Earnings Call: Q1 2016

May 26, 2016

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 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'd like to turn the call over to Paul Raines, Chief Executive Officer. Please go ahead, sir. Good afternoon, and welcome to the GameStop earnings call. I want to thank our worldwide team for another great effort in the Q1 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 and Development Mike Mahler, 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 believe 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 GameStop branded stores to distinguish from our technology brands as well as our ThinkGeek stores. 2nd, we have introduced a reference to GameStop, the corporation as GME to distinguish the store brand from our overall corporate identity. 3rd, 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 4th, we established some new targets for our digital collectibles and tech brands businesses. Now let me start by giving you a few highlights from the quarter. Our Technology Brands business had 500 plus operating earnings growth on 62% sales growth. Traffic comps were 1% and gross profit comps were 7%. We are pleased with our performance in the Tech Brands segment and currently expect to close the 2 previously announced AT and 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 and T, Simply Mac and Cricket formats. Global comps in our video game business came in at a negative 6.2%, overlapping a positive 8.6% comp from last year in the Q1 in our video game business. As we described in the press release, we overlapped significant titles and also saw a shift of Uncharted out of the Q1. Pre owned declined 3.7%, but still outgrew the new software category. Our non GAAP digital sales increased 16%, continuing our growth trajectory in that space. Last but not least, our collectibles business grew about 2 60%, proving that the category is vibrant and adjacent to our base. Top licenses and products for the Q1 were 5 Nights at Freddy's, Pokemon, Minecraft and Marvel. We opened our 1st New York City ThinkGeek store earlier this month at 33rd and Broadway and now have 4 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 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 accelerating 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 Forrester Research might be of interest to you and it is available on our website. Their report summarizes the 4 takeaways we highlighted at our Investor Day. The first is that we have added a new $1,000,000,000 run rate business outside our core GameStop branded stores called Technology Brands with great growth prospects. The second is that we added $2,000,000,000 categories inside our GameStop branded stores. The first is digital with a sustainable $1,000,000,000 non GAAP revenue base and the second is collectibles, which is well on its way to a $1,000,000,000 revenue line. The 3rd takeaway is that physical video gaming is cyclical, but has a very long tail and 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 4th takeaway was that all of these combined to make GME a growing and diversified company. We reported net income we reported record net income in 2015 for GME and we continue to guide to record net income for 2016. For the 2nd quarter, our guidance reflects the cyclical nature of the video game business as we await updates from E3. The 2nd 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 brands businesses will be significantly positive in the Q2. Remember that in the video game segment, we are overlapping an 8% comp last year and a 41% growth rate in our overall earnings per share in Q2 of 2015. Only 2 years ago, our Q2 earnings per share were $0.22 So the midpoint of our guidance reflects about 20% growth over the 2 year period. We are excited about E3 and expect to hear major news on virtual reality as well as potential new consoles. These events have traditionally been a catalyst for GME shares and Mike Hogan has done some modeling of potential impact that he will share with you in his remarks. Tony Bartel will also update you on our expectations for E3. With that, I will turn the call over to Rob Lloyd. Thank you, Paul. Good afternoon, everyone. We had a successful Q1. We're pleased with our GAAP earnings of $0.63 per share at the high end of guidance and our earnings of $0.66 per share excluding charges. The comps and earnings exceeded our guidance range while sales were within our expectations. Highlights include sales growth in Tech Brands is 62% to over 165,000,000 dollars Tech Brands operating earnings of $18,800,000 compared to $3,100,000 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 $82,300,000 in sales, Again, well on our way to our full year goal of $450,000,000 to $500,000,000 As you can see in Schedule 1 to the release, we're now disclosing collectibles as its own sales and margin category. It was previously included in other. Consolidated gross margins were 34.3%, up 3 30 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 most 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 include a 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 toward 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 $7,000,000 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 Q1 totaling $4,100,000 relating to the final cost to exit Puerto Rico as we discussed on our last call. The charges were $2,600,000 net of tax. Operating earnings were down 4.7% for the quarter, excluding the Puerto Rico costs. International operating earnings in Q1 improved $1,500,000 over last year's Q1. SG and A as a percentage of sales increased from 23.3% in the prior year quarter to 26.4% for this year's Q1. 