Gamestop Corp. Business Information, Profile, and History

Company Perspectives:

Our goal is to enhance our position as the nation's largest specialty retailer of new and used video game products and PC entertainment software by focusing on the following strategies: Targeting a Broad Audience of Game Players; Enhancing Our Image as a Destination Location; Offering the Largest Selection of Used Video Game Products; Building the GameStop Brand; Providing a First-to-Market Distribution Network; Investing in Our Information Systems and Distribution Capabilities.

History of Game Stop Corp.

GameStop Corp. is the largest U.S. player in the retail sector specializing in video game and PC entertainment software, and also ranks in the top five in the broader toy retailing sector. In addition to new and used software, GameStop's stores also sell new and used video game equipment. The company operates approximately 1,750 retail stores located in 49 states (the exception being Wyoming), the District of Columbia, Puerto Rico, and Ireland, primarily under the GameStop brand. Nearly two-thirds of the stores are located in strip shopping centers, and these average about 1,500 square feet in size. Most of the remainder are located in shopping malls and are smaller on average, approximately 1,200 square feet. GameStop also operates an e-commerce web site at www.gamestop.com and publishes Game Informer, one of the leading multiplatform video game magazines, with more than 1.5 million subscribers.

Early Years of Babbage's

GameStop has a lineage that includes several retailing names now relegated to the historical graveyard. One of the key predecessors was Babbage's, Inc., named for Charles Babbage, the 19th-century British mathematician generally credited with inventing the first major forerunner of a computer. Babbage's traces its roots to two Harvard Business School classmates, James B. McCurry and Gary M. Kusin. At Harvard during the mid-1970s, McCurry and Kusin discussed going into business together but went in separate directions after graduation. McCurry became a consultant for Bain & Company's San Francisco office, while Kusin became a Dallas-based general merchandise manager for the Sanger-Harris division of Federated Department Stores. In 1982 McCurry approached Kusin with a business proposal to establish a chain of software stores that would capitalize on the burgeoning computer and home video game industries. His idea was based on the expectation that increasing consumer interest in computer equipment and games would make the specialty store the ideal marketing outlet. Kusin, who had been watching such specialty stores gradually take over department store business, liked the idea, and, at the end of the year, both men quit their jobs and began seeking startup financing for a software business.

McCurry and Kusin's business plan met with little interest among venture capitalists until February 1983, when businessman Ross Perot--who knew Kusin's family in Texarkana--offered to provide a $3 million credit line in exchange for one-third ownership in the company. Perot also advised the entrepreneurs to shelve their plan for immediately opening 20 stores in favor of establishing one outlet, which they would manage themselves until they knew the business inside and out. McCurry and Kusin took Perot's money and advice, and, on Memorial Day 1983, they opened the first Babbage's store in a Dallas regional mall. McCurry, the company's chairperson, managed the company's finances, while Kusin, the company's president, acquired software products from local distributors. Both partners took turns opening and closing the store and seeing to other administrative details.

During this time, McCurry and Kusin tested their business strategy, which involved four key provisions: a constantly updated mix of products, a competitive pricing system, a flexible store design with sections devoted to various computer and entertainment system platforms and software categories, and an enthusiastic, noncommissioned sales staff that would not intimidate customers with technical jargon. Two months after opening the first Babbage's store, McCurry and Kusin met their sales projections and hired their first full-time employee, Mary Evans, who later became vice-president of stores. Between Labor Day and Thanksgiving of 1983, Evans helped open and manage four more Dallas-area stores.

Babbage's set a precedent of selling entertainment software for the most popular computer and video game systems. At the time, the dominant home video game system was the Atari 2600, which featured four-color graphics. Eventually Atari was superseded by Nintendo and Sega of America systems, and Babbage's redirected its product line accordingly.

In 1984, Babbage's first full year of operations, the company lost $560,000 on sales of $3 million. Two years later, it broke even after generating nearly $10 million in revenues from an expanded chain of 23 stores, financed through the private sales of company stock. In 1987 Babbage's added another 35 stores and began selling software for the then-dominant eight-bit Nintendo Entertainment System with 16-color graphics. For fiscal 1987, the company earned $1.16 million on sales of $29 million.

