The Daily Magic Formula Stock for 11/18/2008 is GameStop Corp. According to the Magic Formula Investing Web Site, the ebit yield is 15% and the EBIT ROIC is 75-100 %.
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GameStop Corp. (â€śGameStop,â€ť â€śwe,â€ť â€śus,â€ť â€śour,â€ť or the â€śCompanyâ€ť) is the worldâ€™s largest retailer of video game products and PC entertainment software. We sell new and used video game hardware, video game software and accessories, as well as PC entertainment software, and related accessories and other merchandise. As of February 2, 2008, we operated 5,264 stores in the United States, Australia, Canada and Europe, primarily under the names GameStop and EB Games. We also operate the electronic commerce websites www.gamestop.com and www.ebgames.com and publish Game Informer , the industryâ€™s largest multi-platform video game magazine in the United States based on circulation, with approximately 2.9 million subscribers.
In the fiscal year ended February 2, 2008, we operated our business in the following segments: United States, Canada, Australia and Europe. Of our 5,264 stores, 4,061 stores are included in the United States segment and 287, 280 and 636 stores are included in the Canadian, Australian and European segments, respectively. Each of the segments consists primarily of retail operations, with all stores engaged in the sale of new and used video game systems, software and accessories which we refer to as video game products and PC entertainment software and related accessories. Our used video game products provide a unique value proposition to our customers, and our purchasing of used video game products provides our customers with an opportunity to trade in their used video game products for store credits and apply those credits towards other merchandise, which in turn, increases sales. These products are substantially the same regardless of geographic location, with the primary differences in merchandise carried being the timing of release of new products in the various segments. Stores in all segments are similar in size at an average of approximately 1,500 square feet each.
The Company began operations in November 1996. In October 1999, the Company was acquired by, and became a wholly-owned subsidiary of, Barnes & Noble, Inc. (â€śBarnes & Nobleâ€ť). In June 2000, Barnes & Noble acquired Funco, Inc. (â€śFuncoâ€ť), a 400-store retailer of video game products in the U.S. In February 2002, GameStop completed an initial public offering of its Class A common stock and was a majority-owned subsidiary of Barnes & Noble until November 2004, when Barnes & Noble distributed its holdings of outstanding GameStop Class B common stock to its stockholders. In October 2005, GameStop acquired the operations of Electronics Boutique Holdings Corp. (â€śEBâ€ť or â€śElectronics Boutiqueâ€ť), a 2,300-store video game retailer in the U.S. and 12 other countries, by merging its existing operations with EB under GameStop Corp. (the â€śmergersâ€ť).
On February 7, 2007, all outstanding Class B common stock of the Company was converted into Class A common stock of the Company on a one-for-one basis and the Company no longer has any Class B common stock. On March 16, 2007, the Company completed a two-for-one stock split of its Class A common stock (the â€śStock Splitâ€ť). As of February 2, 2008, our Class A common stock traded on the New York Stock Exchange (â€śNYSEâ€ť) under the symbol GME.
Our corporate office and one of our distribution facilities are housed in a 510,000 square foot facility in Grapevine, Texas.
On February 7, 2008, the Board of Directors of the Company authorized a buyback of the Companyâ€™s senior notes in the amount of $130 million. The timing and amount of the repurchases will be determined by the Companyâ€™s management based on their evaluation of market conditions and other factors. In addition, the repurchases may be suspended or discontinued at any time. At the time of filing, the Company had repurchased $24.7 million of its senior notes pursuant to this new authorization and delivered the senior notes to the trustee for cancellation. The associated loss on the retirement of debt is $1.9 million, which consists of the premium paid to retire the senior notes and the write-off of the deferred financing fees and the original issue discount on the senior notes.
On March 28, 2008, the Company entered into a stock purchase agreement with Free Record Shop Holding B.V., a Dutch company, to purchase all of the outstanding stock of Free Record Shop Norway AS, a Norwegian private limited liability company (â€śFRSâ€ť). FRS operates approximately 50 record stores in Norway and also operates office and warehouse facilities in Oslo, Norway. During fiscal 2008, the Company intends to convert these stores into video game stores with an inventory assortment similar to its other stores in Norway. The Company will include the results of operations of FRS, which are not expected to be material, in its financial statements beginning on the closing date of the acquisition, which is expected to be April 5, 2008.
Disclosure Regarding Forward-looking Statements
This report on Form 10-K and other oral and written statements made by the Company to the public contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the â€śSecurities Actâ€ť), and Section 21E of the Securities Exchange Act of 1934, as amended (the â€śExchange Actâ€ť). The forward-looking statements involve a number of risks and uncertainties. A number of factors could cause our actual results, performance, achievements or industry results to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. These factors include, but are not limited to:
â€˘ our reliance on suppliers and vendors for sufficient quantities of their products and for new product releases;
â€˘ economic conditions affecting the electronic game industry and the markets in which GameStop operates;
â€˘ the competitive environment in the electronic game industry;
â€˘ our ability to open and operate new stores;
â€˘ our ability to attract and retain qualified personnel;
â€˘ the impact and costs of litigation and regulatory compliance;
â€˘ unanticipated litigation results;
â€˘ the risks involved with our international operations;
â€˘ alternate sources of distribution of video game software; and
â€˘ other factors described in this Form 10-K, including those set forth under the caption, â€śItem 1A. Risk Factors.â€ť
In some cases, forward-looking statements can be identified by the use of terms such as â€śanticipates,â€ť â€śbelieves,â€ť â€ścontinues,â€ť â€ścould,â€ť â€śestimates,â€ť â€śexpects,â€ť â€śintends,â€ť â€śmay,â€ť â€śplans,â€ť â€śpotential,â€ť â€śpredicts,â€ť â€świll,â€ť â€śshould,â€ť â€śseeks,â€ť â€śpro formaâ€ť or similar expressions. These statements are only predictions based on current expectations and assumptions and involve known and unknown risks, uncertainties and other factors that may cause our or our industryâ€™s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. You should not place undue reliance on these forward-looking statements.
Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this Form 10-K. In light of these risks and uncertainties, the forward-looking events and circumstances contained in this Form 10-K may not occur, causing actual results to differ materially from those anticipated or implied by our forward-looking statements.
Based upon estimates compiled by various market research firms, management estimates that the combined market for video game products and PC entertainment software exceeded $36 billion in 2007 in the countries in which we operate. According to NPD Group, Inc., a market research firm (â€śthe NPD Groupâ€ť), the electronic game industry was an approximately $18.6 billion market in the United States in 2007. Of this $18.6 billion market, approximately $17.7 billion was attributable to video game products, excluding sales of used video game products, and approximately $910 million was attributable to PC entertainment software. International Development Group, a market research firm, estimates that retail sales of video game hardware and software and PC entertainment software totaled approximately $15.6 billion in Europe in 2007. The NPD Group has reported that video game retail sales in Canada were approximately $1.5 billion in 2007. According to the independent market research group GfK, the Australian market for video game products was approximately $1.1 billion in 2007.
New Video Game Products. The Entertainment Software Association, or ESA, estimates that 67% of all American heads of households play video or computer games. We expect the following trends to result in increased sales of video game products:
â€˘ Hardware Platform Technology Evolution. Video game hardware has evolved significantly from the early products launched in the 1980s. The processing speed of video game hardware has increased from 8-bit speeds in the 1980s to high speed processors in next-generation systems, such as the Sony PlayStation 3 launched in November 2006 in North America and the first quarter of fiscal 2007 in Australia and Europe, the Nintendo Wii launched in November 2006 worldwide, and Microsoft Xbox 360, launched in the fourth quarter of 2005 in North America and Europe and the first quarter of 2006 in Australia. In addition, portable handheld video game devices have evolved from the 8-bit Nintendo Game Boy to the 128-bit Nintendo DS, which was introduced in November 2004 in North America and the first quarter of 2005 in Australia and Europe, and the Sony PlayStation Portable (the â€śPSPâ€ť), which was introduced in March 2005 in North America and September 2005 in Australia and Europe. Technological developments in both chip processing speed and data storage have provided significant improvements in advanced graphics and audio quality, which allow software developers to create more advanced games, encourage existing players to upgrade their hardware platforms and attract new video game players to purchase an initial system. As general computer technology advances, we expect video game technology to make similar advances.
â€˘ Next-Generation Systems Provide Multiple Capabilities Beyond Gaming. Many next-generation hardware platforms, including the Sony PlayStation 2 and 3 and Microsoft Xbox and Xbox 360, utilize a DVD software format and have the potential to serve as multi-purpose entertainment centers by doubling as a player for DVD movies and compact discs. In addition, the Sony PlayStation 3 and PSP, the Nintendo DS and Wii and Microsoft Xbox 360 all provide internet connectivity and the Sony PlayStation 3 plays Blu-ray discs.
â€˘ Backward Compatibility. The Sony PlayStation 2 and 3, the Nintendo DS and Wii and Microsoft Xbox 360 are, to some extent, backward compatible, meaning that titles produced for the earlier version of the hardware platform may be used on the new hardware platform. We believe that during the initial launch phase of next-generation platforms, backward compatibility results in more stable industry growth because the decrease in consumer demand for products associated with existing hardware platforms that typically precedes the release of next-generation hardware platforms is diminished.
â€˘ Introduction of Next-Generation Hardware Platforms Drives Software Demand. Sales of video game software generally increase as next-generation platforms mature and gain wider acceptance. Historically, when a new platform is released, a limited number of compatible game titles are immediately available, but the selection grows rapidly as manufacturers and third-party publishers develop and release game titles for that new platform.
â€˘ Broadening Demographic Appeal. While the typical electronic game enthusiast is male between the ages of 14 and 35, the electronic game industry is broadening its appeal. More females are playing electronic video games, in part due to the development of video game products that appeal to them. According to ESA, approximately 38% of all electronic game players are female. ESA also states that 36% of parents say they play computer and video games and that 80% of gamer parents play video games with their kids. According to ESA, the average game player is 33 years old; however, the video game market also includes approximately 24% of Americans over the age of 50. In addition, the availability of used video game products for sale has enabled a lower-economic demographic, that may not have been able to afford the considerably more expensive new video game products, to participate in the video game industry.
Used Video Game Products. As the installed base of video game hardware platforms has increased and new hardware platforms are introduced, a considerable market for used video game hardware and software has developed. Based on reports published by NPD Group, we believe that, as of December 2006, the installed base of video game hardware systems in the United States, based on original sales, totaled over 150 million units of recent generation technology, including approximately 3.2 million Sony PlayStation 3 units, 7.3 million Nintendo Wii units, 9.1 million Microsoft Xbox 360 units, 10.5 million Sony PSP units, 41 million Sony PlayStation 2 units, 14 million Microsoft Xbox units, 12 million Nintendo GameCube units, 17.5 million Nintendo DS units and 36 million Game Boy Advance SP and Game Boy Advance units. Hardware manufacturers and third-party software publishers have produced a wide variety of software titles for each of these hardware platforms. Based on internal company estimates, we believe that the installed base of video game software units in the United States exceeds 1.2 billion units. According to the International Development Group, the installed base of hardware systems in Europe is approximately 101 million units. As the substantial installed base of video game hardware and software continues to grow, there is a growing demand for used video game products.
PC Entertainment Software. PC entertainment software is generally sold in the form of CD-ROMs and played on multimedia PCs featuring fast processors, expanded memories, and enhanced graphics and audio capabilities.
Our goal is to strengthen our position as the worldâ€™s largest retailer of new and used video game products and PC entertainment software by focusing on the following strategies:
Continuing to Execute Our Proven Growth Strategies. We intend to continue to execute our proven growth strategies, including:
â€˘ Continuing to open new stores in our domestic and international target markets; and
â€˘ Increasing our comparable store sales and operating earnings by capitalizing on industry growth and increasing sales of used video game products.
