ITEM 1.
BUSINESS
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. Our fiscal year ends on the Saturday nearest to January 31 of each calendar year. This Annual Report on Form 10-K focuses on our last three fiscal years ended as follows: fiscal 2013 ended February 1, 2014; fiscal 2012 ended February 2, 2013; and fiscal 2011 ended January 28, 2012. With the exception of fiscal 2012, which included 53 weeks, all other fiscal years presented include 52 weeks. References to 2013, 2012 and 2011 are to our fiscal years unless otherwise specified.
Our Business
We are the leading global specialty retailer of toys and juvenile products as measured by Net sales. Toys “R” Us is recognized as the toy and juvenile (including baby) authority. We sell a variety of products in the core toy, entertainment, juvenile, learning and seasonal categories through our retail locations and the Internet. Our brand names are highly recognized in North America, Europe and Asia, and our expertise in the toy and juvenile retail space, our broad range of product offerings, our substantial scale and geographic footprint and our strong vendor relationships account for our market-leading position and distinguish us from the competition. We believe we offer the most comprehensive year-round selection of toys and juvenile products among omnichannel retailers, including a broad assortment of private label and exclusive merchandise unique to our stores.
As of February 1, 2014, we operated 1,577 stores and licensed an additional 185 stores. These stores are located in 36 countries and jurisdictions around the world under the Toys “R” Us, Babies “R” Us and FAO Schwarz banners. In addition, we operate Toys “R” Us Express stores (“Express stores”), smaller format stores primarily open on a short-term basis during the holiday season. During the fiscal 2013 holiday season, we operated 265 Express stores, of which 120 were still open as of February 1, 2014. Of the 120 Express stores that remained open, 60 have been included in our overall store count as they each have a cumulative lease term of at least two years. We also own and operate websites including Toysrus.com, Babiesrus.com, eToys.com, FAO.com and toys.com, as well as other Internet sites we operate in our international markets. For fiscal 2013, we generated Net sales of $12.5 billion, Net loss attributable to Toys “R” Us, Inc. of $1.0 billion and Adjusted EBITDA of $588 million. For the definition of Adjusted EBITDA, an explanation of why we present it and a description of the limitations of this non-GAAP measure, as well as a reconciliation to Net loss attributable to Toys “R” Us, Inc., see Item 6 entitled “SELECTED FINANCIAL DATA” of this Annual Report on Form 10-K.
History
Our Company was founded in Washington D.C. in 1948 when Charles Lazarus opened a baby furniture store, Children’s Bargain Town. The Toys “R” Us name made its debut in 1957. In 1978, we completed an initial public offering of our common stock. When Charles Lazarus retired as our Chief Executive Officer (“CEO”) in 1994, we operated or licensed over 1,000 stores in 17 countries and jurisdictions. In 1996, we established the Babies “R” Us brand, further solidifying our reputation as a leading consumer destination for children and their families.
On July 21, 2005, we were acquired by an investment group led by entities advised by or affiliated with Bain Capital Partners, LLC, Kohlberg Kravis Roberts & Co. L.P., and Vornado Realty Trust. We refer to this collective ownership group as our “Sponsors.” Upon the completion of this acquisition, we became a private company.
Strategy and Strengths
We believe we offer our customers the most comprehensive year-round selection of merchandise in the retail toy and juvenile (including baby) categories among omnichannel retailers through our “R” Us branded stores and through the Internet. On average, our domestic and international stores (other than Express stores) offer 12,000 and 7,000 items year-round, respectively. Express stores, due to their size, typically carry 2,000 items. We believe that our differentiated product assortment, private label and exclusively licensed product offerings and expert service enable us to command a reputation as the shopping destination for toys and juvenile (including baby) products. We seek to differentiate ourselves from our competitors in several key areas, including product selection, product presentation, service, in-store experience and marketing. We are able to provide vendors with a year-round distribution outlet for the broadest assortment of their products. We continue to strengthen our Toys “R” Us - Domestic (“Domestic”) and Toys “R” Us - International (“International”) segments by:
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offering value to customers through a convenient omnichannel (store and Internet) shopping experience;
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reaching customers, through differentiated value propositions, with our portfolio of e-commerce brands;
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achieving a high degree of customer interaction by leveraging our comprehensive baby registry and birthday club in the United States and our Domestic and International loyalty programs;
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continuing to refine our in-store customer experience and improving customer service;
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renovating and updating or relocating our existing stores to enhance the shopping experience and continually reviewing the market for new store opportunities; and
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enhancing our product offerings and adding private label and exclusive products to our mix, including unique and exceptional items sold through the FAO Schwarz brand.
We have well-developed omnichannel capabilities through which we integrate our e-commerce and brick-and-mortar businesses. The “Buy Online, Pick Up In Store” program, available within all stores in the United States and the United Kingdom, offers customers the ability to browse and shop from the comfort of their own homes, while giving them the flexibility to pick up their purchases in-store, usually within the same day. In addition, our “Ship to Store” program allows customers in the United States to purchase online items that may not be currently available in their local store, and have their order delivered to the local store of their choice, free of shipping charges. We also have “Pay In-Store,” which enables customers to shop online and pay for their items in any one of our stores across the United States.
In addition, the “Ship from Store” program leverages inventory from the majority of our U.S. stores to improve the speed with which customers receive their online orders, as well as provide an additional option to fulfill these orders. This feature is also available in several of our international countries. In addition, our loyalty programs, including the Babies “R” Us Registry, Geoffrey’s Birthday Club and Rewards “R” Us, all offer online functionality which we believe deepens our relationship with our customers and complements the in-store experience.
Internationally, we have an online presence in Australia, Austria, Canada, China, France, Germany, Japan, the Netherlands, Portugal, Spain, Switzerland and the United Kingdom. Additionally, we offer international shipping for online orders to more than 60 countries across Asia, the Caribbean, Central America, Europe, North America and South America. This service allows customers to place orders domestically and have them delivered across the world, and more importantly, it allows us to expand the global reach of our brands to countries where we do not currently have any physical stores. For fiscals 2013, 2012 and 2011, our consolidated e-commerce business generated net sales of $1.2 billion, $1.1 billion and $1.0 billion, respectively.
We believe that we may have the potential to grow the number of stores in our international store portfolio, particularly those in the emerging economies which are seeing overall GDP growth and rising incomes. In line with this strategy, Toys (Labuan) Holding Limited (“Labuan”) increased stores operated from 100 Toys “R” Us retail stores at February 2, 2013 (90 which were acquired in fiscal 2011) to 129 stores at February 1, 2014.
We will also continue to focus on competitive pricing, increasing our private label penetration and increasing our use of direct sourcing. We will also continue to optimize our cost structure and enhance efficiencies throughout the organization to manage our selling, general and administrative expenditures.
Domestically, we continued the use of several programs that benefited customers during our holiday selling season. We offered a free, no minimum purchase layaway program early in the season, which allowed customers to take full advantage of the flexible payment terms provided by layaway. During fiscal 2013, we modified our layaway program to allow subsequent payments to be made online. In addition, our “Price Match Guarantee” program matched competitors’ in-store pricing on identical items, as well as identical items sold on our websites. During fiscal 2013, we enhanced our “Price Match Guarantee” program to include selected online retailer pricing.
Our juvenile business targets the pre-natal to infant market which allows us to offer the broadest range of juvenile (including baby) products and deliver a high level of customer service and product knowledge. Our Babies “R” Us Registry and juvenile product assortment allows us to capture new customers during pregnancy, helping them prepare for the arrival of their newborn. Because first-time parents tend to make multiple product purchases during a relatively short period of time, we seek to provide the expectant parent with a “one-stop shopping” venue for all baby product needs, providing what we believe is one of the most complete selections of baby-related products in the marketplace. We then become a resource for infant products such as baby formula, diapers and solid foods, as well as baby clothing and learning aids. We believe this opportunity to establish first contact with new parents enables us to develop long-lasting customer relationships with them as their children grow and they transition to becoming consumers of our products. We continue to build on these relationships as these children mature and eventually become parents themselves. Additionally, juvenile merchandise staples such as baby formula, diapers and infant clothing provide us with a mitigant to the inherent seasonality in the toy business.
We also provide an integrated shopping format by combining the Toys “R” Us and Babies “R” Us merchandise offerings under one roof creating a “one-stop shopping” experience for our customers. We call this format a side-by-side (“SBS”) store. SBS stores are a combination of Toys “R” Us stores and Babies “R” Us stores, and may be the result of a conversion or relocation and, in certain cases, may be accompanied by the closure of one or more existing stores. In addition, SBS stores may also be constructed in a new location and market. As of February 1, 2014, we have converted existing stores into 283 SBS store formats. In addition, we have opened 117 SBS stores (58 of which were relocations of existing stores).
Over the past several months, we have developed our long-term strategic plan, which we believe will address foundational issues needed to improve the business over the short-term, while allowing us to implement new initiatives which we believe will put the Company on track for profitable growth in the future. Our TRU Transformation strategy is grounded in three strategic pillars: Transform the Customer Experience; Develop High Performing, Highly Engaged, Diverse Talent; and Become Fit for Growth. Our strategy focuses on providing a better customer experience in-store and online; improving store conditions; creating meaningful customer relationships through loyalty, as well as clear and targeted marketing programs; making progress on price perception; putting disciplines back into inventory management; improving our in-stock position; right-sizing our cost structure; and working with vendor partners to drive category leadership and differentiation. Our customer promise is to provide the broadest selection of products to help kids and babies develop, learn, have fun and be safe; be the easiest place to research and find solutions throughout the journey of parenthood; be the best resource for children’s gift giving occasions; offer fair prices; deliver expert service and unique services; and provide customers the ability to shop whenever, wherever and however they want.
As of February 1, 2014, we operated 1,577 retail stores and licensed an additional 185 retail stores worldwide in the following formats:
Operated Stores
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867 traditional toy stores, which typically range in size from 20,000 to 50,000 square feet and devote 5,000 square feet to boutique areas for juvenile (including baby) products (including 97 Babies “R” Us Express (“BRU Express”) and Juvenile Expansion formats which devote an additional 4,000 square feet and 1,000 square feet, respectively, for juvenile - including baby - products);
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400 SBS stores, which typically range in size from 30,000 to 70,000 square feet and devote 20,000 to 40,000 square feet to traditional toy products and 10,000 to 30,000 square feet to juvenile (including baby) products;
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247 juvenile stores, which typically range in size from 30,000 to 45,000 square feet and devote 3,000 square feet to traditional toy products;
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60 Express stores, which typically range in size from 2,000 to 7,000 square feet, each with a cumulative lease term of at least two years; and
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3 flagship store locations (the Toys “R” Us store in Times Square, the FAO Schwarz store on 5th Avenue and the Babies “R” Us store in Union Square - all in New York City), which range in size from 55,000 to 105,000 square feet.
Licensed Stores
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185 “R” Us branded retail stores ranging in various sizes. Licensing fees did not have a material impact on our Net sales.
In addition to these stores, during the fiscal 2013 holiday selling season, we operated an additional 205 Express stores globally in shopping malls, outlet malls and other shopping centers located in high traffic areas. These locations typically range in size from 2,000 to 7,000 square feet, each has a cumulative lease term of less than two years and are not included in our overall store count.
Our extensive experience in retail site selection has resulted in a portfolio of stores that includes attractive locations in many of our chosen markets. Markets for new stores and formats are selected on the basis of proximity to other “R” Us branded stores, demographic factors, population growth potential, competitive environment, availability of real estate and cost. Once a potential market is identified, we select a suitable location based upon several criteria, including size of the property, access to major commercial thoroughfares, proximity of other strong anchor stores, visibility and parking capacity.
Our Business Segments
Our business has two reportable segments: Domestic and International. See Note 11 to our Consolidated Financial Statements entitled “SEGMENTS” for our segments’ financial results. The following is a brief description of our segments:
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Domestic - Our Domestic segment sells a variety of products in the core toy, entertainment, juvenile (including baby), learning and seasonal categories through 873 stores that operate in 49 states in the United States and Puerto Rico and through the Internet. Domestic Net sales in fiscal 2013 were derived from 382 traditional toy stores (including 79 BRU Express and Juvenile Expansion formats), 232 juvenile stores, 214 SBS stores, 42 permanent Express stores and our three flagship stores in New York City. Additionally, we generated Net sales through our temporary Express store locations. Domestic Net sales were $7.6 billion for fiscal 2013, which accounts for 61% of our consolidated Net sales.
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International - Our International segment sells a variety of products in the core toy, entertainment, juvenile (including baby), learning and seasonal categories through 704 operated and 185 licensed stores in 35 countries and jurisdictions and through the Internet. In addition to fees received from licensed stores, International Net sales in
fiscal 2013 were derived from 485 traditional toy stores (including 18 BRU Express formats), 186 SBS stores, 18 permanent Express stores and 15 juvenile stores. Additionally, we generated Net sales through our temporary Express store locations. Our operated stores are located in Australia, Austria, Brunei, Canada, China, France, Germany, Hong Kong, Japan, Malaysia, Poland, Portugal, Singapore, Spain, Switzerland, Taiwan, Thailand and the United Kingdom. International Net sales were $4.9 billion for fiscal 2013, which accounts for 39% of our consolidated Net sales.
Product Selection and Merchandise
Our product offerings are focused on serving the needs of parents, grandparents and other gift-givers interested in purchasing merchandise in our primary product categories:
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Core Toy - boys and girls toys, such as action figures, dolls and doll accessories, role play toys and vehicles;
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Entertainment - video game software, systems and accessories, tablet computers, electronics and other related products;
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Juvenile - focused on serving newborns and children up to four years of age by offering a broad array of products, such as baby gear, infant care products, apparel, commodities, furniture, bedding and room décor;
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Learning - educational electronics and developmental toys, such as our Imaginarium products in the United States and World of Imagination products at our International locations, construction toys, games, creative activities and pre-school merchandise which includes learning products, activities and toys; and
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Seasonal - toys and other products geared toward holidays (including Christmas, Hanukkah, Three Kings, Carnival, Easter, Golden Week and Halloween) and summer activities, as well as bikes, sporting goods, play sets and other outdoor products.
We offer a wide selection of popular national toy and juvenile brands including many products that are exclusively offered at, or launched at, our stores. Over the past few years, we have worked with key resources to obtain exclusive products and expand our private label brands enabling us to earn higher margins and offer products that our customers will not find elsewhere. We offer a broad selection of private label merchandise under names such as BABIES “R” US, JOURNEY GIRLS, IMAGINARIUM, FAST LANE, YOU & ME, JUST LIKE HOME, TRUE HEROES, TOTALLY ME!, DREAM DAZZLERS and FAO SCHWARZ in our stores. We believe these private label brands provide a platform on which we can expand our product offerings in the future and will further differentiate our products and allow us to enhance profitability. We utilize our sourcing office in China to work with our vendors and expand our private label product offerings.
Marketing
We believe that we have achieved our leading market position largely as a result of building highly recognized brand names, strong loyalty programs and delivering knowledgeable service to our customers. We use a variety of broad-based and targeted marketing and advertising strategies to reach consumers. These strategies include mass marketing programs such as direct mail, e-mail marketing, targeted magazine advertisements, catalogs/rotos and other inserts in national or local newspapers, national television and radio, targeted door-to-door distribution, direct mailings to loyalty program members and in-store marketing. Our most significant single piece of advertising is “The Great Big Toys “R” Us Book” promotional catalog release, which is distributed through direct mail, newspapers and in-stores during the fourth quarter holiday selling season. We also utilize social and digital media to communicate with our customers and keep them informed of new promotions, programs and products.
In addition, we offer unique benefits such as loyalty programs to our customers, including the Rewards “R” Us program, which rewards members for the purchases they make at our stores and online at Toysrus.com and Babiesrus.com. Through the Rewards “R” Us program, members are able to take advantage of a variety of exclusive one-time and ongoing benefits, deals and promotions.
Our comprehensive baby registry offered in our stores and on the Internet allows an expectant parent to list desired products and enables gift-givers to tailor purchases to the expectant parent’s specific needs and wishes. Our baby registry also facilitates our direct marketing and customer relationship initiatives, which includes mailings to expecting mothers and new parents.
Other programs include our Wish List, which allows parents and kids to create a tailored list of desired toys that gift-givers can utilize to make their purchases; Geoffrey’s Birthday Club, in which parents receive exciting offers and incentives to help prepare for their child’s birthday and kids receive special gifts and greetings from Geoffrey the Giraffe; and our Credit Card Program, which offers co-branded and private label credit cards in order for customers to finance purchases at our stores, online and at other businesses, and receive loyalty benefits, deals and promotions in exchange.
The merchandising and marketing teams work closely to present the products in an engaging and innovative manner and we are focused on enhancing our in-store signage, which is carefully coordinated so that it is consistent with the current television, radio and print advertisements. We regularly change our banners and in-store promotions, which are advertised throughout the
year, to attract consumers to visit the stores, to generate strong customer frequency and to increase average sales per customer. Our websites are used to support and supplement the promotion of products in “R” Us branded stores.
Customer Service
Compared with multi-line mass merchandisers, we believe we are able to provide knowledgeable service to our customers through our highly trained sales force. We train our store associates extensively to deepen their product knowledge and enhance their targeted selling skills in order to improve customer service in our stores. We are continually working to improve the allocation of products within our stores and reduce waiting times at checkout counters. For the added convenience of our customers, we offer a layaway program and provide a home delivery service.
In addition to our baby registry, we offer a variety of helpful publications and innovative programs, classes and services for the expectant parent, including frequent in-store product demonstrations.
Safety Focus
We have taken a leadership position on product safety. We believe that we have put in place industry-leading product safety standards that meet or exceed United States federally mandated and/or global regulatory requirements in the countries in which we operate. In addition, through our dedicated safety website, safety boards in stores, e-mail communications and partnerships with noted safety experts and organizations, we provide resources that are used by parents, grandparents and childcare providers to ensure they have the most up-to-date information on product safety and recalls.
Corporate Philanthropy and Community Service
We are proud to have a long tradition at Toys “R” Us of supporting numerous children’s charities. The Toys “R” Us Children’s Fund Inc., a public charity, and the Company together have contributed millions of dollars to charities that keep children safe and help them in times of need. We actively support charities such as the Marine Toys For Tots Foundation, Autism Speaks, Alex’s Lemonade Stand Foundation, Special Olympics and Save the Children, among others. Each year the Company also produces the Toys “R” Us Toy Guide for Differently-Abled Kids, a resource featuring specially selected toys that encourage play for children with physical, cognitive and developmental disabilities. The Company encourages its employees to become active in charitable endeavors by matching contributions they make to qualified charities of their choice, and through Volunteer Match, a program that helps them identify charities to assist in their communities. The Company also manages the Geoffrey Fund, Inc., a non-profit organization. The Geoffrey Fund’s sole purpose is to provide assistance to employees affected by natural and personal disasters and relies on donations from employees and funds from the Company to carry out its mission.
Market and Competition
We are the leading global specialty retailer of toys and juvenile products as measured by Net sales. As a specialty retailer, we are able to focus solely on the toys and juvenile products market.
In the domestic market, we compete with mass merchandisers, such as Walmart, Target and Kmart; consumer electronics retailers, such as Best Buy and GameStop; Internet and catalog businesses, such as Amazon.com (“Amazon”); national and regional specialty, department and discount store chains; as well as local retailers in the geographic areas we serve. Our baby registry competes with baby registries of mass merchandisers, other specialty retail formats, such as buybuy BABY, and regional retailers. In the International toy and electronics markets, we compete with mass merchandisers, discounters and specialty retailers such as Argos, Auchan, Bic Camera, Carrefour, El Corte Ingles, King Jouet, Mothercare, Walmart, and Yamada Denki. The domestic and international mass merchandisers and discounters aggressively price items in the traditional toy and electronic product categories with larger dedicated selling space during the holiday season in order to build traffic for other store departments.
We believe the principal competitive factors in the toy, juvenile (including baby) and video game products markets are product variety, price, quality, availability, advertising and promotion, convenience or store location, safety and customer support and service. We believe we are able to effectively compete by providing a broader range of merchandise, maintaining in-stock positions, as well as convenient locations, knowledgeable customer service and competitive pricing.
Seasonality
Our global business is highly seasonal with sales and earnings highest in the fourth quarter due to the fourth quarter holiday selling season. During fiscals 2013, 2012 and 2011, 42%, 43% and 43%, respectively, of our total Net sales were generated in the fourth quarter. We typically incur net losses in each of the first three quarters of the year, with a substantial portion of our earnings generated in the fourth quarter, with the exception of the fourth quarter of fiscal 2013 which resulted in a net loss. We seek to continuously improve our ability to manage the numerous demands of a highly seasonal business, from the areas of product sourcing and distribution, to the challenges of delivering high sales volumes and excellent customer service during
peak business periods. Over the past 65 years, we have developed substantial experience and expertise in managing the increased demand during the holiday season which we believe favorably differentiates us from our competition.
License Agreements
We have license agreements with unaffiliated third party operators located outside the United States. The agreements are largely structured with royalty income paid as a percentage of sales for the use of our trademarks, trade name and branding. While this business format remains a small piece of our overall International business operations, we continue to look for opportunities for market expansion. Our preferred approach is to open stores in our Company-operated format, but we may choose partnerships or licensed arrangements where we believe it is appropriate due to business climate and risks.
Geographic Distribution of Domestic Stores
The following table sets forth the location of our Domestic stores as of February 1, 2014:
(1)
This includes 42 Express stores that each have a cumulative lease term of at least two years and excludes the remaining 47 temporary Express store locations which remained open as of February 1, 2014. During the fiscal 2013 holiday selling season, we operated 219 Express stores domestically.
Geographic Distribution of International Stores
The following table sets forth the location of our International operated stores as of February 1, 2014:
(1)
This includes 18 Express stores that each have a cumulative lease term of at least two years and excludes the remaining 13 temporary Express store locations which remained open as of February 1, 2014. During the fiscal 2013 holiday selling season, we operated 46 Express stores internationally.
The following table sets forth the location of our International licensed stores as of February 1, 2014:
Employees
As of February 1, 2014, we employed 67,000 full-time and part-time individuals worldwide, with 42,000 domestically and 25,000 internationally. These numbers do not include the individuals employed by licensees of our stores. Due to the seasonality of our business, we employed 114,000 full-time and part-time employees worldwide during the fiscal 2013 holiday season.
Distribution
We operate 20 distribution centers including 10 that support our Domestic operations and 10 that support our International operations (excluding licensed operations). These distribution centers employ warehouse management systems and material handling equipment that help to minimize overall inventory levels and distribution costs. We have agreements with third party logistics providers JB Hunt Transport, Inc. and Performance Team Freight Systems, Inc. to manage all services related to the delivery of inventory from our distribution centers to our stores. We believe the flexibility afforded by our warehouse/distribution system and the utilization of third party providers to distribute merchandise provides us with operating efficiencies and the ability to maintain a superior in-stock inventory position at our stores. We continuously seek to improve our supply chain management, optimize our inventory assortment and upgrade our automated replenishment system to improve inventory turnover.
We also have an agreement with Exel, Inc., a leading North American contract logistics provider, who provides additional warehousing and fulfillment services for our Internet operations in the United States. We utilize various third party providers who furnish similar services in our international markets.
Our Vendors
We procure the merchandise that we offer to our customers from a wide variety of domestic and international vendors. In fiscal 2013, we had 3,900 active vendor relationships. For fiscal 2013, our top 20 vendors worldwide, based on our purchase volume in USD, represented 46% of the total products we purchased.
Given our market leadership position, we have been able to develop partnerships with many of our vendors. We provide vendors with a year-round platform for their brand and let them use our stores to test their products. We use our New York City flagship stores (our Toys “R” Us Times Square store, our FAO Schwarz 5th Avenue store and our Babies “R” Us Union Square store) as venues to introduce new products. In return, we obtain greater access to products in demand, support for advertising and marketing efforts, and exclusive access to merchandise.
Financial Information About Our Segments
Financial information about our segments and our operations in different geographical areas for the last three fiscal years is set forth in Note 11 to the Consolidated Financial Statements entitled “SEGMENTS.”
Trademarks and Licensing
“TOYS “R” US®,” “BABIES “R” US®,” “IMAGINARIUM®,” “GEOFFREY®,” “JOURNEY GIRLS®,” “FAST LANE®,” “DREAM DAZZLERS®,” “YOU & ME®,” the reverse “R” monogram logo and the Geoffrey character logo, as well as variations of our family of “R” Us marks, either have been registered, or have trademark applications pending, with the United States Patent and Trademark Office and with the trademark registries of many other countries. These trademarks are material to our business operations. We believe that our rights to these properties are adequately protected. In addition, we own the United States trademarks (along with certain trademark rights in other countries) associated with eToys.com and KB Toys. We also own the exclusive right and license to use the FAO SCHWARZ trademarks.
Available Information
Our investor relations website is Toysrusinc.com. On this website under “INVESTOR RELATIONS, SEC FILINGS,” we make available, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K, as well as amendments to those reports as soon as reasonably practicable after we electronically file with the Securities and Exchange Commission (“SEC”).
We are not incorporating by reference in this Annual Report on Form 10-K any information from our websites.
The public may read and copy any materials the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site, www.sec.gov, that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.
ITEM 1A.
ITEM 1A.
RISK FACTORS
Investors should carefully consider the risks described below together with all of the other information in this Annual Report on Form 10-K. The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties not presently known to us, or that we currently believe to be less significant than the following risk factors, may also adversely affect our business and operations. If any of the following risks actually occur, our business, financial condition, cash flows or results of operations could be materially adversely affected.
Risks Relating to Our Business
Our business is highly seasonal, and our financial performance depends on the results of the fourth quarter of each fiscal year and, as a result, our operating results could be materially adversely affected if we achieve less than satisfactory sales prior to or during the holiday season.
Our business is highly seasonal. During fiscals 2013, 2012 and 2011, 42%, 43% and 43%, respectively, of our total Net sales were generated in the fourth quarter. We typically incur net losses in each of the first three quarters of the year, with a substantial portion of our earnings generated in the fourth quarter, with the exception of the fourth quarter of fiscal 2013, which resulted in a net loss. As a result, we depend significantly upon the fourth quarter holiday selling season. If we achieve less than satisfactory sales, operating earnings or cash flows from operating activities during the fourth quarter, we may not be able to compensate sufficiently for the lower sales, operating earnings or cash flows from operating activities during the first three quarters of the fiscal year. Our results in any given period may be affected by dates on which important holidays fall and the shopping patterns relating to those holidays. Additionally, the concentrated nature of our seasonal sales means that our operating results could be materially adversely affected if we achieve less than satisfactory sales prior to or during the holiday season, including as a result of natural disasters and labor strikes, work stoppages, terrorist acts or disruptive global political events, prior to or during the holiday season, as described below.
Our industry is highly competitive and competitive conditions may materially adversely affect our revenues and overall profitability.
The retail industry is highly and increasingly competitive and our results of operations are sensitive to, and may be materially adversely affected by competitive pricing, promotional pressures, competitor credit programs, additional competitor store openings, growth of e-commerce competitors and other factors. As a specialty retailer that primarily focuses on toys and juvenile products, we compete with discount and mass merchandisers, such as Walmart and Target, national and regional chains and department stores, as well as local retailers in the markets we serve. We also compete with national and local discount stores, consumer electronics retailers, supermarkets and warehouse clubs, as well as Internet and catalog businesses, such as Amazon. Competition is principally based on product variety, price, quality, availability, advertising and promotion, convenience or store location, safety and customer support and service. We believe that some of our competitors in the toy market and juvenile products market, as well as in the other markets in which we compete, have a larger market share than our market share. In addition, some of our competitors have greater financial resources, lower merchandise acquisition costs and lower operating expenses than we do.
Much of the merchandise we sell is also available from various retailers at competitive prices. Discount and mass merchandisers use aggressive pricing policies and enlarged toy-selling areas during the holiday season to increase sales and build traffic for other store departments. Our business is vulnerable to shifts in demand and pricing, as well as consumer preferences.
We may be vulnerable to competitive pressures from e-commerce activity in the market, both as they may impact our own e-commerce business, and as they may impact the operating results and investment values of our existing physical stores. The Internet provides greater price transparency of our merchandise that is widely available to customers. Our “Price Match Guarantee” may lead to reduced margins as a result of intense price competition, especially during the holiday selling season. In addition, sales of video games have been impacted by a shift to sales in channels other than traditional retail stores, including direct online distribution to customers through download or cloud play, which eliminates the need for a retailer. Also, competitors’ recent launches of subscription models for diapers, formula, and other commodities eliminate the need for a customer to visit our stores or e-commerce websites. We believe that this e-commerce activity has adversely affected our sales and profitability, and any increase in the proportion of our customers’ purchases via the Internet could materially adversely affect our sales and profitability from physical stores.
The baby registry market is highly competitive, based on convenience, quality and selection of merchandise offerings and functionality. Our baby registry primarily competes with the baby registries of mass merchandisers and other specialty format and regional retailers. Some of our competitors have been aggressively advertising and marketing their baby registries through
national television, magazine and Internet campaigns. These trends present consumers with more choices for their baby registry needs, and as a result, increase competition for our baby registry.
If we fail to compete successfully, we could face lower sales and may decide or be compelled to offer greater discounts to our customers, which could result in decreased profitability.
Our sales may be adversely affected by changes in economic factors and changes in consumer spending patterns.
Many economic and other factors outside our control, including consumer confidence, consumer spending levels, employment levels, consumer debt levels, inflation and deflation, as well as the availability of consumer credit, affect consumer spending habits. A significant deterioration in the global financial markets and economic environment, recessions or an uncertain economic outlook adversely affects consumer spending habits and results in lower levels of economic activity. The domestic and international political situation, including the economic health of various political jurisdictions, also affects economic conditions and consumer confidence. In addition, changing economic and regulatory conditions and increasing consumer credit delinquencies may cause banks to re-evaluate their lending practices and terms which could have an adverse effect on our credit card program and consequently, an adverse effect on our sales. Any of these events and factors could cause consumers to curtail spending and could have a negative impact on our financial performance and position in future fiscal periods.
Our operations have significant liquidity and capital requirements and depend on the availability of adequate financing on reasonable terms. If our lenders are unable to fund borrowings under their credit commitments or we are unable to borrow, it could have a significant negative effect on our business.
We have significant liquidity and capital requirements. Among other things, the seasonality of our businesses requires us to purchase merchandise well in advance of the fourth quarter holiday selling season. We depend on our ability to generate cash flows from operating activities, as well as on borrowings under our revolving credit facilities and our credit lines, to finance the carrying costs of this inventory and to pay for capital expenditures and operating expenses. As of February 1, 2014, we had outstanding borrowings of $5 million under the Toys “R” Us - Japan, Ltd. (“Toys - Japan”) unsecured credit lines, outstanding borrowings on our Labuan uncommitted lines of credit of $12 million due on demand and no outstanding borrowings under the $1.85 billion secured revolving credit facility (“ABL Facility”), the European and Australian asset-based revolving credit facility (the “European ABL Facility”) or the Toys - Japan uncommitted line of credit due on demand. As of February 1, 2014, we had unused availability under committed lines of credit of $1.2 billion. For fiscal 2013, peak borrowings under all of our revolving credit facilities and credit lines were $715 million, as we purchased merchandise for the fourth quarter holiday selling season. If our lenders are unable to fund borrowings under their credit commitments or we are unable to borrow, it could have a significant negative effect on our business. In addition, any adverse change to our credit ratings or our business could negatively impact our ability to refinance our debt on satisfactory terms and could have the effect of increasing our financing costs. While we believe we currently have adequate sources of funds to provide for our ongoing operations and capital requirements for at least the next 12 months, any inability on our part to have future access to financing, when needed, would have a negative effect on our business.
A loss of, or reduction in, trade credit from our vendors could reduce our liquidity, increase our working capital needs and/or limit our ability to purchase products.
Trade credit from our vendors is an important source of financing for the purchase of the inventory we sell in our stores. Accordingly, the loss of, or reduction in, trade credit could have a significant adverse impact on our inventory levels and operating cash flow and negatively impact our liquidity. Our vendors may seek credit insurance to protect against non-payment of amounts due to them. If credit insurance is not available to vendors at reasonable terms or at all, vendors may demand accelerated payment of amounts due to them or require advance payments or letters of credit before goods are shipped to us. Any adverse changes in our trade credit for these or other reasons could increase our costs of financing our inventory or negatively impact our ability to deliver products to our customers, which could in turn negatively affect our financial performance.
We may not retain or attract customers if we fail to successfully implement our strategic initiatives, which could result in lower sales and a failure to realize the benefit of the expenditures incurred for these initiatives.
