GameStop (GME 2.93%) recently posted surprisingly weak third-quarter earnings results. Sales and profit were both below guidance, which management explained by pointing to one major video game release that was pushed into the fourth quarter. Investors punished the stock anyway, sending it down 13% on the day. Shares are now 24% lower than where they started the year.
After the earnings announcement, CEO J. Paul Raines and other executives held a conference call with financial analysts to provide context on the results. Here are five key points that management made on the call (all quotes are courtesy of Seeking Alpha).
Third-quarter guidance was basically right
The shift of Assassin's Creed by a week affected our quarter by $0.05 per share. And the overlap of Grand Theft Auto presented a large comp impact. GameStop's two-year comp for the third quarter is 18%, among the highest in retail.
--CEO J. Paul Raines
Three months ago, GameStop provided guidance for the third quarter that called for comparable store sales to grow by between 1% and 5%, and for earnings per share of roughly $0.61. Instead, the company posted a 2% comps decline and EPS of just $0.57. Management explained that nearly all of the shortfall can be explained by Assassin's Creed's shifted release date, which cut $0.05 out of per share earnings and two percentage points off of comps. Of course, that doesn't explain the downbeat guidance for the fourth quarter -- but more on that later.
Digital sales are an opportunity, not just a threat
Our 52% [digital] growth is higher than the growth reported in the most recent quarter by our four largest publishing partners. Year-to-date, our digital growth is also higher than this group. Our console digital growth alone is 72% as we continue to play a vital role in the discovery and affordability of digital content.
--President Tony Bartel
GameStop dominates the physical market for video game sales in both hardware and software. That success also extends into the digital segment that stock bears claim will eventually kill the business. Third quarter results, however, don't show that negative thesis playing out at the moment: GameStop booked $210 million of third-quarter digital sales, up 52% over the prior year. GameStop is even performing well by this metric on popular next-gen titles like Destiny, which delivered a high volume of digital sales for the retailer.
Diversification is progressing well
We are very pleased with how these new businesses have added to our revenues and profit in the year since we acquired them.
--Chief Financial Officer Robert Lloyd
"Technology brands" is the name that GameStop gives to its fledgling businesses that aren't tied directly to the video game market. Right now, that category is mostly made up of the buying, selling, and trading of consumer electronics along with wireless service revenue through the retailer's ownership of Spring Mobile, Cricket, and Simply Mac stores. In total, these businesses contributed 11% of third-quarter profit and helped boost gross margin higher to nearly 30% of sales. Management is expecting further strong growth from this segment next year thanks to a growing relationship with AT&T and a new cycle of popular Apple products in the pipeline.
Holiday quarter downgrade
The decline in prior-gen software sales due to the transition to next-gen console has been steeper than expected and titles that moved out of 2014 will both have an impact on our results this year.
--Chief Financial Officer Robert Lloyd
The fact that it came with a lowered outlook for the holiday quarter was the biggest surprise in GameStop's earnings announcement. After all, this period now includes a boost from the Assassin's Creed title that management had blamed for the third-quarter weakness.
According to executives, though, sales and profit growth will be weaker this quarter mostly because gamers are abandoning the Xbox 360 and PlayStation 3 consoles at a faster rate than expected. That dynamic is a long-term positive for GameStop's business, as it points to a larger installed base of next-gen consoles and a bigger market for used games in the future. But the short-term hit should last until early next year, management said.
The stock might be cheap
We have been more aggressive this year in terms of making sure that our buyback plan takes advantage of when the [stock] price moves down and I don't see any reason why that would change in the fourth quarter.
--Chief Financial Officer Robert Lloyd
GameStop allocated $144 million in the third quarter to stock buybacks, which is more than it has spent in any quarter since the repurchase program began in 2011. In fact, CEO Raines plainly stated in the call that management believes "shares are undervalued."
At 11 times trailing earnings and a price/sales ratio of 0.5, shares are near the cheapest valuation that they've seen all year. Executives hinted that they have room to tap into debt markets to accelerate their repurchasing plans. And last week's 13% drop could be just the opportunity they've been looking for.
