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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 29, 2011 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, learning and seasonal product categories worldwide. Our reportable segments are Toys "R" Us - Domestic ("Domestic"), which provides toy and juvenile product offerings in 49 states and Puerto Rico, and Toys "R" Us - International ("International"), which operates or licenses stores in 33 foreign countries and jurisdictions. As of April 30, 2011, there were 1,396 operated and 223 licensed "R" Us branded retail stores worldwide. In addition, as of April 30, 2011, we operated 95 Toys "R" Us Express stores ("Express stores"), including 24 Express stores with a cumulative lease term of at least two years which have been included in the Domestic store count. Domestic and International segments also include their respective Internet operations. On March 11, 2011, an earthquake hit the Northeast coast of Japan, causing significant damage to the surrounding region. The Company's organization and assets in Japan were not materially damaged by the earthquake and resulting tsunami and no stores were closed for a significant period of time. However, the implications of these events and the resulting damage to the nation's infrastructure, consumer confidence and overall economy remain unclear. As of June 10, 2011, all of our Japanese stores are open and operating. During the first quarter of fiscal 2011, we have not experienced a significant change in operating results and do not foresee a significant change in our Toys "R" Us-Japan, Ltd. ("Toys-Japan") business throughout the remainder of fiscal 2011 as a result of the earthquake and resulting tsunami. We determined that the Toys-Japan reporting unit did not incur a triggering event for interim goodwill impairment testing as of the end of the first quarter of fiscal 2011. 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 weeks ended April 30, 2011 compared to the thirteen weeks ended May 1, 2010: 13 Weeks Ended April 30, May 1, ($ In millions) 2011 2010 Net sales $ 2,636 $ 2,608 Gross margin as a percentage of Net sales 37.1% 36.2% Selling, general and administrative expenses as a percentage of Net sales 34.0% 32.9% Net loss attributable to Toys "R" Us, Inc. $ (67) $ (55) Net sales for the thirteen weeks ended April 30, 2011 increased by $28 million compared to the same period last year primarily due to the impact of foreign currency translation which increased Net sales by approximately $70 million. Excluding the impact of foreign currency translation, the decrease in Net sales for the thirteen weeks ended April 30, 2011 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, partially offset by an increase in net sales from our Internet operations and locations that were recently converted or relocated to our side-by-side ("SBS") and "R" Superstore ("SSBS") store formats. Additionally offsetting the decrease in Net sales was an increase in net sales from new locations, which includes Express stores. Gross margin, as a percentage of Net sales, for the thirteen weeks ended April 30, 2011 was primarily impacted by improvements in sales mix and margin rate improvements in certain categories. Selling, general and administrative expenses ("SG&A"), as a percentage of Net sales, for the thirteen weeks ended April 30, 2011 increased compared to the same period last year primarily as a result of an increase in expenses associated with payroll, rent, advertising and credit card processing fees. Partially offsetting these increases was a decrease in litigation settlement expenses for 20 -------------------------------------------------------------------------------- Table of Contents certain legal matters. Foreign currency translation increased SG&A by approximately $24 million for the thirteen weeks ended April 30, 2011. Net loss attributable to Toys "R" Us, Inc. for the thirteen weeks ended April 30, 2011 increased primarily as a result of an increase in SG&A and Depreciation and amortization, partially offset by an increase in Gross margin compared to the same period last year. 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, we can better gauge how the core store base is performing since it 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 weeks ended April 30, 2011 and May 1, 2010: 13 Weeks Ended April 30, 2011 vs. May 1, 2010 vs. 2010 2009 Domestic (2.1)% 1.9% International (1.9)% (1.4)% 21 -------------------------------------------------------------------------------- Table of Contents Percentage of Net Sales by Product Category 13 Weeks Ended April 30, May 1, Domestic: 2011 2010 Core Toy 10.7% 10.0% Entertainment 9.3% 10.1% Juvenile 50.7% 51.0% Learning 14.6% 13.4% Seasonal 13.2% 14.4% Other (1) 1.5% 1.1% Total 100% 100% (1) Consists primarily of shipping and other non-product related revenues. 