GameStop Corp. - Annual Report: 2011 (Form 10-K)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

Commission File No. 1-32637

 

 

 

 

GameStop Corp.

(Exact name of registrant as specified in its Charter)

 

 

Registrant’s telephone number, including area code:

(817) 424-2000

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

                    (Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The aggregate market value of the voting and non-voting stock held by non-affiliates of the registrant was approximately $3,015,000,000, based upon the closing market price of $20.05 per share of Class A Common Stock on the New York Stock Exchange as of July 30, 2010.

 

Number of shares of $.001 par value Class A Common Stock outstanding as of March 23, 2011: 140,700,393

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the definitive proxy statement of the registrant to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, for the 2011 Annual Meeting of Stockholders are incorporated by reference into Part III.

 

TABLE OF CONTENTS

 

 

 

General

 

GameStop Corp. (together with its predecessor companies, “GameStop,” “we,” “us,” “our,” or the “Company”) is the world’s largest multichannel 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 other merchandise. As of January 29, 2011, we operated 6,670 stores in the United States, Australia, Canada and Europe, primarily under the names GameStop, EB Games and Micromania. We also operate electronic commerce Web sites under the names www.gamestop.com, www.ebgames.com.au, www.gamestop.ca, www.gamestop.it, www.gamestop.es, www.gamestop.ie, www.gamestop.de and www.micromania.fr. In addition, we publish Game Informer magazine, the industry’s largest multi-platform video game magazine in the United States based on circulation, with approximately 5.7 million subscribers, and operate the online video gaming Web site www.kongregate.com.

 

In the fiscal year ended January 29, 2011, we operated our business in the following segments: United States, Canada, Australia and Europe. Of our 6,670 stores, 4,536 stores are included in the United States segment and 345, 405 and 1,384 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. We also sell various types of products that relate to the digital category, including network point cards, prepaid digital and online timecards and digitally downloadable software. Our 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, language translations and the timing of roll-outs of newly developed technology enabling the sale of new products, such as digital add-on content. Stores in all segments are similar in size at an average of approximately 1,400 square feet. Our corporate office and one of our distribution facilities are housed in a 518,000 square foot facility in Grapevine, Texas.

 

The Company began operations in November 1996. In February 2002, GameStop completed an initial public offering of its Class A common stock. In October 2005, GameStop acquired the operations of Electronics Boutique Holdings Corp. (“EB”), 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 “EB merger”).

 

On November 17, 2008, GameStop France SAS, a wholly-owned subsidiary of the Company, completed the acquisition of substantially all of the outstanding capital stock of SFMI Micromania SAS (“Micromania”) for $580.4 million, net of cash acquired (the “Micromania acquisition”). Micromania is a leading retailer of video and computer games in France with 379 locations, 328 of which were operating at the date of acquisition. The Company’s operating results for the 52 weeks ended January 29, 2011 (“fiscal 2010”) and January 30, 2010 (“fiscal 2009”) include Micromania’s results; whereas, the Company’s operating results for the 52 weeks ended January 31, 2009 (“fiscal 2008”) include only 11 weeks of Micromania’s results.

 

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 “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). 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:

 

 

In some cases, forward-looking statements can be identified by the use of terms such as “anticipates,” “believes,” “continues,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “will,” “should,” “seeks,” “pro forma” 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 industry’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.

 

Industry Background

 

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 2010 in the parts of the world in which we operate. According to NPD Group, Inc., a market research firm (the “NPD Group”), the electronic game industry was an approximately $18.5 billion market in the United States in 2010, the majority of which was attributable to video game products, excluding sales of used video game products. International Development Group, a market research firm (“IDG”), estimates that retail sales of video game hardware and software and PC entertainment software totaled approximately $14.3 billion in Europe in 2010. The NPD Group has reported that video game retail sales in Canada were approximately $1.7 billion in 2010. According to the independent market research firm GfK Group, the Australian market for video game products was approximately $1.7 billion in 2010.

Based on internal estimates compiled from a variety of third-party sources, which estimate portions of the digital video game market, the North American market for digital mobile, social, console and PC games was approximately $6 billion in 2010 and the market is expected to grow to approximately $12 billion by 2015.

 

New Video Game Products.  The Entertainment Software Association (“ESA”) estimates that 65% of all American households play video or computer games. We expect the following trends to result in increased sales of video game products:

 

 

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 the NPD Group, we believe that, as of December 2010, the installed base of video game hardware systems in the United States, based on original sales, totaled over 249 million units of handheld and console video game systems. Of the total installed base, 141 million were comprised of the current generation of video game platforms as follows: 15.4 million Sony PlayStation 3 units, 34.2 million Nintendo Wii units, 25.4 million Microsoft Xbox 360 units, 19 million Sony PSP units and 47.3 million Nintendo DS units. The

remainder of the installed base consists of legacy video game platforms, including Sony PlayStation 2, Microsoft Xbox, Nintendo’s GameCube and Game Boy Advance. According to IDG, the installed base of hardware systems as of December 2010 in Europe is approximately 153 million units. Of the total European installed base, 114 million were comprised of the current generation of video game platforms as follows: 14.7 million Sony PlayStation 3 units, 24.9 million Nintendo Wii units, 13.7 million Microsoft Xbox 360 units, 14.8 million Sony PSP units and 46 million Nintendo DS 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 currently exceeds 1.98 billion units. As the substantial installed base of video game hardware and software continues to expand, there is a growing demand for used video game products.

 

PC Entertainment Software.  PC entertainment software is generally played on multimedia PCs featuring fast processors, expanded memories, and enhanced graphics and audio capabilities.

 

Casual Gaming.  The casual game market has grown rapidly over the last few years. Casual games are generally defined as simple, easy-to-use, free or very low-priced games played through the internet in Web browsers, on dedicated gaming Web sites or on mobile phones or other mobile devices. Casual games cost less to develop and distribute than a traditional console video game and are often supported by in-game advertising or user-purchased premium content. The typical casual gamer is predominantly female and older than a traditional console video game player.

 

Business and Growth Strategy

 

Our goal is to continue to be the world’s largest multichannel retailer of new and used video game products and PC entertainment software and provide the best video game content to our customers anytime, anywhere and on any device. We plan to strengthen that position by executing the following strategies:

 

Continuing to Execute our Proven Strategies.  We intend to continue to execute our proven strategies, including:

 

 

 

 

 

Expand our Digital Growth Strategy to Protect and Expand our Market Leadership Position.  We expect that future growth in the video game industry will be driven by the sale of video games delivered in digital form and the expansion of other forms of gaming. We currently sell various types of products that relate to the digital category, including Xbox Live, PlayStation and Nintendo network point cards, as well as prepaid digital and online timecards and digitally downloadable software. We operate an online video game platform called Kongregate.com which we acquired in August 2010. We continue to make significant investments in e-commerce, digital delivery systems, online video game aggregation, digital kiosks and in-store and Web site functionality to enable our customers to access digital content and eliminate friction in the digital sales and delivery process. We plan to continue to invest in

these types of processes and channels to grow our digital sales base and enhance our market leadership position in the video game industry and in the digital aggregation and distribution category.

 

Targeting a Broad Audience of Game Players.  We have created store and online environments 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 “hottest” 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. Our online properties, including e-commerce sites and Kongregate.com, continue to evolve to meet the needs of consumers looking to research or buy traditional boxed product video games, download the latest PC games or play browser and casual games on their PCs or Android mobile devices.

 

Enhancing our Image as a Destination Location.  Our stores and e-commerce sites serve as destination locations for game players and gift givers due to our broad selection of products, compelling PowerUp Rewards loyalty programs, 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. In our stores, 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, making them the most knowledgeable associates in the video game retail market. Our stores are equipped with several video game sampling areas, which provide our customers with the opportunity to play games before purchase, as well as equipment to play video game clips.

 

Kongregate.com serves as a destination for gamers seeking the latest in online game play with over 35,000 games from over 8,000 developers in a social environment in which gamers can connect with their friends and compare achievements. Many of the favorite Kongregate games are available through the Kongregate app in the Android marketplace for use on Android mobile devices.

 

Consistently Achieving High New Release Market Share.  We employ a variety of rapid-response distribution methods in our efforts to be the first-to-market and consistently in stock for new video game products and PC entertainment software. This highly efficient distribution network is essential, as a significant portion of a new title’s sales will be generated in the first few days and weeks following its release. As the world’s largest retailer of video game products and PC entertainment software with a proven capability to distribute new releases to our customers quickly, we believe that we regularly receive a large allocation of popular new video game products and PC entertainment software. On a daily basis, we actively monitor sales trends, customer reservations and store manager feedback to ensure a high in-stock position for each store. To assist our customers in obtaining immediate access to new releases, we offer our customers the opportunity to pre-order products in our stores or through our Web sites prior to their release.

 

Investing in our Information Systems and Distribution Capabilities.  We employ sophisticated and fully-integrated inventory management, store-level point of sale and financial systems and state-of-the-art distribution facilities. These systems enable us to maximize the efficiency of the flow of over 4,500 SKUs, improve store efficiency, optimize store in-stock positions and carry a broad selection of inventory. Our proprietary inventory management systems enable us to maximize sales of new release titles and avoid markdowns as titles mature and utilize electronic point-of-sale equipment that provides corporate and regional headquarters with daily information regarding store-level sales and available inventory levels to automatically generate replenishment shipments to each store at least twice a week. In addition, our highly-customized inventory management systems allow us to actively manage the pricing and product availability of our used video game products across our store base and to reallocate our inventory as necessary. Our systems enable each store to carry a merchandise assortment uniquely tailored to its own sales mix and customer needs. Our ability to react quickly to consumer purchasing trends has resulted in a target mix of inventory, reduced shipping and handling costs for overstocks and reduced our need to discount products.

Operating Segments

 

We identified our four operating segments based on a combination of geographic areas, the methods with which we analyze performance and how we divide management responsibility. Segment results for the United States include retail operations in the 50 states, the District of Columbia, Guam and Puerto Rico, the electronic commerce Web site www.gamestop.com, Game Informer magazine, and the online video gaming Web sites www.kongregate.com and www.joltonline.com. Segment results for Canada include retail and e-commerce operations in stores throughout Canada and segment results for Australia include retail and e-commerce operations in Australia and New Zealand. Segment results for Europe include retail and e-commerce operations in 13 European countries.

 

Our U.S. segment is supported by distribution centers in Texas and Kentucky, and further supported by the use of third-party distribution centers for new release titles. We distribute merchandise to our Canadian segment from distribution centers in Ontario. We have a distribution center near Brisbane, Australia which supports our Australian operations and a small distribution facility in New Zealand which supports the stores in New Zealand. European segment operations are supported by six regionally-located distribution centers.

 

All of our segments purchase products from many of the same vendors, including Sony Corporation (“Sony”) and Electronic Arts. Products from certain other vendors such as Microsoft and Nintendo are obtained either directly from the manufacturer or publisher or through distributors depending upon the particular market in which we operate.

 

Additional information, including financial information, regarding our operating segments can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” elsewhere in this Annual Report on Form 10-K and in Note 17 of “Notes to Consolidated Financial Statements.”

 

Merchandise

 

Substantially all of our revenues are derived from the sale of tangible products; however, we also sell downloadable software and subscription, time and points cards which do not involve physical product. Our product offerings consist of new and used video game products, PC entertainment software, and related products, such as video game accessories and strategy guides. Our in-store inventory generally consists of a constantly changing selection of over 4,500 SKUs. We have buying groups in each of our segments that negotiate terms, discounts and cooperative advertising allowances for the stores in their respective geographic areas. We use customer requests and feedback, advance orders, industry magazines and product reviews to determine which new releases are expected to be hits. Advance orders are tracked at individual stores to distribute titles and capture demand effectively. This merchandise management is essential because a significant portion of a game’s sales are usually generated in the first days and weeks following its release.

 

Video Game Hardware.  We offer the video game platforms of all major manufacturers, including the Sony PlayStation 2 and 3 and PSP, Microsoft Xbox 360 and Kinect, the Nintendo DSi, DSi XL and Wii. We also offer extended service agreements on video game hardware and software. In support of our strategy to be the destination location for electronic game players, we aggressively promote the sale of video game platforms. Video game hardware sales are generally driven by the introduction of new platform technology and the reduction in price points as platforms mature. Due to our strong relationships with the manufacturers of these platforms, we often receive disproportionately large allocations of new release hardware products, which is an important component of our strategy to be the destination of choice for electronic game players. We believe that selling video game hardware increases store traffic and promotes customer loyalty, leading to increased sales of video game software and accessories, which have higher gross margins than video game hardware.

 

Video Game Software.  We purchase new video game software from the leading manufacturers, including Sony, Nintendo and Microsoft, as well as over 50 third-party game publishers, such as Electronic Arts and Activision. We are one of the largest customers of video game titles sold by these publishers. We generally carry over 1,000 SKUs of new video game software at any given time across a variety of genres, including Sports, Action, Strategy, Adventure/Role Playing and Simulation. In 2010, we began selling digitally downloadable add-on content developed by publishers for existing games.

Used Video Game Products.  We believe we are the largest retailer of used video games in the world. We provide our customers with an opportunity to trade in their used video game products in our stores in exchange for store credits which can be applied towards the purchase of other products, primarily new merchandise. We have the largest selection (approximately 3,000 SKUs) of used video game titles which have an average price of $16 as compared to an average price of $42 for new video game titles and which generate significantly higher gross margins than new video game products. Our trade-in program provides our customers with a unique value proposition which is generally unavailable at mass merchants, toy stores and consumer electronics retailers. This program provides us with an inventory of used video game products which we resell to our more value-oriented customers. In addition, our highly-customized inventory management system allows us to actively manage the pricing and product availability of our used video game products across our store base and to reallocate our inventory as necessary. Our trade-in program also allows us to be one of the only suppliers of previous generation platforms and related video games. We also operate refurbishment centers in the U.S., Canada, Australia and Europe where defective video game products can be tested, repaired, relabeled, repackaged and redistributed back to our stores.

 

PC Entertainment and Other Software.  We purchase PC entertainment software from over 20 publishers, including Electronic Arts, Microsoft and Activision. We offer PC entertainment software across a variety of genres, including Sports, Action, Strategy, Adventure/Role Playing and Simulation.

