant titles and also saw a shift of uncharted out of the first quarter. Pre-owned declined 3.7% but still outgrew the new category. Our non-GAAP digital sales increased 16%, continuing our growth trajectory in that space. Last but not least our collectibles business grew about 260% proving that the category is vibrant and adjacent to our base. Top licenses and the products for the first quarter were Five Nights at Freddie's, Pokemon, Minecraft and Marvel. We opened our first New York City ThinkGeek store earlier this month at 33rd and Broadway and now have four standalone stores in the United States. You can see some pictures of that store in the supplemental deck. We also have 34 collectible stores overseas. We have spent time following up with several analysts and investors since our Investor Day and have had good dialogue on our strategy. The key point we made at our Investor Day is that our GameStop branded stores are in increasing profitability over the last several years thanks to digital, collectible and Omni-channel businesses we have developed inside them. We are not just a physical gaming store. On the tech brand side, we also have accelerated profitability in our core stores. For those of you looking for a succinct external summary of our Investor Day event, the recent case study published by Forester Research might be of interest to you and it is available on our website. Their report summarizes the four takeaway's we highlighted at our Investor Day. The first is that we have added a new billion dollar run-rate business outside our core GameStop branded stores called technology brands with great growth prospects. The second is that we added $2 billion categories inside our two GameStop branded stores. The first is digital with a sustainable billion dollar non-GAAP revenue base and the second is collectibles which is well on its way to a billion dollar revenue line. The third takeaway is that physical video gaming is cyclical but has a very long tail but we have significant share in the category. Virtual reality and new consoles are a wildcard in that business segment and could dramatically change the growth projections. And the fourth takeaway was that all of these combined to make GME a growing and diversified company. We reported record net income in 2015 for GME and we continue to guide the record income for 2016. For the second quarter, our guidance reflects the cyclical nature of the video game business as we await updates from E3. The second quarter is traditionally the low point of the year for video gaming and we expect more of the same dynamic to play out on traffic and software and hardware growth. Our digital, collectibles and technology brand businesses will be significantly positive in the second quarter. Remember that in the video game segment we are overlapping 8% comp last year and a 41% growth rate in our overall earnings per share in Q2 of 2015. Only two years ago our Q2 earnings per share was $0.22 so the mid-point of our guidance reflects about 20% growth over the two-year period. We are excited about E3 and expect to hear major news on virtual reality and potential new consoles. These events have traditionally been a catalyst for GME shares and Mike Hogan has done some modelling of potential impact that he will share with you in his remarks. Tony Bartel will also update you on our expectations from E3. With that I will turn the call over to Rob Lloyd.

