GameStop Corp. (NYSE:GME) Q1 2019 Results Conference Call June 4, 2019 5:00 PM ET
George Sherman - Chief Executive Officer
Rob Lloyd - COO and CFO
Conference Call Participants
Ray Stochel - Consumer Edge Research
Joseph Feldman - Telsey Advisory Group
Seth Sigman - Credit Suisse
Anthony Chukumba - Loop Capital Markets
Curtis Nagle - Bank of America Merrill Lynch
Thank you. And welcome to GameStop's First Quarter Fiscal 2019 Earnings Conference Call. This conference call will include forward-looking statements, which are subject to various risks and uncertainties that could cause actual results to differ materially from expectations.
Any such statements should be considered in conjunction with the cautionary statements and safe harbor statement in the earnings release and risk factors discussed in reports filed with the SEC. GameStop assumes no obligation to update any of these forward-looking statements or information. A reconciliation and other information regarding non-GAAP financial measures discussed on the call can be found in the Company's earnings release issued earlier today, as well as in the Investor section of the Company's website.
Now, I would now like to turn the call over to the Company's Chief Executive Officer, George Sherman.
Thank you. Good afternoon everyone, and thank you for joining us today on our first quarter earnings call. Joining me on today’s call is Rob Lloyd, outgoing COO and CFO who will give an overview of our first quarter results following my comments. It’s great to be with you today my first earnings call since joining GameStop in April.
As we get started, I want to thank the board for the opportunity to be here at GameStop. I appreciate the confidence they have shown in me and recognize the significance of the opportunity in front of us. I’m excited by it and extremely passionate about tackling the challenges facing us as we position GameStop to evolve for the future and protect and expand our leadership position in the video game space.
As I've been digging into our business, it’s clear to me that we need to transform to remain a viable player in our industry, which is currently undergoing meaningful technological change. And while the industry grows and attracts new customers, our recent performance shows me that we have work to do to evolve and transform. We owe it to our team to develop a better strategy and a better product for our customer.
We have hard work in front of us but we're up to the challenge, and I know the team and our great associates across the organization want to win. The challenge is a significant one. We must immediately address SG&A that’s been allowed to deleverage, execute on opportunities to optimize the current business, and develop new revenue streams for our future. Doing so will require immediate action on our part and an ongoing sense of urgency that is off the charts.
To that end, we have taken the following actions. As you saw late last week, we solidified our go-forward leadership team. We've established a transformation office and a framework for execution. We've shown a commitment to focusing on the core elements of our business that are meaningful to our future and divesting of those that aren’t, and demonstrated that we'll have a disciplined approach to capital allocation.
I'd first like to start today by going a little deeper on each of those actions; first, putting our go-forward leadership team in place. Jim Bell joined us yesterday as our new Executive Vice President and Chief Financial Officer. And with that appointment, we announced that Rob Lloyd will be departing the Company after nearly 23 years with GameStop. Most recently, Jim served as CFO and Interim-CEO of Wok Holdings, the parent company of P.F. Chang's Pei Wei and True Food Kitchen restaurants, and led their overall strategic plan and omni-channel digital transformation.
Previously, he served as CFO and Interim CEO at Coldwater Creek, CFO of Red Lion Hotels, and held senior finance roles with Harry & David and the Gap. We also announced the hiring of Chris Homeister as our Executive Vice President and Chief Merchandising Officer effective June 10th. Chris is not only a retail industry veteran but has experience specifically in gaming. Chris served as CEO of the tile company and previously spent over seven years at Best Buy, including roles as Senior Vice President of Digital Merchandising and Senior Vice President of Entertainment, leading the gaming business.
Finally, effective yesterday, we appointed Frank Hamlin to Executive Vice President and Chief Customer Officer. Frank, who previously served as our Senior Vice President and Chief Marketing Officer will be responsible for strategy, marketing, data analytics, loyalty platforms, and new growth concepts. Frank's an internal force for changing our business model, and I'm thrilled to elevate both his role and responsibilities.
Along with Dan Kaufman, who transitioned out of his prior role to focus his efforts full time on leading our transformation office, this rounds-out our leadership table that will guide GameStop through significant change over the next several years. I'm thrilled to welcome Jim and Chris to GameStop and congratulate Frank and Dan on their new roles. I couldn't be happier with our ability to attract leaders of this caliber who are committed to positioning GameStop for the future.
