GameStop Corp. (GME) Q3 2015 Earnings Report, Transcript and Summary

Good day and welcome to GameStop Corporation's third quarter 2015 earnings conference call. A supplemental slide presentation is available at investor.gamestop.com. [Operator Instructions] I would like to remind you that this call is covered by the Safe Harbor disclosure contained in GameStop's public documents and is the property of GameStop. It is not for rebroadcast or use by any other party without the prior written consent of GameStop. At this time, I'd like to turn the call over to Mr. Paul Raines. Please go ahead, sir.

Thank you, operator, and welcome to the third quarter earnings call for GameStop. We thank our associates around the world for their effort this quarter; and especially want to recognize our associates at Micromania, in France, for the challenges they are facing, all of GameStop stands with you. We are watching events in France and Europe carefully and we will react as events unfold. Joining me today on our call are Rob Lloyd, Chief Financial Officer; Tony Bartel, Chief Operating Officer; Mike Mauler, President of International; Mike Hogan, Executive Vice President of Strategic Business; Mike Buskey, President of U.S. Stores; and Matt Hodges, our Vice President of Public and Investor Relations. While diluted earnings per share was within our range, the quarter was challenging due to underperformance of Halo and Assassin's Creed late in the quarter and lack of sales acceleration from hardware price cuts during the quarter. There has been some discussion of Halo being a large full game download title, but our research indicates it performed at about the same level as other titles. Tony will reconcile that data in his remarks. On a more positive note, our pre-owned business had another good growth quarter at 4.9%, well ahead of overall software growth. In constant currency, this marks the seventh consecutive quarter of positive growth for pre-owned. We expect pre-owned to be at plan this year with solid growth in the fourth quarter. Our digital business grew 13.8% in constant currency and is on track to achieve over $1 billion in receipts this year. Our collectibles or Loot business also had nice growth, on track for reaching $300 million in sale this year and expanding our gross margin rate by 150 basis points in the other category. We also now have 22 Loot stores open around the world and two ThinkGeek stores in the U.S., one in Orlando, Florida and one in Palisades, New York. The third ThinkGeek store will open soon right here in Texas. Tech Brands continues to expand rapidly as we invest to build toward our goal of $1.5 billion in revenues by 2019. During the quarter, sales grew 64% and helped drive gross profit dollar growth of 81% in mobile and consumer electronics segment. We acquired 21 AT&T reseller stores during this quarter and another 87 at the beginning of the fourth quarter. Reseller acquisitions for the year totaled 239 stores for $112 million. We continue to seize opportunities to grow this business by reinvesting into more acquisitions in highly-fragmented dealer space. Our relationships with AT&T and Apple are strong. Overall, we believe GameStop's redeployment of cash flows from our video games businesses into adjacent retailing categories is the right strategy. This strategy is built on our core competencies in real estate, human talent, ability to deploy capital effectively, buy-sell-trade and PowerUp rewards. In total, revenues from non-physical gaming now comprise 17% of sales and 26% of gross profit, up from 23% last quarter, and these areas continue to grow rapidly. Over the last couple of weeks, we have seen some disruption in our shares, but we encourage investors to stay the course. GameStop achieved record third quarter gross profit and we expanded our gross margin 280 basis points on the strength of non-video game categories. Since November 2013, our overall gross margin rate has expanded by 400 basis points. GameStop continues to have dominant share in the video game space and we are focused on continuing to generate positive returns through diversification into other attractive segments. We have reconfirmed guidance for the fourth quarter and are fully prepared for the upcoming holiday season. I will now turn the call over to Rob.

