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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 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 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO__________
COMMISSION FILE NUMBER: 000-24603
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ELECTRONICS BOUTIQUE HOLDINGS CORP.
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 51-0379406
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(STATE OF INCORPORATION) (IRS EMPLOYER IDENTIFICATION NUMBER)
931 SOUTH MATLACK STREET
WEST CHESTER, PENNSYLVANIA 19382
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(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
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
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 OF 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] NO [ ]
THE AGGREGATE MARKET VALUE OF COMMON STOCK HELD BY NON-AFFILIATES, BASED UPON
THE CLOSING SALE PRICE AS REPORTED ON THE NASDAQ NATIONAL MARKET ON APRIL 1,
1999, WAS APPROXIMATELY $282,368,800.
AT APRIL 1, 1999, THERE WERE 20,169,200 SHARES OF COMMON STOCK OUTSTANDING.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the 1999 Annual Meeting of
Shareholders are incorporated by reference in Part III hereof.
FORM 10-K
FOR THE FISCAL YEAR ENDED JANUARY 30, 1999
INDEX
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PART I PAGE
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Item 1 - Business 1
Item 1A - Executive Officers of the Company 13
Item 2 - Properties 14
Item 3 - Legal Proceedings 14
Item 4 - Submission of Matters to a Vote of Security Holders 14
PART II
Item 5 - Market for the Registrant's Common Equity and Related Stockholder
Matters 15
Item 6 - Selected Financial Data 16
Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations 18
Item 7A - Quantitative and Qualitative Disclosures About Market Risk 24
Item 8 - Consolidated Financial Statements 25
Item 9 - Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 42
PART III
Items 10- 13 - Directors and Executive Officers of the Company 42
PART IV
Item 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K
42
SIGNATURES 43
PART I
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
WHEN USED IN THIS ANNUAL REPORT ON FORM 10-K, THE WORDS "EXPECT,"
"ESTIMATE," "ANTICIPATE," "INTEND," "PREDICT," "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 OF 1995. FORWARD-LOOKING STATEMENTS
APPEAR IN A NUMBER OF PLACES IN THIS ANNUAL REPORT ON FORM 10-K AND INCLUDE
STATEMENTS REGARDING THE INTENT, BELIEF OR CURRENT EXPECTATIONS OF THE COMPANY,
ITS DIRECTORS OR ITS OFFICERS WITH RESPECT TO, AMONG OTHER THINGS: (I) TRENDS
AFFECTING THE COMPANY'S FINANCIAL CONDITION OR RESULTS OF OPERATIONS; AND (II)
THE COMPANY'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
GENERAL
Electronics Boutique Holdings Corp. (the "Company") believes that it is
among the world's largest specialty retailers of electronic games. The Company's
primary products are video games and PC entertainment software, supported by the
sale of video game hardware, PC productivity software, PC accessories and
interactive toys. As of January 30, 1999, the Company operated 528 stores in 44
states, Puerto Rico, Canada, Australia and South Korea, primarily under the
names Electronics Boutique and Stop 'N Save Software. The Company also operated
a commercial website under the URL address of EBWORLD.COM. As of such date, the
Company provided management services for Electronics Boutique Plc. ("EB-UK"),
which operated 159 stores and 17 department store-based concessions in the
United Kingdom and Ireland. As of January 30, 1999, the Company also managed 29
mall-based WaldenSoftware stores for Borders Group, Inc. The Company's stores
are primarily located in high traffic areas in regional shopping malls and
average 1,200 square feet in size.
The Company's core customer is the electronic game enthusiast who demands
immediate access to new title releases and who generally purchases more video
game titles and PC entertainment software than the average electronic game
consumer. The Company believes that it attracts the core game enthusiast due to
the Company's: (i) specialty store focus on the electronic game category; (ii)
ability to stock sought-after new releases on its stores' shelves immediately
after release by publishers; (iii) breadth of product selection; and (iv)
knowledgeable sales associates, who are often game enthusiasts themselves and
who have extensive knowledge of game titles and features. The Company places
significant emphasis on offering its customers immediate access to new releases
and has designed its product merchandising strategy and distribution systems to
facilitate such access. The Company introduces, on average, 20 new game titles
in its stores per week. The Company believes that this FIRST TO MARKET strategy
establishes its stores as the logical destination of choice for electronic game
enthusiasts. The Company's strict inventory management system enables it to (i)
maintain over 2,600 active SKUs, (ii) replenish its large and geographically
dispersed store base on a daily basis, and (iii) minimize mark-downs as titles
mature. The Company supports its product offerings with a strong commitment to
customer service, which the Company believes distinguishes it from its
competitors. All sales associates receive extensive training on video game and
PC entertainment software products, system requirements and selling techniques.
RISK FACTORS
DEPENDENCE ON NEW PRODUCT INTRODUCTIONS. The Company is highly dependent
upon the continued introduction of new and enhanced video game and PC hardware
and software. The failure of manufacturers to introduce new or enhanced video
game systems, a decline in the continued technological development and use of
multimedia PCs or the failure of software publishers to develop popular game and
entertainment titles for current or future generation game systems or PCs could
have a material adverse effect on the Company's results of operations and
financial condition.
1
VIDEO GAME SYSTEMS AND SOFTWARE PRODUCT CYCLES. The video game market has
historically been cyclical in nature. Following the introduction of new
generation systems, sales of new generation hardware and related titles steadily
increase, while sales of prior generation hardware and related titles steadily
decrease. New generation systems historically have been introduced every four to
five years. Sales of prior generation hardware systems historically have peaked
in the year of introduction of next generation systems, and sales of prior
generation titles historically have peaked in the following year. The failure of
the industry's leading video game systems manufacturers to introduce next
generation systems, or significant enhancements to existing systems, could lead
to a significant decrease in sales of hardware systems and related titles by the
Company. Any such decrease could have a material adverse effect on the Company's
results of operations and financial condition. See "Business--Products."
TECHNOLOGICAL OBSOLESCENCE. The video game and PC industry is subject to
rapid technological changes. The failure of the Company to respond quickly to
such technological changes and to assess accurately their influence on customer
preferences could have a material adverse effect on the Company's results of
operations and financial condition. In addition, technological advances, such as
the ready availability of games and other entertainment software on the Internet
and the ability to down-load such games onto PCs for repeated use, could make
the retail sale of video games and PC entertainment software obsolete. Further
developments in these technologies or other technologies which expand the
ability to access software through other sources could have a material adverse
effect on the Company's results of operations and financial condition.
NEW STORE OPENINGS. The Company's continued growth will depend, in part, on
its ability to open and operate new stores on a profitable basis. The Company
currently intends to open approximately 100 new stores in the current fiscal
year. The Company's ability to open new stores on a timely and profitable basis
is subject to various contingencies, some of which are beyond the Company's
control. These contingencies include the Company's ability to locate suitable
store sites, negotiate acceptable lease terms, build-out or refurbish sites on a
timely and cost-effective basis, hire, train and retain skilled associates,
obtain adequate capital resources and successfully integrate new stores into
existing operations. In addition, the management services agreement between the
Company and EB-UK (the "UK Services Agreement") significantly restricts the
Company's ability to open stores in Europe. See "Business--Management Services."
There can be no assurance that the Company will be able to achieve its planned
expansion or that its new stores will achieve levels of sales and profitability
comparable to the Company's existing stores. Failure of the Company to achieve
its planned expansion on a profitable basis could have a material adverse effect
on the Company's results of operations and financial condition. See
"Business--Retail Operations."
COMPETITION. The electronic game industry is intensely competitive and
subject to rapid changes in consumer preferences and frequent new product
introductions. The Company competes with other video game and PC software
specialty stores located in malls and other locations, 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. Increased competition may lead to reduced
profit margins on video games and PC entertainment software, which could have a
material adverse effect on the Company's results of operations and financial
condition. In addition, video games are available for rental from many video
stores. Further, there can be no assurance that other methods of distribution
will not emerge in the future which would result in increased competition for
the Company. Many of the Company's competitors have longer operating histories
and significantly greater financial, managerial, creative, sales and marketing
and other resources than the Company. The Company also competes with other forms
of entertainment activities, including movies, television, theater, sporting
events and family entertainment centers. The Company's failure to compete
effectively or a decrease in the popularity of video games and PC entertainment
software would have a material adverse effect on the Company's results of
operations and financial condition. See "Business--Competition."
In addition, the Company's ability to retain its existing customers and
attract new customers depends on numerous factors, some of which are beyond the
Company's control. These factors include: (i) the continued introduction of new
and enhanced video game and PC hardware and software; (ii) the availability and
timeliness of new product releases at the Company's stores; and (iii) the
Company's reputation in the industry.
SEASONALITY AND QUARTERLY RESULTS. The Company's business is affected by the
seasonal patterns common to most retailers. Historically, its highest net sales,
management fees and net income have been generated during the fourth quarter,
which includes the holiday selling season. During the year ended January 30,
1999 ("fiscal 1999"),
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approximately 44% of the Company's total revenues and approximately 82% of the
Company's operating income were generated during the fourth quarter.
Accordingly, any adverse trend in net sales for such period could have a
material adverse effect on the Company's results of operations for the quarter
as well as for the entire year. In addition, the Company's results of operations
may fluctuate from quarter to quarter depending upon, among other things, 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 in the Company's merchandise mix. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Seasonality and Quarterly Results."
DEPENDENCE ON SUPPLIERS. The Company purchases a significant amount of
products from Sony Computer Entertainment ("Sony"), Nintendo of America
("Nintendo") and Electronic Arts, Inc. ("Electronics Arts") and often receives
quantities of certain products disproportionate to its market share from these
suppliers upon initial release. During fiscal 1999, products purchased from
Sony, Nintendo and Electronic Arts accounted for 11.0%, 10.8% and 9.3%,
respectively, of the Company's net sales. The Company believes that the loss of
any of these companies as a supplier could have a material adverse effect on the
Company's results of operations and financial condition. In addition, the
Company's financial performance is in large part dependent upon the business
terms it obtains from its suppliers, including unit prices, unsold product
return policies, advertising and market development allowances, freight charges
and payment terms. If the Company is unable to maintain favorable business terms
with its suppliers, its results of operations and financial condition could be
materially adversely affected.
During fiscal 1999, approximately 36% of the Company's product purchases
were from domestic distributors of products manufactured overseas, primarily in
Asia. To the extent that the Company's distributors rely on overseas sources for
a large portion of their products, any event causing a disruption of imports,
including the imposition of import restrictions, could have a material adverse
effect on the Company's results of operations and financial condition. In
addition, during the past two years, certain Asian currencies have devalued
significantly in relation to the U.S. dollar and financial markets in Asia have
experienced significant turmoil. There can be no assurance that the Company's
ability to purchase from domestic distributors products manufactured in Asia
would not be materially adversely affected by such developments. Trade
restrictions in the form of tariffs or quotas, or both, applicable to such
products could also affect the importation of such products generally and could
increase the cost and reduce the supply of such products available to the
Company.
RISKS OF INTERNATIONAL RETAIL OPERATIONS. The Company has retail operations
in various foreign countries, including Canada, South Korea and Australia, and
intends to pursue opportunities that may arise in these and other countries. Net
sales in these foreign countries represented 9.3% of the Company's net sales in
fiscal 1999. The Company is subject to the risks inherent in conducting business
across national boundaries, including currency exchange rate fluctuations,
currency devaluations, international incidents, military outbreaks, economic
downturns, government instability, nationalization of foreign assets, government
protectionism and changes in governmental policy, any of which could adversely
affect the Company's business in one or more of its international markets. Since
most of the Company's operations are domestic, the Company does not believe that
currency exchange rate fluctuations would have a material adverse effect on the
Company's results of operations and financial condition and, accordingly, does
not hedge its risk in this area. The Company intends to monitor its exposure to
currency exchange rate fluctuations as it expands its international presence and
to reevaluate its hedging strategies as appropriate.
LEASE EXPIRATIONS AND TERMINATIONS. As of January 30, 1999, 83 of the
Company's stores (15.7% of all stores) were operated under leases with terms
that expire in less than one year. Prior to the Company's initial public
offering, all of the leases of The Electronics Boutique, Inc. ("EB") were
assigned to the Company. Substantially all of the leases either required the
landlord's prior consent to assign or permitted assignment upon satisfaction of
certain conditions. EB did not solicit and the Company does not intend to
solicit landlord consents for the assignment of the leases; accordingly,
affected landlords could seek to terminate their leases. There can be no
assurance that the Company will be able to maintain its existing store locations
as leases expire or are terminated by landlords or that the Company will be able
to locate suitable alternative sites on acceptable terms. The Company's failure
to maintain existing store locations or to locate alternative sites could have a
material adverse effect on the Company's results of operations and financial
condition. See "Business--Properties."
3
IMPACT OF GENERAL ECONOMIC CONDITIONS. The Company's business is sensitive
to consumer spending patterns, which in turn are subject to prevailing economic
conditions. Adverse local, regional or national economic conditions may cause
shifts in consumer spending that could have a material adverse effect on the
Company's results of operations and financial condition.
CONTROL BY MAJORITY SHAREHOLDER. EB Nevada, Inc. ("EB Nevada") is the
beneficial owner of approximately 75.2% of the outstanding shares of Common
Stock. Accordingly, James Kim, the Company's chairman, his wife and certain
trusts established for the benefit of their children (collectively, the "Kim
Shareholders"), through their ownership of all of the outstanding capital stock
of EB, EB Nevada's sole stockholder, will be able to control the Company, elect
all the directors and generally direct the affairs of the Company. Under a
credit facility with Fleet Capital Corporation ("Fleet"), the Kim Shareholders
are obligated to own, directly or indirectly, not less than 25.0% of the issued
and outstanding capital stock of the Company. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources."