Second, our multiyear transformation process is underway. As I mentioned, Dan Kaufman, formerly our Executive Vice President, Chief Legal and Administrative Officer, will lead the program office along with other key leaders from the business solely focused on this initiative. This will be a multi-work stream effort addressing cost and efficiency, business optimization, and new revenue streams. To aid us in our thinking and speed of execution, we've engaged a tier-one consulting group that is now fully deployed within GameStop. However, the GameStop organization will own and drive the process.
As part of the transformation and as you heard in April, the team introduced an operating profit improvement initiative. Shortly after my arrival, I began to form a team of key leaders to launch what we now refer to as GameStop reboot. This is a holistic and extensive review of all aspects of our business and how we can transform it. This is going to be a critical piece of our transformation. It is not simply a cost-cutting initiative though there will be an element of that to the overall process.
I expect this process to drive margin improvement, including some better sourcing, pricing and promotion, and leveraging our scale. The goal is to focus on our business today, while we develop the businesses that will drive tomorrow. Over the next several quarters, this is my top priority, and I intend to be transparent about our progress with all of our stakeholders, including the investment community.
I already know there are areas of the business that we can execute better, and I'm confident that this process will help us improve our organization. The importance of this program cannot be overstated, and it's safe to say the aspirations for GameStop reboot go well beyond our previously announced $100 million operation profit improvement goal. However, we cannot simply optimize our way back to growth. Rather, we must transform our business.
Throughout our transformation process, we'll be deliberate and act with urgency. We’ll seek efficiencies in our operations to improve our performance in the near term, while we identify, test, and implement these initiatives that will help shape our strategy for the future. Simply stated, I am committed to addressing the foundational areas of our business that present immediate opportunities and quickly. I’ve a few thoughts on where we see opportunities in the business.
Our stores, I believe we can leverage and improve the store experience. Conceptually speaking, we know that 20% of our SKUs drive 80% of our business. Space allocation, therefore, is a near term opportunity. We need to de-clutter our stores and focus on the key SKUs that are driving our business. We also need to ensure that we have the proper inventory levels and merchandising behind those SKUs.
Collectibles are a natural extension, and we’ll continue to get better at that piece of the business through inventory optimization and expand the assortment of exclusive products that our customers desire.
We are testing several initiatives focused on experiential elements in our stores that we believe will drive growth in the long term. These tests are designed to focus on several elements, including gaming, new and pre-owned, collectibles, immersive and interactive experiences, and pop culture. We are committed to testing, learning, and implementing our transformation quickly through our think big, start small, scale quickly, all of the disciplined approach to measuring results and ROI. In the coming quarters, we’re share more about this initiative in how we believe we can improve our operating model.
Merchandising opportunities, I've told our team that we don’t have a real estate problem. We have a merchandise allocation opportunity that we need to address in a big way. This can be done with existing resources of very minimal investment, and we'll go a long way improving the customer experience.
Here's what that entails. Focus on driving accessories, software, and hardware, even as we come to what appears to be the end of the current console cycle. Focus on pricing and promotion optimization as part of our larger profit improvement initiative. We need a cohesive pricing strategy that clearly communicates value to our customers across pre-owned and new products, while playing within the parameters of our vendors and reflecting the value of their innovative products.
Coming back to the immediate actions we have taken to address the business. Third, we've shown the commitment to being laser-focused on the core elements of our business that are important to our future, while divesting of the things that are not. As you've seen, we’re in the process of divesting of our Simply Mac business, and anticipate the sales closing late second quarter or early third quarter. This marks the completion of our technology brands divesture.
We’re also announcing today we were continuing to reorganize our ThinkGeek business. We're further streamline that business by transitioning the thinkgeek.com platform within our GameStop omni-channel experience. We've very successful collectibles business and need to harness the power of the team and the investment made in that team going forward.
Fourth, we'll have a disciplined approach to capital allocation. We announced earlier today that our board has eliminated our quarterly dividend. The board did not take this decision lightly, and we remain committed to return capital to shareholders when it's prudent. That said, in the near term we are confident that redirecting capital towards debt reduction and reserving capital for successful transformation initiatives will put us in a better position to drive increased shareholder value over the long term.
Our cash position remains strong as is our ability to drive cash well. Along with our recent $350 million debt reduction, this redeployment of capital will further increase our financial flexibility and expand our options. As we've outlined today, the initiatives and opportunities in front of us are compelling, and we want to give our team maximum flexibility as we execute on this.