Targeting a Broad Audience of Game Players. We have created a store environment targeting a broad audience including the electronic game enthusiast, the casual gamer and the seasonal gift giver. Our stores focus on the electronic game enthusiast who demands the latest merchandise featuring the â€śhottestâ€ť technology immediately on the day of release and the value-oriented customer who wants a wide selection of value-priced used video game products. Our stores offer the opportunity to trade in used video game products in exchange for store credits applicable to future purchases, which, in turn, drives more sales.
Enhancing our Image as a Destination Location. Our stores serve as destination locations for game players and gift givers due to our broad selection of products, knowledgeable sales associates, game-oriented environment and unique pricing proposition. We offer all major video game platforms, provide a broad assortment of video game products and offer a larger and more current selection of merchandise than other retailers. We provide a high level of customer service by hiring game enthusiasts and providing them with ongoing sales training, as well as training in the latest technical and functional elements of our products and services. Our stores are equipped with several video game sampling areas, which provide our customers the opportunity to play games before purchase, as well as equipment to play video game clips.
Offering the Largest Selection of Used Video Game Products. We believe we are the largest retailer of used video games in the world and carry the broadest selection of used video game products for both current and previous generation platforms. We are one of the only retailers that provides video game software for previous generation platforms, giving us a unique advantage in the video game retail industry. The opportunity to trade in and purchase used video game products offers our customers a unique value proposition generally unavailable at most mass merchants, toy stores and consumer electronics retailers. We obtain most of our used video game products from trade-ins made in our stores by our customers. Used video game products generate significantly higher gross margins than new video game products.
Building the GameStop Brand. Substantially all of GameStopâ€™s U.S. and European stores are operated under the GameStop name, including stores acquired from EB. Building the GameStop brand has enabled us to leverage brand awareness and to capture advertising and marketing efficiencies. Our branding strategy is further supported by the GameStop â€śEdgeâ€ť loyalty card and our website. The GameStop loyalty card, which is obtained as a bonus with a paid subscription to our Game Informer magazine, offers customers discounts on selected merchandise in our stores. Our websites allow our customers to buy games on-line and to learn about the latest video game products and PC entertainment software and their availability in our stores. In 2007, GameStop introduced its new brand tagline â€śPower to the Playersâ€ť and launched a T.V., radio and newspaper advertising campaign to increase brand awareness of the GameStop brand.
Leonard Riggio is a director and Chair of the Executive Committee. Mr. Riggio was the Chairman of the Board of Historical GameStop or its predecessor companies from November 1996 until Historical GameStopâ€™s initial public offering in February 2002. He has served as an executive officer or director in the video game industry since 1987. Mr. Riggio has been Chairman of the Board and a principal stockholder of Barnes & Noble, Inc. (â€śBarnes & Nobleâ€ť) since its inception in 1986 and served as Chief Executive Officer from its inception in 1986 until February 2002. Since 1965, Mr. Riggio has been Chairman of the Board, Chief Executive Officer and the principal stockholder of Barnes & Noble College Booksellers, Inc. (â€śB&N Collegeâ€ť), one of the largest operators of college bookstores in the country. Since 1985, Mr. Riggio has been Chairman of the Board and a principal beneficial owner of MBS Textbook Exchange, Inc., one of the nationâ€™s largest wholesalers of college textbooks.
Stanley (Mickey) Steinberg is a director. Mr. Steinberg has served as a director since the mergers in October 2005. Mr. Steinberg served as a director of EB from September 1998 until the completion of the mergers. Mr. Steinberg currently serves as a consultant to multiple companies in the real estate investment, development, design and construction business, as well as in the trade show business. From August 1994 to June 1998, Mr. Steinberg served as Chairman of Sony Retail Entertainment. From 1989 to 1994, Mr. Steinberg served as Executive Vice President and Chief Operating Officer of Walt Disney Imagineering, responsible for the development, design and construction of all Disney theme parks. Mr. Steinberg serves on the board of directors of two privately held companies â€” AMC, Inc., the owner and manager of AmericasMart, an Atlanta trade show center, and ECI Group, an Atlanta apartment development, construction and management company.
Gerald R. Szczepanski is a director, Chair of the Compensation Committee and a member of the Audit Committee and the Nominating and Corporate Governance Committee. Mr. Szczepanski is currently retired. Mr. Szczepanski was the co-founder, and, from 1994 to 2005, the Chairman and Chief Executive Officer of Gadzooks, Inc., a publicly traded specialty retailer of casual clothing and accessories for teenagers. On February 3, 2004, Gadzooks, Inc. filed a voluntary petition under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division (Case No. 04-31486-11).
Lawrence S. Zilavy is a director and a member of the Audit Committee. Mr. Zilavy has served as a director since October 2005. Mr. Zilavy is Senior Vice President of B&N College. Mr. Zilavy was Executive Vice President, Corporate Finance and Strategic Planning for Barnes & Noble from May 2003 until November 2004 and was Chief Financial Officer of Barnes & Noble from June 2002 through April 2003. Mr. Zilavy is also a director of Barnes & Noble, The Hain Celestial Group, Inc., and the non-profit Community Resource Exchange, as well as a trustee of St. Francis College in New York City.
R. Richard Fontaine has been our Chairman of the Board and Chief Executive Officer since Historical GameStopâ€™s initial public offering in February 2002. Mr. Fontaine is also a member of the Executive Committee.
Mr. Fontaine has served as the Chief Executive Officer of our predecessor companies since November 1996. He has been an executive officer or director in the video game industry since 1988.
Daniel A. DeMatteo has been our Vice Chairman and Chief Operating Officer since March 2005. Prior to March 2005, Mr. DeMatteo served as President and Chief Operating Officer of the Company or our predecessor companies since November 1996. He has served on our board since 2002 and has been an executive officer in the video game industry since 1988.
