Good day and welcome to the GameStop Corporation Second 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 all 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, CEO. Please go ahead, sir.

Thank you, operator. And welcome to the second quarter earnings call for GameStop. We thank our associates for their hard work serving our customers every day. We also want to reach out to all our associates in the areas affected by the Louisiana floods, as well as the earthquake in Italy. Our thoughts are with you and we are supporting you through our internal gamer fund foundation and our HR teams. Speaking today on our call are Rob Lloyd, Chief Financial Officer; Tony Bartel, Chief Operating Officer; and Jason Ellis, Senior Vice President of Technology Brands. Our executive staff are in the room as well. As we pointed out in our press release, we achieved earnings at the higher end of our guidance, but the process was different from what we had originally planned. Our Technology Brands business performed well beyond expectations with revenues up 55% and operating earnings of $13.9 million. This segment contributed close to 24% of our overall earnings, and we reaffirm our guidance of $85 million to $100 million of operating earnings in fiscal 2016. All of this success in Tech Brands comes as we also acquired 507 AT&T stores from three different dealers for approximately $440 million. These deals are intense and require a massive effort across our organizations in Dallas and Salt Lake City, and I am proud of the entire team in getting them across the finish line. Jason Ellis is here today to share his thoughts with you. A key point to understand on the dealer acquisitions, usually these are individual entrepreneurs who have held these enterprises for many years and have decided to begin seeking an exit. As they start their process, it is vitally important to present GME as a viable buyer, not just from a financial point of view,…

Thanks, Paul. Good afternoon everyone. In a testament to our diversification strategy and new school metrics, we deliver earnings on the higher side of our guidance range despite the challenges we faced in the core video game business in second quarter. Our earnings of $0.27 per share resulted from significant contributions by Tech Brands and Collectibles. Tech Brands' revenues grew 54.6% to $175.9 million and Tech Brands' operating earnings were $13.9 million, compared to $400,000 last year. Collectibles sales grew 120% to $90 million. On the strength of our new higher margin businesses, consolidated gross margins were 37.9%, an all-time high, up 500 basis points from last year. As you know, NPD results were down 31% in hardware and 12.5% in software for the quarter. We saw declines in hardware of 33.4% and in software of 18.2%. The largest titles in the quarter were released in May with very difficult overlaps in June and even July. We gained share in May with titles like Uncharted 4 and Overwatch. We lost share in June and July, which happens when there are no notable titles. We saw a noticeable dropoff in hardware sales after announcements or rumors of console refreshes leading into and during E3. Paul mentioned that we completed three AT&T acquisitions. We had one transaction closed at the end of May and the other two on the first day of the third quarter. Now for more depth on our results. Total sales decreased 7.4% in the quarter, greater than we expected due to the hardware declines. The FX impact on sales was marginal at negative $5.1 million for the quarter, and we don't expect much impact for the full year. Comparable store sales decreased 10.6% for the quarter driven by the decline in hardware and software. U.S. comp was down…

Thanks, Rob. As we expected and consistent with Q1, the second quarter again showed the power of the transformation efforts as strong performance in our Tech Brands, collectibles and digital businesses offset the anticipated decline in the video game category. Jason will address impressive Tech Brands results. So I will cover our collectibles, digital and physical video game results. Our collectible sales continued their strong growth increasing 120% for the quarter. We completed the expansion of collectibles in all U.S. stores, increasing our collectibles dedicated space by more than 100% compared to last year. In select stores, we are testing a store within a store concept where over one-third of the floor spaces is dedicated to collectibles. We will have this in about 300 stores before the holiday season. We also opened 10 dedicated collectibles stores worldwide during the quarter and now have 47 including four ThinkGeek stores in the U.S. As you know, we target a 20% IRR on all of our developments and we are exceeding those targets by over 50% in the stores that we have opened so far. We've opened seven more dedicated stores since the end of the quarter and are on track to have over 80 dedicated stores by the end of the year. For those of you in New York, I urge you to stop by our 33rd and Broadway store, which has recently been converted to a hybrid format. While the Collectibles business may experience sales spikes due to large IP launches, there are significant events or product launches nearly every week of the year, making the category much more consistent and predictable than the video game business. A sample of some of the bigger properties is provided on slide 18. As an example of how quickly we can react to the…

