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TOYS R US INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) As used herein, the "Company," "we," "us," or "our" means Toys "R" Us, Inc. and its subsidiaries, except as expressly indicated or unless the context otherwise requires. The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help facilitate an understanding of our financial condition and our historical results of operations for the periods presented. This MD&A should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended January 28, 2012 and the Condensed Consolidated Financial Statements and the accompanying notes thereto, and contains forward-looking statements that involve risks and uncertainties. See "Forward-Looking Statements" below. Our Business We generate sales, earnings and cash flows by retailing merchandise in our core toy, entertainment, juvenile (including baby), learning and seasonal product categories worldwide. Our reportable segments are Toys "R" Us - Domestic ("Domestic"), which provides toy and juvenile (including baby) product offerings in 49 states and Puerto Rico, and Toys "R" Us - International ("International"), which operates or licenses stores in 35 foreign countries and jurisdictions. As of October 27, 2012, there were 1,526 operated and 155 licensed "R" Us branded retail stores worldwide. In addition, as of October 27, 2012, we operated 268 Toys "R" Us Express stores ("Express stores"), including 46 Express stores with a cumulative lease term of at least two years. Domestic and International segments also include their respective Internet operations. On October 29, 2012, Hurricane Sandy hit the eastern coast of the United States, causing significant damage to the surrounding region, including several of our stores. The Company's organization and assets were not materially damaged by the hurricane, net of insurance claims. Financial Performance As discussed in more detail in this MD&A, the following financial data presents an overview of our financial performance for the thirteen and thirty-nine weeks ended October 27, 2012 compared to the thirteen and thirty-nine weeks ended October 29, 2011: 13 Weeks Ended 39 Weeks Ended October 27, October 29, October 27, October 29, ($ In millions) 2012 2011 2012 2011 Net sales $ 2,609 $ 2,700 $ 7,773 $ 7,984 Gross margin 967 986 2,982 2,989 Gross margin as a percentage of Net sales 37.1 % 36.5 % 38.4 % 37.4 % Selling, general and administrative expenses $ 962 $ 973 $ 2,747 $ 2,755 Selling, general and administrative expenses as a percentage of Net sales 36.9 % 36.0 % 35.3 % 34.5 % Net loss $ (105 ) $ (93 ) $ (201 ) $ (194 ) Net sales decreased by $91 million and $211 million for the thirteen and thirty-nine weeks ended October 27, 2012, respectively, compared to the same periods last year. Foreign currency translation decreased Net sales by approximately $30 million and $91 million for the thirteen and thirty-nine weeks ended October 27, 2012, respectively. Excluding the impact of foreign currency translation, the decline in Net sales for both periods was primarily due to a decrease in comparable store net sales. Partially offsetting the decrease in Net sales was an increase in net sales from new locations within our International segment, including stores acquired in the Toys (Labuan) Holding Limited ("Labuan") acquisition. Gross margin, as a percentage of Net sales for the thirteen and thirty-nine weeks ended October 27, 2012 increased by 0.6 percentage points and 1.0 percentage point, respectively, compared to the same periods last year primarily as a result of margin rate improvements within product categories and improvements in sales mix away from lower margin products. Selling, general and administrative expenses ("SG&A") for the thirteen and thirty-nine weeks ended October 27, 2012 decreased by $11 million and $8 million, respectively, compared to the same periods last year. Foreign currency translation decreased SG&A by approximately $12 million and $35 million for the thirteen and thirty-nine weeks ended October 27, 2012, respectively. Excluding the impact of foreign currency translation, the increase in SG&A for the thirteen and thirty-nine weeks ended October 27, 2012 was primarily due to the inclusion of expenses associated with Labuan, partially offset by a decrease in payroll expenses and advertising and promotional expenses. 