13 Weeks Ended April 30, May 1, International: 2011 2010 Core Toy 18.0% 17.9% Entertainment 11.0% 11.9% Juvenile 28.4% 28.5% Learning 22.4% 21.9% Seasonal 19.3% 18.9% Other (1) 0.9% 0.9% Total 100% 100% (1) Consists primarily of license fees from unaffiliated third parties and other non-product related revenues. Store Count by Segment April 30, May 1, 2011 2010 Change Domestic (1)(3) 873 848 25 International - Operated (2) 523 514 9 International - Licensed 223 203 20 Total (3) 1,619 1,565 54 (1) Store count as of April 30, 2011 includes 109 SBS stores, 32 SSBS stores, 14 Babies "R" Us Express ("BRU Express") stores and 65 Juvenile Expansions. Store count as of May 1, 2010 included 64 SBS stores, 26 SSBS stores, 13 BRU Express stores and 64 Juvenile Expansions. (2) Store count as of April 30, 2011 includes 123 SBS stores and seven BRU Express stores. Store count as of May 1, 2010 included 84 SBS stores and two BRU Express stores. (3) 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 April 30, 2011, there were 79 Domestic and 16 International Express stores open, 24 of which have been included in our overall store count within our Domestic segment. As of May 1, 2010, there were 29 Domestic Express stores open and one International Express store open. None of the Express stores were included in our overall store count as of May 1, 2010. 22 -------------------------------------------------------------------------------- Table of Contents Net Loss Attributable to Toys "R" Us, Inc. 13 Weeks Ended April 30, May 1, (In millions) 2011 2010 Change Toys "R" Us - Consolidated $ (67) $ (55) $ (12) Net loss attributable to Toys "R" Us, Inc. increased by $12 million to $67 million for the thirteen weeks ended April 30, 2011, compared to $55 million for the same period last year. The increase in Net loss attributable to Toys "R" Us, Inc. was primarily due to an increase in SG&A of $39 million predominantly related to an increase in expenses associated with payroll, rent, advertising and credit card processing fees, partially offset by a decrease in litigation settlement expenses for certain legal matters. Additionally contributing to the loss was an increase in Depreciation and amortization of $4 million. Partially offsetting these amounts was an increase in Gross margin of $33 million primarily due to improvements in sales mix and margin rate improvements in certain categories. Net Sales 13 Weeks Ended Percentage of Net Sales April 30, May 1, April 30, May 1, ($ In millions) 2011 2010 $ Change % Change 2011 2010 Domestic $ 1,643 $ 1,671 $ (28) (1.7)% 62.3% 64.1% International 993 937 56 6.0% 37.7% 35.9% Toys "R" Us - Consolidated $ 2,636 $ 2,608 $ 28 1.1% 100.0% 100.0% Net sales increased by $28 million or 1.1%, to $2,636 million for the thirteen weeks ended April 30, 2011, compared to $2,608 million for the same period last year. Net sales for the thirteen weeks ended April 30, 2011 included the impact of foreign currency translation which increased Net sales by approximately $70 million. Excluding the impact of foreign currency translation, the decrease in Net sales for the thirteen weeks ended April 30, 2011 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, partially offset by an increase in net sales from our Internet operations and locations that were recently converted or relocated to our SBS and SSBS store formats. Additionally offsetting the decrease in Net sales was an increase in net sales from new locations, which includes Express stores. Domestic Net sales for the Domestic segment decreased by $28 million or 1.7%, to $1,643 million for the thirteen weeks ended April 30, 2011, compared to $1,671 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 2.1%, partially offset by an increase in net sales from new locations. The decrease in comparable store net sales resulted primarily from decreases in our seasonal and juvenile categories. The decrease in our seasonal category was primarily due to decreased sales of outdoor products as a result of cooler weather. The decrease in our juvenile category was primarily due to decreased sales of commodities. Partially offsetting these decreases was an increase in our learning and core toy categories. The increase in our learning category was primarily due to increased sales of construction toys and electronic educational products. The increase in our core toy category was primarily due to increased sales of action figures and dolls. International Net sales for the International segment increased by $56 million or 6.0%, to $993 million for the thirteen weeks ended April 30, 2011, compared to $937 million for the same period last year. Excluding a $70 million increase in Net sales due to foreign currency translation, International Net sales decreased primarily as a result of a decrease in comparable store net sales of 1.9%. Partially offsetting the decrease was an increase in net sales from new locations. The decrease in comparable store net sales resulted primarily from decreases in our entertainment and juvenile categories. The decrease in our entertainment category was driven by fewer releases of new video game software and accessories. The decrease in our 23-------------------------------------------------------------------------------- Table of Contents juvenile category was primarily due to a decline in sales of wooden furniture and baby gear. Partially offsetting these decreases was an increase in our core toy category primarily as a result of strong sales of action figures. Cost of Sales and Gross Margin We record the costs associated with operating our distribution networks as a part of SG&A, including those costs that primarily relate to transporting merchandise from distribution centers to stores. Therefore, our consolidated Gross margin may not be comparable to the gross margins of other retailers that include similar costs in their cost of sales. The following are reflected in "Cost of sales": • the cost of merchandise acquired from vendors; • freight in; • provision for excess and obsolete inventory; • shipping costs to consumers; • provision for inventory shortages; and • credits and allowances from our merchandise vendors. 