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GameStop Continues to Fall Apart

Timothy Green, The Motley Fool

Video game retailer GameStop (NYSE: GME) reported its fourth-quarter results after the market closed on Tuesday. It wasn't pretty. While comparable sales edged up during the quarter thanks to a calendar shift and the timing of Call of Duty, total sales from continuing operations plunged 7.6% year over year.

On top of the sales decline, asset impairment charges and other one-time items totaling $334.5 million led to a gigantic net loss. Excluding those charges, adjusted net income per share declined by 17% to $1.45.

A man in business attire sits at a desk with his hand on his face while looking at a piece of paper.

Image source: Getty Images.

Almost nothing went right

Sales in most of GameStop's segments declined in the fourth quarter. New hardware sales were down 9.8%, new software sales dropped 7.8%, and the highly profitable pre-owned segment suffered a 21.3% sales decline. Both accessories and collectibles sales were up double-digit percentages, but neither category is as profitable as the cash cow used games business.

The decline in the used games business is particularly troubling. That segment carried a gross margin of 42.4% in the fourth quarter, the highest among GameStop's segments other than the small amount of digital revenue the company generates. As console games shift away from physical discs toward digital downloads, the very concept of a used game is at risk of vanishing.

Used and value video game products were responsible for more than one-third of GameStop's gross profit in 2018, so this ongoing contraction is a big problem. Gross profit from the segment declined by 17% in 2018.

GameStop booked $413.4 million worth of goodwill impairments during the fourth quarter, along with $12.9 million of additional intangible asset impairments. This was partially offset by a gain associated with the company's divestiture of its Spring Mobile business. The net result was a GAAP net loss of $188 million for the quarter. For the full year, GameStop wrote off nearly $1 billion of goodwill.

Terrible guidance and cost cuts

GameStop does not expect things to get better this year. The company sees fiscal 2019 comparable store sales declining by 5% to 10%, with total sales declining by the same percentage. The company neglected to give earnings guidance, because of planned cost savings and the recent hiring of a new CEO. But it should be safe to say that adjusted earnings are going to plummet this year.

GameStop plans to improve annualized operating profit by about $100 million as part of its cost savings and profit improvement plan. This won't have much of an effect on fiscal 2019 results because of the timing of the initiatives. Areas of focus include supply chain efficiencies, operations improvements, expense savings, and pricing and promotion optimization. In other words, across-the-board cost cuts are coming.

Scissors cutting a piece of paper with the word costs.

Image source: Getty Images.

The problem with this plan is that GameStop can't cost cut its way out of the mess it finds itself in. We're in the final innings of the era of physical game discs. GameStop as a business doesn't make any sense if most people download games, and that seems to be where the industry is headed. Cost cutting doesn't work if the business is circling the drain. Ask Sears. Or RadioShack. Or Circuit City.

The good news is that GameStop's balance sheet looks fine following the $700 million sale of its Spring Mobile business. The company has $1.6 billion of cash and only about $800 million debt, and it plans to use some of that cash to retire $350 million of its debt this month. This net cash position buys the company time, and it is still profitable on an adjusted basis.

But GameStop's problems will only get worse as game subscription and streaming services proliferate. If you think the used games business is struggling now, wait until even more console gamers abandon physical discs.

It's hard to see much of a path forward for GameStop that doesn't involve a completely different business model.

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Timothy Green has no position in any of the stocks mentioned. The Motley Fool owns shares of GameStop and has the following options: short April 2019 $13 calls on GameStop. The Motley Fool has a disclosure policy.