We continue to implement a series of customer-oriented strategic programs designed to differentiate and strengthen our core merchandise content and service levels and to expand and enhance our merchandise offerings. We seek to improve the effectiveness of our marketing and advertising programs for our “R” Us stores and e-commerce business. The success of these and other initiatives will depend on various factors, including the implementation of our strategy, the appeal of our store and website formats, our ability to offer new products to customers, our financial condition, our ability to respond to changing consumer preferences and competitive and economic conditions. We continuously endeavor to minimize our operating expenses, without adversely affecting the profitability of the business. If we fail to implement successfully some or all of our
strategic initiatives, we may be unable to retain or attract customers, which could result in lower sales and a failure to realize the benefit of the expenditures incurred for these initiatives.
If we cannot increase profitability within existing stores or open new stores, our performance may be materially adversely affected.
Our performance is dependent on maintaining and increasing sales in existing stores and the ability to successfully open profitable new stores. Increases in sales in existing stores are dependent on factors such as competition, merchandise selection, store operations and other factors discussed in these Risk Factors. Our ability to successfully open new stores and expand into additional market areas depends in part on the following factors, which are in part beyond our control:
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the availability of sufficient funds for the expansion;
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the availability of attractive store locations and the ability to accurately assess the demographic or retail environment and customer demand at a given location;
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the ability to negotiate favorable lease terms and obtain the necessary permits and zoning approvals;
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the absence of occupancy delays;
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the ability to construct, furnish and supply a store in a timely and cost effective manner;
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the ability to hire and train new personnel, especially store managers, in a cost effective manner; and
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general economic conditions.
Delays or failures in successfully opening new stores, or achieving lower than expected sales in existing or new stores, could materially adversely affect our profitability. In addition, we may not be able to anticipate all of the challenges imposed by the expansion of our operations and, as a result, may not meet our targets for opening new stores or relocating stores or expanding profitably.
Some of our new stores may be located in areas where we have little or no meaningful experience. Those markets may have different market conditions, consumer preferences and discretionary spending patterns than our existing markets, which may cause our new stores to be less successful than stores in our existing markets. Other new stores may be located in areas where we have existing stores. Although we have experience in these markets, increasing the number of locations may result in unanticipated over-saturation of markets and temporarily or permanently divert customers and sales from our existing stores, thereby adversely affecting our overall financial performance.
Our sales may be adversely affected if we fail to respond to changes in consumer preferences in a timely manner.
Our financial performance depends on our ability to identify, originate and define product trends, as well as to anticipate, gauge and react to changing consumer preferences in a timely manner. Our products must appeal to a broad range of consumers whose preferences cannot be predicted with certainty and are subject to change. Our business fluctuates according to changes in consumer preferences dictated in part by fashion trends, perceived value and season. These fluctuations affect the merchandise in stock since purchase orders are written well in advance of the holiday season and, at times, before fashion trends and high-demand brands are evidenced by consumer purchases. If we overestimate the market for our products, we may be faced with significant excess inventories, which could result in increased expenses and reduced margins associated with having to liquidate obsolete inventory at lower prices or write it off. In fiscal 2013, we wrote down $51 million of excess and obsolete inventory. Conversely, if we underestimate the market for our products, we will miss opportunities for increased sales and profits, which would place us at a competitive disadvantage.
Sales of video games and video game systems may be adversely affected by changing trends in the interactive entertainment industry including the rise in popularity of browser, mobile, tablet and social games distributed through alternative channels.
Sales of video games and video game systems, which have accounted for 7%, 7% and 8% of our annual Net sales for fiscals 2013, 2012 and 2011, respectively, have been impacted by trends in the interactive entertainment industry. Video games are now played on a wide variety of products, including mobile phones, tablets, social networking websites and other devices. The popularity of such non-traditional gaming has increased greatly and this popularity is expected to continue to grow. Browser, mobile, tablet and social gaming is accessed through hardware other than the consoles and traditional hand-held video game devices we sell and its games are available through websites or proprietary app stores via direct online distribution at a fraction of the cost of console games. While we continue to develop and implement various strategies to incorporate these new trends into our offerings, including launching our own tablet with its dedicated app store and selling third party tablets and devices, we can provide no assurances that these strategies will be successful or contribute to profitability.
The success and expansion of our e-commerce business depends on our ability to provide quality service to our customers and if we are not able to provide such services, our operating results may be materially adversely affected.
Our Internet operations are subject to a number of risks and uncertainties which are in part beyond our control, including the following:
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failure of our Internet service providers to perform their services properly and in a timely and efficient manner;
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changes in consumer willingness to purchase goods via the Internet;
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increases in software filters that may inhibit our ability to market our products through e-mail messages to our customers and increases in consumer privacy concerns relating to the Internet;
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changes in applicable federal and state regulation, such as the Federal Trade Commission Act, the Children’s Online Privacy Act, the Fair Credit Reporting Act and the Gramm-Leach-Bliley Act and similar types of international laws;
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breaches of Internet security;
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failures in our Internet infrastructure or the failure of systems or third parties, such as telephone or electric power service, resulting in website downtime or other problems;
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failure by us to process online customer orders properly and on time, which may negatively impact future online and in-store purchases by such customers;
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failure by our service provider to provide warehousing and fulfillment services, which may negatively impact future online and in store purchases by customers; and
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failure to keep up with changes in technology.
If we are not able to provide satisfactory service to our Internet customers, our future operating results may be materially adversely affected. Further, we may be vulnerable to the special competitive pressures from the growing e-commerce activity in our market, as they may impact our own e-commerce business.
The decrease of birth rates in countries where we operate could negatively affect our business.
Most of our end-customers are newborns and children and, as a result, our revenues are dependent on the birth rates in countries where we operate. In recent years, many countries have experienced a sharp drop in birth rates as their population ages and education and income levels increase. A continued and significant decline in the number of newborns and children in these countries could have a material adverse effect on our operating results.
We depend on key vendors to supply the merchandise that we sell to our customers and our vendors’ failure to supply quality merchandise in a timely manner may damage our reputation and brands and harm our business.
Our performance depends, in part, on our ability to purchase our merchandise in sufficient quantities at competitive prices. We purchase our merchandise from numerous international and domestic manufacturers and importers. We have no contractual assurances of continued supply, pricing or access to new products, and any vendor could change the terms upon which they sell to us or discontinue selling to us at any time. We may not be able to purchase desired merchandise in sufficient quantities on terms acceptable to us in the future. Better than expected sales demand may also lead to customer backorders and lower in-stock positions of our merchandise.
In fiscal 2013, we had approximately 3,900 active vendor relationships through which we procure the merchandise that we offer to our customers. For fiscal 2013, our top 20 vendors worldwide, based on our purchase volume in USD, represented 46% of the total products we purchased. An inability to purchase suitable merchandise on acceptable terms or the loss of one or more key vendors could have a negative effect on our business and operating results and could cause us to miss products that we feel are important to our assortment. We may not be able to develop relationships with new vendors, and products from alternative sources, if any, may be of a lesser quality and/or more expensive than those from existing vendors.
In addition, our vendors are subject to various risks, including raw material costs, inflation, labor disputes, union organizing activities, financial liquidity, product merchantability, inclement weather, natural disasters and general economic and political conditions that could limit our vendors’ ability to provide us with quality merchandise on a timely basis and at prices and payment terms that are commercially acceptable. For these or other reasons, one or more of our vendors might not adhere to our quality control standards, and we might not identify the deficiency before merchandise ships to our stores or customers. In addition, our vendors may have difficulty adjusting to our changing demands and growing business. Our vendors’ failure to manufacture or import quality merchandise in a timely and effective manner could damage our reputation and brands, and could lead to an increase in customer litigation against us and an increase in our routine and non-routine litigation costs. Further, any merchandise that does not meet our quality standards could become subject to a recall, which could damage our reputation and brands and harm our business.
If our vendors fail to provide promotional support consistent with past levels, our sales, earnings and cash flow could be materially adversely affected.
Our vendors typically provide us with promotional support for the sale of their products in our stores and on our websites. We also receive allowances for volume-related purchases. As part of this support, we receive allowances, payments and credits from the vendors which reduce our cost of goods sold, support the promotion and merchandising of the products we sell and drive sales at our stores and on our websites. We cannot provide assurance that vendors will continue to provide this support consistent with past levels. If our vendors fail to do so, our sales, earnings and cash flow could be materially adversely affected.
If current store locations become unattractive, and attractive new locations are not available for a reasonable price, we may be adversely affected.
The success of any store depends in substantial part on its location. There can be no assurance that current locations will continue to be attractive as demographic patterns change. Neighborhood or economic conditions where stores are located could decline in the future, resulting in potentially reduced sales in these locations. If we cannot obtain desirable locations at reasonable prices, our ability to implement our strategy will be adversely affected.
We have substantial obligations under long-term leases that could materially adversely affect our financial condition and prevent us from fulfilling our obligations.
As of February 1, 2014, we leased 1,270 of our properties from third-parties pursuant to long-term space and ground leases. Total rent expense, net of sublease income, was $609 million, $628 million and $588 million for fiscals 2013, 2012 and 2011, respectively, and is expected to be approximately $597 million for fiscal 2014. Many of our leases provide for scheduled increases in rent. The substantial obligations under our leases could further exacerbate the risks described below under “Our substantial indebtedness could adversely affect our ability to raise additional capital to fund our operations or refinance our maturing debt, limit our ability to react to changes in the economy or our industries, expose us to interest rate risk to the extent of our variable rate debt and prevent us from meeting our obligations under our various debt instruments.”
If we are unable to renew or replace our current store leases or if we are unable to enter into leases for additional stores on favorable terms, or if one or more of our current leases are terminated prior to expiration of their stated term and we cannot find suitable alternate locations, our growth and profitability could be negatively impacted.
We currently have ground leasehold interests in 16% and long-term space leasehold interests in 62% of our domestic and international store locations. Most of our current leases provide for our unilateral option to renew for several additional periods at specific rental rates. Our ability to re-negotiate favorable terms on an expiring lease or to negotiate favorable terms for a suitable alternate location or for additional store locations could depend on conditions in the real estate market, competition for desirable properties and our relationships with current and prospective landlords or may depend on other factors that are not within our control. Any or all of these factors and conditions could negatively impact our growth and profitability.
Our business, financial condition and results of operations are subject to risks arising from the international scope of our operations which could negatively impact our financial condition and results of operations.
We conduct a significant portion of our business outside the United States. For fiscals 2013, 2012 and 2011, 39%, 40% and 40% of our Net sales, respectively, were generated outside the United States. In addition, as of February 1, 2014 and February 2, 2013, 35% of our long-lived assets, respectively, were located outside of the United States. Weakened global economic conditions, particularly the weakened and unstable environment in parts of Europe, could continue to affect us through lower sales as a result of reduced demand and the effects of foreign currency translation. All of our foreign operations are subject to risks inherent in conducting business abroad, including the challenges of different economic conditions in each of the countries, possible nationalization or expropriation, price and currency exchange controls, fluctuations in the relative values of currencies as described below, limited protection of intellectual property in certain jurisdictions, political instability and restrictive governmental actions.
The products we sell are sourced from a variety of international suppliers, with China being a significant source. Additionally, a growing portion of our stores are located in China and as a consequence, our financial results are expected to become increasingly affected by our results in China, and our business is increasingly exposed to risks there. Political or financial instability, trade restrictions, labor unrest, transport capacity and costs, port security or other events that could slow port activities and affect foreign trade are beyond our control and could disrupt our supply of merchandise and/or materially adversely affect our results of operations. In addition, changes in the costs of procuring commodities used in our merchandise or the costs related to our supply chain, including labor, fuel, tariffs, and currency exchange rates could have a material adverse effect on gross margin, expenses and results of operations.
In addition, any significant or prolonged deterioration in US - China relations could adversely affect our China business. Certain risks and uncertainties of doing business in China are solely within the control of the Chinese government, and Chinese law regulates the scope of our foreign investments and business conducted within China. There are also uncertainties regarding the interpretation and application of laws and regulations and the enforceability of intellectual property and contract rights in China.
Our business is subject to fluctuations in foreign currency exchange rates and such fluctuations may have a material adverse effect on our business, financial condition and results of operations.
Exchange rate fluctuations may affect the translated value of our earnings and cash flow associated with our international operations, as well as the translation of net asset or liability positions that are denominated in foreign currencies. In countries outside of the United States where we operate stores, we generate revenues and incur operating expenses and selling, general and administrative expenses denominated in local currencies. In many countries where we do not operate stores, our licensees pay royalties in USD. However, as the royalties are calculated based on local currency sales, our revenues are still impacted by fluctuations in exchange rates. In fiscal years 2013, 2012 and 2011, 39%, 40% and 40% of our Net sales, respectively, were completed in a currency other than the USD, the majority of which were denominated in yen, Euros, Canadian dollars and pounds. In fiscal 2013, our reported operating earnings would have decreased or increased $20 million if all foreign currencies uniformly weakened or strengthened by 10% relative to the USD.
We enter into foreign exchange agreements from time to time with financial institutions to reduce our exposure to fluctuations in currency exchange rates referred to as hedging activities. However, these hedging activities may not eliminate foreign currency risk entirely and involve costs and risks of their own. Although we hedge some exposures to changes in foreign currency exchange rates arising in the ordinary course of business, foreign currency fluctuations may have a material adverse effect on our business, financial condition and results of operations.
Because of our extensive international operations, we could be adversely affected by violations of the United States Foreign Corrupt Practices Act and similar worldwide anti-bribery laws.
The United States Foreign Corrupt Practices Act and similar worldwide anti-bribery laws generally prohibit companies and their intermediaries from making improper payments to non-U.S. officials for the purpose of obtaining or retaining business. Our policies mandate compliance with these anti-bribery laws. We cannot provide assurance that our internal control policies and procedures always will protect us from reckless or criminal acts committed by our employees or agents. Violations of these laws, or allegations of such violations, could disrupt our business, damage our reputation and result in a material adverse effect on our financial condition, results of operations and cash flows.
International events could delay or prevent the delivery of products to our stores, which could negatively affect our sales and profitability.
A significant portion of products we sell are manufactured outside of the United States, primarily in Asia. As a result, any event causing a disruption of imports, including labor strikes, work stoppages, boycotts, safety issues on materials, the imposition of trade restrictions in the form of tariffs, embargoes or export controls, “anti-dumping” duties, port security or other events that could slow port activities, could increase the cost and reduce the supply of products available to us. In addition, port-labor issues, rail congestion and trucking shortages can have an impact on all direct importers. Although we attempt to anticipate and manage such situations, both our sales and profitability could be materially adversely impacted by any such developments in the future.
Our results may be materially adversely affected by fluctuations in raw material and energy costs.
Our results may be affected by the prices of the components and raw materials used in the manufacture of our toys and juvenile products. These prices may fluctuate based on a number of factors beyond our control, including: oil prices, changes in supply and demand, general economic conditions, labor costs, competition, import duties, tariffs, currency exchange rates and government regulation. In addition, energy costs have fluctuated dramatically in the past. These fluctuations may result in an increase in our transportation costs for distribution, utility costs for our retail stores and overall costs to purchase products from our vendors.
We may not be able to adjust the prices of our products, especially in the short-term, to recover these cost increases in raw materials and energy. A continual rise in raw material and energy costs could adversely affect consumer spending and demand for our products and increase our operating costs, both of which could have a material adverse effect on our financial condition and results of operations.
A significant disruption to our distribution network or to the timely receipt of inventory could adversely impact sales or increase our transportation costs, which would decrease our profits.
We rely on our ability to replenish depleted inventory in our stores through deliveries to our distribution centers from vendors and then from the distribution centers or direct ship vendors to our stores by various means of transportation, including shipments by sea, rail, air and truck. We rely on various third-party vendors to manage services related to the delivery of inventory from distribution centers to our stores. Unexpected delays in deliveries or increases in transportation costs (including from increased fuel costs) could significantly decrease our ability to make sales and earn profits. In addition, labor shortages or labor disagreements in the transportation industry or long-term disruptions to the national and international transportation infrastructure that lead to delays or interruptions of deliveries could negatively affect our business.
Product safety issues, including product recalls, could harm our reputation, divert resources, reduce sales and increase costs.
The products we sell in our stores are subject to regulation by the Federal Consumer Product Safety Commission and similar state and international regulatory authorities. As a result, such products have been and could be in the future subject to recalls and other remedial actions. Product safety concerns may require us to voluntarily remove selected products from our stores. Such recalls and voluntary removal of products can result in, among other things, lost sales, diverted resources, potential harm to our reputation and increased customer service costs, which could have a material adverse effect on our business, financial condition and results of operations.
Our business exposes us to personal injury and product liability claims which could result in adverse publicity and harm to our brands and our results of operations.
We are from time to time subject to claims due to the injury of an individual in our stores or on our property. In addition, we have in the past been subject to product liability claims for the products that we sell. Subject to certain exceptions, our purchase orders generally require the manufacturer to indemnify us against any product liability claims; however, if the manufacturer does not have insurance or becomes insolvent, there is a risk we would not be indemnified. Any personal injury or product liability claim made against us, whether or not it has merit, could be time consuming and costly to defend, resulting in adverse publicity, or damage to our reputation, and have an adverse effect on our results of operations.
Adverse litigation judgments or settlements resulting from legal proceedings in which we may be involved could expose us to monetary damages or limit our ability to operate our business.
We are involved in private actions, investigations and various other legal proceedings by employees, suppliers, competitors, government agencies or others. The results of such litigation, investigations and other legal proceedings are inherently unpredictable. Any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and divert significant resources. If any of these legal proceedings were to be determined adversely to us, we could be exposed to monetary damages or limits on our ability to operate our business, which could have a material adverse effect on our business, financial condition and results of operations.
Healthcare reform legislation could have an adverse impact on our business, financial condition and results of operations.
The enacted healthcare reform legislation under the Patient Protection and Affordable Care Act and Health Care and Education Reconciliation Act of 2010 is expected to impact our healthcare cost structure and may increase our employee healthcare related expenses. Provisions of this law have become and will become effective at various dates over the next several years and many of the regulations and guidance for the law have not been implemented. We are evaluating the potential additional impact the healthcare reform legislation will have on our business as regulations and guidance are finalized. Due to the breadth and complexity of this law, the lack of implementing regulations and interpretive guidance and the phased-in nature of new requirements, we cannot predict with certainty the future effect of this law on our results. Because it may increase the costs of providing medical insurance to our employees, the new healthcare legislation may adversely affect our results of operations, financial condition and cash flow.
We are subject to certain regulatory and legal requirements. If we fail to comply with regulatory or legal requirements, our business and results of operations may be materially adversely affected.
We are subject to numerous regulatory and legal requirements. Our policies, procedures and internal controls are designed to comply with all applicable laws and regulations, including those imposed by the Federal Trade Commission, the Sarbanes-Oxley Act of 2002 and the SEC. In addition, our business activities require us to comply with complex regulatory and legal issues on a local, national and worldwide basis (including, in some cases, more stringent local labor laws or regulations). Future legislative and regulatory actions relating to credit cards could also have an adverse impact on our credit card program and our sales. Additionally, we may be subject to new disclosure and reporting requirements, established under existing or new state or federal laws. Failure to comply with such laws and regulations could adversely affect our operations, involve
significant expense and divert management’s attention and resources from other matters, which in turn could materially harm our business and results of operations.
Our business operations could be disrupted if our information technology systems fail to perform adequately or we are unable to protect the integrity and security of our customers’ information.
We depend largely upon our information technology systems in the conduct of all aspects of our operations. If our information technology systems fail to perform as anticipated, we could experience difficulties in virtually any area of our operations, including but not limited to replenishing inventories or in delivering our products to store locations in response to consumer demands. Any of these or other systems-related problems could, in turn, materially adversely affect our sales and profitability.
Other sophisticated retailers have recently suffered serious security breaches. A compromise of our security systems (or a design flaw in our system environment) could result in unauthorized access to certain personal information about our customers (including credit card and gift registry information) which could adversely affect our reputation with our customers and others, as well as our operations, and could result in litigation against us or the imposition of penalties. In addition, a security breach could require that we expend significant additional resources related to our information security systems.
Natural disasters, inclement weather, pandemic outbreaks, terrorist acts or disruptive global political events could cause permanent or temporary distribution center or store closures, impair our ability to purchase, receive or replenish inventory, or decrease customer traffic, all of which could result in lost sales and otherwise materially adversely affect our financial performance.
The occurrence of one or more natural disasters, such as hurricanes, fires, floods, earthquakes, tornadoes and volcano eruptions, or inclement weather such as frequent or unusually heavy snow, ice or rain storms, or extended periods of unseasonable temperatures, or the occurrence of pandemic outbreaks, labor strikes, work stoppages, terrorist acts or disruptive global political events, such as civil unrest in countries in which we operate stores or our suppliers are located, or similar disruptions could materially adversely affect our operations and financial performance. To the extent these events impact one or more of our key vendors or result in the closure of one or more of our distribution centers or a significant number of stores, our operations and financial performance could be materially adversely affected through an inability to make deliveries to our stores and through lost sales. In addition, these events could result in increases in fuel (or other energy) prices or a fuel shortage, delays in opening new stores, the temporary lack of an adequate work force in a market, the temporary or long-term disruption in the supply of products from some local and overseas vendors, the temporary disruption in the transport of goods from overseas, delay in the delivery of goods to our distribution centers or stores, the temporary reduction in the availability of products in our stores and disruption to our information systems. These events also can have indirect consequences such as increases in the costs of insurance if they result in significant loss of property or other insurable damage.
Our results of operations could suffer if we lose key management or are unable to attract and retain experienced senior management for our business.
Our future success depends to a significant degree on the skills, experience and efforts of our senior management team. The loss of services of any of these individuals, or the inability to attract and retain qualified individuals for key management positions, could harm our business and financial performance.
We may experience fluctuations in our tax obligations and effective tax rate, which could materially adversely affect our results of operations.
We are subject to taxes in the United States and numerous international jurisdictions. We record tax expense based on current tax payments and our estimates of future tax payments, which include reserves for estimates of probable settlements of international and domestic tax audits. At any one time, many tax years are subject to audit by various taxing jurisdictions. The results of these audits and negotiations with taxing authorities may affect the ultimate settlement of these issues. As a result, we expect that throughout the year there could be ongoing variability in our quarterly tax rates as taxable events occur and exposures are re-evaluated. Further, our effective tax rate in a given financial statement period may be materially impacted by changes in tax laws, changes in the mix and level of earnings by taxing jurisdiction, changes to existing accounting rules or regulations, or by changes to our ownership or capital structures. Fluctuations in our tax obligations and effective tax rate could materially adversely affect our results of operations.
Changes to accounting rules or regulations may materially adversely affect our results of operations.
Changes to existing accounting rules or regulations may impact our future results of operations. New accounting rules or regulations and varying interpretations of existing accounting rules or regulations have occurred and may occur in the future. Future changes to accounting rules or regulations may materially adversely affect our reported results of operations and financial position.
Our total assets include goodwill and substantial amounts of property and equipment. Changes to estimates or projections related to such assets, or operating results that are lower than our current estimates at certain store locations, may cause us to incur impairment charges that could materially adversely affect our results of operations.
Our total assets include substantial amounts of property, equipment and goodwill. We make certain estimates and projections in connection with impairment analyses for these assets, in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 360, “Property, Plant and Equipment” (“ASC 360”), and ASC Topic 350, “Intangibles-Goodwill and Other” (“ASC 350”). We review the carrying value of these assets for impairment whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable in accordance with ASC 360 or ASC 350. We will record an impairment loss when the carrying value of the underlying asset, asset group or reporting unit exceeds its fair value. These calculations require us to make a number of estimates and projections of future results. During fiscal 2013, we recorded impairment losses of $44 million on property and equipment and impaired $378 million of goodwill associated with our Toys-Domestic and Toys-Japan reporting units. Refer to “CRITICAL ACCOUNTING POLICIES” within Item 7 entitled “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” for further details. If these estimates or projections change, we may be required to record additional impairment charges on certain of these assets. If these impairment charges are significant, our results of operations could be materially adversely affected.
We may from time to time pursue acquisitions, which could have an adverse impact on our business, as could the integration of the businesses following acquisition.
We may from time to time acquire complementary companies or businesses. Acquisitions may result in unanticipated costs, delays or other operational or financial problems related to integrating the acquired company and business with our Company, which may result in the diversion of our capital and our management’s attention from other business issues and opportunities. We may not be able to successfully integrate operations that we acquire, including their personnel, technology, financial systems, distribution and general business operations and procedures. We cannot provide assurance that any acquisition we make will be successful and our operating results may be adversely impacted by the integration of a new business and its financial results.
The Sponsors control us and may have conflicts of interest with us.
Investment funds or groups advised by or affiliated with the Sponsors currently control us through their ownership of 98% of our voting common stock. As a result, the Sponsors have control over our decisions to enter into any corporate transaction and have the ability to prevent any transaction that requires the approval of stockholders. In addition, the Sponsors may have an interest in pursuing dispositions, acquisitions, financings or other transactions that, in their judgment, could enhance their equity investments, even though such transactions might involve risks to us as a company.
The Sponsors may direct us to make significant changes to our business operations and strategy, including with respect to, among other things, store openings and closings, new product and service offerings, sales of real estate and other assets, employee headcount levels and initiatives to reduce costs and expenses. We cannot provide assurance that our future business operations will remain broadly in line with our existing operations or that significant real estate and other assets will not be sold.
The Sponsors are also in the business of making investments for their own accounts in companies, and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us. One or more of the Sponsors may also pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us. So long as investment funds associated with or designated by the Sponsors continue to indirectly own a significant amount of the outstanding shares of our common stock, the Sponsors will continue to be able to strongly influence or effectively control our decisions.
Risks Related to Our Substantial Indebtedness
Our substantial indebtedness could adversely affect our ability to raise additional capital to fund our operations or refinance our maturing debt, limit our ability to react to changes in the economy or our industries, expose us to interest rate risk to the extent of our variable rate debt and prevent us from meeting our obligations under our various debt instruments.
We are, and we expect to continue to be, highly leveraged. As of February 1, 2014, our total indebtedness was $5.0 billion, of which $2.9 billion was secured indebtedness. Our substantial indebtedness could have significant consequences, including, among others, the following:
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increasing our vulnerability to general economic and industry conditions;
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requiring a substantial portion of cash flows from operating activities to be dedicated to the payment of principal and interest on our indebtedness, and as a result, reducing our ability to use our cash flows to fund our operations and capital expenditures, capitalize on future business opportunities, expand our business and execute our strategy;
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increasing the difficulty for us to make scheduled payments on our outstanding debt and other obligations, as our business may not be able to generate sufficient cash flows from operating activities to meet our debt service obligations;
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exposing us to the risk of increased interest expense due to changes in borrowing spreads and short-term interest rates;
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causing us to make non-strategic divestitures;
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limiting our ability to obtain additional financing for working capital, capital expenditures, debt service requirements and general, corporate or other purposes; and
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limiting our ability to adjust to changing market conditions and reacting to competitive pressure, and placing us at a competitive disadvantage compared to our competitors who are less leveraged.
Despite our current level of indebtedness, we may still be able to incur substantially more debt. This could further exacerbate the risks to our financial condition described above.
We may be able to incur additional indebtedness in the future, including under our current outstanding credit facilities. Although our indentures, credit agreements and the other documents governing our other indebtedness contain restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of qualifications and exceptions, and the additional indebtedness incurred in compliance with these restrictions could be substantial. These restrictions also will not prevent us from incurring obligations that do not constitute indebtedness. If new indebtedness is added to our current debt levels, the related risks that we now face could intensify.
If our cash flows and capital resources are insufficient to fund our debt service obligations or we are unable to refinance our indebtedness, we may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.
Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial condition and operating performance, which are subject to prevailing global economic and market conditions and to certain financial, business and other factors beyond our control. Even if we were able to refinance or obtain additional financing, the costs of new indebtedness could be substantially higher than the costs of our existing indebtedness.
If our cash flows and capital resources are insufficient to fund our debt service obligations or we are unable to refinance our indebtedness, we could face substantial liquidity problems, and we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital or restructure our indebtedness. These alternative measures may not be successful and may not permit us to meet our debt obligations. If we were unable to repay amounts when due, the lenders could proceed against the collateral granted to them to secure that indebtedness.
Our debt agreements contain covenants that limit our flexibility in operating our business.
Toys “R” Us, Inc. is a holding company and conducts its operations through its subsidiaries, certain of which have incurred their own indebtedness. As specified in certain of our subsidiaries’ debt agreements, there are restrictions on our ability to obtain funds from our subsidiaries through dividends, loans or advances. The agreements governing our indebtedness contain various covenants that limit our ability to engage in specified types of transactions, and may materially adversely affect our ability to operate our business. Among other things, these covenants limit our ability to:
•
incur certain additional indebtedness;
•
transfer money between Toys “R” Us, Inc. (the “Parent Company”) and our various subsidiaries;
•
pay dividends on, repurchase or make distributions with respect to our or our subsidiaries’ capital stock or make other restricted payments;
•
issue stock of subsidiaries;
•
make certain investments, loans or advances;
•
transfer and sell certain assets;
•
create or permit liens on assets;
•
consolidate, merge, sell or otherwise dispose of all or substantially all of our assets;
•
enter into certain transactions with our affiliates; and
•
amend certain documents.
A breach of any of these covenants could result in default under one or more of our debt agreements, which could prompt the lenders to declare all amounts outstanding under one or more of our debt agreements to be immediately due and payable and terminate all commitments to extend further credit. If we were unable to repay those amounts, the lenders could proceed against the collateral granted to them to secure that indebtedness. If the lenders under the debt agreements accelerate the
repayment of borrowings, we cannot ensure that we will have sufficient assets and funds to repay the borrowings under our debt agreements.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2.
PROPERTIES
The following summarizes our worldwide operating stores and distribution centers as of February 1, 2014 (excluding licensed operations in our International segment):
(1)
Owned buildings on leased land.
(2)
This includes 42 and 18 Express stores within our Domestic and International segments, respectively, that each have a cumulative lease term of at least two years and excludes the remaining 47 and 13 temporary Express store locations within our Domestic and International segments, respectively, which remained open as of February 1, 2014. During the fiscal 2013 holiday selling season, we operated 219 Domestic and 46 International Express stores.
(3)
Represents total square footage occupied, excluding any space dedicated to mezzanines (with the exception of our flagship stores), catwalks, parking lots and decks.
See also the sections of Item 1 entitled “Geographic Distribution of Domestic Stores” and “Geographic Distribution of International Stores” of this Annual Report on Form 10-K.
As described above, a significant part of our properties are ground leased (i.e. properties where we own the building but we do not retain fee ownership in the underlying land) or space leased (i.e. we lease a store from a property owner). We lease substantially all of our properties from unrelated third parties, pursuant to leases that vary as to their terms, rental provisions and expiration dates. Substantially all of our leases are considered triple-net leases, which require us to pay all costs and expenses arising in connection with the ownership, operation, leasing, use, maintenance and repair of these properties. These costs include real estate taxes and assessments, utility charges, license and permit fees and insurance premiums, among other things. Virtually all of our leases include options that allow us to renew or extend the lease term beyond the initial lease period, subject to terms and conditions. In addition, many of our leases include early termination options, which we may exercise under specified conditions, including, upon damage, destruction or condemnation of a specified percentage of the value or land area of the property. A portion of our leased stores have contingent rentals, where the lease payments depend on factors that are not measurable at the inception of the lease, such as future sales volume. Contingent rent expense was $10 million, $12 million and $12 million for fiscals 2013, 2012 and 2011, respectively.
We own our headquarters, comprising 585,000 square feet of space, in Wayne, New Jersey.
As of February 1, 2014, we maintained 90 former stores that are no longer part of our operations. Approximately half of these surplus facilities are owned and the remaining locations are leased. We have tenants in more than half of these facilities, and we continue to market those facilities without tenants for disposition or leasing opportunities. The net costs associated with these facilities are reflected in our Consolidated Financial Statements, but the number of surplus facilities is not included above.
Portions of our debt are secured by direct and indirect interests in certain of our properties. See Note 2 to the Consolidated Financial Statements entitled “SHORT-TERM BORROWINGS AND LONG-TERM DEBT” for further details.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
In October 2013, the Company paid $25 million to satisfy a judgment against the Company in a wrongful death products liability case entitled Aleo v. SLB Toys USA, Inc., et al. (Superior Court of Massachusetts, Essex County, No. 2008-02149-A).