23-------------------------------------------------------------------------------- Table of Contents Net loss increased by $12 million for the thirteen weeks ended October 27, 2012 compared to the same period last year primarily due to an increase in Interest expense and a decline in Gross margin dollars. This was partially offset by an increase in Income tax benefit, a decrease in SG&A and an increase in Other income, net. Net loss for the thirty-nine weeks ended October 27, 2012 increased by $7 million compared to the same period last year primarily due to a decrease in Income tax benefit. This was partially offset by a decrease in SG&A and an increase in Other income, net. Comparable Store Net Sales In computing comparable store net sales, we include stores that have been open for at least 56 weeks (1 year and 4 weeks) from their "soft" opening date. A soft opening is typically two weeks prior to the grand opening. Express stores with a cumulative lease term of at least two years and that have been open for at least 56 weeks from their "soft" opening date are also included in our comparable store net sales computation. Comparable stores include the following: • stores that have been remodeled (including conversions) while remaining open; • stores that have been relocated and/or expanded to new buildings within the same trade area, in which the new store opens at about the same time as the old store closes; • stores that have expanded within their current locations; and • sales from our Internet businesses. By measuring the year-over-year sales of merchandise in the stores that have been open for a full comparable 56 weeks or more and on-line, we can better gauge how the core store base and e-commerce businesses are performing since comparable store net sales excludes the impact of store openings and closings. Various factors affect comparable store net sales, including the number of and timing of stores we open, close, convert, relocate or expand, the number of transactions, the average transaction amount, the general retail sales environment, current local and global economic conditions, consumer preferences and buying trends, changes in sales mix among distribution channels, our ability to efficiently source and distribute products, changes in our merchandise mix, competition, the timing of the release of new merchandise and our promotional events, the success of marketing programs and the cannibalization of existing store net sales by new stores. Among other things, weather conditions can affect comparable store net sales because inclement weather may discourage travel or require temporary store closures, thereby reducing customer traffic. These factors have caused our comparable store net sales to fluctuate significantly in the past on a monthly, quarterly and annual basis and, as a result, we expect that comparable store net sales will continue to fluctuate in the future. The following table discloses the change in our comparable store net sales for the thirteen and thirty-nine weeks ended October 27, 2012 and October 29, 2011: 13 Weeks Ended 39 Weeks Ended October 27, 2012 October 29, 2011 October 27, 2012 October 29, 2011 vs. 2011 vs. 2010 vs. 2011 vs. 2010 Domestic (4.1 )% (2.2 )% (2.8 )% (2.2 )% International (1) (4.6 )% (3.9 )% (4.7 )% (2.7 )% (1) International comparable store net sales does not include stores acquired in the Labuan acquisition as they have not been included in our operations for at least 56 weeks (1 year and 4 weeks). 24-------------------------------------------------------------------------------- Table of Contents Store Count by Segment October 27, October 29, 2012 2011 Change Domestic (1) 875 876 (1 ) International - Operated (2)(3) 651 533 118 International - Licensed (3) 155 237 (82 ) Total (4) 1,681 1,646 35 (1) Store count as of October 27, 2012 includes 203 side-by-side ("SBS") stores, 21 Babies "R" Us Express ("BRU Express") stores and 62 Juvenile Expansions. Store count as of October 29, 2011 included 183 SBS stores, 20 BRU Express stores and 62 Juvenile Expansions. (2) Store count as of October 27, 2012 includes 166 SBS stores and 17 BRU Express stores. Store count as of October 29, 2011 included 143 SBS stores and 13 BRU Express stores. (3) Operated store count as of October 27, 2012 includes 102 stores in China and Southeast Asia in conjunction with the acquisition of Labuan on October 31, 2011, 89 of which were previously licensed as of October 29, 2011. Refer to Note 9 to the Condensed Consolidated Financial Statements entitled "Acquisitions and Dispositions" for further details. (4) Express stores with a cumulative lease term of at least two years