Thank you, Paul. Good morning. We're in the room here getting a lot of air conditioner noise or heating noise that's coming through, I apologize for that. I'll start today by covering the results for the third quarter. Sales decreased 3.6% in the quarter, but grew 1.2% excluding FX. Comparable store sales decreased 1.1%, due primarily to slower than expected hardware sales. Gross margins expanded 280 basis points on the strength of growth and margin expansion in mobile and collectibles. SG&A as a percentage of sales increased from 23.6% in the prior-year quarter to 26.1% due to investment supporting Tech Brands' expansion. I'll provide more color on that shortly. Interest expense increased $3.4 million, because the $350 million in debt was outstanding for the entire quarter this year versus a few weeks last year. Adjusted net income decreased 11.4% and adjusted EPS decreased 5.3%, due to the decrease in sales and gross profit in the video game segments and due to investment supporting Tech Brands' expansion. Foreign currency movement reduced sales by approximately $100 million and reduced EPS by $0.02 when compared to last year. Now, I'll recap sales and margin during the quarter for some of the categories. Hardware sales decreased 20.4% or 15.4% excluding FX, because of the reduction in price on the PS4 in October and the Xbox One late last year, and because of the overlap of the Destiny Bundle, which drove 147% increase in new hardware in Q3 2014. Software sales declined 9.3% or 4.2% excluding FX, because of the overlap of Destiny. Pre-owned revenue grew 0.6% or plus-4.9% excluding FX, as we saw continued growth in next-gen pre-owned hardware and software. Pre-owned margin rate were 46.0%, at the high-end of the guidance we gave on our last call. Digital receipts on a non-GAAP basis grew 8.7% or 13.8% excluding FX, to $228.6 million for the quarter. As we said in the release, growth was led by sales of digital content for Destiny: The Taken King. GAAP digital revenues declined 27.1% year-over-year due to FX impact and because of accounting for Kongregate on a net commission basis. We will overlap that change in accounting for Kongregate in the fourth quarter. Mobile revenues increased 31.1%, driven by a 64.2% growth in our Technology Brands revenues to $140.1 million. And gross margins increased from 40.1% in Q3 last year to 55.4%, as Tech Brands becomes a greater portion of the mix in this category and as margin rates in the Tech Brands business continue to expand. We continue to invest in Tech Brands store growth. During the third quarter we incurred $5.9 million in pre-opening costs for the 79 stores opened and the 40 or so stores to be opened during the fourth quarter. The RadioShack and GameStop conversions are taking longer than we anticipated to open. And the payroll, carrying costs, pre-opening rent and normal ramp to store profitability are impacting our Tech Brands' results. As a result, the $6.5 million of operating income generated was less than we expected, an EPS impact of $0.02 to $0.03. But we expect significant profit growth from Tech Brands in the fourth quarter, as the bulk of the openings and conversions are behind us. Revenues in the other category increased 60.8% to $138.3 million, driven by sales of interactive toys and the growth of our collectibles business. Some other data points are as follows. We closed a net of 19 video game stores around the world. We opened eight collectible stores during the quarter. We repurchased $44.9 million in stock in the quarter or 1.02 million shares on an average price of $43.85. Now, let's move on to fourth quarter guidance. As stated in our earnings release, we expect same-store sales to range from negative-1% to plus-6% and revenue growth to range from flat to plus-6%. Changes in foreign currency rates are expected to negatively impact revenues by $120 million as compared to the fourth quarter last year and will negatively impact EPS by approximately $0.02 to $0.03 more than we planned earlier this year. We expect to continue to expand gross margins compared to the prior-year quarter, as our mobile and collectibles businesses continue to grow. As I stated earlier, operating earnings for Tech Brands are expected to grow significantly in the fourth quarter. We are guiding EPS for the fourth quarter to range from $2.12 to $2.32 per share and reiterating our full year guidance of $3.66 to $3.86 per share. You should model 106 million shares outstanding for the fourth quarter and 107 million for the full year, based on buybacks through the end of the third quarter. For the full year, total revenues are now expected to range from flat-to-positive 3% and same-store sales are now expected to range from positive-2% to positive-6%. I'll now turn it over to Tony for his comments.

