OPERATING REVIEW
Summary of results
This is the first set of results for
the Company which shows a fall in both sales and profits,
but nonetheless I am pleased to report that the Games
Workshop Hobby, and the business which supports and maintains
it, continues to enjoy good health. For the last two
years we have been concerned that, for Games Workshop,
the Lord of the Rings business might create a bubble
effect* which might not be sustainable, but we have to
confess that we underestimated the impact which this
would have on our sales and profits in the last quarter
of this financial year. Once the level of the decline
became clear, we acted quickly to slow down our production
and to reduce unnecessary costs throughout the business.
We see this as a temporary reduction in sales for a business
which has proven its growth credentials over many years,
credentials we expect to re-establish. We are therefore
not taking short-term actions on our cost base which
would prejudice our ability to grow in the long term.
To reiterate, we continue to see the Company as a growth
business. Nevertheless, following the phenomenal growth
of the past few years, which has proven to be unsustainable,
we do need to call ‘time
out’ while we re-establish
our more normal pattern of growth in sales and profits.
We know what we need to do: we need to stick to the basics of our business model, which is designing and manufacturing the best model soldiers in the world, and getting these into the hands of hobbyists wherever they may be. There are no quick fixes or smart tricks, nor are we looking for any. The basics of the business remain sound in all of our territories. Both new and existing hobbyists continue to engage with our products, the quality of which we believe remains without peer.
* ‘We reported last year that DeAgostini, a third party business which had been granted a licence by the Games Workshop Group to produce a serialised gaming supplement based upon our Lord of the Rings tabletop battle game, launched its ‘Battle Games in Middle-earth’ product in the UK. This product, which was sold through traditional magazine newsstand distribution channels, was heavily TV advertised, and this resulted in an unexpected increase in the sales of our Lord of the Rings products. At the time we indicated that this ‘bubble’ effect increase in sales might not be sustainable in the future.’ (extract from the 2004 annual report)
Sales
The following chart sets this year’s turnover in
the context of the yearly development of the Group’s
sales:
Total sales - £m
The downturn in sales in the final quarter has been most evident in Continental Europe and the UK, territories which have experienced particularly strong growth in recent years buoyed especially by sales of the Lord of the Rings products.
Sales by territory
cc - constant currency*
* Constant currency growth is calculated by comparing sales in the underlying currencies for 2004 and 2005, both converted at the 2004 average exchange rates as set out in the financial review.
The Group has a single business segment, the Games Workshop Hobby. This is supported and promoted by our own hobby stores, through which 46% of sales are made. As we continue to grow the Hobby, we have opened another 21 stores during the year taking our total to 327. Sales are also made through independent retailers and direct, through the internet and mail order. An analysis of sales for each of the geographical segments is given below:
Sales by channel
Continental Europe
There are five autonomous sales businesses
in Continental Europe, whose mission it is to develop
the Games Workshop Hobby in France, Germany, Spain, Northern
Europe and Italy. We now have 99 Games Workshop Hobby
stores, up from 90 last year. Sales grew modestly in
Germany and Northern Europe but fell in the other businesses
during the year, in particular during the last quarter.
Nevertheless, we continue to see growth in community
activity and in the number of people attending our annual
Games Day celebrations of the Hobby, which augurs well
for the future.
UK
We have 120 Games Workshop Hobby stores in the UK
(2004: 117). Our UK business has seen a slowdown in sales
throughout the year, but the last quarter was particularly
tough. We have simplified the management structure
to improve the effectiveness of decision making and
implementation in the business, and to ensure that
the balance between customer facing and back office
roles remains healthy.
The Americas
2005 has been a year of consolidation and
bedding in for our operations in the Americas, which
for us comprises the USA and Canada, after the significant
investment and structural change which we effected in
2004. We believe that we now have a sales infrastructure
which can deliver long-term growth to the Group. Last
year we established three new regional sales offices
for the US in Chicago (Mid-West), Los Angeles (West)
and Memphis (South), in addition to the Baltimore (North-East)
operation; Baltimore was previously our sales centre
for the entire country. These offices, and the dedicated
sales teams which each has established, are now responsible
for sales in each region, and for providing customer
service both through independent retailers and through
our own Games Workshop Hobby stores. To support these
efforts on the ground we have opened a further eight
new Games Workshop Hobby stores, taking the total to
81 in the Americas. Sales in the year through our own
stores and through the direct internet and mail order
channels have continued to show healthy growth, while
sales to independent retailers have been in decline.