In addition to the litigation discussed above, we are, and in the future, may be involved in various other lawsuits, claims and proceedings incident to the ordinary course of business. The results of litigation are inherently unpredictable. Any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in diversion of significant resources. We are not able to estimate an aggregate amount or range of reasonably possible losses for those legal matters for which losses are not probable and estimable, primarily for the following reasons: (i) many of the relevant legal proceedings are in preliminary stages, and until such proceedings develop further, there is often uncertainty regarding the relevant facts and circumstances at issue and potential liability; and (ii) many of these proceedings involve matters of which the outcomes are inherently difficult to predict. However, based upon our historical experience with similar matters, we do not expect that any such additional losses would be material to our consolidated financial position, results of operations or cash flows.
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURES
None.
PART II
ITEM 5.
ITEM 5.
MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our shares of common stock, $0.001 par value (“Common Stock”) are privately held by our Sponsors, our officers, certain employees and a private investor and there is no established public trading market for our Common Stock. As of March 1, 2014, there were approximately 400 holders of our Common Stock. During fiscals 2013, 2012 and 2011, no dividends were paid out to shareholders. See Note 2 to our Consolidated Financial Statements entitled “SHORT-TERM BORROWINGS AND LONG-TERM DEBT” for a discussion of our debt agreements which restrict our ability to pay dividends and obtain funds from certain of our subsidiaries through dividends, loans or advances.
On November 5, 2013, and in connection with his employment as President, Toys “R” Us, U.S., Harry J. Mullany III purchased 22,728 shares of Common Stock for a purchase price of $22.00 per share pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended.
In November 2013, certain participants under the 2010 Incentive Plan were offered an opportunity to exchange certain of their outstanding stock options (“Old Options”) and all outstanding performance shares or units for a grant of one new stock option (“New Options”) for every two Old Options canceled, which New Options have an exercise price of $22.00. The New Options vest 50% on the second anniversary of the awards with the remaining portion vesting in equal annual installments over the subsequent two years (subject to the earlier expiration in certain circumstances), subject to the participant’s continued employment with the Company and will vest automatically upon a change in control and certain other circumstances. On December 23, 2013, the Company closed its offer and a total of 919,599 and 104,240 Old Options and performance shares or units were canceled, respectively, and a total of 459,805 New Options were issued under the 2010 Incentive Plan in a private offer to exchange pursuant to Section 4(a)(2) or Rule 701 of the Securities Act of 1933, as amended.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
(1)
Our fiscal year ends on the Saturday nearest to January 31 of each calendar year. With the exception of fiscal 2012, which included 53 weeks, all other fiscal years presented include 52 weeks.
(2)
Refer to the Adjusted EBITDA table within this section for certain income and expense items that management believes make it more difficult to assess the Company’s actual operating performance.
(3)
Includes current portion of long-term debt and short-term borrowings. See Note 2 to our Consolidated Financial Statements entitled “SHORT-TERM BORROWINGS AND LONG-TERM DEBT” for further details.
(4)
As a result of the Labuan acquisition, on October 31, 2011, 90 of our licensed stores became part of our operated locations upon acquisition. As of February 1, 2014, February 2, 2013 and January 28, 2012, International operated stores included 129, 100 and 92 Labuan stores, respectively. See Note 17 to our Consolidated Financial Statements entitled “ACQUISITIONS” for further details.
(5)
Adjusted EBITDA is defined as EBITDA (earnings (loss) before net interest income (expense), income tax expense (benefit), depreciation and amortization), as further adjusted to exclude the effects of certain income and expense items that management believes make it more difficult to assess the Company’s actual operating performance including certain items which are generally non-recurring. We have historically excluded the impact of such items from internal performance assessments. We believe that excluding items such as Sponsors’ management and advisory fees, goodwill and asset impairment charges, restructuring charges, impact of litigation, noncontrolling interest, net gains on sales of properties and the other charges specified below, helps investors compare our operating performance with our results in prior periods. We believe it is appropriate to exclude these items as they are not related to ongoing operating performance and, therefore, limit comparability between periods and between us and similar companies.
We believe Adjusted EBITDA is useful to investors because it is frequently used by securities analysts, investors and other interested parties in the evaluation of companies in our industry. Investors of the Company regularly request Adjusted EBITDA as a supplemental analytical measure to, and in conjunction with, the Company’s financial data prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). We understand that these investors use Adjusted EBITDA, among other things, to assess our period-to-period operating performance and to gain insight into the manner in which management analyzes operating performance.
In addition, we believe that Adjusted EBITDA is useful in evaluating our operating performance compared to that of other companies in our industry because the calculation of EBITDA and Adjusted EBITDA generally eliminates the effects of financing and income taxes and the accounting effects of capital spending and acquisitions, which items may vary for different companies for reasons unrelated to overall operating performance. We use these non-GAAP financial measures for planning and forecasting and measuring results against the forecast and in certain cases we use similar measures for bonus targets for certain of our employees. Using several measures to evaluate the business allows us and investors to assess our relative performance against our competitors.
Although we believe that Adjusted EBITDA can make an evaluation of our operating performance more consistent because it removes items that do not reflect our core operations, other companies, even in the same industry, may define Adjusted EBITDA differently than we do. As a result, it may be difficult to use Adjusted EBITDA or similarly named non-GAAP measures that other companies may use to compare the performance of those companies to our performance. The Company does not, and investors should not, place undue reliance on EBITDA or Adjusted EBITDA as measures of operating performance.
Reconciliation of Net (loss) earnings attributable to Toys “R” Us, Inc. to EBITDA and Adjusted EBITDA is as follows:
(a)
Represents litigation expenses recorded for certain legal matters. See Note 14 to our Consolidated Financial Statements entitled “LITIGATION AND LEGAL PROCEEDINGS” for further details.
(b)
Represents fees expensed to the Sponsors in accordance with the advisory agreement. The advisory fee paid to the Sponsors increases 5% per year during the ten-year term of the agreement with the exception of fiscal 2009. See Note 16 to our Consolidated Financial Statements entitled “RELATED PARTY TRANSACTIONS” for further details.
(c)
Represents a non-cash cumulative correction of prior period accrued vacation accounting in fiscal 2013. The adjustment in fiscal 2010 represents a non-cash cumulative correction of prior period straight-line lease accounting.
(d)
Asset impairments primarily due to the identification of underperforming stores and the relocation of certain stores. See Note 1 to our Consolidated Financial Statements entitled “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” and Note 4 to our Consolidated Financial Statements entitled “FAIR VALUE MEASUREMENTS” for further details.
(e)
Represents the incremental compensation expense related to one-time executive awards, the fair market value remeasurement of existing liability awards and the repurchase of awards by the Company upon termination.
(f)
Represents state and city property transfer taxes recognized in fiscal 2010 related to the merger transaction in fiscal 2005, a portion of which were settled in fiscal 2012.
(g)
Restructuring and other charges consist primarily of costs incurred from the Company’s 2003 and 2005 restructuring initiatives. The additional charges are primarily due to changes in management’s estimates for events such as lease terminations, assignments and sublease income adjustments.
(h)
Represents the sale of properties. See Note 5 to our Consolidated Financial Statements entitled “PROPERTY AND EQUIPMENT” for further details.
(i)
Represents noncontrolling interests in Labuan for fiscal 2011 through fiscal 2013, and Toys - Japan for fiscals 2009 and 2010.
(j)
Represents a $51 million gain recorded in Other income, net related to the litigation settlement with Amazon in fiscal 2009.
(k)
In fiscal 2011, in conjunction with the completion of the liquidation of TRU (HK) Limited, our wholly-owned subsidiary, we recognized a $1 million loss.
(l)
Represents costs incurred in conjunction with the acquisition of 70% ownership interest in Labuan from Li & Fung. See Note 17 to our Consolidated Financial Statements entitled “ACQUISITIONS” for further details.
(m)
Represents the write-off of damaged assets and repairs from a hurricane that hit the east coast of the United States, store fires in Australia, an earthquake and resulting tsunami that hit the Northeast coast of Japan and other property losses, net of insurance claims.
(n)
Represents certain officers’ severance and store closure costs.
(o)
Represents the incremental expense related to the write-down of excess and obsolete inventory.
(p)
Represents the impairment of goodwill associated with our Toys-Domestic and Toys-Japan reporting units. Refer to “CRITICAL ACCOUNTING POLICIES” within Item 7
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 Consolidated Financial Statements and the accompanying notes, and contains forward-looking statements that involve risks and uncertainties. See “Forward-Looking Statements” and Item 1A entitled “RISK FACTORS” of this Annual Report on Form 10-K. Our MD&A includes the following sections:
EXECUTIVE OVERVIEW provides an overview of our business.
RESULTS OF OPERATIONS provides an analysis of our financial performance and of our consolidated and segment results of operations for fiscal 2013 compared to fiscal 2012 and fiscal 2012 compared to fiscal 2011. With the exception of fiscal 2012, which included 53 weeks, all other fiscal years presented include 52 weeks.
LIQUIDITY AND CAPITAL RESOURCES provides an overview of our financing, capital expenditures, cash flows and contractual obligations.
CRITICAL ACCOUNTING POLICIES provides a discussion of our accounting policies that require critical judgment, assumptions and estimates.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS provides a brief description of significant accounting standards which were adopted during fiscal 2013. This section also refers to Note 18 to our Consolidated Financial Statements entitled “RECENT ACCOUNTING PRONOUNCEMENTS” for accounting standards which we have not yet been required to implement and may be applicable to our future operations.
EXECUTIVE OVERVIEW
Our Business
We are the leading global specialty retailer of toys and juvenile products as measured by Net sales. Toys “R” Us is recognized as the toy and juvenile (including baby) authority. We sell a variety of products in the core toy, entertainment, juvenile, learning and seasonal categories through our retail locations and the Internet. Our brand names are highly recognized in North America, Europe and Asia, and our expertise in the toy and juvenile retail space, our broad range of product offerings, our substantial scale and geographic footprint and our strong vendor relationships account for our market-leading position and distinguish us from the competition. We believe we offer the most comprehensive year-round selection of toys and juvenile products among omnichannel retailers, including a broad assortment of private label and exclusive merchandise unique to our stores.
As of February 1, 2014, we operated 1,577 stores and licensed an additional 185 stores. These stores are located in 36 countries and jurisdictions around the world under the Toys “R” Us, Babies “R” Us and FAO Schwarz banners. In addition, we operate Express stores, smaller format stores primarily open on a short-term basis during the holiday season. During the fiscal 2013 holiday season, we operated 265 Express stores, of which 120 were still open as of February 1, 2014. Of the 120 Express stores that remained open, 60 have been included in our overall store count as they each have a cumulative lease term of at least two years. We also own and operate websites including Toysrus.com, Babiesrus.com, eToys.com, FAO.com and toys.com, as well as other Internet sites we operate in our international markets. For fiscal 2013, we generated Net sales of $12.5 billion, Net loss attributable to Toys “R” Us, Inc. of $1.0 billion and Adjusted EBITDA of $588 million. For the definition of Adjusted EBITDA, an explanation of why we present it and a description of the limitations of this non-GAAP measure, as well as a reconciliation to Net loss attributable to Toys “R” Us, Inc., see Item 6 entitled “SELECTED FINANCIAL DATA” of this Annual Report on Form 10-K.
We believe we offer our customers the most comprehensive year-round selection of merchandise in the retail toy and juvenile (including baby) categories among omnichannel retailers through our “R” Us branded stores and through the Internet. On average, our domestic and international stores (other than Express stores) offer 12,000 and 7,000 items year-round, respectively. Express stores, due to their size, typically carry 2,000 items. We believe that our differentiated product assortment, private label and exclusively licensed product offerings and expert service enable us to command a reputation as the shopping destination for toys and juvenile (including baby) products. We seek to differentiate ourselves from our competitors in several key areas, including product selection, product presentation, service, in-store experience and marketing. We are able to provide vendors with a year-round distribution outlet for the broadest assortment of their products. We continue to strengthen our Domestic and International segments by:
•
offering value to customers through a convenient omnichannel (store and Internet) shopping experience;
•
reaching customers, through differentiated value propositions, with our portfolio of e-commerce brands;
•
achieving a high degree of customer interaction by leveraging our comprehensive baby registry and birthday club in the United States and our Domestic and International loyalty programs;
•
continuing to refine our in-store customer experience and improving customer service;
•
renovating and updating or relocating our existing stores to enhance the shopping experience and continually reviewing the market for new store opportunities; and
•
enhancing our product offerings and adding private label and exclusive products to our mix, including unique and exceptional items sold through the FAO Schwarz brand.
We have well-developed omnichannel capabilities through which we integrate our e-commerce and brick-and-mortar businesses. The “Buy Online, Pick Up In Store” program, available within all stores in the United States and the United Kingdom, offers customers the ability to browse and shop from the comfort of their own homes, while giving them the flexibility to pick up their purchases in-store, usually within the same day. In addition, our “Ship to Store” program allows customers in the United States to purchase online items that may not be currently available in their local store, and have their order delivered to the local store of their choice, free of shipping charges. We also have “Pay In-Store,” which enables customers to shop online and pay for their items in any one of our stores across the United States.
In addition, the “Ship from Store” program leverages inventory from the majority of our U.S. stores to improve the speed with which customers receive their online orders, as well as provide an additional option to fulfill these orders. This feature is also available in several of our international countries. In addition, our loyalty programs, including the Babies “R” Us Registry, Geoffrey’s Birthday Club and Rewards “R” Us, all offer online functionality which we believe deepens our relationship with our customers and complements the in-store experience.
Internationally, we have an online presence in Australia, Austria, Canada, China, France, Germany, Japan, the Netherlands, Portugal, Spain, Switzerland and the United Kingdom. Additionally, we offer international shipping for online orders to more than 60 countries across Asia, the Caribbean, Central America, Europe, North America and South America. This service allows customers to place orders domestically and have them delivered across the world, and more importantly, it allows us to expand the global reach of our brands to countries where we do not currently have any physical stores. For fiscals 2013, 2012 and 2011, our consolidated e-commerce business generated net sales of $1.2 billion, $1.1 billion and $1.0 billion, respectively.
We believe that we may have the potential to grow the number of stores in our international store portfolio, particularly those in the emerging economies which are seeing overall GDP growth and rising incomes. In line with this strategy, Labuan increased stores operated from 100 Toys “R” Us retail stores at February 2, 2013 (90 which were acquired in fiscal 2011) to 129 stores at February 1, 2014.
We will also continue to focus on competitive pricing, increasing our private label penetration and increasing our use of direct sourcing. We will also continue to optimize our cost structure and enhance efficiencies throughout the organization to manage our selling, general and administrative expenditures.
Domestically, we continued the use of several programs that benefited customers during our holiday selling season. We offered a free, no minimum purchase layaway program early in the season, which allowed customers to take full advantage of the flexible payment terms provided by layaway. During fiscal 2013, we modified our layaway program to allow subsequent payments to be made online. In addition, our “Price Match Guarantee” program matched competitors’ in-store pricing on identical items, as well as identical items sold on our websites. During fiscal 2013, we enhanced our “Price Match Guarantee” program to include selected online retailer pricing.
Our juvenile business targets the pre-natal to infant market which allows us to offer the broadest range of juvenile (including baby) products and deliver a high level of customer service and product knowledge. Our Babies “R” Us Registry and juvenile product assortment allows us to capture new customers during pregnancy, helping them prepare for the arrival of their newborn. Because first-time parents tend to make multiple product purchases during a relatively short period of time, we seek to provide the expectant parent with a “one-stop shopping” venue for all baby product needs, providing what we believe is one of the most complete selections of baby-related products in the marketplace. We then become a resource for infant products such as baby formula, diapers and solid foods, as well as baby clothing and learning aids. We believe this opportunity to establish first contact with new parents enables us to develop long-lasting customer relationships with them as their children grow and they transition to becoming consumers of our products. We continue to build on these relationships as these children mature and eventually become parents themselves. Additionally, juvenile merchandise staples such as baby formula, diapers and infant clothing provide us with a mitigant to the inherent seasonality in the toy business.
We also provide an integrated shopping format by combining the Toys “R” Us and Babies “R” Us merchandise offerings under one roof creating a “one-stop shopping” experience for our customers. We call this format a SBS store. SBS stores are a combination of Toys “R” Us stores and Babies “R” Us stores, and may be the result of a conversion or relocation and, in certain cases, may be accompanied by the closure of one or more existing stores. In addition, SBS stores may also be constructed in a new location and market. As of February 1, 2014, we have converted existing stores into 283 SBS store formats. In addition, we have opened 117 SBS stores (58 of which were relocations of existing stores).
Over the past several months, we have developed our long-term strategic plan, which we believe will address foundational issues needed to improve the business over the short-term, while allowing us to implement new initiatives which we believe will put the Company on track for profitable growth in the future. Our TRU Transformation strategy is grounded in three strategic pillars: Transform the Customer Experience; Develop High Performing, Highly Engaged, Diverse Talent; and Become Fit for Growth. Our strategy focuses on providing a better customer experience in-store and online; improving store conditions; creating meaningful customer relationships through loyalty, as well as clear and targeted marketing programs; making progress on price perception; putting disciplines back into inventory management; improving our in-stock position; right-sizing our cost structure; and working with vendor partners to drive category leadership and differentiation. Our customer promise is to provide the broadest selection of products to help kids and babies develop, learn, have fun and be safe; be the easiest place to research and find solutions throughout the journey of parenthood; be the best resource for children’s gift giving occasions; offer fair prices; deliver expert service and unique services; and provide customers the ability to shop whenever, wherever and however they want.
As of February 1, 2014, we operated 1,577 retail stores and licensed an additional 185 retail stores worldwide in the following formats:
Operated Stores
•
867 traditional toy stores, which typically range in size from 20,000 to 50,000 square feet and devote 5,000 square feet to boutique areas for juvenile (including baby) products (including 97 BRU Express and Juvenile Expansion formats which devote an additional 4,000 square feet and 1,000 square feet, respectively, for juvenile - including baby - products);
•
400 SBS stores, which typically range in size from 30,000 to 70,000 square feet and devote 20,000 to 40,000 square feet to traditional toy products and 10,000 to 30,000 square feet to juvenile (including baby) products;
•
247 juvenile stores, which typically range in size from 30,000 to 45,000 square feet and devote 3,000 square feet to traditional toy products;
•
60 Express stores, which typically range in size from 2,000 to 7,000 square feet, each with a cumulative lease term of at least two years; and
•
3 flagship store locations (the Toys “R” Us store in Times Square, the FAO Schwarz store on 5th Avenue and the Babies “R” Us store in Union Square - all in New York City), which range in size from 55,000 to 105,000 square feet.
Licensed Stores
•
185 “R” Us branded retail stores ranging in various sizes. Licensing fees did not have a material impact on our Net sales.
In addition to these stores, during the fiscal 2013 holiday selling season, we operated an additional 205 Express stores globally in shopping malls, outlet malls and other shopping centers located in high traffic areas. These locations typically range in size from 2,000 to 7,000 square feet, each has a cumulative lease term of less than two years and are not included in our overall store count.
Our extensive experience in retail site selection has resulted in a portfolio of stores that includes attractive locations in many of our chosen markets. Markets for new stores and formats are selected on the basis of proximity to other “R” Us branded stores, demographic factors, population growth potential, competitive environment, availability of real estate and cost. Once a potential market is identified, we select a suitable location based upon several criteria, including size of the property, access to major commercial thoroughfares, proximity of other strong anchor stores, visibility and parking capacity.
Our Business Segments
Our business has two reportable segments: Domestic and International. See Note 11 to our Consolidated Financial Statements entitled “SEGMENTS” for our segments’ financial results. The following is a brief description of our segments:
•
Domestic - Our Domestic segment sells a variety of products in the core toy, entertainment, juvenile (including baby), learning and seasonal categories through 873 stores that operate in 49 states in the United States and Puerto Rico and through the Internet. Domestic Net sales in fiscal 2013 were derived from 382 traditional toy stores (including 79 BRU Express and Juvenile Expansion formats), 232 juvenile stores, 214 SBS stores, 42 permanent Express stores and our three flagship stores in New York City. Additionally, we generated Net sales through our temporary Express store locations. Domestic Net sales were $7.6 billion for fiscal 2013, which accounts for 61% of our consolidated Net sales.
•
International - Our International segment sells a variety of products in the core toy, entertainment, juvenile (including baby), learning and seasonal categories through 704 operated and 185 licensed stores in 35 countries and jurisdictions and through the Internet. In addition to fees received from licensed stores, International Net sales in fiscal 2013 were derived from 485 traditional toy stores (including 18 BRU Express formats), 186 SBS stores, 18 permanent Express stores and 15 juvenile stores. Additionally, we generated Net sales through our temporary Express store locations. Our operated stores are located in Australia, Austria, Brunei, Canada, China, France, Germany, Hong Kong, Japan, Malaysia, Poland, Portugal, Singapore, Spain, Switzerland, Taiwan, Thailand and the United Kingdom. International Net sales were $4.9 billion for fiscal 2013, which accounts for 39% of our consolidated Net sales.
In order to properly judge our business performance, it is necessary to be aware of the following challenges and risks:
•
Liquidity and capital requirements - Our operations have significant liquidity and capital requirements and depend on the availability of adequate financing on reasonable terms. If our lenders are unable to fund borrowings under their credit commitments or we are unable to borrow, it could have a significant negative effect on our business.
•
E-commerce opportunities - The success and expansion of our e-commerce business depends on our ability to provide quality service to our customers and if we are not able to provide such services, our operating results may be materially adversely affected. We may be vulnerable to competitive pressures from the growing e-commerce activity in our market, such as price transparency, alternative distribution of video games and subscription models for commodities.
•
Seasonality - Our business is highly seasonal with a substantial portion of our sales and earnings generated in the fourth quarter, with the exception of the fourth quarter of fiscal 2013, which resulted in a net loss. During fiscals 2013, 2012 and 2011, 42%, 43% and 43%, respectively, of the Net sales from our worldwide business were generated in the fourth quarter.
•
Increased competition - Our businesses operate in a highly competitive retail market. We compete on the basis of product variety, price, quality, availability, advertising and promotion, convenience or store location, safety, customer support and service. We face strong competition from discount and mass merchandisers, national and regional chains and department stores, consumer electronics retailers, local retailers in the markets we serve and Internet and catalog businesses.
•
International - We conduct a significant portion of our business outside the United States. For fiscals 2013, 2012 and 2011, 39%, 40% and 40% of our Net sales, respectively, were generated outside the United States. Weakened global economic conditions, particularly the weakened and unstable environment in parts of Europe, could continue to affect us through lower sales due to reduced demand and the effects of foreign currency translation.
RESULTS OF OPERATIONS
Financial Performance
As discussed in more detail in this MD&A, the following financial data represents an overview of our financial performance for fiscals 2013, 2012 and 2011:
Net sales decreased by $1.0 billion in fiscal 2013 compared to fiscal 2012. Foreign currency translation decreased Net sales by $329 million. Excluding the impact of foreign currency translation, the decrease in Net sales was primarily due to a decrease in comparable store net sales, partially offset by an increase in net sales from new locations within our International segment.
Gross margin, as a percentage of Net sales, decreased by 1.6 percentage points in fiscal 2013 compared to fiscal 2012 primarily as a result of margin rate declines across all Domestic categories due in part to our competitive pricing strategy and to our inventory clearance efforts, as well as an inventory write-down recorded within our Domestic segment. Partially offsetting these decreases was an increase in vendor allowances recorded within our International segment and improvements in sales mix away from lower margin products within our Domestic and International segments.
Selling, general and administrative expenses (“SG&A”) decreased by $31 million in fiscal 2013 compared to fiscal 2012. Foreign currency translation decreased SG&A by $98 million. Excluding the impact of foreign currency translation, the increase in SG&A was primarily due to increases in occupancy costs, predominantly as a result of new stores and store improvements, litigation expenses related to the judgment in the Aleo v. SLB Toys USA Inc. (“Aleo”) case, and payroll expenses predominantly related to additional accrued vacation expense resulting from a prior period correction.
Net loss attributable to Toys “R” Us, Inc. was $1,039 million for fiscal 2013, compared to Net earnings attributable to Toys “R” Us, Inc. of $38 million for fiscal 2012, a change of $1,077 million. The Net loss attributable to Toys “R” Us, Inc. was primarily due to a decrease in Gross margin dollars, an impairment to goodwill and an increase in Income tax 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. 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 fiscal years ended February 1, 2014, February 2, 2013 and January 28, 2012:
(1)
Our reporting period for fiscals 2013 and 2011 includes 52 weeks compared to 53 weeks for fiscal 2012. Therefore, comparable store net sales for fiscal 2012 has been adjusted by one week as compared to Net sales.
(2)
For fiscal 2012, international comparable store net sales includes sales from stores acquired in the Labuan acquisition 56 weeks from their acquisition in fiscal 2011.
Percentage of Net Sales by Product Category
(1)
Consists primarily of shipping and other non-product related revenues.
(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
(1)
Store count as of February 1, 2014 includes 20 BRU Express stores and 59 Juvenile Expansions. Store count as of February 2, 2013 included 21 BRU Express stores and 62 Juvenile Expansions. Store count as of January 28, 2012 included 20 BRU Express and 62 Juvenile Expansions.
(2)
Store count as of February 1, 2014 includes 18 BRU Express stores. Store count as of February 2, 2013 included 17 BRU Express Stores. Store count as of January 28, 2012 included 14 BRU Express stores.
(3)
Express stores with a cumulative lease term of at least two years are included in our overall store count, while remaining locations are excluded. As of February 1, 2014, there were 89 Domestic and 31 International Express stores open, 42 and 18 of which have been included in our overall store count within our Domestic and International segments, respectively. As of February 2, 2013, there were 84 Domestic and 41 International Express stores open, 36 and 23 of which were included in our overall store count within our Domestic and International segments, respectively. As of January 28, 2012, there were 47 Domestic and 43 International Express stores open, 31 of which were included in our overall store count within our Domestic segment, and none of which were included within our International segment.
(4)
Excluded from our overall store count are 185, 163 and 151 International licensed stores as of February 1, 2014, February 2, 2013 and January 28, 2012, respectively.
(5)
Excludes stores closed as a result of conversions and relocations.
(6)
The one conversion in fiscal 2013 was accompanied by multiple store closings. Of the 13 conversions in fiscal 2012, one was accompanied by multiple store closings.
(7)
Of the seven relocations in fiscal 2013, two were accompanied by multiple store closings. Of the six relocations in fiscal 2012, three were accompanied by multiple store closings.
Fiscal 2013 Compared to Fiscal 2012
Net (Loss) Earnings Attributable to Toys “R” Us, Inc.
Net loss attributable to Toys “R” Us, Inc. was $1,039 million in fiscal 2013, compared to Net earnings attributable to Toys “R” Us, Inc. of $38 million in fiscal 2012, a change of $1,077 million. The Net loss attributable to Toys “R” Us, Inc. was primarily
due to a decrease in Gross margin dollars of $562 million, a $378 million goodwill impairment associated with our Toys-Domestic and Toys-Japan reporting units and an increase in Income tax expense of $116 million principally due to an increase in expense for non-routine, discrete items, partially offset by a benefit associated with the decrease in pre-tax earnings.
Net Sales
Net sales decreased by $1.0 billion or 7.4%, to $12,543 million in fiscal 2013, compared to $13,543 million in fiscal 2012. The impact of foreign currency translation decreased Net sales in fiscal 2013 by $329 million. Our reporting period for fiscal 2013 included 52 weeks compared to 53 weeks for fiscal 2012, which included an additional week of net sales of $152 million.
Excluding the impact of foreign currency translation, the decrease in Net sales for fiscal 2013 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 and lower average transaction amounts. Partially offsetting the decline in Net sales was an increase in Net sales from new locations within our International segment.
Domestic
Net sales for the Domestic segment decreased by $511 million or 6.3%, to $7,638 million in fiscal 2013, compared to $8,149 million in fiscal 2012. The decrease in Net sales was primarily a result of a decrease in comparable store net sales of 5.0%. Our reporting period for fiscal 2013 included 52 weeks compared to 53 weeks for fiscal 2012, which included an additional week of net sales of $95 million.
The decrease in comparable store net sales resulted primarily from decreases in our juvenile (including baby), entertainment and learning categories. The decrease in our juvenile (including baby) category was predominantly due to decreased sales of infant care products. The decrease in our entertainment category was primarily due to decreased sales of video game software. The decrease in our learning category was primarily due to decreased sales of educational electronics and construction toys.
International
Net sales for the International segment decreased by $489 million or 9.1%, to $4,905 million in fiscal 2013, compared to $5,394 million in fiscal 2012. Excluding a $329 million decrease in Net sales due to foreign currency translation, International Net sales decreased primarily due to a decrease in comparable store net sales of 3.3%. Partially offsetting this decrease was an increase in net sales from new locations. Our reporting period for fiscal 2013 included 52 weeks compared to 53 weeks for fiscal 2012, which included an additional week of net sales of $57 million.
The decrease in comparable store net sales resulted primarily from decreases in our entertainment and juvenile (including baby) categories. The decrease in our entertainment category was primarily due to decreased sales of video game systems and software. The decrease in our juvenile (including baby) category was primarily due to decreased sales of baby gear and apparel.
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
Gross margin decreased by $562 million to $4,389 million in fiscal 2013, compared to $4,951 million in fiscal 2012. Foreign currency translation decreased Gross margin by $110 million.
Gross margin, as a percentage of Net sales, decreased by 1.6 percentage points in fiscal 2013 compared to fiscal 2012. Gross margin, as a percentage of Net sales, was primarily impacted by margin rate declines across all Domestic categories due in part to our competitive pricing strategy and to our inventory clearance efforts, as well as an inventory write-down recorded within our Domestic segment. Partially offsetting these decreases was an increase in vendor allowances recorded within our International segment and improvements in sales mix away from lower margin products within our Domestic and International segments, predominantly in our entertainment category.
Domestic
Gross margin decreased by $396 million to $2,489 million in fiscal 2013, compared to $2,885 million in fiscal 2012. Gross margin, as a percentage of Net sales, decreased by 2.8 percentage points in fiscal 2013 compared to fiscal 2012.
The decrease in Gross margin, as a percentage of Net sales, resulted primarily from margin rate declines across all categories due in part to our competitive pricing strategy and to our inventory clearance efforts, as well as an inventory write-down of excess and obsolete inventory. Partially offsetting these decreases were improvements in sales mix away from lower margin products, predominantly in our entertainment category.
International
Gross margin decreased by $166 million to $1,900 million in fiscal 2013, compared to $2,066 million in fiscal 2012. Foreign currency translation decreased Gross margin by $110 million. Gross margin, as a percentage of Net sales, increased by 0.4 percentage points in fiscal 2013 compared to fiscal 2012.
The increase in Gross margin, as a percentage of Net sales, resulted primarily from an increase in vendor allowances due to sales mix compared to the same period last year. Additionally contributing to the increase in Gross margin, as a percentage of Net sales, were improvements in sales mix away from lower margin products, predominantly in our entertainment category.
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.
SG&A decreased by $31 million to $4,010 million in fiscal 2013, compared to $4,041 million in fiscal 2012. Foreign currency translation decreased SG&A by $98 million. As a percentage of Net sales, SG&A increased by 2.2 percentage points.
Excluding the impact of foreign currency translation, the increase in SG&A was primarily due to a $24 million increase in occupancy costs, predominantly as a result of new stores and store improvements, and a $20 million increase in litigation expense related to the judgment in the Aleo case. Refer to Note 14 to our Consolidated Financial Statements entitled
“LITIGATION AND LEGAL PROCEEDINGS” for further details. Also contributing to the increase in SG&A was an increase in payroll expenses predominantly related to an additional $17 million of accrued vacation expense resulting from a prior period correction. Refer to Note 1 to our Consolidated Financial Statements entitled “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” for further details.
Depreciation and Amortization
Depreciation and amortization decreased by $19 million to $388 million in fiscal 2013, compared to $407 million in fiscal 2012. Foreign currency translation decreased depreciation and amortization by $8 million. Excluding the impact of foreign currency translation, the decrease in Depreciation and amortization was primarily due to assets that were fully depreciated in the current year.
Goodwill Impairment
Goodwill impairment was $378 million in fiscal 2013. The amount recorded in fiscal 2013 was comprised of $361 million related to our Toys-Domestic reporting unit and $17 million related to our Toys-Japan reporting unit.
Refer to the “CRITICAL ACCOUNTING POLICIES” section below and Note 1 to our Consolidated Financial Statements entitled “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” for further details.
Other Income, Net
Other income, net includes the following:
•
credit card program income;
•
gift card breakage income;
•
impairment of long-lived assets;
•
net gains on sales of properties;
•
foreign exchange gains and losses; and
•
other operating income and expenses.
Other income, net decreased by $16 million to $37 million in fiscal 2013, compared to $53 million in fiscal 2012. The decrease was primarily due to a $33 million increase in impairment of long-lived assets, partially offset by an $11 million increase in credit card program income and a $4 million increase in net gains on sales of properties.