DEPENDENCE ON KEY PERSONNEL. The success of the Company will depend on its
ability to attract, motivate and retain key management associates for its stores
and skilled merchandising, marketing and administrative personnel at the
Company's headquarters. In the past, the Company has been successful in
maintaining the continuity of its management team, including its executive
officers, Joseph J. Firestone, its President and Chief Executive Officer,
Jeffrey W. Griffiths, its Senior Vice President of Merchandising and
Distribution and John R. Panichello, its Senior Vice President and Chief
Financial Officer. However, there can be no assurance that the Company will
continue to be successful in attracting and retaining such personnel. The loss
of the services of one or more of such persons or other key personnel could have
a material adverse effect on the Company's results of operations and financial
condition. See "Executive Officers of the Company."
YEAR 2000 COMPLIANCE. The Company uses a significant number of computer
software programs and operating systems in its internal operations, including
applications used in inventory management, distribution, financial business
systems and various administrative functions. To the extent that these software
applications contain source code that is unable to interpret appropriately the
upcoming calendar year 2000, some level of modification or even possible
replacement of such source code or applications will be necessary. The Company
is currently modifying its computer software programs and operating systems to
make them "Year 2000" compliant and intends to complete its "Year 2000"
compliance program before December 31, 1999. The Company expects aggregate
spending of approximately $900,000 in connection with its "Year 2000" compliance
program. However, there can be no assurance that the costs necessary to update
software, or potential systems interruptions, will not exceed such amount and
have a material adverse effect on the Company's results of operations or
financial condition. See "Business--Management Information Systems" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Year 2000 Strategy".
INDUSTRY OVERVIEW
The electronic game industry is segmented into two primary product
platforms: video games and PC entertainment software.
VIDEO GAMES. Video game play requires two components, video game consoles
(hardware) and video game titles (software). Video game consoles are specialized
processing devices which are connected to a free-standing monitor or, typically,
a television set. Video game titles are small cartridges or CD-Roms that are
inserted into a video game console. The video game market is currently dominated
by two manufacturers, Nintendo and Sony, each of which manufactures proprietary
hardware (in the form of console systems) and publishes game titles which run on
their systems but cannot run on those of its competitors. Third party publishers
also produce a wide range of game titles for each of these major hardware
systems. Growth in the video game industry has been primarily driven by the
periodic introduction of new generations of hardware systems. The current 32/64
bit systems offer highly developed, three-dimensional graphics capabilities,
speed, and sound effects. The current installed base of video game hardware
systems in the United States includes 15.8 million Sony Playstations and 9.7
million Nintendo 64 units. Manufacturers have introduced next generation
hardware technologies every four to five years. Sales of prior generation video
game titles generally peak five years after the introduction of new hardware
systems.
4
Total domestic retail sales of video game titles, hardware and accessories
was approximately $6.1 billion in calendar 1998, an increase of approximately
21% over retail sales in the prior year. This increase was primarily the result
of an increased penetration rate of the fourth generation of video game hardware
technology (32/64 bit systems), which was introduced in calendar years 1995 and
1996. As was the case with each prior generation, the introduction of the new
hardware technology has led to an increase in the total installed base of the
new technology over that of the prior generation. The enhanced technological
features of new hardware expand gaming capabilities, thereby encouraging
existing players to upgrade their hardware platforms, and simultaneously
attracting new video game players to purchase their first systems. Management
believes that continued growth in sales of the current generation of hardware
technology and related software will continue in calendar year 1999. It is
anticipated that the current generation of hardware systems will be replaced by
a new generation of systems, beginning with the expected U.S. introduction of a
new Sega system called "Dreamcast," which Sega is targeting for release in
September of 1999. Additionally, Sony has announced the expected U.S. release of
its next generation system, Playstation2, for the fall of 2000.
PC ENTERTAINMENT SOFTWARE. PC entertainment software is generally sold in
the form of a CD-Rom and played on multimedia PCs featuring fast processors,
expanded memories, and enhanced graphics and audio capabilities. The PC
entertainment software industry is more fragmented than the video game industry,
with game publishers producing game titles which can be used on most PCs. The
market for PC entertainment software has experienced steady growth in recent
years, due primarily to the growth in the installed base of multimedia PCs. The
domestic installed base of multimedia PCs has increased from approximately 14
million units in calendar 1995 to approximately 34 million units in calendar
1998. Domestic unit sales of PC entertainment software have increased from
approximately 23 million units in calendar 1995 to approximately 54 million
units in calendar 1998. Domestic retail sales of PC entertainment software
totaled approximately $1.3 billion in calendar 1998, an increase of
approximately 4.5% over retail sales in the prior year. It is anticipated that
the recent introduction of multimedia PCs priced at or below $1,000 will
accelerate 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 as well as sales of PC entertainment software have experienced
comparable increases to those experienced domestically.
The typical electronic game consumer is male, between the ages of 14 and 34,
and lives in a household with income in excess of $50,000. Owners of video game
hardware systems purchase an average of 3.2 game titles per year. The Company
believes that many electronic game players purchase video game titles as well as
PC entertainment software. Electronic games are principally sold through retail
channels, including mass merchants, toy retail chains, electronics retailers,
computer retailers, specialty software retailers, wholesale clubs, internet and
mail order.
BUSINESS STRATEGY
The Company seeks to enhance its position as one of the world's premier
specialty retailers of video game titles and PC entertainment software.
BREADTH OF TITLE SELECTION. The Company offers its customers an extensive
selection of video game titles and PC entertainment software at competitive
prices. The Company's typical store offers approximately 1,650 titles at any
given time from over 120 video game and PC entertainment software vendors. The
title selection in each store is continuously updated and tailored to reflect
the tastes and buying patterns of the store's local market. The Company carries
game titles which are compatible with all major video game hardware systems and
PCs. In addition to video game titles and PC entertainment software, the Company
offers a complementary line of productivity and educational software and PC and
video game accessories and peripheral products, including graphics accelerators,
joysticks, memory cards, books and magazines. By offering all major video game
hardware systems and providing a broad but focused assortment of electronic game
software and accessories, the Company seeks to establish its stores as the
logical destination of choice for electronic game enthusiasts.
IMMEDIATE AVAILABILITY OF NEW RELEASES. The Company strives to be the first
in its markets to offer new video game and PC entertainment software titles upon
their release. New release titles are often preceded by substantial publicity in
the form of advertisements and reviews in publications and, increasingly, are
promoted through television. This publicity tends to create high levels of
demand for new releases among electronic game enthusiasts, often well in advance
of release dates. This demand has afforded the Company an important marketing
opportunity
5
to create excitement surrounding its stores. To assure its customers immediate
access to new releases, the Company offers its customers the opportunity to
purchase video games and PC software prior to their release (the "EB Pre-Sell
Program") and has established a reserve list (the "EB Reserve List") which
guarantees its customers a copy of a new release immediately after its launch.
The Company introduces approximately 20 new game titles in its stores each week.
The Company believes that its FIRST TO MARKET strategy establishes the Company's
stores as the logical destination of choice for electronic game enthusiasts.
HIGHLY EFFECTIVE INVENTORY MANAGEMENT SYSTEM. The Company emphasizes strict
inventory policies in order to effectively manage over 2,600 SKUs, including
video game titles, PC entertainment software, video game consoles, and
accessories. The Company has developed a sophisticated inventory management
system which enables it to maximize sales of new release titles and avoid
markdowns as titles mature. The Company minimizes its inventory risk by: (i)
conducting extensive research on new release titles to forecast anticipated
daily sell-through; (ii) utilizing POS polling technology to provide daily
sales, margin and inventory reports to the Company's merchandising staff; (iii)
managing inventory on a store-by-store basis in order to address local customer
merchandise preferences; and (iv) replenishing store-level inventories daily
from its fully automated distribution center. The Company introduces an average
of 10 new SKUs in its stores each day. As a result of these inventory management
initiatives, the Company has been able to achieve desired in-stock positions and
increase its inventory turns from 5.1x in fiscal 1997 to 5.3x in fiscal 1998 and
to 5.6x in fiscal 1999. In addition, the Company's fiscal 1999 inventory
shortage was 0.6% of cost of sales.
DISCIPLINED STORE OPERATIONS. The Company's management team exercises
significant control over all aspects of its store operations, from product
research, purchasing and distribution to real estate selection, store
development, POS financial reporting, and sales training. The Company believes
that this commitment to operational control enables it to operate substantially
all of its stores on a profitable basis, to quickly identify opportunities to
improve store productivity and to react to shifts in product pricing and
consumer purchasing trends more quickly than its competitors.
KNOWLEDGEABLE SALES ASSOCIATES. The Company believes that its knowledgeable
sales associates provide the Company with an important competitive advantage
over mass merchants, toy retail chains and electronics and computer superstores,
all of which compete with the Company, but generally offer much lower levels of
customer service in the electronic game category than the Company. All sales
associates are given extensive training on video game and PC entertainment
software products, system requirements and selling techniques. Many of the
Company's sales associates are also electronic game enthusiasts. Training is
facilitated through vendor-sponsored EB University seminars, held semi-annually
for field management associates, as well as through regularly scheduled in-store
seminars conducted by District Training Managers who provide merchandise and
sales training to the Company's sales associates. In addition, sales associates
are encouraged to learn about their customers' game preferences. With this
knowledge, sales associates can introduce customers to a selection of electronic
games and accessories which may suit their preferences or enhance the overall
game experience. In addition, the Company's 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
its customers and discourage comparison shopping, the Company maintains an
everyday low pricing policy and supports this policy with price matching (the
"EB Code of Honor Program") and affinity programs. These affinity programs are
the EB Pre-Sell Program and the EB Reserve List. An extensive selection of
merchandise and a high level of customer service complement the Company's
everyday low price policy.
GROWTH STRATEGY
DOMESTIC NEW STORE EXPANSION. The Company plans to expand its domestic
retail operations by opening about 70 Electronics Boutique and Stop 'N Save
Software stores in both existing and new markets in the year ending January 29,
2000 ("fiscal 2000"). In fiscal 1999, the Company opened 50 domestic stores. The
Company's real estate team applies standardized site selection criteria to
secure the best location for its stores when entering a new market or expanding
within an existing market. The Company believes its store formats can operate
profitably in high traffic/high rent malls as well as in lower traffic/lower
rent malls and strip shopping centers. This flexibility provides the Company
with an extensive selection of locations for future store openings.
6
INTERNATIONAL OPPORTUNITIES. As of January 30, 1999, the Company operated 29
stores in Australia, 39 stores in Canada, five stores in South Korea, and
provided management services to EB-UK which as of such date operated 159 stores
and 17 department store-based concessions in the United Kingdom and Ireland. In
fiscal 1999, the Company opened 14 stores in Australia and 12 stores in Canada.
The Company intends to open 15 stores in both Australia and Canada during fiscal
2000. The Company believes that its current international presence will enable
it to leverage its existing distribution and management infrastructure for
further international expansion.
EXPANSION OF ONLINE RETAILING. The Company believes that it was one of the
first video game and PC entertainment software specialty retailers to offer a
World Wide Website enabling both product review and online purchasing. The
Company's core game enthusiast customer is technically proficient and, as such,
the Company believes that online retailing is a natural extension of its current
retail operations. Since the Company believes that its primary distribution
center is well configured to enable fulfillment of online orders, the Company
provides its own fulfillment function. The Company intends to aggressively
pursue strategic alliances with directories, search engines, content providers,
and sites geared toward electronic game players. The Company currently provides
customers with a complete product offering, including access to the Company's
database of over 2,600 items.
STORE PRODUCTIVITY. The Company constantly strives to increase the
productivity of its stores by focusing on:
-Inventory Management and Controls. Utilizing its sophisticated POS and
inventory management systems, including its fully automated distribution
center, the Company seeks to continuously improve the merchandise mix and
in-stock positions in its stores, increase inventory turns and drive down
shrinkage (which, at 0.6% of cost of sales in fiscal 1999, the Company
believes is among the lowest of mall-based retailers).
-Managing Store Payroll. The Company seeks to optimize store payroll
expense by utilizing its sophisticated POS reporting systems to assure the
best possible match of sales associate floor coverage to customer traffic.
In an effort to further enhance its store payroll strategy, the Company is
currently implementing a new system which electronically measures store
customer traffic throughout the day and provides management with an
analysis of sales conversion rates by store and by sales associate. This
system will allow management to further improve its on-going sales
conversion training.
- Pre-owned Electronic Games. 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. The Company offers its customers
a store credit for their pre-owned video game titles. Sales of pre-owned
video game titles generate higher margins than new titles and their
availability in the Company's stores tends to attract the Company's core
game enthusiast customer. The Company believes that a significant
opportunity exists to increase sales of pre-owned game titles and is
currently implementing a number of marketing and merchandising programs,
coupled with incentives to its sales associates, to increase its
participation in the growing market for pre-owned game titles.
RETAIL OPERATIONS
As of January 30, 1999, the Company operated a total of 528 stores in 44
states, Puerto Rico, Canada, Australia and South Korea, primarily under the
names Electronics Boutique and Stop 'N Save Software.
STORE FORMATS. Electronics Boutique 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
stores are primarily located in high traffic areas in regional shopping malls
and generally stock over 2,600 SKUs. The typical mall-based Electronics Boutique
store is approximately 1,200 square feet, but stores range in size from 450
square feet to 1,500 square feet, with retail sales space encompassing
approximately 90% of total square footage. The Company believes that its stores
generate sales per square foot that are among the highest of any mall-based
retailer.