13 Weeks Ended Percentage of Net Sales April 30, May 1, April 30, May 1, ($ In millions) 2011 2010 $ Change 2011 2010 Change Domestic $ 600 $ 600 $ - 36.5% 35.9% 0.6% International 378 345 33 38.1% 36.8% 1.3% Toys "R" Us - Consolidated $ 978 $ 945 $ 33 37.1% 36.2% 0.9% Gross margin increased by $33 million to $978 million for the thirteen weeks ended April 30, 2011, compared to $945 million for the same period last year. Foreign currency translation accounted for approximately $26 million of the increase in Gross margin. Gross margin, as a percentage of Net sales, increased by 0.9 percentage points for the thirteen weeks ended April 30, 2011 compared to the same period last year. Gross margin, as a percentage of Net sales, was primarily impacted by improvements in sales mix and margin rate improvements in certain categories. Domestic Gross margin for the thirteen weeks ended April 30, 2011 was $600 million, consistent with the same period last year. Gross margin, as a percentage of Net sales, for the thirteen weeks ended April 30, 2011 increased by 0.6 percentage points 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 within the juvenile category and sales mix away from lower margin products, predominantly in the entertainment category. International Gross margin increased by $33 million to $378 million for the thirteen weeks ended April 30, 2011, compared to $345 million for the same period last year. Foreign currency translation accounted for approximately $26 million of the increase in Gross margin. Gross margin, as a percentage of Net sales, for the thirteen weeks ended April 30, 2011 increased by 1.3 percentage points compared to the same period last year. The increase in Gross margin, as a percentage of Net sales, resulted primarily from improvements in sales mix towards sales of higher margin learning and seasonal products. Selling, General and Administrative Expenses The following are the types of costs included in SG&A: • store payroll and related payroll benefits; • rent and other store operating expenses; 24 -------------------------------------------------------------------------------- Table of Contents • advertising and promotional expenses; • costs associated with operating our distribution network, including costs related to transporting merchandise from distribution centers to stores; • restructuring charges; and • other corporate-related expenses. 13 Weeks Ended Percentage of Net Sales April 30, May 1, April 30, May 1, ($ In millions) 2011 2010 $ Change 2011 2010 Change Toys "R" Us - Consolidated $ 897 $ 858 $ 39 34.0% 32.9% 1.1% SG&A increased by $39 million to $897 million for the thirteen weeks ended April 30, 2011, compared to $858 million for the same period last year. Foreign currency translation accounted for approximately $24 million of the increase in SG&A. As a percentage of Net sales, SG&A increased by 1.1 percentage points. Excluding the impact of foreign currency translation, the increase in SG&A was primarily due to an increase in payroll expenses of $13 million primarily related to additional store support and corporate employees as well as other compensation expenses. Additionally, rent expense increased by $5 million associated with new locations, advertising and promotional expenses increased by $5 million and we incurred an additional $4 million of expenses associated with credit card processing fees primarily due to an increase in rates from the banks. These increases were partially offset by a decrease in litigation settlement expenses for certain legal matters of approximately $17 million recorded in the first quarter of fiscal 2010. Depreciation and Amortization 13 Weeks Ended April 30, May 1, (In millions) 2011 2010 Change Toys "R" Us - Consolidated $ 98 $ 94 $ 4 Depreciation and amortization increased by $4 million to $98 million for the thirteen weeks ended April 30, 2011, compared to $94 million for the same period last year. The increase was primarily due to the addition of new and relocated locations to our SBS and SSBS formats as well as improvements and enhancements in our information technology systems. Additionally, foreign currency translation increased depreciation and amortization by approximately $2 million. 