Jerome L. Davis is a director and a member of the Compensation Committee and the Nominating and Corporate Governance Committee. Mr. Davis has served as a director since October 2005. Mr. Davis is Executive Vice President of TBM Consulting, Inc. (â€śTBMâ€ť), a firm specializing in using Lean Sigma Â® methods and techniques to rapidly improve client responsiveness and enterprise value. Prior to joining TBM in 2007, Mr. Davis was Chief Executive Officer of Jerome L. Davis & Associates, LLC, a consulting firm focusing on executive leadership, coaching and training in 2006. Mr. Davis was Global Vice President, Service Excellence for Electronic Data Systems, a business and technology services company, from July 2003 until October 2005. From May 2001 to July 2003, he served in various capacities at Electronic Data Systems, including Chief Client Executive Officer and President, Americas for Business Process Management. Prior to joining Electronic Data Systems, Mr. Davis served as President and Executive Officer of the Commercial Solutions Division of Maytag Corporation, a home and commercial appliance company, from October 1999 until May 2001. Mr. Davis served as Senior Vice President of Sales and Corporate Officer for Maytag Appliances Division from March 1998 to September 1999. From March 1992 to February 1998, Mr. Davis was Vice President of National Accounts and Area Vice President for Frito Lay. Mr. Davis also held senior executive positions in Sales and Marketing with Procter & Gamble from 1977 to 1992. Mr. Davis is currently a director and Chair of the Finance and Enterprise Risks Committee and a member of the Nominating and Corporate Governance Committee of Apogee Enterprises, Inc., where he has been a director since 2004.
Steven R. Koonin is a director. Mr. Koonin has served as a director since June 2007. Mr. Koonin is the President of Turner Entertainment Networks, a position he has held since October 2006. Mr. Koonin joined the Turner Entertainment Group in February 2000 and served as Executive Vice President and Chief Operating Officer of the TNT and TBS networks until October 2006, where he was responsible for the rebranding of both networks and the development of some of the most successful series and mini-series in cable television history. Prior to February 2000, Mr. Koonin spent 14 years with The Coca-Cola Company, serving most recently as Vice President of Consumer Marketing. Mr. Koonin is also a director of the Georgia Aquarium and the Fox Theatre.
Michael N. Rosen is a director. Mr. Rosen has served as a director for the Company or our predecessor companies since October 1999. Mr. Rosen is also a member of the Executive Committee and served as the Secretary of the Company or our predecessor companies from October 1999 until May 2007. Mr. Rosen has been a partner at Bryan Cave LLP, counsel to the Company, since their July 2002 combination with Robinson Silverman. Prior to that, Mr. Rosen was Chairman of Robinson Silverman.
Stephanie M. Shern is a director and Chair of the Audit Committee. Mrs. Shern formed Shern Associates LLC in February 2002 to provide business advisory and board services, primarily to publicly-held companies. From May 2001 until February 2002, Mrs. Shern served as Senior Vice President and Global Managing Director of Retail and Consumer Products for Kurt Salmon Associates. From 1995 until April 2001, Mrs. Shern was the Vice Chair and Global Director of Retail and Consumer Products for Ernst & Young LLP and a member of Ernst & Youngâ€™s Management Committee. Mrs. Shern is currently a director and Chair of the Audit Committee of The Scotts/Miracle Gro Company, a director, Chair of the Audit Committee and member of the Compensation Committee of Embarq Corporation, and a director and member of the Audit and Remuneration Committees of Royal Ahold.
Edward A. Volkwein is a director and a member of the Compensation Committee and the Nominating and Corporate Governance Committee. Mr. Volkwein is President and Chief Marketing Officer of Hydro-Photon, Inc., a water purification technology company. Prior to joining Hydro-Photon, Mr. Volkwein had a broad marketing career beginning in brand management for General Foods and Chesebrough-Ponds, Inc. He served as Senior Vice President, Global Advertising and Promotion for Philips Consumer Electronics and as Senior Vice President Marketing for Sega of America, where he was instrumental in developing Sega into a major video game brand. Mr. Volkwein has also held senior executive positions with Funk & Wagnalls and Prince Manufacturing.
MANAGEMENT DISCUSSION FROM LATEST 10K
GameStop Corp. (â€śGameStop,â€ť â€śwe,â€ť â€śus,â€ť â€śour,â€ť or the â€śCompanyâ€ť) is the worldâ€™s largest retailer of video game products and PC entertainment software. We sell new and used video game hardware, video game software and accessories, as well as PC entertainment software and related accessories and other merchandise. As of February 2, 2008, we operated 5,264 stores, in the United States, Australia, Canada and Europe, primarily under the names GameStop and EB Games. We also operate electronic commerce websites under the names www.gamestop.com and www.ebgames.com and publish Game Informer , the industryâ€™s largest multi-platform video game magazine in the United States based on circulation.
Our fiscal year is composed of 52 or 53 weeks ending on the Saturday closest to January 31. The fiscal years ended February 2, 2008 (â€śfiscal 2007â€ť) and January 28, 2006 (â€śfiscal 2005â€ť) consisted of 52 weeks. The fiscal year ended February 3, 2007 (â€śfiscal 2006â€ť) consisted of 53 weeks.
