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What GameStop Wants Investors to Know

By Demitri Kalogeropoulos – Dec 4, 2018 at 9:34AM

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Here are a few highlights from the video game retailer's third-quarter earnings report.

There are significant uncertainties swirling around GameStop's (GME 14.04%) business today. The retailer hasn't had a permanent CEO for several quarters, after all, and it isn't expected to hire a new leader until management completes a review that might result in a major strategic pivot or a deal to take the entire company private.

Its recent earnings results didn't clarify whether that sale will happen, but they did answer some important questions investors had about the health of its business at the start of the holiday shopping period. 

Below are a few highlights from the conference call that interim CEO Shane Kim and his executive team had with investors to put the third-quarter report into perspective. 

A good quarter for new games

As you know, we are the market share leader in the video game industry and we have increased our focus on leveraging that position and our many competitive advantages to further grow our market share. We are very proud that the increased focus has paid off.
-- Kim

Two young men playing video games.

Image source: Getty Images.

The third quarter, and October in particular, was a huge selling period for the video game industry thanks to major releases like Red Dead Redemption 2 and Call of Duty: Black Ops 4. GameStop executed well during this time and grabbed market share in the physical video game space, executives said. Launch promotions around these big releases helped drive customer traffic higher, leading to the retailer's first quarter of positive global comps since late 2017. The healthy demand also lifted results in ancillary categories like accessories and collectibles.

The trade-in business is shrinking

We continued to see declines in pre-owned software, [because] of fewer title launches and a decline in physical software sales earlier in 2018 which affect[ed] inventory levels, [as well as] weakening demand ... [due to greater] digital access to older titles and fewer promotions offered to our customers in the quarter.
-- CFO Robert Lloyd

GameStop is finding it hard to adjust its business model to the new realities of a digital-focused video game industry. Pre-owned software sales fell 13% due to the combination of several negative factors including lower inventory. That represents a worsening from the prior quarter's 10% drop. 

This slump forced the retailer to rely more on the sale of new hardware and new software, but these categories deliver much lower profit margins. As a result, overall gross profitability fell to 33.1% of sales from 34.7% a year earlier. "We continue to face challenges in our traditional physical video game retail business model," Kim said.

A promotion-heavy quarter ahead

We drove strong sales performance over Black Friday weekend and Cyber Monday. However, the overall sales and margin performance are not as strong as we had expected and we are reducing our full-year outlook given our expectation that fourth-quarter sales will skew more toward hardware than initially planned, given what we saw in November.
-- Lloyd

Thanks to a condensed video game release calendar, GameStop's business is so heavily dependent on the holiday shopping season that even small demand shifts during the period can produce big swings in its 2018 outlook. That's what happened in late November, when management noticed that several of its software titles, and a few sales promotions, were underperforming expectations. 

This led to a downward revision to its earnings outlook so that profits should now land between $2.55 and $2.75 per share rather than the prior range of $3.00 to $3.35 per share. That result would still easily cover its generous dividend payment, but it translates into significant profitability struggles despite GameStop's strong hold on the physical video game retailing niche.

Demitrios Kalogeropoulos owns shares of GameStop. The Motley Fool owns shares of GameStop and has the following options: short January 2019 $16 calls on GameStop. The Motley Fool has a disclosure policy.

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