Thank you, Rob. As Paul mentioned, new hardware sales slowed in the final month of the quarter, causing us to miss our comp guidance. We have seen that rebound in the week, since as consumers waited for key games such as Activision's Call of Duty: Black Ops III, Bethesda's Fallout 4 and EA's Star Wars Battlefront to purchase their hardware. Sales of Microsoft's Xbox One and Sony's PlayStation 4 are up 31% during the first two weeks of November. We continue to dominate the new console cycle, selling over one-half of our Xbox One and PS4 software, generating a 53% share during the quarter. However, Halo 5 and Assassin's Creed Syndicate fell short of our expectations. The recent launches of Activision's Call of Duty: Black Ops III and Bethesda's Fallout 4 met our initial expectation. Our EA's Star Wars Battlefront fell short of expectations. Our pre-owned sales grew 4.9% during the quarter, before the impact of FX, outpacing overall sales by 3.7 point and new software sales by 9.1 point. In addition, we accomplish this growth with minimal promotional activity, generating a higher than expected 46% margin rate for our pre-owned business. We have provided Slide 15 in our investor package, which shows variance in growth rates of the new and pre-owned U.S. segments for next-generation and current-generation software. As you can see, pre-owned sales growth on next-generation software of 88%, outpace new software growth of 38%. Likewise, the sales decline in current-generation pre-owned software of 27% was less than a decline in new software of 65%. Consumers are using our trade promotions to fund their purchases of new software and hardware, providing us with a strong inventory position of in-demand games and hardware. Our PS4 and Xbox One pre-owned inventory has grown 44% compared to where it was this time last year. This gives us the opportunity to provide more value through promotions in the fourth quarter. We expect to end the year with pre-owned growth in mid-single digits, before FX, for the full year. Our non-GAAP digital receipts grew 13.8% prior to FX and 8.7% after FX, and we remain on track to deliver $1 billion of digital receipts for the full year. Downloadable content of Destiny: The Taken King and Steam Wallet revenues provided the majority of the growth during the quarter. The Microsoft announcement that they have sold $400 million of Halo 5, coupled with an NPD report that only reported a $119 million of U.S. Halo merchandise, has caused some to posit that digital sales were much higher on this title than on other previous launches. We are in constant discussion with our publishers and platform holders, and we believe that all major full game titles launched in this quarter were in line with previously announced digital download levels. The variance to NPD is reconciled by global sales not reported by NPD, a broader inclusion of SKUs beyond those track by NPD, two additional days of sales in Microsoft's announcement period versus NPD's reporting period and sales that were reported by publishers, but not reported by retailers. I will now share some data and cover about the performance of our non-gaming segments. Our high growth categories such as Digital, Loot and Technology Brands grew convincingly during the quarter and now represent more than one quarter of our Q3 gross margin dollars. In the quarter, Loot was our fastest growing sales category, with global sales increasing by 384% versus prior year. Loot also helped drive an increase in store traffic, customer basket size and gross margin rate. We expect this category to grow to $300 million in sales for the fiscal year. This rapid growth is being driven by leveraging our newly acquired ThinkGeek business; securing a growing number of exclusive products; and having a broad assortment of well-known IPs such as Star Wars, Call of Duty and Fallout that have strong appeal with our customer base. During the quarter, we made great strides in integrating ThinkGeek's capabilities into GameStop's growing omni-channel business. And we continue to expand Zing stores internationally and in the U.S., under the ThinkGeek brand name, ending the quarter with 22 stores including one in U.S. We expect to end fiscal 2015 with approximately 37 stores worldwide. Our Technology Brands stores are offering hottest technology this holiday season and providing great service. In addition to our rapid growth, we continue to be the most productive AT&T dealer as well as a top-performing authorized Apple reseller. As of the end of the third quarter, we had 834 Technology Brands stores, an increase of 104% over Q3 of 2014. Including two acquisitions that we closed on November 1, we've opened 193 new stores consisting of RadioShack conversions, GameStop conversions and greenfield stores and acquired 239 stores year-to-date. Given the constantly changing nature of compensation programs from our partners, the best way to understand growth in the Technology Brands segment is to look at gross profit dollars. During Q3, Tech Brands drove the 81% gross profit dollar growth in the mobile and CE category. We expect for gross profit dollars to increase between 85% and 95% in the fourth quarter. In closing, we see solid demand for our video game products during the fourth quarter. And our Digital, Loot and Technology Brands businesses will provide sales and profit growth, giving us confidence to achieve our fourth quarter guidance and provide strong growth for 2016 as well. With that, I'll turn the call back to you Paul.

Thank you, Tony. And with that, operator, I would say, let's open up the call to questions-and-answers.