Thank you, Tony, and good afternoon. My name is Jason Ellis and I'm responsible for the Technology Brands division of GME. Technology Brands has been a deliberate focus on behalf of our leadership team to diversify GameStop's revenues and profits while at the same time building large businesses that can demonstrate category leadership and provide durable earnings. Since its inception in October of 2013, Technology Brands has successfully leveraged GameStop's core competencies in real estate expertise, multiunit management, buy, sell, trade and capital deployment to create one of the largest consumer technology specialty retail chains in America. The largest business in our division is Spring Mobile, which has recently become AT&T's largest authorized retailer. Spring Mobile has been one of AT&T's most productivity authorized retailers for over 10 years and since being acquired by GameStop has experienced unprecedented growth, building or acquiring more than 1,400 locations and deploying over $750 million in capital, including the recent purchase of more than 500 AT&T authorized retail locations, one of the largest acquisitions GME has ever made. In regard to our most recent acquisitions, these have been a tremendous undertaking on behalf of the entire organization. Last year on the first day of the third quarter, our AT&T division operated 590 retail stores. And this year on the first day of the third quarter, our AT&T division operated 1,424 stores. The addition of 834 retail stores in less than one year evidences GME's ability to move with a high rate of change and continue to enforce our diversification strategy. Last year, the Technology Brands division delivered just over $27 million in operating income. We expect to more than triple that number this year. Most operators would tell you that the heavy lifting starts after the deal closes and larger transactions are more difficult…

Thanks, Jason. With that, we will open up the call for Q&A.

Thank you. [Operator Instructions] At this time, we'll take a question from Ben Schachter with Macquarie.

Hey, guys. When you think about store traffic for the back half of the year, how important will VR be, not necessarily in terms of dollars spent, but just bringing people into the stores? And then relatedly, can you just remind us which hardware launches are now included in the guidance, because I don't believe PlayStation has officially launched a new PlayStation. Just remind us what's going on there. And then for Jason, when we think about the Technology Brands business, are key launches like a new iPhone, how are important are those to what drives traffic growth and sales growth there? Thanks.

Okay. All right. Let's start with number one. Store traffic on VR. I think that's interesting. Tony may or may not have something to share with you.

Sure. Absolutely. We literally have hundreds of stores that have stations in them, VR stations in them today, and in a quarter of our stores, we already have had events that have been strong traffic drivers, partnering very closely with Sony, each of our associates are going to be certified in the PlayStation VR. As you know, at this point, VR is suffering from – in Sony's case, they're not suffering, they just have it launched, but in the other two cases, there is a low production that is not meeting demand. But we see tremendous traffic when we run these events in our stores, and another element of just how much demand there is, we had the quickest sell-out of preorders in our history the last time we were able to put up PS VR for preorder, we were out literally in five minutes. So there is tremendous demand and in the back half of the year, as people come in, as they talk with our associates, they're incredibly knowledgeable and certified in this, we think it will be a good traffic driver far beyond the sales that it will generate.

I think we would all – those of us who have been in the Sony meetings, I think you would see that Sony has taken this very seriously as a very meaningful driver, so there is other stuff they are going to announce that you will hear more of. Question number two, Rob, what hardware is included in the guidance.

Well, the Xbox One S is in the guidance. We started selling it two, three weeks ago. We sold through what we got. We'll start selling the 2 terabyte shortly.

1 terabyte.

1 terabyte. And then the PlayStation, the Neo is in the numbers, but in very light form as not much is known yet. We'll know more obviously after September 7.

And then Jason, you’re going to talk about, I think, iPhones, right?