On October 8, 2005, GameStop Holdings Corp. (â€śHistorical GameStopâ€ť), formerly known as GameStop Corp., and Electronics Boutique Holdings Corp. (â€śEBâ€ť or â€śElectronics Boutiqueâ€ť) completed their previously announced mergers pursuant to the Agreement and Plan of Merger, dated as of April 17, 2005 (the â€śMerger Agreementâ€ť). Upon the consummation of the mergers, Historical GameStop and EB became wholly-owned subsidiaries of the Company, a Delaware corporation formed for the purpose of consummating the business combination (the â€śmergersâ€ť). The mergers of Historical GameStop and EB have been treated as a purchase business combination for accounting purposes, with Historical GameStop designated as the acquirer. Therefore, the historical financial statements of Historical GameStop became the historical financial statements of the Company. The accompanying consolidated financial statements and notes thereto include the results of operations of EB from October 9, 2005 forward. Therefore, the Companyâ€™s operating results for the fiscal year ended January 28, 2006 include 16 weeks of EBâ€™s results and 52 weeks, respectively, of Historical GameStopâ€™s results. The Companyâ€™s operating results for the fiscal years ended February 2, 2008 and February 3, 2007 include 52 weeks and 53 weeks, respectively, for both Historical GameStop and EB. As a result, sales mix, cost of sales, gross profit, selling, general and administrative expenses, depreciation and amortization and interest expense in fiscal 2006 were significantly impacted by including the operations of EB for a full year, as opposed to 16 weeks in fiscal 2005, which included the holiday selling season. Growth in each of these statement of operations line items came from each of the Companyâ€™s business segments.
Under the terms of the Merger Agreement, Historical GameStopâ€™s stockholders received one share of the Companyâ€™s common stock for each share of Historical GameStopâ€™s common stock owned. Approximately 104.2 million shares of the Companyâ€™s common stock were issued in exchange for all outstanding common stock of Historical GameStop based on the one-for-one ratio. EB stockholders received $19.08 in cash and .39398 of a share of the Companyâ€™s common stock for each share of EB common stock owned. In aggregate, 40.5 million shares of the Companyâ€™s common stock were issued to EB stockholders at a value of approximately $437.1 million (based on the closing price of $10.81 of Historical GameStopâ€™s common stock on April 15, 2005, the last trading day before the date the mergers were announced). In addition, approximately $993.3 million in cash was paid in consideration for (i) all outstanding common stock of EB, based upon the pro-ration provisions of the Merger Agreement, and (ii) all outstanding stock options of EB. Including transaction costs of $13.6 million, the total consideration paid was approximately $1.4 billion.
On February 7, 2007, following approval by a majority of the Class B common stockholders in a special meeting of the Companyâ€™s Class B common stockholders, all outstanding Class B common shares were converted into Class A common shares on a one-for-one basis. In addition, on February 9, 2007, the Board of Directors of the Company authorized a two-for-one stock split, effected by a one-for-one stock dividend to stockholders of record at the close of business on February 20, 2007, paid on March 16, 2007 (the â€śStock Splitâ€ť). Unless otherwise indicated, all numbers in this â€śManagementâ€™s Discussion and Analysis of Financial Condition and Results of Operationsâ€ť have been restated to reflect the conversion and the Stock Split.
Growth in the video game industry is driven by the introduction of new technology. In March of fiscal 2005 in the North American markets and September of fiscal 2005 in the Australian and European markets, Sony introduced the PlayStation Portable (the â€śPSPâ€ť) and Microsoft introduced the Xbox 360 in November of fiscal 2005 in North America and Europe and the first quarter of fiscal 2006 in Australia. In November 2006, Nintendo introduced the Wii hardware platform worldwide and Sony introduced the PlayStation 3 hardware platform in the North American markets. Sony introduced the PlayStation 3 platform in the Australian and European markets in March 2007. Typically, in the first full year following the introduction of new video game platforms, sales of new video game hardware increase as a percentage of sales. As video game platforms mature, the sales mix attributable to complementary video game software and accessories, which generate higher gross margins, generally increases in the second and third years. The net effect is generally a decline in gross margins in the first full year following new platform releases and an increase in gross margins in the second and third years. Unit sales of maturing video game platforms are typically also driven by manufacturer-funded retail price decreases, further driving sales of related software and accessories. We expect that the installed base of the hardware platforms listed above and sales of related software and accessories will increase in the future. The Companyâ€™s gross margin in fiscal 2007 and fiscal 2006 was adversely impacted by the recent launches of these new products and subsequent manufacturer-funded retail price decreases for some of these products.
Critical Accounting Policies
The Company believes that the following are its most significant accounting policies which are important in determining the reporting of transactions and events:
Use of Estimates. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. Changes in the estimates and assumptions used by management could have significant impact on the Companyâ€™s financial results. Actual results could differ from those estimates.
Revenue Recognition. Revenue from the sales of the Companyâ€™s products is recognized at the time of sale. The sales of used video game products are recorded at the retail price charged to the customer. Sales returns (which are not significant) are recognized at the time returns are made. Subscription and advertising revenues are recorded upon release of magazines for sale to consumers and are stated net of sales discounts. Magazine subscription revenue is recognized on a straight-line basis over the subscription period. Revenue from the sales of product replacement plans is recognized on a straight-line basis over the coverage period. Gift cards sold to customers are recognized as a liability on the balance sheet until redeemed.
Stock-Based Compensation. In December 2004, the Financial Accounting Standards Board (â€śFASBâ€ť) issued Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Payment , (â€śSFAS 123(R)â€ť). This Statement requires companies to expense the estimated fair value of stock options and similar equity instruments issued to employees in its financial statements. The Company adopted the provisions of SFAS 123(R) using the modified prospective application method beginning on the first day of fiscal 2006. Under SFAS 123(R), the Company records stock-based compensation expense based on the grant-date fair value estimated in accordance with the original provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation , and previously presented in the pro forma footnote disclosures, for all options granted prior to, but not vested as of, the adoption date. In addition, the Company records compensation expense for the share-based awards issued after the adoption date in accordance with SFAS 123(R). As of February 2, 2008, the unrecognized compensation expense related to the unvested portion of our stock options and restricted stock was $13.7 million and $18.8 million, respectively, which is expected to be recognized over a weighted average period of 0.8 and 1.9 years, respectively. Note 1 of â€śNotes to Consolidated Financial Statementsâ€ť provides additional information on stock-based compensation.
Merchandise Inventories. Our merchandise inventories are carried at the lower of cost or market using the average cost method. Under the average cost method, as new product is received from vendors, its current cost is added to the existing cost of product on-hand and this amount is re-averaged over the cumulative units. Used video game products traded in by customers are recorded as inventory at the amount of the store credit given to the customer.