[Operator Instructions] First question comes from Mike Olson with Piper Jaffray.

One quick question, really. You mentioned some weakness for certain titles versus other titles kind of coming-in in plan so far. Could you specifically quantify the weakness of the Star Wars launch relative to your expectations or at least kind of qualitatively was it materially below what you were expecting or just slightly below what you were expecting?

Sure. Tony?

Mike, we're not going to quantify it in actual number. But we had high expectations that diminished somewhat as it got closer, and then it failed to hit those lowered expectations.

And then, I guess, while I have you, just on the digital front, it sounds like what you're saying its Halo, those numbers that we are hearing or maybe 50% of the game coming in digital may not be accurate? And then you mentioned that you think it's coming in more with what we've seen average for other titles. By average, are you talking about kind of the 20% or 25%-ish number that we've been hearing for some of the other titles?

Yes, I think that would be very similar to what we've heard in the other titles. Tony has got some information on this. I think you ought to hear as well.

Yes, and I have more information than I can share. But let me reiterate that we constantly talk with platform holders and with publishers, and we have a very good read and understanding of all titles that launched. We can't share that specific information. Here is what I would say though, in the past, we know that certain publishers and platform holders have reported sell-in and some have even reported sell-in at retail. I'm not saying that that's happened in this case, but that has happened in the past. And so I think I would definitely go back and talk to Microsoft about their announcement, as they are the only ones who can comment on that. Second, they definitely understand exactly what their digital percentage was. They know exactly what they sold and they know exactly what was sold digitally. So again, I would encourage you to go back and ask Microsoft to disclose that number. But again, we talk with platform holders and publishers constantly. We have again this quarter. And we are in full understanding and in full belief that there is no game that was launched this quarter that was materially above a normal digital percent at launch.

Next question comes from Arvind Bhatia with Sterne, Agee.

I guess taking that line of thinking a little bit further, what do you think is your market share in digital downloads? And then, how do you become more of a destination place for digital downloads, just as you have in so many other categories over the years. Particularly in downloadable content, you guys have done so well. How do you convert that success into digital downloads? And then also looking further out to 2016, again, maybe this is for Tony, how do we think about the titles that are coming out? What are your thoughts on hardware, just the industry in general? And then also tying it back to the digital question, how do you see that progressing?

I would say that, remember, that we are a player in digital downloads. I mean you don't do 228 million of digital receipts without having technologies, APIs, relationships, and all those things that you need to sell digital download. Tony maybe you want to talk about some of the intelligence you have in DFC?

Let me share some of that, Arvind. We don't give out specific market share of digital downloads or digital receipts, simply because it's really difficult to find that information. But let me give you some information from DFC, which we've quoted before, we find it to be one of the most credible source when we ought to look at digital share. According to DFC, in the third quarter, digital AAA sales for $60 game releases increased 6% over last year to 6% in total. And it represented only 9% of the total AAA sales mix. So that's coming from a source that we find very credible. So it grew 6% off of a very small base. So that's some of the information that we see. So we don't have our market share specifically. But again, we do have a good understanding from talking with the publishers and the platform holders and that seems to be in line with this information.

And you know the difficulty, of course, here is that digital is a complex animal and people, every publisher measures it in slightly different ways, et cetera. So, Rob, do you have something you want to add on this?

2016.

The 2016 titles, right.

I can talk about the titles that are coming up, we've got -- very excited about Street Fighter V and The Division, Uncharted 4. So those are some that we're very excited about. We've got Star Fox Zero coming out as well. Those are the ones that we can kind of see and are pretty well locked, very excited about that. And we anticipate that digital is going to continue to grow. And remember, that we grew 14% before FX, which is right in line with where the publishers grew. So we continue to see our digital continue to march forward at about the same rate that the publishers are seeing their digital growth.

And then one last one from me. As you looked at your full year guidance, given some of the weakness you cited on the titles, I was wondering what went into your thinking and not kind of giving yourself some more room and maybe tightening up the guidance a little bit now that we're a week away from Thanksgiving, I guess and you have a fairly good idea of the traffic trends, et cetera. Just wondering the confidence level in the forecast for Q4?