Stop 'N Save Software stores are generally larger format stores located in
urban areas and strip and power shopping centers. The Company's merchandising
strategy at its Stop 'N Save Software stores is comparable to its merchandising
strategy at its Electronics Boutique stores. The Company opened its first Stop
'N Save Software store in 1995. Stop 'N Save Software stores range in size from
1,250 to 5,000 square feet, with retail sales space
7
encompassing approximately 90% of total square footage. In addition, the Company
also operates seven stores that sell sports collectibles and memorabilia under
the name Brandywine Sports Collectibles ("BC Sports Collectibles"). The Company
is developing BC Sports Collectibles as a new concept, as it believes the
customer base of BC Sports Collectibles shares many of the same demographic
characteristics as the customer base of the Company's Electronics Boutique
stores. BC Sports Collectibles stores are located in malls and strip and power
shopping centers and generally range in size from 1,000 to 5,000 square feet.
SITE SELECTION. Company representatives visit numerous mall and power and
strip shopping center sites throughout the year in the United States and in
several foreign countries in search of suitable store locations. The Company's
standardized site selection criteria include, but are not limited to: population
demographics; psychographics; traffic count; store-front visibility and
presence; adjacencies; competition; lease terms; and accessible parking. The
Company believes its store formats can operate profitably in high traffic/high
rent malls as well as lower traffic/lower rent malls and shopping centers. The
Company, therefore, believes that there is a large selection of locations
available for future sites and views lease terms as the most critical element in
its selection process. The Company has used its knowledge of its market areas to
negotiate favorable lease terms at many of its store locations, which has
resulted in lowered occupancy costs. The Company regularly reviews the
profitability and prospects of each of its stores and evaluates whether any
underperforming stores should be closed or relocated to more desirable
locations. The Company negotiates with landlords to convert desirable
WaldenSoftware locations into Company stores when their leases terminate.
STORE ECONOMICS. The Company believes that its store concepts offer
attractive unit economics. The Company estimates that the average Electronics
Boutique store had net sales of approximately $1.2 million in fiscal 1999. The
average cost to open an Electronics Boutique store (exclusive of inventory
costs) is $135,000. These costs include furniture, fixtures, leasehold
improvements and equipment. The Company expects such costs to remain constant in
fiscal 2000. The Company's stores have an average opening inventory of $95,000.
The Company's cost to open an international store is approximately the same in
U.S. dollars as the cost to open a domestic store. Historically, the Company's
new stores have generated a positive store operating contribution within the
first 12 months of operations.
STORE OPERATIONS. The Company's North American stores (in the U.S., Canada,
and Puerto Rico) are divided into two geographic regions (East and West), each
consisting of an area encompassing approximately 50% of the Company's stores.
These regions are supervised by two Field Operations Vice Presidents, 11
Regional Vice Presidents/Directors and 42 District Managers. Each District
Manager is responsible for approximately 12 stores. The Company's stores in
Australia and South Korea are supervised by a Regional Vice President. The
Company has a program in the U.S. whereby each region has specialists in sales
training, loss prevention and merchandising in an effort to provide on-going
education and training to store associates. Each of the Company's stores 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
fluctuates greatly depending on seasonal needs. The Company's domestic stores
are open seven days per week and generally ten hours each day. The Company
operates its foreign stores in a manner substantially similar to its domestic
stores.
MANAGEMENT SERVICES
As of January 30, 1999, the Company provided management services to 205
specialty electronic game stores in the United States, the United Kingdom and
Ireland.
EB-UK Stores. The Company provides management services for 159 stores and
17 department store-based concessions in the United Kingdom and Ireland under a
contract with EB-UK, a corporation organized under the laws of the United
Kingdom.
EB-UK is one of the leading specialty retailers of electronic games in the
United Kingdom and Ireland. EB-UK's business strategy is substantially similar
to the business strategy of the Company. 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, and 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 "high street" shopping districts.
8
Under the terms of the UK Services Agreement, the Company provides
management services to EB-UK, including assistance with ordering and purchasing
inventory, store design and acquisition, advertising, promotion and publicity
information and information systems. In exchange, EB-UK is responsible for the
payment of fees (payable in cash or EB-UK stock at the Company's option), equal
to 1.0% of net sales plus a bonus calculated on the basis of net income in
excess of a pre-established target set by EB-UK. The UK Services Agreement
provides for EB-UK to have a right of first refusal on any business opportunity
of which the Company becomes aware in Europe (excluding Scandinavia) relating to
electronic game retailing. The UK Services Agreement also prohibits the Company
from competing with EB-UK in the United Kingdom or Ireland during the term of
the UK Services Agreement, and for one year after its termination. The UK
Services Agreement has an initial term expiring on January 31, 2006. The
stockholders of EB-UK elected Joseph J. Firestone, the Company's President and
Chief Executive Officer, and John R. Panichello, the Company's Senior Vice
President and Chief Financial Officer, to serve as non-executive Directors of
EB-UK.
WALDENSOFTWARE STORES. The Company manages 29 WaldenSoftware stores under a
management contract with Borders Group, Inc. The WaldenSoftware stores are
domestic mall-based stores that offer the same product lines as the Company's
Electronics Boutique stores. The Company provides management services to
WaldenSoftware in exchange for a fixed fee per store plus a bonus calculated on
the basis of net income in excess of the fixed management fee. The Company
manages the stores in a manner substantially similar to the Company's
Electronics Boutique stores. The Company negotiates with landlords to convert
desirable WaldenSoftware locations into Company stores when their leases
terminate.
ONLINE RETAILING
The Company believes that it was one of the first electronic game specialty
retailers to offer a Website that enables visitors to review a broad selection
of products and make purchases online. In 1995, the Company created its Website
and, in 1997, the Website was upgraded to offer online purchasing. The Company
believes that its customer base and product mix are uniquely suited for online
retailing. The Company's customers are generally males who are technically
proficient, a demographic which has traditionally represented the largest
percentage of consumers who make online purchases. Further, the Company's
products are recognizable brand name items, which serves to provide online
customers with a higher degree of confidence that products purchased will meet
the customer's expectations. In addition, the scope of the Company's store
operations enhances the reputation of the Company's Website as a source for
products at competitive prices. The Company believes that the local market
identity provided by the Company's stores is a significant competitive advantage
over competing online retailers.
The Company currently is able to offer access to the Company's database of
over 2,600 items. The Company's Website also features colorful product
descriptions, new release schedules, vendor promotions and other relevant
product information. The Company's Website also serves as a venue for online
interaction between electronic game enthusiasts and popular electronic game
authors, producers and other notables. The Company continually enhances its
Website to broaden its promotional appeal and has recorded a significant
increase in the number of visits to the Website. In fiscal 1999, the Company
recorded nearly 10.2 million unique visits to its Website, compared to a total
of 884,000 unique visits during the 11 months from March 1997 through January
1998. In addition, revenues from the Company's Website in fiscal 1999 were
approximately $4.3 million compared to revenues of approximately $0.4 million
during the first eight months of online purchasing (June 1997 through January
1998). The Company intends to pursue aggressively strategic alliances with
directories, search engines, content providers, and sites geared toward
electronic game players. The Company believes that its current in-house
distribution facilities afford the Company a competitive advantage by enabling
it to fulfill online orders rapidly.
PRODUCTS
The Company's primary product line consists of video game titles, PC
entertainment software titles, video game hardware systems and related accessory
products. The Company also markets selected PC productivity and education
software titles. The Company's in-store inventory at any given time consists of
over 2,600 SKUs.
VIDEO GAME TITLES AND PC ENTERTAINMENT SOFTWARE. The Company carries over
650 video game titles (excluding pre-owned games) and over 1,000 active PC
entertainment software SKUs at any given time. In fiscal 1999, the
9
average sales price of a video game title was $41.00 and the average sales price
of a PC entertainment software title was $28.95. The Company purchases video
game titles directly from the leading manufacturers, which include Nintendo,
Sega and Sony, as well as a variety of third-party game publishers, such as
Electronic Arts, Acclaim Entertainment, Inc. and Midway Home Entertainment, Inc.
The Company ranks as one of the larger domestic customers of video game products
from these publishers. Within the more fragmented PC entertainment software
segment, the Company purchases titles from approximately 90 vendors. The Company
markets electronic games across a variety of genres, including Action, Strategy,
Adventure/Role Playing, Simulation, Sports, Children's Entertainment and Family
Entertainment. The Company maintains a broad selection of popular new release
titles, which are defined by the Company as titles which have been available for
no more than six weeks from the date of their release.
VIDEO GAME HARDWARE. The Company offers the video game hardware systems of
all major manufacturers, including the Sony PlayStation and Nintendo N64. In
support of its strategy to be the logical destination of choice for electronic
game enthusiasts, the Company aggressively promotes the sale of video game
hardware systems. The Company believes that this policy increases store traffic
and promotes customer loyalty, leading to increased sales of video game titles,
which have higher gross margins. The Company also offers extended service
agreements and extensions of manufacturer warranties of the video game systems.
PC EDUCATION AND PRODUCTIVITY SOFTWARE. In addition to its category dominant
assortment of video game and PC entertainment software titles, the Company
offers a selection of educational, personal productivity and finance software
titles. Management believes that these titles also appeal to the electronic game
enthusiasts who comprise the Company's core customer base.
ACCESSORIES. In recent years, the growing popularity of electronic 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, the Company's stores offer approximately
500 accessory product SKUs, including 3-D graphics accelerators, memory cards
and joysticks. The Company also markets instructional books on the most popular
electronic game titles.
INVENTORY MANAGEMENT AND DISTRIBUTION
INVENTORY MANAGEMENT. The Company carefully manages its inventory to
minimize the risk associated with introducing new products. The Company's
merchandising staff evaluates potential products by testing many pre-release
samples received from publishers, reading game reviews, interviewing customers
and store associates, and studying vendor marketing plans. The Company's
centralized merchandising staff also analyzes the EB Pre-Sell Program and EB
Reserve List information and other data to estimate initial demand as well as
the life cycle for a new release. The Company then uses its new product analyses
to plan initial allocations among stores of the total initial purchase of a
newly-released title (which typically ranges from 1,200 to 4,800 units, but has
been as low as 720 units and as high as 150,000 units).
Once initial stocking decisions have been made, the Company uses its
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 the 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. Product shortages and replenishment
allocations among stores are then made based on this data. By focusing on
inventory turnover, the Company's allocation, traffic, buying, distribution and
third party functions operate on a "just in time" replenishment basis.
DISTRIBUTION. The Company's primary distribution center is a 120,000 square
foot facility located in West Chester, Pennsylvania, and supports the Company's
full product line. In addition, the Company has an agreement with a third-party
distribution center in Louisville, Kentucky to support flowthrough operations on
new release and top selling products. These facilities allow the Company to
replenish its stores on a daily basis, thereby reducing inventory levels and
increasing inventory turns, while supporting the Company's FIRST TO MARKET new
release strategy. The Company's rapid processing capability in its distribution
center is facilitated by several advanced inventory management technologies,
including paperless picking and radio frequency support. The Company's ability
to
10
rapidly process incoming shipments of new release titles quickly and distribute
them to all of its stores either that same day or by the next morning enables
the Company to meet peak demand.
During peak sales periods, the Company enters into short-term arrangements
for additional retail distribution centers to ensure timely restocking of all
stores. The Company has also developed a flexible third-party network to provide
additional regional distribution support for new product releases.
The Company believes that it maintains industry-leading distribution and
inventory management systems. The Company believes that these systems promote a
level of efficiency in inventory management which affords the Company an
important competitive advantage. In addition, when managed effectively, stock
balancing and markdown allowances offered selectively by vendors can reduce a
portion of the risk associated with carrying inventory. Products that either
sell poorly at launch or experience a reduction in sales after a successful
launch often can achieve an acceptable rate of sale at a lower price.
MARKETING
IN-STORE PROMOTIONS. The Company's Electronics Boutique stores are primarily
located in high traffic, high visibility areas in regional shopping malls.
Accordingly, the Company's marketing efforts are designed to draw mall patrons
into the Company's stores through the use of window displays and other
attractions visible from the mall concourse. Inside the stores, the Company
features selected products through the use of vendor displays, signs, fliers,
point of purchase materials and end-cap displays. The Company receives
cooperative advertising and market development funds from manufacturers,
distributors, software publishers and accessory suppliers to promote their
respective products.
THE EB PRE-SELL PROGRAM AND THE EB RESERVE LIST. The EB Pre-Sell Program
offers the Company's customers the opportunity to purchase video games and PC
software prior to their release, and the EB Reserve List entitles participants
to be placed on a list for notification when a game has arrived in the Company's
stores. Customers who participate in the EB Pre-Sell Program pay for a game
prior to its release and may receive a promotional gift in connection with the
purchase (e.g., a t-shirt or a watch). The EB Pre-Sell Program and the EB
Reserve List enable the Company's customers to receive a new product on the
first day on which it is available in the Company's stores, and are designed to
enhance the reputation of the Company's stores as the logical destination of
choice for electronic game enthusiasts.
CATALOGS. The Company publishes six or more full color catalogs each year,
which range in size from 48 to 100 pages. These catalogs have been fully vendor
funded since 1986 and feature a broad array of products. The catalogs are
available in the Company's stores and are also mailed to several hundred
thousand households from the Company's proprietary customer lists. The catalogs
are also inserted in leading industry magazines.
PRE-OWNED GAMES. As with music compact discs, 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. The Company offers its customers a store
credit for their pre-owned video game titles, which can be applied towards the
purchase of new or pre-owned products. The Company then resells the pre-owned
video game titles at discount prices, but with gross margins higher than those
for new video game titles. The Company believes its wide assortment of pre-owned
video game titles distinguishes it from its competitors.
OTHER MARKETING PROGRAMS. The Company provides its customers with a
liberal return policy. The Company's customers can return opened software
products for a full credit within ten days after purchase. In addition, the
EB Code of Honor Program discourages comparison shopping, as the Company will
match its competitors' prices. Further, the Company maintains an everyday low
pricing strategy.