Thank you, Paul. Good afternoon everyone, we have a successful first quarter, we are pleased with our GAAP earnings of $0.63 per share at the high-end of guidance and our earnings of $0.66 excluding charges. The comps and earnings exceeded our guidance range while sales were within our expectations. Highlights include sales growth of Tech Brands at 62% to over a $165 million. Tech Brands operating earnings of $18.8 million compared to $3.1 million last year, a record for quarterly Tech Brands profit. We are well on our way to our full year guidance. Growth in our collectibles business of over 250% to $82.3 million in sales again well on our way to full year goal of $450 million to $500 million. As you can see in schedule one to the release, we are now disclosing collectibles as its own sales in margin category, it was previously included in others. Consolidated gross margins with 34.3% up 330 basis points from last year, 42% of our operating earnings in the quarter came from sources other than physical gaming. We will update on this new metric from quarter-to-quarter; however, it will be volatile during the year as the video game business has more seasonality than Tech Brands. This metric will be more meaningful at the end of our fiscal years. Keep in mind that we expect 30% or more of our fiscal 2016 operating earnings to come from sources other than physical gaming. At our Investor Day I covered new school metrics and old school metrics. The numbers I just gave you are new school metrics, margin expansion, growth in our new businesses etcetera. Some of the old school metrics included decline in hardware of 28.8% during the quarter, a decline in software of 7.6% and a decline in pre-owned of 3.7%. Pre-owned margin for the quarter was 46.9% in line with recent quarters as the mix continues to shift towards next gen pre-owned products. Now for a little more depth; sales decreased 4.3% in the quarter as expected. The FX impact on sales was $7 million for the quarter. Therefore, we will not distinguish our results excluding currency. Comparable store sales decreased 6.2% for the quarter, ahead of our guidance of down 9% to down 7%. U.S. comps were down 6.6%, international comps were down 4.9%. Gross margins were 34.3% with expansion coming from the growth of Tech Brands. We incurred charges in the first quarter totaling $4.1 million relating to the final cost to exist Puerto Rico as we discussed on our last call. The charges were $2.6 million net of tax. Operating earnings were down 4.7% for the quarter excluding the Puerto Rico cost. International operating earnings in Q1 improved $1.5 million over last year's first quarter. SG&A as a percentage of sales increased from 23.3% in the prior year quarter to 26.4% for this year's first quarter. The increases were due to the decline in sales overall and the growth of Tech Brands which as we've said in the past carries a higher SG&A rate. The increase in margin rate more than covers the increase in SG&A as a percentage of sales. SG&A in the GameStop branded stores declined slightly year-over-year but increased as a percentage of sales from 22.1% in the first quarter of last year to 24.2% this quarter. Interest expense increased by $5.4 million due to the issuance of senior notes in March. Non-GAAP net income increased $5.4 million or 7.3% for the quarter. Non-GAAP EPS decreased 2.9% for the quarter. Now let's look at sales from some of the categories. Hardware declined 28.8%, the largest impact came from the decline in 3DS comping against the launch last year. This decline was nearly half of the 28.8% decline. Next-gen units decreased 10.2% and next-gen averaging in a price declined 8.4%. Software declined 7.6% in the quarter. The division was a very successful seller with comping against the combination of Battlefield Hardline and Mortal Kombat was very tough as each of those titles sold a million units. Digital receipts increased 16.6% due to the growth of DLC and bundled sales. GAAP digital revenues declined 7.0%, primarily due to a shift in the types of digital product sold and the margin rates of those individual products. Digital gross margin increased 4.5% over Q1 last year with the margin rate reaching 86.4%. Collectibles grew over 250% with the margin rate of 34.8%. The decline in margin year-over-year is due to the addition of Thinkgeek.com. Fulfillment cost for Thinkgeek.com impacted the category margin rate for the quarter by an estimated 200 basis points. We will move the Thinkgeek.com distribution operations from their third-party fulfillment center into our liable distribution center. This will be completed in early 2017 and will include the margin rate. Other key information includes we closed the net of 63 video game stores and now have 3,959 in U.S. and 2,024 internationally. We opened a net of 18 technology brand stores and now have 1,054. We opened two Collectible stores in the quarter. We do not buyback any shares in the first quarter but as we showed on Investor Day, we plan to buyback between $75 million and a $125 million this year. Now I'll move onto second quarter guidance. Revenues are forecasted to range between negative 4% and negative 1% with same-store sales ranging from down 7% to down 4%. The forecasted declines in hardware and software are the primary drivers of the negative competitive. Unchartered moving into our second quarter, essentially offsets the Witcher from last year but we don't have the titles to offset Batman Arkham Knight or the other strong titles from last year. As we look at the months in the quarter, we expect new software for the industry to grow in May with unchartered for June and Overwatch. We expect June and July to reflect an industry decline coming off of Batman and Elder Scrolls in June last year and Rory McIlroy PGA Tour in July. Collectibles are expected to grow more than 90% on $41 million in sales in last year's second quarter. Tech Brand sales are expected to grow more than 50% in the second quarter. The projected increase in operating earnings coming from Tech Brands and the margin from collectibles are expected to offset the declines in video game products sales and operating earnings are forecasted to be flattish for the quarter. We expect interest expense to increase by about $9 million from last year due to the addition of debt. We expect earnings per share for the second quarter to be in a range between $0.23 and $0.30 per share. The projected decline from last year is due largely to the added interest expense. For the full year, we are maintaining our current EPS range of $3.90 to $4.05, and same-store sales range of negative 3% to flat. As Paul mentioned, we expect to close two AT&T reseller acquisitions by July 31. As we said previously, we expect the projected earnings from these two deals to more than offset the interest expense from the date of the debt issuance. Given that we've seen the bottom line impact from interest expense in Q1, and forecasted an impact for Q2 it is safe to assume that we will see accretion in the back half. We will clarify the projected impact on our next call once we've closed both deals. I'll now turn it over to Tony for his comments.