Just to clarify, first of all, Arvind, we mentioned two titles that met our expectations and one that fell below. So I would not say that we feel like there is general weakness in the title. I'll let Rob comment on the guidance.

Yes, I think it's important to remember that the results of the third quarter, well, $0.05 below consensus really for us amounts to about $5 million. With 60% or so of our earnings to be made in the fourth quarter, we believe it's not that difficult to make up that $5 million. And so that's I think the principal reason behind the guidance range we gave.

Next question comes from Seth Sigman with Credit Suisse.

A couple of questions here, mostly focused on the investments you're making, as you try to diversify the business. I guess, one, just trying to understand the core SG&A growth this quarter, how to think about that over the medium term? So when I look at SG&A this quarter, it was up over 9%. What would that look like if you exclude Tech Brands and ThinkGeek?

It's a good question. And you can imagine, Seth, for us, a company that's in transformation of the kind we're in, it's a trade-off everyday. How do we disinvest in the core, as the core becomes a smaller part of our business and how do we invest in these new businesses. And we've had our struggles on some of these. And Rob, I don't know if you want to take that, but that's a key question for us and we're attacking it very aggressively. Rob?

Yes, I think if you were to -- well, let me put it to you this way. The growth in SG&A year-over-year is almost solely attributed to Tech Brands. Obviously, you had some currency impact that worked for us, but x that, Tech Brands is the bulk of that addition. And as we indicated, there are costs that we invested into the openings that impacted the overall Tech Brands number. So I would say that the bulk of those costs are behind us. We would not expect to go into next year with the type of store opening cadence that we talked about. Tony mentioned, 190-plus stores that were opened this year, and so we would not expect to see the same level of investment necessary next year. And of course, with the store base that we now have, as we move forward, whatever investments we do make come on a much larger base.

And just so you know, Seth, one of Rob's primary missions for this budget season is to tighten up our core SG&A, separate from all the new stuff. How do we tighten up the core video games business that we know very well have been at a long time, understand all the different metrics; we've just got to tighten that up a little harder than we have in the past, given the fact that it's a less part of our business than it has been.

To follow-up on Tech Brands, so I mean is there a way to elaborate on the performance on some of the more mature stores? It's kind of hard to see just given all the noise with the investments. If you just simply look at sales per store, it is down year-over-year. I'm not sure that tells the whole story. Anything else you can talk about maybe from a comp perspective or four-wall EBITDA on some of the more mature stores to give investors comfort that you are starting to see a return on some of those more mature stores?

Yes, we watch the Tech Brands' performance in several categories, including the core stores that we acquired, stores that were added as whitespace or conversion stores, by type of store meaning the RadioShack versus other whitespace versus GameStop conversions. We analyze those by year of opening. We analyze each of the acquisitions individually against the pro formas that were created behind them. And other than the store opening cadence being slower than we had anticipated and the conversion cadence, we are very pleased with the base stores. We're very pleased with the whitespace stores that were opened in late '13 and in '14. And we're pleased with the performance of the stores we opened in '15, it's just that they're growing slower than we expected. And we remain very pleased with the performance of the acquisitions that we have made as well. Again, when we acquire a reseller, we can typically increase the productivity by 30%-plus, and that continues as we move forward.

Tony, you may want to share some of the exciting stuff that AT&T is doing, because that's a big part of our growth here, as our DirecTV plan.

Yes, sure. I mean first of all, we are selling all of the hot new products, like you'll get the iPad Pro in all of our Tech Brands stores right now. We got the Apple Watch in all of our Simply Mac stores. And then with AT&T, we're selling DirecTV in all of our Spring Mobile stores as well, which has been an added source of revenue. So all of these programs that AT&T is rolling out and all of the hot new tech that is going to be very popular this holiday season, we're selling that both in our Simply Mac Stores as well as our Spring Mobile stores.

Just one final question, just following-up on Arvind's before. So, Rob, you talked about making up that $5 million shortfall in the fourth quarter. Where do you think you get that back? You also talked about FX being more impactful and a couple of other minor drivers there. I mean, where do you think you can make that up in the fourth quarter?