 

Downloadable Content and Subscription, Time and Points Cards.  The proliferation of online game play through Microsoft Xbox Live, the PlayStation Network and online PC gaming sites has led to consumer demand for subscription, time and points cards (which we call digital currency) and digitally downloadable content for existing video games. We sell a wide variety of digital currency and we have developed technology to sell downloadable content in our stores and on our U.S. Web site. We believe we are the leading retailer for the sale of digital currency and downloadable content for Xbox Live and the PlayStation Network.

 

Accessories and Other Products.  Video game accessories consist primarily of controllers, memory cards and other add-ons and, since September 2010, the Sony Move motion controller. We also carry strategy guides, magazines and trading cards. We carry over 300 SKUs of accessories and other products. In general, this category has higher margins than new video game and PC entertainment products.

 

Store Operations

 

As of January 29, 2011, we operated 6,670 stores, primarily under the names GameStop, EB Games and Micromania. We design our stores to provide an electronic gaming atmosphere with an engaging and visually captivating layout. Our stores are typically 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. We use store configuration, in-store signage and product demonstrations to produce marketing opportunities both for our vendors and for us.

 

Our stores average approximately 1,400 square feet and carry a balanced mix of new and used video game products and PC entertainment software. Our stores are generally located in high-traffic “power strip centers,” local neighborhood strip centers, high-traffic shopping malls and pedestrian areas, primarily in major metropolitan areas. These locations provide easy access and high frequency of visits and, in the case of strip centers and high-traffic pedestrian stores, high visibility. We target strip centers that are conveniently located, have a mass merchant or supermarket anchor tenant and have a high volume of customers.

 

Site Selection and Locations

 

Site Selection.  Site selections for new stores are made after an extensive review of demographic data and other information relating to market potential, competitor access and visibility, compatible nearby tenants, accessible parking, location visibility, lease terms and the location of our other stores. Most of our stores are located in highly visible locations within malls and strip centers. In each of our geographic segments, we have a dedicated staff of real estate personnel experienced in selecting store locations.

Locations.  The table below sets forth the number of our stores located in the U.S., Canada, Europe and Australia as of January 29, 2011:

 

 

 

Game Informer

 

We publish Game Informer magazine, a monthly video game magazine featuring reviews of new title releases, tips and secrets about existing games and news regarding current developments in the electronic game industry. Versions of the magazine are sold through subscription, digitally and through displays in our stores throughout most of the world. Game Informer is the fifth largest consumer publication in the U.S. and for its January 2011 issue, the magazine had approximately 5.7 million paid subscriptions. Game Informer is now provided to PowerUp Rewards loyalty card members as a key feature of each paid PowerUp Rewards membership. Game Informer revenues are

also generated through the sale of advertising space. We also operate the Web site www.gameinformer.com, which is the premier destination for moment-by-moment news, features and reviews related to video gaming. English version results from Game Informer operations are included in the United States segment where the majority of subscriptions and sales are generated. Other international version results from Game Informer operations are included in the segment in which the sales are generated.

 

E-Commerce

 

We operate several electronic commerce Web sites in various countries, including www.gamestop.com, www.ebgames.com.au, www.gamestop.ca, www.gamestop.it, www.gamestop.es, www.gamestop.ie, www.gamestop.de and www.micromania.fr, that allow our customers to buy video game products and other merchandise online and, in some cases, allow customers to reserve merchandise and then pick it up in stores. The sites also offer customers information and content about available games, release dates for upcoming games, and access to store information, such as location and product availability. E-commerce results are included in the geographic segment where the sales originate.

 

Kongregate

 

In August 2010, we purchased Kongregate Inc., the operator of online video gaming site www.kongregate.com, which offers free-to-play video games to over 13 million unique visitors per month. Kongregate earns revenues from in-game advertising and offering game players the opportunity to advance their game play with in-game transactions (called micro-transactions). Kongregate has a proprietary virtual currency called Kreds which can be purchased and then used to pay for in-game transactions. Over 8,000 developers have used the software development kits created by Kongregate to integrate over 35,000 games into the Kongregate.com environment.

 

Advertising

 

Our stores are primarily located in high traffic, high visibility areas of regional shopping malls, strip centers and pedestrian shopping areas. Given the high foot traffic drawn past the stores themselves, we use in-store marketing efforts such as window displays and “coming soon” signs to attract customers, as well as to promote used video game products. Inside the stores, we feature selected products through the use of vendor displays, “coming soon” or preview videos, signs, catalogs, point-of-purchase materials and end-cap displays. These advertising efforts are designed to increase the initial sales of new titles upon their release.

 

On a global basis, we receive cooperative advertising and market development funds from manufacturers, distributors, software publishers and accessory suppliers to promote their respective products. Generally, vendors agree to purchase advertising space in one of our advertising vehicles. Once we run the advertising, the vendor pays to us an agreed amount.

 

In fiscal 2010, we launched our new PowerUp Rewards loyalty program in the United States which gives our customers the ability to sign-up for a free or paid membership that offers points earned on purchases in our stores, on our U.S. Web site and on Kongregate.com, which can be redeemed for discounts or merchandise. The program’s paid tier also includes a subscription to Game Informer magazine, additional discounts on selected merchandise and additional credit on trade-ins in our stores. This program is designed to incent our customers to shop more often at our stores and to allow us to market directly to our customers based on their individual tastes and preferences. Our PowerUp Rewards program provides members with the opportunity to earn one-of-a-kind video game related rewards not available through any other retailer. Vendors also participate in this program to increase the sales of their individual products.

 

In the last several years, as part of our brand-building efforts and targeted growth strategies, we expanded our advertising and promotional activities in certain targeted markets at certain key times of the year. In addition, we expanded our use of television and radio advertising in certain markets to promote brand awareness and store openings. We expect our investment in advertising, including PowerUp Rewards, to increase as we continue to expand our membership base and build our brand.

Information Management

 

Our operating strategy involves providing a broad merchandise selection to our customers as quickly and as cost-effectively as possible. We use our inventory management systems to maximize the efficiency of the flow of products to our stores, enhance store efficiency and optimize store in-stock and overall investment in inventory.

 

Distribution.  We operate distribution facilities in various locations throughout the world, with each location strategically located to support the operations in a particular country or region. In order to enhance our first-to- market distribution network, we also utilize the services of several off-site, third-party operated distribution centers that pick up products from our suppliers, repackage the products for each of our stores and ship those products to our stores by package carriers. Our ability to rapidly process incoming shipments of new release titles at our facilities and third-party facilities and deliver those shipments to all of our stores, either that day or by the next morning, enables us to meet peak demand and replenish stores. Inventory is shipped to each store at least twice a week, or daily, if necessary, in order to keep stores in supply of products. Our distribution facilities also typically support refurbishment of used products to be redistributed to our stores.

 

We distribute products to our U.S. stores through a 362,000 square foot distribution center in Grapevine, Texas and a 260,000 square foot distribution center in Louisville, Kentucky. We currently use the center in Louisville, Kentucky to support our first-to-market distribution efforts, while our Grapevine, Texas facility supports efforts to replenish stores. The state-of-the-art facilities in both U.S. locations are designed to effectively control and minimize inventory levels. Technologically-advanced conveyor systems and flow-through racks control costs and improve speed of fulfillment in both facilities. The technology used in the distribution centers allows for high-volume receiving, distributions to stores and returns to vendors.

 

We distribute merchandise to our Canadian segment from two distribution centers in Brampton, Ontario. We have a distribution center near Brisbane, Australia which supports our Australian operations and a small distribution facility in New Zealand which supports the stores in New Zealand. European segment operations are supported by six regionally-located distribution centers in Milan, Italy; Memmingen, Germany; Arlov, Sweden; Valencia, Spain; Dublin, Ireland; and Paris, France. We continue to invest in state-of-the-art facilities in our distribution centers as the distribution volume, number of stores supported and returns on such investments permit.

 

Digital Distribution.  We have developed proprietary technology to work in conjunction with both Microsoft and Sony to enable us to sell digitally distributed game content in our stores, through our in-store kiosks and on our e-commerce sites. The downloadable content typically available today consists of add-on content developed by publishers for existing games.

 

Management Information Systems.  Our proprietary inventory management systems and point-of-sale technology show daily sales and in-store stock by title by store. Our systems use this data to automatically generate replenishment shipments to each store from our distribution centers, enabling each store to carry a merchandise assortment uniquely tailored to its own sales mix and rate of sale. Our call lists and reservation system also provide our buying staff with information to determine order size and inventory management for store-by-store inventory allocation. We constantly review and edit our merchandise categories with the objective of ensuring that inventory is up-to-date and meets customer needs.

 

To support most of our operations, we use a large-scale, Intel-based computing environment with a state-of-the-art storage area network and a wired and wireless corporate network installed at our U.S. and regional headquarters, and a secure, virtual private network to access and provide services to computing assets located in our stores, distribution centers and satellite offices and to our mobile workforce. This strategy has proven to minimize initial outlay of capital while allowing for flexibility and growth as operations expand. To support certain of our international operations, we use a mid-range, scalable computing environment and a state-of-the-art storage area network. Computing assets and our mobile workforce around the globe access this environment via a secure, virtual private network. Regional communication links exist to each of our distribution centers and offices in international locations with connectivity to our U.S. data center as required by our international, distributed applications.

 

Our in-store point-of-sale system enables us to efficiently manage in-store transactions. This proprietary point-of-sale system has been enhanced to facilitate trade-in transactions, including automatic look-up of trade-in prices and printing of machine-readable bar codes to facilitate in-store restocking of used video games. In addition,

our central database of all used video game products allows us to actively manage the pricing and product availability of our used video game products across our store base and reallocate our used video game products as necessary.

 

Field Management and Staff

 

Each of our stores employs, on average, one manager, one assistant manager and between two and ten sales associates, many of whom are part-time employees. Each store manager is responsible for managing their personnel and the economic performance of their store. We have cultivated a work environment that attracts employees who are actively interested in electronic games. We seek to hire and retain employees who know and enjoy working with our products so that they are better able to assist customers. To encourage them to sell the full range of our products and to maximize our profitability, we provide our employees with targeted incentive programs to drive overall sales and sales of higher margin products. In certain locations, we also provide certain employees with the opportunity to take home and try new video games, which enables them to better discuss those games with our customers. In addition, employees are casually dressed to encourage customer access and increase the “game-oriented” focus of the stores.

 

Our stores communicate with our corporate offices daily via e-mail. This e-mail allows for better tracking of trends in upcoming titles, competitor strategies and in-stock inventory positions. In addition, this communication allows title selection in each store to be continuously updated and tailored to reflect the tastes and buying patterns of the store’s local market. These communications also give field management access to relevant inventory levels and loss prevention information. We have invested in significant management training programs for our store managers and our district managers to enhance their business management skills. We also sponsor annual store managers’ conferences at which we operate an intense educational training program to provide our employees with information about the video game products that will be released by publishers in the holiday season. All video game software publishers are invited to attend the conferences.

 

GameStop’s U.S. store operations are managed by a centrally-located senior vice president of stores, four vice presidents of stores and 31 regional store operations directors. The regions are further divided into districts, each with a district manager covering an average of 15 stores. In total, there are approximately 308 districts. Our international operations are managed by a senior executive, with stores in Europe managed by two senior vice presidents, one vice president and managing directors in each region and our stores in Australia and Canada each managed by a vice president. We also employ regional loss prevention managers who assist the stores in implementing security measures to prevent theft of our products.

 

Customer Service

 

Our store personnel provide value-added services to each customer, such as maintaining lists of regular customers and reserving new releases for customers with a down payment to ensure product availability. In addition, our store personnel readily provide product reviews to ensure customers are making informed purchasing decisions and inform customers of available resources, including Game Informer and our e-commerce sites, to increase a customer’s enjoyment of the product upon purchase.

 

Vendors

 

We purchase substantially all of our new products worldwide from approximately 75 manufacturers and software publishers and several distributors. Purchases from the top ten vendors accounted for approximately 82% of our new product purchases in fiscal 2010. Only Microsoft, Nintendo, Sony, Activision and Electronic Arts (which accounted for 18%, 16%, 16%, 12%, and 10%, respectively) individually accounted for more than 10% of our new product purchases during fiscal 2010. We have established price protections and return privileges with our primary vendors in order to reduce our risk of inventory obsolescence. In addition, we have few purchase contracts with trade vendors and generally conduct business on an order-by-order basis, a practice that is typical throughout the industry. We believe that maintaining and strengthening our long-term relationships with our vendors is essential to our operations and continued expansion. We believe that we have very good relationships with our vendors.

Competition

 

The electronic game industry is intensely competitive and subject to rapid changes in consumer preferences and frequent new product introductions. We compete with mass merchants and regional chains; computer product and consumer electronics stores; other video game and PC software specialty stores; toy retail chains; mail-order businesses; catalogs; direct sales by software publishers; and online retailers and game rental companies. In addition, video games are available for sale and rental from many video stores. Video game products are also distributed through other methods such as digital delivery. We also compete with sellers of used video game products. Additionally, we compete with other forms of entertainment activities, including casual and mobile games, movies, television, theater, sporting events and family entertainment centers.

 

In the U.S., we compete with Wal-Mart Stores, Inc. (“Wal-Mart”); Target Corporation (“Target”); and Best Buy Co., Inc. (“Best Buy”). Competitors in Europe include Game Group plc (“Game Group”) and its subsidiaries, which operate in the United Kingdom, Ireland, Scandinavia, France, Spain and Portugal, and Media Markt and Carrefour, which operate throughout Europe, and other regional hypermarket chains. Competitors in Canada include Wal-Mart, Best Buy and its subsidiary Future Shop. In Australia, competitors include Game Group, K-Mart, Target and JB HiFi stores.

 

Seasonality

 

Our business, like that of many retailers, is seasonal, with the major portion of our sales and operating profit realized during the fourth fiscal quarter, which includes the holiday selling season. During fiscal 2010, we generated approximately 39% of our sales and approximately 57% of our operating earnings during the fourth quarter. During fiscal 2009, we generated approximately 39% of our sales and approximately 55% of our operating earnings during the fourth quarter.

