BUSINESS REVIEW

Summary of results
This has been a tough year for Games Workshop. However, as a result of the actions taken by management, the Group is now preparing itself for the future as a leaner and more responsive organisation, better equipped to face the growth challenges which lie before it.

Our sales performance over the year has been patchy and difficult to predict accurately: a poor first quarter was followed by a more encouraging second quarter; our third quarter was soft, although we finished the year positively. This lack of consistency required us to make two trading statements during the year as small sales shortfalls created large percentile reductions in profits due to the high operational gearing of our business. Management's response to this has been twofold: firstly, a reinvigorated focus on growing sales, and secondly, a cost reduction programme to reduce the overhead base of the business.

In terms of sales growth, while the overall portfolio shows flat sales for the year in constant currency, the evidence from our larger and more established sales businesses is encouraging. In the UK, which is our most mature sales business, we have seen sales growth for eight out of the last nine months of the financial year; the US sales business, which we expect to be a significant engine for future growth, has turned around its sales to independent retailers, which have also been in growth for eight out of the last nine months, and is now seeing sales growth in our own Games Workshop Hobby stores in its target cities; Australia and New Zealand, our second oldest sales business, has recorded growth in constant currency of 8% in the year. Our overall sales have been held back by our performance in Continental Europe – an area which was enjoying strong growth between 2001 and 2004. Management's response to the decline in sales since 2005 has led to changes in the management teams in all but one of our Continental European territories. These changes are designed to allow better focus on sales delivery, and to avoid the distractions of back office and infrastructure matters. Our confidence in growth remains: we have continued to open Games Workshop stores, adding a net eleven to the portfolio this year.

Our efforts to restore the profitability of the business need to focus both on sales and costs. Even though we have set specific and measurable financial targets for the immediate costs and benefits of the cost reduction programme, we see this as a long-term process to ensure that the business only incurs those costs which are necessary to service our customers properly.

In summary, we are confident that sales will return to growth in the future and we are continuing to invest in people and assets to secure that growth; but we are also removing unnecessary costs today and working at preventing their return.

Cost reduction programme
In May this year, we announced the acceleration and intensification of our programme of cost reduction to reduce overheads in the business. There are three key areas of this programme:

• Closing loss making stores
• Rationalisation of the manufacturing and supply chain
• Simplification of the support infrastructure

We have identified 32 stores which are unprofitable due to either low sales or high rents, and which we see as irremedial. Seventeen of the stores identified for closure are in the Americas, and these are located outside our selected metropolitan areas. A further eight are in the UK, six in Continental Europe and one in Asia Pacific. By closing these stores, we are also removing a significant management distraction from our sales businesses.

The rationalisation of elements of our manufacturing and supply chain includes the closure of the tool making facility at Wisbech, UK, which is being relocated to our main Nottingham site where a new tool room is being established. In addition, our Canadian warehouse is being closed and the existing dispatch facility in Memphis will pick up its workload. A further element of the programme is to rationalise inventory management. As automatic inventory replenishment is introduced to our UK stores, we will transfer the responsibility for managing these inventories to our logistics team which also manages our warehouse inventory. This will coincide with a review of the store product range. Inventories will be further reduced by introducing just-in-time manufacturing to our plastics production.

A few years ago we established a divisional structure for the business, which was organised into four separate management units, each with its own support infrastructure. We are simplifying this structure back to one operating management team, while maintaining the control benefits of the reporting and KPIs that each division had developed. Also, in the sales businesses, we are removing the cell management structures from our store chains. We believe that these changes will create a leaner, flatter and more responsive organisation. In addition, we are centralising some support functions (White Dwarf magazine, marketing, IT) further to streamline the customer facing activities and remove unnecessary duplication of back office functions.

We have set specific and measurable financial targets for the costs and benefits of each element of this programme.