In July 1988 Babbage's took its software specialty store concept public, offering 30 percent of the company's equity for $20 million, or $13 a share. Following the public offering, Perot tendered his stake in the company, and Babbage's continued accelerating its expansion drive with the proceeds of stock sales, opening 50 new stores that year to give the company 108 retail outlets. This expansion resulted in rising sales; in 1988, Babbage's annual revenues doubled to $58 million, while earnings shot up 136 percent to $2.7 million.

In 1989, Babbage's began losing business because of severe allocations of video games. Struck by a string of losses in the first three quarters of the year, the company responded by reducing prices on leading computer software titles and adding new cartridge-based video games to its line. Moreover, in the fall, Babbage's helped introduce the new 16-bit, 64-color Sega Genesis entertainment system, which quickly changed the landscape of the video game industry. Because of its superior capabilities, Sega Genesis generated a renewed interest in home video game systems. Rising sales of entertainment systems and software contributed to a strong 1989 holiday sales season for Babbage's, as the company managed a $2.3 million profit on annual sales that increased 62 percent to $95 million.

Early 1990s: Rising Revenues from New Game Systems

Fifty-three new store openings in 1989 (bringing the company's total to 160) and a barrage of new low-profit-margin products pushed the company's earnings and its stock's trading value down. By early 1990, Babbage's stock, which had debuted at $13, had plummeted to less than $5. Babbage's responded to its financial troubles by scaling back the company's expansion program--opening only 19 stores in 1990--and focusing on cost-control measures and improved inventory turnover. Moreover, a new computerized point-of-sale inventory system was established, tracking sales and inventory after each business day and automatically generating orders for shipment from the company's Dallas warehouse the following morning. Powered by a surge in video game systems and software--including Sega's 16-bit Genesis and Nintendo's handheld Game Boy player--the company's revenues rose 39 percent to $132.8 million in 1990 as earnings increased to $4.1 million.

Opal P. Ferraro, who joined Baggage's in 1986 as controller, was named chief financial officer in 1991, and, two years later, Ferraro joined McCurry and Kusin as the only other company officer on Babbage's board of directors. With the company in improved financial shape, Babbage's boosted its number of stores from 178 to 204 and reported 1991 earnings of $5.58 million on sales of $168.3 million.

In 1992 Babbage's added more than 40 new stores and began selling a CD-ROM peripheral attachment for the Sega 16-bit system that allowed interaction with digitized video footage. Sparked by a price war in the computer industry, sales of IBM-compatible software and 16-bit video systems and software rose substantially, and the company's stock value increased accordingly, climbing to more than $24 per share. The company's earnings also increased 21 percent to $6.78 million, and sales jumped 24 percent to $209.1 million.

In the fall of 1993, Babbage's began selling Panasonic's 32-bit game system, which operated through compact discs. This new technology threatened to render the 16-bit systems obsolete, and Babbage's experienced rapid declines in its sales of video game systems and software during the Christmas season, with the average Babbage's store posting 5 percent lower sales than a year earlier. Realizing that the market for 16-bit technology had matured, Babbage's slashed prices on hundreds of video game titles early the following year in an effort to unload its inventory of the increasingly dated software.

In 1993 Babbage's opened 56 new stores. The company, however, generated only a 12 percent increase in sales, and, for the first time since 1989, increased revenues did not translate into higher earnings for the company. Earnings fell 36 percent to $4.3 million that year as entertainment software continued to comprise about two-thirds of Babbage's business. Education and productivity software, along with computer supplies and accessories, cumulatively accounted for the remaining third.

1994 Merger with Software Etc., Creating NeoStar Retail Group

Babbage's entered 1994 with a 300-store chain and plans to open between 30 and 40 more stores that year. As a result of holiday season price reductions, Babbage's stores had substantially reduced their inventory. The company was in a stronger financial position, however, as it had no long-term debt and maintained a cash surplus of $10.5 million. Babbage's entered the mid-1990s facing increasing competition from other software specialty stores, mass merchandisers (such as Wal-Mart Stores, Inc.), computers centers and superstores, electronics stores (particularly Best Buy Co., Inc. and Circuit City Stores, Inc.), toy stores, and mail-order outlets, many of which were larger operations and had greater resources at their disposal. In order to better position itself within this increasingly competitive environment, Babbage's elected to merge with another specialty software retailer.