 

Trademarks

 

We have a number of trademarks and servicemarks, including “GameStop,” “Game Informer,” “EB Games,” “Electronics Boutique,” “Kongregate,” “Power to the Players,” and “PowerUp Rewards,” which have been registered by us with the United States Patent and Trademark Office. For many of our trademarks and servicemarks, including “Micromania”, we also have registered or have registrations pending with the trademark authorities throughout the world. We maintain a policy of pursuing registration of our principal marks and opposing any infringement of our marks.

 

Employees

 

We have approximately 17,000 full-time salaried and hourly employees and between 31,000 and 51,000 part-time hourly employees worldwide, depending on the time of year. Fluctuation in the number of part-time hourly employees is due to the seasonality of our business. We believe that our relationship with our employees is excellent. Some of our international employees are covered by collective bargaining agreements, while none of our U.S. employees are represented by a labor union or are members of a collective bargaining unit.

 

Available Information

 

We make available on our corporate Web site (www.gamestopcorp.com), under “Investor Relations — SEC Filings,” free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon as reasonably practicable after we electronically file or furnish such material with the Securities and Exchange Commission (“SEC”). You may read and copy this information or obtain copies of this information by mail from the Public Reference Room of the SEC, 100 F Street, N.E., Washington, D.C. 20549, at prescribed rates. Further information on the operation of the SEC’s Public Reference Room in Washington, D.C. can be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains a Web site that contains reports, proxy statements and other information about issuers, like GameStop, who file electronically with the SEC. The address of that site is http://www.sec.gov. In addition to copies of our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, the Company’s Code of Standards, Ethics and Conduct is available on our Web site under “Investor Relations — Corporate Governance” and is available to our stockholders in

print, free of charge, upon written request to the Company’s Investor Relations Department at GameStop Corp., 625 Westport Parkway, Grapevine, Texas 76051.

 

 

An investment in our Company involves a high degree of risk. You should carefully consider the risks below, together with the other information contained in this report, before you make an investment decision with respect to our Company. The risks described below are not the only ones facing our Company. Additional risks not presently known to us, or that we consider immaterial, may also impair our business operations. Any of the following risks could materially adversely affect our business, operating results or financial condition, and could cause a decline in the trading price of our common stock and the value of your investment.

 

Risks Related to Our Business

 

We depend upon our key personnel and they would be difficult to replace.

 

Our success depends upon our ability to attract, motivate and retain key management for our stores and skilled merchandising, marketing, financial and administrative personnel at our headquarters. We depend upon the continued services of our key executive officers: Daniel A. DeMatteo, our Executive Chairman; J. Paul Raines, our Chief Executive Officer; Tony D. Bartel, our President; Robert A. Lloyd, our Executive Vice President and Chief Financial Officer; and Michael Mauler, our Executive Vice President-International. The loss of services of any of our key personnel could have a negative impact on our business.

 

We depend upon the timely delivery of products.

 

We depend on major hardware manufacturers, primarily Sony, Nintendo and Microsoft, to deliver new and existing video game platforms and new innovations on a timely basis and in anticipated quantities. In addition, we depend on software publishers to introduce new and updated software titles. Any material delay in the introduction or delivery, or limited allocations, of hardware platforms or software titles could result in reduced sales in one or more fiscal quarters.

 

We depend upon third parties to develop products and software.

 

Our business depends upon the continued development of new and enhanced video game platforms and accessories, PC hardware and video game and PC entertainment software. Our business could suffer due to the failure of manufacturers to develop new or enhanced video game platforms, a decline in the continued technological development and use of multimedia PCs, or the failure of software publishers to develop popular game and entertainment titles for current or future generation video game systems or PC hardware.

 

Our ability to obtain favorable terms from our suppliers may impact our financial results.

 

Our financial results depend significantly upon the business terms we can obtain from our suppliers, including competitive prices, unsold product return policies, advertising and market development allowances, freight charges and payment terms. We purchase substantially all of our products directly from manufacturers, software publishers and, in some cases, distributors. Our largest vendors worldwide are Microsoft, Nintendo, Sony, Activision and Electronic Arts, which accounted for 18%, 16%, 16%, 12% and 10%, respectively, of our new product purchases in fiscal 2010. If our suppliers do not provide us with favorable business terms, we may not be able to offer products to our customers at competitive prices.

 

If our vendors fail to provide marketing and merchandising support at historical levels, our sales and earnings could be negatively impacted.

 

The manufacturers of video game hardware and software and PC entertainment software have typically provided retailers with significant marketing and merchandising support for their products. As part of this support, we receive cooperative advertising and market development payments from these vendors. These cooperative advertising and market development payments enable us to actively promote and merchandise the products we sell

and drive sales at our stores and on our Web sites. We cannot assure you that vendors will continue to provide this support at historical levels. If they fail to do so, our sales and earnings could be negatively impacted.

 

The electronic game industry is cyclical, which could cause significant fluctuation in our earnings.

 

The electronic game industry has been cyclical in nature in response to the introduction and maturation of new technology. Following the introduction of new video game platforms, sales of these platforms and related software and accessories generally increase due to initial demand, while sales of older platforms and related products generally decrease as customers migrate toward the new platforms. New video game platforms have historically been introduced approximately every five years. The current generation of video game consoles were introduced in 2005 and 2006. In 2010, Microsoft introduced the Kinect, a motion sensing accessory for the Xbox 360, and Sony introduced the Move, a motion control accessory for the PlayStation 3. These accessories are designed to take advantage of the processing power in the current platforms and are believed to extend the current video game hardware cycle beyond the historical five-year length. If these new motion accessories fail to appeal to consumers or if video game platform manufacturers fail to develop new hardware platforms, our sales of video game products could decline.

 

Pressure from our competitors may force us to reduce our prices or increase spending, which could decrease our profitability.

 

The electronic game industry is intensely competitive and subject to rapid changes in consumer preferences and frequent new product introductions. We compete with mass merchants and regional chains, including Wal-Mart and Target; computer product and consumer electronics stores, including Best Buy; other U.S. and international video game and PC software specialty stores located in malls and other locations, such as Game Group, Carrefour and Media Markt; toy retail chains; mail-order businesses; catalogs; direct sales by software publishers; and online retailers and game rental companies. Some of our competitors have longer operating histories and may have greater financial resources than we do. In addition, video game products and content are increasingly being digitally distributed and other methods may emerge in the future. We also compete with other sellers of used video game products. Additionally, we compete with other forms of entertainment activities, including browser, social and mobile games, movies, television, theater, sporting events and family entertainment centers. If we lose customers to our competitors, or if we reduce our prices or increase our spending to maintain our customers, we may be less profitable.

 

International events could delay or prevent the delivery of products to our suppliers.

 

Our suppliers rely on foreign sources, primarily in Asia, to manufacture a portion of the products we purchase from them. As a result, any event causing a disruption of imports, including natural disasters or the imposition of import restrictions or trade restrictions in the form of tariffs or quotas, could increase the cost and reduce the supply of products available to us, which could lower our sales and profitability.

 

Our international operations expose us to numerous risks.

 

We have international retail operations in Australia, Canada and Europe. Because release schedules for hardware and software introduction in these markets often differ from release schedules in the United States, the timing of increases and decreases in foreign sales may differ from the timing of increases and decreases in domestic sales. We are also subject to a number of other factors that may affect our current or future international operations. These include:

 

 

There may be possible changes in our global tax rate.

 

As a result of our operations in many foreign countries, our global tax rate is derived from a combination of applicable tax rates in the various jurisdictions in which we operate. Depending upon the sources of our income, any agreements we may have with taxing authorities in various jurisdictions and the tax filing positions we take in various jurisdictions, our overall tax rate may be higher than other companies or higher than our tax rates have been in the past. We base our estimate of an annual effective tax rate at any given point in time on a calculated mix of the tax rates applicable to our Company and to estimates of the amount of income to be derived in any given jurisdiction. A change in the mix of our business from year to year and from country to country, changes in rules related to accounting for income taxes, changes in tax laws in any of the multiple jurisdictions in which we operate or adverse outcomes from the tax audits that regularly are in process in any jurisdiction in which we operate could result in an unfavorable change in our overall tax rate, which could have a material adverse effect on our business and results of our operations.

 

If we are unable to renew or enter into new leases on favorable terms, our revenue growth may decline.

 

All of our retail stores are located in leased premises. If the cost of leasing existing stores increases, we cannot assure you that we will be able to maintain our existing store locations as leases expire. In addition, we may not be able to enter into new leases on favorable terms or at all, or we may not be able to locate suitable alternative sites or additional sites for new store expansion in a timely manner. Our revenues and earnings may decline if we fail to maintain existing store locations, enter into new leases, locate alternative sites or find additional sites for new store expansion.

 

Restrictions on our ability to take trade-ins of and sell used video game products could negatively affect our financial condition and results of operations.

 

Our financial results depend on our ability to take trade-ins of, and sell, used video game products within our stores. Actions by manufacturers or publishers of video game products or governmental authorities to limit our ability to take trade-ins or sell used video game products could have a negative impact on our sales and earnings.

 

If we fail to keep pace with changing industry technology, we will be at a competitive disadvantage.

 

The interactive entertainment industry is characterized by swiftly changing technology, evolving industry standards, frequent new and enhanced product introductions and product obsolescence. These characteristics require us to respond quickly to technological changes and to understand their impact on our customers’ preferences. If we fail to keep pace with these changes, our business may suffer.

 

Technological advances in the delivery and types of video games and PC entertainment software, as well as changes in consumer behavior related to these new technologies, could lower our sales.

 

While it is currently only possible to download a limited amount of video game content to the next generation video game systems and downloading is constrained by bandwidth capacity, this technology is becoming more prevalent. If advances in technology continue to expand our customers’ ability to access and download the current format of video games, PC entertainment software and incremental content for their games through these and other sources, our customers may no longer choose to purchase video games or PC entertainment software in our stores or reduce their purchases in favor of other forms of game delivery. As a result, sales and earnings could decline. While the Company is currently pursuing various strategies to integrate these new delivery methods and competing content into the Company’s business model, including hiring employees with experience in digital gaming and making investments in and acquisitions of digital gaming and technology-based companies, we can provide no assurances that these strategies will be successful or profitable.

 

An adverse trend in sales during the holiday selling season could impact our financial results.

 

Our business, like that of many retailers, is seasonal, with the major portion of our sales and operating profit realized during the fourth fiscal quarter, which includes the holiday selling season. During fiscal 2010, we generated approximately 39% of our sales and approximately 57% of our operating earnings during the fourth quarter. Any

adverse trend in sales during the holiday selling season could lower our results of operations for the fourth quarter and the entire fiscal year.

 

Our results of operations may fluctuate from quarter to quarter, which could affect our business, financial condition and results of operations.

 

Our results of operations may fluctuate from quarter to quarter depending upon several factors, some of which are beyond our control. These factors include:

 

 

These and other factors could affect our business, financial condition and results of operations, and this makes the prediction of our financial results on a quarterly basis difficult. Also, it is possible that our quarterly financial results may be below the expectations of public market analysts.

 

Failure to effectively manage our new store openings could lower our sales and profitability.

 

Our growth strategy depends in part upon opening new stores and operating them profitably. We opened 359 stores in fiscal 2010 and expect to open approximately 300 new stores in fiscal 2011. Our ability to open new stores and operate them profitably depends upon a number of factors, some of which may be beyond our control. These factors include:

 

 

Our growth will also depend on our ability to process increased merchandise volume resulting from new store openings through our inventory management systems and distribution facilities in a timely manner. If we fail to manage new store openings in a timely and cost efficient manner, our growth may decrease.

 

Failure to execute our strategy to close stores and transfer customers and sales to nearby stores.

 

Our strategy includes closing stores which are not meeting our performance hurdles or stores at the end of their lease terms and transferring sales to other nearby GameStop locations. We believe that we can ultimately increase profitability by successfully transferring customers and sales to other stores by marketing directly to the PowerUp Rewards members who have shopped in the stores which we plan to close. If we are unsuccessful in marketing to customers of the stores which we plan to close or in transferring sales to nearby stores, our sales and profitability could be adversely affected.

 

If our management information systems fail to perform or are inadequate, our ability to manage our business could be disrupted.

 

We rely on computerized inventory and management systems to coordinate and manage the activities in our distribution centers, as well as to communicate distribution information to the off-site, third-party operated distribution centers with which we work. The third-party distribution centers pick up products from our suppliers, repackage the products for each of our stores and ship those products to our stores by package carriers. We use

inventory replenishment systems to track sales and inventory. Our ability to rapidly process incoming shipments of new release titles and deliver them to all of our stores, either that day or by the next morning, enables us to meet peak demand and replenish stores at least twice a week, to keep our stores in stock at optimum levels and to move inventory efficiently. If our inventory or management information systems fail to adequately perform these functions, our business could be adversely affected. In addition, if operations in any of our distribution centers were to shut down or be disrupted for a prolonged period of time or if these centers were unable to accommodate the continued store growth in a particular region, our business could suffer.

 

We have made and may make investments and acquisitions which could negatively impact our business if we fail to successfully complete and integrate them.

 

To enhance our efforts to grow and compete, we have made and continue to make investments and acquisitions. These activities include investments in and acquisitions of digital, browser, social and mobile gaming and technology-based companies as the delivery methods for video games continues to evolve. Our plans to pursue future transactions are subject to our ability to identify potential candidates and negotiate favorable terms for these transactions. Accordingly, we cannot assure you that future investments or acquisitions will be completed. In addition, to facilitate future transactions, we may take actions that could dilute the equity interests of our stockholders, increase our debt or cause us to assume contingent liabilities, all of which may have a detrimental effect on the price of our common stock. Finally, if any acquisitions are not successfully integrated with our business, our ongoing operations could be adversely affected. Integration of digital, browser, social and mobile gaming and technology-based companies may be particularly challenging to us as these companies are outside of our historical operating expertise.

 

We may not compete effectively as browser, mobile and social gaming becomes more popular.

 

Gaming continues to evolve. Recently, the popularity of browser, mobile and social gaming has increased greatly and this popularity is expected to continue to grow. Browser, mobile and social gaming is accessed through hardware other than the consoles we sell. If we are unable to respond to this growth in popularity of browser, mobile and social games and transition our business to take advantage of these new forms of gaming, our financial position and results of operations could suffer. While the Company has been and is currently pursuing various strategies to integrate these new forms of gaming into the Company’s business model, we can provide no assurances that these strategies will be successful or profitable.