 
Estimated
total costs
Estimated
annualised benefits
 
£m
£m
Closing loss making stores
1.7
1.2
Rationalisation of the manufacturing and supply chain
2.3
1.7
Simplification of the support infrastructure
2.0
4.1
 
A thin, black line.
A thin, black line.
Total
6.0
7.0
 
A thick, black line.
A thick, black line.

£4.0 million of these costs has been recognised as an exceptional item in these accounts and the balance will be accounted for in 2008.

Dividend
We are using the cash which would have otherwise been applied in paying a final dividend for 2006/7 to finance the cost reduction programme described above. The board remains confident in the future growth and profitability of the Group, but has determined that, until that time, this cash is better used by investing in this programme to secure those future profits.

Sales
This year's revenue, in the context of the yearly and half yearly development of the Group's sales, is as follows:

Total sales - £m

Sales by channel

The Games Workshop Hobby is supported and promoted by our own Games Workshop Hobby stores, through which 49% of sales are made. As we continue to develop the Hobby, we opened 24 and closed 13 stores during the year taking our total at the end of May 2007 to 348. Sales are also made through independent retailers and direct, via the internet and mail order. An analysis of sales for 2006/7 for each of the geographical sectors is given below:

Sales by channel Sales by channel

 

Sales by territory

An analysis of sales for 2006/7 for each of the geographical sectors is given below:

Sales by territory
cc - constant currency*Sales by territory

*Constant currency growth is calculated by comparing sales in the underlying currencies for 2006 and 2007, both converted at the 2006 average exchange rates set out in the financial review.

Continental Europe
There are five stand alone sales businesses in Continental Europe, responsible for development in France, Germany, Northern Europe, Spain and Italy. At the year end, we had 114 Games Workshop Hobby stores, up from 106 last year. Our sales have fallen in France, Germany and Spain, but there has been modest growth in Northern Europe and Italy. Most of the decline has been in our sales to independent retailers, which is the sales channel which enjoyed particularly strong growth during 2003 and 2004 throughout Continental Europe. We have been concerned that our local management teams in Germany and France have been slow to react to the decline in sales since 2005 and have, in addition to the changes mentioned above, appointed our most experienced senior manager as head of sales for Continental Europe in order to increase the focus on profitable growth.

UK
At the end of May 2007, we had 118 Games Workshop Hobby stores in the UK (2006: 119). After a weak first quarter, the business was in modest growth for the rest of the year. In the second half of the year we saw a return to growth in our sales to independent retailers, and our Games Workshop Hobby stores have continued to perform satisfactorily. Our focus has remained on staff training, recruitment and retention, particularly for the key posts of store managers. We continued to keep the cost base under close review, reducing both our back office costs and the regional management structure for the stores.

The Americas
During the year, we opened seven and closed eight Games Workshop Hobby stores in the Americas, which for us comprises the USA and Canada, bringing our total at the end of May 2007 to 82. We have established that our best model both for the development of the Hobby and for management command and control is to focus upon selected metropolitan areas where we can cluster our stores to grow and nurture the Hobby community. Our development plan moving forwards is to recruit staff, bring on middle management and deliver great Games Workshop Hobby activity centred around this metropolitan area strategy. We have concentrated our resources on five metropolitan areas, and in these areas our Games Workshop Hobby stores are enjoying growth. Our store programme has continued to shift the emphasis from the more expensive covered shopping mall stores to cheaper and more flexible strip mall locations. This strategy will also support and develop the independent retailer base in these major metropolitan areas. A key development this year was the stabilisation of our independent retailer base: in the USA we began the year with 729 active accounts and we ended it with 821. Our sales to independent retailers were in growth for eight out of the last nine months, and for the full year they were flat - the first year without a decline since 2002.

Our plan to close loss making stores during 2007/8 includes 17 stores in the Americas. The closure of the stores will improve the profitability of the business in the Americas and will also remove a significant burden from the local management.

Asia Pacific
This territory comprises Australia, New Zealand and Japan. At the year end, we had 34 stores in the whole region (2006: 29). Our operations in Australia and New Zealand enjoyed a successful year, led by a strong performance from our Games Workshop Hobby stores. We opened our second and third stores in Japan during the year and we see this as the beginning of a long-term investment which cost us £0.5 million this year. The initial indications are promising and we expect to open our fourth store shortly.