Refer to Note 1 to our Consolidated Financial Statements entitled “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” for further details.
Interest Expense
Interest expense increased by $44 million to $524 million in fiscal 2013, compared to $480 million in fiscal 2012. The increase was primarily due to $77 million of incremental expense associated with the current year repayment of the $950 million 10.750% senior unsecured notes due fiscal 2017 (the “Propco I Notes”), composed of a redemption premium of $51 million, and the write-off of unamortized original issue discount and deferred debt issuance costs. Partially offsetting the increase was $19 million in savings associated with refinancing the Propco I Notes to a $985 million senior unsecured term loan facility due fiscal 2019 (the “Propco I Term Loan Facility”) at a lower rate of interest, as well as the prior year repayment of the $400 million 7.875% senior notes due fiscal 2013 (the “2013 Notes”), which included a make-whole premium of $18 million.
Interest Income
Interest income decreased by $9 million to $7 million in fiscal 2013, compared to $16 million in fiscal 2012. The decrease was primarily due to the April 2013 maturity of our Vanwall Finance PLC (“Vanwall”) debt security holdings.
Income Tax Expense (Benefit)
The net increase in income tax expense of $116 million in fiscal 2013 compared to fiscal 2012 was principally due to an increase in expense for non-routine, discrete items, partially offset by a benefit associated with the decrease in pre-tax earnings (multiplied by the statutory tax rate).
Our income tax expense in fiscal 2013 was unfavorably impacted by certain non-routine, discrete items, including an increase to our valuation allowance for federal and state as well as certain foreign tax jurisdictions. We have evaluated the available positive and negative evidence and have concluded that, for some of our deferred tax assets, it is more likely than not that these assets will not be realized in the foreseeable future. The increase to our valuation allowance for Federal, state and foreign taxes was predominately due to the fact that, as of the end of fiscal 2013, we have incurred a pre-tax cumulative loss (after adjustments required for tax purposes) over the past three fiscal years. As a result, we have established a valuation allowance to reduce these deferred tax assets for the amount we believe will not be realized. A valuation allowance is a non-cash charge, which does not eliminate the tax loss carry forwards and other deferred tax assets. It reflects a reduction in the benefit we expect is more likely than not to be realized from these items. Also contributing to an increase in the fiscal 2013 tax expense are adjustments to deferred taxes resulting from changes to statutory tax rates in various jurisdictions.
Our income tax expense in fiscal 2012 was unfavorably impacted by certain non-routine, discrete items, including an increase to our valuation allowance for certain state tax jurisdictions. The determination by the Company to increase our valuation allowance was predominantly due to the fact that, as of the end of fiscal 2012, in certain state tax jurisdictions we have incurred a pre-tax cumulative loss (after adjustments required for tax purposes) over the past three fiscal years. Also contributing to an increase in the fiscal 2012 tax expense are adjustments to deferred taxes resulting from changes to statutory tax rates in various jurisdictions. These expense items were partially offset by tax benefits related to the resolution of ongoing tax examinations in various jurisdictions.
Refer to Note 10 to the Consolidated Financial Statements entitled “INCOME TAXES” for further details.
Fiscal 2012 Compared to Fiscal 2011
Net Earnings Attributable to Toys “R” Us, Inc.
Net earnings attributable to Toys “R” Us, Inc. decreased by $111 million to $38 million in fiscal 2012, compared to $149 million in fiscal 2011. The decrease in Net earnings attributable to Toys “R” Us, Inc. was primarily related to an increase in Income tax expense of $54 million and an increase in Interest expense of $38 million, which was predominantly 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 2013 Notes. Additionally contributing to the decrease in Net earnings attributable to Toys “R” Us, Inc. was a decrease in Gross margin dollars of $19 million related to foreign currency translation.
Net Sales
Net sales decreased by $366 million or 2.6%, to $13,543 million in fiscal 2012, compared to $13,909 million in fiscal 2011. The impact of foreign currency translation decreased Net sales in fiscal 2012 by $133 million. Our reporting period for fiscal 2012 included 53 weeks compared to 52 weeks for fiscal 2011, which included an additional week of net sales of $152 million.
Excluding the impact of foreign currency translation, the decrease in Net sales for fiscal 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, partially offset by higher average transaction amounts within our Domestic segment. 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 $244 million or 2.9%, to $8,149 million in fiscal 2012, compared to $8,393 million in fiscal 2011. The decrease in Net sales was primarily a result of a decrease in comparable store net sales of 3.5%. Our reporting period for fiscal 2012 included 53 weeks compared to 52 weeks for fiscal 2011, which included an additional week of net sales of $95 million.
The decrease in comparable store net sales resulted primarily from decreases in our entertainment, juvenile (including baby) and core toy categories. The decrease in our entertainment category was primarily due to decreased sales of video game software and systems. The decrease in our juvenile (including baby) category was predominantly due to decreased sales of apparel and furniture. The decrease in our core toy category was primarily due to decreased sales of action vehicles.
International
Net sales for the International segment decreased by $122 million or 2.2%, to $5,394 million in fiscal 2012, compared to $5,516 million in fiscal 2011. Excluding a $133 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, including stores acquired in the Labuan acquisition. Partially offsetting this increase was a decrease in comparable store net sales of 5.0%. Our reporting period for fiscal 2012 included 53 weeks compared to 52 weeks for fiscal 2011, which included an additional week of net sales of $57 million.
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 decreased sales of action figures. The decrease in our seasonal category was predominantly 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.
Gross Margin
Gross margin decreased by $19 million to $4,951 million in fiscal 2012, compared to $4,970 million in fiscal 2011. Foreign currency translation decreased Gross margin by $53 million.
Gross margin, as a percentage of Net sales, increased by 0.9 percentage points in fiscal 2012 compared to fiscal 2011. Gross margin, as a percentage of Net sales, was primarily impacted by margin rate improvements across all categories and improvements in sales mix away from lower margin products.
Domestic
Gross margin increased by $9 million to $2,885 million in fiscal 2012, compared to $2,876 million in fiscal 2011. Gross margin, as a percentage of Net sales, increased by 1.1 percentage points in fiscal 2012 compared to fiscal 2011.
The increase in Gross margin, as a percentage of Net sales, resulted primarily from improvements in margin rates, predominantly in our learning and seasonal categories. Additionally contributing to the increase were improvements in sales mix away from lower margin products, primarily in our entertainment category.
International
Gross margin decreased by $28 million to $2,066 million in fiscal 2012, compared to $2,094 million in fiscal 2011. Foreign currency translation decreased Gross margin by $53 million. Gross margin, as a percentage of Net sales, increased by 0.3 percentage points in fiscal 2012 compared to fiscal 2011.
The increase in Gross margin, as a percentage of Net sales, resulted primarily from improvements in margin rates, predominantly in our entertainment and core toy categories.
Selling, General and Administrative Expenses
SG&A increased by $12 million to $4,041 million in fiscal 2012, compared to $4,029 million in fiscal 2011. Foreign currency translation decreased SG&A by $43 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 a $70 million increase in expenses associated with Labuan, which was acquired on October 31, 2011. In addition, rent expense attributable to new and existing locations increased by $29 million. These increases were partially offset by a decrease of $33 million in advertising and promotional expenses and a decrease of $13 million in expenses associated with credit card processing fees.
Depreciation and Amortization
Depreciation and amortization increased by $4 million to $407 million for fiscal 2012, compared to $403 million in fiscal 2011. Foreign currency translation decreased depreciation and amortization by $3 million. Excluding the impact of foreign currency translation, the increase in Depreciation and amortization was primarily due to the amortization of intangible assets in conjunction with the Labuan acquisition in fiscal 2011.
Other Income, Net
Other income, net increased by $9 million to $53 million in fiscal 2012, compared to $44 million in fiscal 2011. The increase was primarily due to a $9 million increase in credit card program income and an increase of $3 million in advertising income from our websites, partially offset by a $5 million increase in impairment of long-lived assets.
Refer to Note 1 to our Consolidated Financial Statements entitled “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” for further details.
Interest Expense
Interest expense increased by $38 million to $480 million in fiscal 2012, compared to $442 million in fiscal 2011. The increase was primarily due to the issuance of the 2017 Notes and the repayment of the 2013 Notes, which included a make-whole premium of $18 million. Additionally contributing to the increase in Interest expense was $11 million related to the issuance of the $225 million new tranche of term loans due fiscal 2018 in April 2012.
Interest Income
Interest income increased by $6 million to $16 million in fiscal 2012, compared to $10 million in fiscal 2011. The increase was primarily due to the accretion of the Vanwall securities we held to face value, the majority of which were purchased in the third quarter of fiscal 2011.
Income Tax Expense (Benefit)
The net increase in income tax expense of $54 million in fiscal 2012 compared to fiscal 2011 was principally due to an increase in expense for non-routine, discrete items, partially offset by a benefit associated with the decrease in pre-tax earnings (multiplied by the statutory tax rate).
Our income tax expense in fiscal 2012 was unfavorably impacted by certain non-routine, discrete items, including an increase to our valuation allowance for certain state tax jurisdictions. The determination by the Company to increase our valuation allowance was predominantly due to the fact that, as of the end of fiscal 2012, in certain state tax jurisdictions we have incurred a pre-tax cumulative loss (after adjustments required for tax purposes) over the past three fiscal years. A valuation allowance is a non-cash charge, which does not prevent us from using tax loss carryforwards and other deferred tax assets in future periods. It reflects a reduction in the benefit we expect is more likely than not to be realized from these items. Also contributing to an increase in the fiscal 2012 tax expense are adjustments to deferred taxes resulting from changes to statutory tax rates in various jurisdictions. These expense items were partially offset by tax benefits related to the resolution of ongoing tax examinations in various jurisdictions.
Our income tax benefit in fiscal 2011 was favorably impacted by certain non-routine, discrete items, including benefits associated with a decrease in our valuation allowance due to the improved operating performance of one of our foreign subsidiaries, which will allow for the use of certain tax loss carryforwards and other tax attributes. Also contributing to the fiscal 2011 benefit to a lesser extent was a reduction in the liability for unrecognized tax benefits due to the resolution of ongoing tax examinations in various jurisdictions. Refer to Note 10 to the Consolidated Financial Statements entitled “INCOME TAXES” for further details.
LIQUIDITY AND CAPITAL RESOURCES
Overview
As of February 1, 2014, we were in compliance with all of the covenants related to our outstanding debt. At February 1, 2014, under our $1.85 billion secured revolving credit facility (“ABL Facility”), we had no outstanding borrowings, a total of $103 million of outstanding letters of credit and excess availability of $969 million. We are also subject to a minimum excess availability covenant, which was $125 million at February 1, 2014, with remaining availability of $844 million in excess of the covenant.
Toys-Japan currently has an agreement with a syndicate of financial institutions, which includes two unsecured loan commitment lines of credit (“Tranche 1” and “Tranche 2”). On June 25, 2013, Toys-Japan entered into an agreement with a syndicate of financial institutions to refinance Tranche 1. As a result, Tranche 1 is available in amounts up to ¥13.0 billion ($127 million at February 1, 2014), expiring on June 30, 2015. At February 1, 2014, we had outstanding borrowings of $5 million under Tranche 1, with $122 million of remaining borrowing availability.
Tranche 2 is available in amounts of up to ¥12.0 billion ($118 million at February 1, 2014), expiring on June 27, 2014. At February 1, 2014, we had no outstanding borrowings under Tranche 2, with $118 million of remaining availability.
Toys-Japan also has an uncommitted line of credit with total availability of ¥2.8 billion ($28 million at February 1, 2014), which will renew April 1 of each year unless otherwise canceled. As of February 1, 2014, we had no outstanding borrowings under the uncommitted line of credit.
Our European and Australian asset-based revolving credit facility as amended (the “European ABL Facility”) provides for a five-year £138 million ($227 million at February 1, 2014) asset-based senior secured revolving credit facility which will expire on March 8, 2016. At February 1, 2014, we had no outstanding borrowings under the European ABL Facility with $107 million of remaining availability.
Labuan has several uncommitted unsecured lines of credit with various financial institutions with total availability of HK$302 million ($39 million at February 1, 2014). As of February 1, 2014, we had $12 million of borrowings and $3 million of bank guarantees issued under these facilities. The remaining availability under these facilities was $24 million.
We are dependent on the borrowings provided by our lenders to support our working capital needs, capital expenditures and to service debt. As of February 1, 2014, we have funds available to finance our operations under our European ABL Facility through March 2016, our ABL Facility through August 2015, and our Toys-Japan unsecured credit lines with a tranche maturing June 2014 and a tranche maturing June 2015. In addition, Labuan and Toys-Japan have uncommitted lines of credit, which are due on demand. 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 represents the purchase of inventory), servicing debt, remodeling existing stores (including conversions), financing construction of new stores and paying expenses, such as payroll costs and rental expense, 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. For fiscal 2013, peak borrowings under our revolving credit facilities and credit lines amounted to $715 million.
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 ability to refinance our maturing debt and available resources in the future.
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 and remodeling existing stores (including conversions), as well as improving and enhancing our e-commerce and other information technology and logistics systems. Capital expenditures are funded primarily through cash provided by operating activities, as well as available cash.
The following table presents our capital expenditures for each of the past three fiscal years:
(1)
Includes store updates and projects other than conversions.
(2)
Includes single format stores (including Express stores) as well as SBS relocations.
(3)
Primarily includes SBS conversions as well as other juvenile integration remodels.
Cash Flows
Cash Flows Provided by Operating Activities
Net cash provided by operating activities for fiscal 2013 was $144 million, a decrease of $393 million compared to fiscal 2012. The decrease in Net cash provided by operating activities was principally the result of a current year Net loss due to a decline in Net sales. The decrease was partially offset by the timing of vendor payments.
Net cash provided by operating activities for fiscal 2012 was $537 million, an increase of $218 million compared to fiscal 2011. The increase in Net cash provided by operating activities was primarily the result of the timing of vendor payments and a decrease in purchases of merchandise inventories due to our relatively higher levels of merchandise inventories as of January 28, 2012. Also contributing to the increase in Net cash provided by operating activities was the collection of income tax receivables in fiscal 2012.
Cash Flows Used in Investing Activities
Net cash used in investing activities for fiscal 2013 was $205 million, a decrease of $62 million compared to fiscal 2012. The decrease in Net cash used in investing activities was due to current year proceeds of $52 million from the repayment of the Vanwall debt securities held by us, a $48 million reduction in capital expenditures, $15 million in prior year payments related to the Labuan acquisition, and a $15 million increase in proceeds received from sales of fixed assets. The decrease in Net cash used in investing activities was partially offset by a $48 million increase in restricted cash in conjunction with the terms of the New UK Propco Facility Agreement and the current year purchase of $20 million in debt securities of Debussy DTC Plc (“Debussy”). Refer to Note 2 to our Consolidated Financial Statements entitled “SHORT-TERM BORROWINGS AND LONG-TERM DEBT” for further details.
Net cash used in investing activities for fiscal 2012 was $267 million, a decrease of $187 million compared to fiscal 2011. The decrease in Net cash used in investing activities was primarily due to a decline in capital expenditures of $94 million, a decrease of $55 million in payments related to the fiscal 2011 Labuan acquisition, and a $28 million decrease attributable to the change in restricted cash.
Cash Flows (Used in) Provided by Financing Activities
Net cash used in financing activities was $388 million for fiscal 2013, compared to net cash provided by financing activities of $147 million for fiscal 2012. The net cash used in financing activities was primarily due to a $509 million decrease in net debt borrowings compared to the prior year, as well as an increase of $22 million in capitalized debt issuance costs primarily in conjunction with our New UK Propco Facility Agreement and Propco I Term Loan Facility in the current year. Refer to Note 2
to our Consolidated Financial Statements entitled “SHORT-TERM BORROWINGS AND LONG-TERM DEBT” for further details.
Net cash provided by financing activities for fiscal 2012 was $147 million, compared to net cash used in financing activities of $185 million for fiscal 2011. The net cash provided by financing activities was primarily due to a $346 million increase in net debt borrowings, partially offset by an increase of $11 million in capitalized debt issuance costs compared to fiscal 2011.
Debt
Our credit facilities, loan agreements and indentures contain customary covenants, including, among other things, covenants that restrict our ability to incur certain additional indebtedness, pay dividends, make restricted payments or certain investments, create or permit liens on assets, sell assets, engage in mergers or consolidations, and place restrictions on the ability of certain of our subsidiaries to provide funds to us through dividends, loans or advances. We conduct our operations through our subsidiaries, most of which are subject to restrictions on their ability to provide funds to us. The amount of total net assets that were subject to these restrictions was $700 million as of February 1, 2014.
Certain of our agreements also contain various and customary events of default with respect to the indebtedness, including, without limitation, the failure to pay interest or principal when the same is due under the agreements, cross default provisions, the failure of representations and warranties contained in the agreements to be true and certain insolvency events. If an event of default occurs and is continuing under these agreements, the principal amounts outstanding thereunder, together with all accrued and unpaid interest and other amounts owed thereunder, may be declared immediately due and payable by the lenders. Were such an event to occur, we would be forced to seek new financing that may not be on as favorable terms as our current facilities or be available at all. As of February 1, 2014, we had total indebtedness of $5.0 billion, of which $2.9 billion was secured indebtedness. Our ability to refinance our indebtedness on favorable terms, or at all, is directly affected by global economic and financial conditions and other economic factors that may be outside our control. In addition, our ability to incur secured indebtedness (which may enable us to achieve better pricing than the incurrence of unsecured indebtedness) depends in part on the covenants in our credit facilities and indentures and the value of our assets, which depends, in turn, on the strength of our cash flows, results of operations, economic and market conditions and other factors. We are currently in compliance with our covenants relating to our debt. Refer to Note 2 to the Consolidated Financial Statements entitled “SHORT-TERM BORROWINGS AND LONG-TERM DEBT” for further details regarding our debt and any of the transactions described below.
During fiscal 2013, the following events occurred with respect to our debt structure:
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On February 27, 2013, Toys “R” Us France Real Estate SAS (“TRU France Real Estate”) entered into a five year senior secured term loan facility agreement (the “France Propco Facility Agreement”) for an aggregate principal amount of €48 million. The net proceeds of the loan under the France Propco Facility Agreement, together with cash on hand, were used to repay the principal balance of the €61 million French real estate credit facility due fiscal 2013.
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On February 28, 2013, Toys-Japan entered into an additional bank loan with a financial institution for ¥2.0 billion. The loan will mature on February 26, 2021.
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On March 25, 2013, Toys “R” Us Properties (UK) Limited (“UK Propco”) entered into a facility agreement (the “New UK Propco Facility Agreement”), which was funded on March 28, 2013, for an aggregate principal amount of £263 million. The net proceeds of the loan under the New UK Propco Facility Agreement, together with cash on hand, were used to repay the principal balance of the £406 million UK real estate senior and junior credit facilities due fiscal 2013.
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On June 25, 2013, Toys-Japan entered into an agreement with a syndicate of financial institutions to refinance Tranche 1. As a result, Tranche 1 is available in amounts of up to ¥13.0 billion, expiring on June 30, 2015.
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On August 21, 2013, Toys “R” Us Property Company I, LLC and its subsidiaries (“TRU Propco I”) entered into the Propco I Term Loan Facility. The Propco I Term Loan Facility was issued at a discount of $10 million, which resulted in the receipt of gross proceeds of $975 million. The proceeds, together with other funds available to TRU Propco I, were used to redeem in full the Propco I Notes, plus accrued interest, premiums and expenses, and to pay fees and expenses relating to the Propco I Term Loan Facility.
Subsequent Event
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On March 21, 2014, Toys-Delaware and certain of its subsidiaries amended and restated the credit agreement for its ABL Facility in order to extend the maturity date of the facility and amend certain other provisions. The ABL Facility as amended will continue to provide for $1.85 billion of revolving commitments, and permits Toys-Delaware to request an increase in commitments by up to $1.15 billion, subject to certain conditions, including obtaining new or increased commitments from new or existing lenders. The ABL Facility has a final maturity date of March 21, 2019,
with a springing maturity date if the Toys-Delaware term loans due fiscal 2016 and fiscal 2018 and the Toys-Delaware secured notes due fiscal 2016 are not repaid 30 days prior to maturity.
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, exchange 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 16 to the Consolidated Financial Statements entitled “RELATED PARTY TRANSACTIONS.”
Contractual Obligations
Our contractual obligations consist mainly of payments for operating leases related to real estate used in the operation of our business, Long-term debt and related interest and product purchase obligations. The following table summarizes our contractual obligations as of February 1, 2014, except as noted below:
(1)
Excluded from the minimum rental commitments displayed above are $2.0 billion related to options to extend ground lease terms that are reasonably assured of being exercised, the balance of which is predominantly related to fiscals 2019 and thereafter.
(2)
Included in capital leases and financing obligations displayed above is $65 million of interest.
(3)
Excludes the impact of the March 21, 2014 refinancing of the ABL Facility. See Note 2 to our Consolidated Financial Statements entitled “SHORT-TERM BORROWINGS AND LONG-TERM DEBT” for further details.
(4)
Excludes finance obligations associated with capital projects and capital lease obligations, which are included in “Capital leases and financing obligations.”
(5)
In an effort to manage interest rate exposure, we periodically enter into interest rate swaps and interest rate caps. Interest payments presented are net of interest rate swaps or caps.
(6)
Interest payments for our ABL Facility, European ABL Facility and our Toys-Japan unsecured credit lines were estimated based on the average borrowings under each of the facilities in fiscal 2013.
(7)
Purchase obligations consist primarily of open purchase orders for merchandise as well as an agreement to purchase fixed or minimum quantities of goods that are not included in our Consolidated Balance Sheet as of February 1, 2014.
(8)
Includes pension obligations, risk management liabilities, and other general obligations and contractual commitments.
(9)
The above table does not reflect liabilities for uncertain tax positions of $33 million, which includes $3 million of current liabilities. The amount and timing of payments with respect to these items are subject to a number of uncertainties such that we are unable to make sufficiently reliable estimates of the timing and amount of future payments.
(10)
The above table does not reflect the potential acquisition of Li & Fung’s 30% interest in Labuan. The terms of the agreement provide us with the future option to acquire Li & Fung’s 30% interest in the business and also provides Li & Fung the option to require us to buy their 30% interest in the business at the end of three years from the acquisition date. See Note 17 to our Consolidated Financial Statements entitled “ACQUISITIONS” for further details.
Obligations under our operating leases and capital leases in the above table do not include real estate taxes, maintenance and insurance, or contingent rent. The following table presents these amounts which were recorded in SG&A in our Consolidated Statements of Operations for fiscals 2013, 2012 and 2011:
Off-balance Sheet Arrangements
We have an off-balance sheet arrangement as a result of the March 25, 2013 New UK Propco Facility Agreement between UK Propco and Debussy. Debussy is a special purpose entity established with the limited purpose of making loans and issuing £263 million of multiple classes of commercial mortgage backed fixed rate notes (the “Debussy Notes”) to third party investors and the Company. We purchased £13 million principal amount of the various classes of the Debussy Notes, which are included in Other assets within the Consolidated Balance Sheet, classified as held-to-maturity and reported at amortized cost. The proceeds from the Debussy Notes were used to fund the new loan under the New UK Propco Facility Agreement.
In accordance with ASC 810, we identified Debussy as a VIE because Debussy, by design, has insufficient equity investment at risk and its equity investment holders at risk lack the ability through voting or similar rights, to direct the activities that most significantly impact Debussy’s economic performance. Additionally, we evaluated our variable interests in Debussy and third party investors’ involvement and concluded that we are not the primary beneficiary and therefore should not consolidate Debussy as we do not hold the power to direct the activities that most significantly impact Debussy’s economic performance.
Effects of Inflation
Our results of operations and financial condition are presented based on historical cost. While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we believe the effects of inflation, if any, on our results of operations and financial condition have been immaterial.
CRITICAL ACCOUNTING POLICIES
Our Consolidated Financial Statements have been prepared in accordance with GAAP. 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 Consolidated 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 Consolidated Financial Statements.
We believe the following are our most critical accounting policies that include significant judgments and estimates used in the preparation of our Consolidated Financial Statements. We consider an accounting policy to be critical if it requires assumptions to be made that were uncertain at the time they were made, and if changes in these assumptions could have a material impact on our consolidated financial condition or results of operations.
Merchandise Inventories
We value our merchandise inventories at the lower of cost or market, as determined by the weighted average cost method. Cost of sales under the weighted average cost method represents the weighted average cost of the individual items sold. Cost of sales under the weighted average cost method is also affected by adjustments to reflect current market conditions, merchandise allowances from vendors, expected inventory shortages and estimated losses from obsolete and slow-moving inventory.
Merchandise inventories and related reserves are reviewed on an interim basis and adjusted, as appropriate, to reflect management’s current estimates. These estimates are derived using available data, our historical experience, estimated inventory turnover and current purchase forecasts. Various types of negotiated allowances received from our vendors are generally treated as adjustments to the purchase price of our merchandise inventories. We adjust our estimates for vendor allowances and our provision for expected inventory shortage to actual amounts at the completion of our physical inventory counts and finalization of all vendor allowance agreements. In addition, we perform an inventory-aging analysis for identifying obsolete and slow-moving inventory. We establish a reserve to reduce the cost of our inventory to its estimated net realizable value based on certain loss indicators which include aged inventory and excess supply on hand, as well as specific
identification methods. In fiscal 2013, we wrote down an incremental $51 million of excess and obsolete inventory as a result of specific identification.
Our estimates may be impacted by changes in certain underlying assumptions and may not be indicative of future activity. For example, factors such as slower inventory turnover due to changes in competitors’ tactics, consumer preferences, consumer spending and inclement weather could cause excess inventory requiring greater than estimated markdowns to entice consumer purchases. Such factors could also cause sales shortfalls resulting in reduced purchases from vendors and an associated reduction in vendor allowances. Based on our inventory aging analysis for identifying obsolete and slow-moving inventory, a 10% change in our reserve would have impacted pre-tax earnings by $11 million for fiscal 2013.
Long-lived Asset Impairment
We evaluate the carrying value of all long-lived assets, such as property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable, in accordance with ASC 360. Events or circumstances that might warrant an impairment review include, among other things, material declines in operational performance, significant adverse market conditions and significant changes or planned changes in our use of assets, including store relocation, store closure and property sales. When evaluating operating stores for impairment, our asset group is at an individual store level, as that is the lowest level for which cash flows are identifiable. Cash flows for individual operating stores include an allocation of applicable overhead. We will record an impairment loss when the carrying value of the underlying asset group exceeds its estimated fair value.
In determining whether long-lived assets are recoverable, our estimate of undiscounted future cash flows over the estimated life or lease term of a store is based upon our experience, historical operations of the store, an estimate of future store profitability and economic conditions. The future estimates of store profitability require estimating such factors as sales growth, inflation and the overall economic conditions. Since we forecast our future undiscounted cash flows for up to 25 years, our estimates are subject to variability as future results can be difficult to predict. If a long-lived asset is found to be non-recoverable, we record an impairment charge equal to the difference between the asset’s carrying value and fair value. We estimate the fair value of the asset using a valuation method such as discounted cash flow or a relative, market-based approach.
In fiscal 2013, we recorded $44 million of impairment charges related to non-recoverable long-lived assets. These impairments were primarily due to the identification of underperforming stores, the relocation of certain stores, property sales, and a decrease in real estate market values.
Goodwill Impairment
Goodwill is evaluated for impairment annually or whenever we identify certain events or circumstances that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Events or circumstances that might warrant an interim evaluation include, among other things, a significant adverse change in legal factors or in the business climate, an adverse action or assessment by a regulator, unanticipated competition, loss of key personnel and a more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of.
In preparing a qualitative analysis for each of our reporting units, we assess events and circumstances that may impact the fair value and the carrying amount of each reporting unit. The identification of relevant events and circumstances and how these may impact a reporting unit’s fair value or carrying amount involve significant judgments and assumptions. For each reporting unit, we compare its current carrying value as of the testing date to its most recent fair value. Based upon the differential noted, we may decide to perform the first step of the quantitative impairment test or to continue with the qualitative assessment by analyzing whether changes in the business and/or operating environment have occurred since the most recent fair value obtained that may impact this relationship. This assessment includes, but is not limited to, the identification of macroeconomic conditions, industry and market considerations that currently impact the reporting unit’s operating environment, as well as cost factors, overall financial performance including actual and projected operating results, and peer group share price trends. We examine the positive and negative influences of each relevant factor on the reporting unit’s fair value and qualitatively assess the impact that such factors (when considered both individually and in the aggregate) would have on a reporting unit’s fair value since the last full valuation was performed. If, after assessing the totality of events or circumstances, we determine that the potential impact of the positive and negative factors do not indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we will conclude that goodwill is not impaired and performance of the two-step quantitative impairment test is not required.
For the two-step quantitative goodwill impairment test, we compare the current carrying value of the reporting unit to its current fair value to determine whether there is an indication of impairment. First, we determine the current fair value of the reporting unit by blending results from the market multiples approach and the income approach. These valuation approaches consider a number of factors that include, but are not limited to, expected future cash flows, growth rates, discount rates, and
comparable multiples from publicly-traded companies in our industry, and require us to make certain assumptions and estimates regarding industry economic factors and future profitability of our business. It is our policy to conduct impairment testing (both from a qualitative and quantitative perspective) based on our most current business plans, projected future revenues and cash flows, which reflect changes we anticipate in the economy and the industry. The cash flows are based on five-year financial forecasts developed internally by management and are discounted to a present value using discount rates that properly account for the risk and nature of the respective reporting unit’s cash flows and the rates of return market participants would require to invest their capital in our reporting unit. The outcome of the market multiples and income approaches are heavily dependent upon the aforementioned projections. If the carrying value exceeds the fair value, we would then calculate the implied fair value of our reporting unit’s goodwill as compared to its carrying value to determine the appropriate impairment charge, if any. To calculate the implied fair value of goodwill the Company would allocate the reporting unit’s fair value to all of the assets and liabilities of the reporting unit, including any unrecognized intangible assets, in a hypothetical scenario that faithfully represents an acquisition of the reporting unit in a business combination. If the implied fair value of the reporting unit’s goodwill is less than its carrying value, the difference is recorded as an impairment charge, not to exceed the balance of goodwill.
The Company decided to change its annual goodwill impairment testing date from the first day of the fourth quarter (or the first day of the tenth fiscal month) to the last day of the eleventh fiscal month of each fiscal year, which is shortly after the holiday season. The change is preferable as it aligns the timing of the annual impairment test with the timing of the Company’s annual strategic planning process, which will now encompass actual holiday season results, given the later testing date. This change in accounting principle does not delay, accelerate or avoid an impairment charge. The preferability letter obtained from our independent registered public accounting firm is filed as an exhibit to this Annual Report on Form 10-K. In addition, refer to Note 1 to our Consolidated Financial Statements entitled “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” for further details.
At February 1, 2014, our Toys-China and Southeast Asia reporting unit (included in our International segment) had $64 million of Goodwill. At February 2, 2013, our Toys-Domestic reporting unit had $361 million of Goodwill and our Toys-China and Southeast Asia and Toys-Japan reporting units (included in our International segment) had $64 million and $20 million of Goodwill, respectively.
For the fourth quarter of fiscal 2013 goodwill impairment testing, management updated the five-year financial forecasts for fiscal 2014 through fiscal 2018, which contained significant declines in the projected financial performance of the Toys-Domestic and Toys-Japan reporting units compared to the projections used in goodwill impairment tests of prior years. The decrease in financial projections was primarily due to the fiscal 2013 decline in operating results, due in large part to the holiday season. This reduction in revenues and cash flows forecasted for the Toys-Domestic and Toys-Japan reporting units warranted performing the two-step quantitative test. Upon completing the step one quantitative impairment test, it was determined that the carrying values exceeded the respective fair values of each reporting unit and the Company proceeded to step two. The step two quantitative test indicated that the goodwill at each reporting unit was fully impaired. Therefore, goodwill balances of $361 million and $17 million related to Toys-Domestic and Toys-Japan, respectively, were recorded in the Goodwill impairment line within the Consolidated Statement of Operations for the fiscal year ended February 1, 2014. The fair value estimates incorporated in step two of the quantitative assessment were primarily based on third party appraisals, the market approach and the income approach, specifically the relief from royalty method in regards to certain intangible assets. The property appraisals incorporated a significant amount of judgment on the part of the third party valuation specialists regarding appropriate comparable properties and assessments of current market conditions, and the income approach valuations incorporated significant estimates and assumptions made by management including those relating to projected long-term rates of growth, customer attrition and profitability.