 

Litigation and litigation results could negatively impact our future financial condition and results of operations.

 

In the ordinary course of our business, the Company is, from time to time, subject to various litigation and legal proceedings. In the future, the costs or results of such legal proceedings, individually or in the aggregate, could have a negative impact on the Company’s results of operations or financial condition.

 

Legislative actions may cause our general and administrative expenses or income tax expense to increase and impact our future financial condition and results of operations.

 

In order to comply with laws adopted by the U.S. government or other regulatory bodies, we may be required to increase our expenditures and hire additional personnel and additional outside legal, accounting and advisory services, all of which may cause our general and administrative costs or income tax expenses to increase. Changes in the accounting rules could materially increase the expenses that we report under U.S. generally accepted accounting principles (“GAAP”) and adversely affect our operating results.

Risks Relating to Our Indebtedness

 

To service our indebtedness, we will require a significant amount of cash, the availability of which depends on many factors beyond our control.

 

Our ability to make scheduled payments or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. These factors include:

 

 

If our financial condition or operating results materially deteriorate, our relations with our creditors, including holders of our senior notes, the lenders under our senior credit facility and our suppliers, may be materially and adversely impacted.

 

We have debt that could adversely impact cash availability for growth and operations and may increase our vulnerability to general adverse economic and industry conditions.

 

As of January 29, 2011, we had approximately $249.0 million of indebtedness. Our debt service obligations with respect to this indebtedness could have an adverse impact on our earnings and cash flows for as long as the indebtedness is outstanding.

 

Our indebtedness could have important consequences, including the following:

 

 

If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets, seek additional capital or restructure or refinance our indebtedness, including the senior notes. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. Our senior credit facility and the indenture governing the senior notes restrict our ability to dispose of assets and use the proceeds from such dispositions. We may not be able to consummate those dispositions, dispose of our assets at prices that we believe are fair or use the proceeds from asset sales to make payments on the notes and these proceeds may not be adequate to meet any debt service obligations then due.

Because of our floating rate credit facility, we may be adversely affected by interest rate changes.

 

Our financial position may be affected by fluctuations in interest rates, as our senior credit facility is subject to floating interest rates.

 

Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. If we were to borrow against our senior credit facility, a significant increase in interest rates could have an adverse effect on our financial position and results of operations.

 

Our operations are substantially restricted by the indenture governing the senior notes and the terms of our senior credit facility.

 

The indenture for the senior notes imposes, and the terms of any future debt may impose, significant operating and financial restrictions on us. These restrictions, among other things, limit the ability of the issuers of the senior notes and of GameStop’s restricted subsidiaries to:

 

 

We cannot assure you that these covenants will not adversely affect our ability to finance our future operations or capital needs or to pursue available business opportunities.

 

The senior credit facility contains various restrictive covenants prohibiting us, in certain circumstances, from, among other things, prepaying, redeeming or purchasing certain indebtedness.

 

Despite current anticipated indebtedness levels and restrictive covenants, we may incur additional indebtedness in the future.

 

Despite our current level of indebtedness, we may be able to incur substantial additional indebtedness in the future, including additional secured indebtedness. Although the terms of the indenture governing the senior notes and our senior credit facility restrict the issuers of the senior notes and GameStop’s restricted subsidiaries from incurring additional indebtedness, these restrictions are subject to important exceptions and qualifications. If we incur additional indebtedness, the risks that we now face as a result of our leverage could intensify.

 

 

None.

 

All of our stores are leased. Store leases typically provide for an initial lease term of three to ten years, plus renewal options. This arrangement gives us the flexibility to pursue extension or relocation opportunities that arise from changing market conditions. We believe that, as current leases expire, we will be able to obtain either renewals at present locations, leases for equivalent locations in the same area, or be able to close the stores with expiring leases and transfer enough of the sales to other nearby stores to improve, if not at least maintain, profitability.

 

The terms of the store leases for the 6,670 leased stores open as of January 29, 2011 expire as follows:

 

 

At January 29, 2011, the Company owned or leased office and distribution facilities, with lease expiration dates ranging from 2011 to 2019 and an average remaining lease life of approximately four years, in the following locations:

 

 

In addition, we are constructing a 161,000 square foot distribution and administration building in Eagle Farm, Queensland, Australia, estimated to be completed in fiscal 2011.

 

In the ordinary course of the Company’s business, the Company is, from time to time, subject to various legal proceedings, including matters involving wage and hour employee class actions. The Company may enter into discussions regarding settlement of these and other types of lawsuits, and may enter into settlement agreements, if we believe settlement is in the best interest of the Company’s shareholders. Management does not believe that any such existing legal proceedings or settlements, individually or in the aggregate, will have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

 

 

 

Price Range of Common Stock

 

The Company’s Class A common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “GME.”

 

The following table sets forth, for the periods indicated, the high and low sales prices of the Class A common stock on the NYSE Composite Tape:

 

 

 

Approximate Number of Holders of Common Equity

 

As of March 2, 2011, there were approximately 1,509 record holders of the Company’s Class A common stock, par value $.001 per share.

 

Dividends

 

The Company has never declared or paid any dividends on its common stock. We may consider in the future the advisability of paying dividends. However, our payment of dividends is and will continue to be restricted by or subject to, among other limitations, applicable provisions of federal and state laws, our earnings and various business considerations, including our financial condition, results of operations, cash flow, the level of our capital expenditures, our future business prospects, our status as a holding company and such other matters that our Board of Directors deems relevant. In addition, the terms of the indenture governing the senior notes restrict, and the terms of the senior credit facility may restrict, our ability to pay dividends. See “Liquidity and Capital Resources” included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-K.

Issuer Purchases of Equity Securities

 

Purchases by the Company of its equity securities during the fourth quarter of the fiscal year ended January 29, 2011 were as follows:

 

 

 

GameStop Stock Comparative Performance Graph

 

The following graph compares the cumulative total stockholder return on our Class A common stock for the period commencing January 27, 2006 through January 28, 2011 (the last trading date of fiscal 2010) with the cumulative total return on the Standard & Poor’s 500 Stock Index (the “S&P 500”) and the Dow Jones Retailers, Other Specialty Industry Group Index (the “Dow Jones Specialty Retailers Index”) over the same period. Total return values were calculated based on cumulative total return assuming (i) the investment of $100 in our Class A common stock, the S&P 500 and the Dow Jones Specialty Retailers Index on January 27, 2006 and (ii) reinvestment of dividends. The Class A common stock reflects a two-for-one stock split on March 16, 2007.

 

The following stock performance graph and related information shall not be deemed “soliciting material” or “filed” with the SEC, nor should such information be incorporated by reference into any future filings under the Securities Act or the Exchange Act, except to the extent that we specifically incorporate it by reference in such filing.

 

 

 

 

The following table sets forth our selected consolidated financial and operating data for the periods and at the dates indicated. Our fiscal year is composed of 52 or 53 weeks ending on the Saturday closest to January 31. The fiscal year ended February 3, 2007 consisted of 53 weeks and the fiscal years ended January 29, 2011, January 30, 2010, January 31, 2009 and February 2, 2008 consisted of 52 weeks. The “Statement of Operations Data” for the fiscal years ended January 29, 2011, January 30, 2010 and January 31, 2009 and the “Balance Sheet Data” as of January 29, 2011 and January 30, 2010 are derived from, and are qualified by reference to, our audited financial statements which are included elsewhere in this Form 10-K. The “Statement of Operations Data” for fiscal years ended February 2, 2008 and February 3, 2007 and the “Balance Sheet Data” as of January 31, 2009, February 2, 2008 and February 3, 2007 are derived from our audited financial statements which are not included elsewhere in this Form 10-K.

Our selected financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto included elsewhere in this Form 10-K.

 

 

 

 

 

The following discussion should be read in conjunction with the information contained in our consolidated financial statements, including the notes thereto. Statements regarding future economic performance, management’s plans and objectives, and any statements concerning assumptions related to the foregoing contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations constitute forward-looking statements. Certain factors, which may cause actual results to vary materially from these forward-looking statements, accompany such statements or appear elsewhere in this Form 10-K, including the factors disclosed under “Item 1A. — Risk Factors.”

 

General

 

GameStop Corp. (together with its predecessor companies, “GameStop,” “we,” “us,” “our,” or the “Company”) is the world’s largest multichannel retailer of video game products and PC entertainment software. We sell new and used video game hardware, video game software and accessories, PC entertainment software and other merchandise primarily through our GameStop, EB Games and Micromania stores. As of January 29, 2011, we operated 6,670 stores, in the United States, Australia, Canada and Europe, which are primarily located in major shopping malls and strip centers. We also operate electronic commerce Web sites www.gamestop.com, www.ebgames.com.au, www.gamestop.ca, www.gamestop.it, www.gamestop.es, www.gamestop.ie, www.gamestop.de and www.micromania.fr. In addition, we publish Game Informer magazine, the industry’s largest multi-platform video game magazine in the United States based on circulation and operate the online video gaming Web site www.kongregate.com.

 

Our fiscal year is composed of 52 or 53 weeks ending on the Saturday closest to January 31. The fiscal years ended January 29, 2011 (“fiscal 2010”), January 30, 2010 (“fiscal 2009”) and January 31, 2009 (“fiscal 2008”) consisted of 52 weeks.

 

The Company began operations in November 1996. In February 2002, GameStop completed an initial public offering of its Class A common stock. In October 2005, GameStop acquired the operations of Electronics Boutique Holdings Corp. (“EB”), 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 “EB merger”).

 

On November 17, 2008, GameStop France SAS, a wholly-owned subsidiary of the Company, completed the acquisition of substantially all of the outstanding capital stock of SFMI Micromania SAS (“Micromania”) for $580.4 million, net of cash acquired in the transaction. Micromania is the leading retailer of video and computer games in France with 379 locations, 328 of which were operating on the date of acquisition (the “Micromania acquisition”). The Company’s operating results for fiscal 2010 and fiscal 2009 include Micromania’s results and the Company’s operating results for fiscal 2008 include 11 weeks of Micromania’s results.

 

The acquisition of Micromania is an important part of the Company’s European and overall growth strategy and gave the Company an immediate entrance into the second largest video game market in Europe. The amount the Company paid in excess of the fair value of the net assets acquired was primarily for (i) the expected future cash flows derived from the existing business and its infrastructure, (ii) the geographical benefits from adding stores in a new large, growing market without cannibalizing existing sales, (iii) expanding the Company’s expertise in the

European video game market as a whole, and (iv) increasing the Company’s impact on the European market, including increasing its purchasing power.

 

Growth in the video game industry is generally driven by the introduction of new technology. The current generation of hardware consoles (the Sony PlayStation 3, the Microsoft Xbox 360 and the Nintendo Wii) were introduced between 2005 and 2007. The Sony PlayStation Portable (the “PSP”) was introduced in 2005. The Nintendo DSi XL was introduced in early 2010. Typically, following the introduction of new video game platforms, sales of new video game hardware increase as a percentage of total sales in the first full year following introduction. 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 subsequent 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 years subsequent to the first full year following the launch period. Unit sales of maturing video game platforms are typically also driven by manufacturer-funded retail price reductions, 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.

 

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 accounting principles generally accepted in the United States of America (“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 Company’s financial results. Actual results could differ from those estimates.

 

Revenue Recognition.  Revenue from the sales of the Company’s products is recognized at the time of sale and is stated net of sales discounts. 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. Magazine subscription revenue is recognized on a straight-line basis over the subscription period. The revenue from the paid membership of the Company’s PowerUp Rewards loyalty program is recognized over the one-year membership term. 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.

 

The Company sells a variety of digital products which generally allow consumers to download software or play games on the internet. Certain of these products do not require the Company to purchase inventory or take physical possession of, or take title to, inventory. When purchasing these products from the Company, consumers pay a retail price and the Company earns a commission based on a percentage of the retail sale as negotiated with the product publisher. The Company recognizes this commission as revenue on the sale of these digital products.

 

Stock-Based Compensation.  The Company records share-based compensation expense in earnings based on the grant-date fair value of options or restricted stock granted. As of January 29, 2011, the unrecognized compensation expense related to the unvested portion of our stock options and restricted stock was $9.3 million and $14.8 million, respectively, which is expected to be recognized over a weighted average period of 1.7 and 1.7 years, respectively. Note 1 of “Notes to Consolidated Financial Statements” provides additional information on stock-based compensation.

 

Merchandise Inventories.  Our merchandise inventories are carried at the lower of cost or market generally 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.

 

Property and Equipment.  Property and equipment are carried at cost less accumulated depreciation and amortization. Depreciation on furniture, fixtures and equipment is computed using the straight-line method over estimated useful lives (ranging from two to eight years). Maintenance and repairs are expensed as incurred, while betterments and major remodeling costs are capitalized. Leasehold improvements are capitalized and amortized over the shorter of their estimated useful lives or the terms of the respective leases, including renewal options in which the exercise of the option is reasonably assured (generally ranging from three to ten years). Costs incurred to third parties in purchasing management information systems are capitalized and included in property and equipment. These costs are amortized over their estimated useful lives from the date the systems become operational. The Company periodically reviews its property and equipment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable or their depreciation or amortization periods should be accelerated. The Company assesses recoverability based on several factors, including management’s intention with respect to its stores and those stores’ projected undiscounted cash flows. An impairment loss is recognized for the amount by which the carrying amount of the assets exceeds their fair value, as approximated by the present value of their projected cash flows. Write-downs incurred by the Company through January 29, 2011 have not been material.