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 April 30, May 1, (In millions) 2011 2010 Change Toys "R" Us - Consolidated $ 10 $ 12 $ (2) 25 -------------------------------------------------------------------------------- Table of Contents Other income, net decreased by $2 million to $10 million for the thirteen weeks ended April 30, 2011, compared to $12 million for the same period last year. The decrease was primarily due to a decrease of $3 million in credit card program income. Interest Expense 13 Weeks Ended April 30, May 1, (In millions) 2011 2010 Change Toys "R" Us - Consolidated $ 128 $ 125 $ 3 Interest expense increased by $3 million to $128 million for the thirteen weeks ended April 30, 2011, compared to $125 million for the same period last year. The increase was primarily due to $10 million in charges related to our derivative instruments, which was primarily driven by the change in fair value of instruments that do not qualify for hedge accounting. These charges were partially offset by a decrease of $6 million related to lower effective interest rates primarily due to expiration of certain interest rate swaps in fiscal 2010. Interest Income 13 Weeks Ended April 30, May 1, (In millions) 2011 2010 Change Toys "R" Us - Consolidated $ 2 $ 1 $ 1 Interest income for the thirteen weeks ended April 30, 2011 increased by $1 million compared to the same period last year. Income Tax Benefit The following table summarizes our income tax benefit and effective tax rates for the thirteen weeks ended April 30, 2011 and May 1, 2010: 13 Weeks Ended April 30, May 1, ($ In millions) 2011 2010 Loss before income taxes $ (133) $ (119) Income tax benefit 66 63 Effective tax rate (49.6)% (52.9)% The effective tax rates for the thirteen weeks ended April 30, 2011 and May 1, 2010 were based on our forecasted annualized effective tax rates, adjusted for discrete items that occurred within the periods presented. Our forecasted annualized effective tax rate is 47.3% for the thirteen weeks ended April 30, 2011 compared to 44.6% for the same period last year. The difference between our forecasted annualized effective tax rates was primarily due to the increase in taxable permanent adjustments and a change in the mix of earnings between jurisdictions. For the thirteen weeks ended April 30, 2011, our effective tax rate was impacted by a tax benefit of $2 million related to changes to our liability for uncertain tax positions. For the thirteen weeks ended May 1, 2010, our effective tax rate was impacted by tax benefits of $4 million related to state income taxes, $3 million related to adjustments to deferred taxes, $2 million related to adjustments to current taxes payable and $2 million related to changes to our liability for uncertain tax positions. These tax benefits were partially offset by a tax expense of $2 million related to an increase in our valuation allowance. Our expectation of our full year effective tax rate for fiscal 2011 (which includes our forecasted annualized effective tax rate, adjusted for full year discrete items) has not materially changed from our initial expectation disclosed in our Annual Report on Form 10-K for the fiscal year ended January 29, 2011. 26 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Overview As of April 30, 2011, we were in compliance with all of our covenants related to our outstanding debt. At April 30, 2011, under our $1.85 billion secured revolving credit facility ("ABL Facility"), we had no outstanding borrowings, a total of $80 million of outstanding letters of credit and excess availability of $1,136 million. This amount is also subject to the minimum excess availability covenant, which was $125 million at April 30, 2011, with remaining availability of $1,011 million in excess of the covenant. Toys-Japan currently has a credit agreement with a syndicate of financial institutions, which includes two unsecured loan commitment lines of credit ("Tranche 1" and "Tranche 2"). Under the agreement, Tranche 1 is available in amounts of up to ¥14.9 billion ($184 million at April 30, 2011), and expires on June 30, 2013. At April 30, 2011, we had no outstanding borrowings under Tranche 1, with $184 million of remaining availability. On March 18, 2011, Toys-Japan entered into an agreement with a syndicate of financial institutions to refinance Tranche 2. As a result, Tranche 2 is now available in amounts of up to ¥10.0 billion ($123 million at April 30, 2011), expiring on June 29, 2012. At April 30, 2011, we had outstanding long-term borrowings of $100 million under Tranche 2, with $23 million of remaining availability. On March 8, 2011, certain of our foreign subsidiaries amended and restated the credit agreement for our European and Australian asset-based revolving credit facility ("European ABL") in order to extend the maturity date of the facility and amend certain other provisions. The European ABL facility as amended provides for a five-year £128 million asset-based senior secured revolving credit facility which will expire on March 8, 2016. Additionally, on April 29, 2011, we partially exercised the accordion feature which increased availability to include additional lender commitments. This increased the size of the facility from £128 million to £138 million ($231 million at April 30, 2011). At April 30, 2011, we had no outstanding borrowings and $143 million of availability under the European ABL. We are dependent on the borrowings provided by the lenders to support our working capital needs and capital expenditures. Currently we have funds available to finance our operations under