For the Toys-China and Southeast Asia reporting unit we performed a qualitative assessment and determined that it was more likely than not that the respective fair value substantially exceeded the carrying value and noted no goodwill impairment indicators. Refer to Note 1 to our Consolidated Financial Statements entitled, “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” for further details.
Self-Insured Liabilities
We self-insure a substantial portion of our workers’ compensation, general liability, auto liability, property, medical, prescription drug and dental insurance risks, in addition to maintaining third party insurance coverage. We estimate our provisions for losses related to self-insured risks using actuarial techniques and estimates for incurred but not reported claims. We record the liability for workers’ compensation on a discounted basis. We also maintain insurance coverage to limit the exposure related to certain risks. The assumptions underlying the ultimate costs of existing claim losses can vary, which can affect the liability recorded for such claims.
Although we feel our reserves are adequate to cover our estimated liabilities, changes in the underlying assumptions and future economic conditions could have a considerable effect upon future claim costs, which could have a material impact on our Consolidated Financial Statements. Our reserve for self-insurance was $102 million as of February 1, 2014. A 10% change in the value of our self-insured liabilities would have impacted pre-tax earnings by $10 million for the fiscal year ended February 1, 2014.
Revenue Recognition
We recognize revenue in accordance with ASC Topic 605, “Revenue Recognition.” Revenue related to merchandise sales, which is 99.6% of total revenues, is generally recognized for retail sales at the point of sale in the store and when the customer receives the merchandise shipped from our websites. Discounts provided to customers are accounted for as a reduction of sales. We record a reserve for estimated product returns in each reporting period based on historical return experience and changes in customer demand. Actual returns may differ from historical product return patterns, which could impact our financial results in future periods.
Income Taxes
We account for income taxes in accordance with ASC Topic 740, “Income Taxes” (“ASC 740”). Our provision for income taxes and effective tax rates are calculated by legal entity and jurisdiction and are based on a number of factors, including our level of pre-tax earnings, income tax planning strategies, differences between tax laws and accounting rules, statutory tax rates and credits, uncertain tax positions, and valuation allowances. We use significant judgment and estimates in evaluating our tax positions. Our effective tax rate in a given financial statement period may be materially impacted by changes in the mix and level of earnings by taxing jurisdiction.
Tax law and accounting rules often differ as to the timing and treatment of certain items of income and expense. As a result, the tax rate reflected in our tax return (our current or cash tax rate) is different from the tax rate reflected in our Consolidated Financial Statements. Some of the differences are permanent, while other differences are temporary as they will reverse over time. We record deferred tax assets and liabilities for any temporary differences between the assets and liabilities in our Consolidated Financial Statements and their respective tax bases. We establish valuation allowances when we believe it is more likely than not that our deferred tax assets will not be realized. In assessing the need for a valuation allowance, management weighs the available positive and negative evidence, including limitations on the use of tax loss and other carryforwards due to changes in ownership, historic information, projections of future sources of taxable income, including future reversals of taxable temporary differences and future taxable income exclusive of reversing temporary differences and carryforwards, and tax planning strategies. For example, we would establish a valuation allowance for the tax benefit associated with a tax loss carry forward in a tax jurisdiction if we did not expect to generate sufficient taxable income of the appropriate character to utilize the tax loss carry forward prior to its expiration. Changes in future taxable income, tax liabilities and our tax planning strategies may impact our effective tax rate, valuation allowances and the associated carrying value of our deferred tax assets and liabilities.
At any one time our tax returns for numerous tax years are subject to examination by U.S. Federal, state and foreign taxing jurisdictions. ASC 740 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold and measurement attributes for income tax positions taken or expected to be taken on a tax return. Under ASC 740, the impact of an uncertain tax position taken or expected to be taken on an income tax return must be recognized in the financial statements at the largest amount that is more-likely-than-not to be sustained. An uncertain income tax position will not be recognized in the financial statements unless it is more-likely-than-not to be sustained. We adjust these tax liabilities, as well as the related interest and penalties, based on the latest facts and circumstances, including recently enacted tax law changes, published rulings, court cases, and outcomes of tax audits. While we do not expect material changes, it is possible that our actual tax liability will differ from our established tax liabilities for unrecognized tax benefits, and our effective tax rate may be materially impacted. While it is often difficult to predict the final outcome of, the timing of, or the tax treatment of any particular tax position or deduction, we believe that our tax balances reflect the more-likely-than-not outcome of known tax contingencies. We report tax-related interest and penalties as a component of Income tax expense (benefit).
Stock-Based Compensation
The fair value of the common stock shares utilized in valuing stock-based payment awards was determined by the Executive Committee based on management’s recommendations. We engage an independent valuation specialist to assist management and the Executive Committee in determining the fair value of our common stock for these purposes. Management and the Executive Committee rely on the valuations provided by the independent valuation specialist as well as their review of the Company’s historical financial results, business milestones, financial forecast and business outlook as of each award date. The same Company data is reviewed by management, on a periodic basis, to monitor the performance metrics associated with
certain stock-based payment awards as the achievement of established thresholds directly impact the amount of target shares ultimately earned.
The fair value of common stock shares is based on total enterprise value ranges and the total equity value ranges estimated on a non-marketable and minority basis utilizing both the income approach and the market approach guidelines. A range of the two methods was utilized to determine the fair value of the shares. The income approach is a valuation technique that provides an estimation of the fair value of a business based upon the cash flows that it can be expected to generate over time. The market approach is a valuation technique that provides an estimation of fair value based on market prices of publicly traded companies and the relationship to financial results. When warranted, a Black-Scholes option-based model may be utilized in addition to the market and income approaches in order to estimate the fair value of our shares.
The income approach utilized begins with an estimation of the annual cash flows that a business is expected to generate over a discrete projection period. The estimated cash flows for each of the years in the period are then converted to their present value equivalent using a discount rate considered appropriate given the risk of achieving the projected cash flows. The present value of the estimated cash flows are then added to the present value equivalent of the terminal value of the business at the end of the projection period to arrive at an estimate of fair value. Such an approach necessarily relies on estimations of future cash flows that are inherently uncertain, as well as a determination of an appropriate discount rate in order to derive present value equivalents of both the projected cash flows and the terminal value of the business at the end of the period. The use of different estimations of future cash flows or a different discount rate could result in a different indication of fair value.
The market approach utilizes in part a comparison to publicly traded companies deemed to be in similar lines of business. Such companies were then analyzed to determine which were most comparable based on various factors, including industry similarity, financial risk, company size, geographic diversification, growth opportunities, similarity of reaction to macroeconomic factors, profitability, financial data availability and active trading volume. Six companies were included as comparable companies in the market comparable approach. Alternate determinations of which publicly traded entities constituted comparable companies could result in a different indication of fair value.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
In July 2013, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2013-10, “Derivatives and Hedging (Topic 815): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes” (“ASU 2013-10”). ASU 2013-10 permits the Fed Funds Effective Swap Rate to be used as a U.S. benchmark interest rate for hedge accounting purposes, in addition to the U.S. government rate and LIBOR. The Company adopted the amendments in ASU 2013-10, effective July 17, 2013. The adoption did not have an impact on our Consolidated Financial Statements.
In February 2013, the FASB issued ASU No. 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” (“ASU 2013-02”). This amendment requires an entity to present, either on the face of the financial statement or in the notes, the effects on the line items of net income due to significant amounts reclassified out of accumulated other comprehensive income, as well as provide cross-references to other required reclassification disclosures, where applicable. As of February 3, 2013, the Company adopted ASU 2013-02 and has elected to present the significant amounts reclassified in a tabular format in the Notes to the Consolidated Financial Statements
In July 2012, the FASB issued ASU No. 2012-02, “Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment” (“ASU 2012-02”). ASU 2012-02 provides an entity the option to first assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. The results of the qualitative assessment will determine whether it is necessary to perform the quantitative impairment test described in Topic 350. The Company adopted the amendments in ASU 2012-02, effective February 3, 2013. The adoption did not have an impact on our Consolidated Financial Statements.
In December 2011, the FASB issued ASU No. 2011-11, “Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities” (“ASU 2011-11”), which requires an entity to disclose information about derivatives subject to enforceable master netting arrangements, including rights of offset, to enable users of its financial statements to understand the effect of those arrangements on its financial position. Subsequently, in January 2013, the FASB issued ASU 2013-01, “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities” (“ASU 2013-01”), which clarifies which instruments and transactions are subject to the offsetting disclosure requirements established by ASU 2011-11. The Company adopted ASU 2011-11 and ASU 2013-01 as of February 3, 2013, and the presentation and disclosure requirements were applied retrospectively. Other than the enhanced disclosures, the adoption of these pronouncements did not impact our Consolidated Financial Statements.
In December 2011, the FASB issued ASU 2011-10, “Property, Plant, and Equipment (Topic 360): Derecognition of in Substance Real Estate - a Scope Clarification” (“ASU 2011-10”). The purpose of this update is to resolve the diversity in practice about whether the guidance under ASC Subtopic 360-20, “Property, Plant, and Equipment - Real Estate Sales”, applies to a parent that ceases to have a controlling financial interest in a subsidiary, as specified under ASC Subtopic 810-10, “Non-Controlling Interests in Consolidated Financial Statements - an amendment of ARB No. 51”, that is in substance real estate as a result of default on the subsidiary’s nonrecourse debt. ASU 2011-10 clarifies the accounting for such transactions is based on substance rather than form, specifically that the parent should only derecognize the real estate, debt and results of operations of the subsidiary when legal title to the real estate is transferred to the lender and the related nonrecourse debt has been extinguished. The Company adopted the amendments, effective February 3, 2013, and applied the guidance prospectively. The adoption of ASU 2011-10 did not have an impact on our Consolidated Financial Statements.
Refer to Note 18 to our Consolidated Financial Statements entitled “RECENT ACCOUNTING PRONOUNCEMENTS” for a discussion of accounting standards which we have not yet been required to implement and our assessment of their impact to our Consolidated Financial Statements.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk from potential changes in interest rates and foreign currency exchange rates. We regularly evaluate our exposure to these risks and take measures to mitigate these risks on our consolidated financial results. We enter into derivative financial instruments to economically manage our market risks related to interest rate and foreign currency exchange. We do not participate in speculative derivative trading. The analysis below presents our sensitivity to selected hypothetical, instantaneous changes in market interest rates and foreign currency exchange rates as of February 1, 2014.
Foreign Exchange Exposure
Our foreign currency exposure is primarily concentrated in the United Kingdom, Continental Europe, Asia, Canada and Australia. We face currency translation exposures related to translating the results of our worldwide operations into USD because of exchange rate fluctuations during the reporting period.
We face foreign currency exchange transaction exposures related to short-term, cross-currency intercompany loans and merchandise purchases:
•
We enter into short-term, cross-currency intercompany loans with our foreign subsidiaries. The majority of this exposure is economically hedged through the use of foreign currency exchange forward contracts. Our exposure to foreign currency risk related to exchange forward contracts on our short-term, cross-currency intercompany loans has not materially changed from fiscal 2012 to fiscal 2013. As a result, a 10% change in foreign currency exchange rates against the USD would not have a material impact on our pre-tax earnings related to our short-term, cross-currency intercompany loans that were outstanding as of year-end.
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In addition, our foreign subsidiaries make USD denominated merchandise purchases through the normal course of business. From time to time, we enter into foreign exchange forward contracts under our merchandise import program. As of February 1, 2014, we did not have any outstanding foreign exchange forward contracts under our merchandise import programs.
The above sensitivity analysis on our foreign currency exchange transaction exposures related to our short-term, cross-currency intercompany loans assumes our mix of foreign currency-denominated debt instruments and derivatives and all other variables will remain constant in future periods. These assumptions are made in order to facilitate the analysis and are not necessarily indicative of our future intentions.
Changes in foreign exchange rates affect interest expense recorded in relation to our foreign currency-denominated derivative instruments and debt instruments. For each of the fiscal years ended February 1, 2014 and February 2, 2013, we estimate that a 10% hypothetical change in foreign exchange rates would impact our pre-tax earnings due to the effect of foreign currency translation on interest expense related to our foreign currency-denominated derivative instruments and debt instruments by $6 million.
Interest Rate Exposure
We have a variety of fixed and variable rate debt instruments and are exposed to market risks resulting from interest rate fluctuations. In an effort to manage interest rate exposures, we periodically enter into interest rate swaps and interest rate caps. A change in interest rates on variable rate debt impacts our pre-tax earnings, whereas a change in interest rates on fixed rate debt impacts the fair value of debt. A portion of our interest rate contracts are designated for hedge accounting as cash flow and fair value hedges. For designated cash flow hedges, the effective portion of the changes in the fair value of derivatives are recorded in Accumulated other comprehensive (loss) income and subsequently recorded in the Consolidated Statements of
Operations at the time the hedged item affects earnings. For designated fair value hedges, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk is recorded in Interest expense in the Consolidated Statements of Operations.
The following table illustrates the estimated sensitivity of a 1% change in interest rates to our future pre-tax earnings on our derivative instruments and variable rate debt instruments at February 1, 2014:
The above sensitivity analysis assumes our mix of financial instruments and all other variables will remain constant in future periods. These assumptions are made in order to facilitate the analysis and are not necessarily indicative of our future intentions. As of February 2, 2013, we estimated that a 1% hypothetical increase or decrease in interest rates could potentially have caused either a $4 million decrease or a $6 million increase on our pre-tax earnings, respectively. Refer to our Consolidated Financial Statements for further discussion in Note 3 entitled “DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES.” At this time, we do not anticipate material changes to our interest rate risk exposure or to our risk management policies. We believe that we could mitigate potential losses on pre-tax earnings through our risk management objectives, if material changes occur in future periods.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Operations
Consolidated Statements of Comprehensive (Loss) Income
Consolidated Balance Sheets
Consolidated Statements of Cash Flows
Consolidated Statements of Stockholders’ (Deficit) Equity
Notes to the Consolidated Financial Statements
Quarterly Results of Operations (Unaudited)
Schedule I - Parent Company Condensed Financial Statements and Notes to Condensed Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Toys “R” Us, Inc.:
We have audited the accompanying consolidated balance sheets of Toys “R” Us, Inc. and subsidiaries (the “Company”) as of February 1, 2014 and February 2, 2013, and the related consolidated statements of operations, comprehensive (loss) income, stockholders’ (deficit) equity, and cash flows for each of the three fiscal years in the period ended February 1, 2014. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Toys “R” Us, Inc. and subsidiaries as of February 1, 2014 and February 2, 2013, and the results of their operations and their cash flows for each of the three fiscal years in the period ended February 1, 2014, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of February 1, 2014, based on the criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 31, 2014 expressed an unqualified opinion on the Company’s internal control over financial reporting.
/s/ Deloitte & Touche LLP
New York, New York
March 31, 2014
Toys “R” Us, Inc. and Subsidiaries
Consolidated Statements of Operations
See Notes to the Consolidated Financial Statements.
Toys “R” Us, Inc. and Subsidiaries
Consolidated Statements of Comprehensive (Loss) Income
See Notes to the Consolidated Financial Statements.
Toys “R” Us, Inc. and Subsidiaries
Consolidated Balance Sheets
See Notes to the Consolidated Financial Statements.
Toys “R” Us, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
See Notes to the Consolidated Financial Statements.
Toys “R” Us, Inc. and Subsidiaries
Consolidated Statements of Stockholders’ (Deficit) Equity
See Notes to the Consolidated Financial Statements.
Toys “R” Us, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
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. We sell a variety of products in the core toy, entertainment, juvenile, learning and seasonal categories through our retail locations and the Internet. As of February 1, 2014, we operated 1,577 stores and licensed an additional 185 stores. These stores are located in 36 countries and jurisdictions around the world under the Toys “R” Us, Babies “R” Us and FAO Schwarz banners. In addition, we operate Toys “R” Us Express stores (“Express stores”), smaller format stores primarily open on a short-term basis during the holiday season. We also own and operate websites including Toysrus.com, Babiesrus.com, eToys.com, FAO.com and toys.com, as well as other Internet sites we operate in our international markets.
Our Company was founded in Washington D.C. in 1948 when Charles Lazarus opened a baby furniture store, Children’s Bargain Town. The Toys “R” Us name made its debut in 1957. In 1978, we completed an initial public offering of our common stock. When Charles Lazarus retired as our Chief Executive Officer (“CEO”) in 1994, we operated or licensed over 1,000 stores in 17 countries and jurisdictions. In 1996, we established the Babies “R” Us brand, further solidifying our reputation as a leading consumer destination for children and their families.
On July 21, 2005, we were acquired through a $6.6 billion merger (the “Merger”) by an investment group led by entities advised by or affiliated with Bain Capital Partners, LLC (“Bain”), Kohlberg Kravis Roberts & Co. L.P. (together with its affiliates, “KKR”) and Vornado Realty Trust (“Vornado”) (collectively, the “Sponsors”). Upon the completion of this acquisition, we became a private company.
Fiscal Year
Our fiscal year ends on the Saturday nearest to January 31 of each calendar year. Unless otherwise stated, references to years in this report relate to the fiscal years below:
Basis of presentation
The accompanying consolidated financial statements as of February 1, 2014 and February 2, 2013 and for each of the three year periods ended February 1, 2014, February 2, 2013 and January 28, 2012, have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”).
During fiscal 2013, we recorded a $17 million ($11 million net of tax) non-cash charge in Selling, general and administrative expenses (“SG&A”) in our Consolidated Statement of Operations to correct our vacation accrual, with a corresponding increase in Accrued expenses and other current liabilities within the Consolidated Balance Sheet. The adjustment to the vacation accrual was the result of a cumulative prior period correction. Management concluded that the prior period correction did not have a material impact on the current or any previously reported Consolidated Financial Statements.
Principles of Consolidation
The Consolidated Financial Statements include the accounts of the Company. We eliminate all inter-company balances and transactions.
Variable Interest Entities
Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, “Consolidation” (“ASC 810”), requires the consolidation of entities that are controlled by a company through interests other than voting interests. We evaluate our lending vehicles, including our commercial mortgage-backed securities, structured loans and any joint venture interests to determine whether we are the primary beneficiary of a variable interest entity (“VIE”). The primary beneficiary will have a controlling financial interest in a VIE if it has (1) the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and (2) the obligation to absorb losses of the entity that could
potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE.
On March 25, 2013, our indirect wholly-owned subsidiary, Toys “R” Us Properties (UK) Limited (“UK Propco”) entered into a facility agreement (the “New UK Propco Facility Agreement”) with Debussy DTC Plc (“Debussy”), pursuant to which Debussy made loans (collectively, the “New UK Propco Loan”) to UK Propco on March 28, 2013 in the aggregate principal amount of £263 million. Debussy is a special purpose entity established with the limited purpose of making loans and issuing the £263 million of multiple classes of commercial mortgage backed fixed rate notes (the “Debussy Notes”) to third party investors and the Company. Refer to Note 2 entitled “SHORT-TERM BORROWINGS AND LONG-TERM DEBT” for further details.
In accordance with ASC 810, we identified Debussy as a VIE because Debussy, by design, has insufficient equity investment at risk and its equity investment holders at risk lack the ability, through voting or similar rights, to direct the activities that most significantly impact Debussy’s economic performance. Additionally, we evaluated our variable interests in Debussy and third party investors’ involvement in Debussy and concluded that the Company is not the primary beneficiary and therefore should not consolidate Debussy as we do not hold the power to direct the activities that most significantly impact Debussy’s economic performance. The Company has not identified any subsequent changes to Debussy’s governing documents or contractual arrangements that would change the characteristics or adequacy of the entity’s equity investment at risk in accordance with ASC 810.
During fiscal 2006, we identified Vanwall Finance PLC (“Vanwall”) as a VIE and concluded that in accordance with ASC 810, Vanwall should not be consolidated. Since fiscal 2006, prior to the repayment in fiscal 2013, we did not identify any subsequent changes that would have resulted in consolidation as we were not the primary beneficiary of that VIE. During fiscal 2013, we repaid the UK real estate senior and junior credit facilities issued by Vanwall, and thus terminated our interest in the VIE. Refer to Note 2 entitled “SHORT-TERM BORROWINGS AND LONG-TERM DEBT” for further details.
Use of Estimates
The preparation of our Consolidated Financial Statements requires us to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and the related disclosures of contingent assets and liabilities as of the date of the Consolidated Financial Statements and during the applicable periods. We base these estimates on historical experience and other factors that we believe are reasonable under the circumstances. Actual results may differ materially from these estimates and such differences could have a material impact on our Consolidated Financial Statements.
Cash and Cash Equivalents
We consider our highly liquid investments with original maturities of three months or less at acquisition to be cash equivalents. These investments primarily consist of money market funds, bank deposits, term deposits or certificates of deposit. Cash equivalents are stated at cost, which approximates fair value. Book cash overdrafts are reclassified to accounts payable.
Restricted Cash
Restricted cash represents collateral and other cash that is restricted from withdrawal. As of February 1, 2014 and February 2, 2013, we had restricted cash of $53 million and $16 million, respectively.
Accounts and Other Receivables
Accounts and other receivables consist primarily of receivables from vendor allowances and consumer credit card and debit card transactions.
Merchandise Inventories
We value our merchandise inventories at the lower of cost or market, as determined by the weighted average cost method. Cost of sales represents the weighted average cost of the individual items sold and is affected by adjustments to reflect current market conditions, merchandise allowances from vendors, estimated inventory shortages and estimated losses from obsolete and slow-moving inventory.
Property and Equipment, Net
We record property and equipment at cost. Property and leasehold improvements represent capital improvements made to our owned and leased properties. We record depreciation and amortization using the straight-line method over the shorter of the estimated useful lives of the assets or the terms of the respective leases, if applicable.
We capitalize interest for new store construction-in-progress in accordance with ASC Topic 835, “Interest.” Capitalized interest amounts are immaterial.
Asset Retirement Obligations
We account for asset retirement obligations (“ARO”) in accordance with ASC Topic 410, “Asset Retirement and Environmental Obligations,” which requires us to recognize a liability for the fair value of obligations to retire tangible long-lived assets when there is a legal obligation to incur such costs. We recognize a liability for ARO, capitalize asset retirement costs and amortize these costs over the life of the assets. As of February 1, 2014 and February 2, 2013, we had ARO of $66 million, respectively.
Goodwill
Details on goodwill by segment are as follows:
(1)
Foreign currency translation accounted for a $3 million decrease.
At February 1, 2014, our Toys-China and Southeast Asia reporting unit (included in our International segment) had $64 million of Goodwill. At February 2, 2013, our Toys-Domestic reporting unit had $361 million of Goodwill and our Toys-China and Southeast Asia and Toys-Japan reporting units (included in our International segment) had $64 million and $20 million of Goodwill, respectively. As a result of our fourth quarter fiscal 2013 goodwill impairment test, we recorded full impairments of the Toys-Domestic and Toys-Japan reporting unit’s goodwill balances of $361 million and $17 million, respectively, which were recorded in our Consolidated Statement of Operations for the fiscal year ended February 1, 2014. Refer to below and “CRITICAL ACCOUNTING POLICIES” within Item 7 entitled “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” for further details regarding the fiscal 2013 annual impairment tests.
The Company decided to change its annual goodwill impairment testing date from the first day of the fourth quarter (or the first day of the tenth fiscal month) to the last day of the eleventh fiscal month of each fiscal year, which is shortly after the holiday season. The change is preferable as it aligns the timing of the annual impairment test with the timing of the Company’s annual strategic planning process, which will now encompass actual holiday season results, given the later testing date. Historically, approximately 43% of our total Net sales are generated in the fourth quarter. This change in accounting principle does not delay, accelerate or avoid an impairment charge.
Due to significant judgments and estimates that are utilized in an impairment analysis, we determined it was impracticable to objectively conclude, without the use of hindsight, the assumptions that would have been used as of the last day of the eleventh fiscal month for each year prior to fiscal 2013. As such, we will prospectively apply the change in the annual goodwill impairment test beginning on December 28, 2013.
Goodwill is evaluated for impairment annually or whenever we identify certain events or circumstances that would more likely than not reduce the fair value of a reporting unit below its carrying amount, in accordance with the provisions of ASC Topic 350, “Intangibles - Goodwill and Other” (“ASC 350”). Events or circumstances that might warrant an interim evaluation include, among other things, a significant adverse change in legal factors or in the business climate, an adverse action or assessment by a regulator, unanticipated competition, loss of key personnel and a more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of. ASC 350 provides an entity with the option to first assess qualitative factors for each reporting unit to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount prior to performing the two-step quantitative impairment test. The optional qualitative assessment can be performed at the discretion of management for any or all of the reporting units in any given period.
For the two-step quantitative goodwill impairment test, we compare the current carrying value of the reporting unit to its current fair value to determine whether there is an indication of impairment. First, we determine the current fair value of the reporting unit by blending results from the market multiples approach and the income approach. These valuation approaches consider a number of factors that include, but are not limited to, expected future cash flows, growth rates, discount rates, and comparable multiples from publicly-traded companies in our industry, and require us to make certain assumptions and estimates regarding industry economic factors and future profitability of our business. It is our policy to conduct impairment
testing (both from a qualitative and quantitative perspective) based on our most current business plans, projected future revenues and cash flows, which reflect changes we anticipate in the economy and the industry. The cash flows are based on five-year financial forecasts developed internally by management and are discounted to a present value using discount rates that properly account for the risk and nature of the respective reporting unit’s cash flows and the rates of return market participants would require to invest their capital in our reporting unit. The outcome of the market multiples and income approaches are heavily dependent upon the aforementioned projections. If the carrying value exceeds the fair value, we would then calculate the implied fair value of our reporting unit’s goodwill as compared to its carrying value to determine the appropriate impairment charge, if any. To calculate the implied fair value of goodwill the Company would allocate the reporting unit’s fair value to all of the assets and liabilities of the reporting unit, including any unrecognized intangible assets, in a hypothetical scenario that faithfully represents an acquisition of the reporting unit in a business combination. If the implied fair value of the reporting unit’s goodwill is less than its carrying value, the difference is recorded as an impairment charge, not to exceed the balance of goodwill.
For the fourth quarter of fiscal 2013 goodwill impairment testing, management updated the five-year financial forecasts for fiscal 2014 through fiscal 2018, which contained significant declines in the projected financial performance of the Toys-Domestic and Toys-Japan reporting units compared to the projections used in goodwill impairment tests of prior years. The decrease in financial projections was primarily due to the fiscal 2013 decline in operating results, due in large part to the holiday season. This reduction in revenues and cash flows forecasted for the Toys-Domestic and Toys-Japan reporting units warranted performing the two-step quantitative test. Upon completing the step one quantitative impairment test, it was determined that the carrying values exceeded the respective fair values of each reporting unit and the Company proceeded to step two. The step two quantitative test indicated that the goodwill at each reporting unit was fully impaired. Therefore, goodwill balances of $361 million and $17 million related to Toys-Domestic and Toys-Japan, respectively, were recorded in the Goodwill impairment line within the Consolidated Statement of Operations for the fiscal year ended February 1, 2014. The fair value estimates incorporated in step two of the quantitative assessment were primarily based on third party appraisals, the market approach and the income approach, specifically the relief from royalty method in regards to certain intangible assets. The property appraisals incorporated a significant amount of judgment on the part of the third party valuation specialists regarding appropriate comparable properties and assessments of current market conditions, and the income approach valuations incorporated significant estimates and assumptions made by management including those relating to projected long-term rates of growth, customer attrition and profitability.
For the Toys-China and Southeast Asia reporting unit, we performed a qualitative assessment and determined that it was more likely than not that the respective fair value substantially exceeded the carrying value and noted no goodwill impairment indicators.
Debt Issuance Costs
We defer debt issuance costs, which are classified as non-current Other assets, and amortize the costs into Interest expense over the term of the related debt facility. Unamortized amounts at February 1, 2014 and February 2, 2013 were $127 million and $119 million, respectively. Deferred financing fees amortized to Interest expense for fiscals 2013, 2012 and 2011 were $51 million, $36 million and $35 million, respectively, which is inclusive of accelerated amortization due to certain debt repayments and refinancings prior to maturity.
Acquisition of Debt Securities
During fiscal 2013, we acquired £13 million ($20 million at March 28, 2013) principal amount of the various classes of Debussy Notes. These debt securities are included in Other assets within the Consolidated Balance Sheet, classified as held-to-maturity debt and reported at amortized cost. There were no acquisitions of debt securities during fiscal 2012. During fiscal 2011, we acquired from unaffiliated parties $36 million face value debt securities of Vanwall for $26 million. These debt securities were repaid during fiscal 2013 in conjunction with the refinancing of the UK senior and junior credit facilities. Refer to Note 2 entitled “SHORT-TERM BORROWINGS AND LONG-TERM DEBT” for further details.
Insurance Risks
We self-insure a substantial portion of our workers’ compensation, general liability, auto liability, property, medical, prescription drug and dental insurance risks, in addition to maintaining third party insurance coverage. Provisions for losses related to self-insured risks are based upon actuarial techniques and estimates for incurred but not reported claims. We record the liability for workers’ compensation on a discounted basis. We also maintain insurance coverage above retention amounts of $15 million for employment practices liability, $8 million for catastrophic events, $5 million for property, $5 million for general liability, $4 million for auto liability and a minimum of $1 million for workers’ compensation to limit the exposure related to such risks. The assumptions underlying the ultimate costs of existing claim losses are subject to a high degree of unpredictability, which can affect the liability recorded for such claims. As of February 1, 2014 and February 2, 2013, we had
$102 million and $93 million, respectively, of reserves for self-insurance risk which have been included in Accrued expenses and other current liabilities and Other non-current liabilities in our Consolidated Balance Sheets.
Commitments and Contingencies
We are subject to various claims and contingencies related to lawsuits and commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. For additional information on our commitments and contingencies, refer to Note 15 entitled “COMMITMENTS AND CONTINGENCIES.”
Leases
We lease store locations, distribution centers, equipment and land used in our operations. Our lease store locations consist of locations which have buildings that are owned by us and land which is controlled through a ground lease with third parties (“Ground Lease Locations”) and locations that are controlled through straight leases for land and building which we lease from third parties (“Straight Lease Locations”). We account for our leases under the provisions of ASC Topic 840, “Leases” (“ASC 840”), which require that leases be evaluated and classified as operating or capital leases for financial reporting purposes. Assets held under capital lease are included in Property and equipment, net. As of February 1, 2014 and February 2, 2013, accumulated depreciation related to capital leases for property and equipment was $41 million and $55 million, respectively.
We record operating leases on a straight-line basis over the lease term, which includes renewal options only if those options are specified in the lease agreement and if failure to exercise the renewal option imposes a significant economic penalty on us. For Ground Lease Locations, we include renewal options in the lease term through the estimated useful life of the owned building located on the property as failure to renew a ground lease during the estimated useful life of the building would result in forgoing an economic benefit given our significant capital investment at the inception of the lease to construct a new building. For Straight Lease Locations, we do not include renewal options in the lease term as the failure to renew a straight lease does not typically result in a significant economic penalty for us, and therefore renewal cannot be reasonably assured at the inception of the lease. Renewal options are exercised at our sole discretion. The expected lease term is used to determine whether a lease is capital or operating and is used to calculate straight-line rent expense. Additionally, the useful life of buildings and leasehold improvements are limited by the expected lease term. Refer to Note 9 entitled “LEASES” for further details.
Substantially all of our leases include options that allow us to renew or extend the lease term beyond the initial lease period, subject to terms and conditions agreed upon at the inception of the lease. Such terms and conditions include rental rates agreed upon at the inception of the lease that could represent below or above market rental rates later in the life of the lease, depending upon market conditions at the time of such renewal or extension. In addition, many leases include early termination options, which can be exercised under specified conditions, including upon damage, destruction or condemnation of a specified percentage of the value or land area of the property.
Deferred Rent
We recognize fixed minimum rent expense on non-cancelable leases on a straight-line basis over the term of each individual lease starting at the date of possession, including the build-out period, and record the difference between the recognized rental expense and amounts payable under the leases as a deferred rent liability or asset. Deferred rent liabilities in our Consolidated Balance Sheets totaled $374 million and $368 million at February 1, 2014 and February 2, 2013, respectively, of which $12 million was included in Accrued expenses and other current liabilities for each period, respectively. Landlord incentives and abatements are recorded in Deferred rent liabilities and amortized over the term of the lease.