 

Goodwill.  Goodwill, aggregating $1,996.3 million, has been recorded as of January 29, 2011 related to various acquisitions. Goodwill represents the excess purchase price over tangible net assets and identifiable intangible assets acquired. The Company is required to evaluate goodwill and other intangible assets not subject to amortization for impairment at least annually. This test is completed at the beginning of the fourth quarter each fiscal year or when circumstances indicate the carrying value of the goodwill or other intangible assets might be impaired. Goodwill has been assigned to reporting units for the purpose of impairment testing. The Company has four business segments, the United States, Australia, Canada and Europe, which also define our reporting units based upon the similar economic characteristics of operations within each segment, including the nature of products, product distribution and the type of customer and separate management within those regions. The Company estimates fair value based on the discounted cash flows of each reporting unit. The Company uses a two-step process to measure goodwill impairment. If the fair value of the reporting unit is higher than its carrying value, then goodwill is not impaired. If the carrying value of the reporting unit is higher than the fair value, then the second test of goodwill impairment is needed. The second test compares the implied fair value of the reporting unit’s goodwill with its carrying amount. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value, then an impairment loss is recognized in the amount of the excess. If the carrying value of an individual indefinite-life intangible asset exceeds its fair value, such individual indefinite-life intangible asset is written down by the amount of the excess. The Company completed its annual impairment test of goodwill on the first day of the fourth quarter of fiscal 2008, fiscal 2009 and fiscal 2010 and concluded that none of its goodwill was impaired. Note 8 of “Notes to Consolidated Financial Statements” provides additional information concerning goodwill.

 

The discounted cash flow method used to determine the fair value of reporting units requires management to make significant judgments based on the Company’s projected sales and gross margin, annual business plans, future business strategies and economic factors. Discount rates used in the analysis reflect the Company’s weighted average cost of capital, current market rates and the risks associated with the projected

cash flows. The impairment testing process is subject to inherent uncertainties and subjectivity, particularly related to sales and gross margin which can be impacted by various factors including the items listed in Item 1A. Risk Factors. While the fair value is determined based on the best available information at the time of assessment, any changes in business or economic conditions could materially increase or decrease the fair value of the reporting unit’s net assets and, accordingly, could materially increase or decrease any related impairment charge. Based on currently available information and forecasts of the Company’s annual results, we do not anticipate recording any impairment of goodwill or other intangible assets in any of the Company’s reporting units for the fiscal year ending January 28, 2012.

 

Other Intangible Assets and Other Noncurrent Assets.  Other intangible assets consist primarily of tradenames, leasehold rights, advertising relationships and amounts attributed to favorable leasehold interests recorded primarily as a result of the Micromania acquisition and the EB merger. We record intangible assets apart from goodwill if they arise from a contractual right and are capable of being separated from the entity and sold, transferred, licensed, rented or exchanged individually. The useful life and amortization methodology of intangible assets are amortized over the period in which they are expected to contribute directly to cash flows.

 

Tradenames which were recorded as a result of acquisitions, primarily Micromania, are considered indefinite life intangible assets as they are expected to contribute to cash flows indefinitely and are not subject to amortization, but they are subject to annual impairment testing. Leasehold rights which were recorded as a result of the Micromania acquisition represent the value of rights of tenancy under commercial property leases for properties located in France. Rights pertaining to individual leases can be sold by us to a new tenant or recovered by us from the landlord if the exercise of the automatic right of renewal is refused. Leasehold rights are amortized on a straight-line basis over the expected lease term not to exceed 20 years with no residual value. Favorable leasehold interests represent the value of the contractual monthly rental payments that are less than the current market rent at stores acquired as part of the Micromania acquisition or the EB merger. Favorable leasehold interests are amortized on a straight-line basis over their remaining lease term with no expected residual value. For additional information related to the Company’s intangible assets, see Note 8 of “Notes to Consolidated Financial Statements.”

 

Other non-current assets are made up of deposits and deferred financing fees. The deferred financing fees are associated with the Company’s revolving credit facility and the senior notes issued in October 2005 in connection with the financing of the EB merger. The deferred financing fees are being amortized over five and seven years to match the terms of the revolving credit facility and the senior notes, respectively.

 

Cash Consideration Received from Vendors.  The Company and its vendors participate in cooperative advertising programs and other vendor marketing programs in which the vendors provide the Company with cash consideration in exchange for marketing and advertising the vendors’ products. Our accounting for cooperative advertising arrangements and other vendor marketing programs results in a portion of the consideration received from our vendors reducing the product costs in inventory. The consideration serving as a reduction in inventory is recognized in cost of sales as inventory is sold. The amount of vendor allowances recorded as a reduction of inventory is determined by calculating the ratio of vendor allowances in excess of specific, incremental and identifiable advertising and promotional costs to merchandise purchases. The Company then applies this ratio to the value of inventory in determining the amount of vendor reimbursements recorded as a reduction to inventory reflected on the balance sheet. Because of the variability in the timing of our advertising and marketing programs throughout the year, the Company uses significant estimates in determining the amount of vendor allowances recorded as a reduction of inventory in interim periods, including estimates of full year vendor allowances, specific, incremental and identifiable advertising and promotional costs, merchandise purchases and value of inventory. Estimates of full year vendor allowances and the value of inventory are dependent upon estimates of full year merchandise purchases. Determining the amount of vendor allowances recorded as a reduction of inventory at the end of the fiscal year no longer requires the use of estimates as all vendor allowances, specific, incremental and identifiable advertising and promotional costs, merchandise purchases and value of inventory are known.

 

Although management considers its advertising and marketing programs to be effective, we do not believe that we would be able to incur the same level of advertising expenditures if the vendors decreased or

discontinued their allowances. In addition, management believes that the Company’s revenues would be adversely affected if its vendors decreased or discontinued their allowances, but management is unable to quantify the impact.

 

Lease Accounting.  The Company’s method of accounting for rent expense (and related deferred rent liability) and leasehold improvements funded by landlord incentives for allowances under operating leases (tenant improvement allowances) is in conformance with GAAP. For leases that contain predetermined fixed escalations of the minimum rent, we recognize the related rent expense on a straight-line basis and include the impact of escalating rents for periods in which we are reasonably assured of exercising lease options and we include in the lease term any period during which the Company is not obligated to pay rent while the store is being constructed, or “rent holiday.”

 

Income Taxes.  The Company accounts for income taxes utilizing an asset and liability approach, and deferred taxes are determined based on the estimated future tax effect of differences between the financial reporting and tax bases of assets and liabilities using enacted tax rates. As a result of our operations in many foreign countries, our global tax rate is derived from a combination of applicable tax rates in the various jurisdictions in which we operate. We base our estimate of an annual effective tax rate at any given point in time on a calculated mix of the tax rates applicable to our Company and to estimates of the amount of income to be derived in any given jurisdiction. We file our tax returns based on our understanding of the appropriate tax rules and regulations. However, complexities in the tax rules and our operations, as well as positions taken publicly by the taxing authorities, may lead us to conclude that accruals for uncertain tax positions are required. In accordance with GAAP, we maintain accruals for uncertain tax positions until examination of the tax year is completed by the taxing authority, available review periods expire or additional facts and circumstances cause us to change our assessment of the appropriate accrual amount.

 

Consolidated Results of Operations

 

The following table sets forth certain statement of operations items as a percentage of sales for the periods indicated:

 

 

The Company includes purchasing, receiving and distribution costs in selling, general and administrative expenses, rather than cost of sales, in the statement of operations. 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. 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 these classifications as a percentage of sales has not historically been material.

 

The following table sets forth sales (in millions) by significant product category for the periods indicated:

 

 

Other products include PC entertainment and other software, digital products and currency, accessories and magazines.

 

The following table sets forth gross profit (in millions) and gross profit percentages by significant product category for the periods indicated:

 

 

Fiscal 2010 Compared to Fiscal 2009

 

Sales increased $395.7 million, or 4.4%, to $9,473.7 million in the 52 weeks of fiscal 2010 compared to $9,078.0 million in the 52 weeks of fiscal 2009. The increase in sales was primarily attributable to the addition of non-comparable store sales from the 747 stores opened since January 31, 2009, and an increase in comparable store sales of 1.1%. The increase in comparable store sales was primarily due to strong sales of new video game and PC entertainment titles in fiscal 2010 compared to fiscal 2009. Stores are included in our comparable store sales base beginning in the thirteenth month of operation and exclude the effect of changes in foreign exchange rates.

 

New video game hardware sales decreased $36.5 million, or 2.1%, from fiscal 2009 to fiscal 2010, primarily due to a decrease in hardware unit sell-through, primarily in the Nintendo Wii and DSi and Sony PSP, and price cuts which resulted in lower per unit sales, partially offset by the additional sales at new stores added since fiscal 2009. New video game hardware sales decreased as a percentage of sales from 19.3% in fiscal 2009 to 18.1% in fiscal 2010, primarily due to the slow-down in hardware unit sell-through as the new platforms mature, as well as price decreases initiated by the manufacturers in fiscal 2009.

New video game software sales increased $237.8 million, or 6.4%, from fiscal 2009 to fiscal 2010, primarily due to strong sales of new video game titles released in fiscal 2010, compared to fiscal 2009, as well as sales from new stores added since fiscal 2009. New video game software sales increased as a percentage of total sales from 41.1% in fiscal 2009 to 41.9% in fiscal 2010, primarily due to the new release sales growth and the slow-down in hardware unit sell-through discussed above.

 

Used video game product sales increased $75.7 million, or 3.2%, from fiscal 2009 to fiscal 2010, primarily due to the increase in the availability of hardware and software associated with the current generation hardware platforms as those platforms age and expand and the additional sales at new stores added since fiscal 2009. As a percentage of sales, used video game product sales decreased from 26.4% to 26.1%, primarily due to the increase in new release video game software sales and other product sales. Sales of other product categories, including PC entertainment and other software and accessories, increased 9.9%, or $118.7 million, from fiscal 2009 to fiscal 2010, primarily due to stronger sales of newly-released PC entertainment software titles in fiscal 2010 and an increase in revenue associated with the Company’s loyalty program.

 

Cost of sales increased by $292.8 million, or 4.4%, from $6,643.3 million in fiscal 2009 to $6,936.1 million in fiscal 2010 as a result of the increase in sales and the changes in gross profit discussed below.

 

Gross profit increased by $102.9 million, or 4.2%, from $2,434.7 million in fiscal 2009 to $2,537.6 million in fiscal 2010. Gross profit as a percentage of sales was 26.8% in fiscal 2009 and fiscal 2010. Gross profit as a percentage of sales on new video game hardware increased from 6.5% in fiscal 2009 to 7.3% in fiscal 2010 due primarily to an increase in product replacement plan sales. Gross profit as a percentage of sales on new video game software decreased from 21.3% in fiscal 2009 to 20.7% in fiscal 2010, primarily due to a decrease in vendor allowances received, net of advertising expenses. Advertising expenses increased, due in part to expenses associated with the Company’s new loyalty program. Gross profit as a percentage of sales on used video game products decreased from 46.8% in fiscal 2009 to 46.2% in fiscal 2010 primarily due to promotional activities in the holiday selling season and a shift in sales from older hardware and software platform sales, which generate higher gross margins as platforms age, to current generation platform sales which have lower gross margins. Gross profit as a percentage of sales on the other product sales category increased from 33.8% in fiscal 2009 to 34.4% in fiscal 2010 primarily due to a shift in sales to higher margin accessories, increases in revenue associated with the Company’s loyalty program and the increase in sales of digital online game cards, some of which are recorded on a commission basis at 100% margin.

 

Selling, general and administrative expenses increased by $65.2 million, or 4.0%, from $1,635.1 million in fiscal 2009 to $1,700.3 million in fiscal 2010. 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, as well as expenses incurred in our digital and loyalty initiatives in fiscal 2010. Selling, general and administrative expenses as a percentage of sales were 18.0% in fiscal 2009 and fiscal 2010. Selling, general and administrative expenses include $29.6 million and $37.8 million in stock-based compensation expense for fiscal 2010 and fiscal 2009, respectively. Foreign currency transaction gains and (losses) are included in selling, general and administrative expenses and amounted to $2.5 million in fiscal 2010, compared to $3.8 million in fiscal 2009.

 

Depreciation and amortization expense increased $12.1 million from $162.6 million in fiscal 2009 to $174.7 million in fiscal 2010. This increase was primarily due to capital expenditures associated with the opening of 359 new stores during fiscal 2010 and investments in strategic initiatives and management information systems. Depreciation and amortization expense is expected to increase from fiscal 2010 to fiscal 2011 due to continued investments in new stores, management information systems and other strategic initiatives.

 

Interest income resulting from the investment of excess cash balances decreased from $2.2 million in fiscal 2009 to $1.8 million in fiscal 2010 as a result of lower invested cash balances and lower interest rates during fiscal 2010. Interest expense decreased from $45.4 million in fiscal 2009 to $37.0 million in fiscal 2010, primarily due to the retirement of $200.0 million of the Company’s senior notes since January 30, 2010 and the retirement of $100.0 million of the Company’s senior notes during fiscal 2009. Debt extinguishment expense of $6.0 million and $5.3 million was recognized in fiscal 2010 and fiscal 2009, respectively, as a result of the premiums paid related to debt retirement and the recognition of deferred financing fees and unamortized original issue discount.

Income tax expense increased by $1.8 million, from $212.8 million in fiscal 2009 to $214.6 million in fiscal 2010. The Company’s effective tax rate decreased from 36.2% in fiscal 2009 to 34.5% in fiscal 2010 due primarily to the variability in the accounting for the Company’s uncertain tax positions. See Note 12 of “Notes to Consolidated Financial Statements” for additional information regarding income taxes.

 

The factors described above led to an increase in operating earnings of $25.6 million, or 4.0%, from $637.0 million in fiscal 2009 to $662.6 million in fiscal 2010 and an increase in consolidated net income of $31.1 million, or 8.3%, from $375.7 million in fiscal 2009 to $406.8 million in fiscal 2010.

 

In 2009, the Financial Accounting Standards Board (“FASB”) issued new guidance related to the reporting of non-controlling interests in subsidiaries. The $1.2 million and $1.6 million increase in consolidated net income attributable to GameStop shareholders for fiscal 2010 and fiscal 2009, respectively, represents the portion of the net loss of the Company’s non-wholly owned subsidiaries attributable to the minority shareholders’ interest.

 

Fiscal 2009 Compared to Fiscal 2008

 

Sales increased $272.1 million, or 3.1%, to $9,078.0 million in the 52 weeks of fiscal 2009 compared to $8,805.9 million in the 52 weeks of fiscal 2008. The increase in sales was attributable to the addition of non-comparable store sales from the 1,062 stores opened since February 2, 2008, combined with the additional sales from the Micromania acquisition for an approximate total of $896 million and increases related to changes in foreign exchange rates of $25.9 million, offset by a decrease in comparable store sales of 7.9%. The decrease in comparable store sales was due primarily to a decrease in consumer traffic worldwide as a result of the continued macroeconomic weakness and a slow-down in hardware unit sell-through.