Other activities
Computer games licensing
We have in place three third party licences with publishers of computer games: THQ Inc. for Warhammer 40,000, NAMCO BANDAI Games America Inc. for Warhammer and Electronic Arts Inc. (which acquired Mythic Entertainment Inc. during the year) which is developing a massively multiplayer online role-play game set in the Warhammer world. We understand that this online role-play game (WAR - Warhammer Online: Age of Reckoning) is due to be launched during the first half of the 2008 calendar year. We expect licensing income to fluctuate from year to year, depending on the commercial success of the products created by our licensees.

BL Publishing
Our publishing business, which made sales of £3.1 million this year (2006: £2.6 million), continues to develop as a small but profitable niche publishing portfolio, focusing on fantasy and science fiction titles.

Sabertooth Games
This US based collectible card game business, which has been struggling to break even since we acquired it in 2002, has enjoyed significant success this year with its Universal Fighting System collectible card game which has begun the turnaround of the fortunes of this small business. Sales for the year were $2.3 million (2006: $1.1 million).

Workforce
This has been a particularly hard year for everybody at Games Workshop. We have lost some dear and old friends; many families are facing the worry and hardship of redundancy. Nevertheless there is determination and resolve to drive forward our sales plans and to push through the changes we are making to the cost base. What I find inspiring is the ability our staff are showing, throughout this period of personally disruptive and unsettling structural change, to remain focused on their jobs. All the stakeholders in Games Workshop should remain proud of the workforce we have all over the world.

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 the business
Managing the risks which face our business is what we do every day. Our management structure and the reporting systems which we have developed make this process transparent and accountable. The head of sales is responsible for keeping the Games Workshop Hobby fresh and exciting and for managing market facing risk; the head of operations is responsible for managing product delivery risks; the head of finance is responsible for using our intellectual property appropriately, for managing corporate risks and for ensuring we comply with the ever waxing (and never waning) regulatory environment. 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.

Amongst the product delivery risks are those relating to input prices. The cost of raw materials, such as metal and plastic, represents no more than 4% of our sales and therefore we do not believe that the price volatility of these inputs represents a significant threat to our long-term profitability. In the short term our buying team continues to work to minimise these risks and the people in our manufacturing and supply functions continue to seek process efficiencies to offset any cost impact.

Many of our risks are mitigated by the portfolio effect which we enjoy with different geographies, different routes to market and different currencies. This leads me to conclude, as it does every year, that the main source of risk to this business 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: as I have indicated above, we finished the year positively. Nevertheless, we have yet to establish a consistent pattern of trading in growth, and our cost reduction programme is likely to cause some further volatility, at least during the first quarter of 2007/8. We believe that the business is now returning to growth, but ‘calling the turn’ remains difficult.

We remain confident, nevertheless, that we are right to refer to these as short-term trading issues. Our confidence is based upon the following four fundamentals:

1. The health of the Games Workshop Hobby
Despite the short-term difficulties of this year, our internal measures - both hard and soft - tell us the Hobby is in good health.

2.The long-term growth credentials of the business
We continue to see Games Workshop as a growth business. The chart below sets out our sales progress from 1991. Between 2002 and 2005 our sales were above our normal growth line. We believe that it is only a matter of time and hard work before we re-establish our historic linear growth rate.

Sales - £m
Sales - £m

3. The market opportunity for our existing sales businesses
The chart below shows our sales per capita in our key sales markets, based upon our 2007 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 at least treble the current level of our sales.

Sales per capita by geographical area

Source: Population information is sourced from the 2006 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 the potential sales of Games Workshop

4. The capital infrastructure
We have come to the end of our investment programme, which leaves the business seriously well invested.

These are the reasons why the directors still believe the prospects for the business remain very good.

Tom Kirby
Chairman and chief executive
30 July 2007

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