MANAGEMENT INFORMATION SYSTEMS
The Company's primary management information system is a customized version
of the AS400-based JDA Merchandise Management System. The proprietary
enhancements made by the Company to this program enable management to analyze
total, comparative and new store sales data at the Company, region, district and
store levels.
11
Additional revisions to the program have enhanced analysis of top
selling items, new release sales and gross margin item rankings. The Company
operates its own proprietary store POS and back office systems and believes this
provides a strategic advantage by allowing it to make fast enhancements to meet
business opportunities. The Company has integrated the Shoppertrak customer
counting technology into its POS and host systems. This combination of
technology provides centralized access to store traffic and sales conversion
information by store and hour. The Company has this technology installed in over
20 percent of its stores and intends to continue implementation aggressively.
The Company plans to continue to invest in its management information system by,
among other things, upgrading its global financial reporting and analytical
capabilities through the implementation of the Lawson Associates, Inc. financial
software products in fiscal 2000. The Company intends to further enhance its
management information systems with client server and data warehousing
applications geared towards sales analysis and targeted consumer marketing. The
Company spent $2.0 million for information system improvements, including "Year
2000" expenditures, in fiscal 1999 and has budgeted $2.5 million for fiscal 2000
for additional improvements.
The Company has completed the upgrade of all JDA programs running on the
AS400 system to be "Year 2000" compliant. All other Company software and
hardware products are being inventoried and updated as necessary. The Company
intends to complete addressing of all potential "Year 2000" problems by December
31, 1999. See "Management's Discussion and Analysis of Financial Conditions and
Results of Operations - Year 2000 Strategy."
VENDORS
With the exception of certain personal productivity software titles and
accessories, the Company purchases substantially all of its products directly
from manufacturers and software publishers. The Company's top 25 vendors
accounted for approximately 77% of the Company's purchases in fiscal 1999. The
Company's largest vendors in fiscal 1999 were Sony, Nintendo, Electronic Arts,
D&H Distributing Company, and Havas Interactive Inc. which accounted for 11.0%,
10.8%, 9.3%, 6.2% and 5.6% respectively, of the Company's net sales, with no
other vendor accounting for more than 5.0% of the Company's software or
accessory purchases during that year. The Company believes that maintaining and
strengthening its long-term relationships with its vendors is essential to the
Company's operations and expansion. The Company has no contracts with trade
vendors and conducts business on an order-by-order basis, a practice that is
typical throughout the industry. The Company believes that it has very good
relations with the vendor community.
COMPETITION
The electronic game industry is intensely competitive and subject to rapid
changes in consumer preferences and frequent new product introductions. The
Company believes that key competitive factors are availability of product,
ability to procure product in high demand, knowledgeable service, price,
reputation, and shopping environment. The Company competes with other video game
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 of retail distribution may emerge in
the future which would result in increased competition for the Company. Most of
the Company's competitors have longer operating histories and significantly
greater financial, managerial, creative, sales and marketing and other resources
than the Company. The Company also competes with other forms of entertainment
activities, including movies, television, theater, sporting events and family
entertainment centers. The Company's ability to retain its existing customers
and attract new customers depends on numerous factors, some of which are beyond
the Company's control. These factors include: the continued introduction of new
and enhanced video game and PC hardware and software; the availability and
timeliness of new product releases at the Company's stores; and the Company's
reputation in the industry.
TRADEMARKS/REGISTRATIONS
The Company possesses the Electronics Boutique -Registered Trademark-,
EBX -Registered Trademark-, and Stop 'N Save Software -Registered
Trademark- trademarks as well as other registered trademarks and service
marks, both in the United States and in certain foreign jurisdictions.
The Company believes its marks are valuable and, accordingly, intends to
maintain its marks and the related registrations. The Company is not aware of
any pending claims of infringement or other challenges to the
12
Company's right to use its marks in the United States or elsewhere. The Company
has no patents, licenses, franchises or other concessions which are considered
material to its operations.
ASSOCIATES
As of January 30, 1999, the Company had approximately 3,600 non-seasonal
associates, of which approximately 2,000 were employed on a part-time basis. In
addition, during the calendar 1998 peak holiday shopping season, the Company
hired approximately 640 temporary associates. The Company believes that its
relationship with its associates is good. None of the Company's associates is
represented by a labor union or is a member of a collective bargaining unit.
ITEM 1A. EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth certain information regarding the executive
officers of the Company:
NAME AGE POSITION WITH THE COMPANY
---- --- -------------------------
Joseph J. Firestone 67 President, Chief Executive Officer and Director
Jeffrey W. Griffiths 48 Senior Vice President of Merchandising and
Distribution
John R. Panichello 37 Senior Vice President and Chief Financial
Officer
Joseph J. Firestone. Mr. Firestone has served as the President, Chief
Executive Officer and a Class III Director of the Company since March 1998.
Mr.Firestone served as the President of the Company's predecessor, EB, since
February 1984, and the President and Chief Executive Officer of EB since
February 1995. Mr. Firestone has served as a director of EB-UK since May 1995.
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 the Company's Senior Vice
President of Merchandising and Distribution since March 1998. Mr. Griffiths
served as the Senior Vice President of Merchandising and Distribution of EB
since March 1996. From March 1987 to February 1996, Mr. Griffiths served as EB's
Vice President of Merchandising and, from April 1984 to February 1987, he served
as the Merchandise Manager of EB. Mr. Griffiths serves as the Chairman of the
Interactive Entertainment Merchants Association.
John R. Panichello. Mr. Panichello has served as the Senior Vice President
and Chief Financial Officer of the Company since March 1998. Mr. Panichello
served as the Senior Vice President of Finance of EB and the President of EB's
BC Collectibles division since March 1997. From March 1996 to February 1997, Mr.
Panichello served as EB's Senior Vice President of Finance and, from June 1994
to February 1996, 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. Mr.
Panichello has served as a director of EB-UK since May 1995.
13
ITEM 2. PROPERTIES
STORE LEASES. All of the Company's stores are leased. The table below sets
forth, as of January 30, 1999, the number of the Company's store leases that
will expire each year (assuming the lease is not terminated by either party
prior to the expiration of the term).
NUMBER OF LEASES
FISCAL YEAR IN
WHICH LEASES EXPIRE DOMESTIC INTERNATIONAL
- ------------------- -------- -------------
2000............................................... 78 5
2001............................................... 43 3
2002............................................... 44 3
2003............................................... 42 10
2004............................................... 41 14
2005............................................... 16 24
2006............................................... 33 1
2007............................................... 46 -
2008............................................... 51 1
2009............................................... 60 12
2010 and thereafter................................ 1 -
---- ---
455 73
HEADQUARTERS AND DISTRIBUTION FACILITIES. 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 EB. The lease expires on May 30, 2000 and includes an option to purchase
the property for $6.7 million. In addition, this lease includes four acres
adjacent to the distribution center that will allow the Company to expand its
operations at the West Chester site as required. The Company 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.
ITEM 3. LEGAL PROCEEDINGS
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 will have a material adverse effect on the Company's results of
operations or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of the Company 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 the Company's common stock
as reported by NASDAQ.
FISCAL 1999
-----------
LOW HIGH
------ ------
Second fiscal quarter..................... $13.25 $14.13
Third fiscal quarter...................... 6.63 14.00
Fourth fiscal quarter..................... 11.75 25.75
Such quotations reflect inter-dealer prices, without retail mark-ups,
mark-downs or commissions and may not necessarily reflect actual transactions.
As of April 1, 1999, the Company had approximately 31 shareholders of record
(including Cede & Co., the nominee for Depository Trust Company, a registered
clearing agency) of the 20,169,200 outstanding shares of the Company's Common
Stock. On April 1, 1999, the last reported sale price for the Company's common
stock as quoted by NASDAQ was $14.00 per share.
The Company 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.
15
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth for the periods indicated selected financial
data for the Company for periods subsequent to its initial public offering on
July 28, 1998. Prior periods reflect financial data of the Company's
predecessors, The Electronics Boutique, Inc. and subsidiaries and EB Services
Company LLP. The selected income statement and balance sheet items which follow
have been derived from the Company'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 of management, include all adjustments necessary
to present fairly the information set forth therein including the matters
referred to in footnotes 3 and 4 on page 17.
(in thousands, except per share data and operating data)
YEAR ENDED
-----------------------------------------------------------------
JANUARY 28, FEBRUARY 3, FEBRUARY 1, JANUARY 31, JANUARY 30,
1995 1996 1997 1998 1999
----------- ----------- ----------- ----------- -----------
STATEMENT OF INCOME DATA:
Net sales $ 249,552 $ 268,956 $ 337,059 $ 449,180 $ 570,514
Management fees 1,158 1,905 2,526 4,792 3,405
--------- --------- --------- --------- ---------
Total revenues 250,710 270,861 339,585 453,972 573,919
Cost of goods sold 182,505 199,226 252,813 338,498 431,744
--------- --------- --------- --------- ---------
Gross profit 68,205 71,635 86,772 115,474 142,175
Operating expenses 56,594 58,989 69,828 87,003 99,972
Depreciation and amortization 5,324 6,047 6,615 7,997 9,775
--------- --------- --------- --------- ---------
Income from operations 6,287 6,599 10,329 20,474 32,428
Equity in earnings (loss) of affiliates (634) (1,319) (573) 2,903 (161)
Interest expense, net 1,727 1,818 1,298 1,380 289
Preacquisition loss of subsidiaries (1) - - - 913 -
--------- --------- --------- --------- ---------
Income before income tax expense 3,926 3,462 8,458 22,910 31,978
Income tax expense(2) 286 280 550 846 11,693
--------- --------- --------- --------- ---------
Net income $ 3,640 $ 3,182 $ 7,908 $22,046 $20,285
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
PRO FORMA INCOME DATA:
Pro forma income before income tax
expense (3) $19,909 $31,943
Pro forma income tax provision (3) 8,182 11,866
--------- ---------
Pro forma net income (3) $11,727 $20,076
--------- ---------
--------- ---------
Pro forma net income per share $ 0.74 $1.11
Pro forma weighted average shares
outstanding (4) 15,794 18,084
OPERATING DATA: (5)
Stores open at end of period 325 341 360 452 528
Comparable store sales increase (decrease) (6.6%) 3.5% 20.8% 15.3% 14.1%
AS OF
-----------------------------------------------------------------
JANUARY 28, FEBRUARY 3, FEBRUARY 1, JANUARY 31, JANUARY 30,
1995 1996 1997 1998 1999
----------- ----------- ----------- ----------- -----------
BALANCE SHEET DATA:
Working capital (deficit) $3,344 $ (11,038) $9,893 $ (17,728) $(3,091)
Total assets 82,900 95,515 139,244 142,791 172,047
Total liabilities 66,833 78,066 118,887 114,392 123,205
Stockholders' equity 16,067 17,449 20,357 28,399 48,842
16
(1) The results of operations of Electronics Boutique International, Inc. and
Electronics Boutique Canada, Inc. have been consolidated since the beginning of
the year ending January 31, 1998. Preacquisition loss of subsidiaries represents
losses in Electronics Boutique International, Inc. and Electronics Boutique
Canada, Inc. prior to their acquisition by the Company.
(2) The predecessors to the Company were taxed as an S Corporation and a
partnership. As a result, their taxable income was passed through to their
partners and shareholders 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,
the predecessor to the Company 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) The pro forma net income gives effect to the application of the pro forma
income tax expense that would have been reported had the predecessor companies
been corporations subject to federal and all state income taxes for all periods
prior to the initial public offering and to the effects of (i) a reduction in
depreciation expense and increase in lease expense on the West Chester
distribution center and headquarters that was retained by the predecessor
company; (ii) elimination of the equity in earnings (loss) of investment in
EB-UK and goodwill amortization due to this asset being retained by the
predecessor company.
(4) For fiscal 1998, pro forma weighted average shares outstanding is equal to
the number of shares outstanding upon completion of the Company's initial public
offering.
(5) Does not reflect stores operated by EB-UK and Waldensoftware for which the
Company provides management services. See "Business - Management Services."
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company believes that it is among the world's largest specialty
retailers of electronic games. The Company's primary products are video games
and PC entertainment software, supported by the sale of video game hardware, PC
productivity software and accessories. As of January 30, 1999, the Company
operated a total of 528 stores in 44 states, Puerto Rico, Canada, Australia and
South Korea, primarily under the names Electronics Boutique and Stop 'N Save
Software. In addition, the Company operated a commercial website under the URL
address of EBWORLD.COM. As of such date, the Company also provided management
services for EB-UK., which operated 159 stores and 17 department store-based
concessions in the United Kingdom and Ireland. As of January 30,1999, the
Company also managed 29 mall-based WaldenSoftware stores for Borders Group, Inc.
The Company is a holding company and does not have any significant assets or
liabilities, other than all of the outstanding capital stock of its
subsidiaries.
The fiscal year of the Company ends on the Saturday nearest January 31.
Accordingly the financial statements for the years ended February 1, 1997
("fiscal 1997"), January 31, 1998 ("fiscal 1998") and January 30, 1999 ("fiscal
1999") each include 52 weeks of operations.