The health of our independent retailer customer base
in the USA has been a source of concern for some years
now: we began this year with 958 active accounts and
we have ended it with 798. This consolidation is in part
due to us choosing no longer to work with uneconomic
accounts, and in part due to some accounts going out
of business. We remain confident that the investment
we have put into each region will result in continued
sales growth in our own stores and through our direct
channels. Whether this will also help to restore the
health of our sales to independent retailers, we shall
have to wait and see.
Asia Pacific
This business comprises Australia and New
Zealand, where we now have 27 Games Workshop Hobby stores
(2004: 28). Our sales in local currency in Australia
and New Zealand were flat year on year, the Lord of the
Rings effect being less significant than in the UK or
Continental Europe. The improvement in performance of
this region has resulted from the refocusing of the management
team on Australia and New Zealand following the closure
of our Hong Kong and Singapore activities last year.
Just after the year end we opened our first store in
Tokyo, Japan. While we expect our business here to grow
modestly in its early years, we see this as an exciting
long-term growth area.
Manufacturing and supply chain
We have continued the programme of investment
in our vertically integrated design, manufacturing and distribution
supply chain this year, resulting in the consolidation
of our European supply activities onto our newly developed
Nottingham site. The final stage of this programme, which
involves moving our plastic injection moulding facility
from Wisbech, UK, to Nottingham, will be completed during
the next financial year. This programme is focused upon
ensuring that our supply activities are flexible and
responsive and that the needs of our Continental European
and UK businesses are catered for into the medium term.
This flexibility was well proved during the last quarter
of this financial year when the supply business responded
swiftly to the downturn in sales without a significant
growth in stock levels.
In June 2003 we opened our new Memphis warehousing and distribution facility, and in 2004 we introduced a box packing activity in the new facility. This year we have introduced both metal casting and plastic injection moulding in Memphis, and also bulk distribution for our Asia Pacific business. Going forwards we expect that the Memphis facility will supply the majority of the needs of both our American and Asia Pacific regions.
Other activities
Warhammer Online/computer games licensing
On 21 June 2004,
we announced the termination of our direct involvement
in the development of Warhammer Online, a venture to
operate a massively multiplayer online role-play game
(MMORPG) set in the Warhammer world. We have recently
concluded an agreement with Mythic Entertainment Inc.,
the developer and publisher of Dark Age of Camelot, who
will develop MMORPGs set in the Warhammer world under
licence from Games Workshop. Mythic Entertainment Inc.
expects the first game to be released on PC in 2007.
In addition to the MMORPG licence, we have granted licences in relation to our intellectual property to certain publishers of console and PC based computer games. THQ Inc. published Dawn of War during the year, based on our Warhammer 40,000 property, and we have recently licensed Namco Hometek Inc. to publish games based on our Warhammer property.
BL Publishing
Our publishing business, which made sales
of some £1.3m
this year, has continued its strategy to extend its activities
outside the Warhammer and Warhammer 40,000 intellectual
properties into other fantasy, science fiction and horror
properties published under the Black Flame title. This
business is developing a small but profitable niche publishing
portfolio, while continuing to enhance and develop the
existing Games Workshop intellectual property.
Sabertooth Games
This US based collectible card game
business, which has been struggling to break even since
we acquired it in 2002, is now based in our Memphis facility
to ensure that it can carry on business on a low cost
infrastructure and obtain the maximum benefit from Games
Workshop’s
operational and logistical structures. We believe that
these actions will place this small business (sales this
year of $1.6m) on a firmer footing for the future.
Management structure
Last year we established a divisional
management structure for the business with four management
groups.
Each division has clearly defined responsibilities as follows:
Games Workshop Tabletop Wargaming division – responsible for the development of the Hobby throughout the world. This encompasses the sales businesses in each territory around the world as well as the design studio based in Nottingham.
Manufacturing and Supply division – responsible for the realisation of the designs into manufactured products, and the supply and distribution of those products to our sales businesses and their customers around the world.
Other Activities division – responsible for the sales of all non-tabletop wargaming products, including publishing, collectible card games and computer games.
