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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 consolidated 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 historical results of operations during the periods presented and our financial condition. This MD&A should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended February 1, 2014 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 baby, core toy, entertainment, learning and seasonal product categories worldwide. Our reportable segments are Toys "R" Us - Domestic ("Domestic"), which provides toy and 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 August 2, 2014, there were 1,591 operated and 196 licensed "R" Us branded retail stores worldwide. In addition, as of August 2, 2014, we operated 132 Toys "R" Us Express stores ("Express stores"), including 65 Express stores with a cumulative lease term of at least two years ("Permanent Express"). Domestic and International segments also include their respective Internet operations. Financial Performance As discussed in more detail in this MD&A, the following financial data represents an overview of our financial performance for the thirteen and twenty-six weeks ended August 2, 2014 compared to the thirteen and twenty-six weeks ended August 3, 2013: 13 Weeks Ended 26 Weeks Ended August 2, August 3, August 2, August 3, ($ In millions) 2014 2013 2014 2013 Net sales $ 2,440 $ 2,377 $ 4,919 $ 4,785 Gross margin 916 920 1,834 1,820 Gross margin as a percentage of Net sales 37.5 % 38.7 % 37.3 % 38.0 % Selling, general and administrative expenses $ 878 $ 890 $ 1,795 $ 1,776 Selling, general and administrative expenses as a percentage of Net sales 36.0 % 37.4 % 36.5 % 37.1 % Net loss attributable to Toys "R" Us, Inc. $ (148 ) $ (113 ) $ (344 ) $ (224 ) Non-GAAP Financial Measure: Adjusted EBITDA (1) $ 81 $ 74 $ 102 $ 115 (1) For an explanation of Adjusted EBITDA as a measure of the Company's operating performance and a reconciliation to Net loss attributable to Toys "R" Us, Inc., see "Non-GAAP Financial Measure - Adjusted EBITDA" below. Net sales increased by $63 million and $134 million for the thirteen and twenty-six weeks ended August 2, 2014, respectively, compared to the same periods last year. Foreign currency translation increased Net sales by $7 million for the thirteen weeks ended August 2, 2014 and decreased Net sales by $12 million for the twenty-six weeks ended August 2, 2014. Excluding the impact of foreign currency translation, the increase in Net sales for both periods was primarily due to an increase in our Domestic and International comparable store net sales and an increase in net sales from new locations within our International segment. Gross margin, as a percentage of Net sales for the thirteen and twenty-six weeks ended August 2, 2014 decreased by 1.2 and 0.7 percentage points, respectively, compared to the same periods last year. The decrease for both periods was primarily caused by margin rate declines in our Domestic segment mainly as a result of a $19 million and $8 million net loss on previously identified clearance inventory written down in the fourth quarter of fiscal 2013 for the thirteen and twenty-six weeks ended August 2, 2014, respectively. Selling, general and administrative expenses ("SG&A") for the thirteen weeks ended August 2, 2014 decreased by $12 million, compared to the same period last year. Foreign currency translation increased SG&A by $4 million for the thirteen weeks ended August 2, 2014. Excluding the impact of foreign currency translation, the decrease in SG&A was primarily due to a decrease in legal expenses and favorable current year settlements of insurance claims related to property losses. These decreases were partially offset by an increase in occupancy costs. SG&A for the twenty-six weeks ended August 2, 2014 increased by $19 million, compared to the same period last year. Foreign currency translation decreased SG&A by $1 million 21-------------------------------------------------------------------------------- Table of Contents for the twenty-six weeks ended August 2, 2014. Excluding the impact of foreign currency translation, the increase in SG&A was primarily due to increases in occupancy costs, professional fees and payroll expenses. These increases were partially offset by decreases in legal expenses and advertising expenses. Net loss attributable to Toys "R" Us, Inc. for the thirteen weeks ended August 2, 2014 increased by $35 million compared to the same period last year. The increase for the period was primarily due to a net increase in Income tax, partially offset by decreases in Interest expense and SG&A. Net loss attributable to Toys "R" Us, Inc. for the twenty-six weeks ended August 2, 2014 increased by $120 million compared to the same period last year. The increase for the period was primarily due to a net increase in Income tax and an increase in SG&A, partially offset by a decrease in Interest expense. 