Thanks, Rob. This quarter showed the strength of our transformation strategy as collectibles sales and technology brands profits more than offset a decline of fiscal video game sales, and as a result we exceeded our EPS guidance. In our non-physical business and GameStop branded stores, we saw continued strength in both our digital and collectibles business. In spite of a weaker game slate in 2016, we grew our consoled digital receipts by 19% keeping pace with industry growth. Our Omni channel digital receipts grew 34%. As we detailed at our Investor Day, we are also moving into other growth segments of digital. On July 12, we will launch our first game trust published games, Song of the Deep, developed by Insomniac. We are seeing solid demand for this game in our stores and believe that it will showcase our ability to make a market for great Indie Games. We have several other games slated for release over the next year, in fact, next week we will be announcing our second game under development with ready adapt [ph]. As a reminder, as the publisher, we participate not only in the exclusive sale of physical discs by our GameStop branded stores but we also participate in the profit from digital sales of the game and related collectibles regardless of where they are sold. Also, we are expanding our in-store offerings for in-game purchases such as FIFA and Ultimate Team as well as expanding our sections for full game digital downloads. As we shared at Investor Day, we expect to continue to keep pace with industry digital growth and expect full game downloads to eventually settle in at the 25% to 30% range. Our collectible sales continue to exceed expectations growing at 261%. This growth was driven by expansion of linear feed, especially in the U.S. stores, the acquisition of ThinkGeek.com and the addition of several dedicated collectible stores. In 2016, we are adding 25 new ThinkGeek stores in the U.S. and at least 25 collectible stores internationally. Given the importance of this category, we continue to increase the wall space that we are allocating to collectibles and plan to increase the amount of dedicated space in the U.S. stores by 40% by the end of the third quarter. Turning to technology brands; we had a clean quarter with minimal transition cost showcasing the profit potential that we will see this year. We grew technology brands gross profit by 110% and operating profit by over 500% through a combination of organic same-store profit growth, maturation of the stores we built or acquired last year, and the absence of the conversion cost we incurred last year. Operating income margin was 11.3% in the quarter. Comparable technology brand stores increased traffic by 1% and gross profit dollar by 7% due to strong promotional pricing in mobile devices, strong increases in integrated product sales of Direct TV and broadband and stronger conversion. We continue to the most productive authorized retailer in the AT&T system. Our average store count was up 106% over quarter one of last year reflecting aggressive growth that occurred during 2015 as we acquired stores,, converted GameStop branded and RadioShack stores, and the whitespace stores. As we have previously disclosed, we will be closing two transactions in the second quarter keeping us on-track to achieve our previous guidance of $85 million to $100 million of operating profits of this year in tech brands which is growth of 200% to 260% over full year 2015. As we shared on Investor Day, we have proprietary sales and operational programs that allow us to maximize the productivity of our technology brand stores resulting in an increased productivity of 30% on average when we acquire a store. In addition, we are seeing strong growth in integrated products, direct TV, broadband and digital life as AT&T continues to increase support behind these initiatives. Our physical video games decreased 14% as we rolled over more and stronger releases in 2015 than we had in 2016. Hardware was down 29% as we lapped 2015 successful 3DS launch. We continue to have dominant share in this category and capture significant share at launch of new titles. In fact, we just sold our four millionth PS4 console in the U.S. Our pre-owned business declined 3.7% outpacing our physical video game decline by 10 points and outpacing the physical software decline by 4 points. As you can see on Slide 10, we continue to outpace physical software growth on the new platforms and are seeing less of a decline in pre-owned than we are in the previous gen physical software. Our trade performance exceeded our expectations in the first quarter, so our inventory position is strong with pre-owned inventory and the important Xbox One and PlayStation 4 categories up 47% over last year. We expect E3 to focus on key titles in the back half of the year and console announcements. We also expect VR to generate significant gaming consumer and press interest. As discussed at Investor Day, we expect to be the pre-eminent launch partner for BR headsets to the gaming population as we leverage our proprietary power forged relationships and our buy sell trade model. In closing, our transformation strategy is working and we continue to fill our GameStop branded stores with high growth properties and expand our tech brands business at an aggressive pace. I would now like to turn the call over to Mike Hogan.