In valuing inventory, management is required to make assumptions regarding the necessity of reserves required to value potentially obsolete or over-valued items at the lower of cost or market. Management considers quantities on hand, recent sales, potential price protections and returns to vendors, among other factors, when making these assumptions. Our ability to gauge these factors is dependent upon our ability to forecast customer demand and to provide a well-balanced merchandise assortment. Any inability to forecast customer demand properly could lead to increased costs associated with inventory markdowns. We also adjust inventory based on anticipated physical inventory losses or shrinkage. Physical inventory counts are taken on a regular basis to ensure the reported inventory is accurate. During interim periods, estimates of shrinkage are recorded based on historical losses in the context of current period circumstances.
Consolidated Results of Operations
The Company includes purchasing, receiving and distribution costs in selling, general and administrative expenses, rather than cost of goods sold, in the statement of operations. For the fiscal years ended February 2, 2008, February 3, 2007 and January 28, 2006, these purchasing, receiving and distribution costs amounted to $43.9 million, $35.9 million and $20.8 million, respectively. The Company includes processing fees associated with purchases made by check and credit cards in cost of sales, rather than selling, general and administrative expenses, in the statement of operations. For the fiscal years ended February 2, 2008, February 3, 2007 and January 28, 2006, these processing fees amounted to $55.2 million, $40.9 million and $20.9 million, respectively. As a result of these classifications, our gross margins are not comparable to those retailers that include purchasing, receiving and distribution costs in cost of sales and include processing fees associated with purchases made by check and credit cards in selling, general and administrative expenses. The net effect of the Companyâ€™s classifications is that its cost of sales as a percentage of sales is higher than, and its selling, general and administrative expenses as a percentage of sales are lower than, they would have been had the Companyâ€™s treatment conformed with those retailers that include purchasing, receiving and distribution costs in cost of sales and include processing fees associated with purchases made by check and credit cards in selling, general and administrative expenses, by 0.2%, 0.1% and 0.0% for the fiscal years ended February 2, 2008, February 3, 2007 and January 28, 2006, respectively.
Fiscal 2007 Compared to Fiscal 2006
Sales increased by $1,775.1 million, or 33.4%, to $7,094.0 million in the 52 weeks of fiscal 2007 compared to $5,318.9 million in the 53 weeks of fiscal 2006. The increase in sales was attributable to the comparable store sales increase of 24.7% for fiscal 2007 when compared to fiscal 2006, the addition of non-comparable store sales from the 1,007 stores opened since January 29, 2006 of approximately $496.2 million and increases related to changes in foreign exchange rates of $109.4 million, offset by sales of $99.1 million for the 53rd week included in fiscal 2006. The comparable store sales increase was driven by continued strong sales of the Nintendo Wii, Microsoftâ€™s Xbox 360 and the Sony PlayStation 3, which completed its worldwide launch during this fiscal year, and their related software and accessories, including several strong video game titles, such as Halo 3 and Guitar Hero III . Stores are included in our comparable store sales base beginning in the thirteenth month of operation. The comparable store sales increase of 24.7% was calculated by using the 52 weeks of fiscal 2007 compared to the most closely comparable 52 weeks of fiscal 2006 with consideration given to the timing of holidays to ensure comparability.
New video game hardware sales increased $595.2 million or 55.4%, from fiscal 2006 to fiscal 2007, primarily due to the sales of hardware units mentioned above, as well as the increase in store count since January 2007, offset by the 53rd week of sales included in fiscal 2006. New video game hardware sales increased as a percentage of sales from 20.2% in fiscal 2006 to 23.5% in fiscal 2007, primarily due to the first full year since the Nintendo Wii and the Sony PlayStation 3 launch as well as increasing sales of Microsoft Xbox 360 and the Nintendo DS.
New video game software sales increased $788.2 million, or 39.2%, from fiscal 2006 to fiscal 2007, primarily due to new stores added in fiscal 2007, sales related to the new hardware platforms and a strong lineup of new video game titles released during the 52 weeks ended February 2, 2008. New video game software sales as a percentage of total sales increased from 37.8% in fiscal 2006 to 39.5% in fiscal 2007 due to increased sales related to the new hardware platforms and the availability of several strong titles in fiscal 2007.
Used video game product sales increased $270.7 million, or 20.6%, from fiscal 2006 to fiscal 2007, primarily due to the increase in new store count, an increase in overall demand for video game products following the launch of new hardware platforms and the strong growth of used video game product sales internationally, offset by the 53rd week of sales in fiscal 2006. As a percentage of sales, used video game product sales decreased from 24.8% to 22.4% primarily due to the strong sales of new video game hardware and software. Sales of other product categories, including PC entertainment and other software and accessories, magazines and trading cards, grew 13.2%, or $121.0 million, from fiscal 2006 to fiscal 2007, primarily due to the increase in store count and the increase in new hardware platform accessories sales, offset by the 53rd week of sales in fiscal 2006.
Cost of sales increased by $1,432.8 million, or 37.2%, from $3,847.5 million in fiscal 2006 to $5,280.3 million in fiscal 2007 as a result of the increase in sales and the changes in gross profit discussed below, offset by the 53rd week of sales in fiscal 2006.