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. Permanent Express stores 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 twenty-six weeks ended August 2, 2014 and August 3, 2013: 13 Weeks Ended 26 Weeks Ended August 2, 2014 August 3, 2013 August 2, 2014 August 3, 2013 vs. 2013 vs. 2012 vs. 2013 vs. 2012 Domestic 1.5 % (4.1 )% (1) 2.7 % (6.2 )% (1) International 2.5 % (3.8 )% 1.7 % (4.8 )% (1) Excludes the effect of an immaterial out of period adjustment. Previously reported comparable store net sales were (3.5)% and (6.0)% for the thirteen and twenty-six weeks ended August 3, 2013, respectively. 22-------------------------------------------------------------------------------- Table of Contents Percentage of Net Sales by Product Category 13 Weeks Ended 26 Weeks Ended August 2, August 3, August 2, August 3, Domestic: 2014 2013 2014 2013 Baby 47.6 % 48.6 % 48.8 % 49.9 % Core Toy 13.2 % 11.9 % 12.6 % 11.8 % Entertainment 6.3 % 5.7 % 7.1 % 6.5 % Learning 17.6 % 16.8 % 17.5 % 16.6 % Seasonal 15.0 % 15.3 % 13.7 % 14.1 % Other (1) 0.3 % 1.7 % 0.3 % 1.1 % Total 100 % 100 % 100 % 100 % (1) Consists primarily of non-product related revenues. 13 Weeks Ended 26 Weeks Ended August 2, August 3, August 2, August 3, International: 2014 2013 2014 2013 Baby 25.0 % 26.4 % 26.0 % 26.6 % Core Toy 19.7 % 19.0 % 19.6 % 19.2 % Entertainment 7.1 % 7.1 % 7.3 % 8.1 % Learning 25.8 % 25.1 % 26.1 % 25.7 % Seasonal 21.5 % 21.5 % 20.1 % 19.5 % Other (1) 0.9 % 0.9 % 0.9 % 0.9 % Total 100 % 100 % 100 % 100 % (1) Consists primarily of licensing fees from unaffiliated third parties and other non-product related revenues. From time to time, we may make revisions to our prior period Net sales by product category to conform to the current period allocation. These revisions did not have a significant impact to our prior year disclosure. Store Count by Segment August 2, August 3, 2014 2013 Change Domestic (1) 878 878 - International - Operated (2) 713 688 25 International - Licensed (3) 196 169 27 Total (4) 1,787 1,735 52 (1) Store count as of August 2, 2014 includes 302 Toys "R" Us ("TRU") stores, 230 Babies "R" Us ("BRU") stores, 214 side-by-side ("SBS") stores, 59 Juvenile Expansions, 20 Babies "R" Us Express ("BRU Express") stores and 53 Permanent Express stores. Store count as of August 3, 2013 included 310 TRU stores, 235 BRU stores, 211 SBS stores, 60 Juvenile Expansions, 20 BRU Express stores and 42 Permanent Express stores. (2) Store count as of August 2, 2014 includes 475 TRU stores, 193 SBS stores, 18 BRU Express stores,15 BRU stores and 12 Permanent Express stores. Store count as of August 3, 2013 included 455 TRU stores, 177 SBS stores, 17 BRU Express stores, 14 BRU stores and 25 Permanent Express stores. The net increase in store count from prior year is predominantly due to 24 stores in China and Southeast Asia. (3) The net increase in store count from prior year is predominantly due to 14 stores in South Africa and 4 stores in South Korea. (4) There were 57 Domestic and 10 International Express stores open as of August 2, 2014 and 59 Domestic and 12 International Express stores open as of August 3, 2013. These stores were not included in our overall store count within our Domestic and International segments and are considered temporary as they have a cumulative lease term of less than two years. 23 -------------------------------------------------------------------------------- Table of Contents Net Loss Attributable to Toys "R" Us, Inc. 13 Weeks Ended 26 Weeks Ended August 2, August 3, August 2, August 3, (In millions) 2014 2013 Change 2014 2013 Change Toys "R" Us - Consolidated $ (148 ) $ (113 ) $ (35 ) $ (344 ) $ (224 ) $ (120 ) Net loss attributable to Toys "R" Us, Inc. increased by $35 million to $148 million for the thirteen weeks ended August 2, 2014, compared to $113 million for the same period last year. The increase in Net loss attributable to Toys "R" Us, Inc. was primarily due to a net increase in Income tax of $52 million, partially offset by decreases in Interest expense of $14 million and SG&A of $12 million. Net loss attributable to Toys "R" Us, Inc. increased by $120 million to $344 million for the twenty-six weeks ended August 2, 2014, compared to $224 million for the same period last year. The increase in Net loss attributable to Toys "R" Us, Inc. was primarily due to a net increase in Income tax of $123 million and an increase in SG&A of $19 million, partially offset by a decrease in Interest expense of $20 million. Net Sales 13 Weeks Ended Percentage of Net Sales August 2, August 3, August 2, August 3, ($ In millions) 2014 2013 $ Change % Change 2014 2013 Domestic $ 1,460 $ 1,450 $ 10 0.7 % 59.8 % 61.0 % International 980 927 53 5.7 % 40.2 % 39.0 % Toys "R" Us - Consolidated $ 2,440 $ 2,377 $ 63 2.7 % 100.0 % 100.0 % Net sales increased by $63 million or 2.7%, to $2,440 million for the thirteen weeks ended August 2, 2014, compared to $2,377 million for the same period last year. Net sales for the thirteen weeks ended August 2, 2014 included the impact of foreign currency translation, which increased Net sales by $7 million. Excluding the impact of foreign currency translation, the increase in Net sales for the thirteen weeks ended August 2, 2014 was primarily due to an increase in our Domestic and International comparable store net sales. The increase in comparable store net sales was primarily driven by an increase in the number of transactions. Additionally contributing to the increase in Net sales was an increase in net sales from new locations within our International segment. 