These efforts are centered around transformation of our core business, not acquisitions or further diversification outside the video game business. Rest assured, I'm committed to being a good steward of your capital going forward, and returning capital to shareholders remains a top priority.
I'm clear right about the depth of the challenge in front of us. We have work to do. But I believe we have significant assets that we can leverage. And we're strong at GameStop in part because of the industry. We operate in a strong, exciting and dynamic space. Participants in video gaming are growing in numbers and come from a wide range of demographics. They’re passionate about their games, franchises and competing and winning.
Against this backdrop and combined with our impressive customer base, GameStop occupies a sweet spot. Importantly, I believe that we can parlay all the attributes that make us an industry leader today to become the leader of tomorrow and beyond. I believe our store experience, specifically the customer service offered by our store team, is unparalleled. It will be a tremendous asset as we transform our business.
Our associates are extremely knowledgeable and the resiliency and passion are second to none. I've conducted numerous store visits and witnessed store associates interact on the first name basis with the regular customers. It's obvious to me that their dedication to providing customers with outstanding service and knowledge is fueled by their own love and passion for all things video games.
It's paramount that we continue to provide our associates with all the right tools to keep delivering this excellent customer experience. We have an expansive footprint that provides us with significant access to our customers. And even with its scale, we have flexibility with the lease obligations with an average remaining lease life of two years. I also believe that our PowerUp Rewards program was roughly 60 million members is a huge asset that we can leverage going forward.
Knowing our loyal customers well, anticipating their needs and meeting them what they want to do business, regardless of the format or platform will be a major point of focus going forward. For example, we understand that digital will continue to be a significant part of the video game industry. GameStop needs to be there and I'm committed to ensuring that we will be.
We’re evaluating new revenue streams and how we can and should participate in the digital economy, particularly given the significant number of loyal customers we bring the publishers and console makers. This will take time, but is a necessity to enable us to continue maintaining our position as the leader in the video game space.
Another example of meeting customers where they are is our participation in eSports through partnerships with Infinite eSports and Entertainment, Envy Gaming and several others. Our recent partnership with Complexity Gaming and the opening of the GameStop performance center in Frisco, Texas, at the home of the Dallas Cowboys, will enable us to better support our customers around the world and help them be the best gamers they can be. These are just two of the many large-able assets that we can deploy as we seek to transform the business for the future.
As we transform, we will think big, start small, move quickly and responsibly. While we re-imagine the future of GameStop, our mission in the immediate term is to optimize the current business, so that we can fuel long-term growth. A bifocal approach to run the business means focusing on the existing physical video game and collectibles business as we also develop growth opportunities and new revenue streams that will evolve our business model.
In closing, I'm very excited to be at GameStop. It's a pivotal time for the company and energized by the many opportunities I see before us even in my short time here. We have a tremendous chance to shape the future of GameStop in this evolving and dynamic industry. The changes that have occurred in these first 45 days are important steps in our transformation, but also indicative of the pace of play that I expect from the team that our board expects of me and more broadly with our shareholder base should expect of us.
I'm committed to being transparent as we transform the business, and we'll update you every step along the way. On our next earnings call in September, we will be able to provide additional details on what we're testing and the progress that we've made in our transformation.
I'd now like to turn the call over to Rob Lloyd for recap of the quarter. Thank you.
Thanks, George. Good afternoon, everyone. Before I discuss the first quarter results, I'd like to take a moment to welcome George to the GameStop team. After an extensive search, the entire team is glad to have George on board and leading our transformation as we tackle the challenges ahead.
The team is aligned around doing everything needed to protect and preserve our leadership position in the video game industry, while simultaneously setting the strategic vision for the GameStop of the future. This is a very exciting and pivotal time for the company. The team recognizes the amount of work that is required as we embark on our transformation.
As George previewed, we have a number of initiatives in place that we're beginning to test to determine their viability for the future, initiatives that we believe can help drive growth and improve our performance over the long-term.
One of the initiatives we introduced to you in April, and George just elaborated on, are profit improvement initiative now known as GameStop Reboot is well underway. This is an organization-wide initiative designed to improve our operations for the future and deliver increased efficiency. Since embarking on the plan, our associates and outside partners have made steady progress in identifying opportunities to increase operational efficiencies and reduce costs where possible.