That's right. And thanks for the question, Ben. For this quarter in particular, iPhone is important to the quarter and obviously any Apple product launch will drive traffic to the stores. But thanks to the diversification in the retail stores, we're also excited about the other products like DIRECTV with NFL Sunday Ticket, so there's more than just iPhone in this quarter that will drive traffic.

DIRECTV has not had enough, I think, press on how impactful it can could be for AT&T and for us. Okay.

Next question, operator.

Move now to Colin Sebastian with Robert W. Baird.

Thanks, guys. Have a couple of questions. First, just one quick follow-up to Ben's question on guidance. Is PlayStation VR included now in the second half?

Not huge numbers, right, Rob?

It's in the numbers as well, but the quantities will be very limited, we believe this fall.

Okay. And then with respect to the used margins, just given the 45% number in the quarter and your guidance, is that the level we should expect for Q3 and Q4 even as sales improve seasonally?

I think my comment was 44% to 47%, and what we're seeing there is the ongoing mix shift that drives more of the sales to the next-gen products, and as we said in the past, the next-gen products don't carry the same margin rate as the older generations do. The margins just improve as the generation ages. As well, we've been augmenting our supply with some third party purchases, particularly on the hardware side, and those don't carry the same margin rates as we're used to.

Okay. And then lastly, maybe for Jason, with respect to the latest purchase of AT&T stores, the 507, I was hoping you could add some context around the attributes of the one reseller that will contribute such a large portion of profit, and if that provides some potential for upside to the operating income target? And then also what you see on the horizon in terms of additional roll-up opportunities? Thanks.

So I don't think it was just one operator, but it would be a combination of the three that will gives us the upside potential between now and the run out for the rest of the year. I do believe that there's upside potential in all of them. And as Paul said in his comments, many of the recent purchases are legacy businesses that have been doing the wireless dealer business for a long time, which means they have larger SMF streams. Their businesses are traditionally more profitable than some of the newer businesses, and we've specifically targeted those type of dealers in our acquisition strategy. So, generally, they're higher volume with more legacy customer base, more loyal customers, and we do see that when we put our systems in here, we will see an uptick in productivity. So, overall, those stores will become more profitable. It also will help us leverage our fixed cost structure, so we'll gain some efficiency there as well.

What about the possibility for more dealers?

I'll take a big breath because we just…

It’s hard to talk about it.

…digested all of these 500 stores. But obviously we're hungry for more and we think that there's runway there, and this space is very competitive and it's been around for 20 or more years, and we think that we're a good home for a lot of people that may want to exit. So that door is open.

The other dynamic, Colin, is there's a lot of – as you know, a lot of movement in the telco space to the degree that AT&T wants to exit certain corporate stores, they will pursue us on that too. So, I mean, I think the most important thing is just what an outstanding job our Spring Mobile and Tech Brands teams have done in execution so far.

Colin, this is Rob. I'll say that we gave a range of $85 million to $100 million of operating earnings. And so, obviously, we've reflected that there's some upside inside that range as we add these stores into the mix.

Okay. Thanks, guys.

At this time, we'll take the next question, this will be from Curtis Nagle with Bank of America Merrill Lynch.

Great. Thanks very much for taking the question. So for the first one, I'm just curious what you guys think the impacts could be in terms of building the console base from lower pricing, I guess, I'll call them the non-upgraded consoles including what you guys have in your own pre-owned inventory? And then just a quick follow-up after that.

Okay. Tony, you want to take that?

I think any time there's innovation in the pipeline, it's good for us. It really begins to operate our whole buy, sell, trade business. So like we saw, even as I referenced in our notes, when the two-third of Xbox going to [indiscernible] and Rob said we had very limited quantities, but when we sold out 37% of those had a trade of credit attached to them. And so we do see when innovation hits from a hardware perspective, we're able to really capitalize that on – from a pre-owned perspective. So we welcome any form of innovation and we think that the Xbox One S and whatever it is that Sony is going to talk about as well as the Nintendo and PS VR are all going to be opportunities for us to provide great value for our customers, new innovation and drive excitement in the video game.

One of the things that someone should be modeling is console VR if there's a percentage of trade credits applied to that, similar to hardware.