our European ABL through March 2016, our ABL Facility through August 2015, and our Toys-Japan unsecured credit lines with a Tranche maturing June 2012 and a Tranche maturing June 2013. If our cash flow and capital resources do not provide the necessary liquidity, it could have a significant negative effect on our results of operations. In general, our primary uses of cash are providing for working capital purposes, which principally represent the purchase of inventory, servicing debt, remodeling existing stores (including conversions), financing construction of new stores, and paying expenses, such as payroll costs, to operate our stores. Our working capital needs follow a seasonal pattern, peaking in the third quarter of the year when inventory is purchased for the fourth quarter holiday selling season. Our largest source of operating cash flows is cash collections from our customers. We have been able to meet our cash needs principally by using cash on hand, cash flows from operations and borrowings under our revolving credit facilities and credit lines. Although we believe that cash generated from operations, along with our existing cash, revolving credit facilities and credit lines will be sufficient to fund our expected cash flow requirements and planned capital expenditures for at least the next 12 months, any world-wide financial market disruption could have a negative impact on our available resources in the future. We believe that we have the ability to repay or refinance our current outstanding borrowings maturing within the next 12 months. Capital Expenditures A component of our long-term strategy is our capital expenditure program. Our capital expenditures are primarily for financing construction of new stores, remodeling existing stores (including conversions), as well as improving and enhancing our information technology systems and are funded primarily through cash provided by operating activities, as well as available cash. For fiscal 2011, we plan to increase our capital spending with a continued emphasis on our toy and juvenile integration strategy. 27-------------------------------------------------------------------------------- Table of Contents The following table discloses our capital expenditures for the thirteen weeks ended April 30, 2011 and May 1, 2010: 13 Weeks Ended April 30, May 1, (In millions) 2011 2010 New stores (1) $ 19 $ 2 Conversion projects (2) 12 16 Information technology 12 10 Distribution centers 12 5 Other store-related projects (3) 3 7 Total capital expenditures $ 58 $ 40 (1) Primarily includes SSBS and SBS relocations as well as single format stores (including Express stores). (2) Primarily includes SBS conversions as well as other remodels pursuant to our juvenile integration strategy. (3) Includes other store-related projects (other than conversion projects) such as store updates. Cash Flows 13 Weeks Ended April 30, May 1, (In millions) 2011 2010 $ Change Net cash used in operating activities $ (564) $ (723) $ 159 Net cash used in investing activities (51) (29) (22) Net cash provided by financing activities 74 158 (84) Effect of exchange rate changes on cash and cash equivalents 24 (13) 37 Net decrease during period in cash and cash equivalents $ (517) $ (607) $ 90 Cash Flows Used In Operating Activities During the thirteen weeks ended April 30, 2011, net cash used in operating activities was $564 million compared to $723 million for the thirteen weeks ended May 1, 2010. The decrease in net cash used in operating activities was primarily the result of a decrease in purchases of merchandise inventories related to the early replenishment of inventory in fiscal 2010 for fiscal 2011 at our existing locations as well as new stores and a decrease in payments on accounts payable due to the timing of vendor payments. These decreases were partially offset by a cash settlement payment made in the current year as a result of a litigation settlement. Cash Flows Used In Investing Activities During the thirteen weeks ended April 30, 2011, net cash used in investing activities was $51 million compared to $29 million for the thirteen weeks ended May 1, 2010. The increase in net cash used in investing activities was primarily due to an increase in capital expenditures of $18 million. Cash Flows Provided by Financing Activities During the thirteen weeks ended April 30, 2011, net cash provided by financing activities was $74 million compared to $158 million for the thirteen weeks ended May 1, 2010. The decrease in net cash provided by financing activities was primarily due to a $91 million increase in net debt repayments, partially offset by $10 million paid for the purchase of additional shares of Toys-Japan in the prior year period. Debt Refer to Note 2 to the Condensed Consolidated Financial Statements entitled "Long-term debt" for further details regarding our debt and any of the transactions described below. During the thirteen weeks ended April 30, 2011, we made the following significant changes to our debt structure: On February 28, 2011, Toys-Japan entered into a bank loan with a financial institution totaling ¥1.0 billion ($12 million at April 30, 2011). The loan will mature on February 25, 2016 and bears an interest rate of 1.85% per annum. 