26 Weeks Ended Percentage of Net Sales August 2, August 3, August 2, August 3,($ In millions) 2014 2013 $ Change % Change 2014 2013 Domestic $ 2,999 $ 2,930 $ 69 2.4 % 61.0 % 61.2 % International 1,920 1,855 65 3.5 % 39.0 % 38.8 % Toys "R" Us - Consolidated $ 4,919 $ 4,785 $ 134 2.8 % 100.0 % 100.0 % Net sales increased by $134 million or 2.8%, to $4,919 million for the twenty-six weeks ended August 2, 2014, compared to $4,785 million for the same period last year. Net sales for the twenty-six weeks ended August 2, 2014 included the impact of foreign currency translation, which decreased Net sales by $12 million. Excluding the impact of foreign currency translation, the increase in Net sales for the twenty-six weeks ended August 2, 2014 was primarily due to an increase in our Domestic and International comparable store net sales. The increase in comparable store net sales was primarily driven by an increase in the number of transactions. Additionally contributing to the increase in Net sales was an increase in net sales from new locations within our International segment. Domestic Net sales for the Domestic segment increased by $10 million or 0.7%, to $1,460 million for the thirteen weeks ended August 2, 2014, compared to $1,450 million for the same period last year. The increase in Net sales was primarily a result of an increase in comparable store net sales of 1.5%. The increase in comparable store net sales resulted primarily from increases in our core toy, learning and entertainment categories. The increase in our core toy category was primarily due to increased sales of girls' role play products and accessories. The increase in our learning category was primarily due to increased sales of construction toys. The increase in 24-------------------------------------------------------------------------------- Table of Contents our entertainment category was primarily due to increased sales of video game systems. Partially offsetting these increases was a decrease in our baby product category primarily as a result of decreased sales of apparel. Net sales for the Domestic segment increased by $69 million or 2.4%, to $2,999 million for the twenty-six weeks ended August 2, 2014, compared to $2,930 million for the same period last year. The increase in Net sales was primarily a result of an increase in comparable store net sales of 2.7%. The increase in comparable store net sales resulted primarily from increases in our learning, core toy and entertainment categories. The increase in our learning category was primarily due to increased sales of construction toys. The increase in our core toy category was primarily due to increased sales of girls' role play products and accessories. The increase in our entertainment category was primarily due to increased sales of interactive video game figurines and video game systems. International Net sales for the International segment increased by $53 million or 5.7%, to $980 million for the thirteen weeks ended August 2, 2014, compared to $927 million for the same period last year. Excluding a $7 million increase in Net sales due to foreign currency translation, International Net sales increased primarily as a result of an increase in net sales from new locations and an increase in comparable store net sales of 2.5%. The increase in comparable store net sales resulted primarily from increases in our core toy, learning and seasonal categories. The increase in our core toy category was primarily due to increased sales of action figures. The increase in our learning category was primarily due to increased sales of construction toys. The increase in our seasonal category was primarily due to increased sales of outdoor products. Partially offsetting these increases was a decrease in our baby product category primarily as a result of decreased sales of consumables. Net sales for the International segment increased by $65 million or 3.5%, to $1,920 million for the twenty-six weeks ended August 2, 2014, compared to $1,855 million for the same period last year. Excluding a $12 million decrease in Net sales due to foreign currency translation, International Net sales increased primarily as a result of an increase in net sales from new locations and an increase in comparable store net sales of 1.7%. The increase in comparable store net sales resulted primarily from