Thanks, Tony. I will cover two topics this afternoon. The first, the little color regarding the collectibles category overall and the factors driving GameStop's 261% growth in Q1. The second is an update on virtual reality and new Nintendo console and their potential for driving growth in physical gaming category. As we noted at our April 14 Investor Day, collectibles narrowly defined is an $11 billion category in the US and estimated $18 billion globally. This is a growing but extremely fragmented category with no leader. We believe GameStop plus ThinkGeek can quickly become the market leader. We know that 45% of our PowerUpRewards members already purchased collectibles, and in an average spend of $360 per year, they represent upto half of the total category spend, thus giving us the advantage position in this category. We continue to see extremely strong performance in our collectibles business. We are very much on track to achieve our goals of $450 million to $500 million in 2016 and $1 billion by 2019. At present we have only about 2% to 3% in this category but we believe we can grow that dramatically and keep in mind the $1 billion in 2019 would represent only about 5% to 6% of what will be by then a $16 billion US category. As Rob noted, our Q1 sales of $82.3 million compared favorably versus $22.8 million for Q1 of 2015 representing 261% growth year-over-year. The business can be thought of in terms of three channels. Our GameStop branded stores around the world, dedicated collectible stores and the online business. Each of these channels experienced significant growth year-over-year. Our dedicated collectible stores are exceeding our expectations and we continue to expand rapidly. Globally, we now have 37 dedicated collectible retail stores and our plan is to add at least 50 more by year-end. In our GameStop branded stores we continue to see strong acceptance of collectibles by our existing consumer base. We had great success in attaching incremental purchases to video game titles such as Fallout, Star Wars and Pokémon. Based upon this performance we have increased the space dedicated to collectibles in our stores. Year-over-year collectible sales in GameStop branded stores is up over 200%, this is helping to fuel the continued increase in per store profitability as we discussed at our Investor Day. And of course, we added ThinkGeek.com to the mix which continues to drive overall positive performance. As we explained at Investor Day, our strategy is to implement an integrated marketing calendar leveraging the most significant events, movies, video game launches and other properties to drive continual product news in on-going consumer interest and frequency. To-date this strategy is working well. For example, in the first quarter we capitalized on key movie releases such as Deadpool and Captain America with the broad selection featuring dozens of products in store and online. We leverage PowerUpRewards to attach collectibles on key game releases. This includes Q1 releases such as Street Fighter but also Long Tail Fails from 2015 titles such as Fallout and Five Nights with Freddie's and even older titles such as Minecraft. We saw strong sales from enduring properties such as Star Wars, Doctor Who and Batman. And finally, we executed successful in-store events around indications such as Valentine's Day and May 4, be with you. The collectibles business is proving to be a broad based business with many significant IP drivers across movies and TVs, comics, video games and pop culture. From a category perspective, we expanded our product line into new areas. Some of the most significant new areas of focus are apparel where we expanded watches, socks and backpacks and grew more than 200% and interestingly housewares, where we also grew 200%. The largest category continues to be toys which also grew over 200% versus prior year. Looking ahead, we see a strong lineup of events and properties for the rest of the year. On the movie front obviously, Star Wars Rogue I is a big focus. We also have plans around the new Harry Potter movie, Fantastic piece and where to find them and from DC comics the movie Suicide Squad. Key video game launches for collectibles include Pokémon Sun and Moon, Battlefield, Call of Duty, Final Fantasy IV and South Park, and of course Game of Thrones as well. In short, 2016 is shaping to be a very full calendar of IPs whether movies, video games or pop culture. We feel like we are ahead of the curve in terms of bringing the right exclusive products at the right time and leveraging PowerUpRewards to message the right opportunity to each member. Now a few words on the physical video games category outlook and the potential impact of virtual reality and the new Nintendo console. Back in April, at Investor Day we shared our financial outlook for 2019 that incorporated a modest decline in the physical games business. At the time, we noted those numbers did not include any new console launches and did not include any sales for virtual reality hardware or software. I want to take a minute to lay out some category data that may help quantify the potential impact that these new innovations may have on the physical console gaming category in the near future. Specifically, I want to look at virtual reality products announced for 2016 and a new Nintendo console announced for 2017. We are not speculating on any new Microsoft or Sony consoles at this point. Games that did not model or project the impact of either of these innovations, we are simply looking at historical data and third party projections. We will update this information each quarter and later this year we will provide formal projections once we have more consumer data and initial sales data. Let's turn to Page 16 in the attached slide deck. The green bar on the left represents physical gaming category sales for the US for 2015 which totaled $13.1 billion. Moving over to the two orange bars we can see two external projections or VR sales from Super Data and IDG. These bars represent the projections for launch plus the first two years which in this case would be 2017 and 2018. The projections range from a low of $6.9 billion to a high of $13.6 billion. When added into a $13 billion category, you can get a sense of just how significant the impact could be on physical gaming sales. We are particularly excited about the Sony VR product given the attractive price point, the large installed base and its plug-and-play capability. Now let's move over to the blue bars on the right. Back at Investor Day, we illustrated the potential impact of new console introductions by all three manufacturers through 2019. Since then Nintendo has confirmed that they will be introducing a new console in early 2017. So let's take a look at the potential for just that one new console. Once again, we are not projecting, we are simply looking at the potential for a new console in comparison to prior consoles. Should the new NX perform only slightly better than the VU, it would still generate $2.7 billion of incremental sales over the first two years. Should it perform at even half of the level of V, it would generate $7.5 billion in incremental sales over that timeframe. You can of course supply GameStop's average market share to estimate the impact on GameStop sales. While it is too early to offer definitive projections, we are monitoring the situation closely in terms of product availability and features, consumer awareness and purchase intent we plan to provide update this quarter. I will now turn the call back over to Paul.