28-------------------------------------------------------------------------------- Table of Contents On March 8, 2011, certain of our foreign subsidiaries amended and restated the credit agreement for the European and Australian asset-based revolving credit facility ("European ABL") in order to extend the maturity date of the facility and amend certain other provisions. The European ABL facility as amended provides for a five-year £128 million asset-based senior secured revolving credit facility which will expire on March 8, 2016. Additionally, on April 29, 2011, we partially exercised the accordion feature which increased availability to include additional lender commitments. This increased the size of the facility from £128 million to £138 million ($231 million at April 30, 2011). Loans under the European ABL bear interest at a rate of London Interbank Offered Rate ("LIBOR")/the Euro Interbank Offered Rate ("EURIBOR") plus a margin of 2.50% through the second quarter of fiscal 2011 and thereafter 2.25%, 2.50% or 2.75% depending on historical excess availability. On March 18, 2011, Toys-Japan entered into an agreement with a syndicate of financial institutions to refinance Tranche 2. As a result, Tranche 2 is now available in amounts of up to ¥10.0 billion ($123 million at April 30, 2011), expiring on June 29, 2012, and bears an interest rate of Tokyo Interbank Offered Rate plus 0.80% per annum. Subsequent Events On May 25, 2011, Toys-Delaware and certain of its subsidiaries entered into an Incremental Joinder Agreement (the "Joinder Agreement") to the amended and restated Toys-Delaware secured term loan agreement ("Secured Term Loan"). The Joinder Agreement added a new tranche of term loans in an aggregate principal amount of $400 million ("Incremental Term Loan"), which increased the size of the Secured Term Loan to an aggregate principal amount of $1.1 billion. The Incremental Term Loan was issued at a discount of $4 million which resulted in gross proceeds of $396 million. The gross proceeds were used to pay transaction fees of approximately $7 million, including fees payable to the Sponsors pursuant to their advisory agreement, which will be deferred and expensed over the life of the instrument. The net proceeds from the Incremental Term Loan along with borrowings from our ABL Facility will be used to provide funds to redeem the 7.625% notes due fiscal 2011 (the "2011 Notes"), including accrued interest, premiums and expenses, on or about June 24, 2011. On May 26, 2011, the Company provided notice to the holders of the 2011 Notes that it would redeem all such notes on or about June 24, 2011. The Company estimates that the redemption price will be approximately $1,007.47 per $1,000 principal amount of the 2011 Notes redeemed and that the total redemption price, including interest and premiums, will be approximately $519 million. The redemption price will be finalized prior to the redemption date to reflect the applicable treasury rate in accordance with the indenture governing the 2011 Notes. In accordance with the indenture governing Toys "R" Us Property Company I, LLC's ("TRU Propco I") 10.75% senior notes (the "Notes"), TRU Propco I commenced a tender offer on May 13, 2011 to purchase up to an aggregate principal amount of approximately $25 million of the Notes for cash. The tender offer will expire on June 13, 2011. To the extent that the tender offer is not accepted by holders, TRU Propco I will use such funds as permitted by the indenture governing the Notes, including dividends to us. We and our subsidiaries, as well as the Sponsors or their affiliates, may from time to time acquire debt or debt securities issued by us or our subsidiaries in open market transactions, tender offers, privately negotiated transactions or otherwise. Any such transactions, and the amounts involved, will depend on prevailing market conditions, liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. Refer to Note 8 to our Condensed Consolidated Financial Statements entitled "Related party transactions." Contractual Obligations and Commitments Our contractual obligations consist mainly of payments related to Long-term debt and related interest, operating leases related to real estate used in the operation of our business and product purchase obligations. Refer to the "CONTRACTUAL OBLIGATIONS" section of the Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended January 29, 2011 for details on our contractual obligations and commitments. Subsequent to the end of the first quarter of fiscal 2011, there was a significant change in our contractual obligations and commitments related to Long-term debt and related interest as a result of the Joinder Agreement entered on May 25, 2011. See Note 2 to the Condensed Consolidated Financial Statements entitled "Long-term debt" for further details. Critical Accounting Policies Our Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosures of contingent assets and liabilities as of the date of the financial statements and during the applicable periods. We base these estimates on historical experience and on other factors that we believe are reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions and could have a material impact on our Condensed Consolidated Financial Statements. Refer to the Annual Report on Form 10-K for the fiscal year ended January 29, 2011 for a discussion of critical accounting policies. 