RESULTS OF OPERATIONS
The following table sets forth certain income statement items as a
percentage of total revenues for the periods indicated:
YEAR ENDED
--------------------------------------------------
FEBRUARY 1, JANUARY 31, JANUARY 30,
1997 1998 1999
---- ---- ----
Net sales 99.3% 98.9% 99.4%
Management fees 0.7 1.1 0.6
--------- --------- ---------
Total revenues 100.0 100.0 100.0
Cost of goods sold 74.5 74.6 75.2
Gross profit 25.5 25.4 24.8
Operating expenses 20.5 19.1 17.4
Depreciation and amortization 1.9 1.8 1.7
--------- --------- ---------
Income from operations 3.1 4.5 5.7
Equity in earnings (loss) of affiliates (0.2) 0.7 (0.0)
Interest expense, net 0.4 0.3 0.1
Preacquisition loss of subsidiaries 0.0 0.2 0.0
--------- --------- ---------
Income before income tax expense 2.5 5.1 5.6
Income tax expense 0.2 0.2 2.0
--------- --------- ---------
Net income 2.3% 4.9% 3.6%
--------- --------- ---------
--------- --------- ---------
FISCAL 1999 COMPARED TO FISCAL 1998
Net sales increased by 27.0% from $449.2 million in fiscal 1998 to $570.5
million in fiscal 1999. The increase in net sales was primarily attributable to
a 14.1% increase in comparable store sales, which resulted in a $61.9 million
increase in net sales, and the additional sales volume attributable to 76 net
new stores opened during fiscal 1999. The increase in comparable store sales was
primarily attributable to increases in video game and PC entertainment software
sales as well as continued strong demand for PC accessory products.
Management fees decreased 28.9% from $4.8 million in fiscal 1998 to $3.4
million in fiscal 1999. The decrease was primarily attributable to the Company's
receipt of a $2.2 million bonus under the UK Services Agreement recorded in
fiscal 1998. The Company did not receive a bonus under this agreement in fiscal
1999, nor does it
18
expect to receive such a bonus in the future. The absence of a bonus in fiscal
1999 was partially offset by higher recurring management fees earned in fiscal
1999 under the UK Services Agreement.
Cost of goods sold increased by 27.6% from $338.5 million in fiscal 1998 to
$431.7 million in fiscal 1999. As a percentage of net sales, cost of goods sold
increased from 75.4% in fiscal 1998 to 75.7% in fiscal 1999. The increase in
cost of goods sold as a percentage of net sales was primarily attributable to an
increase in freight expenses and to the Company's decision to reduce prices on
selected electronic game titles in order to increase market share and sales
volume. The increase in freight expenses was the result of several factors. The
Company switched its primary freight carrier and reorganized 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 the Company to its stores as a result of a lower average cost per unit of
product. These increases to cost of goods sold were partially offset by a
reduction in inventory shortage and an increase in purchase discounts earned
from vendors.
Selling, general and administrative expense increased by 14.9% from $87.0
million in fiscal 1998 to $100.0 million in fiscal 1999. As a percentage of
total revenues, selling, general and administrative expense decreased from 19.1%
in fiscal 1998 to 17.4% in fiscal 1999. The $13.0 million increase was primarily
attributable to the increase in the Company'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. The decrease in selling, general and
administrative expense as a percentage of total revenues was primarily
attributable to an increase in net sales, which offset the impact of the above
factors on operating expenses.
Depreciation and amortization expense increased by 22.2% from $8.0 million
in fiscal 1998 to $9.8 million in fiscal 1999. This increase was primarily
attributable to capitalized expenditures for leasehold improvements and
furniture and fixtures for new store openings.
Operating income increased by 58.4% from $20.5 million in fiscal 1998 to
$32.4 million in fiscal 1999. As a percentage of total revenues, operating
income increased from 4.5% in fiscal 1998 to 5.7% in fiscal 1999, as the
increase in cost of goods sold as a percentage of total revenues was more than
offset by the decline in operating expenses as a percentage of total revenues.
Equity in earnings of affiliates decreased by $3.1 million from earnings of
$2.9 million in fiscal 1998 to a loss of $0.2 million in fiscal 1999. The
decrease was attributable to the reorganization of the Company in conjunction
with its initial public offering pursuant to which EB 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 loss on this 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 the Company'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.
Income tax expense increased from $0.8 million in fiscal 1998 to $11.7
million in fiscal 1999. The increase was due to the Company being taxed in
fiscal 1999 as a "C" corporation instead of an S corporation after the date of
the initial public offering.
As a result of all the above factors, the Company's income before income
taxes increased by 39.6% from $22.9 million in fiscal 1998 to $32.0 million in
fiscal 1999.
FISCAL 1998 COMPARED TO FISCAL 1997
Net sales increased by 33.3% from $337.1 million in fiscal 1997 to $449.2
million in fiscal 1998. The increase in net sales was primarily attributable to
(i) a 15.3% increase in comparable store sales, which resulted in a $50.1
million increase in net sales, (ii) the additional sales volume attributable to
45 net new domestic stores, which resulted in a $29.0 million increase in net
sales, and (iii) the consolidation of $33.0 million of net sales from
19
international retail operations, which net sales were fully consolidated as a
result of the acquisition of interests of joint venture partners acquired in
fiscal 1998.
Management fees increased by 89.7% from $2.5 million in fiscal 1997 to $4.8
million in fiscal 1998. This increase was primarily attributable to the $2.2
million bonus earned by the Company under the UK services Agreement with EB-UK.
The Company does not anticipate receiving bonus payments under this agreement in
the future.
Cost of goods sold increased by 33.9% from $252.8 million in fiscal 1997 to
$338.5 million in fiscal 1998. As a percentage of net sales, cost of goods sold
increased from 75.0% in fiscal 1997 to 75.4% in fiscal 1998. The increase in
cost of goods sold as a percentage of net sales was primarily attributable to
the Company's decision to reduce prices for selected electronic game titles in
order to increase market share and sales volume.
Selling, general and administrative expense increased by 24.6% from $69.8
million in fiscal 1997 to $87.0 million in fiscal 1998. As a percentage of total
revenues, selling, general and administrative expense decreased from 20.5% in
fiscal 1997 to 19.1% in fiscal 1998. The $17.2 million increase was primarily a
result of the increase in the Company's store base and the associated increases
in store and headquarter operating expenses. The decrease in selling, general
and administrative expense as a percentage of total revenue was primarily
attributable to an increase in net sales and management fee income without a
proportional increase in corporate and store-level overhead.
Depreciation and amortization expense increased by 20.9% from $6.6 million
in fiscal 1997 to $8.0 million in fiscal 1998. This increase was primarily
attributable to capitalized expenditures for leasehold improvements and
furniture and fixtures for new store openings.
Operating income increased by 98.2% from $10.3 million in fiscal 1997 to
$20.5 million in fiscal 1998. As a percentage of total revenues, operating
income increased from 3.1% in fiscal 1997 to 4.5% in fiscal 1998, as the
increase in cost of goods sold as a percentage of total revenues was more than
offset by the decline in operating expenses as a percentage of total revenues.
Equity in earnings of affiliates increased by $3.5 million from a loss of
$0.6 million in fiscal 1997 to earnings of $2.9 million in fiscal 1998. The
increase was attributable to a $3.2 million increase in equity income recorded
for the Company's 25.1% investment in EB-UK. and the effect of consolidating the
Company's equity interests in Canada and Korea beginning in fiscal 1998.
Interest expense, net, increased by 6.2% from $1.3 million in fiscal 1997 to
$1.4 million in fiscal 1998. The increase was primarily attributable to the
inclusion of foreign operation interest expense in fiscal 1998, which was
partially offset by reduced short-term borrowings and the repayment of long-term
debt in fiscal 1998.
As a result of all the above factors, the Company's income before income
taxes increased by 171% from $8.5 million in fiscal 1997 to $22.9 million in
fiscal 1998.
SEASONALITY AND QUARTERLY RESULTS
The Company's business, like that of most retailers, is highly seasonal. A
significant portion of the Company's net sales, management fees and profits are
generated during the Company's 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
in the Company's merchandise mix.
The following table sets forth certain unaudited quarterly income statement
information for fiscal 1999 and fiscal 1998. The unaudited quarterly information
includes all normal recurring adjustments that management considers necessary
for a fair presentation of the information shown.
20
(in thousands, except for number of stores)
Fiscal 1998 Fiscal 1999
----------------------------------------------------------------------------------
1st 2nd 3rd 4th 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- -------
Total revenues $84,176 $73,394 $94,239 $202,163 $107,301 $102,460 $111,300 $252,858
Gross profit 22,235 19,087 24,179 49,973 27,781 26,556 27,672 60,166
Operating income (loss) 2,159 (1,800) 640 19,475 3,257 90 2,519 26,562
Stores open at
quarter end 393 407 439 452 465 474 500 528
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed its operations through a combination
of cash generated from operations and bank debt. In addition, on July 28, 1998,
the Company completed an initial public offering of 5,000,000 shares of its
common stock. Of the 5,000,000 shares sold, 4,375,000 shares were for the
account of the Company and 625,000 shares were for the account of the selling
shareholder. The transaction resulted in net proceeds (after offering expenses)
to the Company of approximately $55.0 million, which was used to repay $25.7
million under the Company's revolving credit agreement, a $7.0 million demand
note due to the Company's Chairman, James J. Kim, $7.9 million owed by the
Company to a predecessor company, $3.2 million to terminate an outstanding bank
term loan and for working capital purposes. In addition, a predecessor to the
Company retained assets worth $31.0 million in connection with the
reorganization of the Company prior to the completion of its initial public
offering.
The Company generated $30.8 million in cash from operations in fiscal 1999
and $32.3 million in fiscal 1998. The $30.8 million of cash generated from
operations in fiscal 1999 was primarily the result of $20.3 million of net
income, $10.2 million of non-cash charges to net income, an $8.1 million
increase in income taxes payable, and a $7.1 million increase in accrued
expenses, partially offset by a $7.5 million decrease in net affiliate
liabilities and receivables, an increase of $7.3 million in the Company's
investment in merchandise inventories net of accounts payable, and a $0.6
million increase in prepaid expenses and other assets. The $32.3 million of cash
generated from operations in fiscal 1998 was primarily the result of $22.1
million of net income, $5.7 million of non-cash charges to net income, and a
$9.9 million increase in accounts payable and accrued expenses, partially offset
by an increase of $2.5 million in other assets, a $2.1 million increase in due
from affiliates and a $2.0 million decrease in due to affiliates. The Company's
working capital deficit decreased from $17.7 million at January 31, 1998 to $3.1
million at January 30, 1999.
The Company made capital expenditures of $19.6 million in the fiscal 1999,
primarily to open new stores, to remodel existing stores and for leasehold
improvements at the Company's headquarters and primary distribution center. EB
made capital expenditures of $18.5 million in fiscal 1998, primarily for opening
new stores, to remodel existing stores and to purchase its West Chester,
Pennsylvania distribution center which was previously leased.
On March 16, 1998, EB entered into a credit agreement with Fleet, pursuant
to which Fleet agreed to make available an asset based revolving credit and term
loan facility in an amount up to $50.0 million. The revolving credit facility
has been assigned to the Company by EB. The revolving credit facility expires
and is repayable on March 16, 2001. Interest accrues on borrowings at a per
annum rate equal to either LIBOR plus 250 basis points or Fleet's base rate of
interest, at the Company's option. The revolving credit facility is secured by
certain assets, including accounts receivable, inventory, fixtures and
equipment. As of January 30, 1999, the Company had no outstanding borrowings
under the revolving credit facility.
The Company believes that cash generated from its operating activities and
available bank borrowings will be sufficient to fund its operations and store
expansion programs for the next fiscal year.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1 ("SOP 98-1"), Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." The Company
21
intends to adopt this statement in its fiscal 2000 Annual Report as required.
The adoption of SOP 98-1 will not have a material impact on the Company's
results of operations or financial condition.
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"). This statement establishes accounting and reporting standards for
derivative instruments and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measures those instruments at fair value. The Company
plans to adopt this statement in its fiscal 2000 Annual Report as required. As
of January 30, 1999, the Company had no derivative instruments or hedging
activities.
YEAR 2000 STRATEGY
The Company employs a significant number of computer software programs and
computer chip controlled devices in its operations, including applications used
in inventory management, distribution, financial business systems and various
administrative functions. To the extent that these software applications or
devices contain source code that is unable to interpret appropriately the
upcoming calendar year 2000 ("Y2K") issue, the Company may experience varying
levels of system failure or miscalculations. Therefore, some level of
modification or even possible replacement of such source code, applications or
devices will be necessary.
Y2K PROJECT METHODOLOGY AND APPROACH
The Company's Y2K project uses a five-phase methodology and approach, of
which the first two phases are "work-in-progress" phases and are being updated
on an on-going basis. The five phases of the Company's Y2K project are as
follows:
Phase I - Inventory. The Company collects a comprehensive list of items that
may be affected by Y2K issues. Item categories are defined as facilities
("Facilities"), hardware ("Hardware"), software ("Software"), vendor
hardware and software ("Non-EB"), and system feeds and interfaces
("Interfaces"). As of January 30, 1999, the Company had inventoried
approximately 90% of items that it believes may be affected by the Y2K
issue.
Phase II - Assessment. The Company evaluates the inventory to determine
which items will function properly with the change to the new century and
ranks items based on their potential impact to the Company. Each Item is
assigned a priority as follows:
"Critical": Will potentially impair the company's ability to do business
should the item fail.
"Important": Will adversely affect some productivity should the item fail.
"Inconvenient": Will cause minor inconvenience should the item fail.
"Non-Essential": Will have no impact should the item fail.
Based on assigned priorities from phase I and II, the following three phases
will be carried out to the Critical items first, followed by the Important
items, then the Inconvenient items and finally the Non-Essential items if
resources are available. The Company is committed and on track to remediate all
Critical and Important items before July 31, 1999.
Phase III - Remediation. The Company analyzes the items affected by Year
2000, identifying problem areas and repairing non-compliant items.
Phase IV - Testing. The Company performs a thorough test of all remediated
systems, including present and forward date testing to simulate dates in Year
2000.