Financial Instruments
We enter into foreign exchange forward contracts to minimize the risk associated with currency fluctuations relating to our foreign subsidiaries. We also enter into derivative financial arrangements such as interest rate swaps and interest rate caps to hedge interest rate risk associated with our long-term debt. We account for derivative financial instruments in accordance with ASC Topic 815, “Derivatives and Hedging” (“ASC 815”) and record all derivatives as either assets or liabilities on the Consolidated Balance Sheets measured at estimated fair value and recognize the changes in fair value as unrealized gains and losses. The recognition of these gains and losses depends on our intended use of the derivatives and resulting designation. We record the changes in fair value of derivative instruments, which do not qualify and therefore are not designated for hedge accounting, in our Consolidated Statements of Operations. If we determine that we do qualify for hedge accounting treatment, the following is a summary of the impact on our Consolidated Financial Statements:
•
For designated cash flow hedges, the effective portion of the changes in the fair value of derivatives is recorded in Accumulated other comprehensive (loss) income and subsequently recorded in Interest expense in the Consolidated Statements of Operations at the time the hedged item affects earnings.
•
For designated cash flow hedges, the ineffective portion of a hedged derivative instrument’s change in fair value is immediately recognized in Interest expense in the Consolidated Statements of Operations.
•
For designated fair value hedges, the change in the fair value of the derivative as well as the offsetting change in fair value of the hedged item attributable to the hedged risk are recorded in Interest expense in the Consolidated Statements of Operations.
Refer to Note 3 entitled “DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES” for more information related to our accounting for derivative financial instruments. We did not have significant credit risk related to our financial instruments at February 1, 2014 and February 2, 2013.
Revenue Recognition
We generally recognize sales, net of customer coupons and other sales incentives, at the time the customer takes possession of merchandise, either at the point of sale in our stores or at the time the customer receives shipment of products purchased from our websites. We recognize the sale from layaway transactions when our customer satisfies all payment obligations and takes possession of the merchandise. Sales are recorded net of sales, use and value added taxes.
Other revenues of $56 million, $72 million and $79 million for fiscals 2013, 2012 and 2011, respectively, are included in Net sales. Other revenues consist of warranty income, licensing fees and non-core product related revenue.
We have license agreements with unaffiliated third party operators located outside the United States. The agreements are largely structured with royalty income paid as a percentage of sales for the use of our trademarks, trade name and branding. Licensing fees for fiscals 2013, 2012 and 2011 were $16 million, $16 million and $18 million, respectively.
Reserve for Sales Returns
We reserve amounts for sales returns for estimated product returns by our customers based on historical return experience, changes in customer demand, known returns we have not received, and other assumptions. The balances of our reserve for sales returns were $10 million and $11 million at February 1, 2014 and February 2, 2013, respectively.
Cost of Sales and Selling, General & Administrative Expenses
The following table illustrates what is reflected in each expense category:
“Cost of sales”
“SG&A”
• the cost of merchandise acquired from vendors;
• freight in;
• provision for excess and obsolete inventory;
• shipping costs to customers;
• provision for inventory shortages; and
• credits and allowances from our merchandise vendors.
• 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.
Credits and Allowances Received from Vendors
We receive credits and allowances that are related to formal agreements negotiated with our vendors. These credits and allowances are predominantly for product markdowns, cooperative advertising, promotions and volume related purchases. We generally treat credits and allowances, including cooperative advertising allowances, as a reduction of product cost in accordance with the provisions of ASC Topic 605, “Revenue Recognition” (“ASC 605”) since such funds are not a reimbursement of specific, incremental, identifiable SG&A costs incurred by us in selling the vendors’ products.
Advertising Costs
Gross advertising costs are recognized in SG&A at the point of first broadcast or distribution and were $433 million, $449 million and $483 million in fiscals 2013, 2012 and 2011, respectively.
Pre-opening Costs
The cost of start-up activities, including organization costs, related to new store openings are expensed as incurred.
Costs of Computer Software
We capitalize certain costs associated with computer software developed or obtained for internal use in accordance with the provisions of ASC 350. We capitalize those costs from the acquisition of external materials and services associated with developing or obtaining internal use computer software. We capitalize certain payroll costs for employees that are directly associated with internal use computer software projects once specific criteria of ASC 350 are met. We expense those costs that are associated with preliminary stage activities, training, maintenance, and all other post-implementation stage activities as they are incurred. We amortize all costs capitalized in connection with internal use computer software projects on a straight-line basis over a useful life of five years, beginning when the software is ready for its intended use. We amortized computer software costs of $31 million, $27 million and $22 million for fiscals 2013, 2012 and 2011, respectively.
Other Income, net
Other income, net includes the following:
(1)
Includes advertising income from our websites, fixed asset write-offs, gains and losses resulting from foreign currency translation related to operations and other miscellaneous income and expense charges.
Credit Card Program
We currently operate under a Credit Card Program agreement (the “Agreement”) with a third-party credit lender to offer co-branded and private label credit cards to our customers. Our agreement with Chase Bank expired during fiscal 2012 at which time we entered into a seven-year Agreement with a new third-party credit lender, GE Retail Bank. There were no funds owed to Chase Bank as well as no material changes to the types of incentives we receive under the Agreement. The credit lender provides financing for our customers to purchase merchandise at our stores for all cardholders and other businesses for co-branded cardholders. We received an up-front incentive payment in fiscal 2012 for entering into the Agreement with GE Retail Bank, which was deferred and is being amortized ratably over the life of the Agreement. In addition, we receive bounty fees for credit card activations and royalties on the co-branded and private label credit cards, for which rates increased under the GE Retail Bank Agreement. Bounty fees and royalties are recognized when earned and realizable. During fiscals 2013, 2012 and 2011, we recognized credit card program income of $33 million, $22 million and $13 million, respectively.
Gift Card Breakage
We sell gift cards to customers in our retail stores, through our websites and through third parties and, in certain cases, provide gift cards for returned merchandise and in connection with promotions. We recognize income from gift card sales when the customer redeems the gift card, as well as an estimated amount of unredeemed liabilities (“breakage”). Gift card breakage is recognized proportionately, utilizing management estimates and assumptions based on actual redemptions, the estimated useful life of the gift card and an estimated breakage rate of unredeemed liabilities. Our estimated gift card breakage represents the remaining unused portion of the gift card liability for which the likelihood of redemption is remote and for which we have determined that we do not have a legal obligation to remit the value to the relevant jurisdictions. Income related to customer gift card redemption is included in Net sales, whereas income related to gift card breakage is recorded in Other income, net in our Consolidated Financial Statements. We recognize breakage income and derecognize the gift card liability for unredeemed gift cards in proportion to actual redemptions of gift cards. We recognized $24 million, $21 million and $22 million of gift card breakage income in fiscals 2013, 2012 and 2011, respectively.
Net Gains on Sales of Properties
Net gains on sales of properties were $8 million, $4 million and $3 million for fiscals 2013, 2012 and 2011, respectively. Refer to Note 5 entitled “PROPERTY AND EQUIPMENT” for further information.
Impairment of Long-Lived Assets and Costs Associated with Exit Activities
We evaluate the carrying value of all long-lived assets, which include property, equipment and finite-lived intangibles, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable, in accordance with ASC Topic 360, “Property, Plant and Equipment.” Events or circumstances that might warrant an impairment review include, among other things, material declines in operational performance, significant adverse market conditions and significant changes or planned changes in our use of assets, including store relocation, store closure and property sales. If a long-lived asset is found to be non-recoverable, we record an impairment charge equal to the difference between the asset’s carrying value and fair value. This evaluation requires management to make judgments relating to future cash flows, growth rates, and economic and market conditions. These evaluations are based on determining the fair value of an asset using a valuation method such as discounted cash flow or a relative, market-based approach.
During fiscals 2013, 2012 and 2011, we recorded total impairment losses of $44 million, $11 million and $6 million, respectively. Impairment losses are recorded in Other income, net within our Consolidated Statements of Operations. These impairments were primarily due to the identification of underperforming stores and the relocation of certain stores.
For any store closing where a lease obligation still exists, we record the estimated future liability associated with the rental obligation less any estimated sublease income on the date the store is closed in accordance with ASC Topic 420, “Exit or Disposal Cost Obligations.”
Foreign Currency Translation
The functional currencies of our foreign subsidiaries are as follows:
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Australian dollar for our subsidiary in Australia;
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British pound sterling for our subsidiary in the United Kingdom;
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Brunei dollar for our subsidiary in Brunei;
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Canadian dollar for our subsidiary in Canada;
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Chinese yuan for our subsidiary in China;
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Euro for our subsidiaries in Austria, France, Germany, Spain and Portugal;
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Hong Kong dollar for our subsidiaries in Hong Kong;
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Japanese yen for our subsidiary in Japan;
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Malaysian ringgit for our subsidiary in Malaysia;
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Polish zloty for our subsidiary in Poland;
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Singapore dollar for our subsidiary in Singapore;
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Swiss franc for our subsidiary in Switzerland;
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Taiwan dollar for our subsidiary in Taiwan; and
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Thailand baht for our subsidiary in Thailand.
Assets and liabilities are translated into USD using the current exchange rates in effect at the balance sheet date, while revenues and expenses are translated using the average exchange rates during the applicable reporting period. The resulting translation adjustments are recorded in Accumulated other comprehensive (loss) income within the Consolidated Statements of Stockholders’ (Deficit) Equity.
Gains and losses resulting from foreign currency transactions related to operations are included in Other income, net. Foreign currency transactions related to short-term, cross-currency intercompany loans amounted to gains of $1 million, $2 million and $11 million for fiscals 2013, 2012 and 2011, respectively. Such amounts were included in Interest expense.
We economically hedge the majority of these short-term, cross-currency intercompany loans with foreign currency forward contracts. These derivative contracts were not designated as hedges and are recorded on our Consolidated Balance Sheets at fair value with a gain or loss recorded on the Consolidated Statements of Operations in Interest expense. For fiscals 2013, 2012 and 2011, we recorded losses of $1 million, $2 million and $4 million, respectively. Refer to Note 3 entitled “DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES” for further details.
Income Taxes
We account for income taxes in accordance with ASC Topic 740, “Income Taxes” (“ASC 740”). Our provision for income taxes and effective tax rates are calculated by legal entity and jurisdiction and are based on a number of factors, including our level of pre-tax earnings, income tax planning strategies, differences between tax laws and accounting rules, statutory tax rates and credits, uncertain tax positions and valuation allowances. We use significant judgment and estimates in evaluating our tax positions. Our effective tax rate in a given financial statement period may be materially impacted by changes in the mix and level of earnings by taxing jurisdiction.
Under ASC 740, deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the Consolidated Financial Statements. Valuation allowances are established when, in management’s judgment, it is more likely than not that our deferred tax assets will not be realized. In assessing the need for a valuation allowance, management weighs the available positive and negative evidence, including limitations on the use of tax loss and other carryforwards due to changes in ownership, historic information, projections of future sources of taxable income, including future reversals of taxable temporary differences and future taxable income exclusive of reversing temporary differences and carryforwards and tax planning strategies.
At any one time, our tax returns for numerous tax years are subject to examination by U.S. Federal, state and foreign taxing jurisdictions. ASC 740 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold and measurement attributes for income tax positions taken or expected to be taken on a tax return. Under ASC 740, the impact of an uncertain tax position taken or expected to be taken on an income tax return must be recognized in the financial statements at the largest amount that is more-likely-than-not to be sustained. An uncertain income tax position will not be recognized in the financial statements unless it is more-likely-than-not to be sustained. We adjust these tax liabilities, as well as the related interest and penalties, based on the latest facts and circumstances, including recently enacted tax law changes, published rulings, court cases and outcomes of tax audits. While we do not expect material changes, it is possible that our actual tax liability will differ from our established tax liabilities for unrecognized tax benefits, and our effective tax rate may be materially impacted. While it is often difficult to predict the final outcome of, the timing of or the tax treatment of any particular tax position or deduction, we believe that our tax balances reflect the more-likely-than-not outcome of known tax contingencies. We report tax-related interest and penalties as a component of Income tax expense (benefit).
At February 1, 2014 and February 2, 2013, we reported unrecognized tax benefits in Accrued expenses and other current liabilities and Other non-current liabilities in our Consolidated Balance Sheets. These tax liabilities do not include a portion of our unrecognized tax benefits, which have been recorded as either a reduction of Deferred tax assets related to tax loss carryforwards or a reduction of taxes receivable. For further information, refer to Note 10 entitled “INCOME TAXES.”
Temporary Equity
On October 31, 2011, the Company recognized Noncontrolling interest in the amount of $24 million which was measured at fair value at the acquisition date. Refer to Note 17 entitled “ACQUISITIONS” for further details. In accordance with the terms of the agreement, the Noncontrolling interest is redeemable for cash or common stock of the Company at the option of the holder. As such, the Noncontrolling interest has been recorded in Temporary Equity in our Consolidated Balance Sheets at its redemption value.
In addition, as a result of modifications made to our stock-based compensation plans during fiscal 2013, certain equity awards are redeemable for cash at the option of the holder and redemption is probable. In accordance with ASC Topic 718, “Compensation - Stock Compensation” (“ASC 718”) and ASC Topic 480, “Distinguishing Liabilities from Equity” (“ASC 480”), the shares have been recorded in Temporary Equity in our Consolidated Balance Sheet at their redemption value. Refer to Note 7 entitled “STOCK-BASED COMPENSATION” for further details.
The reconciliation of the changes in Temporary Equity is as follows:
Stock-Based Compensation
Under the provisions of ASC 718, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period. We have applied ASC 718 to new awards and to awards modified, repurchased or canceled since January 29, 2006. For further information, refer to Note 7 entitled “STOCK-BASED COMPENSATION.”
NOTE 2 - SHORT-TERM BORROWINGS AND LONG-TERM DEBT
A summary of the Company’s consolidated Short-term borrowings and Long-term debt as well as the effective interest rates on our outstanding variable rate debt as of February 1, 2014 and February 2, 2013, respectively, is outlined in the table below:
(1)
On February 27, 2013, Toys “R” Us France Real Estate SAS (“TRU France Real Estate”) entered into a five year senior secured term loan facility agreement (the “France Propco Facility Agreement”) for an aggregate principal amount of €48 million. The net proceeds of the loan under the France Propco Facility Agreement, together with cash on hand, were used to repay the principal balance of the €61 million French real estate credit facility due fiscal 2013.
(2)
On March 25, 2013, UK Propco entered into the New UK Propco Facility Agreement, which was funded on March 28, 2013, for an aggregate principal amount of £263 million. The net proceeds of the loan under the New UK Propco Facility Agreement, together with cash on hand, were used to repay the principal balance of the UK real estate senior and junior credit facilities due fiscal 2013.
(3)
Toys “R” Us-Japan, Ltd. (“Toys-Japan”) currently has an agreement with a syndicate of financial institutions, which includes two unsecured loan commitment lines of credit (“Tranche 1” and “Tranche 2”). On June 25, 2013, Toys-Japan entered into an agreement to refinance Tranche 1 of its committed lines of credit.
(4)
Represents obligations of Toys “R” Us - Delaware, Inc. (“Toys-Delaware”).
(5)
Represents obligations of Toys “R” Us Property Company I, LLC and its subsidiaries (“TRU Propco I”). On August 21, 2013, TRU Propco I entered into a senior unsecured term loan facility for an aggregate principal amount of $985 million due fiscal 2019 (the “Propco I Term Loan Facility”). The proceeds, together with other funds available to TRU Propco I, were used to redeem in full TRU Propco I’s $950 million senior unsecured 10.750% notes due fiscal 2017, plus accrued interest, premiums and fees.
(6)
Represents obligations of Toys “R” Us, Inc. (the “Parent Company”) legal entity. For further details on Parent Company information, refer to Schedule I - Parent Company Condensed Financial Statements and Notes to the Condensed Financial Statements.
(7)
Represents obligations of Toys “R” Us Property Company II, LLC (“TRU Propco II”).
(8)
On February 28, 2013, Toys-Japan entered into an additional bank loan with a financial institution for ¥2.0 billion.
(9)
Represents obligations of the Parent Company and Toys-Delaware.
(10)
We maintain derivative instruments on certain of our long-term debt, which impact our effective interest rates. Refer to Note 3 entitled “DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES” for further details.
As of February 1, 2014, we had total indebtedness of $5.0 billion, of which $2.9 billion was secured indebtedness. Toys “R” Us, Inc. is a holding company and conducts its operations through its subsidiaries, certain of which have incurred their own indebtedness. Our credit facilities, loan agreements and indentures contain customary covenants, including, among other things, covenants that restrict our ability to:
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incur certain additional indebtedness;
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transfer money between the Parent Company and our various subsidiaries;
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pay dividends on, repurchase or make distributions with respect to our or our subsidiaries’ capital stock or make other restricted payments;
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issue stock of subsidiaries;
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make certain investments, loans or advances;
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transfer and sell certain assets;
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create or permit liens on assets;
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consolidate, merge, sell or otherwise dispose of all or substantially all of our assets;
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enter into certain transactions with our affiliates; and
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amend certain documents.
The amount of total net assets that were subject to such restrictions was $700 million as of February 1, 2014. Our agreements also contain various and customary events of default with respect to the indebtedness, including, without limitation, the failure to pay interest or principal when the same is due under the agreements, cross default and cross acceleration provisions, the failure of representations and warranties contained in the agreements to be true and certain insolvency events. If an event of default occurs and is continuing, the principal amounts outstanding thereunder, together with all accrued and unpaid interest and other amounts owed thereunder, may be declared immediately due and payable by the lenders.
We are dependent on the borrowings provided by the lenders to support our working capital needs, capital expenditures and to service debt. As of February 1, 2014, we have funds available to finance our operations under our European and Australian asset-based revolving credit facility (“European ABL Facility”) through March 2016, our Secured revolving credit facility (“ABL Facility”) through August 2015 and our Toys-Japan unsecured credit lines with a tranche maturing June 2014 and a tranche maturing June 2015. In addition, Labuan and Toys-Japan have uncommitted lines of credit due on demand.
The total fair values of our Long-term debt, with carrying values of $5.0 billion and $5.3 billion at February 1, 2014 and February 2, 2013, were $4.6 billion and $5.4 billion, respectively. The fair values of our Long-term debt are estimated using the quoted market prices for the same or similar issues and other pertinent information available to management as of the end of the respective periods. A portion of these instruments are classified as Level 3, as these are not publicly traded and therefore we are unable to obtain quoted market prices. The fair value of these Level 3 debt instruments totaled $0.8 billion and $1.1 billion at February 1, 2014 and February 2, 2013.
The annual maturities of our Short-term borrowings and Long-term debt, including current portions, at February 1, 2014 are as follows:
Labuan uncommitted lines of credit, due on demand ($12 million at February 1, 2014)
Labuan has several uncommitted unsecured lines of credit with various financial institutions with total availability of HK$302 million ($39 million at February 1, 2014). As of February 1, 2014, we had $12 million of borrowings, which has been included in Accrued expenses and other liabilities on our Consolidated Balance Sheet, and $3 million of bank guarantees issued under these facilities. The remaining availability under these facilities was $24 million. The average interest rate on the drawn borrowings was 2.36% and 2.06% as of February 1, 2014 and February 2, 2013, respectively.
Toys-Japan unsecured credit lines, expire fiscals 2014-2015 ($5 million at February 1, 2014)
Toys-Japan currently has an agreement with a syndicate of financial institutions, which includes the Tranche 1 and Tranche 2 unsecured loan commitment lines of credit. On June 25, 2013, Toys-Japan entered into an agreement with a syndicate of financial institutions to refinance Tranche 1. As a result, Tranche 1 is available in amounts up to ¥13.0 billion ($127 million at February 1, 2014), expiring on June 30, 2015, and bears an interest rate of Tokyo Interbank Offered Rate (“TIBOR”) plus 0.80% per annum. We paid fees of $2 million to refinance Tranche 1, which are capitalized as deferred debt issuance costs and amortized over the term of the agreement. As of February 1, 2014, deferred debt issuance costs for this agreement were $1 million and have been included in Other assets on our Consolidated Balance Sheet. At February 1, 2014, we had outstanding borrowings of $5 million under Tranche 1, with $122 million of remaining borrowing availability.
Tranche 2 is available in amounts of up to ¥12.0 billion ($118 million at February 1, 2014), expiring on June 27, 2014, and bears an interest rate of TIBOR plus 0.80% per annum. Deferred debt issuance costs for this agreement were nominal and $1 million at February 1, 2014 and February 2, 2013, respectively, and have been included in Other assets on our Consolidated Balance Sheets. At February 1, 2014, we had no outstanding borrowings under Tranche 2, with $118 million of remaining availability.
These agreements contain covenants that require, among other things, Toys-Japan to maintain a certain level of net assets and profitability during the agreement terms, including provisions that require Toys-Japan to not incur two consecutive years of ordinary loss in accordance with accounting principles generally accepted in Japan (“JGAAP”), as defined in the credit agreement. The agreement also restricts Toys-Japan from paying dividends or making loans to affiliates without lender consent.
Additionally, Toys-Japan has an uncommitted line of credit with total availability of ¥2.8 billion ($28 million at February 1, 2014), which will renew April 1 of each year unless otherwise canceled. The uncommitted line of credit bears an interest rate of TIBOR plus 0.50%. As of February 1, 2014, we had no outstanding borrowings under the uncommitted line of credit.
$1.85 billion ABL Facility, expires fiscal 2015 ($0 million at February 1, 2014)
The ABL Facility provides for $1.85 billion of revolving commitments maturing on August 10, 2015, which could increase by $650 million, subject to certain conditions. The ABL Facility bears a tiered floating interest rate of London Interbank Offered Rate (“LIBOR”) plus a margin of between 2.50% and 3.00% depending on usage, or, at the option of Toys-Delaware, an interest rate equal to a prime rate plus a margin of between 1.50% and 2.00% depending on usage. In addition, the ABL Facility requires the Company to pay, on a quarterly basis, a tiered unused commitment fee ranging from 0.375% to 0.625% of the average daily balance of unused commitments.
At February 1, 2014, under our ABL facility, we had no outstanding borrowings, a total of $103 million of outstanding letters of credit and excess availability of $969 million. This amount is also subject to the minimum excess availability covenant, which was $125 million at February 1, 2014, with remaining availability of $844 million in excess of the covenant. Deferred debt
issuance costs for this credit facility were $19 million and $32 million at February 1, 2014 and February 2, 2013, respectively, and have been included in Other assets on our Consolidated Balance Sheets.
Subsequent Event
On March 21, 2014, Toys-Delaware and certain of its subsidiaries amended and restated the credit agreement for its ABL Facility in order to extend the maturity date of the facility and amend certain other provisions. The ABL Facility as amended will continue to provide for $1.85 billion of revolving commitments, and permits Toys-Delaware to request an increase in commitments by up to $1.15 billion, subject to certain conditions, including obtaining new or increased commitments from new or existing lenders. The ABL Facility has a final maturity date of March 21, 2019, with a springing maturity date if the Toys-Delaware term loans due fiscal 2016 and fiscal 2018 and the Toys-Delaware secured notes due fiscal 2016 are not repaid 30 days prior to maturity. The ABL Facility as amended bears a tiered floating interest rate of LIBOR plus a margin of between 1.50% and 1.75% depending on usage (or, at the election of the borrower, a tiered floating interest rate based on the agent’s prime rate plus a margin of between 0.50% and 0.75% depending on usage). A commitment fee is payable on the undrawn portion of the ABL Facility in an amount equal to 0.25% per annum of the average daily balance of unused commitments during each calendar quarter.
The ABL facility will continue to be available for general corporate purposes and the issuance of letters of credit. Borrowings under this credit facility are secured by tangible and intangible assets of Toys-Delaware and certain of its subsidiaries, subject to specific exclusions stated in the credit agreement. The credit agreement contains covenants that, among other things, restrict Toys-Delaware’s ability to incur certain additional indebtedness, create or permit liens on assets, engage in mergers or consolidations, make investments, loans or advances, sell or transfer assets, pay dividends or distributions, repurchase capital stock or make other restricted payments, repay or prepay certain debt, engage in transactions with affiliates, amend material documents and change fiscal year. The ABL Facility, as amended pursuant to the amended and restated credit agreement, requires Toys-Delaware to maintain excess availability at all times of no less than $125 million and to sweep cash toward prepayment of the loans if excess availability falls below $150 million for any three days in a 30-day period (or if certain specified defaults are continuing or if excess availability falls below $130 million at any time). Availability is determined pursuant to a borrowing base, consisting of specified percentages of eligible inventory and eligible credit card receivables and certain real estate less any applicable availability reserves.
European ABL Facility, expires fiscal 2016 ($0 million at February 1, 2014)
On March 8, 2011, certain of our foreign subsidiaries amended and restated the credit agreement for the European ABL Facility 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 ($227 million at February 1, 2014). Loans under the European ABL Facility bear interest at a rate of LIBOR or the Euro Interbank Offered Rate (“EURIBOR”) plus a margin of 2.25%, 2.50% or 2.75% depending on historical excess availability. In addition, a commitment fee accrues on any unused portion of the commitments at a rate per annum of 0.375% or 0.50% based on usage. Deferred debt issuance costs for this credit facility were $4 million and $7 million at February 1, 2014 and February 2, 2013, respectively, and have been included in Other assets on our Consolidated Balance Sheets.
Borrowings under the European ABL Facility are subject, among other things, to the terms of a borrowing base derived from the value of eligible inventory and/or eligible credit card receivables of certain of Toys “R” Us Europe, LLC’s (“Toys Europe”) and Toys “R” Us Australia Holdings, LLC’s (“Toys Australia”) subsidiaries organized in Australia, England and France. The terms of the European ABL Facility include a customary cash dominion trigger requiring the cash of certain of Toys Europe’s and Toys Australia’s subsidiaries to be applied to pay down outstanding loans if availability falls below certain thresholds. The European ABL Facility also contains a springing fixed charge coverage ratio of 1.00 to 1.00 based on earnings before interest, taxes, depreciation and amortization (“EBITDA”) (as defined in the agreement governing the European ABL Facility) and fixed charges of Toys Europe, Toys Australia and their subsidiaries. Borrowings under the European ABL Facility are guaranteed by Toys Europe, Toys Australia and certain of their material subsidiaries, with certain customary local law limitations and to the extent such guarantees do not result in adverse tax consequences. Borrowings are secured by substantially all of the assets of Toys Europe, Toys Australia and the UK and Australian obligors, as well as by share pledges over the shares of certain other material subsidiaries and pledges over certain of their assets (including bank accounts and certain receivables). The European ABL Facility contains covenants that, among other things, restrict the ability of Toys Europe and Toys Australia and their respective subsidiaries to incur certain additional indebtedness, create or permit liens on assets, repurchase or pay dividends or make certain other restricted payments on capital stock, make acquisitions or investments or engage in mergers or consolidations. At February 1, 2014, we had no outstanding borrowings and $107 million of availability under the European ABL Facility.
€53 million Spanish real estate credit facility, due fiscal 2015 ($71 million at February 1, 2014)
On January 29, 2013, Toys “R” Us Iberia Real Estate S.L.U. (“TRU Iberia Real Estate”) entered into a three year senior secured term loan facility agreement (the “Spain Propco Facility Agreement”) for an aggregate principal amount of €75 million. The net proceeds of the loan under the Spain Propco Facility Agreement, together with cash on hand were used to provide funds to repay the principal amount under the €126 million Spanish real estate credit facility due fiscal 2012. TRU Iberia Real Estate owns freehold and leasehold interests in properties in various retail markets throughout Spain. Under an operating company/property company structure, TRU Iberia Real Estate leases these properties on a triple-net basis to Toys “R” Us Iberia, SA (“Spain Opco”). Substantially all of TRU Iberia Real Estate’s revenues and cash flows are derived from payments from Spain Opco under a series of uniform lease agreements. The loan is secured by 26 properties located in Spain. The Spain Propco Facility Agreement will mature on January 29, 2016 and bears interest equal to the EURIBOR plus 6.00%. We have entered into an interest rate cap as required under the Spain Propco Facility Agreement capping EURIBOR at 2.00% per annum. TRU Iberia Real Estate is required to repay the principal of the loan in installments equal to €22.5 million, €22.5 million and €30 million in the first, second and third years of the loan, respectively. As such, we have repaid the first installment of €22.5 million during fiscal 2013, and the second installment of €22.5 million ($30 million at February 1, 2014) has been classified as Current portion of long-term debt on our Consolidated Balance Sheet. Deferred debt issuance costs for this credit facility were $5 million and $7 million at February 1, 2014 and February 2, 2013, respectively, and have been included in Other assets on our Consolidated Balance Sheets.
Our Parent Company has provided the lenders with a deficiency guarantee with respect to certain losses the lenders may suffer in certain circumstances. The Spain Propco Facility Agreement contains covenants that, among other things, restrict the ability of TRU Iberia Real Estate to incur additional indebtedness, pay dividends or make other distributions, make restricted payments or certain investments, create or permit liens on assets, sell assets or engage in mergers or consolidations. The agreement also contains financial covenants including a loan to value covenant, an interest coverage ratio covenant and an EBITDA to rent covenant related to Spain Opco.
7.375% senior secured notes, due fiscal 2016 ($357 million at February 1, 2014)
On August 24, 2010, Toys-Delaware completed the offering of the 7.375% Senior Secured Notes, which will mature on September 1, 2016 (the “Toys-Delaware Secured Notes”). These notes were issued at par. In conjunction with the offering, we entered into a receive-fixed, pay variable interest rate swap on December 7, 2010. The swap has been designated as a fair value hedge. Investment funds or accounts advised by KKR owned an aggregate of $9 million and $5 million of the Toys-Delaware Secured Notes as of February 1, 2014 and February 2, 2013, respectively. Deferred debt issuance costs for the Toys-Delaware Secured Notes were $5 million and $6 million at February 1, 2014 and February 2, 2013, respectively, and have been included in Other assets on our Consolidated Balance Sheets.
The indenture governing the Toys-Delaware Secured Notes contains covenants, including, among other things, covenants that restrict the ability of Toys-Delaware to incur additional indebtedness, sell assets, enter into affiliate transactions, pay dividends or make other distributions, make investments and other restricted payments or create liens. These covenants are subject to a number of important qualifications and limitations. Certain covenants will be suspended at any time the Toys-Delaware Secured Notes are rated “investment grade.” As of February 1, 2014, the Toys-Delaware Secured Notes are not “investment grade.” In addition, the indenture contains other customary terms and covenants, including certain events of default after which the Toys-Delaware Secured Notes may be declared or become due and payable immediately. The Toys-Delaware Secured Notes are redeemable, in whole or in part, at specified redemption prices, plus accrued and unpaid interest, if any. Following specified kinds of changes of control with respect to us or Toys-Delaware, Toys-Delaware will be required to offer to purchase the Toys-Delaware Secured Notes at a purchase price in cash equal to 101% of their principal amount, plus accrued and unpaid interest, if any, to the date of purchase. Interest on the Toys-Delaware Secured Notes is payable in cash semi-annually in arrears through maturity on March 1 and September 1 of each year. The Toys-Delaware Secured Notes have not been and will not be registered under the Securities Act of 1933, as amended (the “Securities Act”) and may not be offered or sold except pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act.
Further, the Toys-Delaware Secured Notes are guaranteed by certain of Toys-Delaware subsidiaries and the borrowings thereunder are secured by the trademarks and certain other intellectual property of Geoffrey, LLC, our wholly owned subsidiary, and the assets securing the ABL Facility including inventory, accounts receivable, equipment and certain other personal property owned or acquired by Toys-Delaware and certain of its subsidiaries. The Toys-Delaware Secured Notes are secured on a pari passu basis with the obligations under the Secured Term Loan Facility and the Incremental Secured Term Loan as described below.
Secured term loan facility, due fiscal 2016 ($646 million at February 1, 2014)
Concurrent with the offering of the Toys-Delaware Secured Notes, Toys-Delaware amended and restated the secured term loan originally due fiscal 2012 to extend the maturity date of this loan facility and amend certain other provisions. The amended secured term loan facility is in an aggregate principal amount of $700 million (the “Secured Term Loan Facility”) and was issued at a discount of $11 million which resulted in proceeds of $689 million. Investment funds or accounts advised by KKR owned an aggregate of $70 million and $67 million of the Secured Term Loan Facility as of February 1, 2014 and February 2, 2013, respectively. The Secured Term Loan Facility will mature on September 1, 2016 and bears interest equal to LIBOR (with a floor of 1.50%) plus 4.50%, which is subject to a step down of 0.25% based on total leverage. In addition, pursuant to the terms of the agreement, Toys-Delaware is required to make quarterly principal payments equal to 0.25% ($7 million per year) of the original principal amount of the loan. As such, this amount has been classified as Current portion of long-term debt on our Consolidated Balance Sheet as of February 1, 2014. Deferred debt issuance costs for the Secured Term Loan Facility were $7 million and $10 million at February 1, 2014 and February 2, 2013, respectively, and have been included in Other assets on our Consolidated Balance Sheets.