 

New video game hardware sales decreased $103.7 million, or 5.6%, from fiscal 2008 to fiscal 2009, primarily due to a decrease in consumer traffic as discussed above and price cuts on hardware consoles, partially offset by the additional sales at new stores added since the prior year through growth and acquisition. New video game hardware sales decreased as a percentage of sales from 21.1% in fiscal 2008 to 19.3% in fiscal 2009, primarily due to the slow-down in hardware unit sell-through as the new platforms mature, as well as price decreases initiated by the manufacturers in fiscal 2009.

 

New video game software sales increased $45.9 million, or 1.2%, from fiscal 2008 to fiscal 2009, primarily due to the addition of sales at the new and acquired stores added since fiscal 2008. New video game software sales decreased as a percentage of total sales from 41.9% in fiscal 2008 to 41.1% in fiscal 2009, primarily due to the 18% growth in used video game product sales as discussed below.

 

Used video game product sales increased $367.5 million, or 18.1%, from fiscal 2008 to fiscal 2009, primarily due to an increase in the availability of hardware and software associated with the current generation hardware platforms as those platforms age and expand, the strong growth of used video game product sales internationally, as well as the addition of sales at the new and acquired stores added since fiscal 2008. As a percentage of sales, used video game product sales increased from 23.0% to 26.4%, primarily due to the continued expansion of the installed base of new video game consoles and the availability of used hardware and software from those consoles. Sales of other product categories, including PC entertainment and other software and accessories, decreased 3.0%, or $37.6 million, from fiscal 2008 to fiscal 2009, primarily due to stronger sales of newly released PC entertainment software titles in fiscal 2008.

 

Cost of sales increased by $107.5 million, or 1.6%, from $6,535.8 million in fiscal 2008 to $6,643.3 million in fiscal 2009 as a result of the increase in sales and the changes in gross profit discussed below.

 

Gross profit increased by $164.6 million, or 7.3%, from $2,270.1 million in fiscal 2008 to $2,434.7 million in fiscal 2009. Gross profit as a percentage of sales increased from 25.8% in fiscal 2008 to 26.8% in fiscal 2009. The gross profit percentage increase was caused primarily by the increase in sales of higher margin used video game products as a percentage of total sales in fiscal 2009. Used video game product sales carry a significantly higher margin than new video game hardware or new video game software. Gross profit as a percentage of sales on new video game hardware increased from 6.1% in fiscal 2008 to 6.5% in fiscal 2009 due primarily to an increase in product replacement plan sales. Gross profit as a percentage of sales on new video game software increased from 20.9% in fiscal 2008 to 21.3% in fiscal 2009, primarily due to the mix of software sales and margin in the various

countries in which we operate. Gross profit as a percentage of sales on used video game products decreased from 48.1% in fiscal 2008 to 46.8% in fiscal 2009 primarily due to increased sales of used products in the international segments as a percentage of total sales. International used product sales have a lower margin due to the immaturity of the used business model in those segments. Gross profit as a percentage of sales on the other product sales category increased slightly in fiscal 2009 when compared to fiscal 2008.

 

Selling, general and administrative expenses increased by $189.7 million, or 13.1%, from $1,445.4 million in fiscal 2008 to $1,635.1 million in fiscal 2009. The increase was primarily attributable to the full year effect of the acquisition of Micromania in November of fiscal 2008 and the increase in the number of stores in operation and the related increases in store, distribution and corporate office operating expenses to support the store growth. Selling, general and administrative expenses as a percentage of sales increased from 16.4% in fiscal 2008 to 18.0% in fiscal 2009. The increase in selling, general and administrative expenses as a percentage of sales was primarily due to deleveraging of fixed costs as a result of the decrease in comparable store sales in fiscal 2009. Selling, general and administrative expenses include $37.8 million and $35.4 million in stock-based compensation expense for fiscal 2009 and fiscal 2008, respectively. Foreign currency transaction gains and (losses) are included in selling, general and administrative expenses and amounted to $3.8 million in fiscal 2009, compared to ($6.4) million in fiscal 2008.

 

Depreciation and amortization expense increased $17.6 million from $145.0 million in fiscal 2008 to $162.6 million in fiscal 2009. This increase was primarily due to the acquisition of Micromania, capital expenditures associated with the opening of 388 new stores during fiscal 2009 and investments in management information systems.

 

Interest income from the investment of excess cash balances decreased from $11.6 million in fiscal 2008 to $2.2 million in fiscal 2009 as a result of lower invested cash balances due to the prior year acquisitions and lower interest rates. Interest expense decreased from $50.4 million in fiscal 2008 to $45.4 million in fiscal 2009, primarily due to the retirement of $100.0 million of the Company’s senior notes during fiscal 2009 and the retirement of $30.0 million of the Company’s senior notes during fiscal 2008. Debt extinguishment expense of $5.3 million and $2.3 million was recognized in fiscal 2009 and fiscal 2008, respectively, as a result of the premiums paid related to debt retirement and the recognition of deferred financing fees and unamortized original issue discount.

 

Income tax expense decreased by $22.9 million, from $235.7 million in fiscal 2008 to $212.8 million in fiscal 2009. The Company’s effective tax rate decreased from 37.2% in fiscal 2008 to 36.2% in fiscal 2009 due primarily to audit settlements and statute expirations. See Note 12 of “Notes to Consolidated Financial Statements” for additional information regarding income taxes.

 

The factors described above led to a decrease in operating earnings of $38.1 million, or 5.6%, from $675.1 million in fiscal 2008 to $637.0 million in fiscal 2009 and a decrease in consolidated net income of $22.6 million, or 5.7%, from $398.3 million in fiscal 2008 to $375.7 million in fiscal 2009.

 

The $1.6 million increase in consolidated net income attributable to GameStop shareholders for fiscal 2009 represents the portion of the net loss of the Company’s non-wholly owned subsidiaries attributable to the minority shareholders’ interest.

 

Segment Performance

 

The Company operates its business in the following segments: United States, Canada, Australia and Europe. We identified these segments based on a combination of geographic areas, the methods with which we analyze performance and how we divide management responsibility. 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. These products are substantially the same regardless of geographic location, with the primary differences in merchandise carried being the timing of the release of new products or technologies in the various segments. Stores in all segments are similar in size at an average of approximately 1,400 square feet.

 

As we have expanded our presence in international markets, the Company has increased its operations in foreign currencies, including the euro, Australian dollar, New Zealand dollar, Canadian dollar, British pound, Swiss franc, Danish kroner, Swedish krona, and the Norwegian kroner. The notes issued in connection with the acquisition

of Micromania and the EB merger are reflected in the United States segment. See Note 17 of “Notes to Consolidated Financial Statements” for more information.

 

Sales by operating segment in U.S. dollars were as follows (in millions):

 

 

Operating earnings by operating segment, defined as income from continuing operations before intercompany royalty fees, net interest expense and income taxes, in U.S. dollars were as follows (in millions):

 

 

Total assets by operating segment in U.S. dollars were as follows (in millions):

 

 

Fiscal 2010 Compared to Fiscal 2009

 

United States

 

Segment results for the United States include retail operations in 50 states, the District of Columbia, Puerto Rico and Guam, the electronic commerce Web site www.gamestop.com, Game Informer magazine and www.kongregate.com, an online video gaming site. As of January 29, 2011, the United States segment included 4,536 GameStop stores, compared to 4,429 stores on January 30, 2010. Sales for fiscal 2010 increased 6.5% compared to fiscal 2009 as a result of increased sales at existing stores and the additional sales at the 434 stores opened since January 31, 2009, including the 227 stores opened in fiscal 2010. Sales at existing stores increased primarily due to strong sales of new release video game software and PC entertainment software and increased market share, partially offset by a slow-down in hardware unit sales. Segment operating income for fiscal 2010 increased by 8.6% compared to fiscal 2009, driven by the increase in sales and related margin discussed above.

 

Canada

 

Segment results for Canada include retail operations and an e-commerce site in Canada. Sales in the Canadian segment in the 52 weeks ended January 29, 2011 increased 2.2% compared to the 52 weeks ended January 30, 2010.

The increase in sales was primarily attributable to the favorable impact of changes in exchange rates in fiscal 2010 when compared to fiscal 2009, which had the effect of increasing sales by $38.8 million. Excluding the impact of changes in exchange rates, sales in the Canadian segment decreased 5.7%. The decrease in sales was primarily due to the decrease in sales at existing stores, offset by the additional sales at the 26 stores opened since January 31, 2009. As of January 29, 2011, the Canadian segment had 345 stores compared to 337 stores as of January 30, 2010. The decrease in sales at existing stores was primarily due to weak consumer traffic and a slow-down in hardware unit sell-through and lower price points when compared to fiscal 2009. Segment operating income for fiscal 2010 decreased $12.4 million to $22.6 million compared to $35.0 million for fiscal 2009. The decrease in operating income when compared to the prior year was primarily due to the decrease in sales at existing stores and the increase in selling, general and administrative expenses associated with the increase in the number of stores in operation. The decrease in operating income was partially offset by the favorable impact of changes in exchange rates which had the effect of increasing operating earnings by $1.6 million when compared to fiscal 2009.

 

Australia

 

Segment results for Australia include retail operations and e-commerce sites in Australia and New Zealand. As of January 29, 2011, the Australian segment included 405 stores, compared to 388 stores as of January 30, 2010. Sales for the 52 weeks ended January 29, 2011 increased 6.6% compared to the 52 weeks ended January 30, 2010. The increase in sales was primarily attributable to the favorable impact of changes in exchange rates in fiscal 2010 when compared to fiscal 2009, which had the effect of increasing sales by $63.8 million. Excluding the impact of changes in exchange rates, sales in the Australian segment decreased 5.4%. The decrease in sales was primarily due to the decrease in sales at existing stores offset by the additional sales at the 59 stores opened since January 31, 2009. The decrease in sales at existing stores was primarily due to weak consumer traffic and a slow-down in hardware unit sell-through and lower price points when compared to fiscal 2009. Segment operating income in fiscal 2010 decreased by $5.0 million to $41.0 million when compared to $46.0 million in fiscal 2009. The decrease in operating earnings for fiscal 2010 was due to the decrease in sales at existing stores and the increase in selling, general and administrative expenses associated with the increase in the number of stores in operation. Selling, general and administrative expenses will rise as a percentage of sales during periods of store count growth due to the fixed nature of many store expenses compared to the immature sales at new stores. This decrease in operating earnings was offset by the favorable impact of changes in exchange rates which had the effect of increasing operating earnings by $3.8 million when compared to fiscal 2009.

 

Europe

 

Segment results for Europe include retail operations in 13 European countries and e-commerce operations in five countries. As of January 29, 2011, the European segment operated 1,384 stores, compared to 1,296 stores as of January 30, 2010. For the 52 weeks ended January 29, 2011, European sales decreased 3.2% compared to the 52 weeks ended January 30, 2010. This decrease in sales was due to the unfavorable impact of changes in exchange rates in fiscal 2010, which had the effect of decreasing sales by $106.4 million when compared to fiscal 2009, and a decrease in sales at existing stores. The decrease in sales was partially offset by additional sales at the 228 new stores opened since January 31, 2009. The decrease in sales at existing stores was primarily driven by weak consumer traffic due to the continued macroeconomic weakness and lower hardware sales as a result of a slow-down in hardware unit sell-through and lower price points when compared to fiscal 2009.

 

The segment operating income in Europe for fiscal 2010 increased by $1.0 million to $68.2 million compared to $67.2 million in fiscal 2009. The increase in the operating income was primarily due to an increase in gross margin, driven by an increase in used product sales, partially offset by the unfavorable impact of changes in exchange rates, which had the effect of decreasing operating earnings by $6.5 million when compared to fiscal 2009.

Fiscal 2009 Compared to Fiscal 2008

 

United States

 

As of January 30, 2010, the United States segment included 4,429 GameStop stores, compared to 4,331 stores on January 31, 2009. Sales for the 52 weeks ended January 30, 2010 decreased 3.0% compared to the 52 weeks ended January 31, 2009 as a result of decreased sales at existing stores offset by the opening of 514 new stores, including 207 stores in the 52 weeks ended January 30, 2010. Sales at existing stores decreased partially due to a decrease in consumer traffic as a result of the continued macroeconomic weakness and a slow-down in hardware units sales, offset by an increase in used video game product sales due to an increase in the availability of hardware and software associated with the current generation of hardware platforms as those platforms age and expand. Segment operating income for the 52 weeks ended January 30, 2010 decreased by 7.8% compared to the 52 weeks ended January 31, 2009, driven by the decrease in sales and the deleveraging of the fixed components of selling, general and administrative expenses.

 

Canada

 

Sales in the Canadian segment in the 52 weeks ended January 30, 2010 decreased 10.4% compared to the 52 weeks ended January 31, 2009. The decrease in sales was primarily attributable to decreased sales at existing stores offset by the additional sales at the 47 stores opened during fiscal 2008 and fiscal 2009. As of January 30, 2010, the Canadian segment had 337 stores compared to 325 stores as of January 31, 2009. The decrease in sales at existing stores was primarily due to weak consumer traffic and a slow-down in hardware unit sell-through. Segment operating income for the 52 weeks ended January 30, 2010 increased by 7.4% to $35.0 million compared to the 52 weeks ended January 31, 2009. The increase in operating income when compared to the prior year was primarily due to an increase in gross margin, driven by an increase in used product sales and the favorable impact of changes in exchange rates which had the effect of increasing operating earnings by $1.2 million when compared to fiscal 2008.

 

Australia

 

As of January 30, 2010, the Australian segment included 388 stores, compared to 350 stores as of January 31, 2009. Sales for the 52 weeks ended January 30, 2010 increased 2.0% compared to the 52 weeks ended January 31, 2009. The increase in sales was due to the additional sales at the 112 stores opened during fiscal 2008 and fiscal 2009 and the favorable impact of changes in exchange rates, which had the effect of increasing sales by $5.2 million, offset by a decrease in sales at existing stores. The decrease in sales at existing stores was primarily due to weak consumer traffic and a slow-down in hardware unit sell-through. Segment operating income in the 52 weeks ended January 30, 2010 decreased by 1.7% to $46.0 million when compared to the 52 weeks ended January 31, 2009. The decrease in operating earnings for the 52 weeks ended January 30, 2010 was due to the decrease in sales at existing stores and the increase in selling, general and administrative expenses associated with the increase in the number of stores in operation. Selling, general and administrative expenses will rise as a percentage of sales during periods of store count growth due to the fixed nature of many store expenses compared to the immature sales at new stores. This decrease in operating earnings was offset by the favorable impact of changes in exchange rates which had the effect of increasing operating earnings by $3.6 million when compared to fiscal 2008.