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 and A rate. The increase in margin rate more than covered the increase in SG and A as a percentage of sales. SG and A in the GameStop branded declined slightly year over year, but increased as a percentage of sales from 22.1% in the Q1 of last year to 24.2% this quarter. Interest expense increased by $5,400,000 due to the issuance of senior notes in March. Non GAAP net income decreased $5,400,000 or 7.3 percent for the quarter. Non GAAP EPS decreased 2.9% for the quarter. Now let's look at sales for 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 percent decline. Next gen units decreased 10.2% and next gen average unit price declined 8.4%. Software declined 7.6% in the quarter. The division was a very successful seller, but comping against the combination of Battlefield: Hardline and Mortal Kombat was very tough as each of those titles sold a 1,000,000 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 products 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 2 50% with a margin rate of 34.8%. The decline in margin year over year is due to the addition of thinkgeek.com. Fulfillment costs for ThinkGeek impacted the category margin rate for the quarter by an estimated 200 basis points. We will move the ThinkGeek distribution operations from their 3rd party fulfillment center into our Louisville distribution center. This will be completed in early 2017 and will improve the margin rate. Other key information includes that we closed the net of 63 video game stores and now have 3,009 in the U. S. And 20 24 internationally. We opened a net of 18 Technology Brand stores and now have 1054. We opened 2 collectible stores in the quarter. We did not buy back any shares in the Q1, but as we showed on Investor Day, we plan to buy back between $75,000,000 $125,000,000 this year. Now I'll move on to 2nd quarter guidance. Revenues are forecast 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 comp. Uncharted moving into our Q2 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 Uncharted 4, Doom and Overwatch. We expect June July to reflect an industry decline coming off of Batman and Elder Scrolls in June last year and Rory McElroy's TGA Tour in July. Collectibles are expected to grow more than 90% from $41,000,000 in sales in last year's Q2. Tech brand sales are expected to grow more than 50% in the 2nd 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 product sales and operating earnings are forecasted to be flattish for the quarter. We expect interest expense to increase by about $9,000,000 from last year due to the additional debt. We expect earnings per share for the 2nd 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 the 2 AT and 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 a 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 in physical video game sales and as a result we exceeded our EPS guidance. In our non physical business in 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 console 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 1st GameTrust published game, 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 at Dawn. 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 Madden 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 2 61%. This growth was driven by expansion of linear feet especially in the U. S. Stores, the acquisition of ThinkGeek 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 Q3. Turning to Technology Brands. We had a clean quarter with minimal transition costs, 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 that we built or acquired last year and the absence of the conversion costs we incurred last year. Operating income margin was 11.3% in the quarter. Comparable technology brand stores increased traffic by 1% and gross profit dollars by 7% due to strong promotional pricing on mobile devices, strong increases in integrated product sales of DIRECTV and broadband and stronger conversion. We continue to be the most productive authorized retailer in the AT and T system. Our average store count was up 100 and 6% over quarter 1 of last year reflecting aggressive growth that occurred during 2015 as we acquired stores, converted GameStop branded and RadioShack stores and built white space stores. As we have previously disclosed, we will be closing 2 transactions in the Q2, keeping us on track to achieve our previous guidance of $85,000,000 to $100,000,000 of operating profit this year in Tech Brands, which is growth of 200% to 2 60% over full year 2015. As we shared in Investor Day, we have proprietary sales and operational programs that allow us to maximize the productivity of our technology brand stores, resulting in increased productivity of 30% on average when we acquire a store. In addition, we are seeing strong growth in integrated products, DIRECTV, broadband and digital life as AT and 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 lap 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 4 millionth PS4 console in the U. S. Our premium 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 Q1, so our inventory position is strong with pre owned inventory in the important Xbox 1 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 preeminent launch partner for VR headsets to the gaming population as we leverage our proprietary PowerUp Rewards relationships and our buy sell trade model. In closing, our transformation strategy is working and we continue to fill our GameStop branded stores high growth properties and expand our Tech Brands business at an aggressive pace. I would now like to turn the call over to Mark Hoglund. The first is a 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 the new Nintendo console and their potential for driving growth in the physical gaming category. As we noted at our April 14th Investor Day, collectibles narrowly defined is an $11,000,000,000 category in the U. S. An estimated $18,000,000,000 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 PowerUp Rewards members already purchase collectibles and at an average spend of $3.60 per year, they represent up to 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 $450,000,000 to $500,000,000 for 20.16 $1,000,000,000 by 2019. At present, we have only about 2% to 3% share of this category, but we believe we can grow that dramatically. And keep in mind that $1,000,000,000 in 20.19 would represent only about 5% to 6% of what will by then be a $16,000,000,000 U. S. Category. As Rob noted, our Q1 sales of 82 point $3,000,000 compared very favorably versus $22,800,000 for Q1 of 2015, representing 2 61% growth year over year. The business can be thought of in terms of 3 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 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've had great success in attaching incremental collectibles purchases to video game titles such as Fallout, Star Wars and Pokemon. Based upon this performance, we have increased the space dedicated to collectibles in our stores. Year over year collectibles 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 and ongoing consumer interest and frequency. To date, this strategy is working well. For example, in the Q1, we capitalize on key movie releases such as Deadpool and Captain America with a broad selection featuring dozens of products in store and online. We leverage PowerUp