Phase V - Implementation. The Company places all items that have been
remediated and successfully tested into production.
SUPPLIER ELECTRONIC DATA INTERCHANGE (EDI) STATUS
22
As a retailer, the majority of products the Company resells are purchased
from a relatively small group of manufacturers and/or distributors. In order to
efficiently communicate with these companies, EDI was deployed wherever
possible. At the end of fiscal 1999, the Company had upgraded to the Y2K
compliant EDI "4010" format. However, since a good portion of the Company's
suppliers are still using non-compliant EDI formats, the Company will continue
using the "3020" and "3040" formats with these non-compliant suppliers. These
suppliers are being tracked in the Company's Y2K project database, and every
effort will be made to facilitate 100% Y2K compliance with these suppliers. In
case some suppliers are still Y2K non-compliant by December 31, 1999, the
Company's contingency plan is to communicate with them through facsimile, mail
and/or modem transmissions.
INTERNATIONAL SUBSIDIARIES AND DOMESTIC DISTRIBUTION CENTERS
The Company operates retail stores in Australia, Canada, Puerto Rico and
Korea with regional sales offices in all but Puerto Rico. In addition, the
Company ships products out of its own distribution centers as well as
third-party distribution centers in the continental United States. Instead of
deploying and replicating distributed systems at each of these locations, the
Company implemented a centralized computing environment with telecommunication
networks. This approach simplified the Y2K impact to the Company as a whole
since these locations do not have any Critical systems with which to contend.
Most, if not all, desktop applications and computers are the same as those at
the Company's headquarters. Accordingly, these sites should be less prone to Y2K
problems. Nonetheless, the Company has started to inventory and assess these
systems and will follow immediately with any necessary remediation, testing and
implementation. All locations are expected to be rid of Critical, if any, and
Important Y2K issues by July 31, 1999.
OVERALL Y2K PROJECT STATUS BY PRIORITY (AS OF APRIL 12, 1999)
Complexity Y2K Y2K Y2K Compliant
Priority Count Unit (1) Ready (2) Tested (3) Compliant (4) By (5)
- ------------------ --------- -------------- -------------- -------------- --------------- --------------
Critical 66 1007 87.69% 77.36% 77.26% 7/31/1999
Important 147 284 46.13% 20.07% 19.72% 7/31/1999
Inconvenient 32 37 78.38% 37.84% 32.43% 9/30/1999
Non-essential 4 4 100.00% 0.00% 0.00% TBD
- --------------
(1) Complexity Unit: Measures the aggregate complexity of all items within a
priority group based on resources such as people-hour, time and material
required. The scale ranges from 1 to 700 per item, with 1 representing the
lease amount of complexity.
(2) Y2K Ready: The percentage of the items within a priority group as to which
the Company has received assurances by external providers or believes that
through its own remedial action will be able to process Year 2000 dates
correctly.
(3) Y2K Tested: The percentage of the items within a priority group for which
the Company has begun internal testing for Y2K compliance.
(4) Y2K Compliant: The percentage of the items within a priority group which
the Company believes to be Y2K compliant.
(5) Compliant By: Date by which the Company expects that the entire priority
group will be Y2K compliant.
The Company expects that the aggregate cost of its identification,
assessment, remediation, replacement, testing and implementation efforts related
to the Y2K issue will not exceed $900,000 and that these expenditures will be
funded from operating cash flows. As of January 30, 1999, the Company had
incurred costs of approximately $520,000 related to the Y2K issue, including
analysis, remediation, repair, or replacement of existing software, and upgrades
to existing software which have been expensed as incurred. The Company's
estimates of the costs of achieving Y2K compliance and the dates by which Y2K
compliance will be completed are based on management's best estimate and include
assumptions as to the availability of technical skills of Company associates and
independent contractors, timely compliance by its business partners, and other
factors.
23
The Company has not yet completed its analysis of the operational problems
and costs that may likely result from the failure of the Company to properly
assess and correct all Y2K issues on a timely basis. Therefore, the Company has
not developed a contingency plan for dealing with the most likely worst case
scenarios that could occur. The Company intends to complete its analysis and
contingency planning by December 31, 1999.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company invests cash balances in excess of operating requirements in
short-term investment grade securities, generally with maturities of 90 days or
less. In addition, the Company's revolving credit facility provides for
borrowings which bear interest at variable rates based on either the bank's base
rate or LIBOR plus 250 basis points. The Company had no borrowings outstanding
pursuant to the revolving credit facility as of January 30, 1999. The Company
believes that the effect, if any, of reasonably possible near-term changes in
interest rates on the Company's financial position, results of operations, and
cash flows should not be material.
The Company has retail operations in various foreign countries. The Company
is subject to currency exchange rate and currency devaluation risks due to these
operations. Since over 90% of the Company's net sales are domestic, the Company
does not believe that Currency exchange rate fluctuations would have a material
adverse effect on the Company's results of operations and financial condition
and, accordingly, does not hedge its risk in this area. The Company intends to
monitor its exposure to these risks and reevaluate its hedging strategies as
appropriate.
24
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Independent Auditors' Report 26
Consolidated Balance Sheets 27
Consolidated Statements of Income 28
Consolidated Statements of Stockholders' Equity 29
Consolidated Statements of Cash Flow 30
Notes to Consolidated Financial Statements 31
25
INDEPENDENT AUDITORS REPORT
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 31, 1998 and January 30,
1999, and the related consolidated statements of income, stockholders' equity,
and cash flows for each of the years in the three-year period ended January 30,
1999. The consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 31, 1998 and January 30, 1999, and
the results of their operations and their cash flows for each of the years in
the three-year period ended January 30, 1999, in conformity with generally
accepted accounting principles.
/s/ KPMG LLP
Philadelphia, PA
March 16, 1999
26
ELECTRONICS BOUTIQUE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JANUARY 31, JANUARY 30,
Assets 1998 1999
------------------ -----------------
Current assets:
Cash and cash equivalents $ 20,639,610 $ 42,006,179
Accounts receivable:
Trade and vendors 2,618,382 4,010,293
Other 1,754,691 1,516,085
Due from affiliates (note 8 ) 2,890,554 984,096
Merchandise inventories 52,973,314 65,433,008
Deferred tax asset (note 13) - 2,694,000
Prepaid expenses 2,837,647 969,949
------------------ -----------------
Total current assets 83,714,198 117,613,610
------------------ -----------------
Property and equipment:
Leasehold improvements 40,226,726 46,933,403
Fixtures and equipment 24,884,217 32,362,909
Building 6,200,950 -
Land 632,806 -
Construction in progress 556,663 1,087,964
------------------ -----------------
72,501,362 80,384,276
Less accumulated depreciation and amortization 32,535,305 37,349,298
------------------ -----------------
Net property and equipment 39,966,057 43,034,978
Investment in affiliated company (note 8 ) 11,025,345 -
Goodwill and other intangible assets, net of accumulated amortization
of $120,151 and $482,961 as of January 31, 1998 and January 30, 1999 2,190,766 1,898,395
Deferred tax asset (note 13) - 6,319,000
Other assets 5,894,374 3,181,566
------------------ -----------------
Total assets (note 4) $ 142,790,740 $ 172,047,549
------------------ -----------------
------------------ -----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Revolving credit facility (note 4 ) $ - $ -
Current portion of long-term debt (note 4 ) 2,400,396 99,996
Accounts payable 83,713,983 90,835,578
Accrued expenses (note 3 ) 14,545,119 19,625,068
Income taxes payable 782,988 10,144,023
------------------ -----------------
Total current liabilities 101,442,486 120,704,665
------------------ -----------------
Long-term liabilities:
Notes payable (note 4 ) 10,541,149 8,353
Deferred rent 2,408,579 2,492,140
------------------ -----------------
Total liabilities 114,392,214 123,205,158
------------------ -----------------
Commitments (note 2 )
Stockholders' equity (notes 10 and 12)
Preferred stock - authorized 25,000,000 shares; $.01 par value;
no shares issued and outstanding at January 30, 1999 - -
Common stock - authorized 100,000,000 shares; $.01 par value;
20,169,200 shares issued and outstanding at January 30, 1999 - 201,692
Common stock:
Class A - authorized 5,000 shares; $.10 par value;
1,900 shares issued and outstanding at January 31, 1998 190 -
Class B - authorized 25,000 shares; $.10 par value;
21,000 shares issued and outstanding at January 31, 1998 2,100 -
Partners' capital of EB Services Company LLP at January 31, 1998 1,000 -
Additional paid-in capital 7,584,365 31,541,428
Accumulated other comprehensive expense (1,023,493) (686,920)
Retained earnings 21,834,364 17,786,191
------------------ -----------------
Total stockholders' equity 28,398,526 48,842,391
------------------ -----------------
Total liabilities and stockholders' equity $ 142,790,740 $ 172,047,549
------------------ -----------------
------------------ -----------------
See accompanying notes to consolidated financial statements.
27
ELECTRONICS BOUTIQUE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED
--------------------------------------
FEBRUARY 1, JANUARY 31, JANUARY 30,
1997 1998 1999
----------- ------------ -----------
Net sales $ 337,058,946 $449,179,603 $ 570,514,060
Management fees 2,526,107 4,791,553 3,404,862
----------- ------------ -----------
Total revenues $ 339,585,053 $453,971,156 $ 573,918,922
----------- ------------ -----------
Costs and expenses:
Costs of merchandise sold, including freight 252,812,925 338,497,642 431,743,771
Selling, general and administrative (notes 5 and 6 ) 69,827,537 87,002,305 99,972,451
Depreciation and amortization (notes 7 and 8 ) 6,615,268 7,996,506 9,774,388
----------- ------------ -----------
Operating income 10,329,323 20,474,703 32,428,312
Equity in earnings (loss) of affiliates (note 5) (573,462) 2,902,780 (160,575)
Interest expense, net of interest income of $1,121,562, $1,217,337 and
$829,631 in fiscal years 1997, 1998 and 1999, respectively 1,298,296 1,380,046 289,188
Preacquisition loss of subsidiaries - 913,028 -
----------- ------------ -----------
Income before income taxes 8,457,565 22,910,465 31,978,549
Income tax expense (note 13) 550,000 846,280 11,693,270
----------- ------------ -----------
Net income $ 7,907,565 $ 22,064,185 $ 20,285,279
----------- ------------ -----------
----------- ------------ -----------
PRO FORMA DATA (UNAUDITED) (NOTE 9 ):
Income before income taxes $ 8,457,565 $ 22,910,465 $ 31,978,549
Pro forma income taxes 3,513,265 9,415,631 11,866,084
----------- ------------ -----------
Pro forma net income $ 4,944,300 $ 13,494,834 $ 20,112,465
----------- ------------ -----------
----------- ------------ -----------
Pro forma net income per share - basic $ 0.31 $ 0.85 $ 1.12
----------- ------------ -----------
----------- ------------ -----------
Pro forma weighted average shares outstanding - basic 15,794,200 15,794,200 18,029,777
----------- ------------ -----------
----------- ------------ -----------
Pro forma net income per share - diluted $ 0.31 $ 0.85 $ 1.11
----------- ------------ -----------
----------- ------------ -----------
Pro forma weighted average shares outstanding - diluted 15,794,200 15,794,200 18,084,109
----------- ------------ -----------
----------- ------------ -----------
See accompanying notes to consolidated financial statements.
28
ELECTRONICS BOUTIQUE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
CLASS A CLASS B
PREFERRED STOCK COMMON STOCK COMMON STOCK COMMON STOCK
--------------- ------------ ------------ ------------------------
SHARE AMOUNT SHARE AMOUNT SHARE AMOUNT SHARE AMOUNT
----- ------ ----- ------ ----- ------ ----- ------
Balance, Feb. 3, 1996 - $ - 1,900 $ 190 21,000 $ 2,100 - $ -
Net income - - - - - - - -
Distributions - - - - - - - -
------ ----------- ------ ------------ ------ ----------- ---------- ------------
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
------ ----------- ------ ------------ ------ ----------- ---------- ------------
------ ----------- ------ ------------ ------ ----------- ---------- ------------
ACCUMULATED
PARTNERS' CAPITAL ADDITIONAL OTHER TOTAL
OF EB SERVICES PAID-IN COMPREHENSIVE RETAINED STOCKHOLDERS'
COMPANY LLP CAPITAL INCOME EARNINGS EQUITY
----------- ------- ------ -------- ------
Balance, Feb. 3, 1996 $ - $ 7,584,365 $ - $ 9,862,614 $ 17,449,269
Net income - - - 7,907,565 7,907,565
Distributions - - - (5,000,000) (5,000,000)
---------------- ---------------- ------------------ --------------- ----------------
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
---------------- ---------------- ------------------ --------------- ----------------
---------------- ---------------- ------------------ --------------- ----------------
29
ELECTRONICS BOUTIQUE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED
------------------------------------------------
FEBRUARY 1, JANUARY 31, JANUARY 30,
1997 1998 1999
--------------- --------------- ---------------
Cash flows from operating activities:
Net income $ 7,907,565 $ 22,064,185 $ 20,285,279
Adjustments to reconcile net income to cash provided by
operating activities:
Depreciation of property and equipment 6,555,142 7,571,301 9,375,766
Amortization of other assets 60,126 425,205 398,622
Loss on disposal of property and equipment 1,170,182 620,916 292,623
Equity in loss of affiliates 126,975 (2,902,780) 160,575
Loss on investment in affiliated companies 446,487 - -
Changes in assets and liabilities:
Decrease (increase) in:
Accounts receivable (471,533) 385,737 (828,692)
Due from affiliates (688,891) (2,142,774) 1,906,739
Merchandise inventories (5,646,658) 95,212 (12,309,661)
Prepaid expenses 2,279 (27,311) 1,882,619
Other long-term assets 173,570 (1,641,573) (1,247,378)
(Decrease) increase in:
Accounts payable 21,806,206 8,348,016 4,993,290
Accrued expenses 4,832,902 1,619,154 7,071,901
Due to affiliate 402,478 (1,981,194) (9,453,597)
Income taxes payable 455,187 213,047 8,168,826
Deferred rent (74,711) (368,059) 79,647
--------------- --------------- ---------------
Net cash provided by in operating activities 37,057,306 32,279,082 30,776,559
--------------- --------------- ---------------
Cash flows used in investing activities:
Purchases of property and equipment (8,610,265) (18,470,432) (19,573,171)
Proceeds from disposition of assets 275,722 12,455 132,592
Net cash from businesses acquired - 2,922,411 -
Purchase of investment securities in affiliate - (2,215,933) -
--------------- --------------- ---------------
Net cash used in investing activities (8,334,543) (17,751,499) (19,440,579)
--------------- --------------- ---------------
Cash flows from financing activities:
Distributions (5,000,000) (13,000,000) (19,950,573)
Net proceeds under revolving credit facility (10,000,000) - -
Proceeds from (repayments of) long-term debt 23,400,004 (24,514,276) (12,896,594)
Proceeds from equity offering - - 54,962,500
Capital contribution - 1,000 -
Net cash retained by predecessors - - (12,375,535)
--------------- --------------- ---------------
Net cash provided by (used in) financing activities 8,400,004 (37,513,276) 9,739,798
--------------- --------------- ---------------
Effects of exchange rates on cash - (1,102,543) 290,791
Net increase (decrease) in cash and cash equivalents 37,122,767 (24,088,236) 21,366,569
Cash and cash equivalents, beginning of period 7,605,079 44,727,846 20,639,610
--------------- --------------- ---------------
Cash and cash equivalents, end of period $ 44,727,846 $ 20,639,610 $ 42,006,179
--------------- --------------- ---------------
--------------- --------------- ---------------
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 2,970,932 $ 2,714,593 $ 1,207,210
Income taxes 89,659 672,842 2,853,773
See accompanying notes to consolidated financial statements.