increases in our seasonal and core toy categories. The increase in our seasonal category was primarily due to increased sales of outdoor products. The increase in our core toy category was primarily due to increased sales of action figures. Cost of Sales and Gross Margin We record the costs associated with operating our distribution networks as a part of SG&A, including those costs that primarily relate to transporting merchandise from distribution centers to stores. Therefore, our consolidated Gross margin may not be comparable to the gross margins of other retailers that include similar costs in their cost of sales. The following are reflected in "Cost of sales": • the cost of merchandise acquired from vendors; • freight in; • provision for excess and obsolete inventory; • shipping costs to consumers; • provision for inventory shortages; and • credits and allowances from our merchandise vendors. Gross Margin 13 Weeks Ended Percentage of Net Sales August 2, August 3, August 2, August 3, ($ In millions) 2014 2013 $ Change 2014 2013 Change Domestic $ 506 $ 531 $ (25 ) 34.7 % 36.6 % (1.9 )% International 410 389 21 41.8 % 42.0 % (0.2 )% Toys "R" Us - Consolidated $ 916 $ 920 $ (4 ) 37.5 % 38.7 % (1.2 )% Gross margin decreased by $4 million to $916 million for the thirteen weeks ended August 2, 2014, compared to $920 million for the same period last year. Foreign currency translation increased Gross margin by $4 million. 25-------------------------------------------------------------------------------- Table of Contents Gross margin, as a percentage of Net sales, decreased by 1.2 percentage points for the thirteen weeks ended August 2, 2014 compared to the same period last year. The decrease in Gross margin, as a percentage of Net sales, was primarily caused by margin rate declines in our Domestic segment within certain categories due in part to our promotional and clearance efforts. 26 Weeks Ended Percentage of Net Sales August 2, August 3, August 2, August 3, ($ In millions) 2014 2013 $ Change 2014 2013 Change Domestic $ 1,055 $ 1,069 $ (14 ) 35.2 % 36.5 % (1.3 )% International 779 751 28 40.6 % 40.5 % 0.1 % Toys "R" Us - Consolidated $ 1,834 $ 1,820 $ 14 37.3 % 38.0 % (0.7 )% Gross margin increased by $14 million to $1,834 million for the twenty-six weeks ended August 2, 2014, compared to $1,820 million for the same period last year. Foreign currency translation decreased Gross margin by $1 million. Gross margin, as a percentage of Net sales, decreased by 0.7 percentage points for the twenty-six weeks ended August 2, 2014 compared to the same period last year. The decrease in Gross margin, as a percentage of Net sales, was primarily caused by margin rate declines in our Domestic segment within certain categories due in part to our promotional and clearance efforts. Domestic Gross margin decreased by $25 million to $506 million for the thirteen weeks ended August 2, 2014, compared to $531 million for the same period last year. Gross margin, as a percentage of Net sales, decreased by 1.9 percentage points for the thirteen weeks ended August 2, 2014 compared to the same period last year. The decrease in Gross margin, as a percentage of Net sales, resulted primarily from margin rate declines predominantly in our learning and seasonal categories. The decline is largely due to our promotional and clearance efforts, primarily resulting from an incremental $19 million net loss on previously identified clearance inventory written down in the fourth quarter of fiscal 2013. Gross margin decreased by $14 million to $1,055 million for the twenty-six weeks ended August 2, 2014, compared to $1,069 million for the same period last year. Gross margin, as a percentage of Net sales, decreased by 1.3 percentage points for the twenty-six weeks ended August 2, 2014 compared to the same period last year. The decrease in Gross margin, as a percentage of Net sales, resulted primarily from margin rate declines predominantly in our learning and seasonal categories. The decline is largely due to our promotional and clearance efforts, primarily resulting from an incremental $8 million net loss on previously identified clearance inventory written down in the fourth quarter of fiscal 2013. International Gross margin increased by $21 million to $410 million for the thirteen weeks ended August 2, 2014, compared to $389 million for the same period last year. Foreign currency translation increased Gross margin by $4 million. Gross margin, as a percentage of Net sales, remained relatively consistent for the thirteen weeks ended August 2, 2014. Gross margin increased by $28 million to $779 million for the twenty-six weeks ended August 2, 2014, compared to $751 million for the same period last year. Foreign currency translation decreased Gross margin by $1 million. Gross margin, as a percentage of Net sales, remained relatively consistent for the twenty-six weeks ended August 2, 2014, compared to the same period last year. Selling, General and Administrative Expenses The following are the types of costs included in SG&A: • store payroll and related payroll benefits; • rent and other store operating expenses; • advertising and promotional expenses; • costs associated with operating our distribution network, including costs related to transporting merchandise from distribution centers to stores; • restructuring charges; and • other corporate-related expenses. 