 

Europe

 

Segment results for Europe include retail operations in 13 European countries including France, in which we commenced operations on November 17, 2008 as a result of the Micromania acquisition. As of January 30, 2010, the European segment operated 1,296 stores, compared to 1,201 stores as of January 31, 2009. For the 52 weeks ended January 30, 2010, European sales increased 40.2% compared to the 52 weeks ended January 31, 2009. The increase in sales was primarily due to the additional sales at the 703 new and acquired stores opened between February 3, 2008 and January 30, 2010, including the 328 stores from the Micromania acquisition in November 2008. This increase in sales was offset by the decrease in sales at existing stores and the unfavorable impact of changes in exchange rates recognized in fiscal 2009, which had the effect of decreasing sales by $15.3 million when

compared to fiscal 2008. The decrease in existing store sales was primarily driven by weak consumer traffic due to the continued macroeconomic weakness and a slow-down in hardware unit sell-through.

 

The segment operating income in Europe for the 52 weeks ended January 30, 2010 increased by 2.4% to $67.2 million compared to $65.6 million in the 52 weeks ended January 31, 2009. The increase in the operating income was primarily due to the favorable impact of changes in exchange rates which had the effect of increasing operating earnings by $5.2 million when compared to fiscal 2008. The decrease in operating earnings excluding the exchange rate effect from fiscal 2008 was due to the decrease in sales at existing stores and the increase in selling, general and administrative expenses associated with the increase in the number of stores in operation.

 

Liquidity and Capital Resources

 

Cash Flows

 

During fiscal 2010, cash provided by operations was $591.2 million, compared to cash provided by operations of $644.2 million in fiscal 2009. The decrease in cash provided by operations of $53.0 million from fiscal 2009 to fiscal 2010 was primarily due to an increase in cash used for inventory, partially offset by the increase in accounts payable and accrued liabilities, the increase in prepaid expenses and other current assets and the increase in other long-term liabilities, as well as the changes in the adjustment related to the excess tax benefits realized from the exercise of stock-based awards, which decreased cash provided by operations by $18.6 million. These decreases were partially offset by an increase in cash provided by consolidated net income, including the non-cash adjustments to earnings. The increase in net inventory was primarily due to higher purchases during fiscal 2010, particularly during the holiday season primarily related to hardware units which were at lower in-stock positions at the end of fiscal 2009.

 

During fiscal 2009, cash provided by operations was $644.2 million, compared to cash provided by operations of $549.2 million in fiscal 2008. The increase in cash provided by operations of $95.0 million from fiscal 2008 to fiscal 2009 was primarily due to an increase in cash provided by the decrease in inventory, net of the decrease in accounts payable and accrued liabilities, the increase in income taxes payable and deferred taxes, as well as the changes in the adjustment related to the excess tax benefits realized from the exercise of stock-based awards which decreased by $34.6 million. The decrease in net inventory was primarily due to lower overall purchases during fiscal 2009 as a result of the continued macroeconomic weakness and our efforts to effectively manage inventory levels. Inventory turnover also decreased in fiscal 2009 compared to fiscal 2008, primarily due to the growth in the international segments which have lower inventory turns compared to the United States segment due to their lower overall store count and multiple warehouse facilities. The increase in cash related to income taxes payable and deferred income taxes in fiscal 2009 compared to fiscal 2008 was primarily due to the timing of the recognition of deferred income tax items and the timing of estimated income tax payments at the end of fiscal 2009.

 

Cash used in investing activities was $240.1 million in fiscal 2010, $187.2 million in fiscal 2009 and $820.9 million in fiscal 2008. During fiscal 2010, the Company used $202.0 million for capital expenditures primarily to open 359 stores and to invest in information systems and $38.1 million for acquisitions in support of the Company’s digital initiatives. During fiscal 2009, the Company used $178.8 million for capital expenditures primarily to open 388 new stores and to invest in information systems. In addition, the Company used $8.4 million on acquisitions. During fiscal 2008, the Company used $580.4 million, net of cash acquired, to purchase Micromania and $50.3 million, net of cash acquired, to acquire Free Record Shop Norway AS, The Gamesman Limited and an increased ownership interest in GameStop Group Limited. In addition, during fiscal 2008, $190.2 million of cash was used for capital expenditures primarily to open 674 new stores and to invest in information systems.

 

Cash used in financing activities was $555.6 million in fiscal 2010. Cash used in financing activities was $154.4 million in fiscal 2009 and cash provided by financing activities was $29.6 million in fiscal 2008. The cash flows used in financing activities in fiscal 2010 were primarily for the repurchase of $381.2 million of treasury shares and $200.0 million in principal of the Company’s senior notes. The cash flows used in financing activities in fiscal 2009 were primarily for the repurchase of $100.0 million in principal amount of the Company’s senior notes and the purchase of $58.4 million of treasury shares. The cash flows provided by financing activities in fiscal 2008 were due to cash received related to the issuance of shares associated with stock option exercises of $28.9 million

and for the excess tax benefits realized from the exercise of stock-based awards of $34.2 million. These cash inflows were offset by the repurchase of $30.0 million in principal amount of the Company’s senior notes. In addition, the Company borrowed $425.0 million related to the acquisition of Micromania and subsequently repaid the balance before the end of fiscal 2008.

 

Sources of Liquidity

 

We utilize cash generated from operations and have funds available to us under our revolving credit facility to cover seasonal fluctuations in cash flows and to support our various growth initiatives. Our cash and cash equivalents are carried at cost, which approximates market value, and consist primarily of time deposits with highly rated commercial banks and money market investment funds holding direct U.S. Treasury obligations.

 

On January 4, 2011, the Company entered into a $400 million credit agreement (the “Revolver”), which amends and restates, in its entirety, the Company’s prior credit agreement entered into on October 11, 2005 (the “Credit Agreement”). The Revolver provides for a five-year, $400 million asset-based facility, including a $50 million letter of credit sublimit, secured by substantially all of the Company’s and its domestic subsidiaries’ assets. The Company has the ability to increase the facility, which matures in January 2016, by $150 million under certain circumstances. The extension of the Revolver to 2016 reduces our exposure to potential tightening in the credit markets.

 

The availability under the Revolver is limited to a borrowing base which allows the Company to borrow up to 90% of the appraisal value of the inventory, in each case plus 90% of eligible credit card receivables, net of certain reserves. Letters of credit reduce the amount available to borrow by their face value. The Company’s ability to pay cash dividends, redeem options and repurchase shares is generally permitted, except under certain circumstances, including if Revolver excess availability is less than 20%, or is projected to be within 12 months after such payment. In addition, if Revolver usage is projected to be equal to or greater than 25% of the borrowing base during the prospective 12-month period, the Company is subject to meeting a fixed charge coverage ratio of 1.1:1.0 prior to making such payments. In the event that excess availability under the Revolver is at any time less than the greater of (1) $40 million or (2) 12.5% of the lesser of the total commitment or the borrowing base, the Company will be subject to a fixed charge coverage ratio covenant of 1.1:1.0.

 

The Revolver places certain restrictions on the Company and its subsidiaries, including limitations on asset sales, additional liens, investments, loans, guarantees, acquisitions and the incurrence of additional indebtedness. The per annum interest rate under the Revolver is variable and is calculated by applying a margin (1) for prime rate loans of 1.25% to 1.50% above the highest of (a) the prime rate of the administrative agent, (b) the federal funds effective rate plus 0.50% and (c) the London Interbank Offered (“LIBO”) rate for a 30-day interest period as determined on such day plus 1.00%, and (2) for LIBO rate loans of 2.25% to 2.50% above the LIBO rate. The applicable margin is determined quarterly as a function of the Company’s average daily excess availability under the facility and is set at 1.25% for prime rate loans and 2.25% for LIBO rate loans until the first day of the fiscal quarter of the borrowers commencing on May 1, 2011. In addition, the Company is required to pay a commitment fee of 0.375% or 0.50%, depending on facility usage, for any unused portion of the total commitment under the Revolver. As of January 29, 2011, the applicable margin was 1.25% for prime rate loans and 2.25% for LIBO rate loans, while the required commitment fee was 0.50% for the unused portion of the Revolver.

 

The Revolver provides for customary events of default with corresponding grace periods, including failure to pay any principal or interest when due, failure to comply with covenants, any material representation or warranty made by the Company or the borrowers proving to be false in any material respect, certain bankruptcy, insolvency or receivership events affecting the Company or its subsidiaries, defaults relating to certain other indebtedness, imposition of certain judgments and mergers or the liquidation of the Company or certain of its subsidiaries.

 

During fiscal 2010, the Company borrowed and repaid $120 million under the Credit Agreement. During fiscal 2009, the Company borrowed and repaid $115 million under the Credit Agreement. As of January 29, 2011, there were no borrowings outstanding under the Revolver and letters of credit outstanding totaled $8.2 million.

 

In September 2007, the Company’s Luxembourg subsidiary entered into a discretionary $20.0 million Uncommitted Line of Credit (the “Line of Credit”) with Bank of America. There is no term associated with

the Line of Credit and Bank of America may withdraw the facility at any time without notice. The Line of Credit will be made available to the Company’s foreign subsidiaries for use primarily as a bank overdraft facility for short-term liquidity needs and for the issuance of bank guarantees and letters of credit to support operations. As of January 29, 2011, there were $11.0 million of cash overdrafts outstanding under the Line of Credit and bank guarantees outstanding totaled $5.6 million.

 

In September 2005, the Company, along with GameStop, Inc. as co-issuer (together with the Company, the “Issuers”), completed the offering of $300 million aggregate principal amount of Senior Floating Rate Notes due 2011 (the “Senior Floating Rate Notes”) and $650 million aggregate principal amount of Senior Notes due 2012 (the “Senior Notes” and, together with the Senior Floating Rate Notes, the “Notes”). The Notes were issued under an Indenture, dated September 28, 2005 (the “Indenture”), by and among the Issuers, the subsidiary guarantors party thereto, and Citibank, N.A., as trustee (the “Trustee”). In November 2006, Wilmington Trust Company was appointed as the new Trustee for the Notes.

 

The Senior Notes bear interest at 8.0% per annum, mature on October 1, 2012 and were priced at 98.688%, resulting in a discount at the time of issue of $8.5 million. The discount is being amortized using the effective interest method. As of January 29, 2011, the unamortized original issue discount was $1.0 million. The Issuers pay interest on the Senior Notes semi-annually, in arrears, every April 1 and October 1, to holders of record on the immediately preceding March 15 and September 15, and at maturity.

 

The Indenture contains affirmative and negative covenants customary for such financings, including, among other things, limitations on (1) the incurrence of additional debt, (2) restricted payments, (3) liens, (4) sale and leaseback transactions and (5) asset sales. Events of default provided for in the Indenture include, among other things, failure to pay interest or principal on the Notes, other breaches of covenants in the Indenture, and certain events of bankruptcy and insolvency. As of January 29, 2011, the Company was in compliance with all covenants associated with the Revolver and the Indenture.

 

Under certain conditions, the Issuers may on any one or more occasions prior to maturity redeem up to 100% of the aggregate principal amount of Senior Notes issued under the Indenture at redemption prices at or in excess of 100% of the principal amount thereof plus accrued and unpaid interest, if any, to the redemption date. The circumstances which would limit the percentage of the Notes which may be redeemed or which would require the Company to pay a premium in excess of 100% of the principal amount are defined in the Indenture. Upon a Change of Control (as defined in the Indenture), the Issuers are required to offer to purchase all of the Notes then outstanding at 101% of the principal amount thereof plus accrued and unpaid interest, if any, to the date of purchase. The Issuers may acquire Senior Notes by means other than redemption, whether by tender offer, open market purchases, negotiated transactions or otherwise, in accordance with applicable securities laws, so long as such acquisitions do not otherwise violate the terms of the Indenture.

 

In November 2008, in connection with the acquisition of Micromania, the Company entered into a Term Loan Agreement (the “Term Loan Agreement”) with Bank of America, N.A. and Banc of America Securities LLC. The Term Loan Agreement provided for term loans (“Term Loans”) in the aggregate of $150 million, consisting of a $50 million secured term loan (“Term Loan A”) and a $100 million unsecured term loan (“Term Loan B”). The effective interest rate on Term Loan A was 5.75% per annum and the effective rate on Term Loan B ranged from 5.0% to 5.75% per annum.

 

In addition to the $150 million under the Term Loans, the Company borrowed $275 million under the Credit Agreement to complete the acquisition of Micromania in November 2008. As of January 31, 2009, the Credit Agreement and the Term Loans were repaid in full.

 

As of January 30, 2010 and January 29, 2011, the only long-term debt outstanding was the Senior Notes.

 

The maturity on the $250 million Senior Notes, gross of the unamortized original issue discount of $1.0 million, occurs in the fiscal year ending January 2013.

Uses of Capital

 

Our future capital requirements will depend on the number of new stores we open and the timing of those openings within a given fiscal year. We opened 359 stores in fiscal 2010. We expect to open approximately 300 stores in fiscal 2011. Capital expenditures for fiscal 2011 are projected to be approximately $170 million, to be used primarily to fund continued digital initiatives, new store openings, store remodels and invest in distribution and information systems in support of operations.

 

Between May 2006 and October 2010, the Company repurchased and redeemed the $300 million of Senior Floating Rate Notes and $400 million of Senior Notes under previously announced buybacks authorized by its Board of Directors. All of the authorized amounts were repurchased or redeemed and the repurchased Notes were delivered to the Trustee for cancellation. The associated loss on the retirement of debt was $6.0 million, $5.3 million and $2.3 million for the 52 week periods ended January 29, 2011, January 30, 2010 and January 31, 2009, respectively, which consisted of the premium paid to retire the Notes and the write-off of the deferred financing fees and the original issue discount on the Notes.