are included in our overall store count, while the remaining locations are excluded. As of October 27, 2012, there were 219 Domestic and 49 International Express stores open, 36 and 10 of which have been included in our overall store count within our Domestic and International segments, respectively. Included in the 219 Domestic Express store count are 24 Toys "R" Us Express-branded departments located within Macy's Inc. stores nationwide. As of October 29, 2011, there were 141 Domestic and 49 International Express stores open, 29 of which were included in our overall store count within our Domestic segment, and none of which were included within our International segment. Net Loss 13 Weeks Ended 39 Weeks Ended October 27, October 29, October 27, October 29, (In millions) 2012 2011 Change 2012 2011 Change Toys "R" Us - Consolidated $ (105 ) $ (93 ) $ (12 ) $ (201 ) $ (194 ) $ (7 ) Net loss increased by $12 million to $105 million for the thirteen weeks ended October 27, 2012, compared to $93 million for the same period last year. The increase in Net loss predominately related to an increase in Interest expense of $29 million due to the issuance of the $450 million aggregate principal amount of 10.375% senior notes due fiscal 2017 (the "2017 Notes"), and the repayment of the $400 million outstanding principal amount of our 7.875% senior notes due fiscal 2013 (the "2013 Notes"). Additionally contributing to the decline was a decrease in Gross margin dollars of $19 million. These amounts were partially offset by an increase in Income tax benefit of $15 million, a decrease in SG&A of $11 million and an increase in Other income, net of $6 million. Net loss increased by $7 million to $201 million for the thirty-nine weeks ended October 27, 2012, compared to $194 million for the same period last year. The increase in Net loss was primarily due to a decrease in Income tax benefit of $21 million. Partially offsetting this amount was a decrease in SG&A of $8 million and an increase in Other income, net of $9 million. Net Sales 13 Weeks Ended Percentage of Net Sales October 27, October 29, October 27, October 29, ($ In millions) 2012 2011 $ Change % Change 2012 2011 Domestic $ 1,504 $ 1,578 $ (74 ) (4.7 )% 57.6 % 58.4 % International 1,105 1,122 (17 ) (1.5 )% 42.4 % 41.6 % Toys "R" Us - Consolidated $ 2,609 $ 2,700 $ (91 ) (3.4 )% 100.0 % 100.0 % 25-------------------------------------------------------------------------------- Table of Contents Net sales decreased by $91 million or 3.4%, to $2,609 million for the thirteen weeks ended October 27, 2012, compared to $2,700 million for the same period last year. Net sales for the thirteen weeks ended October 27, 2012 included the impact of foreign currency translation, which decreased Net sales by approximately $30 million. Excluding the impact of foreign currency translation, the decrease in Net sales for the thirteen weeks ended October 27, 2012 was primarily due to a decrease in comparable store net sales. The decrease in comparable store net sales was primarily driven by a decrease in the number of transactions as well as an increase in product orders associated with this year's Domestic layaway program (which defers the recognition of sales into the period when the customer picks up the order), partially offset by higher average transaction amounts. Additionally offsetting the decrease in Net sales was an increase in net sales from new locations within our International segment, including stores acquired in the Labuan acquisition. 39 Weeks Ended Percentage of Net Sales October 27, October 29, October 27, October 29, ($ In millions) 2012 2011 $ Change % Change 2012 2011 Domestic $ 4,626 $ 4,795 $ (169 ) (3.5 )% 59.5 % 60.1 % International 3,147 3,189 (42 ) (1.3 )% 40.5 % 39.9 % Toys "R" Us - Consolidated $ 7,773 $ 7,984 $ (211 ) (2.6 )% 100.0 % 100.0 % Net sales decreased by $211 million or 2.6%, to $7,773 million for the thirty-nine weeks ended October 27, 2012, compared to $7,984 million for the same period last year. Net sales for the thirty-nine weeks ended October 27, 2012 included the impact of foreign currency translation, which decreased Net sales by approximately $91 million. Excluding the impact of foreign currency translation, the decrease in Net sales for the thirty-nine weeks ended October 27, 2012 was primarily due to a decrease in comparable store net sales. The decrease in comparable store net sales was primarily driven by a decrease in the number of transactions as well as an increase in product orders