Software Etc. Stores, Inc., Babbage's merger partner, began in 1984 as a division of B. Dalton Bookseller Inc., then owned by Dayton Hudson Corporation. That year, B. Dalton began adding Software Etc. "stores-within-a-store" to its bookstores. Late in 1986, however, Dayton Hudson sold B. Dalton to Barnes & Noble, Inc. (B&N), Leonard Riggio (the chairman and founder of B&N), and Dutch retailer Vendex International N.V. Riggio played a key role in separating Software Etc. from B. Dalton, and the former began operating as Software Etc. Stores, Inc. in 1987. A gradual physical separation began as well, as Software Etc. units moved out of B. Dalton bookstores and into their own, largely mall-based, standalone stores. The chain was also expanded to nearly 200 units by the end of 1988, and its product mix was altered, away from entertainment software toward higher-end PC and Mac software applications. Software Etc. then broadened its product line in 1990, once again selling video game software. The company's timing was excellent as it was able to ride the latest crest in the video game sector in the early 1990s, registering 20 to 30 percent annual increases in same-store sales (that is, sales at stores open at least one year). Revenues for the fiscal year ending in October 1991 reached $152 million, up $35 million from the previous year. Early in 1992, operating about 230 stores in 37 states and the District of Columbia, Software Etc. Stores completed an initial public offering of 2.3 million shares of common stock at $11 per share.

By the completion of the merger with Babbage's in December 1994, Software Etc. was operating about 380 stores and had annual revenues of about $240 million. Babbage's had about 335 stores and revenues of $230 million. There was little overlap between the two chains: the two operated stores in fewer than 50 of the same malls. Combined, the chains fielded stores in more than half of the 1,200 malls in the Unites States--making it the largest consumer software specialty retailer in the country. The deal was structured as a stock swap in which both Babbage's and Software Etc. shareholders received shares in a newly formed holding company, NeoStar Retail Group, Inc. Babbage's, Inc. and Software Etc. Stores, Inc. became subsidiaries of NeoStar, and each chain retained their separate identities. Riggio was named chairman of NeoStar's executive committee; Babbage's chairman, McCurry, became board chairman and CEO of NeoStar; and Kusin, president of Babbage's, and Daniel DeMatteo, president of Software Etc., continued in those same roles. In February 1995, however, Kusin left the company, and DeMatteo was named president and COO of NeoStar. Headquarters for NeoStar were established in Dallas, where Babbage's had been based.

The 1995 introductions of a new generation of video game systems, the Sega Saturn and Sony Playstation, both 32-bit systems, failed to provide the boost to NeoStar that the previous new waves of hardware had given to the company's predecessors. One key reason was competition. Previously, Babbage's and Software Etc. stores were two of the few places where the latest systems and games were available early on. By the mid-1990s, mass-market retailers such as Wal-Mart, Best Buy, Target, and Toys "R" Us, Inc. had stepped strongly into the market. As a result, sales began declining, and NeoStar managed to post only a minuscule profit of $120,000 for the fiscal year ending in January 1996 on sales of $513.5 million. In the first quarter of the following year, same-store sales fell 9 percent and the loss of $8.3 million was more than double that of the previous year. This prompted management and organizational changes. DeMatteo resigned and McCurry took on the additional post of president. NeoStar's three retail units (the third operating leased software departments within Barnes & Noble bookstores) were combined into one organization, and Alan C. Bush was brought onboard as its head. Bush was the former president of Tandy Corporation's Computer City division. Soon thereafter, in July 1996, Barnes & Noble took over management of the software departments at its stores.