Well, I think we can see it in inside the video games business with demand through the holiday season. We definitely see it in the Loot category. As you know, with the launch of the Star Wars game and movie, Star Wars collectibles products are pretty hot right now as well as performance within our Tech Brands segment.

Our next question comes from Colin Sebastian with Robert Baird.

I have a couple of questions, mostly as follow-ups, but first maybe to try put a finer points on some of the concerns around console downloads. I wonder, if you could talk about your observations of GameStop customers specifically in terms of their purchase of physical games or maybe attach rate? And then secondly, whether you're actively adjusting trade-in values to keep this group loyal to the physical product? And I have one follow-up.

I think this is something we look at, I mean, almost everyday. Tony, so you want to take that on?

Sure. In terms of attach we still have -- we're seeing strong attach, well outpace; and we're about double the rest of the industry in terms of attach rates of physical games to our consoles and we're seeing at. And when you look at the entire launch, plus we add back our digital attach plus our physical attach, we're roughly in line with previous launches. So there is no doubt that our digital attach is much higher than last time we launched, when we launch 360 in PS3. But combined, we're at similar levels to what we were at this time in the cycle last launch. In terms of trade-in price, no, actually we're finding that we do not need to increase our trade-in pricing. We have been promotional, but it's within our trade price. I think what you're seeing is that consumers are finding those trade prices. We're using PowerUp Rewards in a very powerful way to make sure the people are aware of that. And we've had some very successful promotions that have gotten us flush with in-demand Xbox One and PS4 inventory for the fourth quarter. So we're excited that we were able to do that without increasing trade-in prices.

And Rob, I hate to keep pestering you on this, but just given some of the question we're getting, to put the Q4 guidance into further context. Would you say that it's appropriately conservative, given some of the moving parts that Tony talked about or is there still some risk to those numbers, if Star Wars does not improve?

We expect Star Wars to be one of the strongest titles for the holiday seasons, so sort of move beyond launch and think about Star Wars as a brand with the movie coming out. So we expect it to get back towards our on-track for our expectations. So we think, as we talked about the guidance internally as a team, prior to issuing the release, we think the guidance is appropriate.

Next question comes from Brian Nagel with Oppenheimer.

So my question and I think it's very much going to be a follow-up to some of the prior questions. But with respect to the new software sales, so if we look at the results today and even the trends for a while now at GameStop and step back, I guess one of the concerns out there that weighs upon the sentence with your stock is that, at this point in this product cycle, I guess one would think that software sales would be much more robust and at the time of launch you'll sell a lot better. The question I have, and maybe you could opine just on that thought. But also as we look into the holiday, given your history in the video gaming business, given your history at this point in the cycle, what gives you the confidence that names that, like a follow-up to the prior question, a Star Wars name, that there will be a reacceleration, a further acceleration in sales. Even some of the other titles that have not performed quite as well as one would have thought it from the onset?

I mean, I think in terms of new software sales, we're surprised a little bit by it too. As you know, we expect growth in that category, holiday behaves very differently. And we've got to understand, we've been at this a long time. We know that there are certain things. Tony, maybe you want to?

Sure. And I think when it come to Star Wars, let me reiterate what Rob, said, I think Star Wars wallet got off to a slow start. Given the buzz around the movie, we anticipate that this game is going to be a very strong game, when the movie launches in mid-December. Not to mention the fact that we have it prominently displayed in our Black Friday, and in fact we're the only retailer that has it with significant discount, which is also going to guide sales. So while Star Wars is off to a bit of a slow start, we do think that it is going to rally very strong, as we get to closer to the movie. And I think from a holiday perspective, our Black Friday has been out there. We've got a lot of exclusive content. Loot gives us a whole new way to bring in new customers. So we're excited about the holiday season.

The other thing too is that the install base on hardwares is so much greater than it has been. You've got believe there is going to be people chasing software for that install base. I mean they can't all be streaming Netflix, right. There's got to be some people playing video games on all those consoles. So that gives us a little bit of optimism.

I will point out to that our Black Friday ad leaked before the launch of Star Wars. And given the pricing that we've got in the Black Friday ad, we're really not clear as to what impact that may have had on our results during the launch.