Gross profit increased by $342.3 million, or 23.3%, from $1,471.4 million in fiscal 2006 to $1,813.7 million in fiscal 2007. Gross profit as a percentage of sales decreased from 27.7% in fiscal 2006 to 25.6% in fiscal 2007. The gross profit percentage decrease was caused primarily by the increase in sales of new video game hardware as a percentage of total sales in fiscal 2007. New video game hardware typically carries a much lower margin than sales in the other product categories. Gross profit as a percentage of sales was also impacted by a decrease in the excess of vendor allowances received over marketing and advertising expenses. Vendor allowances received during fiscal 2006 were abnormally high due to the launches of the Nintendo Wii and the Sony PlayStation 3 and returned to normal levels in fiscal 2007. In addition, net vendor allowances decreased due to higher expenditures on marketing and advertising from fiscal 2006 to fiscal 2007 in support of the Companyâ€™s branding campaign. These factors led to a decrease in gross profit as a percentage of sales on new video game hardware, new video game software and other products from 7.2%, 21.2% and 34.4% of sales, respectively, in fiscal 2006 to 6.5%, 20.8% and 33.9% of sales, respectively, in fiscal 2007. Gross profit as a percentage of sales on used video game products decreased from 49.5% in fiscal 2006 to 48.7% in fiscal 2007 due to increased promotional expenses and higher refurbishment costs associated with an increase in production of refurbished hardware platforms during fiscal 2007.
Selling, general and administrative expenses increased by $160.9 million, or 15.8%, from $1,021.1 million in fiscal 2006 to $1,182.0 million in fiscal 2007. The increase was primarily attributable to the increase in the number of stores in operation, and the related increases in store, distribution and corporate office operating expenses, offset by expenses from the 53rd week included in fiscal 2006. Selling, general and administrative expenses as a percentage of sales decreased from 19.2% in fiscal 2006 to 16.7% in fiscal 2007. The decrease in selling, general and administrative expenses as a percentage of sales was primarily due to leveraging as a result of the higher sales associated with the introduction of the new video game systems and synergies associated with the acquisition of EB. Selling, general and administrative expenses include $26.9 and $21.0 million in stock-based compensation expense for fiscal 2007 and fiscal 2006, respectively, in accordance with SFAS 123(R). Foreign currency transaction gains and (losses) are included in selling, general and administrative expenses and amounted to $8.6 million in fiscal 2007, compared to ($1.0) million in fiscal 2006.
Depreciation and amortization expense increased from $109.9 million in fiscal 2006 to $130.3 million in fiscal 2007. This increase of $20.4 million was due primarily to capital expenditures for 586 new GameStop stores. Depreciation and amortization expense will increase from fiscal 2007 to fiscal 2008 due to continued capital expenditures for new stores and management information systems.
Interest income resulting from the investment of excess cash balances increased from $11.3 million in fiscal 2006 to $13.8 million in fiscal 2007 due to interest earned on invested assets. Interest expense decreased from $84.7 million in fiscal 2006 to $61.6 million in fiscal 2007, primarily due to the retirement of $20.0 million of the Companyâ€™s senior notes and $250.0 million of the Companyâ€™s senior floating rate notes since February 3, 2007. Debt extinguishment expense of $12.6 million was recognized in fiscal 2007 as a result of the premiums paid related to debt retirement and the recognition of deferred financing fees and unamortized original issue discount. Debt extinguishment expense of $6.1 million was incurred in fiscal 2006 for the loss associated with the Companyâ€™s repurchase of $50.0 million of its senior notes payable and $50.0 million of its senior floating rate notes payable.
Income tax expense increased by $56.8 million, from $96.0 million in fiscal 2006 to $152.8 million in fiscal 2007. The Companyâ€™s effective tax rate decreased from 37.8% in fiscal 2006 to 34.6% in fiscal 2007 due to the release of foreign valuation allowances on net operating losses and the recognition of foreign tax credits not previously benefited. See Note 12 of â€śNotes to Consolidated Financial Statementsâ€ť for additional information regarding income taxes.
The factors described above led to an increase in operating earnings of $167.7 million, or 50.3%, from $333.7 million in fiscal 2006 to $501.4 million in fiscal 2007 and an increase in net earnings of $130.0 million, or 82.1%, from $158.3 million in fiscal 2006 to $288.3 million in fiscal 2007.
Daniel A. DeMatteo
Good morning and welcome to GameStop's second quarter conference call. I am Dan DeMatteo, GameStopâ€™s Vice Chairman and Chief Operating officer. Dick Fontaine, our Chairman and CEO, could not be with us this morning, as he is recovering at home from minor surgery from this past weekend. With me today is David Carlson, our Executive Vice President and Chief Financial Officer.
This morning we released our financial results for our second quarter 2008 and gave guidance for the remainder of the year. Given the economic environment we are operating in, our performance could only be described as spectacular. Clearly the consumer has accepted the great entertainment value that videogames provide. With sales increasing 35%, comps increasing 20%, and earnings increasing 162%, we could not be more pleased with our results. These results were achieved through great leveraging of our SG&A expenses on strong comp sales. David will give you more details of the specifics for the quarter financially.
Once again our model, which creates value for the old games consumers are no longer playing, did well with the budget-stretched consumer. As a matter of fact, we had five of our top 10 trade weeks of all time in this second quarter and our June trades set a new monthly record.
Also, our Nintendo Wii trades, which some people were concerned about, grew five times faster than the average, as we focused on converting this new consumer to our trade model through our marketing activities and sales associates.
You may have seen our TV ads this summer promoting our trade-in message. As a result of all this trade activity, our used sales grew 32% and we expect continued great sales growth over the rest of the year in the used category.
If we analyze U.S. videogame sales in the quarter, as reported by NPD, the growth has been driven by an ever-growing installed base of next generation consoles and handheld systems and new genres. And the installed base growth continued in the quarter, with these systems growing 44% on top of 55% last year, led by growth of the PS3, Wii, and Xbox 360. Also, handheld systems performed well, with 32% growth in the category during the quarter.
Clearly the installed base this year will grow over last year, the year in which many predicted was the peak. Again, we believe this cycle will be broader and longer than any cycle of the past, as videogames are truly becoming mass entertainment for consumers of all ages.
As we all remember, last year had the release of Halo 3 in the third quarter, GameStopâ€™s best-selling title of all time, which resulted in 46% comps. This year we see a much broader lineup of titles that will drive sales in the third and fourth quarter and, along with growth in our used sales, has allowed us to increase our back half sales and earnings guidance. And again, David will discuss this further.