 

The changes in the carrying amount of the Senior Notes for the Company for the 52 weeks ended January 30, 2010 and the 52 weeks ended January 29, 2011 were as follows, in millions:

 

 

We used cash to expand the Company through acquisitions. On November 17, 2008, GameStop France SAS, a wholly owned subsidiary of GameStop, completed the acquisition of substantially all of the outstanding capital stock of SFMI Micromania from its shareholders for approximately $580.4 million, net of cash acquired. Micromania is a leading retailer of video and computer games in France with 379 stores as of January 29, 2011. The Company funded the transaction with cash on hand, a draw on the Credit Agreement totaling $275 million, and the Term Loans.

 

In addition to the Micromania acquisition, the Company completed other acquisitions in fiscal 2008 with a total consideration of $50.3 million. During fiscal 2010 and fiscal 2009, the Company used $38.1 million and $8.4 million, respectively, for acquisitions which were primarily for the Company’s overall digital growth strategy.

 

On January 11, 2010, the Board of Directors of the Company approved a $300 million share repurchase program authorizing the Company to repurchase its common stock. For fiscal 2009, the number of shares repurchased were 6.1 million for an average price per share of $20.12. In September 2010, the Board of Directors of the Company approved an additional $300 million share repurchase program authorizing the Company to repurchase its common stock. For fiscal 2010, the number of shares repurchased were 17.1 million for an average price per share of $19.84. On February 4, 2011, the Board of Directors of the Company authorized a $500 million repurchase fund to be used for share repurchases of its common stock and/or to retire the Company’s Senior Notes. This plan replaced the September 2010 $300 million stock repurchase plan which had $138.4 million remaining. As of March 24, 2011, the Company has purchased an additional 5.9 million shares for an average price per share of $19.88 with $382.3 million remaining under the outstanding authorization.

 

Based on our current operating plans, we believe that available cash balances, cash generated from our operating activities and funds available under the Revolver will be sufficient to fund our operations, required payments on the Senior Notes, digital initiatives, store expansion and remodeling activities and corporate capital expenditure programs for at least the next 12 months.

Contractual Obligations

 

The following table sets forth our contractual obligations as of January 29, 2011:

 

 

 

 

In addition to minimum rentals, the operating leases generally require the Company to pay all insurance, taxes and other maintenance costs and may provide for percentage rentals. Percentage rentals are based on sales performance in excess of specified minimums at various stores. Leases with step rent provisions, escalation clauses or other lease concessions are accounted for on a straight-line basis over the lease term, including renewal options for those leases in which it is reasonably assured that the Company will exercise the renewal option. The Company does not have leases with capital improvement funding.

 

The Company has entered into employment agreements with Daniel A. DeMatteo, Executive Chairman; R. Richard Fontaine, Chairman International; J. Paul Raines, Chief Executive Officer; Tony D. Bartel, President and Robert A. Lloyd, Executive Vice President and Chief Financial Officer. The term of the employment agreement with Mr. DeMatteo commenced on April 11, 2005, when he was Chief Operating Officer of the Company, and was renewed in April 2010 with an expiration date of March 3, 2013. The term of the employment agreement with Mr. Fontaine commenced on April 11, 2005, when he was Chairman and Chief Executive Officer of the Company, and was renewed in April 2010 with an expiration date of March 3, 2013. The term of the employment agreement for Mr. Raines commenced on September 7, 2008 and continues for a period of three years thereafter. The term of the employment agreement for Mr. Bartel commenced on October 24, 2008 and continues for a period of three years thereafter. The term of the employment agreement for Mr. Lloyd commenced on June 2, 2010 and continues for a period of three years thereafter.

 

Each of the employment agreements was amended on February 9, 2011 to eliminate the right of each executive to terminate his employment agreement as a result of a change-in-control of the Company. The amendments also eliminated the automatic renewal provision of each agreement, except for Mr. Fontaine, whose agreement does not contain an automatic renewal provision. The minimum annual salaries during the term of employment under the amended and restated employment agreements for Messrs. DeMatteo, Fontaine, Raines, Bartel and Lloyd shall be no less than $1,250,000, $600,000, $1,000,000, $750,000 and $500,000, respectively. The Board of Directors of the Company has set the annual salaries of Messrs. DeMatteo, Raines, Bartel and Lloyd for fiscal 2011 at $1,250,000, $1,030,000, $775,000 and $550,000, respectively. The employment agreement for Mr. Fontaine stipulates that his annual salary for the period between March 27, 2011 and March 3, 2013 will be $600,000.

 

As of January 29, 2011, we had standby letters of credit outstanding in the amount of $8.2 million and had bank guarantees outstanding in the amount of $17.7 million, $6.1 million of which are cash collateralized.

 

As of January 29, 2011, the Company had $24.9 million of income tax liability, including accrued interest and penalties related to unrecognized tax benefits in other long-term liabilities in its consolidated balance sheet. At the time of this filing, the settlement period for the noncurrent portion of our income tax liability cannot be determined. In addition, any payments related to unrecognized tax benefits would be partially offset by reductions in payments in other jurisdictions.

In 2003, the Company purchased a 51% controlling interest in GameStop Group Limited, which operates stores in Ireland and the United Kingdom. Under the terms of the purchase agreement, the minority interest owners have the ability to require the Company to purchase their remaining shares in incremental percentages at a price to be determined based partially on the Company’s price to earnings ratio and GameStop Group Limited’s earnings. Shares representing 16% were purchased in June 2008 and an additional 16% was purchased in July 2009, bringing the Company’s total interest in GameStop Group Limited to approximately 84%. The Company already consolidates the results of GameStop Group Limited; therefore, any additional amounts acquired will not have a material effect on the Company’s financial statements.

 

Off-Balance Sheet Arrangements

 

As of January 29, 2011, the Company had no off-balance sheet arrangements as defined in Item 303 of Regulation S-K.

 

Impact of Inflation

 

We do not believe that inflation has had a material effect on our net sales or results of operations.

 

Certain Relationships and Related Transactions

 

The Company has various relationships with Barnes & Noble, Inc. (“Barnes & Noble”), a related party through a common stockholder who is the Chairman of the Board of Directors of Barnes & Noble and a member of the Company’s Board of Directors. The Company operates departments within eight bookstores operated by Barnes & Noble, whereby the Company pays a license fee to Barnes & Noble on the gross sales of such departments. Additionally, www.gamestop.com is the exclusive specialty video game retailer listed on www.bn.com, Barnes & Noble’s e-commerce site whereby the Company pays a fee to Barnes & Noble for sales of video game or PC entertainment products sold through www.bn.com. The Company also continues to incur costs related to its participation in Barnes & Noble’s workers’ compensation, property and general liability insurance programs prior to June 2005. During the 52 weeks ended January 29, 2011, January 30, 2010 and January 31, 2009, the charges related to these transactions amounted to $1.4 million, $1.6 million and $1.9 million, respectively.

 

Recent Accounting Standards and Pronouncements

 

In January 2010, the FASB issued Accounting Standards Update (“ASU”) ASU 2010-6, Improving Disclosures About Fair Value Measurements. On January 31, 2010, the Company adopted ASU 2010-6, which requires reporting entities to make new disclosures about recurring or nonrecurring fair-value measurements, including significant transfers into and out of the standard’s Level 1 and Level 2 fair-value measurements and information on purchases, sales, issuances, and settlements on a gross basis for Level 3 fair-value measurements. ASU 2010-6 is effective for annual reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which are effective for annual periods beginning after December 15, 2010. The adoption of ASU 2010-6 did not have a material impact on the Company’s consolidated financial statements.

 

On January 31, 2010, the Company adopted ASU 2010-09, Subsequent Events — Amendments to Certain Recognition and Disclosure Requirements, which amends Accounting Standards Codification (“ASC”) Topic 855, Subsequent Events, so that SEC filers no longer are required to disclose the date through which subsequent events have been evaluated in originally issued and revised financial statements. The adoption of ASU 2010-09 did not have a material impact on the Company’s consolidated financial statements.

 

In December 2010, the FASB issued ASU 2010-28, Intangibles — Goodwill and Other. ASU 2010-28 modifies step one of the goodwill impairment test for reporting units with zero or negative carrying amounts and offers guidance on when to perform step two of the testing. For those reporting units, an entity is required to perform step two of the goodwill impairment test if it is more likely than not that a goodwill impairment exists based upon factors such as unanticipated competition, the loss of key personnel and adverse regulatory changes. ASU 2010-28 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. The adoption of ASU 2010-28 is not expected to have a material effect on the Company’s consolidated financial statements.

In December 2010, the FASB issued ASU 2010-29, which updates the guidance in ASC 805, Business Combinations, to clarify that pro forma disclosures should be presented as if a business combination occurred at the beginning of the prior annual period for purposes of preparing both the current reporting period and the prior reporting period pro forma financial information. These disclosures should be accompanied by a narrative description about the nature and amount of material, nonrecurring pro forma adjustments. ASU 2010-29 is effective for business combinations consummated in periods beginning after December 15, 2010, and is required to be applied prospectively as of the date of adoption. The adoption of ASU 2010-29 is not expected to have a material effect on the Company’s consolidated financial statements.

 

Seasonality

 

Our business, like that of many retailers, is seasonal, with the major portion of sales and operating profit realized during the fourth quarter which includes the holiday selling season. Results for any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year. Quarterly results may fluctuate materially depending upon, among other factors, the timing of new product introductions and new store openings, sales contributed by new stores, increases or decreases in comparable store sales, adverse weather conditions, shifts in the timing of certain holidays or promotions and changes in our merchandise mix.

 

 

Interest Rate Exposure

 

Our Revolver’s per annum interest rate is variable and is based on one of (i) the U.S. prime rate, (ii) the LIBO rate or (iii) the U.S. federal funds rate. We do not use derivative financial instruments to hedge interest rate exposure. We limit our interest rate risks by investing our excess cash balances in short-term, highly-liquid instruments with a maturity of one year or less. In addition, the Senior Notes outstanding carry a fixed interest rate. We do not expect any material losses from our invested cash balances, and we believe that our interest rate exposure is modest.

 

Foreign Currency Risk

 

The Company uses forward exchange contracts, foreign currency options and cross-currency swaps (together, the “Foreign Currency Contracts”) to manage currency risk primarily related to intercompany loans denominated in non-functional currencies and certain foreign currency assets and liabilities. The Foreign Currency Contracts are not designated as hedges and, therefore, changes in the fair values of these derivatives are recognized in earnings, thereby offsetting the current earnings effect of the re-measurement of related intercompany loans and foreign currency assets and liabilities. For the fiscal year ended January 29, 2011, the Company recognized a $7.1 million loss in selling, general and administrative expenses related to the trading of derivative instruments. The aggregate fair value of the Foreign Currency Contracts as of January 29, 2011 was a net asset of $1.2 million as measured by observable inputs obtained from market news reporting services, such as Bloomberg and The Wall Street Journal, and industry-standard models that consider various assumptions, including quoted forward prices, time value, volatility factors, and contractual prices for the underlying instruments, as well as other relevant economic measures. A hypothetical strengthening or weakening of 10% in the foreign exchange rates underlying the Foreign Currency Contracts from the market rate as of January 29, 2011 would result in a (loss) or gain in value of the forwards, options and swaps of ($20.5) million or $20.5 million, respectively.

 

We do not use derivative financial instruments for trading or speculative purposes. We are exposed to counterparty credit risk on all of our derivative financial instruments and cash equivalent investments. The Company manages counterparty risk according to the guidelines and controls established under comprehensive risk management and investment policies. We continuously monitor our counterparty credit risk and utilize a number of different counterparties to minimize our exposure to potential defaults. We do not require collateral under derivative or investment agreements.

 

 

See Item 15(a)(1) and (2) of this Form 10-K.

 

None.

 

 

(a) Evaluation of Disclosure Controls and Procedures

 

As of the end of the period covered by this report, the Company’s management conducted an evaluation, under the supervision and with the participation of the principal executive officer and principal financial officer, of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) at the reasonable assurance level. Based on this evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives and that the Company’s disclosure controls and procedures are effective at the reasonable assurance level. Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in the Company’s periodic reports.

 

(b) Management’s Annual Report on Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control — Integrated Framework, our management concluded that our internal control over financial reporting was effective at the reasonable assurance level as of January 29, 2011. The effectiveness of our internal control over financial reporting as of January 29, 2011 has been audited by BDO USA, LLP, an independent registered public accounting firm, as stated in their report which is included in this Form 10-K.

 

(c) Changes in Internal Control Over Financial Reporting

 

There was no change in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the Company’s most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

None.

 

 

Code of Ethics

 

The Company has adopted a Code of Ethics for Senior Financial and Executive Officers that is applicable to the Company’s Executive Chairman, Chairman International, Chief Executive Officer, President, Chief Financial Officer, Chief Accounting Officer, any Executive Vice President of the Company and any Vice President of the Company employed in a finance or accounting role. This Code of Ethics is filed as Exhibit 14.1 to this Form 10-K. The Company also has adopted a Code of Standards, Ethics and Conduct applicable to all of the Company’s management-level employees, which is filed as Exhibit 14.2 to this Form 10-K.

 

In accordance with SEC rules, the Company intends to disclose any amendment (other than any technical, administrative, or other non-substantive amendment) to either of the above Codes, or any waiver of any provision

thereof with respect to any of the executive officers listed in the paragraph above, on the Company’s Web site (www.gamestop.com) within four business days following such amendment or waiver.

 

 

 

 

 

 

(a) The following documents are filed as a part of this Form 10-K:

 

(1) Index and Consolidated Financial Statements

 

The list of consolidated financial statements set forth in the accompanying Index to Consolidated Financial Statements at page F-1 herein is incorporated herein by reference. Such consolidated financial statements are filed as part of this report on Form 10-K.

 

(2) Financial Statement Schedules required to be filed by Item 8 of this Form 10-K:

 

The following financial statement schedule for the 52 weeks ended January 29, 2011, January 30, 2010 and January 31, 2009 is filed as part of this report on Form 10-K and should be read in conjunction with our Consolidated Financial Statements appearing elsewhere in this Form 10-K:

Schedule

 

Schedule II — Valuation and Qualifying Accounts

 

For the 52 weeks ended January 29, 2011, January 30, 2010 and January 31, 2009: