QuickLinks-- Click here to rapidly navigate through this documentUNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON,
Washington, D.C. 20549FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended January 29, 2000 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to__________
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended February 1, 2003
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from toCommission File Number: 000-24603
ELECTRONICS BOUTIQUE HOLDINGS CORP.
----------------------------------- (Exact
(Exact Name of Registrant as Specified in its Charter)Delaware 51-0379406 --------------------------------------------------- (State of Incorporation) (IRS Employer Identification Number) 931 South Matlack Street West Chester, Pennsylvania 19382 ----------------------------------------------------------- (Address of principal executive offices) (Zip
Delaware 51-0379406 (State of Incorporation) (IRS Employer Identification Number)
931 South Matlack Street
West Chester, Pennsylvania
19382(Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code:610/430-8100
Securities registered pursuant to Section 12(b) of the Act:
None
Title of Each Class Name of Each Exchange on
Which RegisteredN/A N/A Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value (Title
Common Stock, $.01 par value (Title of Class) 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
OFof 1934 during the preceding 12 months (or 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/X/ý NO/ / TheoIndicate by check mark if disclosure of delinquent filers pursuant to Item 405 of regulation S-K 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 the Form 10-K. o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES ý NO o
As of August 3, 2002, the aggregate market value of
Common Stockcommon stock held by non-affiliates of the registrant, based upon the closing sale price as reported on the NASDAQ National Marketon April 6, 2000,of $24.01 per share, was approximately$438,940,077.$342,239,813. Shares of the registrant's common stock owned by its executive officers and directors were excluded from this calculation; however, such exclusion does not represent a conclusion by the registrant that the executive officers or directors are affiliates of the registrant.At April
6, 2000,24, 2003, there were22,224,81425,891,158 shares of common stock outstanding.Documents Incorporated by Reference
Portions of the definitive Proxy Statement for the
20002003 Annual Meeting ofShareholdersStockholders are incorporated by reference in Part III hereof.
FORM 10-K
FOR THE FISCAL YEAR ENDEDJANUARY 29, 2000FEBRUARY 1, 2003
INDEX
Page PART I Page ----Item 1— Business 1 - Business 1Item 1A -1A—Executive Officers of the Company 15 Item 2 -2—Properties 16 Item 3 -3—Legal Proceedings 16 Item 4 -4—Submission of Matters to a Vote of Security Holders 1617
PART IIItem 5 -5—Market for the Registrant's Common Equity and Related Stockholder Matters 17 Item 6 -6—Selected Financial Data 1817 Item 7 -7—Management's Discussion and Analysis of Financial Condition and Results of Operations 20 Item 7A -7A—Quantitative and Qualitative Disclosures About Market Risk 2433 Item 8 -8—Consolidated Financial Statements 26and Financial Statement Schedule34 Item 9 -9—Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 4259
PART IIIItem 10-10—Directors and Executive Officers of the Company 4259 Item 11-11—Executive Compensation 4259 Item 12-12—Security Ownership of Certain Beneficial Owners and Management 4259 Item 13-13—Certain Relationships and Related Transactions 4259
PART IVItem 14 -14—Controls and Procedures 59 Item 15— Exhibits Financial Statement Schedulesand Reports on Form 8-K4259 SIGNATURES 4561
PART IPRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS WHEN USED IN THIS ANNUAL REPORT ON FORMPreliminary Note Regarding Forward-Looking Statements
When used in this Annual Report on Form 10-K,
THE WORDS "EXPECT,the words "expect,""ESTIMATE,"estimate,""ANTICIPATE,"anticipate,""INTEND,"intend,""PREDICT,"predict,""BELIEVE,"believe,"AND SIMILAR EXPRESSIONS AND VARIATIONS THEREOF ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF AND SUBJECT TO THE SAFE HARBOR CREATED BY THE PRIVATE SECURITIES LITIGATION REFORM ACT OFand similar expressions and variations thereof are intended to identify forward-looking statements within the meaning of and subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995.FORWARD-LOOKING STATEMENTS APPEAR IN A NUMBER OF PLACES IN THIS ANNUAL REPORT ON FORMForward-looking statements appear in a number of places in this Annual Report on Form 10-KAND INCLUDE STATEMENTS REGARDING THE INTENT, BELIEF OR CURRENT EXPECTATIONS OF ELECTRONICS BOUTIQUE, ITS DIRECTORS OR ITS OFFICERS WITH RESPECT TO, AMONG OTHER THINGS: (I) TRENDS AFFECTING ELECTRONICS BOUTIQUE'S FINANCIAL CONDITION OR RESULTS OF OPERATIONS; AND (II) ELECTRONICS BOUTIQUE'S BUSINESS AND GROWTH STRATEGIES. READERS ARE CAUTIONED THAT ANY SUCH FORWARD-LOOKING STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE RISKS AND UNCERTAINTIES, AND THAT ACTUAL RESULTS OR OUTCOMES MAY DIFFER MATERIALLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS, INCLUDING THOSE SET FORTH IN ITEM 1. "BUSINESS - RISK FACTORS". ITEM 1. BUSINESS GENERALand include statements regarding the intent, belief or current expectations of Electronics Boutique,Holdings Corp. ("its directors or its officers with respect to, among other things: (i) trends affecting ElectronicsBoutique") believes it isBoutique's financial condition or results of operations; and (ii) Electronics Boutique's business and growth strategies. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results or outcomes may differ materially from those projected in the forward-looking statements as a result of various factors, including those set forth in Item 1. "Business—Risk Factors".General
We believe we are among the world's largest specialty retailers of
electronic games. We sellvideogamesgame hardware and software, PC entertainment softwaresupported by the sale of video game hardware, PC productivity software, PCand related accessories andrelatedproducts.We offer our products through our large and growing store base, which, asAs ofJanuary 29, 2000, included 619February 1, 2003, we operated 1,145 stores,located in 46 states, Puerto Rico, Canada, Australia and South Korea, operatingprimarily under the names Electronics Boutique andStop 'N Save SoftwareEB Games, in Australia, Canada, Denmark, Germany, Italy, New Zealand, Norway, Puerto Rico, South Korea, Sweden and the United States. We also operate a commercial website under the URL addresswww.ebgames.com. Our compound annual growth rates for sales and pre-tax net income from fiscal 1999 throughour web site at WWW.EBWORLD.COM. In additionfiscal 2003 were 21.7% and 16.9%, respectively (after giving effect toour retailing activities, we provide management services for Electronics Boutique, plc ("EB-UK"), a leading specialty retailerthe adoption ofelectronic gamesEITF 02-16 as of the beginning of fiscal 2003).The interactive entertainment industry is an approximately $11.7 billion market in the United
Kingdom, SwedenStates that has grown at a compound annual growth rate of 21.2% over the last two years. The introductions of Sony's PlayStation 2 in late 2000, Nintendo's Game Boy Advance in June 2001, andIreland,Nintendo's GameCube and Microsoft's Xbox in November 2001, represent the most significant video game hardware introductions since 1996. According to International Development Group, a leading market research firm in our industry, calendar 2003 is expected to be the peak year forWaldensoftware stores on behalfhardware unit sales in the United States, with console and handheld sales expected to reach almost 24 million units. With the growing hardware installed base, we expect to see significant growth in software sales over the next two years. We believe our position, as the destination ofBorders Group, Inc. Our stores are primarily located in high traffic areas in regional shopping malls and average 1,200 square feet in size. Our core customer ischoice for theelectronic game enthusiastavid gamer, will enable us to benefit from this rapid industry growth.We serve the avid gamer who demands immediate access to new
title releasesrelease titles and who generally purchases more video game titles and PC entertainment software than the averageelectronic game consumer.gamer. As a result, our tie ratio of software units sold to hardware units sold is consistently above the industry average. We believe that we attract both thecore game enthusiastavid and casual gamer due to our:-
- •
- specialty store focus
on the electronic game category, -in malls and strip centers;- •
- ability to stock sought-after new
releases, -releases;- •
- wide variety of pre-owned titles;
- •
- breadth of product
selection,selection; and-- •
- knowledgeable sales associates.
Our "FIRST TO MARKET" strategy establishes our stores and web site as the destination of choice for electronic game enthusiasts.We believe that our vendors recognize the importance of our
core game enthusiastcustomer base and, consequently, oftenrewardgrant uswithdisproportionately large allocations ofnewly-releasednew release titles and products. Weplansupport our1
stores through a highly effective centralized inventory management system. This system enables us to
growexecute ourrevenues"first-to-market" new release strategy andoperating income by: - expanding our domesticefficiently manage overall inventory levels in order to maximize the sale of newstore base, - focusing on online retailing, - increasing store productivity,products during peak periods and- pursuing international opportunities.avoid markdowns as titles mature.We
believe wewereoneincorporated under the laws of thefirst video gameState of Delaware in March 1998 as a holding company for our operating activities. Our predecessor was incorporated in the Commonwealth of Pennsylvania in 1977.We maintain an informational website under the URL addresswww.ebholdings.com. The reports we file pursuant to the Exchange Act (Form 10-K, Form 10-Q, Form 8-K) may be accessed through this website following our filings with the Securities and
PC entertainment software specialty retailersExchange Commission.Risk Factors
Risks Related to
offer a web site with product reviewsthe Interactive Entertainment IndustryManufacturers may fail to introduce or delay the introduction of new products, which could hurt our ability to attract and
online purchasing. Our core customer tends to be Internet savvy, making e-commerce a necessary and natural progression of our retailing platform. We believe our success in store-based retailing, our strong market identity and existing infrastructure differentiates EBWORLD.COM from other online retailers. 1RISK FACTORS DEPENDENCE ON NEW PRODUCT INTRODUCTIONS.retain customers.We are highly dependent on the introduction of new and enhanced video game
and PChardware and software and PC entertainment software by manufacturers for our success. If manufacturers fail to introduce or delay the introduction of newgames and systems,products, we would have difficulty attracting and retaining customers to buy the products wesell. Any failure to attract and retain customerssell, which could adversely affect our business. Many of the factors that impact our ability tooffersell new productsand to attract and retain customers,arelargelybeyond ourcontrol. These factors include: -control, including:
- •
- our dependence upon manufacturers to introduce new or enhanced video game
systems, -systems;- •
- our reliance upon continued technological
development and the continued use of PCs, -development;- •
- our dependence upon software publishers to develop popular game and entertainment titles for
future generationgame systems orPCs,PCs; and-- •
- the availability and timeliness of new product
releases atreleases.The interactive entertainment industry is cyclical, which could cause significant fluctuations in our
stores. VIDEO GAME SYSTEMS AND SOFTWARE PRODUCT CYCLES.earnings.Demand for video game systems and software fluctuates in relation to the introduction of next-generation hardware and related software titles.
Following the introduction of next-generation products, sales of the new products increase steadily, while sales of the prior-generation products steadily decrease.Manufacturers have historically introduced next-generation systems every four to five years.Peak salesSales volumes ofprior-generation hardware tend to occurnew video game systems and related software titles are generally higher in theyearinitial stages of the products' life cycles. As a product reaches the end of its life cycle, demand for the product will generally decline as our customers anticipate the introduction of next-generationsystems, while peak sales of prior-generation software titles tend to occur in the year following the peak of prior-generation hardware.products. If leading video gamesystemssystem manufacturers fail to continue to introduce next-generation systems, or fail tomake significant enhancements toenhance existing systems on a periodic basis, our sales of hardware systems and related software titles will decrease, whichdecreasecould havea materialan adverse effect on our results of operations and financial condition.See "Business-Products." TECHNOLOGICAL OBSOLESCENCE.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
industries areentertainment 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 website. We2
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.
If we fail to keep pace with rapidly 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 rapid 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. In
particular, many video games and other entertainment software are readily available onaddition, some of these technological changes, such as theInternet. Theability to downloadelectronicvideo games onto PCs orvideo game console systemsplay games over the Internet through consoles could make the retail sale of video games and PC entertainment software obsolete. Ifthisadvances in technologycontinuescontinue to expand our customers' ability to access software through other sources, ourrevenuessales and earnings coulddecline. NEW STORE OPENINGS.be negatively impacted.Risks Related to Our Business
If we fail to manage new store openings or renew existing locations as they expire, our operational and financial results could be negatively impacted.
Our growth
will dependdepends on our ability to open and operate new stores profitably. We currently intend to open approximately100 to 125275 new stores inthe currentfiscalyear.2004. Our ability to open new stores in a timely andprofitablyprofitable manner depends uponseveralnumerous contingencies,many of which are beyond our control. The contingencies include: -including our ability to locate and lease suitable store sites,negotiate acceptable lease terms, andbuild outor refurbishthese sites on a timely and cost-effective basis,- our ability tohire and trainand retain skillednew associates, and- our ability tointegratenewthese stores intoitsour existing operations.In addition, our services agreement with EB-UK significantly restricts our ability to open stores in Europe. See "Business - Management Services."We cannot assure you that we will be able to achieve our planned expansion or that our new stores will achieve sales and profitability levels comparable to our existing stores.See "Business - Retail Operations." COMPETITION. The electronic gameAs of February 1, 2003, approximately 10% of our stores were operated under leases with terms that expire in less than one year. We cannot assure you that we will be able to maintain these existing store locations as leases expire or that we will be able to locate suitable alternative sites on acceptable terms.
If we do not compete effectively, we will lose customers and our earnings will decline.
We face intense competition in the interactive entertainment industry
is intensely competitiveandsubjectthis could lead torapid changes in consumer preferencesreduced sales andfrequent new product introductions.profit margins. We compete with:-
- •
- video game and PC software specialty
stores located in malls and other locations, -stores;- •
- mass
merchants, -merchants;- •
- toy retail
chains, -chains;- •
- online
retailers, - mail-order businesses, 2- catalogs, -retailers;- •
- direct-to-consumer software
publishers, and -publishers;- •
- office supply, computer product and consumer electronics
superstores. Increased competition may lead to reduced profit margins on video gamessuperstores; andPC entertainment software. In addition, customers can rent video games from many video stores and cable television providers. Further, it is likely that other methods- •
- emerging alternative channels of
distribution will emerge in the future, which would result in increased competition. Manydistribution.Some of
ourthese competitors have longer operating histories and significantly greater financial, managerial, creative, sales and marketing and other resources than we have. We also compete with other forms of entertainment activities, including movies, television, theater, sporting events and family entertainment centers.3
If we
dofail to successfully complete and integrate future acquisitions, our business could be negatively impacted.As part of our efforts to grow and compete, we may engage in acquisitions. Our plans to pursue future acquisitions are subject to our ability to negotiate favorable terms for these acquisitions. Accordingly, we cannot assure you that future acquisitions will be completed. In addition, to facilitate future acquisitions, 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
compete effectively,successfully integrated with ourrevenues and earnings maybusiness, our ongoing operations could be adversely affected.See "Business - Competition." SEASONALITY AND QUARTERLY RESULTS.Our services agreement with The Game Group Plc restricts our ability to expand our business in Europe and litigation with Game Group could adversely affect our business and earnings.
Our services agreement with Game Group (formerly The Electronics Boutique Plc) prohibits us from competing with Game Group in the United Kingdom until January 2007. The services agreement also requires that, until January 2006, we report to Game Group any opportunity relating to the interactive entertainment retailing business that we become aware of in Europe (excluding Scandinavia) which could be made available to Game Group and that we use reasonable endeavors to procure that each and every such opportunity is first offered to Game Group, on the same terms, including as to cost. As a result, Game Group could impede our expansion in Europe by pursuing opportunities in Europe which we report to it, and entering into agreements with our intended business partners. Game Group has publicly stated that it intends to expand its business into continental Europe. Our compliance with the services agreement will delay and could prevent, limit, or increase the cost of, any acquisitions in continental Europe. We have in the past had disagreements with Game Group in connection with the services agreement. These disagreements have resulted in litigation and could result in additional litigation.
Under the services agreement, Game Group is responsible for the payment of fees equal to 1.0% of Game Group's adjusted sales, plus a bonus calculated on the basis of net income in excess of a pre-established target set by Game Group. In fiscal 2003, we received approximately $7.4 million in management fees from Game Group.
Our operating results fluctuate from period to period, which could result in a lower price for our common stock.
Our business is affected by seasonal patterns. We historically generate our highest net sales, management fees and net income during the fourth quarter, which includes the holiday selling season. During
the year ended January 29, 2000 ("fiscal2000"),2003, we generated approximately43%40.5% of our net sales and approximately68%86.0% of our operating incomewere generatedduring the fourth quarter. Accordingly, any adverse trend in net sales during the holiday selling season couldhurtadversely affect our results of operations for the fourth quarteras well as forand the entire year. In addition to our dependence on fourth quarter sales, our resultsof operations mayfluctuate from quarter to quarter depending upon a variety of factors, most of which wecannotcan not control. Thesefactorsinclude:-
- •
- the timing of new product
introductions andintroductions;- •
- the timing of new store
openings, - net sales contributed by new stores, - increases or decreases in comparable store sales, - adverse weather conditions, -openings;- •
- general economic conditions;
- •
- weather;
- •
- shifts in the timing of certain holidays or
promotions,promotions; and-- •
- changes in our merchandise mix.
Any one or more of these factors could affect our business, financial condition and results of operations, and this makes4
These fluctuations make the prediction of our financial results
of operationson a quarterly basis difficult.Also, it is possible thatIf we fail to obtain products from our
quarterly results of operations maydomestic and overseas suppliers, our sales and gross profit will bebelow the expectations of public market analysts and investors. This couldadverselyaffect the price of our common stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Seasonality and Quarterly Results." DEPENDENCE ON SUPPLIERS.affected.We rely heavily upon our suppliers to provide us with new products as quickly as possible. We purchase a significant amount of products from
Nintendo of America ("Nintendo")Sony Computer Entertainment, Inc., Electronic Arts, Inc.("Electronic Arts"),SegaMicrosoft Corp. and Nintendo of America, Inc.("Sega"),and Sony Computer Entertainment ("Sony")and often receive shipments of new release products which are disproportionately large relative to our share of the overall consumer video game market. During fiscal2000, we purchased products2003, our purchases from Sony, Electronic Arts, Microsoft and NintendoSegarepresented 14.8%, 12.3%, 11.5% andSony, which represented 10.5%, 10.4%, 8.7% and 7.1%9.3%, respectively, of ournetgross purchases. We believe that the loss of any of these suppliers could reduce our product offerings, which could cause us to be at a competitive disadvantage. In addition, our financial performance largely depends upon the business terms we obtain from our suppliers, including competitive prices, unsold product return policies, advertising and market development allowances, freight charges and payment terms. Our failure to maintain favorable business terms with our suppliers could adversely affect our ability to offer products to consumers at competitive prices.During fiscal
2000,2003, approximately one-third of our product purchases werefrom domestic distributorsof products manufacturedoverseas,outside of the United States, primarily in Asia. To the extent that our distributors rely on overseas sources fora large portion oftheir products, any event causing a disruption of imports, including the imposition of import restrictions, couldhurtadversely affect our business.In addition, in the recent past, many Asian currencies were devalued significantly in relation to the U.S. dollar, and financial markets in Asia experienced significant turmoil. We cannot assure you that these events will not occur again in the future, and if these events do occur, our business could be harmed.Trade restrictions in the form of tariffs or quotas, or both, applicable to the products we sell could also affect the importation ofthosethese productsgenerallyand could increase the cost and reduce the supply of products available to us.3GROWTH OF INTERNET AS MEANS OF E-COMMERCE.If
the e-commerce market does not growour management information systems fail to perform orgrows more slowly than we expect, our business may not grow as quickly as we anticipate. A number of factors could prevent the acceptance and growth of e-commerce, including the following: - e-commerce is at an early stage and buyers may be unwilling to shift their traditional purchasing to online purchasing, - increased government regulation or taxation may adversely affect the viability of e-commerce, and - adverse publicity and consumer concern about the reliability, cost, ease of access, quality of services, capacity, performance and security of e-commerce transactions could discourage its acceptance and growth. E-COMMERCE STRATEGY. Our e-commerce strategy depends in part onare inadequate, our ability tosignificantly increasemanage our business could be disrupted.We rely on a warehouse management system used in our domestic distribution centers and an inventory replenishment system to track sales
of our products over the Internet. We are pursuing opportunities to sell our products over the Internet through our web site EBWORLD.COM as well as through Internet marketing partnerships with America Online, MSN,andSnowball.com. This is a relatively new business and marketing strategy for us and involves risks and uncertainties. We may not succeed in marketing our products over the Internet. In addition, our Internet strategy will requireinventory. Our systems allow us tosignificantly increaseexecute ouradvertising"first-to-market" new release strategy, to keep our stores in stock at optimum levels andmarketing expenditures.to move inventory efficiently. If our management information systems fail to adequately perform theseexpenditures do not result in significant sales,functions, ourresults of operations willbusiness could be adversely affected.See "Business - Online Retailing." RISK OF INTERNATIONAL OPERATIONS.Our international operations expose us to numerous risks.
We have international retail operations in
various foreign countries, includingAustralia, Canada, Denmark, Germany, Italy, New Zealand, Norway, South Korea andAustralia, and we intend to pursue opportunities that may arise in these and other countries.Sweden. Net sales in these foreign countries represented12.2%approximately 19% of our net sales in fiscal2000.2003. Because release schedules for hardware and software introduction in these countries 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 or decreases in domestic sales. We are also subject tothe risks inherent in conducting business across national boundaries, any onea number of other factors whichcould negatively impact our business. These risks include: - economic downturns, - currency exchange rate fluctuations, - changes in governmental policy, - international incidents, - military outbreaks, - government instability, - nationalization of foreign assets, and - government protectionism. We cannot assure you that one or more of these factors will notmay impair our current or future internationaloperationsopportunities. These include:
- •
- economic downturns;
- •
- currency exchange rate fluctuations;
- •
- international incidents; and
as a result, harm- •
- government instability.
5
We depend upon our
overall business. LEASE EXPIRATIONS AND TERMINATIONS. As of January 29, 2000, 84 of our stores (13.6% of all stores) were operated under leases with terms that expire in less than one year. We cannot assure you that we willkey personnel and they would beabledifficult tomaintain our existing store locations as leases expire, that we will be able to locate suitable alternative sites on acceptable terms or find additional sites for new store expansion. If we fail to maintain existing store locations, locate to alternative sites or find additional sites for new store expansion, our revenues and earnings may decline. See "Business Properties." DEPENDENCE ON KEY PERSONNEL.replace.Our success depends upon our ability to attract, motivate and retain key management associates for our stores and skilled merchandising, marketing and administrative personnel at our headquarters.
In the past,While we have been successful in maintaining the continuity of our management team, including our executive officers,Joseph J. Firestone, our President and Chief Executive Officer, Jeffrey W. Griffiths, our Senior Vice President of Merchandising and Distribution and President of EBKids, Seth P. Levy, our Senior Vice President and Chief Information Officer and the President of EBWORLD.COM and John R. Panichello, our Senior Vice President and Chief Financial Officer and President of BC Sports Collectibles. However,we cannot assure you that we will continue to be successfulin attracting andretaining such personnel.CONTROL BY MAJORITY SHAREHOLDER.If we fail to retain qualified personnel, our business could suffer.Other Risks
The Kim family has significant control of our company and can make decisions that could adversely affect our stock price and prevent a change of control.
EB Nevada Inc.
("EB Nevada"), a company indirectly controlled by James Kim, his wife and certain trusts for the benefit of his children,beneficially ownowns approximately61.5%44.7% of the4outstanding shares of our common stock. Accordingly, the Kim family effectively controls our company and all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This control Electronics Boutique.may have the effect of delaying, preventing or deterring a change in control of our company and could deprive our stockholders of an opportunity to receive a premium for their common stock as part of any sale or acquisition. Under a credit facility we have with Fleet Capital Corporation, if the Kim familyis obligated todoes not own,directly orindirectlynot less thanthrough EB Nevada, at least 25% ofthe issued andour outstanding capital stock, we may be declared in default under the credit facility.Our status as a holding company and our credit facility restrict our ability to pay dividends on our common stock.
We are a holding company and do not have any material assets other than our ownership interests in our subsidiaries. Our common stock will be junior in right of
Electronics Boutique. See "Management's Discussionpayment to all of our existing andAnalysisfuture liabilities and obligations and, by virtue ofFinancial Conditionthe fact that we are a holding company, our common stock will be structurally junior in right of payment to all existing andResultsfuture liabilities and obligations ofOperations - Liquidityeach of our subsidiaries. We have not declared or paid dividends on our common stock since our initial public offering in July 1998. In addition, our credit facility with Fleet Capital Corporation restricts our ability to declare or pay dividends on our common stock.Our income taxes could increase in the future.
Our corporate structure includes the use of Delaware holding companies and
Capital Resources." INDUSTRY OVERVIEWsubsidiaries that hold our intellectual property and facilitate financing for our operations. Certain state taxing authorities have begun to review their positions with respect to income tax deductions taken as a result of these structures. If some or all of the income tax deductions resulting from our corporate structure are disallowed in the future, the income taxes we pay could increase, which will negatively impact our earnings.Our certificate of incorporation and bylaws contain anti-takeover protections, which may discourage or prevent a takeover of our company, even if an acquisition would be beneficial to our stockholders.
Certain provisions of our certificate of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if a takeover would benefit our stockholders.
6
Industry Overview
The
electronic gameinteractive entertainment industry issegmented intocomprised of two primary productplatforms:categories, video games and PC entertainment software.VIDEO GAMES.Video
game play requires two components, video game consoles, known as hardware, andgames. Domestic retail sales of video game titlesknown as software. Video game consolesand hardware systems were approximately $9.1 billion in 2002. According to International Development Group, domestic software sales areconnectedexpected toa free-standing monitor or, typically, a television set. Video game titlesgrow approximately 10.7% in 2003 while hardware unit sales aresmall cartridges or CD-Roms that are inserted into a video game console. From 1996expected toSeptember 1999, the video game market was dominated by two manufacturers, Nintendo and Sony, each of which manufactures proprietary hardware in the form of console systems and publishes game titles that run on their console systems but cannot run on their competitors' systems. In September 1999, the Sega Dreamcast console system was introduced in the U.S. Third-party publishers also produce a wide range of game titles for each of these major hardware systems.peak with 1.9% growth over 2002. Growth in the industry has been driven bythecontinued improvements in systems technology,thesubstantial growth in the number of titles available across game categories and the emergence of well-capitalized software publishers with significant advertising budgets to support new releases.Total domestic retail sales of video game titles, hardware and accessories were approximately $7.2 billion in 1999, which represents an increase of 14% over 1998. This increase was primarily the result of the introduction of the Sega Dreamcast console and related software titles and the continuing penetration of the 32/64 bit, fourth generation of video game hardware technology, originally introduced in 1995 and 1996 under the Sony PlayStation and Nintendo 64 brands. As with each prior generation, the introduction of a new hardware technology has led to an increase in the installed base of game console systems.Enhanced technological features of new hardware platforms expand gaming capabilities, encourage existing players to upgrade their hardware platforms andsimultaneouslyattract new video game players to purchase their first systems.We believe that Sega Dreamcast, which was introducedFrom 1996 to
the U.S. and Canadian markets inSeptember 1999,representsNintendo and Sony, each of which manufactures proprietary hardware, dominated thefirstvideo game market. Sony introduced the PlayStation in 1995 and Nintendo introduced the Nintendo 64 in 1996. In September 1999, Sega introduced the Sega Dreamcast. In October 2000, Sony introduced the PlayStation 2, which represented a significant improvement in graphics,performance,processing power and audio quality over thecurrent 32/64 bit systems. Sony,systems in use at the time. Nintendoand Microsoft have also announced plansintroduced the Game Boy Advance, the successor tointroduce their next-generation consoles. Sony's PlayStation 2, expected to bethe highly successful Game Boy, in June 2001. Nintendo's GameCube, introduced in2000, will feature significant performance improvements and importantly, backward compatibility with current-generation PlayStation software, which may reduce obsolescence of current-generation software titles. Nintendo's console, expected to be introduced inNovember 2001,code named Dolphin, will also featurefeatures significant performance enhancements over thecurrent N64Nintendo 64 system andwill beis based onDVDCD technology as compared to thecurrentprior cartridge-based technology. Microsoft'sX-Box,Xbox, alsoexpected to belaunched in November 2001, provides advanced graphics and Internet connectivity. In March 2003, Nintendo introducedin 2001, is expected to provide significant graphical improvement over current generation systems as well as internet connectivity. Historically, just prior toa significantly enhanced design of theintroduction of next-generation hardware and software products, sales of prior-generation hardware products peak and the sales of prior-generation software titles peak in the following year.Game Boy Advance, Game Boy Advance SP. We believe that thecurrent transition to next-generation platforms may result in less cyclical sales for current-generation systemsinteractive entertainment industry is experiencing an expansion cycle, which started with the introduction of Game Boy Advance, PlayStation 2, GameCube andsoftware. This is due to: -Xbox.At year-end 2002, the
continuing strong pace of introductions by software publishers of new releases for the current 32/64 bit and next generation systems, - significant mass media advertising and promotional activity to support new titles, - consumer anticipation that the next-generation Sony game console system will be backward compatible with current-generation games. At year end 1999, the currentinstalled base of video game hardware systems in the United States totaled21.8approximately 15.9 millionSonyPlayStation 2 units,13.24.6 millionNintendo 64Xbox units, 3.6 million GameCube units and1.311.7 millionSega DreamcastGame Boy Advance units. Hardware manufacturers and third-party publishers produce a wide range of game titles for each of these major hardware systems. In addition, according to NPD Group, Inc., a market research firm, sales of video game systems accessories were estimated to be approximately $1.3 billion in 2002.PC
ENTERTAINMENT SOFTWARE.entertainment software. Domestic retail sales of PC entertainment software were approximately $1.4 billion in 2002, down slightly from the prior year. According to International Development Group, PC entertainment software sales are expected to decline 1% to 2% annually over the next several years. PC entertainment software is generally sold in the form of CD-Roms and played on multimedia PCs featuring fast processors, expanded memories, and enhanced graphics and audio capabilities. The5market for PC entertainment software has experienced steady growth in recent years, due primarily to the growth in the installed base of multimedia PCs. Thedomestic installed base of multimedia PCs has increased from approximately1414.0 million units in 1995 to approximately4263.8 million units in1999. Domestic unit sales of PC entertainment software have increased from approximately 23 million units in 1995 to approximately 60 million units in 1999. Domestic retail sales of PC entertainment software totaled approximately $1.4 billion in 1999, an increase of approximately 7.5% over 1998. We believe that multimedia PCs priced well below $1,000 will contribute to growth in PC unit sales and broaden the appeal of home PCs as an alternative source of in-home entertainment. Worldwide, the installed base of multimedia PCs and sales of PC entertainment software has grown at a rate comparable to the rate of growth in the United States. CUSTOMERS.2002.Customers. We believe the typical
electronic game consumergamer is male, single, between the ages of 14 and 34, and lives in a household with an annual income in excess of $50,000. We also believe that our customers are often opinion leaders in the interactive entertainment industry, influencing the buying decisions of friends and family. According to a study conducted by Ziff Davis Media Game Group, our core customer, theMillennium Gamer Study, owners ofavid gamer, owns multiple video game hardware systemspurchaseand purchases an average of3.212 game titles peryear. We believe thatyear, significantly more than the average gamer. In addition, manyelectronicvideo game players purchasevideo game titlesPC entertainment software as well asPC entertainment software. Electronic games are principally sold through retail channels, including specialty retailers like Electronics Boutique, as well as mass merchants, toy retail chains, electronics retailers, computer retailers, wholesale clubs, the Internet and mail order. BUSINESS STRATEGYvideo game titles.7
Competitive Strengths
We seek to enhance our position as one of the world's largest specialty retailers of video game titles and PC entertainment
software. BREADTH OF TITLE SELECTION.software by focusing on the following:Breadth of title selection. We offer our customers an extensive selection of video game titles and PC entertainment software at competitive prices. Our typical store offers
approximately 1,350over 1,400 titles (excluding pre-owned games) at any given time from over9060 video game and PC entertainment software vendors.Most of theseThese titles are also available on ourweb site.website. We continuously update our title selection in each store to reflect the tastes and buying patterns of the store's local market. We carry game titles which are compatible with all major video game hardware systems and PCs. In addition to video game titles and PC entertainment software, we offer a complementary line ofproductivity and educational software andPC and video game accessories and peripheral products, includinggraphics accelerators,controllers, joysticks, memory cards, DVD remotes, books and magazines. By offering all major video game hardware systems and providing a broad but focused assortment ofelectronicvideo game software and accessories and PC entertainment software, we seek to establish our stores andweb sitewebsite as the destination of choice forelectronic game enthusiasts. IMMEDIATE AVAILABILITY OF NEW RELEASES.avid gamers.Immediate availability of new releases. We strive to be the first in our markets to offer new video game and PC entertainment software titles upon their release.
New-releaseWe believe that vendors recognize the importance of our video game enthusiast customer base and, consequently, often grant us disproportionately large allocations of new release products. Our inventory management systems then rapidly move the products from our distribution centers to our stores. New release titles are often preceded by substantial publicity in the form of print advertisements and reviews in publications and, increasingly, are promoted through televisionadvertisements.advertisements by the game and software publishers. This publicity tends to create high levels of demand for new releases amongelectronicvideo game enthusiasts, often well in advance of release dates. This demand has afforded us an important marketing opportunity tocreate excitement surroundingdrive traffic to our stores and ourweb site.website.To assure our customers immediate access to new releases, we offer our customers the
opportunity to purchase"EB Pre-Sell Program" through which they can reserve video games and PC entertainment softwareprior to theirfor delivery upon our receipt and releasethroughof the"EB Pre-Sell Program," which guarantees customers a copy of a new release immediately after its launch. We also have established the "EB Reserve List," which entitles participants on this list to be notified when a game has arrived in our stores.product. On average, we introduce2029 new game titles in our stores and on ourweb sitewebsite each week.HIGHLY EFFECTIVE INVENTORY MANAGEMENT SYSTEM.Highly effective inventory management system. We
emphasize strict inventory policies in order to manage over 2,000 SKUs, including video game titles, PC entertainment software, video game consoles, accessories and related products. Ourhave a highly effective inventory management system that enables us to maximize sales ofnew-releasenew release titles and avoid markdowns as titles mature.We minimizeThe system forecasts our inventoryrisk by: - conducting extensive researchrequirements onnew-release titles to forecast anticipatedan individual store basis, aggregates our total requirements and manages the dailysell-through, - utilizing POS polling technology to provide daily sales, margin and inventory reportsreplenishment function from our automated distribution centers to ourmerchandising staff, - managing inventorystores. This results in improved in-stock levels in our stores.Knowledgeable sales associates. We believe that our knowledgeable sales associates, many of whom are avid gamers, and our higher level of customer service provide us with an important advantage over competitors such as mass merchants, toy retail chains, and office supply, computer product and consumer electronics superstores. We provide all of our sales associates with training and information on video game and PC entertainment products, system requirements and selling techniques through vendor-sponsored "EB University" seminars, held for store managers and field managers, and through regularly scheduled in-store seminars for our sales associates. We also encourage our sales associates to learn about customers' game preferences. With this knowledge, sales associates introduce customers to a
store-by-store basis to address local customer merchandiseselection of games and accessories that may suit their preferences and- replenishing store-level inventories daily fromadvise them of new releases suited to their interests, thereby enhancing ourfully-automated distribution centers. 6We introduce an average of 10 new SKUs in our stores and on our web site each day. As a result of these inventory management initiatives, we have achieved desired in-stock positions and our inventory turns in fiscal 2000 were 5.4x. In addition, our fiscal 2000 inventory shortage was less than 0.6% as a percentage of sales. DISCIPLINED STORE OPERATIONS.customers' overall gaming experience.Disciplined store operations. Our management team exercises significant control over all aspects of our store operations,
fromincluding product research, purchasing,anddistribution,to real estatesite selection, store development, POS financial reporting and sales training. We believe that this commitment to operational control enables usto: - operate substantially all of our stores on a profitable basis, -to identify opportunities to improve store productivity quickly and-to8
react quickly to shifts in product pricing and consumer purchasing trends.
KNOWLEDGEABLE SALES ASSOCIATES.Webelieve that our knowledgeable sales associates provide us with an important competitive advantage over mass merchants, toy retail chains and office supply, computer product and consumer electronics superstores, all of which compete with us, but generally offer much lower levels of customer service in the electronic game category than we do. We provide all of our sales associates extensive training on video game and PC entertainment software products, system requirements and selling techniques. Many of our sales associates are also electronic game enthusiasts. We facilitate training through vendor-sponsored EB University seminars, held semi-annually for store managers and field management associates, and through regularly scheduled in-store seminars conducted by our District Managers. In addition, we encourage sales associates to learn about their customers' game preferences. With this knowledge, sales associates can introduce customers to a selection of electronic games and accessories that may suit their preferences or enhance customers' overall game experience. In addition, our sales associates advise customers of pending new releases suited to the customer's expressed interests. VALUE PRICING AND AFFINITY PROGRAMS. In an effort to offer maximum value to our customers and discourage comparison shopping, we maintain an everyday low pricing policy and support this policy with our EB Pre-Sell and EB Reserve List affinity programs, as well as a price matching policy. Our price matching program is known as the EB Code of Honor Program. An extensive selection of merchandise and a high level of customer service complement our "everyday low price" policy. GROWTH STRATEGY DOMESTIC NEW STORE EXPANSION. We plan to expand our domestic retail operations by opening about 85 stores in both existing and new markets in the year ending February 3, 2001 ("fiscal 2001"). In fiscal 2000, we opened 62 domestic stores. Our real estate team applies standardized site-selection criteria to secure the best location for our stores when entering a new market or expanding within an existing market. We believe our store formats can operate profitably in high traffic/high rent malls as well as in lower traffic/lower rent malls, central business districts and strip shopping centers. This flexibility provides us with an extensive selection of locations for future store openings. EXPANSION OF ONLINE RETAILING. We believe our core customer base is Internet savvy, making e-commerce a necessary and natural progression of our retailing platform. Our web site benefits from a strong market identity and brand name, which we believe contributes to confident e-commerce purchasing decisions. We believe that our merchandise is ideally suited for sale on the Internet because it is easy and cost-efficient to ship, gift-oriented, and it benefits from vendor-sponsored promotion. Additionally, user-friendly information is readily available on our web site for the products we sell. Our e-commerce web site also enables us to gain access to customers who do not live near any of our stores, especially with respect to foreign sales. As foreign demand warrants, we intend to open international distribution centers to increase fulfillment efficiency. We also intend to expand aggressively our customer base through national media campaigns, advertising through Internet properties, such as America Online, MSN and Snowball.com and continued pursuit of strategic alliances with directories, search engines and content providers. STORE PRODUCTIVITY. We constantlystrive to increase the productivity of our stores byfocusing on the following areas: - Inventory Management and Controls. We useactively managing ourPOS and inventory management systems, including our fully automated distribution centers, to improve our merchandise mix and in-stock positions, increase inventory turns and 7drive down shrinkage which, at less than 0.6% as a percentage of sales in fiscal 2000, we believe is among the lowest of mall-based retailers. - Managing Store Payroll. We seek to optimize storepayroll expenseby utilizingand operating ourPOS reporting systemsstores as efficiently as possible. In order toassure the best possible matchdisplay most ofsales associate floor coverage to customer traffic.our products on our stores' shelves, we maintain selling space which averages approximately 90% of our stores' total square footage in each of our store formats. In an effort to enhance ourstore payroll strategy,sales conversion rates, in many of our stores wecontinue to implementutilize a system, known asShoppertrak,ShopperTrak, that electronically measures store customer traffic throughout the day and provides us with an analysis of sales conversion rates by store and by sales associate.This system allows usWe also utilize our POS reporting systems tocontinueassure the best possible match of sales associate floor coverage toimprove our sales conversion rates. - Pre-owned Electronic Games. As a result of the proliferation of new titles and the tendency of electronic game playerscustomer traffic.Value pricing. In an effort to
seek new game challenges after mastering a particular title, a growing market for pre-owned video game titles has evolved in recent years. Weoffer maximum value to our customers and discourage comparison shopping, we maintain an "everyday low price" policy on advertised merchandise. We complement this policy with an extensive selection of merchandise and astorehigh level of customer service. We also offer a pre-owned program which allows customers to save additional money by trading in their used games for creditfor their pre-owned video game titles. Sales of pre-owned video game titles generate higher margins than new titles and their availabilitytoward any product sold in ourstores tendsstores. The trade-ins are then resold toattractother customers at lower prices than ourcore game enthusiast customer. We believe thatnew products to offer asignificant opportunity continues to exist to increase salesbroader range ofpre-owned game titlesproducts andwe have implemented a number of marketing and merchandising programs, coupled with incentives toprice choices for oursales associates, to increase our participationcustomers.Leadership in
the growing market for pre-owned titles. INTERNATIONAL OPPORTUNITIES. As of January 29, 2000, we operated 43 stores in Australia, 54 stores in Canada and five stores in South Korea. In fiscal 2000, we opened 14 stores in Australia and 15 stores in Canada. We intend to open approximately 15 stores in Australia, five stores in New Zealand, and 20 stores in Canada during fiscal 2001. We also provide management services to EB-UK which, as of January 29, 2000, operated 280 stores and 18 department store-based concessions in the United Kingdom, Ireland and Sweden.e-business. We believe that ourcurrentcustomers are generally more familiar with the Internet and with online retailing than the average consumer. Our website offers over 5,000 new and pre-owned stock keeping units, known as SKUs, that are available for immediate shipping to our customers. In addition, we have designed our website to serve our customers by providing product reviews, access to new releases, user-friendly online purchasing and the ability to pre-order video games and PC entertainment software.Growth Strategy
New store expansion. We believe that there are domestic and international
presence will enable usopportunities for significant new store growth. Over the last four fiscal years, we have more than doubled our store base. We plan toleverageopen approximately 275 new stores in fiscal 2004.Domestic opportunity. We plan to open approximately 200 new stores in fiscal 2004 in the United States. We plan to continue to open stores in selected malls. In addition, we plan to accelerate growth in urban areas, central business districts and strip and power shopping centers. We expect our
existing distributionstores in these locations to require lower initial investments, generate higher gross margins on lower revenue andmanagement infrastructure for further expansion. RETAIL OPERATIONShave a lower operating cost structure than our mall-based stores. These stores, which typically carry a wider assortment of pre-owned video games than our mall-based stores, target the more value conscious gamer.International opportunity. In fiscal 2002, we began a store expansion program in continental Europe which includes both the opening of new stores and the acquisition of regional chains. As of
January 29, 2000,February 1, 2003, we operated a total of619290 stores in46 states,Australia, Canada, Denmark, Germany, Italy, New Zealand, Norway, South Korea, and Sweden. We plan to open approximately 75 new stores in fiscal 2004 in these markets.The interactive entertainment market in continental Europe is approximately $7.0 billion in size and has consumer demand characteristics similar to the U.S. market. We believe retail competition in the interactive entertainment industry is weaker throughout continental Europe than in the United States. There are very few specialty interactive entertainment retail chains in continental Europe and the existing specialty chains are small and undercapitalized, with little or no investment in distribution and information systems. Most video games are sold in Europe through general merchandise stores that offer less service and a smaller product selection than our stores. We believe that our store model, merchandising expertise and strong vendor relationships should enable us to gain significant market share in our targeted continental European markets over the next several years.
9
Expansion of online retailing. We believe that our core customer tends to be an Internet user, and we strive to meet their needs through our website,www.ebgames.com., which provides product reviews, access to new release titles, user friendly online purchasing and the ability to pre-order video games and PC entertainment software.
Retail Operations
As of February 1, 2003, we operated a total of 1,145 stores in the United States, Australia, Canada, Denmark, Germany, Italy, New Zealand, Norway, Puerto Rico,
Canada, AustraliaSouth Korea andSouth Korea,Sweden, primarily under the names Electronics Boutique andStop 'N Save Software. STORE FORMATS. Electronics BoutiqueEB Games.Store formats. Many of our stores are specialty retail stores
that offer video game hardware and game titles, PC entertainment, educational and productivity software, and video game and PC accessories. Electronics Boutique and EBX stores arelocatedprimarilyin high traffic areas in regional shoppingmallsmalls. As of February 1, 2003, we operated 768 stores with this format in the United States andgenerally stock over 2,000 SKUs. The typical mall-based Electronics Boutique store isCanada. These stores average approximately 1,200 squarefeet, but stores range in size from 450 square feet to 2,700 square feet, with retail selling space averaging approximately 90% of total square footage.feet. We believe that our mall-based stores generate sales per square foot that are among the highest of any mall-based retailer.Stop 'N Save SoftwareIn addition to our mall-based stores,
are generally larger-formatwe also operate many storeslocatedin urban areas, central business districts, and strip and power shopping centers.We openedThese stores are generally larger than ourfirst Stop 'N Save Software store in 1995. Our merchandising strategy at our Stop 'N Save Softwaremall-based stores,resembles our merchandising strategy at our Electronics Boutique stores. Stop 'N Save Software stores range in size from 1,250 to 5,000 square feet, with retail selling spaceaveraging approximately90%1,700 square feet. We began our expansion into these other locations in fiscal 2001, and as oftotal square footage. In addition,February 1, 2003, weoperate 15operated 213 stores with this format. We believe that these stores do not compete directly with mall-based stores due to their locations and their focus on pre-owned games. The balance of our stores thatsellwere open as of February 1, 2003 were located outside of the United States and Canada and are comprised of mall-based stores as well as multiple other formats.We typically locate our stores in malls and strip and power shopping centers and we believe that there are many suitable locations available for future sites. We use standardized site selection criteria for each of our formats to choose sites.
As of the first quarter of fiscal 2003, we operated 22 stores that sold sports collectibles and memorabilia under the name BC Sports
Collectibles. We believe the customer base of BC SportsCollectiblesshares many of the same demographic characteristics as the customer base of our Electronics Boutique stores. We believe BC Sports Collectiblesand 29 storesgenerate higher sales volumes if they are located in metropolitan areas which are in close proximity to cities with several professional sports franchises. We locate our BC Sports Collectibles stores in malls and strip and power shopping centers. The stores generally range in size from 1,000 to 5,000 square feet. We opened our first EBKids store in September 1999. EBKids is a new concept we are testing in which we will offer an assortment ofthat sold interactive and developmental toys and family-friendly, non-violent softwarethatunder the EBKids brand. In February 2002, webelieve will appealannounced our decision toa younger customer, ages 4-12 years old. This new store formatsell the BC Sports Collectibles chain andproduct offering is designedto8give parentsclose the EBKids chain. We made this strategic decision to enable us to focus all of our resources—management, capital, andyoung children a shopping destination which is family-friendly, free of game titles that include mature content and which capitalizessystems—on theElectronics Boutique brand name. SITE SELECTION. We visit numerous mall and strip and power shopping center sites throughout the year in the United States and in several foreign countries in search of suitable store locations. Our standardized site selection criteria include: - lease terms, - population demographics, - psychographics, - traffic count, - store-front visibility and presence, - adjacencies, - competition, and - accessible parking. We believe our store formats can operate profitably in high traffic/high rent malls as well as lower traffic/lower rent malls and shopping centers. Accordingly, we believe that there are a large selection of locations available for future sites. We view lease terms as the most critical elementgrowth opportunities in oursite selection process. We have used our knowledgecore interactive entertainment market. The closing of the EBKids stores was completed in May 2002 and the sale of ourmarket areas to negotiate favorable lease terms at many of our22 storelocations, which has resultedBC Sports Collectibles business closed inlower occupancy costs. We regularly review the profitability and prospects of each of our stores and evaluate whether any underperforming stores should be closed or relocated to more desirable locations. We negotiate with landlords to convert desirable Waldensoftware locations into Electronics Boutique stores when their leases terminate. See "Management Services". STORE ECONOMICS. We believe that our store concepts offer attractive unitNovember 2002.Store economics.
We estimate that the average Electronics Boutique store had net sales of approximately $1.3 million in fiscal 2000.The average cost,to open an Electronics Boutiquenet of payables, of opening a new mall-based store in fiscal2000 (exclusive of inventory costs)2003 was approximately$163,000. These costs include$164,000. This included approximately $148,000 for furniture, fixtures, equipment and leaseholdimprovementsimprovements. Pre-opening expenses are minimal andequipment. Our stores have anare included in the store's expenses for the first month of operation.The average cost, net of payables, of opening
inventorya new strip center store in fiscal 2003 was approximately $77,000. This includes approximately $62,000 for furniture, fixtures, equipment and leasehold improvements. Pre-opening expenses are minimal and are included in the store's expenses for the first month of$95,000.operation.The cost to open an international store is approximately the same in U.S. dollars as the cost to open a domestic store. Typically, our new stores have generated a positive store operating contribution within the first 12 months of operations.
STORE OPERATIONS.We regularly review the profitability and prospects of each of our stores and evaluate whether any under performing stores should be closed or relocated to more desirable locations.10
Following the opening of a store, we utilize inventory management and controls and manage store payroll in an effort to maximize profitability. Our POS and inventory management systems allow us to analyze merchandise mix and in-stock positions and reduce shrinkage. We also utilize various payroll management and efficiency systems to improve sales conversions and store profitability.
Store operations. We divide our North American store base
(in the U.S., Canada,(United States andPuerto Rico) is equally dividedCanada) intotwo11 geographic regions,East and West. These regionswhich are supervised bytwo Fieldour President of Stores—North America and Canada, our Vice President of Store OperationsVice Presidents, 11(Canada), Regional Vice Presidents/Directors and46District Managers.EachOur Senior Vice President of International Operations, who is based in France, supervises our international operations other than in Canada. Managing Directors, District Managers and Area Managers supervise our stores in Denmark, Germany, Italy, Norway and Sweden. A General Manager,is responsible for approximately 12 stores. OurRegional Director, District Managers and Area Managers supervise our stores in Australia, New Zealand and SouthKorea are supervised by a Managing Director.Korea.Each of our stores typically has a full-time manager and a full-time assistant manager in addition to hourly sales associates, most of whom work part-time. The number of hourly sales associates in each store fluctuates depending on our seasonal needs. Our domestic stores are open seven days per week and generally ten hours each day. We operate our international stores in a manner
substantiallysimilar to our domestic stores.ONLINE RETAILING In April 1999, we established EBWORLD.COM as a separateOnline Retailing
We launched our e-commerce
subsidiary to accelerate the growthwebsite,ebworld.com, in August 1997. As part of ourInternet business. Inrebranding initiative, we changed the name of the website toebgames.com earlier this year. Online orders have increased year over year and our e-commerce operating subsidiary has been profitable since fiscal2000, we recorded 19.6 million visits to our web site compared to 10.2 million in fiscal 1999. In addition, revenues from our web site in fiscal 2000 were $14.1 million compared to revenues of $4.3 million in fiscal 1999.2002.The Internet represents a
logical extension ofcomplementary channel to ourtraditionalstore-based retail business.We believeOur own surveys indicate that ourcustomers are generally more familiar with the Internet and with online retailing than are most consumers. In addition, we believe that our web site'swebsite's detailed product reviews, game previews, new release schedules, product notification services, industry news and advanced search capabilitieswillappeal to aworldwide audience of game enthusiasts. Our experience in store-based retailing provides us with asignificantadvantage over online only competitors. We believe that the breadthportion of ourstore-based operations and the strength of the Electronics Boutique brand name will differentiate EBWORLD.COM from other online competition. EBWORLD.COMgamer audience.Ebgames.com utilizes our merchandising9expertise ebgames.com leverages our distribution andto leverage ourand strong vendor relationshipsandto provide online customers withan extensive selection of titles.over 5,000 new and pre-owned SKUs that are available for immediate shipping. Further,EBWORLD.COMorderfulfillment capabilitieswhich have supportedto provide delivery of new release titles to online consumers on the same day they are available in ourdirect-to-consumer catalog operations for more than 10 years. Our marketing strategy for EBWORLD.COM has primarily consisted of alliances with directories, search engines, content providers, targeted advertising and related web sites which feature electronic games. As an example, EBWORLD.COM is the exclusive commerce provider of games for the IGN.com, network of web sites and IGN.com provides EBWORLD.COM with electronic game-related content. IGN.com, a part of Snowball.com, is a leading online provider of entertainment content. EBWORLD.COM launched a new marketing campaign during the third and fourth quarters of fiscal 2000 which was designed to increase customer awareness of EBWORLD.COM among game enthusiasts. The marketing campaign featured an assortment of current, popular products, and was targeted to attract the mass market as well as the avid gaming community. It was supported through national print, radio and television advertising.stores.We
alsobelieve thatthis advertising campaign drove sales at our stores through association withInternet broadband technology will play an important role in theElectronics Boutique brand name, as the stores have traditionally depended on mall traffic, and not company-sponsored advertising,future of online retailing. We continue todraw customers. We have implemented many initiatives designedexplore different ways tomaintain the competitive position of EBWORLD.COM and to ensure thatassume a leadership role in the onlinestore can support significant further growth in customer traffic, salesdistribution of games. Adoption of this new technology by consumers has been limited. However, as adoption of this technology grows andearnings. These initiatives include: IMPROVED CUSTOMER SERVICE. We have expanded our customer service capabilities by opening a customer contact center located in Las Vegas, Nevada, during the second quarter of fiscal 2000. The customer contact center is open seven days a week, 16 hours a day and upother game delivery technologies emerge, we expect to24 hours a day during the peak selling season, and is staffed by trained customer sales representatives who respond to EBWORLD.COM customer inquiries via telephone, e-mail or instant messaging. The center is designed to provide a high level of customer service comparable to that available within our stores. ENHANCED ORDER FULFILLMENT AND DISTRIBUTION. To enhance our order fulfillment capabilities, we began shipping from our Louisville, Kentucky distribution center in the third quarter of fiscal 2000. We have also expanded our capacity for processing orders by upgrading our order fulfillment software and increasing staffing and equipment dedicated to online order fulfillment. UPGRADED WEB SITE. We have upgraded our web site to increase performance and customer usability. The new web site design provides customers with a faster and more convenient shopping experience through more efficient use of graphics and straightforward navigation. To best accommodate our increased Internet traffic, we have moved our web site to an external hosting data center, which allows us to add hardware and increase bandwidth as necessary to maintain peak performance. MANAGEMENT SERVICES As of January 29, 2000, we provided management services to 311 specialty electronic game stores in the United States, the United Kingdom, Ireland and Sweden. EB-UK STORES. As of January 29, 2000, we provided management services for 280 stores and 18 department store-based concessions in the United Kingdom, Ireland and Sweden under a contract with EB-UK, a corporation organized under the laws of the United Kingdom. EB-UKactively pursue these opportunities.Game Group Services Agreement
Game Group is one of the leading specialty retailers of
electronic gamesinteractive entertainment in the United Kingdom, Ireland, France, Spain andIreland. EB-UK'sSweden, operating over 400 stores. Game Group's business strategy is substantially similar to our business strategy.EB-UK strives to offer its customers an extensive selection of video games and PC entertainment software, immediate availability of new releases, knowledgeable sales associates, value pricing and other customer incentive programs. EB-UK also has a highly effective inventory management system and distribution center. EB-UK stores are generally located in malls and "high street" shopping districts.Under the terms of a services agreement, at theUK Services Agreement,request of Game Group, we are required to provide management services,to EB-UK,including assistance with ordering and purchasing inventory, store design and acquisition, advertising, promotion, publicity and10information systems. In exchange, EB-UKWe also license the use of the name Electronics Boutique to Game Group. Game Group is responsible for the payment of fees, payable, at our option, in cash orEB-UKGame Group stock, equal to 1.0% ofnetGame Group's adjusted sales, plus a bonus calculated on the basis of net income in excess of a pre-established target set byEB-UK.Game Group. InMay 1999, EB-UK acquired a competitorfiscal 2003, we received approximately $7.4 million inthe United Kingdom, which should serve to increase EB-UK's net sales in the future.management fees from Game Group. TheUK Services Agreement provides for EB-UK to have a right of first refusal on any business opportunity of which we become aware in Europe (excluding Scandinavia) relating to electronic game retailing. The UK Services Agreementservices agreement prohibits us from competing withEB-UKGame Group in the United Kingdomor Ireland during the term of the UK Services Agreement, and foruntil one year afterits termination.the termination of the11
services agreement, currently scheduled for January 2006. The
UK Services Agreement has an initial term expiring onservices agreement also requires that, until January31, 2006. EB-UK's right2006, we report to Game Group any opportunity relating to the interactive entertainment retailing business which we become aware of in Europe (excluding Scandinavia) which could be made available to Game Group and usethe Electronics Boutique name terminates six months after the UK Services Agreement expires on January 31, 2006. WALDENSOFTWARE STORES. We manage 13 Waldensoftware stores under a management contract with Bordersreasonable endeavors to procure that each and every such opportunity is first offered to Game Group,Inc. The Waldensoftware stores are domestic, mall-based stores that offer similar product lines as our Electronics Boutique stores. We provide management services to Waldensoftware in exchange for a fixed fee per store plus a bonus calculatedon thebasis of net income in excess of the fixed management fee. We manage the stores in a manner substantially similarsame terms, including as toour Electronics Boutique stores. We negotiate with landlords to convert desirable Waldensoftware locations into Electronics Boutique stores when their leases terminate. PRODUCTScost.Products
Our product line consists of video game titles, PC entertainment software titles, video game hardware systems, related products and toys, trading cards and
accessory products. We also market selected PC productivity and educational software titles.accessories. Our in-store inventory at any given timeconsistsaverages over 2,400 SKUs.Video game titles and PC entertainment software. We carry an average of over
2,000 SKUs. VIDEO GAME TITLES AND1,400 video game and PCENTERTAINMENT SOFTWARE. We carry over 650 video gameentertainment software titles (excluding pre-owned games)and over 1,000 active PC entertainment software SKUsat any given time. We purchase video game titles directly from the leading console manufacturers, which includeNintendo, SegaSony, Microsoft andSony,Nintendo, as well as a variety of third-partygamesoftware publishers, such as Electronic Arts,Acclaim Entertainment,Take-Two Interactive Software, Inc., Activision, Inc., Sega Corporation, andMidway Home Entertainment,THQ Inc. Werank asare one of thelargerlargest domestic customers of video game productsfromsold by these publishers. We currently purchase titles fromapproximately 90 vendors. We market electronic gamesover 60 vendors across a variety of genres, including Action, Strategy, Adventure/Role Playing, Simulation, Sports, Children's Entertainment and Family Entertainment. We maintain a broad selection of popularnew-releasenew release titles, which we define as titles that have been available forno moreless than six weeks from the date of their release.VIDEO GAME HARDWARE.Pre-owned video games and PC entertainment software. As a result of the proliferation of new titles and the tendency of gamers to seek new game challenges after mastering a particular title, a growing market for pre-owned game titles has evolved. We carry over 1,300 pre-owned SKUs in our typical store. We allow customers to trade in pre-owned games in our stores. We believe that the opportunity to trade-in games and the availability of pre-owned titles in our stores is attractive to the value conscious gamer and differentiates us from most of our competition, which do not generally accept trade-ins or offer pre-owned games. In return for a trade-in the customers receive a store credit, which can be applied towards the purchase of new or pre-owned products. At our in-house product reclamation center, these trade-ins can be tested, cleaned, relabeled, repackaged, repriced and redistributed back to the stores. These trade-ins are then resold in our stores at a discount to the price of new releases. Sales of pre-owned games generate significantly higher margins than new titles. We believe that availability of pre-owned games in our stores attracts our core game enthusiast customer and drives traffic into our stores.
Video game hardware. We sell the video game hardware systems of all major manufacturers, including
the SonySony's PlayStationNintendo 64, Nintendo2, Nintendo's GameCube and Game Boy Advance and Microsoft's Xbox. While we offer theSega Dreamcast. In supportnewest technology in video game systems, we also offer a wide range of the older video game systems through ourstrategypre-owned program. Our pre-owned program affords customers the opportunity tobe the destination of choice for electronic game enthusiasts, we aggressively promote the sale oftrade-in older video game hardwaresystems. We believe that this policy increases store traffic and promotes customer loyalty, leading to increased salesfor credit towards the purchase ofvideo game titles, which typically have higher gross margins than video game hardwareone of the latest systems. We also offer extended service agreements and extensions of manufacturer warrantiesoffor the video game systems.RELATED PRODUCTS AND TRADING CARDS. We offer an assortment of trading cards, such as Pokemon and Star Wars products, that appeal to the same core customer group as our video game customer. We also offer action figures that are related to video game characters. We experienced an increase in the sale of related products in fiscal 2000, driven particularly by sales of Pokemon products. PC EDUCATION AND PRODUCTIVITY SOFTWARE. In addition to our category dominant assortment of video game and PC entertainment software titles, we offer a complementary selection of educational, personal productivity and finance software titles. We believe that these titles also appeal to our core customer base. ACCESSORIES.Accessories. In recent years, the growing popularity of
electronicvideo games has led to an increase in sales of accessory products, which generally have higher gross margins than hardware and software products.Accessory products enhance the total gaming experience. Presently, weWe currently offer approximately500600 accessory product SKUs, including3-D graphics accelerators,controllers and memorycards and joysticks.cards. We also market instructional books and strategy guides on the most popularelectronicvideo game titles.11INVENTORY MANAGEMENT AND DISTRIBUTION INVENTORY MANAGEMENT.Related products and trading cards. We offer an assortment of trading cards, such as Yu-Gi-Oh and Magic The Gathering products, that appeal to our core customers. We also offer collectable action figures and gaming magazines.
Inventory Management and Distribution
Inventory management. We do extensive research prior to the release of new products and titles and carefully manage our inventory to minimize the risk associated with introducing new
products.products and titles. Our centralized merchandising staff evaluates potential productsby testing many pre-release samples received from publishers, reading game reviews, interviewing customersandstore associates, and studying vendor marketing plans. Our centralized merchandising staff alsoanalyzes the EB Pre-Sell Programand EB Reserve Listinformation and other data to estimate initial demand and the projected life cycle for a new release. We then use our new product analyses to plan our initial purchases and allocations among our stores andweb site of the total initial purchase of a newly-released title. We use our management information system to measure, on a daily basis, SKU level sales, gross margins and inventory balances. After sales histories for a particular product are compiled, appropriate stock levels are designed for that specific product. Sales levels are continuously monitored by our merchandising staff, which receives sales and inventory reports by SKU on a daily basis through POS polling technology as well as recommended order quantities and product discontinuations from each store. Replenishment allocations among stores are then made based on this data. We focus on inventory turnover by operating our allocation, traffic, buying, distribution and third party functions on a "just in time" replenishment basis. This focus allows us to minimizewebsite. Through our inventoryriskreplenishment system, we forecast andwe believe provides us with a competitive advantage. DISTRIBUTION. Our primaryactively manage our ongoing inventory requirements on an individual store and aggregate basis.Distribution. We currently operate three distribution
center occupies approximately 93,000 square feetcenters in the United States, each of which focuses on separate components of our business. Our 97,500 square foot facilitylocatedin West Chester,Pennsylvania. We opened an additionalPennsylvania handles staple products and online fulfillment. Our 80,000 square foot distributionfacility at ourcenter in West Chester, Pennsylvaniasite in November 1999. In addition, in April 1999, we leased a 52,000handles returns and reclamation. Our 200,000 square foot distribution center in Louisville, Kentuckyto support flow throughsupports flow-through operations on newrelease andreleases, top sellingproducts.products and online fulfillment. We also have a 120,000 square foot facility in Canada, a 70,000 square foot facility in Australia and four smaller European facilities in Denmark, Germany, Italy and Sweden.These distribution facilities allow us to replenish our stores on a daily basis
thereby reducing inventory levels and increasing inventory turns, whilesupporting our"FIRST TO MARKET""first-to-market" new-release strategy. Our rapid processing capability in our distributioncentercenters is facilitated by several advanced inventory management technologies, including paperless picking and radio frequency support.Our ability to rapidly process incoming shipments of new-release titles quickly and distribute them to all ofWe also use a warehouse management system in ourstores eitherdomestic distribution centers thatsame day or by the next morningenables us tomeet peak demand. We also believe that ourbetter manage labor and freight costs. Our distribution networkprovides a competitive advantage for EBWORLD.COM since our distribution and inventory management systems enableenables us to provide immediate delivery service to our online customers.During peak sales periods, we may enter into short-term arrangements for additional retail distribution centers to ensure timely restocking of allMarketing
In-store promotions. Many of our
stores. We have also developed a flexible third-party network to provide additional regional distribution support for new product releases. MARKETING IN-STORE PROMOTIONS. Our Electronics Boutiquestores areprimarilylocated in high traffic, high visibility areas in regional shopping malls. Accordingly, our marketing efforts at these stores are designed to draw mall patrons into our stores through the use of window displays and other attractions visible to shoppers in the mall concourse. We actively publicize our other stores through a variety of media, including print, radio and selected local television advertising. Insidetheall of our stores, we feature selected products through the use of vendor displays, signs, fliers, point of purchase materials and end-cap displays.We receive cooperativeA majority of these promotions are funded through advertising allowances and market development funds from manufacturers, distributors, software publishers and accessorysuppliers to promote their respective products. THE EB PRE-SELL PROGRAM AND THE EB RESERVE LIST. The EB Pre-Sell Program offers our customers the opportunity to purchase video games and PC software prior to their release, and the EB Reserve List entitles participants to be notified whensuppliers.In January 2003, as a
game has arrivedcombined effort with Ziff Davis Media, GMR magazine was launched in our stores. GMR magazine is a monthly publication providing news and reviews on the latest products for PC and video gamers. Customerswho participate in the EB Pre-Sell Program pay forthat purchase agame priorten-month subscription toits release and may receive a promotional gift in connection with the purchase (such as a t-shirt). The EB Pre-Sell Program and the EB Reserve List enable our customersGMR are eligible to receive anew productdiscount on thefirst day it is availablepurchase of pre-owned products in ourstores and on our web site, and are designed to enhance our reputation as the destination of choice for electronic game enthusiasts. CATALOGS.stores.Catalogs. We publish
sixeight or more full color catalogs each yearwhich rangeranging in size from4852 to 100pages and feature a broad array of products. Thepages. Our vendors fund the cost of thesecatalogs is funded by our software, hardware and accessories vendors.catalogs. The catalogs are available in our stores and are mailed to several hundred thousand households from our proprietary customer lists. The catalogs are also inserted in leading industry magazines.12EBWORLD.COM. We have continued to pursue strategic on-line alliances with directories, search engines, content providers and web sites in order to grow our customer base. As an example, EBWORLD.COM is the exclusive commerce provider of games for the IGN.com network of web sites and IGN.com provides EBWORLD.COM with electronic game-related content. IGN.com is a leading online provider of entertainment content. We advertise on other networks including America Online, Ziff-Davis Inc. and CNET. Additionally, EBWORLD.COM is a Gold Tenant in the Electronic Gaming category of America Online's shop@home site. We also have a similar e-commerce agreement with CNET related to their shopper.com site. In the third quarter of fiscal 2000, we launched a new marketing initiative that was designed to increase market penetration among game enthusiasts and broaden overall market awareness. This campaign included national print, radio and television advertising. PRE-OWNED GAMES. Video game software has a useful life of thousands of plays. As a result of the proliferation of new titles and the tendency of electronic game players to seek new game challenges after mastering a particular title, a growing market for pre-owned video game titles has evolved in recent years. We offer our customers a store credit for their pre-owned video game titles, which can be applied towards the purchase of new or pre-owned products. We then resell the pre-owned video game titles at discount prices, but with gross profit margins higher than those for new video game titles.Ebgames.com. We believe our
wide assortmentonline presence and marketing initiatives play a key role in strengthening our brand identity. Our online marketing initiatives focus on partnering with companies that operate other websites, such as CNET. These initiatives enable us to access the broad reach ofpre-owned videothe Internet at a low cost. We also advertise in gametitles distinguishes us from our competitors. OTHER MARKETING PROGRAMS. We provide our customersfocused magazines and online witha liberal return policy. Our customers can return opened software products for a full credit within ten days after purchase. We maintain an "everyday low pricing" policy. TRAINING AND DEVELOPMENT We place an emphasis on trainingportals such as AOL anddeveloping our sales associates and store managers. We believe that our training and developmental programs make our sales associates and store managers more knowledgeable and enthusiastic about our product offerings, providing us with an important competitive advantage over mass merchants, toy retail chains and electronics and computer superstores. In addition, we believe by providing extensive associate training we have a higher employee retention rate than most mall-based specialty retailers. We provide training and development at the store level, through regularly scheduled seminars conducted by our District Managers, and through EB University. EB University is a semi-annual, vendor-sponsored, multiday seminar encompassing sales training, extensive product demonstrations and a variety of team building exercises. In September 1999, we hosted our EB University seminar in Orlando, Florida, where substantially all of our store and field managers were present. This event was attended by 123 vendors, displaying and demonstrating their latest product offerings. MANAGEMENT INFORMATION SYSTEMSMSN.13
Management Information Systems
Our primary management information system is a customized version of the AS400-based JDA Merchandise Management System. We have made proprietary enhancements to this program, which enable us to analyze total, comparative and new store sales and inventory data at the company, region, district and store levels.
Additional revisions to the program have enhanced analysis of top selling items, new-release sales and gross margin item rankings.We operate our own proprietary store POS and back office systems and believe this provides a strategic advantage by allowing us to makefastenhancements to meet businessopportunities.opportunities quickly. We have integrated theShoppertrakShopperTrak customer counting technology into our POS and our AS400 system. This combination of technology provides centralized access to store traffic and sales conversion information by store andhour.hour at our store locations.Vendors
We
have completed the rollout of this technology to all stores. In fiscal 2000, we continued to invest in our management information system by, among other things, upgrading our global financial reporting and analytical capabilities through the implementation of the Lawson Associates, Inc. financial software products. We intend to enhance our management information systems further with client server and data warehousing applications to improve sales analysis and targeted consumer marketing. We spent $2.5 million for information system improvements, including "Year 2000" expenditures, in fiscal 2000. We have budgeted $3.7 million for fiscal 2001 for additional improvements. 13We have completed the upgrade of all software programs and hardware to be "Year 2000" compliant. See "Management's Discussion and Analysis of Financial Conditions and Results of Operations - Year 2000 Readiness." VENDORS With the exception of certain personal productivity software titles and accessories, wepurchase substantially all of our products directly from manufacturers and software publishers. Our top 25 vendors accounted for approximately79%88% of our purchases in fiscal2000.2003. Our largest vendors in fiscal20002003 were Sony, Electronics Arts,Nintendo, Sega,Microsoft andSonyNintendo, which accounted for10.5%14.8%,10.4%12.3%,8.7%11.5% and7.1%9.3%, respectively, of ournetgross purchases. No other vendor accounted for more than 5.0% of our software or accessory purchases during fiscal2000.2003. We believe thatmaintaining and strengthening our long-termwe have good relationships with ourvendorsvendors. Maintaining and strengthening these relationships is essential to our operations and continued expansion.We
have no contractsparticipate in marketing programs with each of our key product vendors, including Sony, Electronic Arts, Microsoft and Nintendo. Under these programs, we are eligible to receive marketing allowances from product vendors provided we perform certain specified marketing and merchandising events and activities pursuant to the terms of written agreements we negotiate with our vendors for each event or activity. Typical events or activities are print advertising, television advertising, product catalog advertising, in-store display promotions, Internet advertising, and product training and promotion at our national tradevendors and conduct business on an order-by-order basis, a practice that is typical throughout the industry. We believe that we have very good relations with the vendor community. COMPETITIONshow.Competition
The
electronic gameinteractive entertainment industry is intensely competitive and subject to rapid changes in consumer preferences and frequent new product introductions. Webelieve that key competitive factors are: - ability to procure high-demand product, - knowledgeable service, - price, - reputation, and - shopping environment. Wecompete with other specialty retailers of videogamegames and PC software,stores located in malls,as well as with mass merchants, toy retail chains,mail-order businesses,catalogs, direct sales by software publishers, online retailers, and office supply, computer product and consumer electronics superstores. In addition, video games are available for rental from many video stores. Further, other methods ofretaildistribution may emerge in the future,which would resultresulting in increased competition.SomeEnvironmental Matters
Under various federal, state and local and foreign environmental laws and regulations, a current or previous owner or occupant of
our competitorsreal property may become liable for fines as well as the costs of removal or remediation of hazardous substances present or generated at the premises, at times without regard to fault. Although we havelonger operating historiesnot been notified of, andsignificantly greater financial, managerial, creative, sales and marketing and other resources than us. We also compete with other formsare not aware of,entertainment activities, including movies, television, theater, sporting events and family entertainment centers. Our ability to retain our existing customers and attract new customers depends on numerous factors, some of which are beyond our control. These factors includeany current environmental liability, claim or non-compliance, it is possible that we may incur fines or remediation costs in thecontinued introduction of new and enhanced video game and PC hardware and software, and the availability and timeliness of new product releases at our stores. TRADEMARKS/REGISTRATIONSfuture.Trademarks/Registrations
We possess registered trademarks for Electronics
Boutique-TM-Boutique® (and design),EBX-TM-EBX® andStop 'N Save Software-TM-. We also possess trademarks for BC Sports Collectibles-TM- and EBWORLD.COM-TM-ebworld.com® as well as other registered trademarks and service marks, both in the United States and in certain foreign jurisdictions. We also haveanumerous trademarkapplication for EBKids pending.applications pending in the United States and in certain foreign jurisdictions, including EB Games andebgames.com.14
We believe our trademarks are valid and valuable and intend to maintain our trademarks and their related registrations. We do not know of any pending claims of infringement or other challenges to our right to use our marks in the United States or elsewhere. We have no patents, licenses, franchises or other concessions
whichthat areconsideredmaterial to our operations.ASSOCIATESAssociates
As of
January 29, 2000,February 1, 2003, we had approximately4,6007,660 non-seasonalassociates, of which approximately 2,600associates. Approximately 3,650 were employed on a part-time basis, and 700 were employed on a temporary basis. In addition, during the calendar19992002 peak holiday shopping season, we hired approximately9301,300 temporary associates. We believe that our relationship with our associates is good. None of our associates is represented by a labor union or is a member of a collective bargaining unit.14ITEM
Item 1A.EXECUTIVE OFFICERS OF ELECTRONICS BOUTIQUE The following table setsExecutive Officers of Electronics BoutiqueSet forth
certainbelow is information regarding the executive officers of Electronics Boutique:
Name Age Position ---- --- --------Joseph J. Firestone 68Jeffrey W. Griffiths 52 President, Chief Executive Officer and Director Jeffrey W. Griffiths 49 Senior Vice President of Merchandising and Distribution; President, EB Kids
John R. Panichello38 Senior
41
Executive Vice President and Chief Operating Officer
James A. Smith
47
Senior Vice President, Chief FinancialOfficer; President, BC Sports CollectiblesOfficer and Secretary
Seth P. Levy42
45
Senior Vice President, Logistics and Chief Information Officer; President,EBWorld.comEB Games Online, Inc.
Steven R. Morgan
51
Senior Vice President, President of Stores—North America and President of Canadian OperationsJoseph J. Firestone.Mr.
FirestoneGriffiths, age 52, has served asthe President, Chief Executive Officer and a Class III Director of Electronics Boutique since March 1998. Mr.Firestone served as the President of Electronics Boutique's predecessor, EB, since February 1984, andthe President and Chief Executive Officer ofEBElectronics Boutique and a Class I Director sinceFebruary 1995. Mr. FirestoneJune 2001. Prior thereto, he served asa director of EB-UK from May 1995 until November 1999. Mr. Firestone also serves on the Executive Advisory Board of the Center for Retailing Education and Research of the University of Florida and as a Director of the National Retail Federation. Jeffrey W. Griffiths. Mr. Griffiths has served as Electronics Boutique'sSenior Vice President of Merchandising and Distributionsincefrom March1998.1998 to June 2001. Mr. Griffiths served astheSenior Vice President of Merchandising and Distribution of EB,sinceour predecessor, from March1996.1996 to March 1998. From March 1987 to February 1996, Mr. Griffiths served asEB'sVice President of Merchandising of EB, and from April 1984 to February 1987 he served astheMerchandiseManager of EB. Mr. Griffiths serves as the Chairman of the Interactive Entertainment Merchants Association. John R. Panichello.Manager.Mr. Panichello, age 41, has served as
the SeniorExecutive Vice President and ChiefFinancialOperating Officer since April 2002. Prior thereto, Mr. Panichello served as Senior Vice President, Chief Operating Officer, President of EB GameWorld and BC Sports Collectibles (a former division of Electronics Boutique) and Secretary of Electronics Boutiquesincefrom June 2001 to April 2002. Mr. Panichello served as Senior Vice President, Chief Financial Officer, President of EB GameWorld and BC Sports Collectibles and Secretary of Electronics Boutique from June 2000 to June 2001. Mr. Panichello served as Senior Vice President, Chief Financial Officer, President of BC Sports Collectibles and Secretary of Electronics Boutique from March1998.1998 to June 2000. Mr. Panichello served as the Senior Vice President of Finance of EB and the President ofEB'sthe BC Sports Collectibles divisionsincefrom March1997. From March 19961997 to February1997,1998. Mr. Panichello served as EB'sSeniorVice President of Finance and Treasurer from June 1994 to February1996, he served as the Vice President and Treasurer of EB. Mr. Panichello served as the President and Chief Executive Officer of Panichello & Company, a certified public accounting firm, from May 1990 to May 1994.1997. Mr. Panichello served as a director ofEB-UKGame Group from May 1995untilto November 1999.Seth P. Levy.Mr.LevyPanichello is a Certified Public Accountant. Mr. Panichello is the husband of Susan Y. Kim and the son-in-law of James J. Kim. Mr. Panichello serves on the Board of Directors of the Interactive Entertainment Merchants Association.Mr. Smith, age 47, has served as Senior Vice President, Chief Financial Officer and Secretary since June 2001. Prior thereto, Mr. Smith served as Senior Vice President of Finance of Electronics Boutique from August 2000 to June 2001. Mr. Smith served as Electronics Boutique's Vice President-Finance
15
from May 1998 to August 2000. From 1996 to 1998, Mr. Smith served as Vice President and Controller of EB, our predecessor, and from 1993 to March 1996, he served as Controller of EB.
Mr. Levy, age 45, has served as Senior Vice President, Logistics, Chief Information Officer
of Electronics Boutiqueand the President ofElectronics Boutique's EBWorld.com subsidiaryEB Games Online, Inc. since June 2001. Prior thereto, he served as Senior Vice President, Chief Information Officer and the President of EB Games Online, Inc. from March1999.1999 to June 2001. From February 1997 to March 1999, Mr. Levy served asElectronics Boutique'sthe Vice President and Chief Information Officer. From 1991untilto February 1997, Mr. Levy served as the Director of System Development for the May Merchandising and May Department Stores International divisions of May Department Stores.15ITEMMr. Morgan, age 51, has served as Senior Vice President, President of Stores—North America and President of Canadian Operations since April 2002. Prior thereto, Mr. Morgan served as Senior Vice President of Stores of Electronics Boutique and Canadian Operations from June 2001 to April 2002. Mr. Morgan served as Senior Vice President of Stores of Electronics Boutique from January 2001 to June 2001. From May 1998 to January 2001, Mr. Morgan served as President and CEO of Millennium Futures, Inc., a commodity trading company. From July 1996 to May 1998, he served as Senior Vice President, Director of Stores at Filene's Department Stores. From May 1988 to July 1996, he served as Regional Vice President at Filene's Department Stores.
Item 2.PROPERTIES STORE LEASES.PropertiesStore leases. All of
Electronics Boutique'sour stores are leased.The table below sets forth, asAs ofJanuary 29, 2000, the numberFebruary 1, 2003, we had 1,145 stores. In general, our mall-based leases have initial terms ofour store leases that will expire each year (assuming the lease is not terminated by either party priorseven tothe expirationten years. Our strip and power center locations typically have initial terms ofthe term).
Number of Leases ---------------- Fiscal Year In which Leases Expire Domestic International - ------------------- -------- -------------2001............................................... 73 11 2002............................................... 46 4 2003............................................... 43 9 2004............................................... 41 14 2005............................................... 25 29 2006............................................... 34 8 2007............................................... 41 - 2008............................................... 61 1 2009............................................... 76 12 2010............................................... 75 14 2011 and thereafter................................ 2 - ---- ----- 517 102HEADQUARTERS. Electronics Boutique leases its headquartersthree to five years with at least one or more renewal options.Headquarters and
its primarydistributioncenter, which are located in a singlecenters. We own our 140,000 square footbuilding on several acresheadquarters in West Chester, Pennsylvania.The lease expires on May 30, 2000 andThis building includesan option to purchase the property for $6.7 million DISTRIBUTION CENTERS.a 97,500 square foot distribution center. In addition,to our West Chester, Pennsylvaniawe own an adjacent 80,000 square foot distribution facility. We lease a 200,000 square foot distribution center inApril 1999 we leasedLouisville, Kentucky. This lease expires in May 2005. We also lease a 52,000 square foot building in Louisville,KentuckyKentucky; however we subleased a portion of this building in January 2003. The lease for the building expires in March 2004. In Brampton, Ontario, Canada, we own a 120,000 square foot distribution and office facility. In Pinkenba, Queensland, Australia, we own a 70,000 square foot distribution and office facility. We also lease small distribution facilities in Denmark, Germany, Italy and Sweden.Customer service call center. We lease a 17,900 square foot customer service telephone call center in Las Vegas, Nevada, from which
supports flow through operations on new releases and top-sellingwe respond to consumers' inquiries regarding our products. The lease expires inAprilJune 2004.Electronics Boutique also leases a 41,000 square foot facility located in West Chester, Pennsylvania primarily used for returns processing and bulk storage. This lease expires on July 31, 2000.We
have also built an additional 80,000 square foot distribution facility on several acres of land we acquired adjacent to our West Chester, Pennsylvania site. It opened in November 1999. ITEM 3. LEGAL PROCEEDINGS Electronics Boutique isare involved from time to time in legal proceedings arising in the ordinary course of our business. In February 2003, our affiliates, The Electronics Boutique, Inc. and EB Services Company, LLP, prevailed in the appeal of a major civil lawsuit brought against those companies by Game Group. Game Group filed the appeal in October 2002 after judgment was entered against it in the trial of the matter.Game Group filed suit in March 2002 in the Chancery Division of the High Court of Justice in the United Kingdom. It sought a ruling that, because of an alleged change of control of EB Services Company, it was entitled to terminate the services agreement between itself and EB Services Company that had been in effect since 1995 and that does not expire by its
business.terms until at least 2006. Pursuant to the services agreement, EB Services Company receives significant fees from Game Group. The fees were approximately $7.4 million for the fiscal year ended February 1, 2003. In October 2002, the Chancery Division ruled that Game Group was not entitled to terminate the services agreement.In the opinion of management, no pending proceedings
willcould have a material adverse effect onElectronics Boutique'sour results ofoperationsoperation or financial condition.ITEM
Item 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 16Submission of Matters to a Vote of Security Holders None
Item 5.
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERSMarket for Registrant's Common Equity and Related Stockholder MattersThe common stock of Electronics Boutique was first traded publicly on July 28, 1998. The stock is quoted on the NASDAQ National Market under the symbol ELBO. The table below represents the high and low bid prices of Electronics Boutique's common stock as reported by NASDAQ.
Fiscal 1999 Fiscal 2000 ----------- ----------- Low High Low High --- ---- --- ----First fiscal quarter..................... $12.13 $19.88 Second fiscal quarter.................... $13.25 $14.13 13.50 18.38 Third fiscal quarter...................... 6.63 14.00 16.63 26.31 Fourth fiscal quarter..................... 11.75 25.75 14.00 25.38
Fiscal 2002 Fiscal 2003 Low High Low High First fiscal quarter $ 17.00 $ 28.90 $ 28.03 $ 38.55 Second fiscal quarter 27.75 36.10 21.30 32.24 Third fiscal quarter 23.41 42.07 21.02 29.38 Fourth fiscal quarter 31.66 44.51 13.10 31.81 Such quotations reflect inter-dealer prices, without retail mark-ups, mark-downs or commissions and may not necessarily reflect actual transactions.
As of April
6, 2000, the Company24, 2003, we had approximately3935 shareholders of record (including Cede & Co., the nominee for Depository Trust Company, a registered clearing agency) of the22,224,81425,891,158 outstanding shares ofthe Company's Common Stock.Electronics Boutique's common stock. On April6, 2000,24, 2003, the last reported sale price forthe Company'sElectronics Boutique's common stock as quoted by NASDAQ was$19.75$18.58 per share.Electronics Boutique has not paid any dividends on its common stock to
date and does not anticipate paying any dividends on the common stock in the forseeable future. 17ITEMdate.
Item 6.SELECTED FINANCIAL DATASelected Financial DataThe following table sets forth for the periods indicated selected financial and other data for Electronics Boutique for periods subsequent to its initial public offering on July 28, 1998. Prior periods reflect financial data of Electronics Boutique's predecessors, The Electronics Boutique, Inc. ("EB") and subsidiaries and EB Services Company
LLP.LLP ("EB Services"). Theselectedstatement of incomestatementdata and balance sheetitemsdata, which follow, have been derived from Electronics Boutique's consolidated financial statements. This information 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 pro forma data, in the opinion of17
management, include all adjustments necessary to present fairly the information set forth therein including the matters referred to in
footnotes 3Notes 1 and4 on page 19.2 to the consolidated financial statements.
(in thousands, except per share data and operating data) YEAR ENDED ----------------------------------------------------------------- FEBRUARY 3, FEBRUARY 1, JANUARY 31, JANUARY 30, JANUARY 29, 1996 1997 1998 1999 2000 ----------- ----------- ---------- ----------- ----------- STATEMENT OF INCOME DATA:Net sales $ 268,956 $ 337,059 $ 449,180 $ 570,514 $ 723,801 Management fees 1,905 2,526 4,792 3,405 4,873 ------------ ----------- ------------ ----------- ------------ Total revenues 270,861 339,585 453,972 573,919 728,674 Cost of goods sold 199,226 252,813 338,498 431,744 546,451 ------------ ----------- ------------ ----------- ------------ Gross profit 71,635 86,772 115,474 142,175 182,223 Operating expenses 58,989 69,828 87,003 99,972 133,534 Depreciation and amortization 6,047 6,615 7,997 9,775 12,278 ------------ ----------- ------------ ----------- ------------ Income from operations 6,599 10,329 20,474 32,428 36,411 Equity in earnings (loss) of affiliates (1,319) (573) 2,903 (161) - Interest (income) expense, net 1,818 1,298 1,380 289 (1,427) Preacquisition loss of subsidiaries (1) 913 ------------ ----------- ------------ ----------- ------------ - - - - Income before income tax expense 3,462 8,458 22,910 31,978 37,838 Income tax expense(2) 280 550 846 11,693 15,008 ------------ ----------- ------------ ----------- ------------ Net income $ 3,182 $ 7,908 $22,064 $20,285 $22,830 ============ =========== ============ =========== ============ Net income per share - basic $ 1.11 ============ Weighted average shares outstanding - basic 20,559 ============ Net income per share - diluted $ 1.10 ============ Weighted average shares outstanding - diluted 20,762 ============ PRO FORMA INCOME DATA: Income before income taxes (3) $ 8,458 $22,910 $31,978 Pro forma income taxes (3) 3,514 9,415 11,866 ----------- ------------ ----------- Pro forma net income (3) $ 4,944 $13,495 $20,112 =========== ============ =========== Pro forma net income per share - basic $ 0.31 $ 0.85 $ 1.12 =========== ============ =========== Pro forma weighted average shares outstanding - basic (4) 15,794 15,794 18,030 =========== ============ =========== Pro forma net income per share - diluted $ 0.31 $ 0.85 $ 1.11 =========== ============ =========== Pro forma weighted average shares outstanding - diluted (4) 15,794 15,794 18,084 =========== ============ =========== OPERATING DATA: (5) Stores open at end of period 341 360 452 528 619 Comparable store sales increase 3.5% 20.8% 15.3% 14.1% 11.6%
Year Ended January 30,
1999January 29,
2000February 3,
2001February 2,
2002February 1,
2003(Amounts in thousands, except per share data and operating data) Statement of Income Data: Net sales $ 595,859 $ 758,120 $ 802,851 $ 1,059,338 $ 1,309,226 Management fees 3,405 4,873 4,425 5,889 7,553 Total revenues 599,264 762,993 807,276 1,065,227 1,316,779 Cost of goods sold 457,089 580,770 626,939 826,599 971,204 Gross profit 142,175 182,223 180,337 238,628 345,575 Selling, general and administrative expense 99,972 133,534 144,466 179,464 267,566 Restructuring and asset impairment charge (reversal)(1) — — — 12,638 (2,611 ) Depreciation and amortization �� 9,775 12,278 15,855 19,750 22,524 Income from operations 32,428 36,411 20,016 26,776 58,096 Equity in earnings (loss) of affiliates (161 ) — — — — Other income — — 1,550 — — Interest (income) expense, net 289 (1,427 ) (3,096 ) (1,884 ) (1,677 ) Income before income tax expense and cumulative effect of change in accounting principle 31,978 37,838 24,662 28,660 59,773 Income tax expense(2) 11,693 15,008 9,791 10,948 22,373 Income before cumulative effect of change in accounting principle 20,285 22,830 14,871 17,712 37,400 Cumulative effect of change in accounting principle, net of tax(3) — — — — (4,773 ) Net income $ 20,285 $ 22,830 $ 14,871 $ 17,712 $ 32,627
Income per share before cumulative effect of change in accounting principle:
Basic $ 1.11 $ 0.67 $ 0.74 $ 1.44 Diluted $ 1.10 $ 0.66 $ 0.73 $ 1.42
Per share cumulative effect of change in accounting principle:
Basic $ (0.18 ) Diluted $ (0.18 )
Net income per share:
Basic $ 1.11 $ 0.67 $ 0.74 $ 1.26 Diluted $ 1.10 $ 0.66 $ 0.73 $ 1.24
Weighted average shares outstanding:
Basic 20,559 22,254 23,868 25,833 Diluted 20,762 22,466 24,230 26,247 18
AS OF --------------------------------------------------------------- FEBRUARY 3, FEBRUARY 1, JANUARY 31, JANUARY 30, JANUARY 29, 1996 1997 1998 1999 2000 ----------- ----------- ---------- ----------- ----------- BALANCE SHEET DATA:Working capital (deficit) $ (11,038) $ 9,893 $ (17,728) $(3,091) $ 42,567 Total assets 95,515 139,244 142,791 172,047 275,513 Total liabilities 78,066 118,887 114,392 123,205 159,026 Stockholders' equity 17,449 20,357 28,399 48,842 116,487- ----------------------
Pro forma Income Data: (unaudited)
Income before income taxes $ 31,978 Pro forma income taxes(4) 11,866 Pro forma net income(4) $ 20,112 Pro forma net income per share—basic $ 1.12 Pro forma weighted average shares outstanding—basic(5) 18,030 Pro forma net income per share—diluted $ 1.11 Pro forma weighted average shares outstanding—diluted(5) 18,084 Operating Data:(6)(unaudited) Stores open at end of period 528 619 737 937 1,145 Comparable store sales increase(7) 14.1 % 11.6 % (4.5 %) 20.8 % 8.3 %
As of January 30,
1999January 29,
2000February 3,
2001February 2,
2002February 1,
2003Balance Sheet Data: Working capital (deficit) $ (3,091 ) $ 42,567 $ 30,133 $ 121,446 $ 144,497 Total assets 172,047 275,513 267,239 425,838 521,614 Long-term debt 8 — — 143 — Total liabilities 123,205 159,026 136,019 188,678 247,114 Stockholders' equity 48,842 116,487 131,220 237,160 274,500
- (1)
The results- In fiscal 2002, the restructuring and asset impairment charge of $12.6 million resulted from our adoption of a plan to close the operations of
two subsidiaries, Electronics Boutique International, Inc.all 29 EB Kids stores andElectronics Boutique Canada, Inc. have been consolidated sincesell thebeginning22 store BC Sports Collectibles business. The charge represents a $3.5 million write down of store leasehold improvements, a $2.3 million write down of store furniture, fixtures and equipment and $6.7 million in lease termination costs. In fiscal 2003, the $2.6 million net reversal of theyear ending January 31, 1998. Preacquisition lossrestructuring and asset impairment charge resulted primarily from store lease related accruals that were not necessary due to the terms ofsubsidiaries represents losses in Electronics Boutique International, Inc. and Electronics Boutique Canada, Inc. prior to their acquisition by Electronics Boutique.the sale of the BC Sports Collectibles business.- (2)
- Prior to our initial public offering, our predecessors were taxed as an S Corporation and a partnership. As a result, their taxable income was passed through to their partners and
shareholdersstockholders for federal income tax purposes. Accordingly, for periods prior to the initial public offering on July 28, 1998, the financial statements do not include a provision for federal income taxes. Additionally, a predecessor to us elected to be treated as an S Corporation for some states, while remaining subject to corporate tax in other states and, as a result, the financial statements prior to July 28, 1998, provide for certain state income taxes. After the initial public offering, both federal and state taxes as a C corporation have been reflected.- (3)
- We changed our accounting policy with respect to the recording of vendor advertising allowances effective retroactively as of the beginning of fiscal 2003. As a result, we recorded a non-cash charge of $4.8 million, net of income tax, in the first quarter of fiscal 2003 for the cumulative effect of the change in accounting principle on fiscal years prior to fiscal 2003. Prior to this change, we recognized all vendor advertising allowances as an offset to selling, general and administrative expenses. Vendor advertising allowances in excess of advertising expense of
19
$40.9 million, $35.8 million, $24.2 million and $27.4 million were reflected as an offset to selling, general and administrative expense in fiscal 2002, fiscal 2001, fiscal 2000 and fiscal 1999, respectively.
- (4)
- The pro forma net income gives effect to the application of the pro forma income tax expense that would have been reported had
The Electronics Boutique, Inc.EB and EB ServicesLLPbeen subject to federal and all state income taxes for fiscalyears 1997, 1998 andyear 1999.(4)- (5)
- Pro forma weighted average shares outstanding gives effect to the number of shares that would have been outstanding upon completion of the initial public offering and related transactions for periods prior to the initial public offering.
(5)- (6)
- Does not reflect stores operated by
EB-UKGame Group and WaldenSoftware for which we currently provide or have provided management services. See"Business -"Business—Management Services."19ITEM- (7)
- Comparable store sales are based on stores in operation for over one year. Comparable store sales results for fiscal 2001 represents the 52 week period ending January 27, 2001.
Item 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEWManagement's Discussion and Analysis of Financial Condition and Results of OperationsOverview
We believe that we are among the world's largest specialty retailers of
electronic games. Our primary products arevideogamesgame hardware and software, PC entertainment softwaresupported by the sale of video game hardware, PC productivity softwareandaccessories.related accessories and products. As ofJanuary 29, 2000,February 1, 2003, we operated a total of6191,145 stores in 46 states, Australia, Canada, Denmark, Germany, Italy, New Zealand, Norway, Puerto Rico,Canada, Australia andSouth Korea and Sweden—primarily under the names Electronics Boutique andStop 'N Save Software.EB Games. In addition, we operated a commercial website under the URL address ofEBWORLD.COM.ebgames.com. As of such date, we also provided management services forEB-UK,Game Group, which operated280over 400 stores and18department store-based concessions in the United Kingdom, Spain, France, Sweden and Ireland.As of January 29, 2000, we also managed 13 mall-based WaldenSoftware stores for Borders Group, Inc.We are a holding company and do not have any significant assets or liabilities, other than all of the outstanding capital stock of our subsidiaries.TheOur fiscal year
of Electronics Boutiqueends on the Saturday nearest January 31. Accordingly the financial statements for the years endedJanuary 31, 1998February 2, 2002 ("fiscal1998"2002"), January 30, 1999and February 1, 2003 ("fiscal1999") and January 29, 2000 ("fiscal 2000"2003") each include 52 weeks of operations and the year ending February 3, 2001 ("fiscal 2001") includes 53 weeks of operations.RESULTS OF OPERATIONSChange in Accounting Principle
In November 2002, the Emerging Issues Task Force ("EITF") reached consensus on Issue 02-16, Accounting by a Customer (Including a Reseller) for Cash Consideration Received from a Vendor. Issue 02-16 addresses the accounting for cash consideration received from a vendor by a reseller for various vendor funded allowances, including cooperative advertising support. Issue 02-16 is effective for new arrangements or modifications to existing arrangements entered into after December 31, 2002, although early adoption is permitted. We elected to adopt early, effective February 3, 2002, the provisions of Issue 02-16 in the preparation of this Annual Report on Form 10-K. Accordingly, in fiscal 2003, we recorded a cumulative effect of accounting change of $7.6 million, $4.8 million net of income tax, for the impact of this adoption on prior fiscal years. As of February 1, 2003, $10.0 million of our vendor advertising allowances has been recorded as a reduction of inventory and will be recognized in cost of goods sold as inventory is sold. This adoption has also resulted in the reclassification of $45.3 million of vendor advertising reimbursements earned in fiscal 2003 from selling, general, and administrative expense. The fiscal 2003 impact on income before cumulative effect of change in accounting principle was a charge of $1.5 million, or $0.06 per diluted share.
20
In accordance with the provisions of Issue 02-16, vendor advertising allowances which exceed specific, incremental and identifiable costs incurred in relation to the advertising and promotional events we conduct for our vendors are to be classified as a reduction in the purchase price of merchandise and recognized in income as the merchandise is sold. The amount of vendor allowances to be recorded as a reduction of inventory was determined by calculating the ratio of vendor allowances in excess of specific, incremental and identifiable advertising and promotional costs to merchandise purchases. We then applied this ratio to the value of inventory in determining the amount of the vendor reimbursements to be recorded as a reduction to inventory reflected on the balance sheet. This methodology resulted in a $7.6 million reduction in inventory as of February 3, 2002, the date of adoption of Issue 02-16. The $7.6 million, $4.8 million net of tax, is recorded as a cumulative effect of accounting change in fiscal year 2003. As of February 1, 2003, the methodology resulted in $10.0 million recorded as a reduction of inventory.
The following table reflects the vendor allowances received and how they were classified in the financial statements (actual and pro forma for the change in accounting) for fiscal 2001, fiscal 2002 and fiscal 2003:
Fiscal 2001 Fiscal 2002 Fiscal 2003 (Amounts in thousands) Actual Total vendor allowances $ 45,830 $ 49,102 $ 54,116
Gross profit
$
180,337
$
238,628
$
345,575
Percent to total revenues 22.3 % 22.4 % 26.2 %
Amount classified as reduction in cost of goods sold
—
—
$
42,925
Percent to total revenues — — 3.3 %
Amount classified as reduction in selling, general & administrative
$
45,830
$
49,102
$
8,829
Percent to total revenues 5.7 % 4.6 % 0.7 %
Amount classified as a reduction in merchandise inventory
$
9,989
Pro forma
Gross profit $ 218,544 $ 280,722 Percent to total revenues 27.1 % 26.4 %
Amount classified as reduction in cost of goods sold
$
38,207
$
42,094
Percent to total revenues 4.7 % 3.9 %
Amount classified as reduction in selling, general & administrative
$
6,729
$
6,192
Percent to total revenues 0.8 % 0.6 %
Amount classified as a reduction in merchandise inventory
$
6,812
$
7,628
Prior to adoption of Issue 02-16, all vendor advertising allowances were recognized as an offset to selling, general and administrative expenses. These allowances exceeded the specific, incremental costs of the advertising and promotional events conducted by us. The portion of the allowances in excess of the specific, incremental costs was recorded as an offset to other operating expenses within selling, general and administrative expenses. These other operating expenses, which were incurred to support advertising and promotional expenses, included such items as: marketing and merchandise department expenses to develop, promote and manage the events; direct store and store supervisory payroll expenses to implement, manage and monitor the events; distribution expenses associated with receiving and shipping of materials necessary for the events; and corporate expenses related to the design, production and maintenance of Internet advertising events.
21
The following pro forma financial information for fiscal 2001 and fiscal 2002 reflects the impact of Issue 02-16 as if it had been adopted prior to fiscal 2001:
Consolidated Statements of Income
(Amounts in thousands, except per share amounts)
As reported
Fiscal
2001(1)Pro Forma
Fiscal
2001As reported
Fiscal
2002(1)Pro Forma
Fiscal
2002Net sales $ 802,851 $ 802,851 $ 1,059,338 $ 1,059,338 Management fees 4,425 4,425 5,889 5,889 Total revenues 807,276 807,276 1,065,227 1,065,227
Cost of goods sold
626,939
588,732
826,599
784,505Gross profit 180,337 218,544 238,628 280,722
Costs and expenses:
Selling, general and administrative expenses 144,466 183,567 179,464 222,374 Restructuring and asset impairment charge — — 12,638 12,638 Depreciation and amortization 15,855 15,855 19,750 19,750 Operating income 20,016 19,122 26,776 25,960 Other income 1,550 1,550 — — Interest income, net 3,096 3,096 1,884 1,884 Income before income taxes 24,662 23,768 28,660 27,844 Income tax expense 9,791 9,436 �� 10,948 10,636 Net income $ 14,871 $ 14,332 $ 17,712 $ 17,208 Earnings per share: Basic $ 0.67 $ 0.64 $ 0.74 $ 0.72 Diluted $ 0.66 $ 0.64 $ 0.73 $ 0.71 Weighted average shares outstanding: Basic 22,254 22,254 23,868 23,868 Diluted 22,466 22,466 24,230 24,230 Selected Balance Sheet information: Merchandise inventories 100,185 93,373 149,792 142,164 Stockholders' equity 131,220 127,112 237,160 232,387
- (1)
- Effective in the second quarter of fiscal 2003, Electronics Boutique changed the income statement classification for pre-owned merchandise trade-in activity to be consistent with industry practice. Previously, we recorded a reduction to both revenue and cost of goods sold for the cost of the pre-owned merchandise accepted for trade. The reclassification of these transactions increased both revenues and cost of goods sold by $36.5 million and $50.1 million in fiscal years 2001 and 2002, respectively. There was no impact on operating income or net income for any period as a result of this reclassification.
22
Results of operations
The following table sets forth certain income statement items as a percentage of total revenues for the periods indicated:
YEAR ENDED ----------------------------------------- JANUARY 31, JANUARY 30 JANUARY 29, 1998 1999 2000 --------- --------- ----------Net sales 98.9% 99.4% 99.3% Management fees 1.1 0.6 0.7 --------- --------- ---------- Total revenues 100.0 100.0 100.0 Cost of goods sold 74.6 75.2 75.0 Gross profit 25.4 24.8 25.0 Operating expenses 19.1 17.4 18.3 Depreciation and amortization 1.8 1.7 1.7 --------- --------- ---------- Income from operations 4.5 5.7 5.0 Equity in earnings of affiliates 0.7 -- -- Interest expense (income), net 0.3 0.1 (0.2) Preacquisition loss of subsidiaries 0.2 -- -- --------- --------- ---------- Income before income tax expense 5.1 5.6 5.2 Income tax expense 0.2 2.0 2.1 --------- --------- ---------- Net income 4.9% 3.6% 3.1% ========= ========= ==========FISCAL 2000 COMPARED TO FISCAL 1999
Year Ended February 3,
2001February 2,
2002February 1,
2003Net sales 99.5 % 99.4 % 99.4 % Management fees 0.5 0.6 0.6 Total revenues 100.0 100.0 100.0 Cost of goods sold 77.7 77.6 73.8 Gross profit 22.3 22.4 26.2 Selling, general and administrative expense 17.9 16.8 20.3 Restructuring and asset impairment charge (reversal) — 1.2 (.2 ) Depreciation and amortization 2.0 1.9 1.7 Income from operations 2.4 2.5 4.4 Other income 0.2 — — Interest income, net 0.4 0.2 0.1 Income before income tax expense and cumulative effect of change in accounting principle 3.0 2.7 4.5 Income tax expense 1.2 1.0 1.7 Income before cumulative effect of change in accounting principle 1.8 1.7 2.8 Cumulative effect of change in accounting principle, net of tax — — (0.3 ) Net Income 1.8 % 1.7 % 2.5 % Fiscal 2003 Compared to Fiscal 2002
Net sales increased by
26.9%23.6% from$570.5$1,059.3 million in fiscal19992002 to$723.8$1,309.2 million in fiscal2000.2003. The increase in net sales was primarily attributable toan 11.6% increase in comparable store sales, which resulted in a $65.1 million increase in net sales, andthe additional sales volumeattributable to 91 netfrom 270 new stores, approximately $102.0 million, opened during fiscal2000. Comparable2003 and a comparable store saleswere positively impacted primarilyincrease of 8.3%, or $84.8 million. The increase was driven bythe releasecontinuing strong sales ofthe Sega Dreamcast console system in the third fiscal quarter, which was supported by a strong supply ofSony's PlayStation 2 software,titles through the end of the fiscal year. In addition, throughout the year there was a strong demand for Nintendo Game Boy software and hardwareas well astoy categories including software-related action figuresa full year of sales from Nintendo's GameCube andPokemon trading cards.Microsoft's Xbox which were introduced in November 2001, and Nintendo's Game Boy Advance which was introduced in June 2001.Management fees increased
43.1%28.3% from$3.4$5.9 million in fiscal19992002 to$4.9$7.6 million in fiscal2000.2003. The increasewas primarily attributable to additionalin management fees earnedfrom Electronics Boutique plc. on the sales of a 20newly acquired competitor which occurred in May 1999 and to a $543,000 performance fee earned for fiscal 2000 and an additional $248,000 performance fee earned for fiscal 1999 and recordedin fiscal2000 under2003 was primarily due to an increase in Game Group's sales along with a more favorable currency exchange rate between theconsulting agreement with Border's Group, Inc.British pound and U.S. dollar in fiscal 2003. In addition we earned $150,000 in management fees from Sports Collectibles Acquisition Corporation ("SCAC") in fiscal 2003.Cost of goods sold increased by
26.6%17.5% from$431.7$826.6 million in fiscal19992002 to$546.5$971.2 million in fiscal2000.2003. As a percentage of net sales, cost of goods sold decreased from75.7%78.0% in fiscal19992002 to75.5%74.2% in fiscal2000. The2003. This decrease in cost of goods sold, as a percentage of net sales, was partially due to a reclassification of $42.9 million, or 3.3% of net sales, of fiscal 2003 vendor advertising allowances from selling, general and administrative expense in connection with our change in accounting policy. The balance of the decrease was primarily attributable toincreasesthe shift in sales from low margin hardware to higher margin software of 0.7% and reduced freight costs of 0.3%. These improvements were partially offset by a decrease in sales ofNintendo Game Boy softwarehigher margin PC product accounting for 0.3%. Cost of goods sold does not include purchasing andhardware, Pokemon trading cards toysdistribution center operating costs of approximately $15.3 million in fiscal23
2003 and
software-related action figures that carry higher overall margins than$13.9 million in fiscal 2002, which are included in selling, general and administrative costs. Accordingly, our cost of goods sold may not be comparable to theconsole video game category.cost of goods sold of other retailers.Selling, general and administrative expense increased
by 33.6%49.1% from$100.0$179.5 million in fiscal19992002 to$133.5$267.6 million in fiscal2000.2003. Of the $88.1 million increase, $45.3 million, or 3.4% of total revenues, was attributable to the reclassification of vendor advertising allowances in connection with our change in accounting policy. The remaining $42.8 million of the increase was due to the increase in our domestic and international stores base and the associated increases in store expenses of $35.5 million and headquarter expenses of $7.9 million, which was partially offset by an increase in net promotional and marketing reimbursements of $1.3 million prior to the reclassification. As a percentage of total revenues, selling, general and administrative expense increased from17.4%16.8% in fiscal19992002 to18.3%20.3% in fiscal2000. The $33.5 million increase was primarily attributable to the increase in Electronics Boutique's domestic and international store base and the associated increases in store, distribution, and headquarter operating expenses, which was partially offset by an increase in promotional and marketing reimbursements. In addition, $10.7 million was incurred in connection with an advertising and promotional campaign that began in the third quarter of fiscal 2000 primarily for Electronics Boutique's e-commerce business. The increase in selling, general and administrative expense as a percentage of total revenues was primarily attributable to the expenses associated with the advertising and promotional campaign in addition to other increases in operating expenses, partially offset by the increase in net sales.2003.Depreciation and amortization expense increased by
25.6%14.0%, from$9.8$19.8 million in fiscal19992002 to$12.3$22.5 million in fiscal2000. This2003. The increase was primarily attributable to capitalized expenditures for leasehold improvements and furniture and fixtures for new store openings, remodeling of existing stores,for leaseholdand capital improvements,andfurniture and fixtures and computer software at corporate headquarters.In fiscal 2002, the restructuring and asset impairment charge of $12.6 million resulted from our adoption of a plan to close the operations of all 29 EB Kids stores and sell the 22 store BC Sports Collectibles business. The charge represents a $3.5 million write down of store leasehold improvements, a $2.3 million write down of store furniture, fixtures and equipment and $6.7 million in lease termination costs. In fiscal 2003, the $2.6 million net reversal of the restructuring and asset impairment charge resulted primarily from store lease related accruals that were not necessary due to the terms of the sale of the BC Sports Collectibles business.
Operating income increased by
12.3%117.0%, from$32.4$26.8 million in fiscal19992002 to$36.4$58.1 million in fiscal2000.2003. As a percentage of total revenues, operating incomedecreasedincreased from5.7%2.5% in fiscal19992002 to5.0%4.4% in fiscal2000, as2003. Excluding thedecrease in$2.3 million charge to cost of goods soldas a percentageand the $12.6 million restructuring and asset impairment charge in fiscal 2002, operating income would have been $41.7 million, or 3.9% of total revenueswas more than offset byin fiscal 2002. Excluding theincrease$2.6 million reversal of the restructuring and asset impairment charge inselling, general and administrative expenses as a percentagefiscal 2003, operating income would have been $55.5 million, or 4.2% of totalrevenues.revenues in fiscal 2003.Interest
expense,income, net,improveddecreased by 11.0%, froman expense of $0.3$1.9 million in fiscal19992002 toincome of $1.4$1.7 million in fiscal2000.2003. Thechangedecrease wasprimarily attributabledue to lower interestincome earned from investing excess cash in short term investments from the secondary offering in November 1999 and to the repayment of Electronics Boutique's debt with the proceeds of the initial public offering in fiscal 1999. As a result of all the above factors, Electronics Boutique's income before income taxes increased by 18.3% from $32.0 million in fiscal 1999 to $37.8 million in fiscal 2000.rates on short-term investments.Income tax expense increased by 104.4%, from
$11.7$10.9 million in fiscal19992002 to$15.0$22.4 million in fiscal2000.2003. As a percentage of pre-tax income, income tax expenseincreaseddecreased from36.6%38.2% in fiscal19992002 to39.7%37.4% in fiscal2000. The increase2003. Our effective tax rate decreased from the prior year principally as apercentageresult ofpre-taxan increase in operations in foreign jurisdictions that have a lower tax rate than the United States and an increase in tax-exempt interest income.We changed our accounting policy with respect to the recording of vendor advertising allowances effective retroactively as of the beginning of fiscal 2003. As a result, we recorded a non-cash charge of $4.8 million, net of income
was due to Electronics Boutique being taxedtax, in the first quarter of fiscal2000 as a "C" corporation, whereas income in2003 for the cumulative effect of the change on fiscal1999years prior tothe initial public offering on July 28, 1998 was taxed as an S corporation. FISCAL 1999 COMPARED TO FISCAL 1998fiscal 2003.Fiscal 2002 Compared to Fiscal 2001
Net sales increased by
27.0%31.9%, from$449.2$802.9 million in fiscal19982001 to$570.5$1,059.3 million in fiscal1999.2002. Fiscal 2001 included 53 weeks of net sales compared to 52 weeks in fiscal 2002 partially offsetting the increase. The increase in net sales was primarily attributable toa 14.1% increase in comparable store sales, which resulted in a $61.9 million increase in net sales, andthe additional sales volumeattributable to 76 netfrom 210 new stores, approximately $81.0 million, opened during fiscal1999.2002 and a comparable store sales24
increase of 20.8%, or $152.4 million. The increase
in comparable storewas driven by continuing strong saleswas primarily attributable to increases in video gameof Sony's PlayStation 2 hardware andPC entertainmentrelated software,salesas well ascontinued strong demand for PC accessory products.the introduction of Nintendo's Game Boy Advance in June 2001 and GameCube in November 2001, and Microsoft's Xbox in November 2001.Management fees
decreased 28.9%increased 33.1% from$4.8$4.4 million in fiscal19982001 to$3.4$5.9 million in fiscal1999.2002. Thedecrease was primarily attributable to Electronics Boutique's receipt of a $2.2 million bonus under the UK Services Agreement recordedincrease infiscal 1998. Electronics Boutique did not receive a bonus under this agreement in fiscal 211999, nor do we expect to receive such a bonus in the future. The absence of a bonus in fiscal 1999 was partially offset by higher recurringmanagement fees earned in fiscal1999 under the UK Services Agreement.2002 was due to an increase in Game Group's sales.Cost of goods sold increased by
27.6%31.8%, from$338.5$626.9 million in fiscal19982001 to$431.7$826.6 million in fiscal1999.2002. As a percentage of net sales, cost of goods soldincreaseddecreased from75.4%78.1% in fiscal19982001 to75.7%78.0% in fiscal1999.2002. Theincreasedecrease in cost of goods sold, as a percentage of net sales, was primarily attributable to several factors such as increased margins on PC products and a successful tiered pricing strategy of approximately 1.1%, reduced freight costs of approximately 0.5% and an increase infreight expenseshigh margin pre-owned sales of approximately 0.3%. These improvements were partially offset by the increased sales of low margin hardware sales of approximately 1.6% and the $2.3 million or 0.2% charge related toElectronics Boutique'sthe write-down of inventory associated with our decision toreduce prices on selected electronic game titlesdiscontinue our EB Kids operations and sell our BC Sports Collectibles business. Cost of goods sold does not include purchasing and distribution center operating costs of approximately $13.9 million inorder to increase market sharefiscal 2002 andsales volume. The increase$12.9 million infreight expenses was the result of several factors. Electronics Boutique switched its primary freight carrierfiscal 2001, which are included in our selling, general andreorganized its third-party distribution framework in order to improve service and merchandise availability to its stores. There was also an increase in the overall number of units shipped by Electronics Boutique to its stores as a result of a lower average cost per unit of product. These increases toadministrative costs. Accordingly, our cost of goods soldwere partially offset by a reduction in inventory shortage and an increase in purchase discounts earned from vendors.may not be comparable to the cost of goods sold of other retailers.Selling, general and administrative expense increased
by 14.9%24.2%, from$87.0$144.5 million in fiscal19982001 to$100.0$179.5 million in fiscal1999.2002. The $35.0 million increase was primarily attributable to the increase in our domestic and international stores base and the associated increases in store expenses of $31.9 million, headquarter expenses of $7.4 million and distribution expenses of $0.8 million, which was partially offset by an increase in promotional and marketing reimbursements of $5.1 million. As a percentage of total revenues, selling, general and administrative expense decreased from19.1%17.9% in fiscal19982001 to17.4%16.8% in fiscal1999. The $13.0 million increase was primarily attributable to the increase in Electronics Boutique's domestic and international store base and the associated increases in store, distribution, and headquarter operating expenses, which were partially offset by an increase in promotional and marketing reimbursements.2002. The decrease in selling, general, and administrative expense as a percentage of total revenues was primarily attributable toanthe increase innet sales, which offset the impact of the above factors on operating expenses.comparable store sales.Depreciation and amortization expense increased by
22.2%24.6%, from$8.0$15.9 million in fiscal19982001 to$9.8$19.8 million in fiscal1999. This2002. The increase was primarily attributable to capitalized expenditures for leasehold improvements and furniture and fixtures for new storeopenings.openings, remodeling of existing stores, and capital improvements, furniture and fixtures and computer software at the corporate headquarters. In addition, in fiscal 2002 we had a full year of depreciation, or an increase of $670,000 over the prior year, on capital expenditures we made in fiscal 2001 for the purchases of our corporate headquarters and distribution facility in West Chester, Pennsylvania, the relocation to a larger distribution facility in Louisville, Kentucky, and the construction of new distribution and office facilities in Australia and Canada.The restructuring and asset impairment charge of $12.6 million resulted from our adoption of a plan to close the operations of all 29 EB Kids stores and sell the 22 store BC Sports Collectibles business. The charge represents a $3.5 million write down of store leasehold improvements, a $2.3 million write down of store furniture, fixtures and equipment and $6.7 million in lease termination costs.
Operating income increased by
58.4%33.8%, from$20.5$20.0 million in fiscal19982001 to$32.4$26.8 million in fiscal1999.2002. As a percentage of total revenues, operating income increased from4.5%2.4% in fiscal19982001 to5.7%2.5% infiscal 1999, as2002. Excluding theincrease in$2.3 million charge to cost of goods soldas a percentageand the $12.6 million restructuring and asset impairment charge, operating income for fiscal 2002 would have been $41.7 million, or 3.9% of totalrevenuesrevenues.Other income of $1.6 million was
more than offset byrecorded in fiscal 2001. This income was thedecline in operatingresult of a termination fee on the acquisition of Funco, Inc. of $3.5 million, net of associated expensesas a percentageoftotal revenues. Equity in earnings of affiliates$1.9 million.25
Interest income, net, decreased by
$3.1 million39.2%, fromearnings of $2.9$3.1 million in fiscal19982001 toa loss of $0.2$1.9 million in fiscal1999.2002. The decrease wasattributabledue tothe reorganization of Electronics Boutique in conjunction with its initial public offering pursuant to which EB, a predecessor company, retained the 25.1% investment in EB-UK. The loss of $0.2 million in fiscal 1999 was attributable to this investment and was recorded prior to the July 1998 reorganization. There will be no future equity income or losslower interest rates onthis investment. Interest expense, net, decreased by 79.1% from $1.4 million in fiscal 1998 to $0.3 million in fiscal 1999. The decrease was primarily attributable to the repayment of Electronics Boutique's debt with the proceeds of the initial public offering and the interest income earned from investing the excess cash in short term investments during the third and fourth quarters of fiscal 1999. As a result of all the above factors, Electronics Boutique's income before income taxes increased by 39.6% from $22.9 million in fiscal 1998 to $32.0 million in fiscal 1999.short-term investments.Income tax expense increased by 11.8%, from
$0.8$9.8 million in fiscal19982001 to$11.7$10.9 million in fiscal1999. The increase was due to Electronics Boutique being taxed2002. As a percentage of pre-tax income, income tax expense decreased from 39.7% in fiscal19992001 to 38.2% in fiscal 2002. Our effective tax rate decreased from the prior year principally as a"C" corporation insteadresult of a reduction of state tax expense as well as anS corporation afterincrease in operations in foreign jurisdictions that have a lower tax rate than thedate of the initial public offering. 22SEASONALITY AND QUARTERLY RESULTS Electronics Boutique'sUnited States.Seasonality and Quarterly Results
Our business, like that of most retailers, is highly seasonal. A significant portion of our net sales, management fees and profits are generated during
Electronics Boutique'sour fourth fiscal 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, net 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 inElectronics Boutique'sour merchandise mix.26
The following table sets forth certain unaudited quarterly income statement information for fiscal
19992002 and fiscal2000.2003. The unaudited quarterly information includes all normal recurring adjustments that management considers necessary for a fair presentation of the information shown.
(in thousands, except for number of stores) Fiscal 1999 Fiscal 2000 ---------------------------------------------------------------------------------- 1st 2nd 3rd 4th 1st 2nd 3rd 4th Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter --------- -------- -------- --------- --------- -------- -------- --------Total revenues $107,301 $102,460 $111,300 $252,858 $123,605 $113,095 $177,410 $314,564 Gross profit 27,781 26,556 27,672 60,166 33,167 30,756 41,430 76,870 Operating income 3,257 90 2,519 26,562 4,435 941 6,291 24,744 Stores open at quarter end 465 474 500 528 550 564 595 619LIQUIDITY AND CAPITAL RESOURCES
Fiscal 2003 (Restated)(1) 1st
Quarter(2)2nd
Quarter3rd
Quarter4th
Quarter(Amounts in thousands, except for earnings per share and number of stores) Total revenues $ 237,640 $ 262,635 $ 282,960 $ 533,544 Gross profit 63,044 66,174 75,129 141,228 Operating income 1,918 549 5,682 49,947 Income before cumulative effect of change in accounting principle 1,471 594 3,742 31,593 Net income (loss) (3,302 ) 594 3,742 31,593
Income per share before cumulative effect of change in accounting principle:
—Basic 0.06 0.02 0.14 1.22 —Diluted 0.06 0.02 0.14 1.21
Net income (loss) per share:
—Basic (0.13 ) 0.02 0.14 1.22 —Diluted (0.13 ) 0.02 0.14 1.21
Stores open at quarter end
948
994
1,078
1,145
Fiscal 2003 (as reported)(3) 1st
Quarter(2)2nd
Quarter3rd
Quarter4th
QuarterTotal revenues $ 237,640 $ 262,635 $ 282,960 $ 533,544 Gross profit 56,800 60,144 66,055 120,286 Operating income 553 714 11,186 48,004 Net income 627 696 7,144 30,410
Net income per share
—Basic 0.02 0.03 0.28 1.18 —Diluted 0.02 0.03 0.27 1.16
Stores open at quarter end
948
994
1,078
1,145
Fiscal 2002 (as reported) 1st
Quarter(2)2nd
Quarter3rd
Quarter4th
QuarterTotal revenues $ 189,657 $ 189,907 $ 182,153 $ 503,510 Gross profit 41,734 45,938 46,762 104,194 Operating income (loss) (2,842 ) (2,704 ) 4,289 28,033 Net income (loss) (1,418 ) (1,532 ) 2,920 17,742
Net income (loss) per share
— Basic (0.06 ) (0.07 ) 0.12 0.69 — Diluted (0.06 ) (0.07 ) 0.11 0.67
Stores open at quarter end
763
813
878
937
- (1)
- We changed our accounting policy with respect to the recording of vendor advertising allowances effective retroactively as of the beginning of fiscal 2003. As a result, we recorded a non-cash charge of $7.6 million, $4.8 million net of income tax, in the first quarter of fiscal 2003 for the cumulative effect of the change on fiscal years prior to fiscal 2003. Quarterly results for fiscal 2003
27
have been restated to reflect this new accounting policy. See Note 2 to the consolidated financial statements for more details on this change in accounting principle.
- (2)
- Effective in the second quarter of fiscal 2003, Electronics Boutique
haschanged the income statement classification for pre-owned merchandise trade-in activity to be consistent with industry practice. Previously, we recorded a reduction to both revenue and cost of goods sold for the cost of the pre-owned merchandise accepted for trade. The reclassification of these transactions increased both revenues and cost of goods sold by $9.8 million and $20.0 million in the first quarters of fiscal 2002 and fiscal 2003, respectively. There was no impact on operating income or net income as a result of this reclassification.- (3)
- Table represents results of operations prior to adoption of EITF Issue 02-16, "Accounting by a Customer (Including a Reseller) for Cash Consideration Received from a Vendor."
The $1.9 million of operating income in the first quarter of fiscal 2003 includes a $508,000 pre-tax restructuring reversal ($314,000 after-tax, or $0.01 per diluted share). This reversal related primarily to reversals of lease related accruals for the EB Kids stores. The $5.7 million of operating income in the third quarter of fiscal 2003 includes a $2.2 million pre-tax restructuring reversal ($1.4 million after-tax, or $0.05 per diluted share). This reversal related to store lease accruals that were not necessary due to the terms of the sale of the BC Sports Collectibles business.
The $28.0 million of operating income in the fourth quarter of fiscal 2002 includes a $14.9 million pre-tax charge ($9.2 million after-tax, or $0.35 per diluted share) related to costs associated with our decision to close our EB Kids operations and sell our BC Sports Collectibles business. The pre-tax charge was recorded as follows: $2.3 million related to a write-down of inventory within cost of goods sold and $12.6 million as a restructuring and asset impairment charge.
Liquidity and Capital Resources
We have historically financed
ouroperations through a combination of cash generated from operations, equity offerings and bank debt. OnNovember 23, 1999, Electronics BoutiqueAugust 14, 2001, we completed asecondarypublic offering of3,500,0004,600,000 shares of common stock. Of the3,500,0004,600,000 shares sold,2,000,0002,500,000 shares were for the account of the Electronics Boutique and1,500,0002,100,000 shares were for the account of EB Nevada Inc., a selling shareholder controlled by theselling shareholder.Kim family. The transaction resulted in net proceeds (after offering expenses) toElectronics Boutiqueus of approximately$40.0$68.2 million.Electronics BoutiqueWe generated
$37.5$27.1 million in cash from operations in fiscal20002003 and$30.8$31.4 million in fiscal1999.2002. The$37.5$27.1 million of cash generated from operations in fiscal20002003 was primarily the result of$22.8$32.6 millionofin net income,$12.6$23.9 millionofin non-cash charges to net income, an$8.9increase of $8.2 million in accrued expenses and a $6.1 million increase in income taxes payable, partially offset by a $38.5 million increase in merchandise inventory, net of accounts payable, a $2.1 million increase in accountspayablereceivable, a $1.6 million increase in prepaid expenses, and a $1.6 increase in other long-term assets. In fiscal 2003, the $38.5 million increase in inventory, net of accounts payable, was due to anincrease in merchandise inventories, a $1.7increased store base coupled with slower than expected holiday sales. The $8.2 million increase in accrued expenses was primarily due to an increased store base anda $0.4 million decrease in deferred taxes, partially offset by a $5.3 millionan increase inreceivables, a $3.5 million increase in prepaid expenses.customer liabilities. The$30.8$31.4 million of cash generated from operations in fiscal19992002 was primarily the result of$20.3$17.7 million of net income, $10.2 million of non-cash charges to net income,an $8.1a $32.8 million increase inincome taxesaccounts payable, an increase of $10.2 million in accrued expenses and deferred rent, and a$7.1$14.1 million increase inaccrued expenses,taxes payable, partially offset by a$7.5$3.6 milliondecreaseincrease innet affiliate liabilities and receivables, anaccounts receivable, a $47.0 million increaseof $7.3 million in Electronics Boutique's investmentin merchandise inventories,net of accounts payable, anda$0.6$2.3 million increase in prepaid expenses, and a $0.7 million increase in other long-term assets.Electronics Boutique's working capital changed from a deficitIn fiscal 2002, merchandise inventories and related accounts payable increased primarily due to the higher average cost of$3.1 million at January 30, 1999products associated with the new console systems introduced in the year and also due to apositive $42.6 million at January 29, 2000. Electronics Boutique27% increase in our store base over the prior year.28
We made capital expenditures of
$31.8$35.8 million inthefiscal2000,2003, primarily to open new stores, to remodel existing stores, tobuildrebrand 96 existing stores to the new EB Games name, and to enhance the inventory system in the Louisville distribution center. In fiscal 2003, we also made investments of $1.6 million to acquire additional interests in our European subsidiaries and to acquire anew distribution centerfive store retail chain inWest Chester, Pennsylvania, for leasehold improvements at Electronics Boutique's headquarters and primary distribution center, and for equipment and leasehold improvements at a new customer service facility in Las Vegas, Nevada to support our Internet and catalog sales operations.the U.S. We made capital expenditures of$19.6$23.7 million in fiscal1999,2002, primarilyfor openingto open new stores, to remodel existing stores, to purchase and install a new inventory system in the Louisville distribution center and topurchase our West Chester,renovate and expand the Pennsylvania corporate headquarters. In fiscal 2002, we also made investments of $9.2 million to acquire various assets and businesses in several European countries including 32 retail stores, distributioncenter which was previously leased. 23On March 16, 1998, EB entered intocenters, and mail order and Internet businesses.We have a
credit agreement with Fleet, pursuant to which Fleet agreed to make available an$50 million asset based revolving creditand term loanfacilityin an amount up to $50.0 million.with Fleet Capital Corp. The revolving credit facility has beenassigned to Electronics Boutique by EB. The revolving credit facility expires and is repayablerenewed for a one-year term expiring on March 16,2001.2004. Interest accrues on borrowings at a per annum rate equal to either LIBOR plus 250 basis points or Fleet's base rate of interest, atElectronics Boutique'sour option. The revolving credit facility is secured by certain assets, including accounts receivable, inventory, fixtures and equipment. As ofJanuary 29, 2000,February 1, 2003, we had no outstanding borrowings under the revolving credit facility.Electronics Boutique believesLetters of credit outstanding with various financial institutions were $1.8 million and $694,000 at February 2, 2002 and February 1, 2003, respectively.
We believe that cash generated from
itsour operating activities and available bank borrowings will be sufficient to funditsour operations and store expansion programs for the next fiscal year.On March 31, 2000,Related Party Transactions
Transactions with Affiliates
In fiscal 1996, The Electronics Boutique, Inc. entered into a
definitive mergerservices agreement with Game Group (formerly The Electronics Boutique Plc) to provide consulting, management, training, and advertising assistance, which expires in January 2006. The agreement was assigned to EB Services Company. The agreement prohibits us from competing in the United Kingdom during the term of the agreement, and for one year after its termination. Game Group is responsible for theacquisitionpayment of fees, payable, at our option, in cash or Game Group stock, equal to 1.0% of Game Group's adjusted sales, plus a bonus calculated on the basis of net income in excess of a pre-established target set by Game Group. The management fee receivable at February 2, 2002 was $573,000 and at February 1, 2003 was $605,000; both were included in accounts receivable-trade and vendors. Management fees received from Game Group for fiscal 2001, fiscal 2002 and fiscal 2003 were $4.4 million, $6.0 million and $7.4 million, respectively. Additionally, the agreement provides that EB Services is to be reimbursed by Game Group for all reasonable travel and subsistence expenses incurred during performance of the agreement. At February 2, 2002 and February 1, 2003, there were no outstanding balances due from Game Group.On November 2, 2002, we sold our BC Sports Collectibles business to SCAC for $2.2 million in cash and the assumption of lease related liabilities in excess of $13 million. The purchaser, SCAC, is owned by the family of James Kim, our Chairman. The transaction included the sale of all
outstanding shares of Funco, Inc. for $17.50 per share or approximately $110 million in cash. On April 6, 2000, Funco, Inc. received a competing offer from Barnes and Noble Inc., for $135 million or approximately $21.00 per share. On April 20, 2000, Electronics Boutique raised our cash offer to $21.00 per share to match the competing offer by Barnes & Noble Inc., which was accepted by Funco, Inc. On April 26, 2000, Barnes and Noble Inc. raised its cash offer to $24.75 per share. Electronics Boutique is currently evaluating whether to match or raise this latest offer. Should we further pursue this acquisition, we believe we could obtain adequate debt financing for completionassets of thedeal. RECENT ACCOUNTING PRONOUNCEMENTSbusiness including inventory, intellectual property and furniture, fixtures and equipment, and transitional services which were provided by us to SCAC for a six-month period after the closing for an additional $300,000. As of February 1, 2003, $150,000 of the services agreement has been earned and recognized as income. The transaction was negotiated and approved by a committee of our Board of Directors comprised solely of independent directors with the assistance of an investment banking firm engaged to solicit offers for the BC Sports Collectibles business.29
Recent Accounting Pronouncements
In
June 1998,August 2001, the FASB issued Statement of FinancialAccountingStandards ("SFAS") No.133,143 "Accounting forDerivative Instruments and Hedging Activities" ("SFAS 133").Asset Retirement Obligations." This statement establishesaccounting and reportingstandards forderivative instruments andaccounting forhedging activities. It requires thatanentity recognize all derivatives as either assets or liabilities inobligation associated with the retirement of a long-lived asset. The statementof financial position and measures those instruments at fair value. The adoptionis effective for our fiscal year ending January 31, 2004. We are finalizing our review of thisstandardstatement and are not expecting a material impact on our consolidated results of operations or financial condition.In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others," an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation are applicable to guarantees issued or modified after December 31, 2002 and are not expected to
materially impact Electronics Boutique's resultshave a material effect on our Consolidated Financial Statements. The disclosure requirements ofoperations,this interpretation were effective on December 31, 2002. The disclosure requirements have been adopted and are included in Note 1 to the consolidated financialcondition or long-term liquidity.statements, "Guarantees".In
June 1999,December 2002, the FASB issued Statementof Financial Accounting StandardsNo.137, Accounting148 "Accounting forDerivative Instruments and Hedging Activities - Deferral of the Effective Date ofStock-Based Compensation." This statement amends FASB Statement No.133123 to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. We adopted the disclosure requirement in this Form 10-K.In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" which addresses consolidation by businesses of variable interest entities. We do not anticipate any impact from this interpretation.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results may differ from those estimates. Our significant accounting policies can be found in Note 1 to the consolidated financial statements. We consider the following policies to be most critical to the portrayal of our financial condition and results of operations.
Inventory Valuation
Merchandise inventories are valued at the lower of cost or market. The cost is determined principally by a weighted-average method. The weighted-average cost method attaches a cost to each SKU, and is a blended average of the original purchase price and those of subsequent purchases or other cost adjustments throughout the life cycle of that SKU.
Inherent in the video game business is the risk of obsolete inventory. As the new generation of products is introduced, demand for the prior generation decreases, thus reducing interest and value of the older games. Some vendors offer us credit to reduce the cost of products that are selling more slowly thus allowing for a reduction in the selling price and reducing the possibility for items to become obsolete. We monitor the aging of our inventory by item and provide a reserve for product that is considered "slow moving", using an established formula based on current inventory and a trailing sales history. We also monitor the difference between the selling ("
SFAS"market"). SFAS 137 delaysprice of each item and its cost and provide a reserve for any differences below such cost.30
We perform regular physical inventories and cycle counts in both our stores and distribution centers to adjust inventory balances and account for shrink and damaged product. An accrual for estimated loss is recorded between the
implementationtiming ofSFAS No. 133 until Electronics Boutique'sthese counts.Reserves of $2.7 million and $2.9 million were recorded against inventory as of February 2, 2002 and February 1, 2003, respectively. Management believes its inventory valuation system results in carrying inventory at the lower of cost or market.
Revenue recognition and Related Policies
We derive revenue primarily from two sources: (i) product revenue, which includes the retail sale of merchandise inventory, warranties, and shipping and handling fees and (ii) management services revenue. Sales are recorded net of estimated amounts for sales returns and other allowances.
Retail sales are recognized as revenue at the point of sale. Mail order and Internet sales are recognized as revenue upon delivery to and acceptance by the customer. Revenues from shipping and handling are recorded in revenue and recognized upon shipment. Warranty revenue is amortized over the life of the warranty contract.
We also engage in the sale and trading of pre-owned video game products. Effective in the second quarter of fiscal
year 2002. As of January 29, 2000,2003, Electronics Boutiquehadchanged the income statement classification for pre-owned merchandise trade-in activity to be consistent with industry practice. Previously, we recorded a reduction to both revenue and cost of goods sold for the cost of the pre-owned merchandise accepted for trade. The reclassification of these transactions increased both revenues and cost of goods sold by $36.5 million for the fifty-three week period ended February 3, 2001 and $50.1 million for the fifty-two week period ended February 2, 2002. There was noderivative instrumentsimpact on operating income orhedging activities. YEAR 2000 READINESS We met our Year 2000 project objectives and completed the project prior to December 31, 1999. We have not experiencednet income for anydisruption in our operationsperiod as a result ofnon-compliancethis reclassification.Revenues for management services are recorded as earned. In fiscal 2003, all management fees earned were derived under service agreements with Game Group and SCAC.
Restructuring Costs
In February 2002, we announced our plan to close all of
vendors,our 29 EB Kids stores and sell our 22 store BC Sports Collectibles business. In fiscal 2002, we recorded a restructuring and asset impairment charge of $12.6 million. The charge represents a $3.5 million write down of store leasehold improvements, a $2.3 million write down of store furniture, fixtures and equipment and $6.7 million in lease termination costs. In fiscal 2003, a $2.6 million net reversal of the restructuring and asset impairment charge resulted primarily from store lease related accruals that were not necessary due to the terms of the sale of the BC Sports Collectibles business.Effective as of the close of business on November 2, 2002, we closed on the sale transaction of the BC Sports Collectibles business to SCAC for $2.2 million in cash and the assumption of the lease related liabilities for each of its 22 stores. The family of James Kim, who is Chairman of Electronics Boutique and a significant investor in our outstanding common stock, owns SCAC. The transaction included the sale of all assets of the business including inventory, intellectual property and furniture, fixtures and equipment, and transitional services which were provided to SCAC for a six-month period after the closing for an additional $300,000. Subsequent to year end, all of the store leases have been assigned to SCAC. We remain contingently liable for these leases and Mr. Kim has entered into an Indemnification Agreement with us for these leases. The purchase agreement provides SCAC the right, exercisable at any time after the second anniversary of the closing date, to assign back to us two of the store leases. We have retained an accrual of $204,000 for the estimated lease termination costs related to this option. These actual costs could be higher than this amount.
31
Income Taxes
We are subject to income tax in many jurisdictions, including the United States, states and localities, and internationally. Income taxes are calculated in accordance with SFAS No. 109, "Accounting for Income Taxes," which requires the use of the asset and liability method. Deferred tax assets and liabilities are recognized based on the difference between the financial
institutions,statement carrying amounts of existing assets and liabilities and their respective tax bases. Inherent in the measurement of deferred balances are certain judgments and interpretations of enacted tax law and published guidance with respect to applicability to our operations. Significant examples of this concept include capitalization policies for various tangible and intangible costs, income and expense recognition and inventory valuation methods. We must also assess the likelihood that our deferred tax assets will be recovered from future taxable income. To the extent we believe that recovery is not more likely than not, we must establish valuation allowances. We have valuation allowances of $534,000 and $546,000 as of February 2, 2002 and February 1, 2003, respectively, due to uncertainties related to our ability to utilize the net operating loss carry forwards of certain foreign subsidiaries. Future tax expense may be impacted by this judgment.Valuation of Long-Lived and Intangible Assets and Goodwill
We assess the impairment of identifiable intangibles and long-lived assets to determine if any part of the carrying value may not be recoverable. Factors we consider important when assessing impairment include:
- •
- significant underperformance relative to expected historical or
other third partiesprojected future operating results;- •
- significant changes in the manner of our use of the acquired assets or
external systems. At this time,thepossibilitystrategy for our overall business;- •
- significant negative industry or economic trends;
- •
- significant decline in our stock price for a sustained period; and
- •
- our market capitalization relative to net book value.
When we determine that the carrying value of an identifiable intangible or long-lived asset may not be recoverable based on one or more of the above indicators, we test for impairment to determine if an impairment charge is needed.
Goodwill is tested annually for impairment. We use a two-step impairment assessment to determine if an impairment charge is needed. The first step of the goodwill impairment test compares the fair value of a
third-party risk arising, which could havereporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired, and the second step of the impairment test is not necessary. If the carrying amount of amaterial risk onreporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss if any. Electronics Boutiqueis not reasonably likely to occur. We developed a Year 2000 program to identify, evaluate, test, upgrade, or replace each of our computer based systems in connection with Year2000 readiness. Wehas completed theprocessannual goodwill impairment test for fiscal 2003 and no charges were required.Net intangible assets, long-lived assets and goodwill amounted to $122.0 million as of
modifying, upgrading, remediatingFebruary 1, 2003. See Note 15 to the consolidated financials statements for more details.Contractual Obligations
We have certain commitments under our operating leases which are disclosed in Note 3 to the consolidated financial statements. Furthermore, for information with respect to our debt and
replacing major computer related systems that were identified as potentially non-compliant by December 31, 1999. Total costs associated with our Year 2000 project were funded with operating cash flowlines of credit, see Note 5 to the consolidated financial statements.32
Item 7A. Quantitative andapproximated $823,000, of which approximately $517,000 was incurred in fiscal 1999 and approximately $306,000 was incurred in fiscal 2000. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Electronics Boutique investsQualitative Disclosures About Market RiskWe invest cash balances in excess of operating requirements in short-term investment grade securities, generally with maturities of 90 days or less. In addition,
Electronics Boutique'sour revolving credit facility provides for borrowings which bear interest at variable rates based on either the bank's base rate or LIBOR plus 250 basispoints. Electronics Boutiquepoints, at our option. We had no borrowings outstanding pursuant to the revolving credit facility as ofJanuary 29, 2000.February 1, 2003. We believe that the effect, if any, of reasonably possible near-term changes in interest rates on our financial position, results of operations, and cash flows should not be material.24Electronics Boutique hasWe have retail operations in various foreign
countries. Electronics Boutique iscountries including Australia, Canada, Denmark, Germany, Italy, New Zealand, Norway, South Korea and Sweden. We are subject to currency exchange rate and currency devaluation risks due to these operations. Since approximately88%81% ofElectronics Boutique'sour net sales are domestic,Electronics Boutique doeswe do not believe that currency exchange rate fluctuationswouldwill have a material adverse effect onElectronics Boutique'sour results of operations and financialconditioncondition. We routinely enter into forward andaccordingly, does not hedge its riskcross-currency swap exchange contracts inthis area.the regular course of business to manage exposure against foreign currency fluctuations on intercompany loans, investments in subsidiaries, and accounts payable. As of February 1, 2003, we have foreign currency forward contracts with a notional amount of $20.3 million and cross-currency swap contracts with a notional amount of $27.4 million. The total fair market value of all contracts is a deficit of approximately $4.9 million. Four contracts for $16.7 million expire during fiscal 2004 and the remaining contracts for $31.0 million expire in future years. We intend to monitor our exposure to these risks andreevaluate itsre-evaluate our hedging strategies as appropriate.25ITEMThe table below provides information about our derivative financial instruments and other financial instruments by functional currency and presents such information in U.S. dollar equivalents. The table summarizes information on instruments and transactions that are sensitive to foreign currency exchange rates, including foreign currency forward exchange agreements and cross currency swap agreements. For foreign currency forward exchange agreements and cross currency swap agreements, the table presents the notional amounts. These notional amounts are generally used to calculate the contractual payments to be exchanged under the contracts.
Fiscal
2004
US$Fiscal
2005
US$Fiscal
2006
US$Fiscal
2007
US$Fiscal
2008
US$Thereafter
US$Total
US$FMV
2003
FYE(Amounts in thousands) Forward Exchange Contracts Contract Amount 16,750 3,550 — — — — 20,300 (961 ) Cross Currency Swap Contracts Contract Amount — 3,000 1,311 22,679 443 — 27,432 (3,978 ) 33
Item 8.CONSOLIDATED FINANCIAL STATEMENTSConsolidated Financial Statements and Financial Statement ScheduleINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
Page -----FINANCIAL STATEMENTS
Independent Auditors' Report27
35Consolidated Balance Sheets 2836 Consolidated Statements of Income 2937 Consolidated Statements of Stockholders' Equity 3038 Consolidated Statements of Cash Flows 3139 Notes to Consolidated Financial Statements 3240
FINANCIAL STATEMENT SCHEDULE
Schedule II—Valuation and Qualifying Accounts
5826INDEPENDENT AUDITORS' REPORT34
The Board of Directors and Stockholders
Electronics Boutique Holdings Corp.:We have audited the accompanying consolidated balance sheets of Electronics Boutique Holdings Corp. and subsidiaries as of
January 30, 1999February 1, 2003 andJanuary 29, 2000,February 2, 2002, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period endedJanuary 29, 2000. TheFebruary 1, 2003. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.We conducted our audits in accordance with auditing standards generally accepted
auditing standards.in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Electronics Boutique Holdings Corp. and subsidiaries as of
January 30, 1999February 1, 2003 andJanuary 29, 2000February 2, 2002 and the results of their operations and their cash flows for each of the years in the three-year period endedJanuary 29, 2000,February 1, 2003, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting
principles. /s/for goodwill and intangible assets in the year ended February 1, 2003. As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for consideration received from a vendor in the year ended February 1, 2003./s/ KPMG LLP
Philadelphia,
PA March 8, 2000 27Pennsylvania
April 17, 2003
ELECTRONICS BOUTIQUE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JANUARY 30, JANUARY 29, Assets 1999 2000 ------------------ ----------------- Current assets:Cash and cash equivalents $ 42,006,179 $ 88,356,091 Accounts receivable: Trade and vendors 4,010,293 9,187,991 Other 1,516,085 2,630,622 Due from affiliates 984,096 - Merchandise inventories 65,433,008 90,550,508 Deferred tax asset (note 12) 2,694,000 3,691,000 Prepaid expenses 969,949 4,524,233 ------------------ ----------------- Total current assets 117,613,610 198,940,445 ------------------ ----------------- Property and equipment: Building & Leasehold improvements 46,933,403 59,816,209 Fixtures and equipment 32,362,909 45,391,518 Land - 908,000 Construction in progress 1,087,964 2,446,460 ------------------ ----------------- 80,384,276 108,562,187 Less accumulated depreciation and amortization 37,349,298 45,566,262 ------------------ ----------------- Net property and equipment 43,034,978 62,995,925 Goodwill and other intangible assets, net of accumulated amortization of $482,961 and $877,968 as of January 30, 1999 and January 29, 2000 1,898,395 1,503,387 Deferred tax asset (note 12) 6,319,000 8,505,732 Other assets 3,181,566 3,567,388 ------------------ ----------------- Total assets (note 4) $ 172,047,549 $ 275,512,877 ================== ================= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Revolving credit facility (note 4 ) $ - $ - Current portion of long-term debt (note 4 ) 99,996 8,353 Accounts payable 90,835,578 122,822,260 Accrued expenses (note 3 ) 19,625,068 23,437,268 Income taxes payable 10,144,023 10,105,424 ------------------ ----------------- Total current liabilities 120,704,665 156,373,305 ------------------ ----------------- Long-term liabilities: Notes payable (note 4 ) 8,353 - Deferred rent 2,492,140 2,653,103 ------------------ ----------------- Total liabilities 123,205,158 159,026,408 ------------------ ----------------- Commitments (note 2 ) Stockholders' equity (notes 9 and 11) Preferred stock - authorized 25,000,000 shares; $.01 par value; no shares issued and outstanding at January 30, 1999 and January 29, 2000 - - Common stock - authorized 100,000,000 shares; $.01 par value; 20,169,200 and 22,221,114 shares issued and outstanding at January 30, 1999 and January 29, 2000, respectively 201,692 222,211 Additional paid-in capital 31,541,428 75,888,405 Accumulated other comprehensive expense (686,920) (240,726) Retained earnings 17,786,191 40,616,579 ------------------ ----------------- Total stockholders' equity 48,842,391 116,486,469 ------------------ ----------------- Total liabilities and stockholders' equity $ 172,047,549 $ 275,512,877 ================== =================
(Amounts in thousands, except per share amounts)
February 2,
2002February 1,
2003Assets
Current assets:
Cash and cash equivalents $ 126,523 $ 121,873 Accounts receivable: Trade and vendors 11,475 14,298 Other 260 263 Merchandise inventories 149,792 226,866 Deferred tax asset 10,971 9,870 Prepaid expenses 7,426 9,310 Total current assets 306,447 382,480
Property and equipment:
Building & leasehold improvements 85,029 97,107 Fixtures and equipment 76,247 93,399 Land 5,277 5,427 Construction in progress 1,176 1,968 167,729 197,901 Less accumulated depreciation and amortization 72,789 87,975 Net property and equipment 94,940 109,926
Goodwill and other intangible assets, net of accumulated amortization of $1,500 and $1,055
8,742
12,041
Deferred tax asset 11,897 11,854 Other noncurrent assets 3,812 5,313 Total assets $ 425,838 $ 521,614
Liabilities and Stockholders' Equity
Current liabilities:
Current portion of long-term debt $ 325 $ — Accounts payable 136,375 176,146 Accrued expenses 34,326 43,242 Income taxes payable 13,975 18,595 Total current liabilities 185,001 237,983
Long-term liabilities:
Notes payable 143 — Deferred rent and other long-term liabilities 3,534 9,131 Total long-term liabilities 3,677 9,131
Total liabilities
188,678
247,114
Stockholders' equity
Preferred stock—authorized 25,000 shares; $.01 par value; no shares issued and outstanding at February 2, 2002 and February 1, 2003 — — Common stock—authorized 100,000 shares; $.01 par value; 25,783 and 25,882 shares issued and outstanding at February 2, 2002 and February 1, 2003, respectively 258 259 Additional paid-in capital 166,312 169,527 Accumulated other comprehensive loss (2,610 ) (1,113 ) Retained earnings 73,200 105,827
Total stockholders' equity
237,160
274,500
Total liabilities and stockholders' equity
$
425,838
$
521,614
See accompanying notes to consolidated financial statements.
2836
ELECTRONICS BOUTIQUE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED -------------------------------------- JANUARY 31, JANUARY 30, JANUARY 29, 1998 1999 2000 ----------- ------------ -----------Net sales $ 449,179,603 $570,514,060 $723,800,624 Management fees 4,791,553 3,404,862 4,872,822 ----------- ------------ ----------- Total revenues $ 453,971,156 $573,918,922 $728,673,446 ----------- ------------ ----------- Costs and expenses: Costs of merchandise sold, including freight 338,497,642 431,743,771 546,451,099 Selling, general and administrative (notes 5 and 6 ) 87,002,305 99,972,451 133,533,992 Depreciation and amortization (notes 5 and 7 ) 7,996,506 9,774,388 12,277,797 ----------- ------------ ----------- Operating income 20,474,703 32,428,312 36,410,558 Equity in earnings (loss) of affiliate (note 5) 2,902,780 (160,575) - Interest expense (income), net of interest income of $1,217,337, $829,631 and $1,590,270 in fiscal years 1998, 1999 and 2000, respectively 1,380,046 289,188 (1,427,603) Preacquisition loss of subsidiaries 913,028 - - ----------- ------------ ----------- Income before income taxes 22,910,465 31,978,549 37,838,161 Income tax expense (note 12) 846,280 11,693,270 15,007,773 ----------- ------------ ----------- Net income $ 22,064,185 $ 20,285,279 $ 22,830,388 =========== ============ =========== Net income per share - basic $ 1.11 =========== Weighted average shares outstanding - basic 20,559,100 =========== Net income per share - diluted $ 1.10 =========== Weighted average shares outstanding - diluted 20,762,249 =========== PRO FORMA DATA (UNAUDITED) (NOTE 8): Income before income taxes $ 22,910,465 $ 31,978,549 Pro forma income taxes 9,415,631 11,866,084 ----------- ------------ Pro forma net income $ 13,494,834 $ 20,112,465 =========== ============ Pro forma net income per share - basic $ 0.85 $ 1.12 =========== ============ Pro forma weighted average shares outstanding - basic 15,794,200 18,029,777 =========== ============ Pro forma net income per share - diluted $ 0.85 $ 1.11 =========== ============ Pro forma weighted average shares outstanding - diluted 15,794,200 18,084,109 =========== ============
(Amounts in thousands, except per share amounts)
Years Ended February 3,
2001February 2,
2002February 1,
2003Net sales $ 802,851 $ 1,059,338 $ 1,309,226 Management fees 4,425 5,889 7,553 Total revenues 807,276 1,065,227 1,316,779
Cost of goods sold
626,939
826,599
971,204
Gross profit
180,337
238,628
345,575
Costs and expenses:
Selling, general and administrative expense 144,466 179,464 267,566 Restructuring and asset impairment charge (reversal) — 12,638 (2,611 ) Depreciation and amortization 15,855 19,750 22,524
Operating income
20,016
26,776
58,096
Other income 1,550 — — Interest income, net 3,096 1,884 1,677
Income before income taxes and cumulative effect of change in accounting principle
24,662
28,660
59,773
Income tax expense 9,791 10,948 22,373
Income before cumulative effect of change in accounting principle
14,871
17,712
37,400
Cumulative effect of change in accounting principle, net of tax
—
—
(4,773
)
Net income
$
14,871
$
17,712
$
32,627
Income per share before cumulative effect of change in accounting principle:
Basic $ 0.67 $ 0.74 $ 1.44 Diluted $ 0.66 $ 0.73 $ 1.42
Per share cumulative effect of change in accounting principle:
Basic $ (0.18 ) Diluted $ (0.18 )
Net income per share:
Basic $ 0.67 $ 0.74 $ 1.26 Diluted $ 0.66 $ 0.73 $ 1.24
Weighted average shares outstanding:
Basic 22,254 23,868 25,833 Diluted 22,466 24,230 26,247 See accompanying notes to consolidated financial statements.
2937
ELECTRONICS BOUTIQUE HOLDINGS CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
CLASS A CLASS B PREFERRED STOCK COMMON STOCK COMMON STOCK COMMON STOCK --------------- ------------ ------------ ------------ SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT ------- ---------- ----------- ---------- ----------- --------- -------------- -----------Balance, Feb. 1, 1997 - $ - 1,900 $ 190 21,000 $ 2,100 - $ - Capital contribution - - - - - - - - Comprehensive income: Net income - - - - - - - - Foreign currency translation - - - - - - - - Total comprehensive income Distributions - - - - - - - - ------- --------------------- ---------------------- ------------------------- ----------- Balance, Jan. 31, 1998 - - 1,900 190 21,000 2,100 - - Effects of reorganization (note 1) - - (1,900) (190) (21,000) (2,100) 20,169,200 201,692 Comprehensive income: Net income - - - - - - - - Foreign currency translation - - - - - - - - Total comprehensive income Distributions - - - - - - - - ------- --------------------- ---------------------- ------------------------- ----------- Balance Jan. 30, 1999 - - - - - - 20,169,200 201,692 ======= ===================== ====================== ========================= =========== Comprehensive income: Net income - - - - - - - - Foreign currency translation - - - - - - - - Total comprehensive income Issuance of common stock - - - - - - 2,000,000 20,000 Exercise of stock options - - - - - - 51,914 519 Tax benefit from stock options exercised and other equity transactions - - - - - - ------- --------------------- ---------------------- ------------------------- ----------- Balance Jan. 29, 2000 - $ - - $ - - $ - 22,221,114 $ 222,211 ======= ===================== ====================== ========================= ===========
ACCUMULATED PARTNERS' CAPITAL ADDITIONAL OTHER TOTAL OF EB SERVICES PAID-IN COMPREHENSIVE RETAINED STOCKHOLDERS' COMPANY LLP CAPITAL INCOME EARNINGS EQUITY ----------------- --------------- ----------------- -------------- ---------------Balance, Feb. 1, 1997 $ $ 7,584,365 $ $ 12,770,179 $ 20,356,834 Capital contribution 1,000 - - - 1,000 Comprehensive income: Net income - - - 22,064,185 22,064,185 Foreign currency translation - - (1,023,493) - (1,023,493) --------------- Total comprehensive income 21,040,692 =============== Distributions - - - (13,000,000) (13,000,000) ----------------- --------------- ----------------- -------------- --------------- Balance, Jan. 31, 1998 1,000 7,584,365 (1,023,493) 21,834,364 28,398,526 Effects of reorganization (note 1) (1,000) 23,957,063 - (3,813,796) 20,341,669 Comprehensive income: Net income - - - 20,285,279 20,285,279 Foreign currency translation - - 336,573 - 336,573 --------------- Total comprehensive income 20,621,852 =============== Distributions - - - (20,519,656) (20,519,656) ----------------- --------------- ----------------- -------------- --------------- Balance Jan. 30, 1999 - 31,541,428 (686,920) 17,786,191 48,842,391 ================= =============== ================= ============== =============== Comprehensive income: Net income - - - 22,830,388 22,830,388 Foreign currency translation - - 446,194 - 446,194 --------------- Total comprehensive income 23,276,582 =============== Issuance of common stock - 40,027,700 - - 40,047,700 Exercise of stock options - 726,277 - - 726,796 Tax benefit from stock options exercised and other equity transactions - 3,593,000 - - 3,593,000 ----------------- --------------- ----------------- -------------- --------------- Balance Jan. 29, 2000 $ - $ 75,888,405 $ (240,726)$ 40,616,579 $ 116,486,469 ================= =============== ================= ============== ===============30ELECTRONICS BOUTIQUE HOLDINGS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED ------------------------------------------------ JANUARY 31, JANUARY 30, JANUARY 29, 1998 1999 2000 --------------- --------------- ---------------Cash flows from operating activities: Net income $ 22,064,185 $ 20,285,279 $ 22,830,388 Adjustments to reconcile net income to cash provided by operating activities: Depreciation of property and equipment 7,571,301 9,375,766 11,882,789 Amortization of other assets 425,205 398,622 395,008 Loss on disposal of property and equipment 620,916 292,623 352,231 Equity in loss of affiliates (2,902,780) 160,575 - Changes in assets and liabilities: Decrease (increase) in: Accounts receivable 385,737 (828,692) (6,258,628) Due from affiliates (2,142,774) 1,906,739 987,909 Merchandise inventories 95,212 (12,309,661) (24,526,184) Prepaid expenses (27,311) 1,882,619 (3,532,696) Deferred taxes - - 413,008 Other long-term assets (1,641,573) (1,247,378) (340,971) (Decrease) increase in: Accounts payable 8,348,016 4,993,290 33,463,199 Accrued expenses 1,619,154 7,071,901 1,715,425 Due to affiliate (1,981,194) (9,453,597) - Income taxes payable 213,047 8,168,826 (49,424) Deferred rent (368,059) 79,647 150,662 --------------- --------------- --------------- Net cash provided by operating activities 32,279,082 30,776,559 37,482,716 --------------- --------------- --------------- Cash flows used in investing activities: Purchases of property and equipment (18,470,432) (19,573,171) (31,756,803) Proceeds from disposition of assets 12,455 132,592 5,323 Net cash from businesses acquired 2,922,411 - - Purchase of investment securities in affiliate (2,215,933) - - --------------- --------------- --------------- Net cash used in investing activities (17,751,499) (19,440,579) (31,751,480) --------------- --------------- --------------- Cash flows from financing activities: Distributions (13,000,000) (19,950,573) - Proceeds from exercise of stock options - - 726,796 Repayments of long-term debt (24,514,276) (12,896,594) (99,996) Proceeds from issuance of common stock - 54,962,500 40,047,700 Capital contribution 1,000 - - Net cash retained by predecessors - (12,375,535) - --------------- --------------- --------------- Net cash provided by (used in) financing activities (37,513,276) 9,739,798 40,674,500 --------------- --------------- --------------- Effects of exchange rates on cash (1,102,543) 290,791 (55,824) Net increase (decrease) in cash and cash equivalents (24,088,236) 21,366,569 46,349,912 Cash and cash equivalents, beginning of period 44,727,846 20,639,610 42,006,179 --------------- --------------- --------------- Cash and cash equivalents, end of period $ 20,639,610 $ 42,006,179 $ 88,356,091 =============== =============== =============== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 2,714,593 $ 1,207,210 $ 187,223 Income taxes 672,842 2,853,773 13,577,519
Consolidated Statements of Stockholders' Equity
(Amounts in thousands)
Preferred stock Common stock Accumulated
other
comprehensive
incomeAdditional
paid-in
capitalRetained
earningsTotal
stockholders'
equityShares Amount Shares Amount Balance Jan. 29, 2000 — $ — 22,221 $ 222 $ 75,888 $ (241 ) $ 40,617 $ 116,486
Comprehensive income:
Net income — — — — — — 14,871 14,871 Foreign currency translation — — — — — (1,311 ) — (1,311 ) Total comprehensive income 13,560
Issuance of common stock
—
—
22
—
312
—
—
312
Exercise of stock options — — 62 1 861 — — 862 Balance Feb. 3, 2001 — — 22,305 223 77,061 (1,552 ) 55,488 131,220
Comprehensive income:
Net income — — — — — — 17,712 17,712 Foreign currency translations — — — — — (1,417 ) — (1,417 ) Hedging activities — — — — — 359 — 359 Total comprehensive income 16,654
Issuance of common stock
—
—
2,519
25
68,586
—
—
68,611
Exercise of stock options — — 959 10 13,926 — — 13,936 Tax benefit from stock options exercised — — — — 6,739 — — 6,739 Balance Feb. 2, 2002 — — 25,783 258 166,312 (2,610 ) 73,200 237,160
Comprehensive income:
Net income — — — — — — 32,627 32,627 Foreign currency translations — — — — — 6,574 — 6,574 Hedging activities — — — — — (5,077 ) — (5,077 ) Total comprehensive income 34,124
Issuance of common stock
—
—
23
—
467
—
—
467
Exercise of stock options — — 76 1 1,190 — — 1,191 Tax benefit from stock options exercised — — — — 1,558 — — 1,558 Balance Feb. 1, 2003 — $ — 25,882 $ 259 $ 169,527 $ (1,113 ) $ 105,827 $ 274,500 See accompanying notes to consolidated financial statements.
3138
ELECTRONICS BOUTIQUE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
Years Ended February 3,
2001February 2,
2002February 1,
2003Cash flows from operating activities: Net income $ 14,871 $ 17,712 $ 32,627 Adjustments to reconcile net income to cash provided by operating activities: Depreciation of property and equipment 15,491 19,493 22,209 Amortization of other assets 365 257 315 Loss on disposal of property and equipment 392 227 649 Deferred taxes (994 ) (9,800 ) 1,284 Foreign currency transaction gain — — (537 ) Changes in assets and liabilities: Decrease (increase) in: Accounts receivable 3,579 (3,617 ) (2,133 ) Merchandise inventories (10,780 ) (47,009 ) (74,831 ) Prepaid expenses (615 ) (2,261 ) (1,567 ) Other long-term assets 240 (660 ) (1,594 ) (Decrease) increase in: Accounts payable (19,535 ) 32,785 36,335 Accrued expenses 734 9,844 8,164 Income taxes payable (3,471 ) 14,095 6,087 Deferred rent and other long-term liabilities 516 357 90 Net cash provided by operating activities 793 31,423 27,098 Cash flows used in investing activities: Purchases of property and equipment (44,817 ) (23,725 ) (35,762 ) Proceeds from disposition of assets 93 93 2,544 Net cash to acquire businesses — (9,223 ) (1,552 ) Net cash used in investing activities (44,724 ) (32,855 ) (34,770 ) Cash flows from financing activities: Proceeds from exercise of stock options 861 13,935 1,191 Repayments of long-term debt (8 ) (24 ) (506 ) Proceeds from issuance of common stock 312 68,612 467 Net cash provided by financing activities 1,165 82,523 1,152
Effects of exchange rates on cash
(479
)
321
1,870
Net increase (decrease) in cash and cash equivalents
(43,245
)
81,412
(4,650
)Cash and cash equivalents, beginning of period 88,356 45,111 126,523 Cash and cash equivalents, end of period $ 45,111 $ 126,523 121,873
Supplemental disclosures of cash flow information:
Cash paid during the period for: Interest $ 5 $ 16 $ 31 Income taxes 13,824 8,221 13,469 See accompanying notes to consolidated financial statements.
39
ELECTRONICS BOUTIQUE HOLDINGS CORP.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
FORMATION OF THE COMPANY Immediately prior to its initial public offering,Description of Business
Electronics Boutique Holdings Corp.
and(collectively with its subsidiaries,(collectively,the "Company")was formed and acquired substantially all of the operating assets and liabilities of its predecessors, The Electronics Boutique, Inc. and its subsidiaries and EB Services Company LLP (collectively, "EB Group") for shares of the Company. This acquisition has been treated as an acquisition between entities under common control and, therefore, reflected at historical cost. The EB Group retained certain assets including cash, accounts receivable, real estate, the cash surrender value of certain split dollar life insurance policies and the ownership of approximately 25% of Electronics Boutique Plc. DESCRIPTION OF BUSINESS The Companyis among the world's largest specialty retailers ofelectronic games.video game hardware and software, PC entertainment software and related accessories and products. The Company operates in only one business segment, as substantially all of its revenues, net income and assets are derived fromitsthese primaryproducts of video games and personal computer entertainment software, supported by the sale of video game hardware, PC productivity software and accessories.products.The Company had 737, 937 and
its predecessors had 452, 528, and 6191,145 operating retail stores throughout the United States, Australia, Canada, Denmark, Germany, Italy, New Zealand, Norway, Puerto Rico,Canada, Australia andSouth Korea, and Sweden atJanuary 31, 1998, January 30, 1999,February 3, 2001, February 2, 2002 andJanuary 29, 2000.February 1, 2003, respectively. Total revenues from the U.S. and foreign operations were91%86% and9%14%, respectively in fiscal19992001 and88%fiscal 2002, and12%81% and 19%, respectively in fiscal2000.2003. Long-lived assets located in the United States and foreign countries were89%79% and11%21%, respectively in fiscal19992002, and 74% and 26%, respectively in fiscal2000.2003. The Company is subject to the risks inherent in conducting business across national boundaries. The Company also operates a mail order business and sellsproductits products via theWorld Wide Web.Internet. Approximately36%32%,31%,38% and30%39% of fiscal1998,2001, fiscal1999,2002 and fiscal20002003 sales, respectively, were generated from merchandise purchased from its three largest vendors.FISCAL YEAR-ENDThe Company is highly dependent on the introduction by its vendors of new and enhanced video game and PC hardware and software.Fiscal Year-End
The fiscal year ends on the Saturday nearest January 31. Accordingly, the financial statements for the years ended
January 31, 1998 (fiscal "1998"), January 30, 1999 (fiscal "1999"February 2, 2002 ("fiscal 2002") andJanuary 29, 2000 (fiscal "2000"February 1, 2003 ("fiscal 2003") each include 52 weeks of operations.PRINCIPLES OF CONSOLIDATION AND COMBINATIONFinancial statements for the year ended February 3, 2001 ("fiscal 2001") include 53 weeks of operations.Principles of Consolidation
The consolidated financial statements include the financial position and results of operations of
the Company sinceElectronics Boutique Holding Corp. and itsinitial public offering on July 28, 1998. Prior to that date, the consolidated financial statements include the financial position and results of operations of the EB Group.subsidiaries. All significant intercompany transactions have been eliminated in consolidation.In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. REVENUE RECOGNITIONRevenue Recognition
Retail sales are recognized as revenue at the point of sale. Mail order and
internetInternet sales are recognized as revenue uponshipment.delivery to and acceptance by the customer. Warranty revenue is amortized over the life of the warranty. Management fees are recognized in the period that related services are provided. Sales are recorded net of estimatedallowanceamounts for sales returns and other allowances.CASH AND CASH EQUIVALENTSShipping and handling fee income from the mail order and Internet operations is recognized as net sales. The Company records shipping and handling costs in cost of goods sold. The Company engages in the sale and trading of pre-owned video game products. See Note 13 for additional information.Cost of Goods Sold
Cost of goods sold includes the following: cost of merchandise purchased from its vendors, freight cost, purchase discounts, vendor advertising allowances in excess of incremental related advertising expenses, volume purchase rebates, and inventory shrinkage expense. The Company's gross margins
40
may not be comparable to those of other retailers or companies in general due to the items the Company includes in cost of goods sold.
Selling, General and Administrative Expenses
Selling, general and administrative costs include the following: retail store operating costs, distribution center operating costs, marketing and promotional expenses net of vendor reimbursements for these expenses, and corporate operating expenses.
Vendor Programs
The Company receives vendor allowances for certain events offered to its vendors. These events include items such as product catalog advertising, in-store display promotions, Internet advertising, co-op print advertising, product training and promotion at the Company's trade show and inclusion in its vendor-of-the-month program.
Prior to fiscal 2003, all vendor advertising allowances were recognized as an offset to selling, general and administrative expenses. In fiscal 2003, the Company adopted the provision of Emerging Issues Task Force Issue 02-16, Accounting by a Customer (Including a Reseller) for Cash Consideration Received from a Vendor, effective retroactively as of the beginning of fiscal 2003. In accordance with the provisions of Issue 02-16, vendor advertising allowances which exceed specific, incremental and identifiable costs incurred in relation to the advertising and promotional events offered by the Company to its vendors are to be classified as a reduction in the purchase price of merchandise. See Note 2 for further discussion.
The vendor allowances reflected in the financial statements were $45.8 million, $49.1 million and $54.1 million in fiscal 2001, fiscal 2002 and fiscal 2003, respectively. Advertising expenses, excluding the vendor allowances, were $10.1 million, $8.2 million and $11.3 million in fiscal 2001, fiscal 2002 and fiscal 2003, respectively.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of three months or less to be cash
equivalents for cash flow purposes. MERCHANDISE INVENTORIESequivalents.Merchandise Inventories
Merchandise is valued at the lower of cost or market. Cost is determined principally by a weighted-average method.
32PROPERTY AND EQUIPMENTProperty and Equipment
Property and equipment is recorded at cost and depreciated or amortized over the estimated useful life of the asset using the straight-line method. The estimated useful lives are as follows:
Leasehold improvements...............improvementsLesser of 10 years or the lease term Furniture and Fixtures...............Fixtures5 years Computer equipment...................equipment3 years Building.............................Buildings 30 years Included in selling, general and administrative costs for fiscal years 1998, 1999 and 2000, are losses of $556,000, $293,000 and $352,000, respectively, primarily related to the write-off of the net book value of property and equipment associated with the closing of nine stores in 1998, ten stores in fiscal 1999, eight stores in fiscal 2000 and the remodeling of several stores each year. DEFERRED REVENUE41
The Company
defers revenue relatedcapitalizes significant costs tothe saleacquire management information systems software and significant costs offrequent buyer cards which entitle the cardholdersystem improvements. Computer software costs are amortized over estimated useful lives of three toreceive discounts on purchases for one year from the date of purchase.five years.Deferred Revenue
is recognized over the one year period the card is valid based on expected usage. The frequent buyer program was discontinued in fiscal 2000. There was no deferred revenue at January 29, 2000.Amounts received under the Company's pre-sell program are recorded as a liability. Revenue is recognized when the customer receives the related product. Certain affinity programs include promotional gifts to customers that are supplied by vendors at no cost to the Company.
GOODWILL AND OTHER INTANGIBLESGoodwill
is beingand Other IntangiblesIn July 2001, the Financial Accounting Standards Board ("FASB") issued Statement No. 141, "Business Combinations," and Statement No. 142, "Goodwill and Other Intangible Assets". Statement No. 141 requires that intangible assets acquired in a purchase method business combination must meet certain criteria to be recognized and reported apart from goodwill and should be used for all business combinations initiated after June 30, 2001. Statement No. 142 states that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually. The adoption of Statement No. 141 by the Company in fiscal 2002 did not have a material impact on
a straight-line basis over periods of up to ten years. Goodwill is evaluated continually to determine whether later events or circumstances warrant revised estimates of useful lives. The Company assesses the recoverability of other intangiblesits financial statements. See Note 15, "Goodwill and Other Intangibles", for disclosures required bydetermining whether the remaining balance can be recovered through projected undiscounted cash flows. OTHER ASSETSStatement No. 142.Other Assets
Other assets consist principally of life insurance programs for certain key executives and security deposits.
COMPUTER SOFTWARE COSTSGuarantees
As of January 1, 2003, the Company has adopted FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others." This Interpretation requires certain disclosures be made by a guarantor in its interim and annual financial statements and requires that liabilities for guarantees entered into on or after January 1, 2003, be recorded at fair value. The Company
capitalizes significantremains contingently liable for the 22 BC Sports Collectibles store leases assigned to Sports Collectibles Acquisition Corporation ("SCAC") which are discussed further in Note 6. Mr. Kim has entered into an indemnification agreement with the Company with respect to these leases. If SCAC were to default on these lease obligations, the Company would be liable to the landlords for up to $13 million in minimum rent and landlord charges. Due to Mr. Kim's agreement to indemnify the Company for any costs arising from the BC Sports Collectibles leases, no accrual was recorded for this potential liability. The purchase agreement provides SCAC the right, exercisable at any time after the second anniversary of the closing date, toacquire management information systems software and significantassign back to the Company two of the store leases. The Company has an accrual of $204,000 for the estimated lease termination costsof system improvements. Computer software costs are amortized over estimated useful lives of threerelated tofive years. LEASING EXPENSESthis option. See Note 6, "Related Party Transactions," for more details on the BC Sports Collectibles sale.42
Leasing Expenses
The Company recognizes lease expense on a straight-line basis over the term of the lease when lease agreements provide for increasing fixed rentals. The difference between lease expense recognized and actual payments made is included in deferred rent and prepaid expenses on the balance sheet.
PREOPENING COSTS AND ADVERTISING EXPENSEPreopening Costs and Advertising Expense
Preopening and start-up costs for new stores are charged to
operations as incurred.the store in the first month of operations. Costs of advertising and sales promotion programs are charged to operations, offset by direct vendor reimbursements, as incurred.VENDOR PROGRAMS The Company receives manufacturer reimbursements for certain training, promotional and marketing activities that offset the expenses of these activities. The expenses and reimbursements are reflected in selling, general and administrative expenses, as incurred or received. 33FOREIGN CURRENCYForeign Currency
The accounts of the foreign subsidiaries are translated in accordance with Statement
of Financial Accounting StandardNo. 52,Foreign"Foreign CurrencyTranslation,Translation", which requires that assets and liabilities of international operations be translated using the exchange rate in effect at the balance sheet date. The results of the operations are translated using an average exchange rate for the year. The effects of the rate fluctuations in translating assets and liabilities of international operations into U.S. dollars are accumulated and reflected asa foreign currency translation adjustmentaccumulated other comprehensive income in the statements of stockholders' equity. Transaction gains and losses are included in net income.The Company currently does not hedge currency exchange rate riskIn June 1998, the FASB issued Statement No. 133, "Accounting for Derivative Instruments and
does not currently believeHedging Activities" as amended by Statement 137 and Statement 138. This statement establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires thatcurrency exchange rate fluctuations have a material adverse effect on its resultsan entity recognize all derivatives as either assets or liabilities in the statement ofoperationsfinancial position andfinancial condition. COMPREHENSIVE INCOME Effective February 1, 1998,measures those instruments at fair value. As required under Statement 137, the Company adopted Statement 133 as amended in fiscal year 2002. The cumulative effect ofFinancial Accounting Standards No. 130, "Reporting Comprehensive Income." This statement requires thatthe adoption of this standard on February 4, 2001 did not materially impact the Company's results of operations, financial condition or long-term liquidity.Market risks relating to the Company's foreign operations result primarily from changes in foreign exchange rates. The Company routinely enters into forward and cross-currency swap exchange contracts in the regular course of business to manage its exposure against foreign currency fluctuations on intercompany loans, investments in subsidiaries, and accounts payable. These contracts vary in length of duration. On February 1, 2003, the Company had a total of seven forward contracts and 27 cross-currency swap contracts. The forward contracts had a notional amount of $20.3 million and the cross-currency swap contracts had a notional amount of $27.4 million. The total fair market value of all
items recognized under accounting standardscontracts at February 1, 2003 was a deficit of approximately $4.9 million, which is recorded within other long-term liabilities on the consolidated balance sheet. On February 2, 2002, the Company had a total of seven forward contracts and seven cross-currency swap contracts. The forward contracts had a notional amount of $17.3 million and the cross-currency swap contracts had a notional amount of $10.8 million. The total fair market value of all contracts at February 2, 2002 was a gain of approximately $300,000. These contracts were purchased ascomponentsfair value hedges ofcomprehensive income be reportedintercompany loans and investments in subsidiaries, and cash flow hedges of trade payables. The Company recorded anannual financial statement that is displayed withimmaterial net loss related to hedge ineffectiveness in fiscal 2002 and fiscal 2003. Changes in the fair value of derivatives are recorded in the sameprominenceincome statement or balance sheet line asother financial statements. The Company has includedtherequired informationchange in value of theStatement of Stockholders' Equity. Accumulated Other Comprehensiveunderlying hedged item. Four contracts for $16.8 million expire during fiscal year 2004 and the remaining contracts for $31.0 million expire in future years.43
Income
includes foreign currency translation adjustments. INCOME TAXESTaxesThe Company is subject to federal and state income taxes as a C
corporation whereas the EB Group had been treated as an S corporation and a partnership for federal and certain state income tax purposes resulting in taxable income being passed through to the shareholders and partners. For purposes of comparison, a pro forma tax charge has been reflected on the statements of income for fiscal 1998 and 1999 to show the results of operations as if the EB Group had been subject to taxes as a C corporation.Corporation. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax creditcarryforwards.carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.NET INCOME PER SHARENet Income Per Share
Basic income per share is calculated by dividing net income by the weighted average number of shares of the Company's Common Stock outstanding during the period. Diluted income per share is calculated by adjusting the weighted average common shares outstanding for the dilutive effect of common stock equivalents related to stock options.
USE OF ESTIMATESThe following is a reconciliation of the basic weighted average number of shares outstanding to the diluted weighted average number of shares outstanding (amounts in thousands):
Fiscal 2001 Fiscal 2002 Fiscal 2003 Weighted average shares outstanding—basic 22,254 23,868 25,833 Dilutive effect of stock options 212 362 414 Weighted average shares outstanding—diluted 22,466 24,230 26,247 Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and 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. Actual results could differ from those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTSFair Value of Financial Instruments
The Company's financial instruments are accounts receivable, accounts payable,
long-term debt,life insurance policies, andcertain long-term investments.foreign exchange contracts. The carrying value of accounts receivable and accounts payable approximates fair value due to the short maturity of these instruments. The carrying value of life insurance policies included in other assets approximates fair value based on estimates received from insurance companies.34The fair value of the foreign exchange contracts is included in the foreign currency note section above. Stock-based Employee Compensation
Effective February 1, 2003, the Company adopted Statement No. 148, "Accounting for Stock-based Compensation—Transition and Disclosures," which requires certain disclosures. The Company accounts for its employee stock options and the purchase plans under the intrinsic value recognition and
44
measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. The following table illustrates the effect on net income if the Company had applied the fair value recognition provisions of Statement No. 123, "Accounting for Stock-based Compensation," to stock-based employee compensation. See Note 9, "Equity Plans," for more details on the Company's stock option and purchase plans.
Fiscal 2001 Fiscal 2002 Fiscal 2003(1) (Amounts in thousands, except per share amounts) Net income, as reported $ 14,871 $ 17,712 $ 32,627 Less: total stock based employee compensation (2,771 ) (3,368 ) (4,796 ) Pro forma net income $ 12,100 $ 14,344 $ 27,831 Earnings per share: Basic—as reported $ 0.67 $ 0.74 $ 1.26 Diluted—as reported $ 0.66 $ 0.73 $ 1.24 Basic—pro forma $ 0.54 $ 0.60 $ 1.08 Diluted—pro forma $ 0.54 $ 0.59 $ 1.06
- (1)
- Fiscal 2003 net income included the cumulative effect of the change in accounting principle of $4.8 million, net of income tax, or $0.18 per share, related to vendor advertising allowance. See Note 2, "Change in Accounting Principle," for further disclosures of the change.
Other New Accounting Pronouncements Adopted
In October 2001, the FASB issued Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement provides guidance for the impairment or disposal of long-lived assets. The Company adopted this statement effective for the fiscal year ended February 1, 2003.
In April 2002, the FASB issued Statement No. 145, "Rescission of FASB Statements No. 4, 44 and 64, and amendment of FASB Statement No. 13." The Company adopted this statement effective for the fiscal year ended February 1, 2003.
In July 2002, the FASB issued Statement No. 146, "Accounting for Restructuring Costs." This statement will impact the reporting of expense related to restructurings initiated after 2002. This statement is effective for activities initiated after December 31, 2002.
The adoption of these pronouncements had no impact on the fiscal 2003 financial statements.
(2) CHANGE IN ACCOUNTING PRINCIPLE
In November 2002, the EITF reached consensus on Issue 02-16, Accounting by a Customer (Including a Reseller) for Cash Consideration Received from a Vendor. Issue 02-16 addresses the accounting for cash consideration received from a vendor by a reseller for various vendor funded allowances, including cooperative advertising support. Issue 02-16 is effective for new arrangements or modifications to existing arrangements entered into after December 31, 2002, although early adoption is permitted. The Company elected to adopt early, effective February 3, 2002, the provisions of Issue 02-16 in the preparation of this Annual Report on Form 10-K. Accordingly, in fiscal 2003, the
45
Company recorded a cumulative effect of accounting change of $7.6 million, $4.8 million net of income tax, for the impact of this adoption on prior fiscal years. As of February 1, 2003, $10.0 million of the Company's vendor advertising allowances has been recorded as a reduction of inventory and will be recognized in cost of sales as inventory is sold. This adoption has also resulted in the reclassification of $45.3 million of vendor advertising reimbursements earned in fiscal 2003 from selling, general, and administrative expense. The fiscal 2003 impact on income before cumulative effect of change in accounting principle was a charge of $1.5 million, or $0.06 per diluted share.
In accordance with the provisions of Issue 02-16, vendor advertising allowances which exceed specific, incremental and identifiable costs incurred in relation to the advertising and promotional events the Company conducts for its vendors are to be classified as a reduction in the purchase price of merchandise and recognized in income as the merchandise is sold. The amount of vendor allowances to be recorded as a reduction of inventory was 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 applied this ratio to the value of inventory in determining the amount of the vendor reimbursements to be recorded as a reduction to inventory reflected on the balance sheet. This methodology resulted in a $7.6 million reduction in inventory as of February 3, 2002, the date of adoption of Issue 02-16. The $7.6 million, $4.8 million net of tax, is recorded as a cumulative effect of accounting change in fiscal year 2003. As of February 1, 2003, the methodology resulted in $10.0 million recorded as a reduction of inventory.
46
The following table reflects the vendor allowances received and how they were classified in the financial statements (actual and pro forma for the change in accounting) for fiscal 2001, fiscal 2002 and fiscal 2003:
Fiscal 2001 Fiscal 2002 Fiscal 2003 (Amounts in thousands) Actual Total vendor allowances $ 45,830 $ 49,102 $ 54,116
Gross profit
$
180,337
$
238,628
$
345,575
Percent to total revenues 22.3 % 22.4 % 26.2 %
Amount classified as a reduction in cost of goods sold
—
—
$
42,925
Percent to total revenues — — 3.3 %
Amount classified as a reduction in selling, general & administrative expense
$
45,830
$
49,102
$
8,829
Percent to total revenues 5.7 % 4.6 % 0.7 %
Amount classified as a reduction of merchandise inventory
$
9,989
Pro forma
Gross profit $ 218,544 $ 280,722 Percent to total revenues 27.1 % 26.4 %
Amount classified as a reduction in cost of goods sold
$
38,207
$
42,094
Percent to total revenues 4.7 % 3.9 %
Amount classified as a reduction in selling, general & administrative expense
$
6,729
$
6,192
Percent to total revenues 0.8 % 0.6 %
Amount classified as a reduction of merchandise inventory
$
6,812
$
7,628
Prior to adoption of Issue 02-16, all vendor advertising allowances were recognized as an offset to selling, general and administrative expenses. These allowances exceeded the specific, incremental costs of the advertising and promotional events conducted by the Company. The portion of the allowances in excess of the specific, incremental costs was recorded as an offset to other operating expenses within selling, general and administrative expenses. These other operating expenses, which were incurred to support advertising and promotional expenses, included such items as: marketing and merchandise department expenses to develop, promote and manage the events; direct store and store supervisory payroll expenses to implement, manage and monitor the events; distribution expenses associated with receiving and shipping of materials necessary for the events; and corporate expenses related to the design, production and maintenance of Internet advertising events.
47
The following pro forma financial information for fiscal 2001 and fiscal 2002 reflects the impact of Issue 02-16 as if it had been adopted prior to fiscal 2001:
Consolidated Statements of Income
(Amounts in thousands, except per share amounts)
As reported
Fiscal
2001Pro Forma
Fiscal
2001As reported
Fiscal
2002Pro Forma
Fiscal
2002Net sales $ 802,851 $ 802,851 $ 1,059,338 $ 1,059,338 Management fees 4,425 4,425 5,889 5,889 Total revenues 807,276 807,276 1,065,227 1,065,227
Cost of goods sold
626,939
588,732
826,599
784,505Gross profit 180,337 218,544 238,628 280,722
Costs and expenses:
Selling, general and administrative 144,466 183,567 179,464 222,374 Restructuring charge — — 12,638 12,638 Depreciation and amortization 15,855 15,855 19,750 19,750 Operating income 20,016 19,122 26,776 25,960 Other income 1,550 1,550 — — Interest income, net 3,096 3,096 1,884 1,884 Income before income taxes 24,662 23,768 28,660 27,844 Income tax expense 9,791 9,436 10,948 10,636 Net income $ 14,871 $ 14,332 $ 17,712 $ 17,208 Earnings per share: Basic $ 0.67 $ 0.64 $ 0.74 $ 0.72 Diluted $ 0.66 $ 0.64 $ 0.73 $ 0.71 Weighted average shares outstanding: Basic 22,254 22,254 23,868 23,868 Diluted 22,466 22,466 24,230 24,230 Selected Balance Sheet information: Merchandise inventories 100,185 93,373 149,792 142,164 Stockholders' equity 131,220 127,112 237,160 232,387 48
(3) COMMITMENTS
LEASE COMMITMENTSLease Commitments
At
January 29, 2000,February 1, 2003, the future annual minimum lease payments under operating leases for the following five fiscal years and thereafter were asfollows:follows (amounts in thousands):
Retail Store Distribution Total lease Locations facilities Commitments -------------- -------------- ----------------Fiscal 2001........................... $ 28,627,942 $ 774,068 $ 29,402,010 Fiscal 2002........................... 27,005,713 471,322 27,477,035 Fiscal 2003........................... 25,204,457 416,001 25,620,457 Fiscal 2004........................... 22,548,106 373,025 22,921,131 Fiscal 2005........................... 20,049,074 112,882 20,161,956 Thereafter............................ 57,102,095 - 57,102,095 -------------- -------------- ---------------- $ 180,537,387 $ 2,147,297 $ 182,684,684 ============== ============== ================
Retail
Store
LocationsDistribution
FacilitiesTotal Lease
CommitmentsFiscal 2004 $ 53,302 $ 1,552 $ 54,854 Fiscal 2005 52,024 1,279 53,303 Fiscal 2006 49,335 595 49,930 Fiscal 2007 46,385 181 46,566 Fiscal 2008 40,739 126 40,865 Thereafter 77,408 463 77,871 $ 319,193 $ 4,196 $ 323,389 The total future minimum lease payments include lease commitments for new retail locations not in operation at
January 29, 2000,February 1, 2003, and exclude contingent rentals based upon sales volume and owner expense reimbursements. The terms of the operating leases for the retail locations provide that, in addition to the minimum lease payments, the Company is required to pay additional rent to the extent retail sales, as defined, exceed amounts set forth in the lease agreements and to reimburse the landlord for the Company's proportionate share of the landlord's costs and expenses incurred in the maintenance and operation of the shopping mall. Contingent rentals were approximately$8,132,000, $10,695,000$10.0 million, $12.5 million and$12,605,000$12.2 million in fiscal1998,2001, fiscal1999,2002 and fiscal2000,2003, respectively. Rent expense, including contingent rental amounts, was approximately$35,138,000, $43,008,000$58.5 million, $72.8 million and$53,178,000$85.1 million in fiscal1998,2001, fiscal19992002 and fiscal2000,2003, respectively.Certain of the Company's lease agreements provide for varying lease payments over the life of the leases. For financial statement purposes, rental expense is recognized on a straight-line basis over the original term of the agreements. Actual lease payments are
greaterless than(less than)the rental expense reflected in the statements of operations by approximately$368,000, ($84,000)$508,000, $462,000 and($161,000)$592,000 for fiscal1998,2001, fiscal19992002 and fiscal2000,2003, respectively.(3)(4) ACCRUED EXPENSES
Accrued expenses consist of the
following:
January 30, January 29, 1999 2000 ----------------- -----------------Employee compensation and related taxes $ 5,801,742 $ 7,439,552 Gift certificates, customer deposits and deferred revenue 4,758,197 5,596,779 Accrued rent 4,152,666 4,970,409 Other accrued liabilities 4,912,463 5,430,528 ----------------- ----------------- Total $ 19,625,068 $ 23,437,268 ================= =================35(4)following (amounts on thousands):
February 2,
2002February 1,
2003Employee compensation and related taxes $ 9,947 $ 12,474 Gift certificates and customer deposits 6,011 11,282 Deferred revenue 6,145 6,961 Accrued rent 4,038 2,060 Other taxes 3,430 4,592 Other accrued liabilities 4,755 5,873 Total $ 34,326 $ 43,242 49
(5) DEBT
The Company had available a revolving credit facility allowing for maximum borrowings of
$50,000,000$50.0 million atJanuary 30, 1999February 2, 2002 andJanuary 29, 2000.February 1, 2003. The facility is subject to an immaterial annual commitment fee. The revolving credit facilityexpires and is repayablewas renewed for a one-year term expiring on March 16,2001.2004. Interest accrues on borrowings at a per annum rate equal to either LIBOR plus 250 basis points or the bank's base rate of interest, at the Company's option. The revolving credit agreement contains restrictive covenants regarding transactions with affiliates, the payment of dividends, and other financial and non-financial matters and is secured by certain assets, including accounts receivable, inventory, fixtures and equipment. If the Kim family does not own, indirectly through EB Nevada, at least 25% of the Company's outstanding capital stock, the Company may be declared in default under the credit facility. There was no outstanding balance atJanuary 30, 1999February 2, 2002 andJanuary 29, 2000February 1, 2003 on this facility.Long-term debtLetters of credit outstanding with various financial institutions were $1.8 million and $694,000 at
January 30, 1999February 2, 2002 andJanuary 29, 2000 is summarized as follows:
January 30, January 29, 1999 2000 -------------- --------------Promissory note, maturing on February 1, 2000 with interest and principal payable monthly at 6.00% as of January 30, 1999 and $ 108,349 $ 8,353 January 29, 2000 Less current installments............................................ 99,996 8,353 ----------------- ---------------- $ 8,353 $ - =============== ================(5)February 1, 2003, respectively.The Company had a line of credit and various bank notes with a total outstanding balance at February 2, 2002 of $468,000. These facilities were paid in full during fiscal 2003.
(6) RELATED PARTY TRANSACTIONS
TRANSACTIONS WITH AFFILIATES Insurance and other expenses have been paid to an affiliated company through intercompany billings. The amount of these expenses was approximately $431,000, $41,000 and $0 for fiscal 1998, fiscal 1999 and fiscal 2000, respectively, and is included in selling, general and administrative expenses.Transactions with Affiliates
In fiscal 1996,
theEB,Group acquired 25 percent of the outstanding shares of Electronics Boutique Plc (formerly Rhino Group Plc). The EB Group accounted for the investment in Electronics Boutique Plc under the equity method, which requires the EB Group to recognize goodwill and 25% of the results of operations of Electronics Boutique Plc from the date of acquisition in fiscal 1996. The goodwill has been amortized over the expected period of benefit of 10 years. The $3,200,000 of goodwill from this transaction resulted in amortization expense of $321,000 in fiscal 1998 and $161,000 in fiscal 1999. The carrying value of the investment exceeded the EB Group's 25 percent share of the underlying net assets of Electronics Boutique Plc by the amount of the goodwill. The investment in Electronics Boutique Plc was retained bya predecessorcompany priortocompletion of the initial public offering bythe Company,in July, 1998. In fiscal 1996, the EB Groupentered into a services agreement withElectronics Boutique PlcGame Group to provide consulting, management, training, and advertising assistance which expires on January 31, 2006. The agreement was assigned to EB Services. The agreement prohibits theCompany.Company from competing in the United Kingdom during the term of the agreement, and for one year after its termination. The agreement provides for a fee to be paid totheEBGroupServices based on a formula of 1% of Game Group's adjusted sales and if budgeted profits are exceeded for the year, a bonus equal to 25% of such excess.For fiscal 1998, a bonus was earned in the amount of $2,206,000.The management fee receivable atJanuary 30, 1999February 2, 2002 was$879,000 and was included in due from affiliates$573,000 and atJanuary 29, 2000February 1, 2003 was$1,301,000 and was$605,000; both were included in accountsreceivable -receivable—trade and vendors.Included in managementManagement fees received from Game Group for fiscal1998,2001, fiscal19992002 and fiscal20002003 was$1,953,000, $2,529,000$4.4 million, $6.0 million and$3,850,000,$7.4 million, respectively. Additionally, the agreement provides thatthe CompanyEB Services is to be reimbursed byElectronics Boutique PlcGame Group for all reasonable travel and subsistence expenses incurredby employees of the Companyduringtheirperformance of the agreement.AmountsAt February 2, 2002 and February 1, 2003, there were no outstandingfor these expenses at January 30, 1999 were $105,000 and were included inbalances due fromaffiliates and at January 29, 2000 were $198,000 and were included in accounts receivable - trade and vendors. 36Equity in earnings (loss) of affiliates includes $2,902,780 for fiscal 1998 and ($160,575) for fiscal 1999 for Electronics Boutique, Plc. The Company leases its headquarters and its primary distribution center, which are located in a single 140,000 square foot building on several acres in West Chester, Pennsylvania, from a majority shareholder. The lease has a two year term expiring on May 30, 2000 and includes an option to purchase the property for $6.7 million. (6) CONSULTING AGREEMENT In July 1993, the EB Group entered into a consulting agreement with a business that owns and operates retail stores. The Company provides consulting, management, administrative, marketing, and advertising assistance to this retail business. The Company received $633,000, $476,000 and $226,000 during fiscal 1998, fiscal 1999 and fiscal 2000, respectively, as reimbursement for incremental costs incurred based on a formula as defined. Amounts owed toGame Group.On November 2, 2002, the Company sold its BC Sports Collectibles business to SCAC for
these items$2.2 million in cash andtrade credit at January 30, 1999 and January 29, 2000 arethe assumption of lease related liabilities in excess of $13 million. The purchaser, SCAC, is owned by the family of James Kim, the Company's Chairman. The transaction includedin accounts receivable. Reimbursements offset selling, general and administrative expenses. Based on certain performance criteria as defined,theCompany can also earn a performance fee. No performance fee was earned for fiscal 1998, $648,000 was earned for fiscal 1999 ($248,000sale ofwhich was recorded in fiscal 2000) and $543,000 was earned for fiscal 2000. (7) ACQUISITIONS EB CANADA In September 1993, the EB Group advanced funds to obtain a 50% interest in a Canadian corporation ("EB Canada") formed for the purpose of selling computer, video games and hand-held entertainment hardware, software, and related peripherals and accessories in shopping malls throughout Canada. The EB Group purchased the remaining 50% of EB Canada in October 1997 for $727,000 and now owns 100% of EB Canada. The fair value ofall assetsacquired totaled $3,879,000, while liabilities assumed totaled $4,332,000 resulting in goodwill of $1,180,000, which is being amortized over the expected period of benefit of ten years. The EB Group consolidated the results of operations of EB Canada since the beginning of fiscal 1998. The $236,000 loss of EB Canada prior to the acquisitionof theremaining 50% by the EB Group in fiscal 1998 has been included in preacquisition loss of subsidiaries on the consolidated statement of income. EB INTERNATIONAL In fiscal 1996, the EB Group formed a subsidiary, EB International, Inc., to establish a 50% interest in a joint venture with a Korean company to operate a chain of retail stores that sells computer software, video games, accessories,business including inventory, intellectual property andsupplies in South Korea. In fiscal 1998, EB International acquired the remaining 50% interest in the joint venture with $611,000 of additional fundsfurniture, fixtures and equipment, and transitional services which were provided by theEB Group. The fair valueCompany to SCAC for a six-month period after the closing for an additional $300,000. As ofassets acquired totaled $3,579,000, while liabilities assumed totaled $3,497,000 resulting in goodwill of $529,000 that is being amortized over the expected period of benefit of ten years. The EB Group has consolidated the results of operationsFebruary 1, 2003, $150,000 of thejoint venture since the beginning of fiscal 1998. The $677,000 lossservices agreement has been earned and recognized as income. Subsequent to year end, all of thejoint venture prior22 store leases have been assigned tothe acquisitionSCAC. The transaction was negotiated and approved by a committee of theremaining 50% byCompany's Board of Directors comprised solely of independent directors with theEB Group in fiscal 1998 has been included in preacquisition lossassistance ofsubsidiaries on the consolidated statement of income. (8) PRO FORMA STATEMENT OF INCOME INFORMATION (UNAUDITED) For purposes of comparison, the following pro forma information for fiscal 1998 and fiscal 1999 is presentedan investment banking firm engaged toshow pro forma income on an after-tax basis as if the EB Group had been subject to taxes as a C corporation.
Fiscal 1998 Fiscal 1999 -------------- --------------Federal statutory tax rate 35.00 % 35.00 % State income taxes, net of federal benefit 3.74 3.18 Loss of foreign subsidiaries 0.51 - Other 1.85 3.34 Change in valuation allowance - (4.41) -------------- -------------- Pro forma income tax rate 41.10 % 37.11 % ============== ==============37Set forth below are pro forma results of operations for fiscal 1998 and fiscal 1999. The following table sets forth the calculation of basic and diluted net income per share:
Fiscal Fiscal 1998 1999 ------------- -------------Income before income taxes $ 22,910,465 $ 31,978,549 Pro forma income taxes 9,415,631 11,866,084 ------------- ------------- Pro forma net income $ 13,494,834 $ 20,112,465 ============= ============= Pro forma net income per share - basic $ 0.85 $ 1.12 ============= ============= Pro forma weighted average shares outstanding - basic 15,794,200 18,029,777 ============= ============= Pro forma net income per share - diluted $ 0.85 $ 1.11 ============= ============= Pro forma weighted average shares outstanding - diluted 15,794,200 18,084,109 ============= =============The pro forma weighted average shares outstanding - basic reflects the effect of shares issued by the Companysolicit offers for theacquisition of substantially all the operating assets and liabilities of the EB Group for periods prior to the initial public offering. The pro forma weighted average shares outstanding - diluted additionally include the effect of dilutive stock options. (9)BC Sports Collectibles business.50
(7) CAPITAL STOCK
On
July 28, 1998,August 14, 2001, the Company completedits reorganization and an initiala public offering of5,000,0004,600,000 shares ofitscommon stock. Of the5,000,0004,600,000 shares sold,4,375,0002,500,000 shares were for the account of theCompanycompany and625,000 shares were for the account of EB Nevada, Inc., the selling shareholder. The net proceeds to the Company, after deducting underwriting discounts and commissions and expenses were $54,962,500. The net proceeds were recorded as an increase to additional paid in capital and common stock. The proceeds were used, in part, to retire debt under the Company's revolving credit facility and to repay an outstanding demand note to the Company's Chairman. On November 23, 1999, the Company completed a secondary offering of 3,500,000 shares of common stock. Of the 3,500,000 shares sold, 2,000,000 shares were for the account of the Company and 1,500,0002,100,000 shares were for the account of EB Nevada Inc., the selling shareholder. The transaction resulted in net proceeds (after offering expenses) to the Company of approximately$40.0$68.2 million.(10)(8) EMPLOYEES' RETIREMENT PLAN
The Company provides employees with retirement benefits under a 401(k) salary reduction plan. Generally, employees are eligible to participate in the plan after attaining age 21 and completing one year of service. Eligible employees may contribute up to
17%60% of their compensation to the plan. Company contributions are at the Company's discretionand may not exceed 15% of an eligible employee's compensation.. Company contributions to the plan are fully vested for eligible employees with five years or more of service. Contributions under this plan were approximately$302,000, $389,000$456,000, $534,000 and$433,000$624,000 in fiscal1998,2001, fiscal19992002 and fiscal2000,2003, respectively.(11)(9) EQUITY
PARTICIPATION PLANPLANSEquity Participation Plan
The Company
in connection with its initial public offering,adoptedanequity participationplanplans (the "Equity Participation Plans"), pursuant to which 2,100,000 and 2,000,000 shares of common stock were reserved in 1998 and 2000, respectively, for issuance upon the exercise of stock options granted to employees, consultants and directors. The exercise price of options granted underthis planthe Equity Participation Plans may not be less than fair market value per share of common stock at the grant date; options become exercisable one to three years after the38grant date and expire over a period of not more than ten years. Exercisability is accelerated on a change in control of the Company, as defined in the plan.Equity Participation Plans.Employee Stock Purchase Plan
Under Electronics Boutique's Employee Stock Purchase Plan (the "Purchase Plan"), associates meeting specific employment qualifications are eligible to participate and can purchase shares quarterly through payroll deductions at the lower of 85% of the fair market value of the stock at the commencement or end of the offering period. The Purchase Plan permits eligible associates to purchase common stock through payroll deductions for up to 10% of qualified compensation. As of February 1, 2003, approximately 958,000 shares remain available for issuance under the Purchase Plan. The weighted-average fair value, net of the 15% discount, of the shares purchased by employees in fiscal 2001, fiscal 2002 and fiscal 2003 was $15.28, $19.08 and $20.27, respectively.
Pro forma information regarding net income and income per share is required by FASB Statement
of Financial Accounting Standard ("FAS")No.123, and has been determined as if the Company had accounted for its employee stock options and the purchase plan under the fair value method ofthat Statement.Statement No. 123. The fair valuefor these optionswas estimated at51
the date of grant using a Black-Scholes
option pricingoption-pricing model with the following weighted average assumptions:
Fiscal 1999 Fiscal 2000 -------------- --------------Expected volatility 50.0 % 62.4 % Risk-free interest rate 4.55 % 4.93 % Expected life in years 3.5 3.0 Dividend yield 0 0
Fiscal 2001 Fiscal 2002 Fiscal 2003 Expected volatility 62.41 % 61.51 % 62.38 % Risk-free interest rate 4.86 % 4.28 % 2.98 % Expected life of options in years 3.0 4.15 4.76 Expected life of purchase rights in months 3.0 3.0 3.0 Dividend yield — % — % — % The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of theThe weighted-average grant-date fair value ofits employee stock options.options granted during fiscal 2001, fiscal 2002 and fiscal 2003 was $6.94, $11.00 and $17.09 respectively.For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's information
follows:follows (amounts in thousands, except per share amounts):
Fiscal 1999 Fiscal 2000 -------------- --------------Net income: As reported (pro forma in fiscal 1999) $ 20,112,465 $ 22,830,388 Pro forma net income $ 19,234,620 $ 20,942,647 Pro forma income per common share: Basic $ 1.07 $ 1.02 Diluted $ 1.06 $ 1.01
Fiscal 2001 Fiscal 2002 Fiscal 2003(1) Net income, as reported $ 14,871 $ 17,712 $ 32,627
Pro forma net income
$
12,100
$
14,344
$
27,831
Pro forma earnings per share:
Basic $ 0.54 $ 0.60 $ 1.08 Diluted $ 0.54 $ 0.59 $ 1.06
- (1)
- The fiscal 2003 net income amount includes the cumulative effect of the change in accounting principle of $4.8 million, net of income tax, related to cooperative advertising allowances. See Note 2, "Change in Accounting Principle," for further disclosures of the change.
