GameStop Corp. — Q1 FY2010 Form 10-Q
Business context and reporting period
GameStop, the video game and PC entertainment retailer, reported unaudited results for the 13 weeks ended May 1, 2010, compared with the 13 weeks ended May 2, 2009. It operated 6,486 stores across the United States, Canada, Australia and Europe. Management cautioned that the business is seasonal and first-quarter results are not indicative of full-year results.
Financial results and liquidity
- Sales: $2.083 billion, up 5.1%. Comparable-store sales declined 1.6%; reported growth included new stores and a $66.0 million favorable foreign-exchange impact.
- Profitability: Gross profit was $570.8 million, up 5.3%, with gross margin unchanged at 27.4%. SG&A rose 7.5% to $403.8 million, or 19.4% of sales versus 19.0%. Operating earnings declined 3.2% to $124.4 million; operating margin was 6.0% versus 6.5%.
- Net income and EPS: Net income attributable to GameStop increased 6.3% to $75.2 million. Diluted EPS was $0.48 versus $0.42; the weighted-average diluted share count fell to 156.5 million from 168.0 million.
- Cash flow: Operations used $257.9 million, versus $268.7 million used a year earlier. Investing activities used $36.0 million, primarily for store openings and technology. Financing activities used $190.6 million, largely for share repurchases. Cash declined $473.5 million from the fiscal-year opening balance.
- Balance sheet and liquidity: Cash was $431.9 million at May 1, down from $905.4 million at January 30 but above $230.3 million a year earlier. Current assets were $1.736 billion and current liabilities $1.285 billion. Inventory was $1.152 billion.
- Debt: Long-term senior notes had a $447.6 million carrying value, bear 8% interest and mature October 1, 2012. The $400 million revolving facility had no borrowings outstanding; letters of credit totaled $8.2 million. The company reported compliance with debt covenants.
Material changes versus the prior comparable period
- New software sales rose 13.3% to $873.1 million, driven by strong new releases; used-product sales increased 4.1% to $570.8 million. Hardware sales fell 12.0% to $348.3 million amid product shortages and lower console price points.
- Gross margin held at 27.4% as stronger software and other-product mix offset lower new-software margin and weaker hardware. New-software gross margin fell to 20.0% from 21.5%; used-product margin remained 48.1%.
- Net income improved despite lower operating earnings, supported by lower interest expense, no debt-extinguishment charge (compared with $2.9 million in 2009), and a lower effective tax rate of 34.8% versus 38.2%.
- Segment operating results weakened outside the U.S.: Europe moved from $5.5 million of operating income to a $0.5 million loss; Canada and Australia also reported lower earnings. U.S. operating earnings increased to $118.6 million.
Outlook, management commentary, risks and unusual items
- Management expected to open approximately 400 stores in FY2010; 74 opened in the quarter. Planned FY2010 capital expenditures were approximately $200 million, with approximately $100 million allocated for acquisitions supporting e-commerce and digital initiatives.
- Management believed cash, operating cash generation and revolver availability would fund operations, debt payments and planned investment for at least the next 12 months. This is a forward-looking assessment, not a guarantee.
- Management cited product availability, weak consumer traffic and macroeconomic conditions as pressures on comparable sales, particularly hardware sales and international operations. Other risks include competition, alternative digital distribution, supplier dependence, store execution, litigation and foreign-currency exposure.
- Foreign-currency contracts produced an $11.9 million gain recorded in SG&A; these instruments are not designated as hedges, so fair-value changes affect reported earnings. A hypothetical 10% currency move was estimated to change contract value by approximately $31.6 million in either direction.
- A wrongful-death lawsuit was dismissed with prejudice at trial but was on appeal; the company said any potential loss if the appeal succeeded could not be estimated. Management did not expect other ordinary-course legal matters to materially affect financial condition, results or liquidity.
- The company repurchased 6.5 million shares during the quarter at an average $19.03, under a $300 million authorization. After quarter-end, it bought another 1.3 million shares at an average $21.43.
Important facts for investors to verify
- Whether hardware supply, comparable-store sales and consumer traffic improved after the quarter, and how durable new-release software growth proved to be.
- Whether SG&A growth and weaker international segment profitability were contained as new stores ramped.
- Cash conversion and inventory levels, given the quarter’s $257.9 million operating cash outflow and $1.152 billion inventory balance.
- Execution and funding of the stated store-opening, capital-spending, acquisition and share-repurchase plans, including revolver availability and covenant conditions.
- Potential earnings volatility from foreign-currency contracts and the outcome of the appealed litigation.