The Secured Term Loan Facility as amended, provides for, among other things, an accordion feature that allows Toys-Delaware to request one or more additional term loans be added to the Secured Term Loan Facility in an aggregate principal amount of up to $700 million, to be reduced on a dollar-for-dollar basis by the aggregate principal amount of one or more additional series of senior secured notes that may be issued after the date of the initial issuance of the Toys-Delaware Secured Notes. We exercised a portion of the accordion feature on May 25, 2011 by adding a new tranche of term loans in an aggregate principal amount of $400 million due fiscal 2018. Refer to “Incremental Secured Term Loan” section below. Additionally, on April 10, 2012, we exercised an additional portion of the accordion feature by adding a new tranche of term loans in an aggregate principal amount of $225 million due fiscal 2018. Refer to the “Second Incremental Secured Term Loan” section below.
The Secured Term Loan Facility contains customary covenants applicable to Toys-Delaware and certain of its subsidiaries, including, among other things, covenants that restrict the ability of Toys-Delaware and certain of its subsidiaries to incur certain additional indebtedness, create or permit liens on assets, or engage in mergers or consolidations, pay dividends, repurchase capital stock, make other restricted payments, make loans or advances, engage in transactions with affiliates, or amend material documents. These covenants are subject to certain exceptions, including among other things to allow for the debt represented by the Toys-Delaware Secured Notes, certain other additional debt incurrences including unsecured, later-maturing debt subject to a fixed charge coverage test and the provision of a cumulative credit exception allowing for Toys-Delaware and certain of its subsidiaries to make investments, pay dividends and make certain other restricted payments subject to Toys-Delaware meeting a fixed charge coverage test. If an event of default under the Secured Term Loan Facility occurs and is continuing, the principal amount outstanding, together with all accrued and unpaid interest and other amounts owed may be declared by the lenders or become immediately due and payable. Toys-Delaware may optionally prepay the outstanding principal balance of the loan at any time.
The Secured Term Loan Facility contains a provision that requires us to repay a specified percentage of excess cash flow generated in the previous fiscal year, as defined in the agreement, starting with the fiscal year ended January 28, 2012. On May 31, 2013, we made a $50 million partial prepayment of the Secured Term Loan Facility, including the Incremental and Second Incremental Secured Term Loans on a pro rata basis. At this time, we do not believe this provision will require a payment for the fiscal year ended February 1, 2014.
Further, the Secured Term Loan Facility is guaranteed by certain of Toys-Delaware subsidiaries and the borrowings thereunder are secured by the trademarks and certain other intellectual property of Geoffrey, LLC, Toys-Delaware’s wholly owned subsidiary, and the assets securing the ABL Facility including inventory, accounts receivable, equipment and certain other personal property owned or acquired by Toys-Delaware and certain of its subsidiaries. The Secured Term Loan Facility is secured on a pari passu basis with the obligations under the Toys-Delaware Secured Notes and the Incremental Secured Term Loan.
10.375% senior notes, due fiscal 2017 ($447 million at February 1, 2014)
On August 1, 2012, we completed the offering of $450 million aggregate principal amount of 10.375% senior notes, which will mature on August 15, 2017 (the “2017 Notes”). The 2017 Notes were issued at a discount of $4 million, which resulted in proceeds of $446 million. Investment funds or accounts advised by KKR owned an aggregate of $9 million and $14 million of the 2017 Notes as of February 1, 2014 and February 2, 2013, respectively. The net proceeds were used to redeem the $400 million outstanding principal amount of our 7.875% senior notes due fiscal 2013 (the “2013 Notes”), including premiums, and for general corporate purposes. As a result of the repayment of the 2013 Notes, we expensed less than $1 million of deferred debt issuance costs. The 2017 Notes are solely the obligation of the Parent Company and are not guaranteed by Toys-Delaware or any of our other subsidiaries. Deferred debt issuance costs for these notes were $10 million and $12 million at February 1, 2014 and February 2, 2013, respectively, and have been included in Other assets on our Consolidated Balance Sheets.
The indenture governing the 2017 Notes contain covenants, including, among other things, covenants that restrict the ability of the Company and its restricted subsidiaries to incur additional indebtedness, pay dividends or make other distributions, make investments and other restricted payments, create liens, sell assets, incur restrictions on the ability of a subsidiary to pay dividends or make other payments, enter into certain transactions with affiliates and consolidate, merge, sell or otherwise dispose of all or substantially all of their assets. These covenants are subject to a number of important qualifications and exceptions and will not be applicable to any of our subsidiaries that are designated as “unrestricted subsidiaries.” As of February 1, 2014, TRU Asia, LLC, our majority owned subsidiary operating in Asia (other than Japan), is an unrestricted subsidiary.
Certain covenants will be suspended at any time the 2017 Notes are rated “investment grade.” As of February 1, 2014, the 2017 Notes are not “investment grade.” In addition, the indenture contains customary terms and covenants, including certain events of default after which the 2017 Notes may be due and payable immediately.
The 2017 Notes may be redeemed, in whole or in part, at any time prior to February 15, 2015 at a price equal to 100% of the aggregate principal amount of the 2017 Notes plus a “make-whole” premium, plus accrued and unpaid interest to the date of redemption. The 2017 Notes will be redeemable, in whole or in part, at any time on or after February 15, 2015 at the specified redemption prices, plus accrued and unpaid interest, if any, to the redemption date. In addition, we may redeem up to 40% of the 2017 Notes before February 15, 2015 with the net cash proceeds from certain equity offerings. Following specified kinds of changes of control, we will be required to make an offer to repurchase all of the 2017 Notes at a purchase price of 101% of their principal amount, plus accrued and unpaid interest, if any, to the repurchase date. Interest on the 2017 Notes is payable in cash semi-annually in arrears on February 15 and August 15 of each year, commencing on February 15, 2013.
On October 11, 2012, pursuant to a registration rights agreement that we entered into in connection with the offering of the 2017 Notes, we commenced a registered exchange offer for the 2017 Notes pursuant to a registration statement under the Securities Act. The exchange offer was completed on November 9, 2012 with 100% of the 2017 Notes exchanged for registered 2017 Notes.
8.500% senior secured notes, due fiscal 2017 ($719 million at February 1, 2014)
On November 20, 2009, TRU Propco II, formerly known as Giraffe Properties, LLC, an indirect wholly-owned subsidiary, completed the offering of $725 million aggregate principal amount of senior secured 8.500% notes, which will mature on December 1, 2017 (the “Propco II Notes”). TRU Propco II owns fee and ground leasehold interests in properties in various retail markets throughout the United States. Under an operating company/property company structure, TRU Propco II leases these properties on a triple-net basis to Toys-Delaware. Substantially all of TRU Propco II’s revenues and cash flows are derived from payments from Toys-Delaware under the master lease agreement between TRU Propco II as landlord and Toys-Delaware as tenant (the “TRU Propco II Master Lease”). The rent under the TRU Propco II Master Lease will increase by 10% every five years during its 20-year term. The Propco II Notes were issued at a discount of $10 million which resulted in proceeds of $715 million. Investment funds or accounts advised by KKR owned an aggregate of $5 million of the Propco II Notes as of February 1, 2014 and February 2, 2013, respectively. The Propco II Notes are solely the obligation of TRU Propco II and are not guaranteed by the Parent Company or Toys-Delaware or any of our other subsidiaries. The Propco II Notes are secured by the first priority security interests in all of the existing and future real estate properties of TRU Propco II and its interest in the TRU Propco II Master Lease. Those real estate properties and interests in the TRU Propco II Master Lease are not available to satisfy or secure the obligations of the Company or its affiliates, other than the obligations of TRU Propco II under the Propco II Notes. Deferred debt issuance costs for these notes were $14 million and $17 million at February 1, 2014 and February 2, 2013, respectively, and have been included in Other assets on our Consolidated Balance Sheets.
The indenture governing the Propco II Notes contains covenants, including, among other things, covenants that restrict the ability of TRU Propco II to incur additional indebtedness, sell assets, enter into affiliate transactions, pay dividends or make other distributions, make other restricted payments and investments, or create liens. The indenture governing the Propco II Notes also contains covenants that limit the ability of the Parent Company to cause or permit Toys-Delaware to incur indebtedness, pay dividends, make distributions or make other restricted payments and investments. These covenants are subject to a number of important qualifications and limitations. The Propco II Notes are redeemable, in whole or in part, at specified redemption prices, plus accrued and unpaid interest, if any. Following specified kinds of changes of control with respect to the Parent Company, Toys-Delaware or TRU Propco II, TRU Propco II will be required to offer to purchase the Propco II Notes at a purchase price in cash equal to 101% of their principal amount, plus accrued and unpaid interest, if any to, but not including, the purchase date. Interest on the Propco II Notes is payable in cash semi-annually in arrears through maturity on June 1 and December 1 of each year.
€47 million French real estate credit facility, due fiscal 2018 ($64 million at February 1, 2014)
On February 27, 2013, TRU France Real Estate entered into the France Propco Facility Agreement for an aggregate principal amount of €48 million. The net proceeds of the loan under the France Propco Facility Agreement, together with cash on hand, were used to repay the principal balance of the €61 million French real estate credit facility due fiscal 2013. TRU France Real Estate owns freehold and leasehold interests in properties in various retail markets throughout France. Under an operating company/property company structure, TRU France Real Estate leases these properties on a triple-net basis to Toys “R” Us SARL (“France Opco”). Substantially all of TRU France Real Estate’s revenues and cash flows are derived from payments from France Opco under a series of amended lease agreements. The loan is secured by nine properties located in France. The France Propco Facility Agreement will mature on February 27, 2018 and bears interest equal to EURIBOR plus 4.50%. We have entered into an interest rate cap as required under the France Propco Facility Agreement capping EURIBOR at 2.50% per annum. Additionally, TRU France Real Estate is required to make principal payments equal to 1.25% per year of the original loan amount. As such, $1 million has been classified as Current portion of long-term debt on our Consolidated Balance Sheet as of February 1, 2014.
In conjunction with the France Propco Facility Agreement, we incurred transaction fees of $4 million, which have been capitalized as deferred debt issuance costs and will be amortized over the term of the agreement. At February 1, 2014, deferred debt issuance costs for this facility were $4 million and have been included in Other assets on our Consolidated Balance Sheets.
The France Propco Facility Agreement contains covenants that, among other things, restrict the ability of TRU France Real Estate to incur additional indebtedness, pay dividends or make other distributions, make restricted payments or certain investments, create or permit liens on assets, sell assets or engage in mergers or consolidations. The agreement also contains financial covenants including a loan to value covenant and an interest coverage ratio covenant relating to France Propco.
Incremental secured term loan, due fiscal 2018 ($372 million at February 1, 2014)
On May 25, 2011, Toys-Delaware and certain of its subsidiaries entered into a Joinder Agreement (the “Joinder Agreement”) to the Secured Term Loan Facility. The Joinder Agreement added a new tranche of term loans in an aggregate principal amount of $400 million due fiscal 2018 (“Incremental Secured Term Loan”).
The Incremental Secured Term Loan was issued at a discount of $4 million which resulted in proceeds of $396 million. Investment funds or accounts advised by KKR owned an aggregate of $50 million and $63 million of the Incremental Secured Term Loan as of February 1, 2014 and February 2, 2013, respectively. On June 24, 2011, the net proceeds from the Incremental Secured Term Loan along with borrowings from our ABL Facility were used to provide funds to redeem the outstanding principal amount of the 7.625% notes due fiscal 2011 for a total redemption price, including interest and premiums, of $519 million. The Incremental Secured Term Loan will mature on May 25, 2018, and bears interest at LIBOR (with a floor of 1.50%) plus 3.75%, which is subject to a step down of 0.25% based on total leverage. Deferred debt issuance costs for these loans were $4 million and $5 million at February 1, 2014 and February 2, 2013, respectively, and have been included in Other assets on our Consolidated Balances Sheets.
The Incremental Secured Term Loan is governed by the Secured Term Loan Facility and has the same collateral, covenants and restrictions as the Secured Term Loan Facility. Pursuant to the terms of the Joinder Agreement, Toys-Delaware is required to make quarterly principal payments equal to 0.25% ($4 million per year) of the original principal amount of the loan. As such, this amount has been classified as Current portion of long-term debt on our Consolidated Balance Sheet as of February 1, 2014. Toys-Delaware may optionally prepay the outstanding principal balance of the Incremental Secured Term Loan at any time.
Second incremental secured term loan, due fiscal 2018 ($210 million at February 1, 2014)
On April 10, 2012, Toys-Delaware and certain of its subsidiaries entered into a Second Joinder Agreement (the
“Second Joinder Agreement”) to the Secured Term Loan Facility. The Second Joinder Agreement added the Second Incremental Secured Term Loan, increasing the total size of the Secured Term Loan Facility to an aggregate principal amount of $1.3 billion.
The Second Incremental Secured Term Loan was borrowed at a discount of $5 million, which resulted in proceeds of $220 million. Investment funds or accounts advised by KKR owned an aggregate of $9 million and $8 million of the Second Incremental Secured Term Loan as of February 1, 2014 and February 2, 2013, respectively. The net proceeds were used by Toys-Delaware for general corporate purposes, including, without limitation, to make restricted payments or other distributions or advances to provide funds to us to repay, refinance, repurchase, redeem, defease or otherwise satisfy any indebtedness of the Company or any of its subsidiaries. The Second Incremental Secured Term Loan will mature on May 25, 2018, and bears interest at LIBOR (with a floor of 1.50%) plus 3.75%, subject to a 0.25% step-down based on our total leverage ratio. Deferred debt issuance costs for these loans were $3 million and $4 million at February 1, 2014 and February 2, 2013, respectively, and have been included in Other assets on our Consolidated Balance Sheets.
The Second Incremental Secured Term Loan is governed by the Secured Term Loan Facility and has the same collateral, covenants and restrictions as the Secured Term Loan Facility. Toys-Delaware is required to make quarterly principal payments equal to 0.25% ($2.25 million per year) of the original principal amount of the loan. As such, this amount has been classified as Current portion of long-term debt on our Consolidated Balance Sheet as of February 1, 2014.
Toys-Delaware may optionally prepay the outstanding principal balance of the Second Incremental Secured Term Loan at any time. Optional prepayments of existing term loans and the Second Incremental Secured Term Loan will be applied ratably among the outstanding existing term loans and the Second Incremental Secured Term Loan, but in the event of a refinancing or repricing transaction in respect of the existing term loans, the proceeds of such refinancing or repricing transaction will be applied to the existing term loans prior to application to the Second Incremental Secured Term Loan.
7.375% senior notes, due fiscal 2018 ($403 million at February 1, 2014)
On September 22, 2003, Toys “R” Us, Inc. issued $400 million in notes bearing interest at a coupon rate of 7.375%, which will mature on October 15, 2018. The notes were issued at a discount of $2 million which resulted in proceeds of $398 million. Simultaneously with the sale of the notes, we entered into interest rate swap agreements. We subsequently terminated the swaps and received a payment of $10 million which is being amortized over the remaining term of the notes. Interest is payable semi-annually on April 15 and October 15 of each year. These notes carry a limitation on creating liens on domestic real property or improvements or the stock or indebtedness of domestic subsidiaries (subject to certain exceptions) that exceed the greater of 10% of the consolidated net tangible assets or 15% of the consolidated capitalization. The covenants also restrict sale and leaseback transactions (subject to certain exceptions) unless net proceeds are at least equal to the sum of all costs incurred in connection with the acquisition of the principal property and a lien would be permitted on such principal property. Deferred debt issuance costs for these notes were $1 million at February 1, 2014 and February 2, 2013, respectively, and have been included in Other assets on our Consolidated Balance Sheets.
Senior unsecured term loan facility, due fiscal 2019 ($973 million at February 1, 2014)
On August 21, 2013, TRU Propco I entered into the Propco I Term Loan Facility for an aggregate principal amount of $985 million. The Propco I Term Loan Facility was issued at a discount of $10 million, which resulted in proceeds of $975 million. The proceeds, together with other funds available to TRU Propco I, were used to redeem in full TRU Propco I’s $950 million senior unsecured 10.750% notes due fiscal 2017 (the “Propco I Notes”), plus accrued interest, premiums and expenses, and to pay fees and expenses relating to the Propco I Term Loan Facility. As a result of the repayment of the Propco I Notes, we expensed $77 million composed of a redemption premium of $51 million, and the write-off of unamortized original issue discount and deferred debt issuance costs during the third quarter of fiscal 2013. Investment funds or accounts advised by KKR owned an aggregate of $17 million of the Propco I Term Loan Facility as of February 1, 2014. In conjunction with the Propco I Term Loan Facility, we incurred transaction fees of $29 million, which are capitalized as deferred debt issuance costs and amortized over the term of the agreement. At February 1, 2014, deferred debt issuance costs for this facility was $27 million and have been included in Other assets on our Consolidated Balance Sheet.
TRU Propco I owns fee and leasehold interests in properties in the United States, which it leases on a long term basis to Toys-Delaware, pursuant to a master lease agreement.
The Propco I Term Loan Facility matures on August 21, 2019 and bears interest equal to, at the option of TRU Propco I, (i) LIBOR plus a margin of 5.00% per annum or (ii) the Base Rate (defined as the highest of (x) the Federal Funds Rate plus 0.50%, (y) the rate of interest in effect for such day as publicly announced from time to time by the Administrative Agent as its “prime rate,” and (z) one-month LIBOR plus 1.00%) plus a margin of 4.00% per annum, each of (i) and (ii)(z) subject to a LIBOR floor of 1.00%. The Propco I Term Loan Facility currently bears interest equal to LIBOR plus a margin of 5.00% per annum. The Propco I Term Loan Facility is guaranteed by all of TRU Propco I’s subsidiaries (the “Guarantors”). The Propco I Term Loan Facility is solely the obligation of TRU Propco I and the Guarantors and is not guaranteed by the Parent Company or Toys-Delaware.
The Propco I Term Loan Facility is required to be repaid in equal quarterly installments commencing January 31, 2014 in aggregate annual amounts equal to 1.00% of the original principal amount, with the balance payable on the final maturity date. As such, $10 million has been classified as Current portion of long-term debt on our Consolidated Balance Sheet as of February 1, 2014. The Propco I Term Loan Facility also requires TRU Propco I to prepay outstanding term loans with 25% of TRU Propco I’s annual excess cash flow (as defined in the Propco I Term Loan Facility), commencing with the fiscal year ending January 31, 2015, subject to the right of the lenders to decline such prepayment (the “Declined Proceeds”). The Propco I Term Loan Facility also requires TRU Propco I to prepay outstanding term loans, subject to certain exceptions and reinvestment rights, in connection with certain asset sales in an amount generally equal to 65% of the appraised value of the real property disposed of in such sale. Propco I may optionally prepay the outstanding principal balance of the loan at any time.
The Propco I Term Loan Facility contains certain affirmative and negative covenants, including, among other things, covenants that, subject to certain exceptions, restrict the ability of TRU Propco I and its subsidiaries to incur certain additional indebtedness, make distributions, create or permit liens on assets, sell or otherwise dispose of assets, or engage in mergers or consolidations. The exceptions include the right of TRU Propco I to make distributions from 75% of excess cash flow plus certain other amounts, including Declined Proceeds, subject to the satisfaction of certain conditions, including satisfaction of a fixed charge ratio (as defined in the Propco I Term Loan Facility) of at least 2.0 to1.0 for 50% of such distributions. If an event of default under the Propco I Term Loan Facility shall occur and be continuing, the principal amount of loans outstanding thereunder, together with all accrued and unpaid interest and other amounts owed thereunder, may be declared immediately due and payable.
£263 million UK real estate credit facility, due fiscal 2020 ($433 million at February 1, 2014)
On March 25, 2013, UK Propco entered into the New UK Propco Facility Agreement with Debussy, pursuant to which Debussy made the New UK Propco Loan to UK Propco on March 28, 2013 in the aggregate principal amount of £263 million. The net proceeds of the New UK Propco Loan, together with cash on hand, were used to repay the principal balance of outstanding under the UK real estate senior and junior credit facilities due fiscal 2013.
UK Propco owns freehold and leasehold interests in properties in various retail markets throughout the United Kingdom. Under an operating company/property company structure, UK Propco leases these properties on a triple-net basis to Toys “R” Us Limited (“UK Opco”). Substantially all of UK Propco’s revenues and cash flows are derived from payments from UK Opco under a series of amended lease agreements. The New UK Propco Loan is secured by, among other things, 31 owned and leased properties held by UK Propco, certain cash reserve accounts which are classified as Restricted cash on the Consolidated Balance Sheet and the stock of UK Propco. The New UK Propco Loan bears interest on a weighted average basis of 6.85% per annum plus mandatory costs and matures on July 7, 2020. The New UK Propco Facility Agreement contains covenants that restrict the ability of UK Propco to incur certain additional indebtedness, make restricted payments or certain investments, create or permit liens on assets, dispose of properties, acquire further property, vary or terminate the lease agreements referred to above, conclude further leases or engage in mergers or consolidations. If an event of default, including an event resulting from the failure to comply with a rent to interest coverage ratio applicable to UK Propco, under the New UK Propco Loan occurs and is continuing, the principal amount outstanding, together with all accrued and unpaid interest and other amounts owed may be declared immediately due and payable by the lenders. The loans are subject to mandatory prepayments in certain cases, including from the proceeds of certain permitted property disposals, and UK Propco may optionally prepay the loans at any time, provided that prior to July 7, 2015 and subject to certain exceptions, the loans may only be prepaid in full. Any prepayment prior to July 7, 2015, subject to certain exceptions, shall be subject to a “make whole” premium. Any prepayment occurring during the first, second and third year after July 7, 2015 are subject to a prepayment fee equal to 3%, 2% and 1%, respectively, of the amount of the loan prepaid.
Debussy is a special purpose entity established with the limited purpose of making loans and issuing £263 million of the Debussy Notes to third party investors and the Company. On July 24, 2013, Debussy completed the securitization of the New UK Propco Loan, the notes of which are now publicly traded on the Irish Stock Exchange. In connection with the securitization, UK Propco entered into an amendment and restatement agreement relating to the UK Propco Facility Agreement. The Company owns and holds £13 million ($22 million as of February 1, 2014) principal amount of the various classes of the Debussy Notes, which are included in Other assets within the Consolidated Balance Sheet, classified as held-to-maturity and reported at amortized cost. For further details regarding the consolidation of Debussy, refer to Note 1 entitled “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES”. In conjunction with the New UK Propco Loan and subsequent securitization, we incurred transaction fees of $23 million, which have been capitalized as deferred debt issuance costs and amortized over the term of the agreement. At February 1, 2014, deferred debt issuance costs for this facility were $21 million and have been included in Other assets on our Consolidated Balance Sheet.
Prior to the refinancing of the UK real estate credit facilities, we designated UK Propco as a “restricted subsidiary” under the indenture for the 2017 Notes. In addition, in connection with the refinancing, $52 million of the Vanwall Finance PLC notes that we owned were repaid. Vanwall was a variable interest entity established with the limited purpose of issuing and administering the UK real estate senior and junior credit facilities due fiscal 2013 under the credit agreement with UK Propco. For further details regarding the consolidation of Vanwall, refer to Note 1 entitled “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.”
Toys-Japan bank loans (1.85% to 2.85%), due fiscals 2013-2021 ($91 million at February 1, 2014)
Toys-Japan had five bank loans with various financial institutions totaling $91 million at February 1, 2014. On January 17, 2011, Toys-Japan entered into a bank loan with a syndicate financial institution for ¥11.5 billion. The loan will mature on January 29, 2016 and bears an interest rate of TIBOR plus 1.50% per annum. In conjunction with the loan, we entered into an interest rate swap, converting the variable rate of interest to a fixed rate of 2.45%. The swap has been designated as a cash flow
hedge. Toys-Japan is required to make principal payments of ¥1.6 billion ($16 million at February 1, 2014) annually in January of each year, with the remaining principal and interest due upon maturity. As of February 1, 2014, the outstanding balance of this loan was ¥6.6 billion or $65 million. On February 28, 2011, Toys-Japan entered into a bank loan with a financial institution totaling ¥1.0 billion. The loan will mature on February 25, 2016 and bears an interest rate of 1.85% per annum. As of February 1, 2014, the balance of this loan was ¥540 million or $5 million. On February 28, 2013, Toys-Japan entered into a bank loan with a financial institution for ¥2.0 billion. The loan will mature on February 26, 2021 and bears an interest rate of 2.18% per annum. Toys-Japan is required to make semi-annual principal payments of ¥125 million ($1 million at February 1, 2014). As of February 1, 2014, the outstanding balance of this loan was ¥1.9 billion or $18 million. The remaining two bank loans, representing $3 million, are amortizing and mature in fiscal 2014. In addition, on March 25, 2013, one of the previously outstanding loans matured. Deferred debt issuance costs for these agreements were $1 million at February 1, 2014 and February 2, 2013, respectively, and have been included in Other assets on our Consolidated Balance Sheets.
These agreements contain covenants that require, among other things, Toys-Japan to maintain a certain level of net assets and profitability during the agreement terms, including provisions that require Toys-Japan to not incur two consecutive years of ordinary loss in accordance with JGAAP, as defined in the credit agreement. The agreement also restricts Toys-Japan from paying dividends or making loans to affiliates without lender consent.
8.750% debentures, due fiscal 2021 ($22 million at February 1, 2014)
On August 29, 1991, Toys “R” Us, Inc. issued $200 million in debentures bearing interest at a coupon rate of 8.750% (the “Debentures”), maturing on September 1, 2021. Interest is payable semi-annually on March 1 and September 1 of each year. On November 2, 2006, Toys-Delaware commenced a cash tender offer for any and all of the outstanding Debentures (the “Tender Offer”) and a related consent solicitation to effect certain amendments to the indenture, eliminating all of the restrictive covenants and certain events of default in the indenture. On November 30, 2006, the Tender Offer expired, and on December 1, 2006, Toys-Delaware consummated the Tender Offer of $178 million (approximately 89.2%) of the outstanding Debentures in the Tender Offer using borrowings under an unsecured credit facility to purchase the tendered Debentures. Deferred debt issuance costs for these notes were nominal at February 1, 2014 and February 2, 2013, respectively, and have been included in Other assets on our Consolidated Balance Sheets.
NOTE 3 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
We are exposed to market risk from potential changes in interest rates and foreign currency exchange rates. We regularly evaluate our exposure and enter into derivative financial instruments to economically manage these risks. We record all derivatives as either assets or liabilities on the Consolidated Balance Sheets measured at estimated fair value and we do not offset assets and liabilities with the same counterparty. We recognize the changes in fair value as unrealized gains and losses. The recognition of these gains or losses depends on our intended use of the derivatives and the resulting designation. In certain defined conditions, we may designate a derivative as a hedge for a particular exposure.
Interest Rate Contracts
We and our subsidiaries have a variety of fixed and variable rate debt instruments and are exposed to market risks resulting from interest rate fluctuations. We enter into interest rate swaps and/or caps to reduce our exposure to variability in expected future cash outflows and changes in the fair value of certain Long-term debt, attributable to the changes in LIBOR, EURIBOR and TIBOR rates. Some of our interest rate contracts contain credit-risk related contingent features and are subject to master netting arrangements. As of February 1, 2014, our interest rate contracts have various maturity dates through February 2018. A portion of our interest rate swaps and caps as of February 1, 2014 are designated as cash flow and fair value hedges in accordance with ASC 815.
The hedge accounting for a designated cash flow hedge requires that the effective portion be recorded to Accumulated other comprehensive (loss) income; the ineffective portion of a cash flow hedge is recorded to Interest expense. We evaluate the effectiveness of our cash flow hedging relationships on an ongoing basis. For our derivatives that are designated as cash flow hedges, no material ineffectiveness was recorded for fiscals 2013, 2012 and 2011, respectively. Reclassifications from Accumulated other comprehensive (loss) income to Interest expense primarily relate to realized Interest expense on interest rate swaps and the amortization of gains (losses) recorded on previously terminated or de-designated swaps. We expect to reclassify a net loss of $2 million in fiscal 2014 to Interest expense from Accumulated other comprehensive (loss) income.
The hedge accounting for a designated fair value hedge requires that the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk be recognized in Interest expense. We evaluate the effectiveness of our fair value hedging relationship on an ongoing basis and recalculate the change in the fair value of the derivative and the underlying hedged item separately. For our derivative that is designated as a fair value hedge, we recorded a nominal net gain
in earnings related to ineffectiveness for fiscal 2013 and we recorded net gains of $5 million and $7 million in earnings related to ineffectiveness for fiscals 2012 and 2011, respectively.
Certain of our agreements with credit-risk related contingent features contain cross-default provisions which provide that we could be declared in default on our derivative obligations if we default on certain specified indebtedness. At February 1, 2014, there were no derivative liabilities related to agreements that contain credit-risk related contingent features. At February 2, 2013, derivative liabilities related to agreements that contain credit-risk related contingent features had a fair value of $1 million. As of February 1, 2014 and February 2, 2013, we were not required to post collateral for any of these derivatives.
The following table presents our outstanding interest rate contracts as of February 1, 2014 and February 2, 2013:
(1)
As of February 1, 2014, these derivatives were designated for hedge accounting.
(2)
The Company de-designated a portion of this interest rate cap in fiscal 2010. As of February 1, 2014 and February 2, 2013, 40% of the $500 million interest rate cap is designated as a cash flow hedge.
(3)
On February 27, 2013, TRU France Real Estate entered into a new interest rate cap to manage its future interest rate exposure in connection with the refinancing of the Company’s French real estate credit facility due in fiscal 2013. The interest rate cap has a notional amount of €47 million ($64 million at February 1, 2014) and matures on February 27, 2018. This cap has been designated a cash flow hedge which institutes a ceiling of 2.50% on the floating-rate EURIBOR exposure associated with our France Propco Facility Agreement.
Foreign Exchange Contracts
We enter into foreign currency forward contracts to economically hedge the USD merchandise purchases of our foreign subsidiaries and our short-term, cross-currency intercompany loans with and between our foreign subsidiaries. We enter into these contracts in order to reduce our exposure to the variability in expected cash outflows attributable to changes in foreign currency rates. These derivative contracts are not designated as hedges and are recorded on our Consolidated Balance Sheets at fair value with a gain or loss recorded on the Consolidated Statements of Operations in Interest expense.
Our foreign exchange contracts typically mature within 12 months. Some of these contracts contain credit-risk related contingent features and are subject to master netting arrangements. Some of these agreements contain provisions which provide that we could be declared in default on our derivative obligations if we default on certain specified indebtedness. At February 1, 2014 and February 2, 2013, derivative liabilities related to agreements that contain credit-risk related contingent features had a fair value of less than $1 million, respectively. We are not required to post collateral for these contracts.
The following table presents our outstanding foreign exchange contracts as of February 1, 2014 and February 2, 2013:
The following table sets forth the net impact of the effective portion of derivatives designated as cash flow hedges on Accumulated other comprehensive (loss) income on our Consolidated Statements of Stockholders’ (Deficit) Equity for the fiscal years ended February 1, 2014, February 2, 2013 and January 28, 2012:
The following table sets forth the impact of derivatives on Interest expense on our Consolidated Statements of Operations for the fiscal years ended February 1, 2014, February 2, 2013 and January 28, 2012:
(1)
Gains and losses related to our short-term, intercompany loan foreign exchange contracts are recorded in Interest expense, in addition to the corresponding foreign exchange gains and losses related to our short-term, cross-currency intercompany loans. For further details related to gains and losses resulting from foreign currency transactions, refer to Note 1 entitled “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.”
The following table contains the notional amounts and related fair values of our derivatives included within our Consolidated Balance Sheets as of February 1, 2014 and February 2, 2013:
(1)
Refer to Note 4 entitled “FAIR VALUE MEASUREMENTS” for the fair value of our derivative instruments classified within the fair value hierarchy.
Offsetting of Derivatives
We present our derivatives at gross fair values in the Consolidated Balance Sheets. However, some of our interest rate and foreign exchange contracts are subject to master netting arrangements which allow net settlements under certain conditions. As of February 1, 2014 and February 2, 2013, the aggregate gross fair value of derivative liabilities which could be net settled against our derivative assets were nominal, respectively, and the aggregate gross fair value of derivative assets which could be net settled against our derivative liabilities were nominal, respectively. As of February 1, 2014 and February 2, 2013, none of the master netting arrangements involved collateral.
NOTE 4 - FAIR VALUE MEASUREMENTS
To determine the fair value of our assets and liabilities, we utilize the established fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Derivative Financial Instruments
Currently, we use derivative financial arrangements to manage a variety of risk exposures, including interest rate risk associated with our Long-term debt and foreign currency risk relating to cross-currency intercompany lending and merchandise purchases. The valuation of our foreign currency contracts is determined using market-based foreign exchange rates, which are classified as Level 2 inputs.