Absolutely. I mean, as is usual, when you have a launch like that that is complex, which this is and it's expensive, which this is, what happens is we tend to get an over allocated portion of that because we can offer trade credits, we offer the first to know list, we offer the preorder benefits and we offer the PowerUp Reward credits that no one else can really match.

And remember, Curtis, right now, Sony has been in and out of our office many times in the past few weeks. So, right now, for example, they're looking at our lists of PowerUp members who own PlayStation 4 and they are thinking about how they are going to promote to those people and figure out how to bring their trade credits in. So we think we’re a very powerful launch partner for them and others, but they will be most important because they have a lot of installed base.

Great. Thanks very much. And then just a quick housekeeping. Just what drove lower AP year-over-year? Was that just I guess higher used inventory relative to new or was it something else? And that's accounts payable?

Well, -- sure.

Thanks for turning that up, Curtis.

Thank you.

Sure.

I knew what you meant. Related to AP is the increase in inventory and Matt's already had a question come in from one of the analysts on that, so let me address that. Inventories increased as a result of the growth of Technology Brands because of ThinkGeek and the growth of the collectibles business and the collectibles dedicated store base. With respect to that, we don't have the same leverage opportunities on the AT&T side or in many cases on the collectibles side, especially with products that we're getting manufactured overseas as we do in the core video game business. We also saw a slowdown in the core video game business and as a result, we had a lot of inventory that sustained us through the quarter and that inventory needed to be paid for at some point in time. So you've got a different leverage ratio this quarter.

And just sorry one quick follow-up on that. Are you maintaining the free cash flow guidance?

Yes.

Okay. Great. Thanks very much. Appreciate it.

Thanks, Curtis.

At this time, we'll move forward to Mike Olson with Piper Jaffray.

Hi, Mike.

Hey, good afternoon, guys. Couple of questions. Could you expand on the reasoning you gave for why your sales were down 18% for new software when NPD was down 12% and how that should be perceived related to market share in that segment?

Sure. So, this is Rob. When there are title launches and we dominate the market share at launch and remember that when we launch games, we typically have 60% to 70% share during the first week of launch, those shares have continued. The opportunity to get that share was dramatically reduced in the second quarter because the title count was dramatically reduced. So what you have then is what we call the catalogue portion of the software business plays a much more dramatic part of what the software sales are in the particular quarter and we have the 60% to 70% share at launch. Our overall share comes in around 40% or so on software. So obviously when a title moves out of that launch phase into what we call the catalog phase, we lose some share. So the lack of titles launching in the quarter is what you saw in the share decline.

The trade currency is much more powerful on a new title launch than it is on a catalog launch. That's our advantage.

Okay. Got it. And then second one is on AT&T stores. I think one of the questions that comes up fairly often is why all these AT&T resellers are getting out of this business and selling to you if it's a business that's got kind of good go forward prospects. Can you just talk about that dynamic and why they may be exiting those businesses because you're wanting to enter that space? Thank you.

That is a great question, Mike. Jason?

Yeah. The good news is that I was one of them originally. So, most of my peers have been in this space for like I said a long time, 15 or 20 years. And the space is just getting more difficult in terms of the infrastructure required to run it and the expertise that's required to do it effectively. So, we're representing one of the most valuable brands the world with AT&T. They've made tremendous investments in their network and other products and services and they expect that our associates will be trained. They expect the retail environment to look a certain way, their customer privacy requirements that need to be maintained and just quite honestly the business is more complicated to run than it was 20 years ago. And some folks just are at the stage where they're not willing or capable of doing that. So, as we've discussed, we're a really good exit for those that are looking for liquidity.

And one of the things about these entrepreneurs running these businesses is in many cases they don't have a succession plan, right, Jason. So they're trying to get out. And you can't just sell to anybody, right, guys? It's an interesting segment for us and it's got a lot of growth.

Thank you.

Thanks, Mike.

Thanks, Mike.

At this time we'll move to Brian Nagel with Oppenheimer.

Hey, Brian.

Hi, good afternoon.

Good afternoon.

My first question, I guess this is for Rob, with regard to the gross margins and your new software business. You discuss this in your prepared comments, because they did shift higher here in the second quarter. Maybe if you could explain in more detail the reasons behind that and then how should we think about the sustainability of that trend for the back half of this year?

Sure. So we talked about the inventory - that we had inventory in the stores that sustained us more through the quarter. So, obviously moving less into stores resulted in a lower freight cost than we had last year. So, a lower freight cost can positively affect your margins. Then on the - we talked about the cooperative advertising dollars. So that's pretty well tied to, based on the accounting rules, when products launch and what the advertising that we get from our publishing partners pertains to. And so there are a lot of dynamics in how you calculate how much gets capitalized of what comes in, in a quarter. And this is down in the weeds. I get that. But it has an impact particularly in a volatile sales environment on what it can do within the gross profit or gross margin rate arena.

So was it fair to say than Rob that if Q3 is a more normal sales environment for new software that there should be less of a benefit to gross margins?

It's fair to say that you would expect gross margins on both hardware and software to go back to the levels they've been at for call it the previous five or six quarters than what you saw in this Q2.

Got it. And my second question, bigger picture in nature, with respect to the collectibles business, again, congratulations on the good numbers you put up there.

Thank you, Brian.

As I talked to our clients, one of the biggest questions I continue to get, I don't p have a great answer for us, where is that - as GameStop continues to grow rapidly in this business where is the share coming from, and to what extent is GameStop taking share from other players or potentially even expanding the market given the advantages you now have in the space?

Yes that's a great question, Brian. Same question I had when we first started talking about this. You'll be fascinated by what you're going to hear. There's two things here to understand about it. And I'm going to let Mike Hogan and Mike Mauler talk about the two different pieces of this. There's the fragmented piece of the market. There's also the potential for licensing. This is a very early market. Mike you want to talk about it.

Yes, sure. I think as we’ve talked before, the licensing in general is - it's over $100 billion business. It's North America. The piece that we're focused on which is really sort of movies TV, video game, pop culture licensees, is around $11 billion. The first answer to your question is that is a growing segment. But in terms of growth of share, if you look at the category today, it's highly fragmented. There's no single player that has more than probably 10% or so share in this category. And its split up a bunch of various kinds of players from mass merch especially to retail to online, a lot of one man shops and so on. So, as we go into this category what we see is there's a real opportunity for GameStop to become kind of the global leader in this and what we see - a good example would be ThinkGeek has been a popular brand for years and people have been coming to the website for years. And as we opened our first ThinkGeek stores we had people coming from several states away to see what was available in that store. It's proven to be a great sort of master brand for us to assimilate that. So we really think that there's category leadership in our future here and opportunity to not only take share, but grow the category. We also think that there's opportunity to go and do bigger things from a licensing perspective. And Mike, you want to talk - you might want to talk about that.

Sure, a little bit. I think outside of the U.S. there really aren't any specialty chains that specialize in collectibles and licensed merchandise. And so worldwide we've just added 6,000 stores to this market, making the product much more accessible to the average consumer who might not in the past have actually looked for this type of product. That's one thing. We saw that also with video games over the last decade where specialty retail made a big difference in growing the market in many different countries. And so what we've seen as we've expanded this product line, what we're seeing people really shift their behaviors. And so as Game of Thrones will come out and people will come into our stores and buy 50 to 100 products for Game of Thrones parties to launch the premier. And so the culture and people's behavior is actually starting to change because we've made the product so accessible. And to Mike's [ph] point we've added a lot of excitement for the product through direct licensing, design and manufacturing. Now there's products you can't get anywhere else. Recently we've licensed worldwide several Pokemon products, including a Pokemon bean bag chair where we had thousands of reservations for it. And it's amazing when you offer really interesting product how people before who never really looked at licensed merchandise find a way to buy it and experience it. So it's really exciting.