29 -------------------------------------------------------------------------------- Table of Contents Recently Adopted Accounting Pronouncements In December 2010, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2010-29, "Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations" ("ASU 2010-29"). The amendments in this ASU specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplementary pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. Effective January 30, 2011, the Company has adopted ASU 2010-29. The adoption of ASU 2010-29 did not have an impact on our Condensed Consolidated Financial Statements. In December 2010, the FASB issued ASU No. 2010-28, "Intangibles - Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts" ("ASU 2010-28"). For reporting units with zero or negative carrying amounts, this ASU requires that an entity perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with the existing guidance and examples, which require that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Effective January 30, 2011, the Company has adopted ASU 2010-28. The adoption of ASU 2010-28 did not have an impact on our Condensed Consolidated Financial Statements. Forward-Looking Statements This Quarterly Report on Form 10-Q may contain "forward looking" statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and such disclosure is intended to be covered by the safe harbors created thereby. These forward looking statements reflect our current views with respect to, among other things, our operations and financial performance. All statements herein or therein that are not historical facts, including statements about our beliefs or expectations, are forward-looking statements. We generally identify these statements by words or phrases, such as "anticipate," "estimate," "plan," "project," "expect," "believe," "intend," "foresee," "forecast," "will," "may," "outlook" or the negative version of these words or other similar words or phrases. These statements discuss, among other things, our strategy, store openings, integration and remodeling, the development, implementation and integration of our Internet business, future financial or operational performance, projected sales or earnings per share for certain periods, comparable store net sales from one period to another, cost savings, results of store closings and restructurings, outcome or impact of pending or threatened litigation, domestic or international developments, nature, amount and allocation of future capital expenditures, growth initiatives, inventory levels, cost of goods, selection and type of merchandise, marketing positions, implementation of safety standards, future financings and other goals and targets and statements of the assumptions underlying or relating to any such statements. These statements are subject to risks, uncertainties, and other factors, including, among others, the seasonality of our business, competition in the retail industry, economic factors and consumer spending patterns, the availability of adequate financing, access to trade credit, changes in consumer preferences, our dependence on key vendors for our merchandise, political and other developments associated with our international operations, costs of goods that we sell, labor costs, transportation costs, domestic and international events affecting the delivery of toys and other products to our stores, product safety issues including product recalls, the existence of adverse litigation, changes in laws that impact our business, our substantial level of indebtedness and related debt-service obligations, restrictions imposed by covenants in our debt agreements and other risks, uncertainties and factors set forth under Item 1A entitled "RISK FACTORS" of our Annual Report on Form 10-K filed on March 24, 2011, as well as our other reports and documents filed with the Securities and Exchange Commission. In addition, we typically earn a disproportionate part of our annual operating earnings in the fourth quarter as a result of seasonal buying patterns and these buying patterns are difficult to forecast with certainty. These factors should not be construed as exhaustive, and should be read in conjunction with the other cautionary statements that are included in this report. We believe that all forward-looking statements are based on reasonable assumptions when made; however, we caution that it is impossible to predict actual results or outcomes or the effects of risks, uncertainties or other factors on anticipated results or outcomes and that, accordingly, one should not place undue reliance on these statements. Forward-looking statements speak only as of the date they were made, and we undertake no obligation to update these statements in light of subsequent events or developments unless required by the Securities and Exchange Commission's rules and regulations. Actual results may differ materially from anticipated results or outcomes discussed in any forward-looking statement. |