Video game retailer GameStop (NYSE:GME) reported strong figures in its first quarter report of fiscal 2014. The company’s gross margins widened 40 basis points to 31.4%, which was a a first quarter record-high. The highlight of the quarter was the pre-owned and value segment’s margins, which was reported to be 49.5%, driven by improvement in consoles and other accessories. The first quarter witnessed an 81% growth in hardware sales, higher than the market-wide growth of 62%. Software sales declined 20%, slightly higher than the 18% market-wide decline in the U.S. ((GameStop 8-K SEC filing, Q1 May 2014))

The company ended the quarter with 6,680 stores – 4,215 U.S. video game stores, 2,195 international video game stores and 270 technology brands stores. GameStop is positive about its future prospects, as revenues from the digital and technology brands segments are showing stronger growth every quarter. For the second quarter, GameStop forecasts same-store sales growth to be in the 12%-19% range, and revenues to increase between 14% and 22%. Diluted EPS is expected to range from $0.12 to $0.20. ((GameStop Q1 earnings call transcript, May 2014))

In our previous article, we discussed the contribution of the company’s core profitable businesses – pre-owned products & value, and video game hardware & software – to the company’s revenue growth in Q1 and the future plans of the company regarding these segments. ^[1] This article deals with how the company’s more recently introduced businesses – digital and retail PC and technology brands – have contributed to its financial and operational results, and their potential growth. The company is extremely positive about its expansion to these upcoming technology brands, as evidenced by its guidance for these segments. ((GameStop’s Investor Day, April 22, 2014))

Our price estimate for the company’s stock is $47, implying a premium of 35% to the current market price.

See our complete analysis of GameStop

Digital Receipts On The Rise

Digital receipts have become a major source of the company’s revenue, with this quarter’s digital receipts equaling about one-third of physical software sales. Gamers are buying content at the time of launch and using trade credits for the transactions, rather than buying the content online. During Titanfall’s launch, about 20% of GameStop’s digital transactions were made through trade credits, higher than the 17% trade payment rate of physical products. Digital receipts, which along with mobile sales represent over a $1 billion business, grew 9.5% year-over-year. The growth was driven by digital currency and strong PC digital sales internationally.

Digital gross margins were comparable to the prior year quarter and were impacted by the mix of underlying products. Non-GAAP digital margins were comparable to software margins, as the non-GAAP digital receipts totaled $189.7 million. With the growing popularity of the concept and increasing demand for easily accessible digital content, the segment’s margins are expected to grow in the upcoming quarters. Trefis expects margins to rise minimally in 2014, but remain a major driving force over the long term.

Technology Brands : Focus On Growth Potential

GameStop is planning to reduce its core GameStop store count by approximately 2% (120-130 stores) this year and is looking to expand its technology brands business. The company projects capital expenditures of approximately $160 million for 2014; $120 million to $125 million for the video games business and another $35 million to $40 million for the Technology Brands stores and infrastructure. In the technology brand space, Spring Mobile, Simply Mac and Cricket are its main source of revenue growth. During Q1, the segment reported $60.2 million of sales and $6 million of operating profit, representing 6% of total operating profit. ^[2] A total of 52 stores were added (36 acquired and 16 opened) during the first quarter and the company plans to acquire or build 300-400 stores during 2014.

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1. GameStop Q1 earnings: Part 1 [↩]
2. GameStop Q1 earnings call transcript, May 2014 [↩]