30
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, Electronics Boutique
Holdings Corp. and 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 Company is among the world's largest specialty retailers of electronic
games. The Company operates in only one business segment, as substantially all
of its revenues, net income and assets are derived from its primary products of
video games and personal computer entertainment software, supported by the sale
of video game hardware, PC productivity software and accessories.
The Company and its predecessors had 360, 452 and 528 operating retail
stores throughout the United States, Puerto Rico, Canada, Australia and South
Korea at February 1, 1997, January 31, 1998 and January 30, 1999,
respectively. Total revenues from the U.S. and foreign operations were 91%
and 9%, respectively, in fiscal 1999. Long-lived assets located in the United
States and foreign countries were 89% and 11%, respectively, in fiscal 1999.
The Company also operates a mail order business and sells product via the
World Wide Web. Approximately 30%, 36% and 31% of fiscal 1997, fiscal 1998,
and fiscal 1999 sales, respectively, were generated from merchandise
purchased from its three largest vendors.
FISCAL YEAR-END
The fiscal year ends on the Saturday nearest January 31. Accordingly, the
financial statements for the years ended February 1, 1997 (fiscal "1997"),
January 31, 1998 (fiscal "1998") and January 30, 1999 (fiscal "1999") each
include 52 weeks of operations.
PRINCIPLES OF CONSOLIDATION AND COMBINATION
The consolidated financial statements include the financial position and
results of operations of the Company since its initial 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. All
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 RECOGNITION
Retail sales are recognized as revenue at point of sale. Mail order and
internet sales are recognized as revenue upon shipment. Management fees are
recognized in the period that related services are provided. Sales are recorded
net of estimated allowance for sales returns and allowances.
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 INVENTORIES
Merchandise is valued at the lower of cost or market. Cost is determined
principally by a weighted-average method.
31
PROPERTY 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............... Lesser of 10 years or the lease term
Furniture and Fixtures............... 5 years
Computer equipment................... 3 years
Building............................. 30 years
Included in selling, general and administrative costs for fiscal years 1997,
1998, and 1999, are losses of $1,170,000, $556,000 and $293,000, respectively,
primarily related to the write-off of the net book value of property and
equipment associated with the closing of nine stores in each of fiscal 1997 and
1998 and ten stores fiscal 1999 and the remodeling of several stores each year.
DEFERRED REVENUE
The Company defers revenue related to the sale of frequent buyer cards which
entitle the cardholder to receive discounts on purchases for one year from the
date of purchase. Revenue is recognized over the one year period the card is
valid based on expected usage.
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 INTANGIBLES
Costs in excess of fair value of net assets acquired are being amortized on
a straight-line basis over periods of up to ten years. The Company assesses the
recoverability of goodwill and other intangibles by determining whether the
remaining balance can be recovered through projected cash flows.
OTHER ASSETS
Other assets consist principally of life insurance programs for certain key
executives and security deposits.
COMPUTER SOFTWARE COSTS
The Company capitalizes significant costs to acquire management information
systems software and significant external costs of system improvements. Computer
software costs are amortized over estimated useful lives of three to five years.
RETAINED EARNINGS
Retained earnings, which represent undistributed earnings of Electronics
Boutique Plc, totaled approximately $1,900,000 at January 31, 1998.
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 EXPENSE
Preopening and start-up costs for new stores are charged to operations as
incurred. Costs of advertising and sales promotion programs are charged to
operations, offset by 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.
32
FOREIGN CURRENCY
The accounts of the foreign subsidiaries are translated in accordance with
Statement of Financial Accounting Standard No. 52, Foreign Currency 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 operations are translated using an average exchange rate for the
year. The effects of rate fluctuations in translating assets and liabilities of
international operations into U.S. dollars are accumulated and reflected as a
foreign currency translation adjustment in the statements of stockholders'
equity. Transaction gains and losses are included in net income.
The Company currently does not hedge currency exchange rate risk and does
not currently believe that currency exchange rate fluctuations have a material
adverse effect on its results of operations and financial condition.
COMPREHENSIVE INCOME
Effective February 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." This statement
requires that all items recognized under accounting standards as components of
comprehensive income be reported in an annual financial statement that is
displayed with the same prominence as other financial statements. The Company
has included the required information in the Statement of Stockholders' Equity.
Accumulated Other Comprehensive Income includes foreign currency translation
adjustments.
INCOME TAXES
The 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 to show the
results of operations as if the EB Group had been subject to taxes as a C
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 credit carryforwards. 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 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 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 INSTRUMENTS
The Company's financial instruments are accounts receivable, accounts
payable, long-term debt, and certain long-term investments. The carrying value
of accounts receivable and accounts payable approximates fair value due to the
short maturity of these instruments. The carrying value of long-term debt
approximates fair value based on current rates available to the Company for debt
with similar maturities. The carrying value of life insurance policies included
in other assets approximates fair value based on estimates received from
insurance companies. The fair market value of the investment in affiliated
company is described in note 8.
33
(2) COMMITMENTS
LEASE COMMITMENTS
At January 30, 1999, the future annual minimum lease payments under
operating leases for the following five fiscal years and thereafter were as
follows:
Retail
Store Distribution Total lease
Locations facilities commitments
----------------- ---------------- -------------------
Fiscal 2000........................... $ 24,575,877 $ 905,105 $ 25,480,982
Fiscal 2001........................... 22,964,358 403,833 23,368,191
Fiscal 2002........................... 21,536,184 101,361 21,637,545
Fiscal 2003........................... 19,661,521 44,730 19,706,251
Fiscal 2004........................... 16,903,742 - 16,903,742
Thereafter............................ 49,625,741 - 49,625,741
----------------- ---------------- -------------------
$ 155,267,424 $ 1,455,029 $ 156,722,453
----------------- ---------------- -------------------
----------------- ---------------- -------------------
The total future minimum lease payments include lease commitments for new
retail locations not in operation at January 30, 1999, 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 $5,422,000,
$8,132,000 and $10,695,000 in fiscal 1997, fiscal 1998,and fiscal 1999,
respectively. Rent expense, including contingent rental amounts, was
approximately $28,448,000, $35,138,000 and $43,008,000 in fiscal 1997, fiscal
1998 and fiscal 1999, 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 greater than (less than) the rental expense reflected
in the statements of operations by approximately $75,000, $368,000 and ($84,000)
for fiscal 1997, fiscal 1998 and fiscal 1999, respectively.
(3) ACCRUED EXPENSES
Accrued expenses consist of the following:
January 31, January 30,
1998 1999
-------------------- --------------------
Employee compensation and related taxes $ 4,442,430 $ 5,801,742
Gift certificates, customer deposits and deferred revenue 3,231,958 4,758,197
Accrued rent 3,179,749 4,152,666
Other accrued liabilities 3,690,982 4,912,463
-------------------- --------------------
Total $ 14,545,119 $ 19,625,068
-------------------- --------------------
-------------------- --------------------
34
(4) DEBT
The EB Group had available a revolving credit facility allowing for maximum
borrowings of $17,000,000 at January 31, 1998. There were no outstanding amounts
at January 31, 1998 on this facility. The EB Group had a second revolving credit
facility allowing for maximum borrowings of $1,000,000 at January 31, 1998.
There was no outstanding balance at January 31, 1998 on this facility. The
Company had available a revolving credit facility allowing for maximum
borrowings of $50,000,000 at January 30, 1999. The revolving credit facility
expires and is repayable on March 16, 2001. 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. There was no outstanding balance at January 30, 1999 on this
facility.
Long-term debt at January 31, 1998 and January 30, 1999 is summarized as
follows:
January 31, January 30,
1998 1999
----------------- ----------------
Bank term loan; interest payable monthly at the bank's prime rate
(8.50% at January 31, 1998). Principal payments of $500,000 payable
semi-annually. $ 5,000,000 $ -
Bank term loan; interest payable monthly at the bank's prime rate
(8.50% at January 31, 1998). Five semi-annual principal payments
of $250,000 on every July 1 and February 1, commencing on July 1, 1996
and continuing through July 1, 1998, with the balance payable
January 31, 1999. 4,000,000 -
Promissory note, maturing on February 1, 2000 with interest and
principal payable monthly at 6.00% as of January 31, 1998 and
January 30, 1999. 208,345 108,349
Bank term loan; interest payable monthly at the U.S. prime rate plus
0.125% (8.625% at January 31, 1998). Principal payments of $66,700,
payable monthly. 3,733,200 -
----------------- ----------------
12,941,545 108,349
Less current installments.................................. 2,400,396 99,996
----------------- ----------------
$ 10,541,149 $ 8,353
----------------- ----------------
----------------- ----------------
(5) RELATED PARTY TRANSACTIONS
LOANS AND ADVANCES FROM AFFILIATES
During fiscal 1997, the EB Group borrowed varying amounts from a company
affiliated through common ownership. The advances bear interest at the prime
rate plus 0.25%. The EB Group and Electronics Boutique Holdings Corp. had no
outstanding borrowings from affiliates at January 31, 1998 and January 30, 1999,
respectively. Interest expense on affiliate borrowings was approximately
$250,000 for fiscal 1997 and $0 for fiscal 1998 and fiscal 1999.
TRANSACTIONS WITH AFFILIATES
Insurance and other expenses are paid to an affiliated company through
intercompany billings. The amount of these expenses was approximately $575,000,
$431,000 and $41,000 for fiscal 1997, fiscal 1998 and fiscal 1999, respectively,
and is included in selling, general and administrative expenses.
35
Equity in earnings (loss) of affiliates includes the following:
Fiscal 1997 Fiscal 1998 Fiscal 1999
------------------ ------------------ -----------------
EB International, Inc.................. $ (373,031) $ - $ -
Electronics Boutique Canada, Inc....... (73,456) - -
Electronics Boutique, Plc.............. (126,975) 2,902,780 (160,575)
------------------ ------------------ -----------------
$ (573,462) $ 2,902,780 $ (160,575)
------------------ ------------------ -----------------
------------------ ------------------ -----------------
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 $641,000, $633,000 and $476,000 during fiscal
1997, fiscal 1998 and fiscal 1999, respectively, as reimbursement for
incremental costs incurred based on a formula as defined. Amounts owed to the
Company for these items and trade credit at January 31, 1998 and January 30,
1999 are included in accounts receivable. Reimbursements offset selling, general
and administrative expenses. Based on certain performance criteria as defined,
the Company can also earn a performance fee. No performance fee was earned for
fiscal 1997 and fiscal 1998 and $400,000 was earned for fiscal 1999.
(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 of assets acquired 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
acquisition of the remaining 50% by the EB Group in fiscal 1998 has been
included in preacquisition loss of subsidiaries on the consolidated and combined
statement of income. The pro forma effect of the acquisition is not material to
fiscal 1997. Prior to fiscal 1998, the investment in EB Canada was accounted for
under the equity method of accounting and, accordingly, the EB Group's
proportionate interest in net income and losses has been reflected in the
statements 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,
and supplies in South Korea. Prior to fiscal 1998, the investment in the joint
venture was accounted for under the equity method of accounting and,
accordingly, the EB Group's proportionate interest in net income and losses has
been reflected in the statements of income. In fiscal 1998 EB International
acquired the remaining 50% interest in the joint venture with $611,000 of
additional funds provided by the EB Group. The fair value of assets 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 operations of the
joint venture since the beginning of fiscal 1998. The $677,000 loss of the joint
venture prior to the acquisition of the remaining 50% by the EB Group in fiscal
1998 has been included in preacquisition loss of subsidiaries on the
consolidated and combined statement of income. The pro forma effect of the
acquisition is not material to fiscal 1997.