Rewards to attach collectibles on key game releases. This includes Q1 releases such as Street Fighter, but also long tail sales from 2015 titles such as Fallout and 5 Nights at Freddy'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 relevant occasions such as Valentine's Day and May 4th be with you. The collectibles business is proving to be a broad based business with many significant IP drivers across movies and TV, comics, video games and pop culture. From a category perspective, we expanded our product lineup 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 over 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 One is a big focus for us. We also have plans around the new Harry Potter movie, Fantastic Beasts and Where to Find Them, and from DC Comics, the movie Suicide Squad. Key video game launches for collectibles include Pokemon Sun and Moon, Battlefield, Call of Duty, Final Fantasy 15 and South Park, and of course, Game of Thrones as well. In short, 2016 is shaping up as a very full calendar of compelling IP, whether movies, video games, TV 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 PowerUp Rewards to message the right opportunity to each member. Now a few words on the physical video game category outlook and the potential impact of virtual reality and a new Nintendo console. Back in April at Investor Day, we shared a financial outlook through 2019 that incorporated a modest decline in the physical games business. At the time, we noted that 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 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. GameStop has not modeled or projected the impact of either of these innovations. We are simply looking at historical data and 3rd 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 U. S. For 2015, which totaled $13,100,000,000 Moving over to the 2 orange bars, we can see 2 external projections for VR sales from SuperData and IDG. These bars represent the projections for launch plus the 1st 2 years, which in this case would be 20172018. Their projections range from a low of $6,900,000,000 to a high of $13,600,000,000 When added into a $13,000,000,000 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 bars on the right. Back at Investor Day, we illustrated the potential impact of new console introductions by all 3 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 Wii U, it would still generate $2,700,000,000 of incremental sales over the 1st 2 years. Should it perform at even half of the level of the Wii, it would generate $7,500,000,000 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 this situation closely in terms of product availability and features, consumer awareness and purchase intent, we plan to provide an update each 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 And we'll take our first question from Mike Olson with Piper Jaffray. Hey, good afternoon. Hey, Mike. I had 2 questions for you. You beat gross margin nicely again 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'd expect gross margin to be for the full year and how much you think it will grow annually going forward for the next few years? And then secondly, on VR, it seems like it would be the case, it's probably obvious that gamers would want to see firsthand and try VR in store. But do you have any kind of evidence to show that that really is the case or is there the risk that gamers just simply buy VR add ons online? Thanks. Thank you, Mike. Let's start with number 2, Tony. Tony and Mike Malorieux, you want to talk about what you're planning on doing with VR in 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, we're able to view that. We had Sony there and they articulated that 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 HCC Vibe product that we have been demonstrating and have sold that we've just expanded that from 10 stores to 100 stores and you will begin to see us roll out as it gets closer PlayStation VR as well. So it's a complex product and it takes a lot of explanation. And as we said at Investor Day, there will be nobody that is better informed or more able to meet the needs of the gaming customer than GameStop for that rollout. Mike, you've got a heavy Sony penetration in Europe. What are your thoughts? We do as 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 support that. We'll see a 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, great. Rob, do you want to tackle the gross margin question? Sure. I 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 Q1 with it settling back down in the Q4 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. Yes. And just as a reminder to everyone, we showed slide at Investor Day. We have expanded gross margin rates at GameStop for the last 4 or 5 years by 300 to 400 basis points 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. Hey, Dan. How's it going? You guys have shown pretty good ability to grow the collectibles category so far. I just was wondering kind of a bigger picture question. Do you think the 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 got both Mike Hogan and Mike Muller here. Just one comment, if anybody hasn't been to 34th and Broadway, please go. It's in the 1st floor of our 2 story store there. So there's a game stop in the 2nd 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 it. 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 discussed, we started piloting this category about 4 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, and he can 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 category, by working closely with on the video game side, our vendors to make LOOT part of the new release launch, working now with IP holders for movies and television shows to have better product offerings, expanding our omni channel through Clean, Inc. As well as playing a role in this. And I would just finally add, in Australia now they're entering their 5th year of LOOT and their in store LOOT sales are still growing in double digits. So it is a category that has a lot of room for expansion. 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 while to come. 