Brian, go to ThinkGeek.com and look at the snore lacks bean bag chair. We're reserving that. We just had a discussion on it earlier. What’s frustrated me is that we can't sell for of it, but it's a fabulous example of what's happening in this category. Here's the global license for a Pokemon chair that we own. And we've got to figure out how to be smarter about reserving it right, so we can do a lot more volume, but it is fascinating what’s happening in this category.

I would be remiss if I didn't mention PowerUp Rewards and some data that I think we had shared previously, we know that almost 50% of our current members are already buying collectibles and we have for example the opportunity to go into PowerUp Rewards and identify everyone is a Pokemon game fan and market products like the [indiscernible] to 30% or so that are fallout fans and direct market fallout related collectibles to them. So, we think that's a big competitive advantage as well.

Appreciate that color.

Look at that bean bag chair, Brian.

Pretty comfortable.

I'll do it right now. Thank you.

We have time for one more question. This will be from David Magee with SunTrust.

Hey, Dave.

Hi, guys. Good afternoon.

Good afternoon.

I have a question regarding the favorite topic of NPD trends and you mentioned that you expected August to be, I think sort of flattish for software. And I guess we can use that as maybe a proxy for what your business might be doing, which would imply a pretty nice trend change from what we saw in the second quarter. My question is, how distortive is it that now NPD includes digital products? Should we discount that more than maybe in the past? How should we sort of view that relationship?

Mike, you want to take that one?

Sure, I don't think it has that much of a material impact. I think the publishers just wanted it to show the broader market. That's all they were trying to accomplish with that.

We've got questions around some of the accuracy of what they're measuring, right?

Yes. I think we would like to know if it's just still game downloads, if it's DLC, if it's Digital currency. So, there's some questions around that that haven't been answered yet.

Okay, fair enough. And then secondly on the Indy games, that sounds very interesting what you're doing with that. How is the pipeline potentially for that over the next couple years? Do you see a pipeline being big enough to really move the needle for GameStop?

I do. As we shared, there's already a second game that is already in the pipeline and I think what you're going to see this evolve into is a combination of games that we publish for game trust and we're going to continue to do that. And I think I talked about four games that we've announced and we have others in the pipeline that we haven't announced yet. So, we have a good pipeline. I think the other opportunity that we have and what we've proved is that when you give something visibility in our stores and our stores are fantastic at marketing things to people and allowing them to afford things, when you do that you open up whole new markets. So, I think not only are you going to see us sell games that we publish, but you're also going to see us bring visibility to games that are out in the marketplace that a lot of people don't know about. Our people are experts at selling. We have PowerUp Rewards. We know what people like and so you'll see some higher investment opportunities like we've done with game trust and what we've done with deformers and what we've done with Song of the Deep and you'll see some level of investment alternative where we're really marketing these. There's still high margin opportunities for us. So we're excited about not just the games that we are publishing, but also the other games that we will bring to market.

That's where all the growth is, right?

One of the largest pieces of the digital industry, I think five times as large as full game downloads.

Yes. It's where all the growth is. That's why we're focused on it.

Great. Thanks and good luck.

Thank you, David.

Thank you.

That will conclude the question-and-answer session. I'll turn it back over to Paul Raines for closing remarks.

Thank you. Thank you for joining us on the quarterly earnings call. If we sit here and reflect as we think about the decline in physical gaming of almost 40% from its peak in 2008 and 2016, our t strategy of diversification has paid off and allowing us to reach the high end of our guidance this quarter, on our way to a record net income year that we're forecasting for this year. With all the great virtual reality and console expectations coming, we believe physical gaming will return to growth in 2017. In addition, our new growth businesses of digital, mobile and collectibles make GME a very compelling investment for the future as we grow 3% to 5% annually to 2019 as we projected at our Investor Day. We hope to see all of you at our annual store manager conference in Anaheim. I think Matt sent some invitations out to everybody and we look forward to seeing you there on September 13, 2016. Thanks a lot.

And again that does conclude today's conference call. Thank you all for your participation.