associated with this year's Domestic layaway program (which defers the recognition of sales into the period when the customer picks up the order), partially offset by higher average transaction amounts. Additionally offsetting the decrease in Net sales was an increase in net sales from new locations within our International segment, including stores acquired in the Labuan acquisition. Domestic Net sales for the Domestic segment decreased by $74 million or 4.7%, to $1,504 million for the thirteen weeks ended October 27, 2012, compared to $1,578 million for the same period last year. The decrease in Net sales was primarily a result of a decrease in comparable store net sales of 4.1%. The decrease in comparable store net sales resulted primarily from decreases in our juvenile (including baby), entertainment and core toy categories. The decrease in our juvenile (including baby) category was primarily due to decreased sales of apparel and infant care products. The decrease in our entertainment category was primarily due to decreased sales of video game software and systems. The decrease in our core toy category was primarily due to decreased sales of action figures. Net sales for the Domestic segment decreased by $169 million or 3.5%, to $4,626 million for the thirty-nine weeks ended October 27, 2012, compared to $4,795 million for the same period last year. The decrease in Net sales was primarily a result of a decrease in comparable store net sales of 2.8%. The decrease in comparable store net sales resulted primarily from decreases in our juvenile (including baby) and entertainment categories. The decrease in our juvenile (including baby) category was primarily due to decreased sales of apparel and infant care products. The decrease in our entertainment category was primarily due to decreased sales of video game software and systems. Partially offsetting these decreases was an increase in our learning category, primarily as a result of increased sales of construction toys. International Net sales for the International segment decreased by $17 million or 1.5%, to $1,105 million for the thirteen weeks ended October 27, 2012, compared to $1,122 million for the same period last year. Excluding a $30 million decrease in Net sales due to foreign currency translation, International Net sales increased primarily as a result of net sales from new locations. The increase in net sales from new locations was offset by a decrease in comparable store net sales of 4.6%. The decrease in comparable store net sales resulted primarily from decreases in our core toy, learning and seasonal categories. The decrease in our core toy category was primarily due to decreased sales of action figures. The decrease in our learning category was primarily due to decreased sales of educational products. The decrease in our seasonal category was primarily due to decreased sales of outdoor products. 26-------------------------------------------------------------------------------- Table of Contents Net sales for the International segment decreased by $42 million or 1.3%, to $3,147 million for the thirty-nine weeks ended October 27, 2012, compared to $3,189 million for the same period last year. Excluding a $91 million decrease in Net sales due to foreign currency translation, International Net sales increased primarily as a result of net sales from new locations. The increase in net sales from new locations was offset by a decrease in comparable store net sales of 4.7%. The decrease in comparable store net sales resulted primarily from decreases in our core toy, seasonal and entertainment categories. The decrease in our core toy category was primarily due to a decline in sales of action figures. The decrease in our seasonal category was primarily due to decreased sales of outdoor products. The decrease in our entertainment category was primarily due to decreased sales of video game systems and software. Cost of Sales and Gross Margin We record the costs associated with operating our distribution networks as a part of SG&A, including those costs that primarily relate to transporting merchandise from distribution centers to stores. Therefore, our consolidated Gross margin may not be comparable to the gross margins of other retailers that include similar costs in their cost of sales. The following are reflected in "Cost of sales": • the cost of merchandise acquired from vendors; • freight in; • provision for excess and obsolete inventory; • shipping costs to consumers; • provision for inventory shortages; and • credits and allowances from our merchandise vendors. 