36
(8) INVESTMENT IN AFFILIATED COMPANY
In fiscal 1996, the EB 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 percent 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 each of fiscal 1997 and 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 goodwill.
At January 31, 1998 the fair market value of the investment was $52,615,000
based on the closing market price quotation of the London Stock Exchange. The
investment in Electronics Boutique Plc was retained by a predecessor company
prior to completion of the initial public offering by the Company in July, 1998.
In fiscal 1996, the EB Group entered into a services agreement with
Electronics Boutique Plc to provide consulting, management, training, and
advertising assistance which expires on January 31, 2006. The agreement was
assigned to the Company. The agreement provides for a fee to be paid to the EB
Group based on a formula of 1% of 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,
which is included in due from affiliates, was $2,826,000 and $879,000 at January
31, 1998 and January 30, 1999. Included in management fees for fiscal 1997,
fiscal 1998 and fiscal 1999 was $1,092,000, $1,953,000 and $2,529,000,
respectively. Additionally, the agreement provides that the Company is to be
reimbursed by Electronics Boutique Plc for all reasonable travel and subsistence
expenses incurred by employees of the Company during their performance of the
agreement. At January 31, 1998 and January 30, 1999, amounts outstanding for
these expenses were $52,000 and $105,000, respectively, and are included in due
from affiliates.
Summary financial information for Electronics Boutique Plc, a UK company, as
of and for the years ended February 1, 1997 and January 31, 1998, are as
follows:
February 1, January 31,
1997 1998
------------------- -------------------
Current Assets................................... $ 29,486,000 $ 49,404,000
Current Liabilities.............................. 22,201,000 31,338,000
------------------- -------------------
Working Capital.................................. 7,285,000 18,016,000
Property, Plant and Equipment, Net............... 13,698,000 15,987,000
------------------- -------------------
Other Assets..................................... 80,000 -
Long-Term Debt................................... 2,086,000 1,825,000
------------------- -------------------
Stockholders' Equity............................. $ 18,977,000 $ 32,178,000
Sales............................................ $ 116,341,000 $ 203,596,000
------------------- -------------------
------------------- -------------------
Net Income..................................... $ 777,000 $ 12,895,000
------------------- -------------------
------------------- -------------------
The summary balance sheet amounts have been converted from UK pounds to U.S.
dollars at year-end published exchange rates. Summary income statement amounts
have been converted using average exchange rates prevailing during the
respective periods.
37
(9) PRO FORMA STATEMENT OF INCOME INFORMATION (UNAUDITED)
For purposes of comparison, the following pro forma information for fiscal
1997, fiscal 1998 and fiscal 1999, respectively, is presented to show pro forma
income on an after-tax basis as if the EB Group had been subject to taxes as a C
corporation.
Fiscal 1997 Fiscal 1998 Fiscal 1999
----------- ----------- -----------
Federal statutory tax rate 34.00 % 35.00 % 35.00 %
State income taxes, net of federal benefit 5.36 3.74 3.18
Loss of foreign subsidiaries 1.80 0.51 -
Other 0.38 1.85 3.34
Change in valuation allowance - - (4.41)
-------------- -------------- --------------
Pro forma income tax rate 41.54 % 41.10 % 37.11 %
-------------- -------------- --------------
-------------- -------------- --------------
Set forth below are pro forma results operations for fiscal 1997, fiscal
1998 and fiscal 1999. The following table sets forth the calculation of basic
and diluted net income per share:
Fiscal 1997 Fiscal 1998 Fiscal 1999
---------------- ---------------- ---------------
Income before income taxes $ 8,457,565 $ 22,910,465 $ 31,978,549
Pro forma income taxes 3,513,265 9,415,631 $ 11,866,084
---------------- ---------------- ---------------
Pro forma net income 4,944,300 13,494,834 20,112,465
---------------- ---------------- ---------------
---------------- ---------------- ---------------
Pro forma net income per share - basic $ 0.31 $ 0.85 $ 1.12
---------------- ---------------- ---------------
---------------- ---------------- ---------------
Pr forma weighted average shares
outstanding - basic 15,794,200 15,794,200 18,029,777
---------------- ---------------- ---------------
---------------- ---------------- ---------------
Pro forma net income per share - diluted $ 0.31 $ 0.85 $ 1.11
---------------- ---------------- ---------------
---------------- ---------------- ---------------
Pro forma weighted average shares
outstanding - diluted 15,794,200 15,794,200 18,084,109
---------------- ---------------- ---------------
---------------- ---------------- ---------------
The pro forma weighted average shares outstanding - basic reflects the
effect of shares issued by the Company for the acquisition 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.
(10) CAPITAL STOCK
As of January 31, 1998, the capital structure of the EB Group consists of
two classes of Common Stock, Class A and Class B. The rights, duties and
privileges of the Class A and Class B common stock are identical in all respects
except that the Class A shares have voting rights and Class B shares have no
voting rights. In addition, preferred stock is authorized that contains a 10%
non-cumulative dividend and is non-participating, non-convertible,
non-redeemable and preferred as to the rights of the holders of the Class A and
Class B common stock in the event of a liquidation of the EB Group.
On July 28, 1998, the Company completed its reorganization and an initial
public offering of 5,000,000 shares of its common stock. Of the 5,000,000 shares
sold, 4,375,000 shares were for the account of the Company and 625,000 were for
the account of 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.
38
(11) 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% of their compensation to the plan. Company
contributions are at the Company's discretion and 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 $357,000, $302,000 and $389,000 in fiscal
1997, fiscal 1998 and fiscal 1999, respectively.
(12) EQUITY PARTICIPATION PLAN
The Company, in connection with its initial public offering, adopted an
equity participation plan pursuant to which 2,100,000 shares of common stock
were reserved for issuance upon the exercise of stock options granted to
employees, consultants and directors. The exercise price of option granted under
this plan may not be less than fair market value per share of common stock at
grant date; options become exercisable one to three years after the grant 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.
Pro forma information regarding net income and income per share is required
by Statement of Financial Accounting Standard ("FAS") No.123, and has been
determined as if the Company had accounted for its employee stock options under
the fair value method of that Statement. The fair value for these options was
estimated at the date of grant using a Black-Scholes option pricing model with
the following weighted average assumptions for fiscal 1999: risk free interest
rate of 4.55%; dividend yield of 0.0%; volatility factors of the expected market
price of the Company's common stock of 50.0%; and a weighted average expected
life of the options of 3.5 years.
The Company's relatively limited period of time as a public company makes
the determination of volatility difficult. For purposes of the FAS 123
calculation, the estimated volatility was determined by reviewing the
volatilities of publicly traded retail companies with similar characteristics.
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 the fair value of its employee stock options.
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
pro forma information follows:
Fiscal 1999
---------------------
Net income:
As reported (pro forma) $ 20,112,465
Pro forma net income $ 19,234,620
Pro forma income per common share:
Basic $ 1.07
Diluted $ 1.06
39
A summary of the Company's stock option activity, and related information for
the fiscal year ended January 30, 1999 follows:
Weighted
Average
Exercise
Options Price
------------------- ------------------
Outstanding at beginning of year - $ -
Granted 1,599,133 14.00
Forfeited 37,800 14.00
------------------- ------------------
Outstanding at end of year 1,561,333 $ 14.00
------------------- ------------------
------------------- ------------------
Exercisable at end of year - -
------------------- ------------------
------------------- ------------------
Weighted average fair value of options
granted during the year $ 5.75
------------------
------------------
The exercise price for all options outstanding as of January 30, 1999 was
$14.00. The average remaining contractual life of those options is 9.5 years.
(13) INCOME TAXES
As discussed in notes 1 and 9, 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 taxes were as follows:
Fiscal 1997 Fiscal 1998 Fiscal 1999
----------------- ----------------- ----------------
Domestic $ 8,457,565 $ 21,354,205 $ 31,331,801
Foreign - 1,556,260 646,748
----------------- ----------------- ----------------
Total $ 8,457,565 $ 22,910,465 $ 31,978,549
----------------- ----------------- ----------------
----------------- ----------------- ----------------
The provision for income taxes for fiscal 1997, fiscal 1998 and fiscal 1999
consists of the following:
Fiscal 1997 Fiscal 1998 Fiscal 1999
----------- ----------- -----------
Federal statutory tax rate 34.00 % 35.00 % 35.00 %
State income taxes, net of federal benefit 6.50 3.69 3.18
S corporation earnings not subject to
federal taxation (34.00) (35.00) (0.22)
Other - - 3.02
Change in valuation allowance - - (4.41)
-------------- -------------- --------------
Income tax expense 6.50 % 3.69 % 36.57 %
-------------- -------------- --------------
-------------- -------------- --------------
Current:
Domestic - Federal $ - $ - $ 9,767,127
Domestic - State 550,000 840,000 3,050,653
Foreign 60,528
Deferred:
Domestic - Federal - - 159,331
Domestic - State - - (719,669)
Foreign - 6,280 (624,700)
-------------- -------------- --------------
Income tax expense $ 550,000 $ 846,280 $ 11,693,270
-------------- -------------- --------------
-------------- -------------- --------------
40
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.
Deferred tax assets:
Inventory capitalized costs $ 1,632,000
Accrued expenses 705,000
Fixed assets 4,962,000
Deferred rent 922,000
Amortization of goodwill 167,000
Foreign net operating loss 839,000
-----------------
Total gross deferred tax asset 9,227,000
Valuation allowance (214,000)
-----------------
Net deferred tax asset $ 9,013,000
-----------------
-----------------
As a result of the acquisition described in Note 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 results from management's assessment that taxable income will more
likely than not be sufficient to realize the net deferred tax assets of
$9,013,000 as of January 30, 1999.
(14) PRO FORMA NET INCOME PER SHARE
The following table presents the computation of basic and diluted pro forma
net income per share:
Fiscal 1997 Fiscal 1998 Fiscal 1999
-------------- -------------- --------------
Basic pro forma net income per share:
Pro forma net income $ 4,944,300 $ 13,494,834 $ 20,112,465
---------------- ----------------- -----------------
---------------- ----------------- -----------------
Pro forma weighted average shares
outstanding 15,794,200 15,794,200 18,029,777
---------------- ----------------- -----------------
---------------- ----------------- -----------------
Pro forma net income per share -
basic $ 0.31 $ 0.85 $ 1.12
---------------- ----------------- -----------------
---------------- ----------------- -----------------
Diluted pro forma net income per share:
Pro forma net income $ 4,944,300 $ 13,494,834 $ 20,112,465
---------------- ----------------- -----------------
---------------- ----------------- -----------------
Pro forma weighted average shares
outstanding 15,794,200 15,794,200 18,029,777
Diluted effect of stock options - - 54,332
---------------- ----------------- -----------------
Pro forma weighted average shares
outstanding 15,794,200 15,794,200 18,084,109
---------------- ----------------- -----------------
---------------- ----------------- -----------------
Pro forma net income per share -
diluted $ 0.31 $ 0.85 $ 1.11
---------------- ----------------- -----------------
---------------- ----------------- -----------------
41
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE None
PART III
ITEMS 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 30, 1999, and in Item 1A hereof. Such information
is incorporated herein by reference and made a part hereof.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Exhibits
3.1 Certificate of Incorporation of the Company *
3.2 Bylaws of the Company *
4.1 Specimen Stock Certificate *
10.1 Form of Indemnification Agreement for Directors and Officers
of the Company*
10.2 Form of 1998 Equity Participation Plan of the Company*
10.3 Services Agreement, dated October 13, 1995, by and between EB
and EB-UK (f/k/a Rhino Group Plc)*
10.4 Loan and Security Agreement, dated March 16, 1998, by and
between EB and Fleet Capital Corporation *
10.5 Joinder Agreement by and between EBOA and Fleet Capital
Corporation *
10.6 Form of Employment Agreement by and between the Company and
Joseph J. Firestone *
10.7 Form of Employment Agreement by and between the Company and
John R. Panichello *
10.8 Form of Employment Agreement by and between the Company and
Jeffrey W. Griffiths *
10.9 Assignment, Bill of Sale, and Assumption Agreement, dated
May 31, 1998, by and between EB and EBOA *
10.10 Form of Registration Rights Agreement between the Company and
EB Nevada*
10.11 Form of Demand Note by and between James J. Kim and EBOA *
10.12 Assignment of Trademarks, dated May 31, 1998, by and between
EB and Elbo *
10.13 Addendum to Assignment of Trademarks by and between EB and
Elbo *
10.14 Form of Agreement of Lease by and between EB and EBOA *
10.15 Agreement and Bill of Sale, dated as of July 13, 1998, by and
between the Company and EB Nevada *
10.16 Agreement and Consent to Assignment and Assumption of
Partnership Interests, dated as of July 13, 1998 *
10.17 Amendment No. 1 to Loan and Security Agreement by and among
EB, EBOA and Fleet Capital Corporation *
10.18 Amendment No. 2 to Loan and Security Agreement by and among
EB, EBOA and Fleet Capital Corporation *
21.1 Subsidiaries of the Company
23.1 Consent of KPMG LLP
27.1 Financial Data Schedule
- --------------
* Incorporated by reference to the Company's Registration Statement on Form S-1
(Registration No. 333-48523)
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of the period
covered by this report.
42
SIGNATURES
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
Date: April 29, 1999
Pursuant 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 29, 1999.
NAME TITLE
- ---- -----
/s/ James J. Kim Chairman of the Board
- -----------------------------------
James J. Kim
/s/ Joseph J. Firestone President and Chief Executive Officer and Director
- ----------------------------------- (Principal Executive Officer)
Joseph J. Firestone
/s/ John R. Panichello Senior Vice President and Chief Financial Officer
- ----------------------------------- (Principal Financial and Accounting Officer)
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
43