Thank you, Mike. And with that we will open it up for some question-and-answers.

Thank you. [Operator Instructions] And we'll take our first question from Mike Olson with Piper Jaffray.

Good afternoon. My questions for you, you beat gross margin in this quarter and I would guess it's somewhat hard to say what the trajectory of gross margin will be going forward given the pace of growth for Tech Brands could be impacted by acquisitions etcetera. But is there anything you can say about where you would expect gross margin to be for the full year and how much is being able to grow annually going forward for the next two years? And then secondly, on VR, it seems like it would be the case -- it's probably obvious that gamers would want to see first-hand and try VR in store. But do you have any kind of evidence to show that that really is the case or there is a risk that gamers simply buy VR at online? Thanks.

Thank you, Mike. Let's start with number two. Tony and Mike Mauler, do you want to talk about what you're planning on doing with VR and store, and we certainly have seen that that is a big part of conversion, all the research from Sony tells us that but do you want to…

Absolutely, and for those of you that were at Investor Day were able to view that. We had Sony there in a articulated -- a major part of their strategy is to make sure that people are able to experience that and that's what we've seen. As people experience this, complex device, it really becomes real to them and so we plan on literally having hundreds of stores that will have VR capability, in fact, that's what we've seen with the ATC product that we have been demonstrating and sold that we just expanded that from 10 stores to 100 stores and you will begin to see us roll out as against closer PlayStation VR as well. So it's a complex product and it takes a lot of explanation. As we've said at Investor Day, there will be nobody that is better informed or more able to meet the needs of the gaming customer and game stuff for that.

Mike, you've got a heavy a Sony penetration in Europe, what are your thoughts?

Well, as Tony said, we're going to see all of our larger stores have VR demos in the store but also in stores that can't support that, we'll see big events in the malls, in front of our stores, and so our intent is really in all the major markets that we're in to have strong demos and events.

Great. Rob, do you want to tackle the gross margin question?

Sure. We've talked briefly about the seasonality of GameStop stores being different than those of Tech Brands and so that's going to impact the gross margin rate as we move through the quarters and we'll continue to see expansion, probably greater expansion in the early quarters of the year like we did in this first quarter with it settling back down in the fourth quarter when the video game business has such a seasonal ramp up. But overall, we see expansion coming for the year and as we continue to grow the technology brands in the future, I would expect that to be the case, although perhaps at a moderated level, these -- kind of increases we showed this quarter obviously would be tough for any business to sustain.

And just as a reminder everyone, we showed a slide at Investor Day, we have expanded gross margin rates at GameStop for the last four or five years by 300 to 400 to 500 basis points, so those are aggressive and don't know if we can reproduce them but we are in more accretive categories.

Thank you.

Thank you, Mike.

We'll take our next question from Brian Nagel with Oppenheimer.

Hi guys, this is Dan Farrell on for Brian Nagel. You guys have shown pretty good ability to grow the collectibles, categories so far, I was just wondering kind of a bigger picture question, do you think that growth is kind of more of an initial market share gain or an expansion of the overall kind of market or a mix of both? And then if you had any initial takeaways from the early openings of the ThinkGeek stores?

We've got both of them, Mike Hogan and Mike Mauler here. Just one comment, if anybody hasn't been to 34th Broadway, please go. It's in the first floor of our two-storey store there. So there is a GameStop in the second store, go downstairs, it's a stunning store and you should go check it out, I think it says a lot about how we're expanding. And let's start, maybe Mike you want to talk about the history of how we got into this. And then Mike Hogan, you want to talk about the depth of the category.