1996-2002: The Riggio/B&N Era Involving Babbage's Etc., Funco, and GameStop

Not able to stem the decline in sales nor to secure enough financing to stock its shelves for the coming holiday season, NeoStar filed for Chapter 11 bankruptcy protection in September 1996. Board member Thomas G. Plaskett was named chairman and charged with leading the reorganization, while McCurry continued to handle day-to-day operations as CEO and president. Plaskett had gained a reputation as a turnaround expert from his failed but valiant attempt to rescue Pan Am Corp. in the late 1980s and early 1990s and from his success at saving Greyhound Lines, Inc. in the mid-1990s. In October 1996 NeoStar announced it would close 42 of its stores, all of which were located near other company stores. When the company could not secure the additional financing it needed in order to reorganize, the stores were placed up for sale. Finally, in November, a group of investors led by Riggio bought the chains for $58.5 million, beating out a rival bid from Electronics Boutique Holdings Corp., Babbage's and Software Etc.'s biggest competitor.

Riggio created a new holding company called Babbage's Etc. LLC, which took over the operation of 467 Babbage's and Software Etc. outlets. The remaining 200 or so stores were shut down. Riggio served as chairman, and he brought R. Richard "Dick" Fontaine back onboard as CEO. Fontaine had been the chief executive of Software Etc. during the late 1980s and early 1990s. Likewise, DeMatteo returned as president and chief operating officer. The two chains began keeping a similar mix of video game and software titles, with an increasing emphasis on the former. Improved operational strategies and the introduction of a new 64-bit Nintendo system helped Babbage's Etc. return to double-digit growth in the late 1990s.

By 1999 Babbage's Etc. had recovered sufficiently to begin growing again. Plans were set for opening 50 new stores that year, and a significant portion of this growth was aimed at expanding the company into the field of strip malls. A new name, GameStop, was selected for the 20 new strip mall outlets. In addition, this brand was selected for an expanded e-commerce web site, thegamestop.com (later shortened to gamestop.com). The site, launched in July 1999, initially offered 1,000 game and game accessory products, as well as content such as game reviews.

In October 1999, shortly after the launch of GameStop and the web site, Riggio and company sold Babbage's Etc. to Barnes & Noble for $215 million. Although some analysts raised their eyebrows at the price B&N paid for Babbage's--more than three times what Riggio's group had paid for it three years earlier--a spate of new game systems augured well for the timing. Sega's Dreamcast and Nintendo's handheld Game Boy Color machines were released in the latter months of 1999 and Sony's 128-bit PlayStation 2 system made a spectacular debut in the fall of 2000.

B&N wasted little time bolstering its new subsidiary. In the spring of 2000 it entered into a bidding war with Electronic Boutique Holdings over Funco, Inc., operator of about 400 FuncoLand video and computer games stores, mainly located in strip malls, with revenues for the fiscal year ending in March 1999 of $206.7 million. B&N emerged victorious, completing a $161.5 million acquisition of Eden Prairie, Minnesota-based Funco in June 2000. The deal was noteworthy both for the significant boost it gave to Babbage's nascent move into strip mall centers and for FuncoLand's major business in used video games. About 40 percent of its revenues came from the sale of used games, which were bought from customers and then resold--with a much higher markup than what was typical for new games. Funco also published Game Informer, one of the industry's leading multiplatform video game magazines. In the structure of this latest deal, B&N acquired Funco, and Babbage's Etc. became a wholly owned subsidiary of Funco. Then in December 2000 Funco changed its name to GameStop, Inc., marking the beginning of what would be a gradual shift to the GameStop name.

As GameStop increased its store count past the 1,000-unit mark during 2001, it received a lift from several more new game system releases: Nintendo's Game Boy Advance, which debuted during the summer, and Microsoft Corporation's long-awaited Xbox console and Nintendo's GameCube system, both launched in November. The industry was clearly on another uptrend: The number of installed video game systems in the United States jumped from 26 million in 2000 to 65.1 million in 2002. The time seemed right for B&N to partially cash in on its foray into gaming, and GameStop Corp. was incorporated in August 2001 in anticipation of an initial public offering.

The first attempt at an initial public offering (IPO), however, failed. B&N had intended to take GameStop public on the NASDAQ in the fall of 2001, but an adverse IPO market thwarted that attempt. Instead, GameStop Corp. was listed on the New York Stock Exchange in February 2002 through the sale of 20.8 million shares at $18 per share. Just prior to the listing, B&N transferred all of its interest in GameStop, Inc. to GameStop Corp. Following the IPO, B&N retained a controlling 67 percent interest in GameStop.

