GameStop (GME 14.04%) is facing some serious challenges to its business right now. The specialty retailer just closed out a second straight year of sharply reduced profits as gamers abandoned the buy-sell-trade model that formed the foundation of its retailing strength.
That's a tough position to be in entering a fiscal year that will be pressured by the end of the latest generation of video game consoles. In fact, the upcoming switchover to new Xbox One and PlayStation devices played a key role in management's forecasting a potential double-digit sales decline in 2019.
CFO Rob Lloyd and his team gave investors context around that prediction in a conference call with analysts, while explaining their reasons for optimism as a new CEO prepares to step into the leadership role in the coming weeks. Below are some highlights from that call.
Surviving through a transitional year
We're pleased to have delivered fiscal 2018 results within our adjusted guidance range, which included fourth quarter and full-year sales growth across video game accessories, collectibles and digital.
GameStop managed its third straight quarter of comparable-store sales growth thanks to robust demand for accessories, collectibles, and digital products. Its new video game hardware sales were steady, too, and new video game software demand only declined slightly, as some major new releases underperformed. These gains offset substantial declines in the core pre-owned video game segment, which shrunk by a painful 17% in the quarter.
Still, the flat sales result for the full year wasn't exactly a win since GameStop's new business is tilted toward lower-margin sales. As pre-owned products fell as a percentage of sales, so did profitability. GameStop's gross margin worsened to 27.9% of sales from 29.1% a year earlier.
No need to panic
Our free cash flow for the year was $232.7 million. From a real estate perspective, our store fleet remains very healthy.
Management was clear-eyed about the fact that major industry trends are working against its core buy-sell-trade business. "We continue to see declines in pre-owned software," Lloyd explained, "reflecting the decline in sales of new physical games and the increasing demand for digitally offered products."
Yet the business is far from collapsing. In fact, nearly all of its stores were cash flow positive in 2018 and GameStop chose to close just 112 units, or about 2% of its global base. Most of these locations are on short-term leases, too, and so the chain has plenty of financial flexibility. This was bolstered by the sale of the Spring Mobile business, which pushed cash on hand up to $1.6 billion from $770 million a year ago. In short, GameStop is in a solid financial position even if its business has no clear path back toward sales growth today.
No tailwinds in the picture
We're working on strategies to improve this [video game] business. But until we see traction, we're planning for the current trends to persist.
The last console transition disrupted GameStop's business in a big way, and that shift occurred at a time when sales were booming and the retailer had a lock on the gaming industry. It's in a far weaker position today, which helps explain why management is taking a conservative outlook to the 2019 business in predicting comps declines of between 5% and 10%.
The hardware business will be pressured as gamers wait for new consoles to come out, and software sales might decline due to weaker title launches. These trends are likely to produce net losses for the first half of the fiscal year, executives said.
Looking further out, investors should learn much more about the direction that incoming CEO George Sherman wants to take the retailer following his April 15 appointment. The existing team has already completed its financial strategic review, leaving Sherman free to focus on more big-picture initiatives. GameStop's last turnaround plan involved diversifying into consumer tech. That pivot failed, but the chain isn't out of the game just yet.