Moving on to our results for the first quarter. Total company sales decreased 13.3% with comp sales down 10.3%. In the U.S., comp store sales decreased 10.2%, while international comps decreased 10.4%. Coming into the year, we anticipated a challenging top line comparison given that we're nearing the end of the current console cycle, comping a stronger title slate released in 2018 and ongoing under performance in our pre-owned video game category.
All three of these expectations came to fruition in the first quarter with hardware sales down 35%, software sales down 4.3% and our pre-owned business declining 20.3%. Despite the challenging sales trends we observed in the quarter, we were pleased to deliver earnings of $0.07 per diluted share, which were much better than our original expectations of breakeven to a loss of $0.05 per diluted share.
The primary driver behind delivering better than expected earnings is due to expense management in the face of the sales decline. Our new video game hardware business decreased 35% for the quarter. An increase in switch console sales was more than offset by declining overall hardware sales across the remaining platforms. Again, this decline in hardware sales is largely a function of being at tail-end of the console cycle as evidenced by the double digit industry declines in the categories for the fiscal quarter.
While the decrease in hardware is significant, it is very similar to the declines reported in early 2013. The last time we experienced a console transition period when Sony and Microsoft announced new generation consoles. We’re in the late stages of the current generation PS4 and Xbox One cycle, and are awaiting official launch date announcements from Sony and Microsoft.
Given the anticipation for innovative new technology in the pipeline, we expect the current trends to persist with customers delaying potential console purchases until new releases are launched. New software sales decreased 4.3% for the quarter, given weaker new title launches this year and comping the strong data war launched last year and increasing a digital adoption. While overall software sales declined, we drove increased market share as demand from Mortal Kombat 11 and Days Gone outpaced the overall industry.
Additionally, we saw a share increase in the quarter for both PlayStation 4 and Xbox 1 software platforms. Our pre-owned business decreased 20.3% for the quarter. We continue to see declines in pre-owned software, reflecting the software demand for new physical games and the increasing popularity of the various digitally offered products.
While we did experienced significant growth in pre-owned switch hardware and software, our overall pre-owned hardware and software segment sales decreased during the third quarter. Accessory sales increased 0.6% for the quarter with continued strong growth in controllers. While headsets continue to comprise a significant part of the accessories business, their 80% growth in 2018 in Q1 driven by the Battle Royale genre created a difficult comparison for the first quarter of 2019.
Digital receipts decreased 6.7% for the quarter, primarily driven by a decrease in full game download and other downloadable content given the weaker new titles this year, and the strength of DLC associated with the digitally sold PlayerUnknown Battleground and season pass for Far Cry 5 last year.
Our collectibles business delivered strong results to support our belief that it will continue to be an important part of our business going forward. Sales increased 10.5% for the quarter. However, excluding thinkgeek.com, category sales growth for the collectibles would have increased 16% in the quarter. Thinkgeek.com has been streamlined to leverage our GameStop omni-channel platform and the team. Gross margins for the collectibles business increased 50% basis points to 32.7%.
Shifting gears to overall gross margins. Our gross margins increased 70 basis points to 30.4% as our overall sales mix shifted incrementally away from hardware, a low margin category, towards higher margin categories of software collectibles and digital. Hardware and software gross margin rates decreased for both the new and pre-owned segments. However, this was more than offset by games across accessories, digital and collectibles.
Moving on to SG&A. For the quarter, SG&A was $430.6 million compared to $456.1 million a year ago, a 5.6% decrease compared to the prior year quarter. The reduced costs were primarily driven by improved expense management, including lower compensation expense compared to last year’s first quarter, which included severance charges related to executive management changes. While we were able to flex down variable costs in the face of though sales, deleveraging SG&A shows there’s more work to be done on our cost structure, as George referenced earlier.
From an operation earnings perspective, we reported operating earnings from continuing operations of $17.5 million in the quarter. This compares to $46.5 million in the prior year quarter. Our effective tax rate was 23% for the quarter.
Moving to our bottom line. First quarter reported net income was $6.8 million and included a loss of $0.7 million from discontinued operations related to the prior sale of Spring Mobile and income from continuing operations of $7.5 million. This compares to the prior quarter net income of $28.2 million, including $7.8 million from discontinued operations and $20.4 million from continuing operations.
From a real estate perspective, our store fleet remains very healthy. As George mentioned, our current average remaining lease life for our video game stores is approximately two years, which gives us tremendous flexibility to manage our footprint. We ended the quarter with 3,777 video game stores in the U.S. and 1,912 internationally, and with 41 domestic collectible stores and 60 international collectible stores.
Moving to the balance sheet, we ended the quarter with $543.2 million in cash, down from the $1.6 billion reported at the end of fiscal 2018. This reflects our typical first quarter working capital needs, the $350 million retirements of our 2019 unsecured notes and $40 million in dividends paid and launch. We also implemented the new lease accounting standards during the quarter, resulting in a right of use asset of $807 million with an offsetting current and long term liability.
From a capital allocation perspective, the board has elected to discontinue the quarterly dividends effective immediately. As George said, we can focus on strengthening the balance sheet and investing in the business to explore new concepts and revenue streams. We do not foresee any acquisitions in the near term. Specifically, as it relates to the additional debt reductions, we've made incremental progress toward paying down our outstanding 2021 unsecured notes.
Since the beginning of the first quarter, we've paid down approximately $39 million towards this obligation. The current balance now stands at $436 million. However, that will not appear on the balance sheet for the first quarter since much of this pay-down activity occurred after the quarter ended.
As of today, we're not announcing any share repurchases and we'll revisit the question once we have clarity on the capital requirements of our long-term strategy and input on our broader approach to capital allocation from our incoming CFO. We have $300 million remaining on the current authorization.
Shifting to our outlook for fiscal 2019. For 2019 CapEx, we expect to remain in the $100 million to $110 million range as we test new concepts and contemplate investments in the business. With our GameStop reboot program underway, we're assessing the level of benefits to operating profit in fiscal 2019 and expect the impact much more beneficial to fiscal 2020 and subsequent years.
As a reminder, we're not providing specific EPS guidance given the leadership changes and the various initiatives being considered for fiscal '19. However, we are providing the following context around various parts of the business that will impact our 2019 results.
With respect to new hardware, as we get closer to the end of the current console cycle for Xbox and PlayStation. We expect demand to continue to decline as some customers choose to wait on the sidelines in anticipation of acquiring the next generation of consoles, which was reflected in our first quarter results.
For new software, we have a tough comp given the stronger title lineup in 2018. In our pre-owned business, we expect recent trends to continue from 2018 and first quarter 2019, given our outlook for both new hardware and software. We are working on strategies to improve this business. But until we see traction, we're planning for the current trends to persist.
In our collectibles business, we expect to continue to build on the strong foundation we've established and see that business growing double digits in 2019 as we continue to refine our product offerings and digital merchandising.
Looking beyond Q1, we note that Q2 2018 adjusted income from continuing operations, again, excluding Spring Mobile, was a loss of $0.10 per diluted share. We anticipate that the profits generated in fiscal 2019 will be heavily back half and Q4 weighted, consistent with the historical seasonality of our business. We are reiterating our full year and comparable store sales guidance, calculated using sales from continuing operations to both decline in the range of down 5% to down 10%.
With that, I'd like to hand the call over to George before we have the operator open the call for your questions.
Thank you, Rob. Given this is your last earnings call at GameStop, I wanted to take time today to thank you for all that you've done for the company of your 23 year career. You oversaw the successful integration and very often led the post-merger integration of several key acquisitions and the roll-up of the U.S. video game market.
You've been a steady hand to the investment community, as well as all the thousands of GameStop associates over the years, particularly over the last two years with the significant changes the organization has experienced. I thank you for helping getting me up to speed in the business, and I wish you well in your next chapter. You'll be missed but know that we appreciate your hard work and dedication over the years. Thank you.
Thank you, George.
With that, operator, I like to open up the call for questions.
Thank you [Operator Instructions]. And we’ll our first question today from Stephanie Wissink with Jefferies.
This is Ashley on for Steph Wissink. Thanks for taking our question. So the collectibles business looks it accelerated sequentially with higher gross margins. Can you talk a little bit about the key drivers and key brands there?
Could you repeat the question please?
So, regarding the collectibles business, it looks like you've accelerated and had higher gross margins. Can you talk about the key drivers and key brands?
Yes, sure. We can talk about that. I think if you look at our collectibles business, we have couple of strong categories. POPS is certainly one of them. So, collectible figurines are in high demand and gets regular traffic into the stores looking for new releases. In addition, our T-shirt business remains quite strong as do the statues within collectibles.
Next we'll hear from Ray Stochel with Consumer Edge Research.
First, thank you so much to Rob for all the help over the years. And thanks to everyone for taking my question today. One starting off would be can you discuss any recent changes to your loyalty program? We've seen some tests in the market around that. And then how do you think longer term about marketing the pre-owned value proposition? And when do we think that we can see some changes to the pre-owned value proposition over the upcoming months and years? Thanks.
I think you're probably referring to a couple pilots that we have in place with PowerUp Rewards. We are looking to provide more of a continuous flow of coupons as part of the PowerUp Rewards program. So, in addition to -- whereas the past benefit was generally centered around pre-owned games, this one gives you actual money to spend in stores on a monthly basis, and it makes a really simple return on investment where you get $60 worth of coupons. So that's in test. It is not something that we’ve rolled, it’s something that we're piloting right now liking the initial results on that one.
On part two, on pre-owned gaming, I think as we look at the pre-owned gaming business and we consider the results of it and we're disappointed with the results a bit. Immediately, the topic of pricing comes to mind, and I'd say just really being clear and compelling on what the value proposition is of pre-owned games relative to new games and ensuring that there is some level of guaranteed value to the customer.
We'll now hear from Colin Sebastian with Robert W. Baird.
It’s actually Ben on for Colin. Two questions, if I could. First on the dividend, could you walk through, I guess the rationale to eliminate it here for the time being, given that there doesn't appear to be any debt coming due until early 2021. Was that reflective of any changes in the free cash flow outlook in the near term or just more clarity around there I guess? And then on the pre-owned business, given the ongoing declines there, are there any tweaks to the loyalty program that you're making that maybe reaccelerate growth or just anymore clarity on expectations for re-acceleration there anytime soon?
Yes, let me start off with the dividend and Rob can join in as well. So, I think that decision was made to, first of all, shore up the balance sheet. So we are addressing what debt we have. I think related to that, and as we mentioned, it is just giving us flexibility for our transformation as we identify new growth channels that we have the ability and the flexibility to invest in them.
I think that's fair. And I'd add that we no longer see the dividend as an effective way to return capital to shareholders. So I think what we look at in the future what Jim will weigh in on with George and the Board as they assess the capital allocation program that will give them an opportunity to redesign that in a way they think is more appropriate. With respect to the pre-owned side of things and you asked about the loyalty program, this is what George was talking about with respect to testing some new pro-benefits that will provide, we think, greater value to the consumer, and a more immediate recognition of the ROI .
We think PowerUp Rewards is a really special capability in-house, 60 million members nearly and just the notion of innovation in testing is one that we’re going to embrace. So while the team is currently working on a pilot for new value proposition, we’ll always do those sorts of things to make sure we are getting the gain the best return on our PowerUp that we can, and it also says, just embracing the data that comes along with PowerUp Rewards.
Joseph Feldman with Telsey Advisory Group has our next question.
I wanted to ask, when you talked about reorganizing ThinkGeek and trying to reorganize or re-platform the website, can you talk a little more what you’re doing on the ThinkGeek side, just a little more clarity there?
Sure. I think you can think of it as inefficiency play as well as leveraging the assets that we’ve built with the collectibles team. We currently have redundant teams and redundant web properties. So, there is the separate thinkgeek.com platform, as well as all the GameStop omni-channel capabilities. What we’ll do with ThinkGeek is produce a redirect, so we’ll be leveraging off the GameStop platform to still have a presence for ThinkGeek and still have that brand at least initially, while we consolidate the backend operations. There's redundancy between collectibles and ThinkGeek that we can run more efficiently.
And then just a follow-up, regarding the debt level, because you guys did comment that with that incremental $160 or so million in cash that you have for the dividend, not paying the dividend that is. Is there a target debt level that you guys would like to be at, again recognizing that you have a little time before it's due, but is there a target in mind that you're trying to get to?
Yes, I wouldn't say there's a hard target in mind. I think recognizing that we have the 2021, they're at a favorable interest rate. We have the cash flow to be able to bring that down to perhaps not as a hard target but to get the debt to EBITDA level a little closer to one to one, and then give Jim and George and team an opportunity to evaluate that line of the entire capital structure and capital allocation policy.
Next, we'll hear from Seth Sigman with Credit Suisse.
I just want to follow up on a couple points, first on the pre-owned business. Just to clarify here. I guess, George, what is your view of the challenges facing that business today? You mentioned value proposition. I wasn't sure if that meant more marketing and communication? Or do you actually think there's an issue with the value proposition? And ultimately, do you think that margins in that business in that category need to be reset?
Yes, thanks Seth for the question. I think you pretty well hit it. I think if you look at the pre-owned business, there's going to be some carry-over, some of the same challenges that the core new gaming business has with digital. But in addition to that, historically, the place has been based more off the supply and demand as opposed to on a clear value proposition on the price of a new game versus a use game.
And we think I'm pretty on there, it has to be at least some consistent delta, so that there's clear rationale for buying the pre-owned games. So that's what we will talk about when we think in terms of pricing strategy around pre-owned is what is that guaranteed benefit look like for the customer and how do we hold the line on that, so there's always certain value.
So I guess the hope is that the changes would help drive better gross profit dollars. But can you help us size up what that could potentially mean for margin rate? Just given that it's typically been one of the highest margin parts of the business.
Yes, I don't think we can give you a specific figure on gross margin rate right now. When I say more broadly, as you talk about the transformation and you look at the aspects of it. Look, there's a cost component. You can certainly predict that there's some immediacy to that or some in year benefit to that. On the middleware, which is business optimization, current business, pricing is one of those things, it is going to work both ways.
When the laws of elasticity say that you can raise the price, we're going to see immediate gross margin dollars. When we're lowering prices, we understand this will be something of a trough for the word to get on that one and for it to take effect. But we certainly believe that we're going to see more gross margin dollars in the long run by having fair and equitable pricing, and just having a clear value prop to the customer.
And just as a follow up here, as we think about the prospects of improving profitability over time. I guess, that $100 million. Is there any change to that timeline? I think we've talked about over the next couple of years. If you could help us narrow in on that a little bit. And then I guess over the medium term. How do we think about the composition of results? So should we be thinking about I guess the first phase of this transformation showing up more in lower SG&A, given the inefficiencies with the medium term or longer term, I guess, more progress on the sales and gross profit side. Help us think about that a little bit.
Again, I think if you think of this in three phases, that's probably the right wins. So you have a cost and efficiency piece of it. You can probably pretty well establish that there's going to be some in-year 2019 benefit from that aspect of the work. It was obviously a far greater benefit when you analyze the savings in 2020, and we're going to continue and delivering the savings in 2020.
Again, on the optimization work, I think that will show up in many categories, indirect procurement will be one of them but also in the form of improved gross margins. So we talked about pricing strategy, a more logical markdown cadence, inventory controls. All these things are more likely to show up on the gross profit rate side of the business. And then the longest pole in the tent and the most difficult piece of this is obviously new growth verticals.
I take a little bit of excitement in the fact that the incubator is now filling up. So we have things in flight, we have test in flight, but we're not prepared to call those rollout successes, yet we actually go test them and thoroughly vet them. And that's going to be the latest arrival is just those new revenue streams. So in order, I think you're right. SG&A is going to be the first thing you're going to see, gross profit raise is going to be the second thing you’re going to see and sales will come third.
We’ll now hear from Anthony Chukumba with Loop Capital Markets.
Thanks for taking my question, and Rob, my thanks as well for all your help over the years. So you mentioned the fact that the video game, current video game cycle, is longitude. And I don't think anyone's going to disagree with that. I was just wondering, what are you hearing, particularly with E3 coming up, I guess just next week. What's the current scuttlebutt that you're hearing in terms of when we'll get consoles, new consoles from Sony and Microsoft? And also, my understanding with that there will be at least one new switch model coming up this year. And is that your expectation as well? Thanks.
Anthony, I'm sorry to disappoint you, but I think we're going to leave the expectations around timing to the console makers themselves.
[Operator Instructions] We’ll now hear from Curtis Nagle with Bank of America Merrill Lynch.
Just turning back to capital allocation perspective, you've mentioned debt reduction, dividend cut, some growth initiatives, but no mention of buybacks. Is that off the table?
As I mentioned in my commentary, we're not announcing any buybacks at this time. We are going to give the new management team an opportunity to get in, learn the business and understand where they see the opportunities in the future for capital allocation.
And then just a follow-up. Would you consider acquisitions as part of the turnaround? Or do you think this will be wholly self-driven?
Yes, we won’t really get more towards self driven. There are no acquisitions that we're talking about looking at this time.
And there are no further questions. I would now like to turn the call back over to George Sherman for closing remarks.
Okay, thank you. Thanks everyone for your participation in today's call. We appreciate your interest in GameStop. We're excited to be here. We have a team that's committed to turning this business around. And we certainly believe that we'll have much more to say overtime. Thank you.
That will conclude today’s conference call. Thank you for your participation.