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 in the 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 then the third thing I would say is with PowerUp Rewards, we've been able to reach out directly to our PowerUp Rewards 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 PowerUp Rewards member as well. And there's new entrants into this category. So for example, we are the official launch partner of Funko's new League of Legend licensed products. So this is the first time that League of Legends by Riot Games is going to put physical product into retail. So 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 or their love of an IP, etcetera. So we think it's got a lot of growth. Great. And then a quick follow-up, if I may. Just in Q2 with the lapping of some stronger new video game releases in the prior year, going into the next quarter, 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 Day, we have detached from the overall video growth rate. So we would expect it to continue to significantly outpace the physical video game market. And would you, I guess, expect it to moderate as it did in Q1 or would you expect the expansion or I think at this point, we'd expect it to be flattish versus a decline in the physical peak. We're still committed to our overall annual guidance of minus plus 2, right? We'll go next to Colin Sebastian with Robert Baird. Great. Thanks, guys. Congrats on a good quarter. Hey! Thank you, Colin. Okay, sure. First off, on looking for a little more detail on Overwatch, launch and how to interact with the monetization? And then secondly, probably to Rob, but SG and A, wondering how we should think about that over the course of year and how you are perhaps able to extract the cost efficiency even as you're expanding format and store location? Great, great. The SG and A is timely. We've been working on that. We met on that today. But let's let Tony start, maybe Tony and Mike Muller 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 not 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 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's 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 2 full days before the servers came on to sell that game. And what we saw was a significant increase well beyond our expectations of Overwatch. And I think Activision would say that they saw an increase as well. And we're very happy with the results. So we see that as a very progressive move and something that we think may take hold in the industry as well. So that's what we saw in the U. S. And Mike, you want to share your experience internationally? Yes. I think we saw the same thing internationally even to a greater degree due to the slower download speeds. Activism is a great partner on this title and it exceeded expectations. And I think what happens when a publisher tries to force additional digital press 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 and 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 the thing about this digital thing, Overwatch is a great title for us. And the thing about it is you have to be insightful about what consumers want, not really pushing your own agenda, but more what consumers want. Rob, you want to talk about SG and A? Sure. So Colin, as we've talked about, the SG and A on the 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 can you'll see an increase in SG and 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. And we talked about on Investor Day that we're taking costs out of the core business and we'll be able to report against that. Thank you. Thanks, Kyle. We have time for 2 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. Hi, Ray. What level of insight can you share on rumors the 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 discs for the pre owned business? We saw those rumors and so obviously we 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 the 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 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 of advantage if it went in that direction on used. But it's early guys and we've got all keep cool head. 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 newness in the category. So what are you seeing now from PowerUp Rewards members that you're surveying 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 a 1000000 PowerUp members express 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're wanting to come and understand what products are available. They're wanting to understand what games are available with those products. So we expect to have all through the fall and have a great opportunity to do a lot of education of people. I would say there's a lot of people who are interested at this point, not that many of them know exactly what they're going to buy yet. So they're going to be looking for more information as it comes out and obviously we want to be the ones to give it to them. Great. Thanks so much. Okay. And we'll go next to Kurt Nagel with Bank of America. Thanks very much for taking the question. Hey, Kurt. Hey, Paul. How are you doing? Good, man. Good. Just a quick question or a follow-up, I guess, on VR. How are preorders 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 $400,000,000 to $500,000,000 for the year? Okay. Tony, you want to start with VR? Sure. On VR, we are full of preorders. So we took all the preorders that we could. They went out very quickly. Now we're filling up our 1st to know list on the devices so that we can go out and tell people. Things like, hey, whenever news comes out, we'll be able to tell them about what that news is. When we get a new allocation of preorders, we'll be able to put that back up. And so like Mike shared, we've had 1,000,000 people express interest. You say a million. Many of them have come on for our 1st amendment. So we're communicating with them all the time. So we see interest as very high and I think it's only going to grow after E3. So that does not mean we're allocated 1,000,000 units. I wish we were. No, I wish we were. We can't disclose our allocation, but it's significantly less than that. But I mean 1,000,000 people on the 1st snow that is a pretty significant interest level. So I would say that's healthy. Rob, free cash flow and increase in inventory? Sure. I don't have the free cash flow for the quarter in front of me. We typically disclose that in the cash flow statement included in our 10 Q. We are not revising our free cash flow estimates for the year at this time. And with respect to inventory at the end of the quarter, there were probably 3 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 you don't get any of the sales yet. And then, the growth of technology brands also created year over year inventory growth. Okay. Thanks very much. Thank you, Curtis. Okay. 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. 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.