Independent GameStop Corp., 2002 and Beyond

Under the continued leadership of Fontaine as chairman and CEO, and DeMatteo as president and COO, GameStop expanded smartly in 2002 and 2003, opening 210 and 300 new stores, respectively. During this period the company rebranded more and more of its stores under the GameStop name, until by 2004 nearly all of the units used that moniker. Two-thirds of the stores were now located in strip malls which were considered more convenient than enclosed shopping malls by most consumers. The company had its best year ever in 2003, posting record sales ($1.58 billion) and record profits ($63.5 million). Perhaps most impressive, GameStop was profitable every quarter. In all of its various past incarnations, it had made money only during the last, holidays-inclusive quarter. GameStop also ventured overseas during 2003, spending $3.3 million to acquire a controlling interest in Gamesworld Group Limited, which ran 16 electronic games stores in Ireland.

Through the first nine months of 2004, GameStop opened another 230 stores. Longer term, the company's executives estimated that it could open several thousand more outlets before having saturated the U.S. market. The rapidly expanding company was quickly outgrowing its headquarters in Grapevine, Texas, and in May 2004 announced that it would move into a larger building in the spring of 2005. Late in the year, GameStop gained its full independence from Barnes & Noble. In October it spent $111.5 million to buy back 6.1 million shares of its stock from B&N. One month later, B&N distributed its remaining 59 percent GameStop stake to B&N shareholders as a tax-free dividend. The newly independent company appeared to have a bright future as the video game industry seemed to be less cyclical than in the past because of the ever-increasing installed hardware base (which reached 86.9 million units in 2003), although the competitive environment continued to loom as a threat to GameStop's long-term prospects.

Principal Subsidiaries: GameStop, Inc.; GameStop.com, Inc.; Marketing Control Services, Inc.; Sunrise Publications, Inc.; Babbage's Etc. LLC; Gamesworld Group Limited (Ireland; 51%).

Principal Competitors: Electronics Boutique Holdings Corp.; Best Buy Co., Inc.; Circuit City Stores, Inc.; Wal-Mart Stores, Inc.; Toys "R" Us, Inc.; Target Corporation; Kmart Corporation; Amazon.com, Inc.

Chronology

• Key Dates:
• 1983: James B. McCurry and Gary M. Kusin found Babbage's, Inc., opening the first Babbage's software store in a Dallas regional mall.
• 1984: B. Dalton Bookseller Inc. creates a division called Software Etc. to open software stores within B. Dalton bookstores.
• 1986: Dayton Hudson Corporation sells B. Dalton to Barnes & Noble, Inc. (B&N) and partners.
• 1987: Software Etc. is split off from B. Dalton, begins operating as Software Etc. Stores, Inc., and starts shift to standalone locations.
• 1988: Babbage's is taken public to accelerate an expansion drive.
• 1992: Software Etc. Stores is taken public.
• 1994: Babbage's merges with Software Etc., forming NeoStar Retail Group, Inc.
• 1996: NeoStar files for Chapter 11 bankruptcy protection; an investor group led by Leonard Riggio buys the Babbage's and Software Etc. chains, operating them within the newly formed Babbage's Etc. LLC.
• 1999: New strip-mall-based chain, GameStop, is launched; e-commerce web site, later called gamestop.com, begins operations; Babbage's Etc. is sold to Barnes & Noble for $215 million.
• 2000: B&N acquires Funco, Inc., operator of 400 FuncoLand video game stores, mainly in strip malls; Babbage's Etc. becomes a wholly owned subsidiary of Funco, which changes its name to GameStop, Inc.
• 2001: GameStop Corp. is incorporated in anticipation of an initial public offering (IPO).
• 2002: B&N completes a partial IPO of GameStop stock; it retains a 67 percent stake in GameStop.
• 2004: B&N distributes its remaining stake in GameStop to B&N shareholders, making GameStop a fully independent corporation.