52
A summary of the Company's stock option activity, and related information for the fiscal year ended
January 30, 1999February 3, 2001, February 2, 2002 andJanuary 29, 2000 follows:February 1, 2003 follows (amounts in thousands, except per share amounts):
Weighted Exercise Price Average - Range per Exercise Price Shares Share -------------------- ---------------- ----------------Outstanding at January 31, 1998 - $ - $ - Granted 1,599,133 14.00 14.00 Forfeited (37,800) 14.00 14.00 --------------------- ---------------- ---------------- Outstanding at January 30, 1999 1,561,333 14.00 14.00 Granted 342,086 17.00 - 24.00 19.82 Exercised (51,914) 14.00 14.00 Forfeited (73,029) 14.00 - 19.88 14.00 --------------------- ---------------- ---------------- Outstanding at January 29, 2000 1,778,476 Exercisable at January 29, 2000 449,716 -
Fiscal 2001 Fiscal 2002 Fiscal 2003 Outstanding at beginning of year 1,779 2,050 2,093 Granted 412 1,085 433 Exercised (61 ) (959 ) (76 ) Forfeited (80 ) (83 ) (62 ) Outstanding at end of year 2,050 2,093 2,388 Exercisable at end of year 989 697 1,215
Weighted average price per share:
Granted $ 15.32 $ 21.37 $ 31.74 Exercised 14.02 14.50 16.72 Forfeited 15.33 17.70 22.59 The weighted average exercise price for all options outstanding and exercisable as of February 2, 2002 and February 1, 2003 were $15.13 and $17.16, respectively. The weighted average exercise price for all options outstanding as of
January 29, 2000 was $15.06.February 2, 2002 and February 1, 2003 were $18.34 and $20.71, respectively.The
average remaining contractual lifetable below summarizes information about stock options outstanding as ofthose options was 8.7 years. 39(12)February 1, 2003 (share amounts in thousands):
Options outstanding Options exercisable Range of exercise prices Number
outstanding as
of February 1,
2003Weighted
average
remaining
contractual lifeWeighted average
exercise priceNumber
exercisable as
of February 1,
2003Weighted
average
exercise price$9.50 - $17.50 868 6.42 $ 14.62 707 $ 14.48 $17.51 - $29.06 860 7.80 $ 18.34 427 $ 18.79 $30.00 $41.65 660 8.69 $ 31.79 81 $ 31.88 2,388 1,215 (10) INCOME TAXES
As discussed in notes 1 and 8, the Company is subject to federal and state income taxes as a C corporation whereas its predecessors had been treated as an S corporation and a partnership for federal and certain state income tax purposes resulting in taxable income being passed through to the shareholders and partners.Income before income
taxestax expense and cumulative effect of change in accounting principle was asfollows:follows (amounts in thousands, except tax rates):
Fiscal 1998 Fiscal 1999 Fiscal 2000 -------------- -------------- --------------Domestic $ 21,354,205 $ 31,331,801 $ 32,585,914 Foreign 1,556,260 646,748 5,252,247 -------------- -------------- -------------- Total $ 22,910,465 $ 31,978,549 $ 37,838,161 ============== ============== ==============
Fiscal 2001 Fiscal 2002 Fiscal 2003 Domestic $ 19,790 $ 25,801 $ 52,989 Foreign 4,872 2,859 6,784 Total $ 24,662 $ 28,660 $ 59,773 53
The provision for income taxes for fiscal
1998,2001, fiscal19992002 and fiscal20002003 consists of the following:
Fiscal 1998 Fiscal 1999 Fiscal 2000 -------------- -------------- --------------Federal statutory tax rate 35.00 % 35.00 % 35.00 % State income taxes, net of federal benefit 3.69 3.18 2.73 Foreign incremental taxes - - 1.06 S corporation earnings not subject to (0.22) - federal taxation (35.00) Other - 3.02 0.63 Change in valuation allowance - (4.41) 0.24 -------------- -------------- -------------- Income tax expense 3.69 % 36.57 % 39.66 % ============== ============== ============== Current: Domestic - Federal $ - $ 9,767,127 $ 12,022,610 Domestic - State 840,000 3,050,653 1,601,952 Foreign 60,528 3,045,359 Deferred: Domestic - Federal - 159,331 (1,245,891) Domestic - State - (719,669) (317,963) Foreign 6,280 (624,700) (98,294) -------------- -------------- -------------- Income tax expense $ 846,280 $ 11,693,270 $ 15,007,773 ============== ============== ==============
Fiscal 2001 Fiscal 2002 Fiscal 2003 Federal statutory tax rate 35.00 % 35.00 % 35.00 % State income taxes, net of federal benefit 1.13 0.51 3.35 Foreign incremental taxes 1.59 0.59 (0.33 ) Other 1.26 1.51 (0.63 ) Change in valuation allowance 0.72 0.59 0.04 Income tax expense 39.70 % 38.20 % 37.43 % Current: Domestic—Federal $ 7,357 $ 16,684 $ 11,191 Domestic—State 1,031 1,825 2,091 Foreign 2,136 2,169 5,092
Deferred:
Domestic—Federal (115 ) (7,167 ) 5,932 Domestic—State (603 ) (1,599 ) 994 Foreign (15 ) (964 ) (2,927 ) Income tax expense $ 9,791 $ 10,948 $ 22,373 Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The following is a summary of the significant components of the Company's deferred tax assets and liabilities as of
January 30, 1999 (fiscal 1999)February 2, 2002 andJanuary 29, 2000 (fiscal 2000).
Deferred tax assets: Fiscal 1999 Fiscal 2000 -------------- ---------------Inventory capitalized costs $ 1,632,000 $ 1,575,272 Accrued expenses 705,000 2,078,001 Fixed assets 4,962,000 7,161,428 Deferred rent 922,000 1,146,428 Amortization of goodwill 167,000 235,603 Foreign net operating loss 839,000 306,000 -------------- --------------- Total gross deferred tax asset 9,277,000 12,502,732 Valuation allowance (214,000) (306,000) --------------- --------------- Net deferred tax asset $ 9,013,000 $ 12,196,732 ============== ===============40As a result of the acquisition describedFebruary 1, 2003 (amounts inNote 1, tax assets were acquired exceeding book basis, resulting in deferred tax assets of $7,828,000, net of a valuation allowance of $1,622,000. The change in the valuation allowance of $1,408,000 in fiscal 1999 results from management's assessment that taxable income willthousands):
February 2,
2002February 1,
2003Deferred tax assets: Inventory $ 1,838 $ 5,825 Accrued expenses 9,133 3,001 State net operating loss 576 1,044 Fixed assets 9,019 7,191 Deferred rent 1,423 1,646 Amortization of goodwill 234 143 Foreign net operating loss 1,179 3,420 Total gross deferred tax asset 23,402 22,270 Valuation allowance (534 ) (546 ) Net deferred tax asset $ 22,868 $ 21,724 Management believes it is more likely than not
bethat the results of future operations will generate sufficient taxable income to realizethe netdeferred tax assets,of $9,013,000 as of January 30, 1999.except for certain net operating loss carryforwards for which the Company has provided a valuation allowance. The increase in the valuation allowance of$92,000$12,000 in fiscal20002003 results from net operating losses from certain foreign subsidiaries.(11) RESTRUCTURING CHARGE
On February 1, 2002, the Board of Directors of the Company adopted a plan related to the closing of the Company's 29 EB Kids stores and the sale of its 22 store BC Sports Collectibles business. A $14.9 million pre-tax charge ($9.2 million after-tax or $0.35 per diluted share) was recorded in fiscal 2002 related to this decision. The pre-tax charge was recorded as follows: $2.3 million related to a
54
write-down of inventory within cost of goods sold and $12.6 million as a restructuring and asset impairment charge. The $12.6 million charge consisted of a $3.5 million write down of store leasehold improvements, a $2.3 million write down of store furniture, fixtures and equipment and $6.7 million in lease termination costs.
The following table summarizes activity in the restructuring accrual for February 2, 2002 and February 1, 2003 (amounts in thousands):
Beginning
BalanceCash
PaymentsCharges Reversals Other Ending
BalanceYear ended February 2, 2002 $ — $ — $ 12,638 $ — $ (5,460 ) $ 7,178 Year ended February 1, 2003 $ 7,178 $ (2,989 ) $ 148 $ (4,193 ) $ 96 $ 240 In the fiscal year ended 2002, the $5.5 million in "Other" related to the write-down of $2.8 million of EB Kids fixed assets and the write-off of $2.7 million of BC Sports Collectibles fixed assets.
In the fiscal year ended 2003, the Company made $3.0 million in cash payments consisting of: $2.2 million paid to landlords for EB Kids lease buy-outs; $177,000 in professional fees related to the EB Kids store closings; and $590,000 in professional fees related to the BC Sports Collectibles sale. The Company reversed $4.2 million of the restructuring accrual consisting of: $3.6 million related to lease termination costs that were not realized due to the sale of the BC Sports Collectibles business and $546,000 due to actual costs being lower than original estimates for the termination of the leases for the EB Kids stores.
As of February 1, 2003, there is still $240,000 remaining of the restructuring accrual. This amount primarily represents a $204,000 accrual for the potential assigning back to the Company two of the BC Sports Collectibles store leases.
(12) LEGAL CONTINGENCIES
The Company is involved from time to time in legal proceedings arising in the ordinary course of its business. In the opinion of management, no pending proceedings could have a material adverse effect on the Company's results of operation or financial condition.
(13) RECLASSIFICATIONS
Effective in the second quarter of fiscal 2003, Electronics Boutique changed the income statement classification for pre-owned merchandise trade-in activity to be consistent with industry practice. Previously, the Company recorded a reduction to both revenue and cost of goods sold for the cost of the pre-owned merchandise accepted for trade. The reclassification of these transactions increased both revenues and cost of goods sold by $36.5 million and $50.1 million in fiscal years 2001 and 2002, respectively. There was no impact on operating income or net income for any period as a result of this reclassification.
55
(14) COMPREHENSIVE INCOME
Comprehensive income is computed as follows (amounts in thousands):
Year ended February 2,
2002February 1,
2003(1)Net income $ 17,712 $ 32,627 Foreign currency translations (1,417 ) 6,574 Hedging activities 359 (5,077 ) Comprehensive income $ 16,654 $ 34,124
- (1)
- The year ended February 1, 2003 net income amount includes the cumulative effect of the change in accounting principle, net of income tax, related to cooperative advertising allowances. See Note 2, "Change in Accounting Principle," for further disclosures of the change.
Gains and (losses) on foreign currency translations are a result of the Company's investment in its foreign subsidiaries in Australia, Canada, Denmark, Germany, Italy, Norway, South Korea and Sweden. Gains and (losses) on hedging activities are primarily the result of foreign exchange forward contracts and cross currency swap agreements the Company has entered into to protect its investments in its European subsidiaries from foreign currency fluctuations. The net gains and (losses) on these activities is primarily the result of the Company's investment in its Australia, Canada and South Korea subsidiaries that have not been hedged.
(15) GOODWILL AND OTHER INTANGIBLES
In July 2001, the FASB issued Statement No. 142, "Goodwill and Other Intangible Assets." Statement No. 142 states that goodwill and intangible assets with indefinite useful lives will no longer be amortized, but instead be tested for impairment at least annually. The following tables show the intangible assets and goodwill as of February 1, 2003 (amounts in thousands):
Amortizable Intangible Assets
Gross Carrying
AmountAccumulated
AmortizationKey Money(1) $ 1,280 $ 237 Other 200 140 Total Intangible Assets $ 1,480 $ 377
- (1)
- Key Money represents payments made to landlords, outgoing tenants or other third parties to enter into certain store leases.
Intangible assets are amortized over their estimated useful lives which range from three to five years. Amortization expense of amortizable intangible assets for the fiscal years 2001, 2002 and 2003 was $53,000, $44,000 and $315,000, respectively. Amortization expense for amortizable intangible assets for the next five years is: $291,000 in fiscal 2004, $240,000 in fiscal 2005, $239,000 in fiscal 2006, $229,000 in fiscal 2007 and $104,000 in fiscal 2008.
56
Goodwill
The changes in carrying amount of goodwill for the year ended February 1, 2003 is as follows (amounts in thousands):
Balance as of February 2, 2002 $ 8,354 Purchase additional 30% of Italian subsidiary(1) 1,005 Reduction in purchase price of Swedish subsidiary(2) (547 ) Planet Games acquisition(3) 63 Buyout of German partner(4) 343 Foreign exchange fluctuations and other 1,720 Balance as of February 1, 2003 $ 10,938
- (1)
- During fiscal 2003, the Company purchased the remaining 30% of the Italian subsidiary from its minority owner. The Company now owns 100% of its Italian subsidiary.
- (2)
- During the second quarter of fiscal 2003, an adjustment was made to the purchase price for the Company's acquisition completed in Sweden in the fourth quarter of fiscal 2002.
- (3)
- During the third quarter of fiscal 2003, the Company acquired the assets of a five store retail chain in Minnesota.
- (4)
- In January 2003, the Company bought out one of its partners in the German subsidiary.
(13) NET INCOME AND PRO FORMA NET INCOME PER SHAREThis resulted in an increase of ownership of .3125%. The Company now owns 99.6875% of its German subsidiary.Comparison to prior year "As Adjusted"
The following table presents prior year reported amounts adjusted to eliminate the
computationeffect ofbasic and diluted actualgoodwill amortization in accordance with Statement No. 142.
February 3,
2001February 2,
2002February 1,
2003(1)(Amounts in thousands, except per share amounts) Net income, as reported $ 14,871 $ 17,712 $ 32,627 Add: goodwill amortization, net of taxes 188 132 — Adjusted net income $ 15,059 $ 17,844 $ 32,627 Basic earnings per share: Net Income $ 0.67 $ 0.74 $ 1.26 Goodwill amortization, net of taxes 0.01 0.01 — Adjusted net income $ 0.68 $ 0.75 $ 1.26 Diluted earnings per share: Net Income $ 0.66 $ 0.73 $ 1.24 Goodwill amortization, net of taxes 0.01 0.01 — Adjusted net income $ 0.67 $ 0.74 $ 1.24
- (1)
- The year ended February 1, 2003 net income amount includes the cumulative effect of the change in accounting principle of $4.8 million, net of income tax, related to cooperative advertising allowances. See Note 2, "Change in Accounting Principle," for further disclosures of the change.
57
(16) ACQUISITIONS
On May 14, 2001, the Company acquired the assets of a Danish company consisting of eight retail stores and
pro forma net income per share:
Fiscal 1998 Fiscal 1999 Fiscal 2000 -------------- -------------- --------------Basic net income per share: Net income $ 22,830,388 ============== Weighted average shares outstanding 20,559,100 ============== Net income per share - basic $ 1.11 ============== Diluted net income per share: Net income $ 22,830,388 ============== Weighted average shares outstanding 20,559,100 Diluted effect of stock options 203,149 -------------- Weighted average shares outstanding 20,762,249 ============== Net income per share - diluted $ 1.10 ============== Basic pro forma net income per share: Pro forma net income $ 13,494,834 $ 20,112,465 ============== ============== Pro forma weighted average shares outstanding 15,794,200 18,029,777 ============== ============== Pro forma net income per share - basic $ 0.85 $ 1.12 ============== ============== Diluted pro forma net income per share: Pro forma net income $ 13,494,834 $ 20,112,465 ============== ============== Pro forma weighted average shares outstanding 15,794,200 18,029,777 Diluted effect of stock options - 54,332 -------------- -------------- Pro forma weighted average shares outstanding 15,794,200 18,084,109 ============== ============== Pro forma net income per share - diluted $ 0.85 $ 1.11 ============== ==============41ITEMan Internet site in Denmark and Norway for approximately $2.2 million.On August 2, 2001, the Company acquired 70% of the capital stock of an Italian company, consisting of 10 retail stores and a distribution facility, for approximately $1.7 million.
On October 5, 2001, the Company paid approximately $631,000 to acquire 90% of the capital stock of a German company, which then acquired assets consisting of three retail stores, a publishing business, a mail order operation and an Internet site.
On November 15, 2001, the Company acquired all the outstanding shares of Tradition Svenska AB, a privately-held video and hobby games retailer with 11 stores located in several cities in Sweden for approximately $4.7 million.
These acquisitions were accounted for using the purchase method of accounting and resulted in goodwill of $7.4 million.
For more details on acquisitions during fiscal 2003, please refer to Note 15, "Goodwill and Other Intangibles."
Schedule II—Valuation and Qualifying Accounts (amounts in thousands)
Period Ended Description Beginning
BalanceCharged to
costs and
expensesDeductions Ending
BalanceDeferred Tax Valuation Allowance February 3, 2001 Deferred tax valuation allowance $ 306 $ 114 $ — $ 420 February 2, 2002 Deferred tax valuation allowance 420 114 — 534 February 1, 2003 Deferred tax valuation allowance 534 12 — 546
Inventory Valuation Allowance
February 3, 2001 Inventory valuation allowance $ 2,828 $ 2,782 $ 3,663 $ 1,947 February 2, 2002 Inventory valuation allowance 1,947 8,284 7,535 2,696 February 1, 2003 Inventory valuation allowance 2,696 6,794 6,605 2,885
Trade Receivables Bad Debt Allowance
February 3, 2001 Trade receivables bad debt allowances $ 250 $ — $ — $ 250 February 2, 2002 Trade receivables bad debt allowances 250 — — 250 February 1, 2003 Trade receivables bad debt allowances 250 — — 250 58
Item 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSUREChanges in and Disagreements with Accountants on Accounting and Financial DisclosureNone
PART
Part IIIITEMS 10-13 DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANYItems 10-13. Directors and Executive Officers of the Company
The information required by Part III (Items 10-13) is set forth in the Company's definitive proxy statement, which will be filed pursuant to Regulation 14A within 120 days of
January 29, 2000,February 1, 2003, and in Item 1A hereof.SuchThe information is incorporated herein by reference and made a part hereof.PARTItem 14.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Financial Schedules attached hereto are as follows: - Schedule II - ValuationControls andQualifying Accounts. 2. Exhibits 1.1ProceduresUnder the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures within 90 days of the filing date of this Annual Report of Form
of Underwriting Agreement(1) 4.1 Specimen Stock Certificate(2) 10.1 Form of Indemnification Agreement for Directors10-K, and,Officers(2) 10.2 Form of 1998 Equity Participation Plan(2) 10.3 Services Agreement, dated October 13, 1995, bybased on their evaluation, our chief executive officer andbetween The Electronics Boutique, Inc.chief financial officer have concluded that these controls andElectronics Boutique plc(f/k/a Rhino Group plc)(2) 10.4 Loan and Security Agreement, dated March 16, 1998, by and between The Electronics Boutique, Inc. and Fleet Capital Corporation(2) 10.5 Joinder Agreement by and between Electronics Boutique of America Inc. and Fleet Capital Corporation(2) 10.6 Form of Employment Agreement by and between Electronics Boutique Holdings Corp. and Joseph J. Firestone(2) 10.7 Form of Employment Agreement by and between Electronics Boutique Holdings Corp. and John R. Panichello(2) 10.8 Form of Employment Agreement by and between Electronics Boutique Holdings Corp and Jeffrey W. Griffiths(2) 10.9 Assignment, Bill of Sale, and Assumption Agreement, dated May 31, 1998, by and between The Electronics Boutique, Inc. and Electronics Boutique of America Inc.(2) 10.10 Form of Registration Rights Agreement between Electronics Boutique Holdings Corp. and EB Nevada(2) 10.11 Form of Demand Note by and between James J. Kim and Electronics Boutique of America Inc.(2) 10.12 Assignment of Trademarks, dated May 31, 1998, by and between The Electronics Boutique, Inc. and Elbo, Inc.(2) 10.13 Addendum to Assignment of Trademarks by and between EB and Elbo(2) 10.14 Form of Agreement of Lease by and between The Electronics Boutique, Inc. and Electronics Boutique of America Inc.(2) 10.15 Agreement and Bill of Sale, datedprocedures were effective as ofJuly 13, 1998,the date of the evaluation. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.Disclosure controls and procedures are our internal controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and
between Electronics Boutique Holdings Corp.reported within the time periods specified in the Securities andEB Nevada(2) 10.16 AgreementExchange Commission's rules andConsentforms. Disclosure controls and procedures include, without limitation, controls and procedures designed toAssignmentensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated andAssumption of Partnership Interests, datedcommunicated to our management, including our chief executive officer and chief financial officer, asof July 13, 1998(2) 10.17 Amendment No. 1appropriate toLoanallow timely decisions regarding required disclosure.
Item 15. Exhibits, Financial Statement Schedules, andSecurity Agreement by and among The Electronics Boutique, Inc., Electronics Boutique of America Inc. and Fleet Capital Corporation(2) 10.18 Amendment No. 2 to Loan and Security Agreement by and among The Electronics Boutique, Inc., Electronics Boutique of America Inc. and Fleet Capital Corporation(2) 4210.19 Form of Employment Agreement by and between Electronics Boutique Holdings Corp. and Seth P. Levy(3) 21.1 Subsidiaries of Electronics Boutique Holdings Corp. 23.1 Auditors' Report and Consent of KPMG LLP 27.1 Financial Data Schedule - -------------- (1) Incorporated by reference from the applicable exhibits of Electronics Boutique's Registration StatementReports on FormS-3 (Reg. No. 333-88561) (2)8-K(a) Documents Filed as Part of Report:
Exhibits:
Exhibit
No.Identification of Exhibit 3.1 Certificate of Incorporation(1) 3.2 Bylaws(1) 4.1 Specimen Stock Certificate(1) 10.1 Form of Indemnification Agreement for Directors and Officers(1) 10.2 Form of 1998 Equity Participation Plan(1) 10.3 Form of 2000 Equity Participation Plan(2) 10.4 Form of Employee Stock Purchase Plan(2) 10.5 Services Agreement, dated October 13, 1995, by and between The Electronics Boutique, Inc. and Electronics Boutique plc (f/k/a Rhino Group plc)(1) 10.6 Loan and Security Agreement, dated March 16, 1998, by and between The Electronics Boutique, Inc. and Fleet Capital Corporation(1) 10.7 Joinder Agreement by and between Electronics Boutique of America Inc. and Fleet Capital Corporation(1) 59
10.8 Amendment No. 1 to Loan and Security Agreement by and among The Electronics Boutique, Inc., Electronics Boutique of America Inc. and Fleet Capital Corporation(1) 10.9 Amendment No. 2 to Loan and Security Agreement by and among The Electronics Boutique, Inc., Electronics Boutique of America Inc. and Fleet Capital Corporation(1) 10.10 Form of Employment Agreement by and between Electronics Boutique Holdings Corp. and Joseph J. Firestone(1) 10.11 Employment Agreement, dated November 7, 2002, by and between Electronics Boutique Holdings Corp. and Jeffrey W. Griffiths * 10.12 Employment Agreement, dated November 7, 2002, by and between Electronics Boutique Holdings Corp and John R. Panichello* 10.13 Employment Agreement, dated November 7, 2002, by and between Electronics Boutique Holdings Corp. and Seth P. Levy* 10.14 Employment Agreement, dated November 7, 2002, by and between Electronics Boutique Holdings Corp. and James A. Smith* 10.15 Form of Employment Agreement by and between Electronics Boutique Holdings Corp. and Steven R. Morgan(3) 10.16 Asset Purchase Agreement, dated as of October 10, 2002, between Electronics Boutique of America Inc. and Sports Collectibles Acquisition Corporation(4) 10.17 Form of Transition Agreement between Electronics Boutique of America Inc. and Sports Collectibles Acquisition Corporation(4) 10.18 Form of Indemnification Agreement between Electronics Boutique of America Inc. and Sports Collectibles Acquisition Corporation(4) 21.1 Subsidiaries of Electronics Boutique Holdings Corp.* 23.1 Consent of KPMG LLP* 99.1 Section 906 Certification of Jeffrey W. Griffiths* 99.2 Section 906 Certification of James A. Smith*
- (1)
- Incorporated by reference from the applicable exhibits of Electronics Boutique's Registration Statement on Form S-1 (Reg. No. 333-48523)
- (2)
- Incorporated by reference from Electronics Boutique's Proxy on Schedule 14A dated June 16, 2000
- (3)
- Incorporated by reference from the applicable exhibits
ofto Electronics Boutique's Annual Report on Form10-Q10-K for thequarterlyperiod endedJuly 31, 1999 - --------------February 3, 2001- (4)
- Incorporated by reference from the applicable exhibits to Electronics Boutique's Report on Form 8-K dated October 10, 2002
- *
- Filed herewith
(b) Reports on Form 8-K
The Company filed a Form 8-K on November 16, 1999 to report the consummation of a public offering of its securities. 43SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Charged to Charged to Period Beginning costs and other Deductions Ending Ended Description Balance expenses accounts (1) Balance - ---------------- -------------------------- ------------ ------------- ------------ ------------- ------------January 30, Deferred tax valuation $ 1,622,000 $ - $ - $ 1,408,000 $ 214,000 1999 allowance January 29, Deferred tax valuation 214,000 92,000 - - 306,000 2000 allowance(1) Realization of deferred tax assets. 44None.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ELECTRONICS BOUTIQUE HOLDINGS CORP. By: /s/ Joseph J. Firestone ----------------------- Joseph J. Firestone President and Chief Executive Officer
ELECTRONICS BOUTIQUE HOLDINGS CORP.
By:
/s/ JEFFREY W. GRIFFITHS
Jeffrey W. Griffiths
President and Chief Executive OfficerDate:
April 28, 2000May 1, 2003Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on
April 28, 2000.May 1, 2003.
Name Title - ---- -----/s/
/s/ JAMES J. KIM
James J. Kim
Chairman of the Board------------------------------ James J. Kim /s/ Joseph J. Firestone
/s/ JEFFREY W. GRIFFITHS
Jeffrey W. Griffiths
President and Chief Executive Officer and Director------------------------------(Principal Executive Officer)Joseph J. Firestone /s/ John R. Panichello
/s/ JAMES A. SMITH
James A. Smith
Senior Vice President and Chief Financial Officer------------------------------(Principal Financial and Accounting Officer)
/s/ DEAN S. ADLER
Dean S. Adler
Director
/s/ SUSAN Y. KIM
Susan Y. Kim
Director
/s/ LOUIS J. SIANA
Louis J. Siana
Director
/s/ STANLEY STEINBERG
Stanley Steinberg
Director
/s/ ALFRED J. STEIN
Alfred J. Stein
Director61
I, Jeffrey W. Griffiths, certify that:
- 1.
- I have reviewed this annual report on Form 10-K of Electronics Boutique Holdings Corp.;
- 2.
- Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
- 3.
- Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
- 4.
- The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
- a)
- Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
- b)
- Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
- c)
- Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
- 5.
- The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
- a)
- All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
- b)
- Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
- 6.
- The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: May 1, 2003 By: /s/ JEFFREY W. GRIFFITHS
Jeffrey W. Griffiths
President and Chief Executive Officer (Principal Executive Officer)62
I, James A. Smith, certify that:
- 1.
- I have reviewed this annual report on Form 10-K of Electronics Boutique Holdings Corp.;
- 2.
- Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
- 3.
- Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
- 4.
- The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
- a.
- Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
- b.
- Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
- c.
- Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
- 5.
- The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
- a.
- All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
- b.
- Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
- 6.
- The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: May 1, 2003 By: /s/ JAMES A. SMITH
James A. Smith
Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)63
10.11
Employment Agreement, dated November 7, 2002, by and between Electronics Boutique Holdings Corp. and Jeffrey W. Griffiths
10.12
Employment Agreement, dated November 7, 2002, by and between Electronics Boutique Holdings Corp. and John R. Panichello/s/ Dean S. Adler Director ------------------------------ Dean S. Adler /s/ Susan Y. Kim Director ------------------------------ Susan Y. Kim /s/ Louis J. Siana Director ------------------------------ Louis J. Siana /s/ Stanley Steinberg Director ------------------------------ Stanley Steinberg
10.13
Employment Agreement, dated November 7, 2002, by and between Electronics Boutique Holdings Corp. and Seth P. Levy
10.14
Employment Agreement, dated November 7, 2002, by and between Electronics Boutique Holdings Corp. and James A. Smith
21.1
Subsidiaries of Electronics Boutique Holdings Corp.
23.1
Consent of KPMG LLP
99.1
Section 906 Certification of Jeffrey W. Griffiths
99.2
Section 906 Certificate of James A. Smith45