The title lineup for the back half includes Fable 2 for the Xbox 360, Call of Duty: World at War for the Xbox 360 and PS3, Gears of War for the 360, Animal Crossing for the Wii, World of Warcraft again for the PC, Guitar Hero World Tour all platforms, Rock Band 2 all platforms, and Kirby Superstar for the Nintendo DS, and many others. You can see the breadth of titles that we have across all of these new platforms.
Now I would like to discuss our new store growth. First, we do not add new stores solely for store count and we try to avoid cannibalization of sales in our existing stores. The goal of our new store program is the expansion of the market by growing our used sales, capitalize on the growth in the industry, and take business from our competitors. Our new stores that opened this year as a group are performing as well as the year before group, and the year before that. In other words, our new store selection process and financial performance continues to succeed our model as it has in the past. In the quarter, we added 125 new store, 68 in the U.S., 28 in Europe, 25 in Australia/New Zealand, and four in Canada.
As we have said in the past, the specialist model, which includes the buy/sell/trade, largest assortment of games, and best-in-class sales support continues to be accepted around the world in all areas we operate.
As a matter of fact, we believe we now have the number one market share of game sales in the U.S., Canada, Australia, Italy, Ireland, Scandinavia, and are closing in on it in the Germanic countries. Therefore, we believe that we have many opportunities for expansion in all countries we operate and continue to look at new countries to expand into.
In our release, we stated that we believe our earnings will continue to grow extremely well next year by at least 25%. While we do not have visibility to many releases next year, we expect the continued growth in the next generation installed base and historical tie ratios, as well as growth in our used games to drive top line sales and earnings.
Now, before I turn it over to Dave this morning, this morning we have had some questions about the apparent loss of share in the quarter. First, comparing our total software growth to U.S. NPD data will not give an accurate picture, as over 27% of our sales are international, and in the second quarter, their release schedule was not as robust as the U.S. As far as we know, there isn't a comparable data source outside the U.S. like NPD.
Next, the mix of titles sold in the quarter will have an effect on our market share like last year in the third quarter where we way over-indexed with Halo 3.
And lastly, we have the used category, which other retailers donâ€™t, growing at the rapid rate of 32% in the quarter.
We are making investments in our infrastructure to support our growth. We continuously make improvements in our used model to drive more trades and manage this inventory.
Our Game Informer magazine just broke the 3.5 million subscriber barrier and we even have an Italian version of it. We are hosting our annual store managers conference in a few weeks that will be attended by all of our field management and 56 of our suppliers. We feel that we are ready for the back half of the year, both U.S. and internationally, and are well-positioned to continue to grow in this fast-growing industry.
With that, I will turn it over to Dave for a more in-depth financial review.
David W. Carlson
Good morning. Before the market opened today, we released our sales and earnings results for the second quarter of fiscal 2008. GameStop sales for the second quarter increased 35% to $1.8 billion, as compared to $1.3 billion in the prior fiscal year. Comparable store sales for the second quarter increased 20%, significantly exceeding our prior expectations of 12% to 14% comps. These results were driven by exceptional performances across all categories.
New hardware sales grew 29%, again exceeding our expectations and building a massive installed base for future growth.
New videogame software sales grew 43%, with the U.S. game release schedule far exceeding the more modest European and Australian releases for the quarter.
Used videogame sales grew an astonishing 32% with the current economic environment continuing to stimulate trade-in. As weâ€™ve explained previously, used videogame growth lags new game growth by six to 12 months and this is playing out as expected.
Net earnings for the quarter were $57.2 million, increasing 162% over prior year quarterâ€™s net earnings of $21.8 million.
Diluted earnings per share for the quarter were $0.34, beating the high-end of previously released guidance by $0.06 per share.
Please note that the acquisition of three record shops in Norway and Finland reduced operating earnings by approximately $2 million during the second quarter and will show up as a reduction to European segment operating earnings when our 10-Q is filed later this month.
Gross margin rate decreased by 20 basis points, due primarily to product mix and the stronger-than-expected sales of hardware during the quarter.
Used videogame margins were especially strong, increasing 120 basis points from the prior year quarter, as fewer promotional activities were needed to drive the business.
SG&A expenses were leveraged by 150 basis points due to strong sales comps and cost controls, particularly in the U.S. segment. This allowed operating earnings to nearly double and operating margins to increase 170 basis points to 5.5%.
Our balance sheet remains strong with $540 million in cash at the end of the quarter and inventories growing ratably to the sales increase during the quarter.
This morning we also issued initial guidance for the third and fourth quarters of 2008, and updated guidance for the full fiscal year. Based on the strong results of the first half and increased confidence in the second half title release schedule, we are increasing various components of our guidance.
First, we had previously expected U.S. videogame software sales to grow between 15% and 20% for 2008, and now we are expecting that growth will exceed 20% for the year.
For the third quarter of 2008, we are expecting diluted earnings per share to range from $0.36 to $0.38, with comparable store sales ranging from flat to plus 2%. As you may recall, the amazingly successful release of Halo 3 and the related hardware sales in the prior year quarter resulted in 46% comps, with no similar title being released in the current quarter.
For the fourth quarter of 2008, we are expecting diluted earnings per share to range from $1.37 to $1.40, representing EPS growth of 23% at the high end.
Comparable store sales growth should range from 8% to 10% for the fourth quarter, with strong results expected across all product categories.
We are raising our diluted EPS guidance for the full year of 2008 to range from $2.45 to $2.50. We now expect full year comparable store sales to grow between 12% and 14% and total sales to grow between 23% and 25%.
Operating margin is expected to be 7.8% at the midpoint of guidance, with gross margins improving 20 basis points from the prior year and SG&A leverage improving by 40 basis points.
Store openings are on target to hit the high end of our 550 to 600 new store range, with new stores performing above expectations, even in this current economic environment.
With that, I will turn it over to the moderator for questions.