Group – responsible for the financing and corporate governance of the activities carried out in the divisions. This also includes intellectual property management, legal, treasury, reporting and investor relations.
This structure has been in place throughout this year, and in addition to improving our business focus we believe that we are now better placed to address the key areas of management recruitment, development and succession planning in a more systematic way.
Workforce
Games Workshop is a special business with an
even more special workforce. Many share a passion for
the Games Workshop Hobby, and those who do not have an
equally strong passion for providing excellent quality
service to support it.
This year has been tough for all of our staff as we see the sales ‘bubble’ deflating. And it remains tough today too. Most of our staff love what they do, but they also love to succeed. It is part of management’s job in Games Workshop to provide reassurance to our staff that success isn’t just about beating last year’s numbers (although that helps), it is about doing your best, every day, to develop and further the business. So long as our staff are doing that, then they get my wholehearted vote of confidence.
So once again, I would like to use this annual report to say thank you to all our staff and I trust that our shareholders will join me.
Risks facing our business
Managing the risks which face
our business is what we do every day. The divisional
management structure referred to above is how we make
this process transparent and accountable. The Games Workshop
Tabletop Wargaming division is responsible for keeping
the Hobby fresh and exciting and for managing market
facing risks, the Manufacturing and Supply division is
responsible for managing product delivery risks, the
Other Activities division is responsible for using our
intellectual property appropriately while not distracting
our tabletop wargaming activities, and Group is responsible
for managing corporate risks. We have a formal risk reporting
process as part of our annual budgeting and planning
cycle, which is linked into the internal and external
audit process, but the management of these risks is an
integral part of the daily management process.
Foremost amongst the market facing risks is our ability to forecast sales and factory demand. As I have indicated elsewhere, we failed this year to accurately forecast the extent of the sales downturn after the last of the Lord of the Rings movies, although our supply business was able to react very swiftly once the decline was upon us. We are currently looking at ways in which we might better predict future sales by using trend analysis and statistical tools – however, we believe it is unlikely that we will again find ourselves with such a significant sales ‘bubble’ caused by third party advertising and movie marketing, neither of which forms part of our normal business model.
Amongst the product delivery risks are those relating to input prices. The cost of core raw materials (metal and plastic) represents no more than 3% of our sales. While the prices of these commodities have shown significant volatility during the last 18 months, we do not believe that this volatility represents a significant threat to our long-term profitability. In the short term, our buying team continues to work hard to minimise these risks and the Manufacturing and Supply division continues to seek process efficiencies to offset any cost impact.
Many of our risks are mitigated by the significant portfolio effect which we usually enjoy with different geographies, different routes to market and different currencies. This leads me to conclude that the main source of risk for us remains management error. This is why management recruitment, development and succession planning are so important.
Prospects
In the short term our trading prospects remain
challenging: it is inherently difficult to predict when
our sales will again re-establish their historical growth
rates once we have put the Lord of the Rings sales ‘bubble’ behind
us.
However, we remain confident that we are right to refer to these as short-term trading issues. This confidence is based upon the following three fundamentals:
1. The long-term growth credentials of the business
As I have indicated above, we see Games Workshop as
a growth business. The chart below sets out our sales
progress from 1991. Between 2002 and 2004, the Lord of
the Rings products took our sales above the normal growth
line, and the ‘bubble’ is now deflating.
We believe that it is only a matter of time before we
resume our historic linear growth rate.
Sales - £m
2. The market opportunity for our existing sales businesses
The chart below shows our sales per capita in our key sales territories, based upon our 2005 sales and the population statistics for each country. In the long term we see no reason why we shouldn’t achieve similar levels of sales penetration in each of these markets to those which we currently have in the UK. Achieving this would result in a multiple of our current level of sales.
Sales per capita by geographical area
Source: Population information is sourced from the 2004 World Population Data Sheet of the Population Reference Bureau. Sales volumes are shown by geographical territory as defined above.
This is not a sales forecast but a rough indication of what the future potential for Games Workshop might be.
3. The health of the Games Workshop Hobby
Despite our short-term difficulties, the Hobby is in good health. Add to that we are coming to the end of our programme of building developments in Nottingham, which leaves the business seriously well invested.
The directors believe the long-term prospects for the business remain very good.
Tom Kirby
Chairman and Chief Executive
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