GameStop (NYSE:GME) reported third-quarter earnings after the market closed on Tuesday, delivering results that were disappointing across the board. The retailer's revenue fell 24.7% on a constant-currency basis, comparable-store sales were down 23.2%, and top- and bottom-line results came in significantly below the market's expectations.

The company posted an adjusted loss of $0.49 per share on sales of $1.44 billion, missing the average analyst target for a per-share loss of $0.11 on sales of $1.62 billion. GameStop also slashed its full-year earnings target, and the stock fell by double-digit percentages in after-hours trading.

Read on for a closer look at the company's troubled quarter and some key quotes from its earnings release and conference call. 

A person wearing headphones and looking at a monitor.

Image source: Getty Images.

1. Steep declines in hardware sales point to a tough year ahead

Despite relatively strong momentum for Nintendo's Switch console and the launch of the new Switch Lite model, GameStop's new-hardware sales plummeted in the third quarter due to big declines for Sony's (NYSE:SNE) PlayStation 4 and Microsoft's (NASDAQ:MSFT) Xbox One. Sales of new video game hardware totaled $189 million in the quarter, down 45.8% year over year.

Here's CEO George Sherman discussing the company's hardware performance and industry trends: "Our third-quarter results continue to reflect the prevailing industry trends, most notably the unprecedented decline in new hardware sales seen across the market as the current generation of gaming consoles reach the end of their life cycle and consumers delay their spending in anticipation of new hardware releases. With console makers set to introduce new and innovative gaming consoles late next year, we anticipate this trend to continue until the fourth quarter of 2020." 

New video game hardware is a low-profit category for GameStop, contributing just $21.3 million of the $441.1 million total gross profit in the third quarter. But console sales tend to correspond with performance for the more-profitable software and accessories segments and are an important indicator for the business. 

2. Collectibles growth decelerates, and all other segments decline

Sales of new hardware suffered the biggest drop-off, but the company saw steep declines almost across the board (with collectibles being the only segment that didn't recede in the quarter). The table below breaks down GameStop's performance for segments other than new hardware across comparable 13-week periods from 2019 and 2018.

Segment Q3 2019 Revenue Q3 2018 Revenue Change (Decline)
New video game software $485.9 million $720.7 million (32.6%)
Pre-owned and value video game products $344.2 million $396.9 million (13.3%)
Video game accessories $156.5 million $180.8 million (13.4%)
Digital $37 million $45.4 million (18.5%)
Collectibles $161.2 million $154.6 million 4.3%
Other $64.7 million $88 million (26.5%)

Source: GameStop.

Even results in the collectibles segment (which includes video-game and pop-culture merchandise like Funko figures and branded clothing) were disappointing. The collectibles segment has been one of the few bright spots at the company over the last couple of years, but it looks like it's starting to slow down as well. Collectibles sales looked a bit better on a currency-adjusted basis, growing 6.1% year over year, but the segment grew 11.7% year over year in the third quarter of 2018 and 26.5% in Q3 2017.

GameStop expects that it can improve profitability for collectibles, but the segment's gross margin actually fell to 33.6% from 37.4% in the prior-year quarter. Sherman explained the decline: "We saw the need to work through some inventory that was not as productive as what's being brought in from a collectible standpoint. So it is the lone category that actually had margin rate go down, and that was a very conscious effort on our part to move through some inventory."

3. An earnings target cut and a challenging business outlook

GameStop had previously guided for adjusted earnings per share to come in between $1.15 and $1.30 for the year, but it cut that target to a range of $0.10 to $0.20. In addition to expectations for soft hardware sales leading up to Q4 2020, the company expects a relatively light software release slate will result in weaker business performance. CFO James Bell discussed the near-term outlook in the third-quarter call:

In light of those trends, we now anticipate consolidated comparable same-store sales for fiscal 2019 to decline in the high teens. As we continue our evaluation of underperforming aspects of our business, we are on track to have between 230 and 250 less stores on a global basis, net of new openings, by the end of fiscal 2019. The closure rate of underperforming stores is very consistent with the last several years and supports our continued efforts to de-densify our fleet to optimize profit production in select markets and trade areas. Approximately 140 of these underperforming stores closed already earlier in the year.

Digital downloads continue to eat into the business, and it doesn't look like the company has an answer to this problem. Its most profitable business has long been sales of pre-owned games. In the good years, GameStop could encourage customers to trade in used games in exchange for new titles, and then resell the used games, creating a very profitable customer engagement loop.

That's going away with the growth of digital distribution. Gross profit for the company's pre-owned and value video game products came in at $147.1 million in the quarter, down roughly 14% year over year, and used-game sales may not get the boost that the company is hoping for with new consoles. Rumors suggest that Microsoft will ship a version of its next-generation system that doesn't have a disc drive, meaning owners of that hypothetical system wouldn't be buying new or used games at GameStop or getting titles by participating in the retailer's trade-in program.

GameStop is banking on new consoles from Sony and Microsoft to re-energize its business late next year, and the new systems will almost certainly be a substantial positive catalyst. With the company valued at less than a tenth of this year's expected sales, the stock might appear cheap by some metrics, but the long-term outlook is dim. Digital distribution will continue to gain ground, and the possibility of disc-less consoles arriving at an earlier stage in the product cycle is troubling.