13 Weeks Ended Percentage of Net Sales October 27, October 29, October 27, October 29, ($ In millions) 2012 2011 $ Change 2012 2011 Change Domestic $ 542 $ 552 $ (10 ) 36.0 % 35.0 % 1.0 % International 425 434 (9 ) 38.5 % 38.7 % (0.2 )% Toys "R" Us - Consolidated $ 967 $ 986 $ (19 ) 37.1 % 36.5 % 0.6 % Gross margin decreased by $19 million to $967 million for the thirteen weeks ended October 27, 2012, compared to $986 million for the same period last year. Foreign currency translation decreased Gross margin by approximately $12 million. Gross margin, as a percentage of Net sales, increased by 0.6 percentage points for the thirteen weeks ended October 27, 2012, compared to the same period last year. Gross margin, as a percentage of Net sales, was primarily impacted by margin rate improvements within product categories and improvements in sales mix away from lower margin products. 39 Weeks Ended Percentage of Net Sales October 27, October 29, October 27, October 29, ($ In millions) 2012 2011 $ Change 2012 2011 Change Domestic $ 1,731 $ 1,735 $ (4 ) 37.4 % 36.2 % 1.2 % International 1,251 1,254 (3 ) 39.8 % 39.3 % 0.5 % Toys "R" Us - Consolidated $ 2,982 $ 2,989 $ (7 ) 38.4 % 37.4 % 1.0 % Gross margin decreased by $7 million to $2,982 million for the thirty-nine weeks ended October 27, 2012, compared to $2,989 million for the same period last year. Foreign currency translation decreased Gross margin by approximately $41 million. Gross margin, as a percentage of Net sales, increased by 1.0 percentage point for the thirty-nine weeks ended October 27, 2012 compared to the same period last year. Gross margin, as a percentage of Net sales, was primarily impacted by margin rate improvements within product categories and improvements in sales mix away from lower margin products. Domestic Gross margin decreased by $10 million to $542 million for the thirteen weeks ended October 27, 2012, compared to $552 million for the same period last year. Gross margin, as a percentage of Net sales, increased by 1.0 percentage point for the thirteen weeks ended October 27, 2012 compared to the same period last year. 27-------------------------------------------------------------------------------- Table of Contents The increase in Gross margin, as a percentage of Net sales, resulted primarily from improvements in margin rates, predominantly in our learning, core toy and juvenile categories. Additionally contributing to the increase were improvements in sales mix away from lower margin products, predominantly in our entertainment category. Gross margin decreased by $4 million to $1,731 million for the thirty-nine weeks ended October 27, 2012, compared to $1,735 million for the same period last year. Gross margin, as a percentage of Net sales, increased by 1.2 percentage points for the thirty-nine weeks ended October 27, 2012 compared to the same period last year. The increase in Gross margin, as a percentage of Net sales, resulted primarily from improvements in margin rates, predominantly in our learning, core toy and seasonal categories. Additionally contributing to the increase were improvements in sales mix away from lower margin products, predominantly in our entertainment category. International Gross margin decreased by $9 million to $425 million for the thirteen weeks ended October 27, 2012, compared to $434 million for the same period last year. Foreign currency translation decreased Gross margin by approximately $12 million. Gross margin, as a percentage of Net sales, decreased by 0.2 percentage points for the thirteen weeks ended October 27, 2012 compared to the same period last year. Gross margin decreased by $3 million to $1,251 million for the thirty-nine weeks ended October 27, 2012, compared to $1,254 million for the same period last year. Foreign currency translation decreased Gross margin by approximately $41 million. Gross margin, as a percentage of Net sales, increased by 0.5 percentage points for the thirty-nine weeks ended October 27, 2012 compared to the same period last year. The increase in Gross margin, as a percentage of Net sales, resulted primarily from improvements in margin rates, predominantly in our core toy and entertainment categories. Selling, General and Administrative Expenses The following are the types of costs included in SG&A: • store payroll and related payroll benefits; • rent and other store operating expenses; • advertising and promotional expenses; • costs associated with operating our distribution network, including costs related to transporting merchandise from distribution centers to stores; • restructuring charges; and • other corporate-related expenses. 