Sure. As we've discussed, we started piling this category about four years ago in Australia. And so I think and we continue to see it grow and so right now what we're seeing I think the market is growing as Mike said earlier, we'll expand on that. And we're also taking a lot of share in a very fragmented market. And we're taking share by improving our merchandising, by improving the space we have in the store dedicated to the category by working closely with on the video game side, our vendors to make part of new release launch, working now with IP holders for movies and television shows to have better product offerings, expanding our Omni-channel through ThinkGeek as well, to trying enrolling this. And I'll just -- on the Australia, now we're entering the fifth year of loop, and those in-store loop sales are still growing in double-digits. So it is a category that has a lot of retention.

Yes, I would just add, Mike mentioned the fragmented category, this is a category with relatively low awareness overall and I think we should expect to see strong category growth and strong consumer penetration growth for quite a wild comp. Second thing I would say is, a lot of the products we're selling are unique products that aren't available anywhere else. And one of the biggest selling products that ThinkGeek created last year was a physical product to go with the game fallout, so kind of bringing the digital reality into physical world, and so we have more and more products that we're creating that are coming to the market for the first time. And so -- and the third thing I would say is what PowerUpRewards, we've been able to reach our directly to our PowerUpRewards members, not just to attach with video games but relative to other titles and other occasions that make sense for folks; for example, a big Star Wars theme around May 4. So we're seeing a growth in purchases per individual PowerUpRewards members as well.

And there is new entrants into this category. So for example, we are the official launch partner for Funko's new League of Legend license product. So it's the first time that League of Legends by Riot Games is going to put physical product into retails. I think we're finding people who didn't know this was an opportunity, customers who didn't know they could actually express their favor, their love of an IP, etcetera. So we think it's got a lot of growth.

All right. A quick follow-up if I may, just -- in Q2 with the lobbing of some stronger -- your video game releases in the prior year. Going into next year, can you kind of talk about your expectations for pre-owned growth given that some of the expectations for new software sales are more subdued?

Sure. Tony, you want to talk about that?

Sure, Dan. Given the fact that we have strong inventory position and like we shared at Investor Day, we have detached from the overall video growth rate. So we would expect to continue to significantly outpace the physical video game market.

And would you -- I guess expect to moderate as it did in Q1 or would you expect the extension or…

I think at this point we expect to be flattish versus a decline in a physical base.

We're still committed to our overall annual guidance of minus 2 to plus 2.

Great. Thanks, guys.

We'll go next to Colin Sebastian with Robert Baird.

Great, thanks guys, congrats on a good quarter.

Thank you, Colin.

Sure. First of all, little more detail on Overwatch [indiscernible]. And then secondly, probably to Rob, SG&A -- wondering how we should think about that for the year and how you are perhaps able to see the contraction of the cost efficiencies even as your expanding format?

Great, great. The SG&A is timely, we've been working on that, we met on it today but let Tony start, maybe Tony and Mike Mauler start with Overwatch.

Sure. Overwatch exceeded our expectations and it was a very strong launch for us. And let me share with you something that you may now know on this, it was actually a very progressive move by one of our strong partners, Activision. They looked and saw that there was demand before the game -- before the midnight launch, to be able to get the physical game. They saw that people were in some cases digitally downloading the game but what they did is said, hey, let's go ahead and see if they -- let's go ahead and give them the physical game before the midnight launch and then we'll turn on the servers because it has become less about picking up the game at midnight, it's become more about when do the servers come on. And what that did was allow us to have two full days before the servers came on to sell that game and what we saw was a significant increase well beyond their expectations of Overwatch and I think Activision would say that they saw an increase as well we're very happy with the result. So we see that as a very progressive move and something that we think may take hold in the industry as well, that's what we saw in the U.S. And Mike, you want to share your experience in international?

Yes, I think we saw the same thing internationally, even to a greater degree due to slower download speeds. Activision is great partner on this title and exceeded expectations. And I think what happens when a publisher tries to force additional digital preference by making just a piece of their offering early, it puts them in a disadvantage and really it's all about customer choice and it hurts the customer as well, and that results in less reservations in sales for a title like that. And so what Activision did as Tony said was really progressive and with phenomenal results.

That's great. It's always -- you know, the thing about this digital thing, Overwatch is a great title for us and the thing about it is you have to insightful about what consumers want, not really pushing your own agenda but more what consumers want. Rob, you want to talk about SG&A?