26-------------------------------------------------------------------------------- Table of Contents 13 Weeks Ended Percentage of Net Sales August 2, August 3, August 2, August 3, ($ In millions) 2014 2013 $ Change 2014 2013 Change Toys "R" Us - Consolidated $ 878 $ 890 $ (12 ) 36.0 % 37.4 % (1.4 )% SG&A decreased by $12 million to $878 million for the thirteen weeks ended August 2, 2014, compared to $890 million for the same period last year. Foreign currency translation increased SG&A by $4 million. As a percentage of Net sales, SG&A decreased by 1.4 percentage points. Excluding the impact of foreign currency translation, the decrease in SG&A was primarily due to a $20 million decrease in legal expenses related to the prior year judgment in the Aleo v. SLB Toys USA, Inc. ("Aleo") case and $7 million in favorable insurance claim settlements in the current year related to property losses. These decreases were partially offset by a $6 million increase in occupancy costs, predominantly as a result of an increase in new stores and an increase in common area maintenance expenses. 26 Weeks Ended Percentage of Net Sales August 2, August 3, August 2, August 3, ($ In millions) 2014 2013 $ Change 2014 2013 Change Toys "R" Us - Consolidated $ 1,795 $ 1,776 $ 19 36.5 % 37.1 % (0.6 )% SG&A increased by $19 million to $1,795 million for the twenty-six weeks ended August 2, 2014, compared to $1,776 million for the same period last year. Foreign currency translation decreased SG&A by $1 million. As a percentage of Net sales, SG&A decreased by 0.6 percentage points. Excluding the impact of foreign currency translation, the increase in SG&A was primarily due to a $25 million increase in occupancy costs, predominantly as a result of an increase in new stores, an increase in utility expenses and closure costs mainly associated with a distribution center. Also contributing to the increase in SG&A was a $12 million increase in professional fees and an $11 million increase in payroll expenses. These increases were partially offset by a $20 million decrease in legal expenses related to the prior year judgment in the Aleo case and a $9 million decrease in advertising expenses. Depreciation and Amortization 13 Weeks Ended 26 Weeks Ended August 2, August 3, August 2, August 3, (In millions) 2014 2013 Change 2014 2013 ChangeToys "R" Us - Consolidated $ 95 $ 95 $ - $ 199 $ 195 $ 4 Depreciation and amortization remained consistent for the thirteen weeks ended August 2, 2014, compared to the same period last year. Depreciation and amortization increased by $4 million for the twenty-six weeks ended August 2, 2014, compared to the same period last year. The increase was primarily due to accelerated depreciation of certain assets, which we committed to dispose of prior to the end of their useful lives, partially offset by fully depreciated assets. Other Income, Net Other income, net includes the following: • credit card program income; • gift card breakage income; • net gains on sales of properties; • impairment of long-lived assets; • foreign exchange gains and losses; and • other operating income and expenses. 27-------------------------------------------------------------------------------- Table of Contents 13 Weeks Ended 26 Weeks Ended August 2, August 3, August 2, August 3, (In millions) 2014 2013 Change 2014 2013 ChangeToys "R" Us - Consolidated $ 15 $ 19 $ (4 ) $ 27 $ 32 $ (5 ) Other income, net decreased by $4 million to $15 million for the thirteen weeks ended August 2, 2014, compared to $19 million for the same period last year. The decrease was primarily due to a $3 million increase in impairment of long-lived assets. Other income, net decreased by $5 million to $27 million for the twenty-six weeks ended August 2, 2014, compared to $32 million for the same period last year. The decrease was primarily due to a $4 million increase in impairment of long-lived assets. Interest Expense 13 Weeks Ended 26 Weeks Ended August 2, August 3, August 2, August 3, (In millions) 2014 2013 Change 2014 2013 Change Toys "R" Us - Consolidated $ 102 $ 116 $ (14 ) $ 210 $ 230 $ (20 ) Interest expense decreased by $14 million and $20 million for the thirteen and twenty-six weeks ended August 2, 2014, respectively, compared to the same periods last year. The decrease for both periods was primarily due to savings associated with refinancing the $950 million 10.750% senior unsecured notes due fiscal 2017 to a $985 million senior unsecured term loan facility due fiscal 2019 at a lower rate of interest. |