GameStop Corp. — Q1 FY2011 Form 10-Q
Business context and reporting period
GameStop is a multichannel video-game retailer operating 6,573 stores across the United States, Australia, Canada and Europe, alongside e-commerce and digital businesses. This unaudited quarter covers the 13 weeks ended April 30, 2011; comparisons are to the 13 weeks ended May 1, 2010. Management cautions that seasonal first-quarter results are not indicative of full-year results; the fourth quarter typically generates the largest share of sales and operating profit.
Financial performance and liquidity
Amounts are in millions of dollars except per-share data and percentages.
| Metric | Q1 FY2011 | Q1 FY2010 |
|---|---|---|
| Sales | $2,281.4 | $2,082.7 |
| Gross profit / margin | $620.2 / 27.2% | $570.8 / 27.4% |
| Operating earnings / margin | $131.1 / 5.8% | $124.5 / 6.0% |
| Net income attributable to GameStop | $80.4 | $75.2 |
| Basic / diluted EPS | $0.56 / $0.56 | $0.49 / $0.48 |
| Cash used in operating activities | $132.5 | $257.8 |
| Cash used in investing activities | $60.1 | $36.1 |
| Cash used in financing activities | $133.0 | $190.6 |
- Sales rose 9.5%, including 5.3% comparable-store growth; foreign exchange added $32.4 million to reported sales. Growth reflected hardware, software and used-product sales, new stores and the Nintendo 3DS launch.
- Gross profit increased 8.7%, but gross margin declined 0.2 percentage points, primarily as lower-margin hardware grew as a share of sales. SG&A rose 9.6% to $442.7 million and remained 19.4% of sales. The $9.3 million derivative-trading loss was recorded in SG&A.
- Cash and cash equivalents were $395.8 million at April 30, 2011, down from $710.8 million at January 29, 2011. The quarter-end balance sheet showed $1,882.8 million of current assets, $1,501.3 million of current liabilities and $4,927.4 million of total assets.
- Operating cash outflow improved by $125.3 million year over year, mainly because working-capital cash use was lower, including reduced inventory purchases and related accounts-payable payments. The quarter nevertheless consumed cash; financing outflows included $139.8 million for treasury-share purchases.
- Long-term senior notes, net of discount, were $249.2 million; the notes carry an 8.0% coupon and mature October 1, 2012. There were no borrowings under the $400 million asset-based revolver and $8.5 million of letters of credit were outstanding. The company reported compliance with debt covenants.
Material changes versus the prior comparable period
- Sales grew across all product categories. New hardware sales increased 24.1%; used-product sales increased 9.5%. Hardware rose to 19.0% of sales from 16.7%, while software declined to 40.1% from 41.9%.
- Operating earnings increased 5.3% and consolidated net income increased 7.0%, but operating margin and gross margin were lower. Net income attributable to GameStop rose 6.9%.
- Interest expense fell to $6.3 million from $10.4 million, primarily reflecting retirement of $200 million of senior notes since January 30, 2010. The estimated effective tax rate increased to 36.0% from 34.9%, primarily due to variability in accounting for uncertain tax positions.
- U.S. operating earnings increased to $131.2 million from $118.6 million. Canada’s operating earnings fell to $0.3 million from $3.8 million; Europe’s operating loss widened to $4.1 million from $0.5 million. Management cited weak existing-store traffic and, in Europe, store-related costs including closures of underperforming locations.
Outlook, risks and contingencies
- Management expected to open approximately 300 stores in FY2011; 62 opened in the quarter. Projected FY2011 capital expenditures were approximately $170 million, and approximately $100 million was 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 investments for at least the next 12 months. This is a forward-looking assessment, not a guarantee.
- Management described continued investment in e-commerce, digital distribution, online gaming, digital kiosks and customer loyalty. It also noted industry risks from alternative software/content distribution and play methods, mobile/social/browser gaming, competition, supplier dependence, economic conditions, international operations and integrating acquisitions.
- Foreign-currency contracts had a net fair-value liability of $6.3 million. A hypothetical 10% move in underlying exchange rates was estimated to change their value by $18.7 million in either direction. These instruments are not designated as hedges; changes in fair value are recognized in earnings.
- Ordinary-course legal matters include wage-and-hour class actions. Management did not believe existing matters or settlements would have a material adverse effect; no material developments in previously reported proceedings were disclosed. Unrecognized tax benefits could change significantly, but management could not estimate a range of possible outcomes.
- The company repurchased 5.9 million shares at an average $19.88 per share under a $500 million authorization for share repurchases and/or senior-note retirement. $382.3 million remained authorized at quarter-end. Repurchases may be suspended or discontinued and are subject to credit-facility restrictions.
Important facts for investors to verify
- Whether comparable-store growth and demand for hardware, software and used products persisted after the Nintendo 3DS launch and the quarter’s favorable foreign-exchange effects.
- Whether margin pressure from hardware mix and promotional activity is offset by higher-margin used and digital sales.
- Whether Europe’s operating losses and weak existing-store traffic improve, and how planned store openings and closures affect costs.
- Whether seasonal working-capital outflows, share repurchases and planned capital spending remain consistent with management’s liquidity assessment and the 2012 senior-note maturity.
- The actual performance and integration costs of digital initiatives and acquisitions, and the earnings and cash-flow effects of foreign-exchange exposures, tax uncertainties and legal matters.