Sure. So Colin as we talked about the SG&A on Tech Brands is higher than it is on the video game business or the GameStop branded stores. So as we grow that business throughout the year, you'll see an increase in SG&A as a percentage of sales but what we'll deliver to you as we report our results quarterly is what's happening overall as well as what's happening in the GameStop branded stores. We talked about on Investor Day that we're taking cost out of the core business and we'll be able to report against that.

Thank you.

Thanks, Colin.

We have time for two more questions. So we'll go next to David Schick with Consumer Edge Research.

Hi guys this is Ray Stochel on for Dave, good afternoon. What level of insight can you share on rumors that new Nintendo console is shifting from disc-based games to cartridges? And if you can't specifically comment on that, can you discuss any historical economic differences between cartridges and disc for the pre-owned business?

We saw those rumors and so we obviously can't comment on them. I don't think we know anything about it anyway. But certainly for us, physical media is a good thing, right. As far as historical guys, anybody have any thoughts on that?

I don't remember anything distinctly different between the economics of pre-owned, whether or not it was disc or cartridge-based. Mike, do you?

Yes, the only difference would be on the refurbishment and pre-owned side and actually cartridges are much simpler to refurbish and repackage, so there is somewhat a little bit advantage in that direction on use.

But its early guys and we've got to keep cool heads, certainly I would say that the fact that there are rumors of that type just confirms for you that this is an important console for next year. It will have physical media, we will play a role in it, our pre-owned business will also play a role. So we're excited about that and of course we love Nintendo IP. So it's all good news.

Absolutely, that's great. And then just the follow-up on the other Nunes [ph] in the category, so what are you seeing now from PowerUpRewards members that you're serving certainly about virtual reality and that's it.

Okay, Mike?

Yes, so we continue to see pretty strong interest. I think one of the things we saw that we shared at Investor Day is we put out what information we've had. We've already had over 1 million of PowerUp members expressed interest in these products. I think at this point we would describe the interest is pretty, the awareness is strong, the interest is growing and what people are doing is they are willing to comment, understand what products are available, they are wanting to understand what gains are available with those products. So we expect to have all through the fall to have a great opportunity to do a lot of education of people. I would say there is a lot of people interested at this point, not that many of them know exactly what they're going to buy at so they are going to be looking for more information as it comes out and obviously we want to be the one that give it to them.

Great. Thanks so much.

Okay.

And we'll go next to Curt Nagle with Bank of America.

Thanks very much for taking the question. Hey Paul, how are you doing?

Good, man.

Good. Just a quick question or a follow-up I guess on VR, however, pre-orders trending relative to expectations. And then just a follow-up, what was free cash flow in the quarter? How much of the inventory was due to pre-owned, the increase and then are you still expecting $400 million to $500 million for the year?

Okay. Tony, you want to start with VR?

Sure. On VR we are full of pre-orders, so we took all the pre-orders that we could, they went out very quickly. Now we're filling up our first in the list on the devices so that we can go out and help people. Things like it never knew what comes out we'll be able to tell them about what that news is. When we get a new allocation of pre-orders we'll be able to put that back up. And so like Mike shared, we've had a million people express interest in it, many of them have come on for first in our list. So we're communicating with them and so we see interest is very high and I think it's going to grow after E3.

So that does not mean we're allocated a million units, which we were. I can't disclose our allocation but it's significantly less than that. But I mean really people first know that it's at pretty significant interest level. So I would say that's healthy. Rob, free cash flow and increase in inventory?

Sure. I don't have a free cash flow for the quarter in front of me, what we typically disclosed that in the cash flow statement included in our 10-Q. We're not revising our free cash flow estimate for the year at this time. And with respect to inventory at the end of the quarter, there were probably three things that happened. We did see a healthy increase in our pre-owned inventory, and we were intentionally building that. We had inventory on-hand for the titles that launched in early May, so you got the inventory in advance of the launch which affects the inventory number at the quarter but unfortunately we don't get it in the sales yet. And then the growth of technology brands also created year-over-year inventory growth.

Good. Thanks very much.

Thank you, Curtis.

That concludes today's question-and-answer session. At this time, I'll turn the conference back to Paul Raines for any closing remarks.

Great, thank you very much. I appreciate everyone attending our call today. We look forward to your interest in E3 and talk to you on the next call. Bye-bye.

This does conclude today's conference. Thank you for your participation. You may now disconnect.