Somewhat of a follow-up to that. You mentioned your Black Friday ad, a lot of the retailers have probably discussed to put out their Black Friday specials. Are you seeing anything in environment this year that would suggest that retailers out in the GameStop may be taking a more aggressive path, aggressive stand towards the video gaming category or even in some cases in pricing?

No. Brian, we're not. I mean there is obviously all this discounting during the holiday that we actually view that our Black Friday ad is one of the most competitive out there this year.

And then, if I could just sneak one more in on a different topic, margins. Some of this you addressed in your prepared comments, but we saw nice margin growth in business driven by, I think it was largely the Tech Brands and newer categories in your stores. Just quickly, how do we think about the sustainability of that going forward?

We think that's -- and that's a product, Brian, of diversification of the business, right. Because remember GameStop historically was a lower margin business. And we've increased, I think I said it in my remarks, we've increased it 400 basis points in three or four years. We think that's very sustainable, because it's contribution of these new categories, which are richer categories. I mean, the real question you should be asking is, can we reel in the SG&A cost in a way that we can bring more of that margin dollar to the bottomline. Is it fair to say, Rob?

Yes. I think that is fair to say. I think it's probably fair to say that within the Tech Brands we are seeing continued margin expansion. And that's as a result of, I'll say, the overlap of the next program. And as it's continued to increase as a percentage of the activity within the store, it is beneficial to margins.

I mean, it's important to do -- the reason we're in these categories, if you go back to our strategic work, the reason we're in these categories is because they are higher margin than video gaming. It would be hard to find categories, by the way, that are lower margin than video gaming by the time you add in the hardware. So Tech Brands, Apple and AT&T as well as Loot are additive to our gross margin. So that's going to create more profitability. Our issue is we've got to control cost on these transition, that's really the biggest part of it. And companies in transformation, we've studied a lot of cases, companies in transformation go through short-term cost pressures like this.

Our next question comes from Curtis Nagle with Bank of America.

So just, I guess, not to pick on gross margin too much. In terms of the Tech brands, I understood, like you said, it's coming from next in a bigger proportion. But is there anything else that's contributing to it? Perhaps help from vendors, like it was just such a big acceleration at least on a rate basis quarter-to-quarter.

Well, I probably should have clarified that if you look at the store counts quarter over quarter over quarter, where the growth is coming from is in the AT&T store base. Cricket and Simply Mac are relatively steady state for us. And so the AT&T store is driving the highest margins. As those grow as a percentage of the Tech Brand category that is also having a dramatic impact.

And then just maybe somewhat of a philosophical question, but just thinking about software, understood what's already been said about digital. Do you think maybe what's going on here is just a transition in terms of franchises, where you have some very big ones plateauing or winding down, the ones that you have coming in just aren't big enough, and could that be a big I guess part of the weakness that we're seeing right now?

Tony, what you think?

What I think is that we have some very strong performance in the franchises that are coming out. What is different is release for this console cycle versus last console cycle is a fact that old-gen or what we call current-gen, now 360 in PS3, are significantly down more than what we had anticipated when we did our original market model. So that's really the change. So it's not that the new games are not producing as much as we anticipated that they were. The difference is that the older generation has eroded more quickly.

And many of these titles are not available on the older generation.

And our final question comes from David Magee with SunTrust.

One question on the back of the last question. Old-gen is sort of winding down, and I think that next year it gets to be a lot smaller as a percent of the overall sector total. And just thinking about that and how hardware has reacted to recent price cuts and so the software attach rates. At this point in time, are you prepared to say that we'll see growth next year net-net in your video game business in 2016?

Hard to say at this point, David. I mean, we're doing a lot of modeling. I don't think we're prepared for saying anything about '16 yet. Guys?

Yes, I think the holiday season is important as a dataset to incorporate into our modeling. And we'll be prepared to talk about that, I think, as spring rolls around.

By the way, David, I will say this, I'll say telecommunications, Loot and Digital will grow very aggressively in '16. I would say that's not going to change. You'll continue to see that. Our business that we're trying to manage is the core video game business, trying to understand it, because it is as you know fairly volatile.

Okay. Well, thank you for your support to GameStop. We appreciate you dialing in today. And we look forward to speaking with you soon. Thanks.