13 Weeks Ended Percentage of Net Sales October 27, October 29, October 27, October 29, ($ In millions) 2012 2011 $ Change 2012 2011 Change Toys "R" Us - Consolidated $ 962 $ 973 $ (11 ) 36.9 % 36.0 % 0.9 % SG&A decreased by $11 million to $962 million for the thirteen weeks ended October 27, 2012, compared to $973 million for the same period last year. Foreign currency translation decreased SG&A by approximately $12 million. As a percentage of Net sales, SG&A increased by 0.9 percentage points. Excluding the impact of foreign currency translation, the increase in SG&A was primarily due to the inclusion of $21 million of expenses associated with Labuan, which was acquired on October 31, 2011. This was partially offset by a decrease of $13 million in payroll expenses and a decrease of $9 million in advertising and promotional expenses. 39 Weeks Ended Percentage of Net Sales October 27, October 29, October 27, October 29, ($ In millions) 2012 2011 $ Change 2012 2011 Change Toys "R" Us - Consolidated $ 2,747 $ 2,755 $ (8 ) 35.3 % 34.5 % 0.8 % 28-------------------------------------------------------------------------------- Table of Contents SG&A decreased by $8 million to $2,747 million for the thirty-nine weeks ended October 27, 2012, compared to $2,755 million for the same period last year. Foreign currency translation decreased SG&A by approximately $35 million. As a percentage of Net sales, SG&A increased by 0.8 percentage points. Excluding the impact of foreign currency translation, the increase in SG&A was primarily due to the inclusion of $60 million of expenses associated with Labuan, which was acquired on October 31, 2011. This was partially offset by a decrease of $20 million in payroll expenses and a decrease of $16 million in advertising and promotional expenses. Depreciation and Amortization 13 Weeks Ended 39 Weeks Ended October 27, October 29, October 27, October 29, (In millions) 2012 2011 Change 2012 2011 Change Toys "R" Us - Consolidated $ 97 $ 99 $ (2 ) $ 297 $ 299 $ (2 ) Depreciation and amortization decreased by $2 million for both the thirteen and thirty-nine weeks ended October 27, 2012 compared to the same periods last year. Foreign currency translation accounted for a decrease of approximately $1 million and $3 million for the thirteen and thirty-nine weeks ended October 27, 2012, respectively. Other Income, Net Other income, net includes the following: • gift card breakage income; • credit card program income; • net gains on sales of properties; • impairment on long-lived assets; • foreign exchange gains and losses; and • other operating income and expenses. 13 Weeks Ended 39 Weeks Ended October 27, October 29, October 27, October 29, (In millions) 2012 2011 Change 2012 2011 Change Toys "R" Us - Consolidated $ 17 $ 11 $ 6 $ 40 $ 31 $ 9 Other income, net increased by $6 million to $17 million for the thirteen weeks ended October 27, 2012, compared to $11 million for the same period last year. The increase was primarily due to a $4 million increase in credit card program income. Other income, net increased by $9 million to $40 million for the thirty-nine weeks ended October 27, 2012, compared to $31 million for the same period last year. The increase was primarily due to a $3 million increase in credit card program income, a $2 million increase in advertising income from our websites, a $1 million increase in net gains on sales of properties and a $1 million increase in gift card breakage income. Interest Expense 13 Weeks Ended 39 Weeks Ended October 27, October 29, October 27, October 29, (In millions) 2012 2011 Change 2012 2011 Change Toys "R" Us - Consolidated $ 135 $ 106 $ 29 $ 350 $ 346 $ 4 Interest expense increased by $29 million and $4 million for the thirteen and thirty-nine weeks ended October 27, 2012, respectively, compared to the same periods last year. The increase for both periods was primarily due to the issuance of the 2017 Notes, the repayment of the 2013 Notes, which included a make-whole premium of approximately $18 million, and the issuance of the Second Incremental Secured Term Loan. Partially offsetting the increase in Interest expense during the thirty-nine weeks ended October 27, 2012 was a reduction in expense related to our derivative instruments. 29-------------------------------------------------------------------------------- Table of Contents |