The valuation of our interest rate contracts is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives,
including the period to maturity, and uses observable market-based inputs, including interest rate curves, foreign exchange rates and implied volatilities. We evaluate the inputs used to value our derivatives at the end of each reporting period.
For our interest rate contracts, we primarily use Level 2 inputs mentioned above to arrive at fair value. Additionally, for interest rate contracts we also incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements taking into account the impact of any applicable credit enhancements, such as collateral postings, thresholds, mutual puts and guarantees. We measure the credit risk of our derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio. The portfolio-level adjustments are then allocated each period to the individual assets or liabilities within the portfolio.
The credit valuation adjustments are calculated by determining the total expected exposure of the derivatives (which incorporates both the current and potential future exposure) and then applying each counterparty’s credit spread to the applicable exposure. The total expected exposure of a derivative is derived using market-observable inputs, such as yield curves and volatilities. The inputs utilized for our own credit spread are based on implied spreads from our debt, which are considered unobservable inputs. These credit valuation adjustments fall within Level 3 of the fair value hierarchy and include estimates of current credit spreads to evaluate the likelihood of default. For counterparties with publicly available credit information, the credit spreads over LIBOR used in the calculations represent implied credit default swap spreads obtained from a third party credit data provider. Generally, significant increases (decreases) in our own credit spread in isolation would result in significantly lower (higher) fair value measurement for these derivatives. Based on the mixed input valuation, we classify these derivatives based on the lowest level in the fair value hierarchy that is significant to the overall fair value of the instrument.
Any transfer into or out of a level of the fair value hierarchy is recognized based on the value of the instruments at the end of the reporting period.
Cash Equivalents
Cash equivalents include highly liquid investments with an original maturity of three months or less at acquisition. Due to the nature and short maturity of these investments, their carrying amount approximates fair value. Therefore, we have determined that our cash equivalents in their entirety are classified as Level 1 within the fair value hierarchy.
The table below presents our assets and liabilities measured at fair value on a recurring basis as of February 1, 2014 and February 2, 2013, aggregated by level in the fair value hierarchy within which those measurements fall.
Fiscal 2013
Fiscal 2012
For the fiscal year ended February 1, 2014, we had no derivative financial instruments within Level 3 of the fair value hierarchy. The table below presents the changes in the fair value of our derivative financial instruments within Level 3 of the fair value hierarchy for the fiscal year ended February 2, 2013.
(1)
Changes in the fair value of our Level 3 derivative financial instruments have been recorded in Interest expense on our Consolidated Statements of Operations. The total amount of unrealized gains for the period included in Interest expense attributable to assets held at February 2, 2013 was $3 million.
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Certain of our assets and liabilities are measured at fair value on a nonrecurring basis. We evaluate the carrying value of all long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The fair value measurements related to long-lived assets held and used classified as Level 3 were determined using a discounted cash flow valuation method. For those assets classified as Level 2 a relative, market-based approach based on offers was utilized. For the fiscal years ended February 1, 2014 and February 2, 2013, we had no impairments to long-lived assets held for sale.
Goodwill is evaluated for impairment annually or whenever we identify certain events or circumstances that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The fair value measurements related to goodwill are classified as Level 3 and were determined by blending results from the market multiples approach and the income approach. These valuation approaches consider a number of factors that include, but are not limited to, expected future cash flows, growth rates, discount rates, and comparable multiples from publicly-traded companies in our industry, and require us to make certain assumptions and estimates regarding industry economic factors and future profitability of our business. Refer to Note 1 entitled “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” for further details on the valuation technique and related inputs for goodwill. For the fiscal year ended February 2, 2013, we had no goodwill impairment.
There have been no changes in valuation technique or related inputs for long-lived assets or goodwill for the fiscal years ended February 1, 2014 and February 2, 2013.
The table below presents our long-lived assets and goodwill evaluated for impairment and measured at fair value on a nonrecurring basis for the fiscal years ended February 1, 2014 and February 2, 2013, aggregated by level in the fair value hierarchy within which those measurements fall. Because these assets are not measured at fair value on a recurring basis, certain carrying amounts and fair value measurements presented in the table may reflect values at earlier measurement dates and may no longer represent their fair values at February 1, 2014 and February 2, 2013. As of February 1, 2014 and
February 2, 2013, we did not have any long-lived assets classified as Level 1, or any goodwill classified as Level 1 or Level 2, respectively, within the fair value hierarchy.
Fiscal 2013
Fiscal 2012
(1)
Refer to Note 1 entitled “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” for further details.
(2)
Includes a foreign currency translation of $3 million.
NOTE 5 - PROPERTY AND EQUIPMENT
The following detail of property and equipment includes estimated useful lives which are generally used to depreciate the assets on a straight-line basis:
Assets held for sale
Assets held for sale represent assets owned by us that we have committed to sell in the near term. As of February 1, 2014, there were no assets held for sale. The following assets were classified as held for sale and included in Prepaid expenses and other current assets on our Consolidated Balance Sheet as of February 2, 2013:
Net gains on sales of properties
During fiscals 2013, 2012 and 2011, we sold idle properties and certain assets for proceeds of $35 million, $20 million and $24 million, respectively, resulting in net gains of $8 million, $4 million and $3 million, respectively.
NOTE 6 - ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
A summary of our Accounts payable, Accrued expenses and other current liabilities as of February 1, 2014 and February 2, 2013 is outlined in the table below:
(1)
Includes $51 million and $47 million of book overdraft cash as of February 1, 2014 and February 2, 2013, respectively.
(2)
Includes $107 million and $104 million of book overdraft cash as of February 1, 2014 and February 2, 2013, respectively.
(3)
Includes, among other items, accrued bonus and other benefits, current deferred tax liabilities, short-term borrowings and other accruals. No individual amount included exceeds 5% of Total current liabilities.
NOTE 7 - STOCK-BASED COMPENSATION
2010 Incentive Plan
In fiscal 2010, we adopted the Toys “R” Us, Inc. 2010 Incentive Plan (the “2010 Incentive Plan”). The 2010 Incentive Plan provides that the total number of shares of our common stock that may be issued is 3,750,000 and the maximum number of such shares of common stock for which incentive stock options may be granted is 500,000. The Board of Directors of the Company has discretion over the amount of shares available for future issuances of stock awards.
Stock options
In fiscals 2013, 2012 and 2011, we granted options under the 2010 Incentive Plan. The options were granted at an exercise price equal to grant date fair market value and generally follow a graded vesting schedule of 50% on the second anniversary of the awards with the remaining portion vesting in equal annual installments over the subsequent two years, subject to the
participant’s continued employment with us, and will vest automatically upon a change of control of the Company. All options expire ten years from the date of the grant.
Restricted Stock
Additionally, concurrent with the grant of the options, additional awards were granted under the 2010 Incentive Plan consisting of service-based restricted stock and restricted stock units, which were valued at a fair market value on the date of grant of $30.00 per share, $44.00 per share and $60.00 per share in fiscals 2013, 2012 and 2011, respectively. The restricted stock units issued in fiscal 2013 for certain officers follow the same graded vesting schedule as the options granted in the same year, while the restricted stock units for other officers cliff vest 100% on the second anniversary of the award, subject to the participant’s continued employment with the Company, and will vest automatically upon a change in control of the Company. The service-based restricted stock and restricted stock units for fiscals 2012 and 2011 follow the same graded vesting schedule as the options granted in those years.
In fiscals 2012 and 2011, certain officers were awarded performance-based restricted stock and restricted stock units valued at a fair market value on the date of the grant of $44.00 and $60.00, respectively. The performance-based awards cliff vest 100% on the third anniversary of the awards if the performance criteria have been met. The performance metrics are based 50% on our consolidated Adjusted Compensation EBITDA performance results and 50% on our total return on invested capital (ROIC) results, each over a three year period.
2013 Two-for-one option exchange
In November 2013, certain participants under the 2010 Incentive Plan were offered an opportunity to exchange certain of their outstanding stock options (“Old Options”) and all outstanding performance shares or units for a grant of one new stock option (“New Options”) for every two Old Options canceled, which New Options have an exercise price of $22.00. On December 23, 2013, the Company closed its offer with a total of 919,599 and 104,240 Old Options and performance shares or units canceled, respectively, and a total of 459,805 New Options issued under the 2010 Incentive Plan. The New Options follow a vesting schedule of 50% on the second anniversary of the awards with the remaining portion vesting in equal annual installments over the subsequent two years (subject to the earlier expiration in accordance with the New Option award agreement), subject to the participant’s continued employment with the Company, and will vest automatically upon a change of control of the Company. We accounted for the modification in accordance with ASC 718. Management has concluded that the modification had a nominal impact on compensation costs.
One-time awards
In connection with the appointment of Antonio Urcelay as CEO announced on October 16, 2013, the Company entered into an employment agreement which provided a one-time award of restricted stock units under the 2010 Incentive Plan, which had a grant date of November 5, 2013. The one-time award has a grant date fair value of $8 million, or $22.00 per share, 50% of which will vest on the earlier of October 16, 2014 or the termination of his employment other than for cause and the remainder of which will vest in equal installments at the end of each fiscal quarter commencing January 31, 2015, with the last portion vesting on October 31, 2015, subject to continued employment through the applicable vesting dates.
Additionally, on November 5, 2013 the Company entered into an employment agreement with Harry J. Mullany III to serve as President, Toys “R” Us, US. The employment agreement provided a one-time award of stock options and restricted stock units under the 2010 Incentive Plan with grant date fair values of $5 million and $2 million, respectively, each at $22.00 per share. Fifty percent of the options will vest in four equal annual installments beginning on the first anniversary of the grant date. The remaining option awards will be subject to time and performance vesting and will only be deemed fully vested when the performance obligations pursuant to Mr. Mullany’s employment agreement are satisfied. The restricted stock units will vest in four equal annual installments beginning on the first anniversary of the grant date. Additionally, Mr. Mullany purchased 22,728 shares of stock at a price of $22.00 per share.
Additionally, in December 2013, the Company granted options to certain participants under the 2010 Incentive Plan with a grant date fair value of $1 million, with an exercise price of $22.00 per share. These options follow the same graded vesting schedule as the New Options described above.
Management Equity Plan
On July 21, 2005, we adopted the Toys “R” Us, Inc. 2005 Management Equity Plan (the “Management Equity Plan”). Under the Management Equity Plan, outstanding awards during fiscal 2013 included service-based options, including rollover options (i.e., options in the Company in lieu of options held prior to the Merger) and restricted stock to officers and other key employees of the Company and its subsidiaries.
The service-based options generally follow a graded vesting schedule of 40% on the second anniversary of the award with the remaining portion vesting in equal annual installments over the subsequent 3 years, subject to the participant’s continued employment with the Company, and vest automatically upon a change of control of the Company. All options generally expire on the tenth anniversary of the date of the grant, or in the case of rollover options, on their original expiration date, unless the terms are amended pursuant to the Management Equity Plan.
The Management Equity Plan permits the sale of non-transferable, restricted stock to certain employees at a purchase price equal to the fair value of the common stock, and also permits grants of restricted stock without consideration. During fiscals 2013, 2012 and 2011, there were no purchases of restricted stock shares under the Management Equity Plan by officers or certain employees of the Company. Under the Management Equity Plan, each participant has the right to require the Company to repurchase all of his or her restricted shares or shares issued or issuable pursuant to stock options in the event of a termination of employment due to death or disability and under specific circumstances upon retirement.
In November 2013, the Company extended the expiration dates of certain outstanding option awards under the Management Equity Plan, which were originally scheduled to expire in fiscals 2015 and 2016, to August 6, 2017. We accounted for the modification in accordance with ASC 718. Management concluded that the modification resulted in incremental compensation costs of $1 million, which was recorded in SG&A in fiscal 2013.
All outstanding options issued under the 2010 Incentive Plan and Management Equity Plan are scheduled to expire at dates ranging from August 6, 2017 to December 23, 2023. We expect to satisfy future option exercises by issuing shares held in treasury or authorized but unissued new shares.
Amendments
Commencing in February 2011, participants in the Management Equity Plan had the right to elect to be bound by the terms and conditions of Amendment No. 3 to the Management Equity Plan. This amendment, among other things, reduced the retirement age criteria, accelerates vesting of all options upon death, disability or retirement, made all participants eligible for put rights upon death, disability or retirement, permitted cashless exercise in certain cases of retirement, and made the non-competition period apply in the case of resignation for any reason and applies the non-competition period for the greater of one year and any severance period for termination without cause. The Company accounted for the modification to the Management Equity Plan in accordance with ASC 718. Generally, options with put rights upon death, disability or retirement are classified as equity awards until such puttable conditions become probable (i.e. upon reaching retirement eligibility). For awards that were required to be liability-classified as a result of the amendment, we record an incremental expense measured as the excess, if any, of the fair value of the modified award over the amount previously recognized when the award retained equity classification. These liability awards are remeasured at their fair market value as of each reporting period through the date of settlement. All liability awards were settled as of February 1, 2014.
Effective March 2012, participants in the Management Equity Plan are bound by the terms and conditions of Amendment No. 4 to the Management Equity Plan (“Amendment No. 4”). This amendment provides for, among other things, a longer exercise period, expiring no later than the original term of the option, and the right to a cashless exercise of options held by a participant who is terminated without cause after four or more years of continuous service. Option holders under the 2010 Incentive Plan have the same rights to a longer exercise period and a cashless exercise right in the event such participant’s employment is terminated without cause (or the participant resigns for good reason) after four or more years of continuous service and in certain cases of retirement, as further described in the form of option award agreement. We accounted for the modification of awards impacted by the terms of Amendment No. 4 in accordance with ASC 718. Management concluded that the modification did not have a material impact on compensation costs.
Effective May 2012, we adopted Amendment No. 5 (“Amendment No. 5”) to the Management Equity Plan. Amendment No. 5 allows any plan participant, as long as he or she remains employed by the Company or its affiliates, the right to put up to 25%, calculated as provided in Amendment No. 5, of his or her Original Investment Shares, the number of shares that would be equal to the value of their original investment to us, during permitted transaction windows, until the occurrence of an initial public offering of the Company. The purchase price per share payable by us in connection with any such put rights shall be the fair market value as of a date determined by our Board of Directors that is the anticipated closing date of the repurchase. We accounted for the modification of awards impacted by the terms of Amendment No. 5 in accordance with ASC 718. As these awards allow the plan participant the right to put a portion of their rollover options, we are required to account for them as liability-classified awards. These liability awards will be remeasured at their fair market value as of each reporting period through the date of settlement. Management has concluded that the modification resulted in incremental compensation costs of $2 million, which was recorded in SG&A in fiscal 2012.
Effective March 2013, we adopted Amendment No. 6 (“Amendment No. 6”) to the Management Equity Plan which provides that any participant in the Management Equity Plan, who is a former employee of the Company or its affiliates as of March 1,
2013 or who continues to be employed by the Company or its affiliates, has the right to put to the Company (i) in 2013, up to 50% of his or her Original Investment Shares held at March 1, 2013 and (ii) in 2014, any or all of the participant’s then remaining Original Investment Shares, in each case, during permitted transaction windows, until the occurrence of an initial public offering of the Company. In each case, the purchase price per share payable by the Company in connection with any such put rights will be the fair market value determined as of a date determined by the Board of Directors that is the anticipated closing date of the repurchase. Additionally effective in March 2013, certain participants under the 2010 Incentive Plan were granted the right to put to the Company any or all of the restricted stock that becomes vested as well as any net shares acquired upon vesting of restricted stock units beginning 6 months after the applicable vesting date of these awards. We accounted for the modification of these awards impacted under the Management Equity Plan and 2010 Incentive Plan in accordance with ASC 718 and ASC 480, and determined that the impacted awards retained equity classification. However, as these equity awards are redeemable for cash at the option of the holder and redemption is probable, the shares have been recorded in temporary equity at their redemption value. The redemption amount will be adjusted at the fair market value as of each reporting period through the date of settlement. Management concluded that the modifications did not have an impact to compensation costs.
Valuation Assumptions
The fair value of each option award modified or granted under the 2010 Incentive Plan and Management Equity Plan is estimated on the date of modification or grant using a lattice option-pricing model that uses the assumptions noted in the following table, along with the associated weighted-average fair values. We use historical data to estimate pre-vesting option forfeitures. To the extent actual results of forfeitures differ from the estimates, such amounts will be recorded as an adjustment in the period the estimates are revised. The expected volatilities are based on a combination of implied and historical volatilities of a peer group of companies, as the Company is a non-publicly traded company. The risk-free rate is based on the United States Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the options. The expected term represents the median time until exercise and is based on contractual terms of the awards, expectations of employee exercise behavior and expectations of liquidity for the underlying shares. The expected dividend yield is based on an assumption that no dividends are expected to be approved in the near future. The following are the weighted-average assumptions used:
For fiscal 2013, the range of assumptions presented includes the assumptions used for the modified option awards as well as the grants issued under the 2010 Incentive Plan.
Options
A summary of option activity under the 2010 Incentive Plan and Management Equity Plan during fiscals 2013, 2012 and 2011 is presented below:
The aggregate intrinsic value of options exercised, which includes options exercised on a net settlement basis, was $4 million, $16 million and $3 million in fiscals 2013, 2012 and 2011, respectively. The total fair value of options vested was $19 million, $23 million and $29 million in fiscals 2013, 2012 and 2011, respectively. We received no proceeds from the exercise of options in fiscal 2013, and less than $1 million and $1 million in fiscals 2012 and 2011, respectively. We paid a nominal amount, $2 million and $2 million in fiscals 2013, 2012 and 2011 respectively, to cash settle share-based liability awards. We paid $8 million, $3 million and less than $1 million in fiscals 2013, 2012 and 2011, respectively, to repurchase shares. We did not recognize any tax benefits as a result of options exercised in fiscal 2013. The tax benefits recognized as a result of the options exercised were $6 million and $1 million in fiscals 2012 and 2011, respectively.
As of February 1, 2014, there was $12 million of total unrecognized compensation cost related to option share-based compensation arrangements granted under the 2010 Incentive Plan and Management Equity Plan. This cost is expected to be recognized over a weighted-average period of 1.9 years.
Restricted Shares and Units
A summary of nonvested restricted share activity under the 2010 Incentive Plan during fiscals 2013, 2012 and 2011 is presented below:
A summary of outstanding restricted stock unit activity under the 2010 Incentive Plan during fiscals 2013, 2012 and 2011 is presented below:
As of February 1, 2014, there was $16 million of total unrecognized compensation cost related to restricted share-based compensation arrangements under the 2010 Incentive Plan. This cost is expected to be recognized over a weighted-average period of 2.0 years.
The fair value of restricted shares vested and restricted stock units converted was $4 million for fiscal 2013, and we did not recognize any tax benefits as a result of the vesting and conversion. The fair value of restricted shares vested and restricted stock units converted, and the tax benefits recognized as a result of the vesting and conversion, were nominal for fiscals 2012 and 2011 respectively.
Performance-Based Shares and Units
A summary of performance-based share activity under the 2010 Incentive Plan during fiscals 2013, 2012 and 2011 is presented below:
A summary of performance-based stock unit activity under the 2010 Incentive Plan during fiscals 2013, 2012 and 2011 is presented below:
The amount of stock-based compensation expense recognized in SG&A and the tax benefit recognized in Income tax expense (benefit) in fiscals 2013, 2012 and 2011 was as follows:
NOTE 8 - ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME
Total other comprehensive (loss) income is included in the Consolidated Statements of Comprehensive (Loss) Income and Consolidated Statements of Stockholders’ (Deficit) Equity. Accumulated other comprehensive (loss) income is reflected in the Consolidated Balance Sheets, as follows:
NOTE 9 - LEASES
We lease a majority of the real estate and certain equipment used in our operations. Most real estate leases require us to pay real estate taxes and other expenses and some leases require additional payments based on percentages of sales.
Minimum rental commitments under non-cancelable operating leases, capital leases and financing obligations as of February 1, 2014 are as follows:
(1)
Excluded from the minimum rental commitments displayed above is $2.0 billion related to options to extend ground lease terms that are reasonably assured of being exercised, the balance of which is predominantly related to fiscals 2019 and thereafter.
(2)
Included in Capital Leases and Financing Obligations displayed above is $65 million of interest.
Total rent expense, net of sublease income, was $609 million, $628 million and $588 million in fiscals 2013, 2012 and 2011, respectively. Sublease income was $19 million, $19 million and $22 million in fiscals 2013, 2012 and 2011, respectively. We remain directly and primarily liable for lease payments to third party landlords for locations where we have subleased all or a portion of the locations to third parties. To the extent that sub-lessees fail to make sublease rental payments, our total net rent expense to the third party landlords would increase in direct proportion.
We record operating leases on a straight-line basis over the lease term, which includes renewal options only if those options are specified in the lease agreement and if failure to exercise the renewal option imposes a significant economic penalty on us. For Ground Lease Locations, we include renewal options in the lease term through the estimated useful life of the owned building located on the property as failure to renew a ground lease during the estimated useful life of the building would result in forgoing an economic benefit given our significant capital investment at the inception of the lease to construct a new building. For Straight Lease Locations, we do not include renewal options in the lease term as the failure to renew a straight lease does not typically result in a significant economic penalty for us, and therefore renewal cannot be reasonably assured at the inception of the lease. Substantially all of our leases include options that allow us to renew or extend the lease term beyond the initial lease period, subject to terms and conditions agreed upon at the inception of the lease. Such terms and conditions include rental rates agreed upon at the inception of the lease that could represent below or above market rental rates later in the life of the lease, depending upon market conditions at the time of such renewal or extension. In addition, many leases include early termination options, which can be exercised under specified conditions, including, upon damage, destruction or condemnation of a specified percentage of the value or land area of the property.
The difference between the recognized rental expense and amounts payable under the leases is recorded as deferred rent liability. Deferred rent liabilities in our Consolidated Balance Sheets totaled $374 million and $368 million at February 1, 2014 and February 2, 2013, respectively, of which $12 million was included in Accrued expenses and other current liabilities, respectively.
Lease payments that depend on factors that are not measurable at the inception of the lease, such as future sales volume, are contingent rentals and are excluded from minimum lease payments. We include contingent rentals in the determination of total rental expense when it is probable that the expense has been incurred and the amount is reasonably estimable. Contingent rent expense was $10 million, $12 million and $12 million for fiscals 2013, 2012 and 2011, respectively. Future payments for maintenance, insurance and taxes to which we are obligated are excluded from minimum lease payments. Tenant allowances received upon entering into certain store leases are deferred and recognized on a straight-line basis as a reduction to rent expense over the lease term.
NOTE 10 - INCOME TAXES
(Loss) earnings before income taxes are as follows:
Income tax expense (benefit) is as follows:
Included within Total Income tax expense (benefit) is benefit of less than $1 million, expense of $1 million and benefit of $4 million related to interest and penalties in fiscals 2013, 2012 and 2011, respectively. The interest and penalties relate to tax payments and refunds for prior period tax filings made or to be made, as well as amounts associated with increases and decreases to unrecognized tax benefits.
We have not provided deferred taxes on $1 million of accumulated foreign earnings as it is management’s intention to reinvest those earnings indefinitely. The unrecognized deferred income tax liability on these earnings, net of associated foreign tax credits and other offsets, is zero.
The effective tax rate reconciliations are as follows:
(1)
Foreign operations include the net impact of: differences between local statutory rates and the U.S. Federal statutory rate; the impact of changes to foreign valuation allowances; the net cost of foreign unrecognized tax benefits; the cost of repatriating foreign earnings, net of foreign tax credits; changes to our assertion regarding the permanent reinvestment of foreign earnings related to certain foreign entities; permanent items related to foreign operations; as well as changes in the tax status of foreign entities.
(2)
Unrecognized tax benefits include benefits related to the resolution of issues in connection with concluding tax examinations, making protective elections, as well as changes to and clarifications of tax rules and regulations. See “Unrecognized Tax Benefits” in this footnote.
(3)
Goodwill impairment represents the U.S. Federal tax cost associated with the amount of Goodwill that was impaired for which we did not have tax basis, and therefore for which we could not take a tax benefit.
The tax effects of temporary differences that give rise to deferred tax assets and liabilities are:
The deferred tax assets and liabilities above are reflected in the Consolidated Balance Sheets as follows:
(1)
The current deferred tax liabilities are included as components of Accrued expenses and other current liabilities in the Consolidated Balance Sheets.
Our gross deferred tax assets above include an offset of $8 million and $6 million of unrecognized tax benefits related to tax loss carryforwards as of February 1, 2014 and February 2, 2013, respectively.
Carryforwards
In addition to the unused portion of losses and credits reported on tax returns, our carryforwards also include interest deductions that are being carried forward due to thin-capitalization and other tax limitations, as well as credits that will be realized in connection with the undistributed earnings of foreign subsidiaries on which we have provided taxes.
Of our $398 million of U.S. Federal tax loss and other carryforwards, less than $1 million will expire during the next 5 years, $168 million will expire during the next 6 to 20 years and $229 million may be carried forward indefinitely. Of our $75 million of state tax loss and other carryforwards, $5 million will expire during the next 5 years, $58 million will expire during the next 6 to 20 years and $12 million may be carried forward indefinitely. Of our $197 million of foreign tax loss and other carryforwards, $2 million will expire during the next 5 years, $9 million will expire during the next 6 to 20 years and $186 million may be carried forward indefinitely.
On July 21, 2005, the Company was acquired by the Sponsors. U.S. Federal and certain state and foreign taxing jurisdictions impose limitations on the amount of tax losses, credits and other carryforwards that can be used to offset current income and tax within any given year when there has been an ownership change. We have evaluated the impact of these limitations and have established a valuation allowance to reduce some of these deferred tax assets to the amount expected to be realized.
Valuation Allowance
We have evaluated the available positive and negative evidence and have concluded that, for some of our deferred tax assets, it is more likely than not that these assets will not be realized in the foreseeable future. The increase to our valuation allowance for U.S. Federal and state jurisdictions, as well as in certain foreign jurisdictions, was predominately due to the fact that, as of the end of fiscal 2013, we have incurred a pre-tax cumulative loss (after adjustments required for tax purposes) over the past three fiscal years. As a result, we have established a valuation allowance to reduce these deferred tax assets for the amount we believe will not be realized. During fiscal 2013, our valuation allowance increased by $376 million. This includes a $246 million increase for U.S. Federal tax, a $47 million increase for state tax and a $83 million increase for foreign tax.
Of our total valuation allowance of $511 million, there is $6 million related to the foreign valuation allowance which, if a benefit is subsequently recognized, will result in a reduction of another asset.
Unrecognized Tax Benefits
A reconciliation of the beginning and ending amounts of gross unrecognized tax benefits (excluding interest and penalties) is as follows:
(1)
Reductions for tax positions of prior years include amounts related to the resolution of issues in connection with concluding tax examinations, making protective elections, as well as changes to and clarifications of tax rules and regulations.
At February 1, 2014, $27 million of the $37 million of unrecognized tax benefits would affect our effective tax rate, if recognized, and the remaining $10 million would affect our deferred tax accounts. In addition, we had $5 million and less than $1 million of accrued interest and penalties, respectively, at February 1, 2014. We had $4 million and less than $1 million of accrued interest and penalties, respectively, at February 2, 2013, and $5 million and less than $1 million of accrued interest and penalties, respectively, at January 28, 2012.
The Company and its subsidiaries are subject to taxation in the United States and various foreign jurisdictions. Of the major jurisdictions, we are subject to examination in: the United States for U.S. Federal purposes for fiscal 2010 and forward and for state purposes for fiscal 2003 and forward; Australia for fiscal 2009 and forward; Canada for fiscal 2005 and forward; France for fiscal 2010 and forward; Germany for fiscal 2009 and forward; Japan for fiscal 2008 and forward; Spain for fiscal 2008 and forward; and the UK for fiscal 2009 and forward. While it is often difficult to predict whether we will prevail, we believe that our tax liabilities for unrecognized tax benefits reflect the more likely than not outcome of known tax contingencies.
We believe that it is reasonably possible that the total amount of unrecognized tax benefits of $43 million (inclusive of tax, interest and penalties) will decrease by $3 million during the next twelve months due to the resolution of ongoing tax examinations and lapses of applicable statutes of limitations.
NOTE 11 - SEGMENTS
We generate sales, earnings and cash flows by retailing numerous product offerings worldwide. We operate all of the “R” Us branded retail stores in the United States and Puerto Rico and 79% of the 889 “R” Us branded retail stores internationally (excluding temporary Express store locations). The balance of the “R” Us branded retail stores outside the United States are
operated by licensees. Licensing fees did not have a material impact on our Net sales. We also own and operate websites including Toysrus.com, Babiesrus.com, eToys.com, FAO.com and toys.com, as well as other Internet sites we operate in our international markets.
Our business has two reportable segments: Toys “R” Us - Domestic (“Domestic”) and Toys “R” Us - International (“International”). The following is a brief description of our segments:
•
Domestic - Our Domestic segment sells a variety of products in the core toy, entertainment, juvenile (including baby), learning and seasonal categories through 873 stores that operate in 49 states in the United States and Puerto Rico and through the Internet. Domestic Net sales in fiscal 2013 were derived from traditional toy stores (including Babies “R” Us Express (“BRU Express”) and Juvenile Expansion formats), juvenile stores, side-by-side (“SBS”) stores, permanent Express stores (cumulative lease term of at least two years) and our flagship stores in New York City. Additionally, we generated Net sales through our temporary Express store locations.
•
International - Our International segment sells a variety of products in the core toy, entertainment, juvenile (including baby), learning and seasonal categories through 704 operated and 185 licensed stores in 35 countries and jurisdictions and through the Internet. In addition to fees received from licensed stores, International Net sales in fiscal 2013 were derived from traditional toy stores (including BRU Express formats), SBS stores, permanent Express stores (cumulative lease term of at least two years) and juvenile stores. Additionally, we generated Net sales through our temporary Express store locations. Our operated stores are located in Australia, Austria, Brunei, Canada, China, France, Germany, Hong Kong, Japan, Malaysia, Poland, Portugal, Singapore, Spain, Switzerland, Taiwan, Thailand and the United Kingdom.
The CEO, who is our Chief Operating Decision Maker, evaluates segment performance primarily based on Net sales and segment Operating (loss) earnings. Segment Operating (loss) earnings excludes corporate related charges and income. All intercompany transactions between the segments have been eliminated. Income tax information by segment has not been included as taxes are calculated at a company-wide level and are not allocated to each segment. Revenues from external customers are derived primarily from merchandise sales and we do not generate material sales from any single customer.
The following tables show our percentage of Net sales by product category:
(1)
Consists primarily of shipping and other non-product related revenues.
(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.
A summary of financial results by reportable segment is as follows:
(1)
Includes Goodwill impairment of $361 million for fiscal 2013. Also includes gift card breakage income of $22 million, $19 million and $17 million for fiscals 2013, 2012 and 2011, respectively. Includes impairment of long-lived assets of $19 million, $8 million and $5 million for fiscals 2013, 2012 and 2011, respectively. In addition, includes the impact of net gains on sales of properties of $8 million, $3 million and $3 million for fiscals 2013, 2012 and 2011, respectively. Property damage write-offs and repairs for fiscals 2012 and 2011 were $6 million and $4 million, respectively. In addition, fiscal 2013 includes a $17 million non-cash cumulative adjustment of accrued vacation, resulting from a prior period correction. Fiscal 2013 also includes $23 million in litigation settlement expenses for certain legal matters, of which $20 million relates to the judgment in the Aleo v. SLB Toys USA Inc. case. For fiscals 2012 and 2011, $1 million and $8 million were included in litigation settlement expenses, respectively. Refer to Note 1 entitled “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” and Note 14 entitled “LITIGATION AND LEGAL PROCEEDINGS” for further details.
(2)
Includes impairment of long-lived assets of $24 million, $3 million and $1 million for fiscals 2013, 2012 and 2011, respectively. Also includes Goodwill impairment of $17 million for fiscal 2013. In addition, includes the impact of net gains on sales of properties of less than $1 million for both fiscals 2013 and 2012, and gift card breakage income of $2 million, $2 million and $5 million for fiscals 2013, 2012 and 2011, respectively. Property damage write-offs and repairs for fiscals 2012 and 2011 were $2 million and $7 million, respectively. Refer to Note 1 entitled “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” and Note 5 entitled “PROPERTY AND EQUIPMENT” for further details.
(3)
Includes impairment of long-lived assets of $1 million for fiscal 2013. In addition, includes the impact of net gains on sales of properties of $1 million for fiscal 2012. Refer to Note 1 entitled “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” for further details.
Certain corporate and other items are reported separately in our disclosure of segment Operating (loss) earnings. In addition to the income items described above, charges include corporate office expenses and shared service center expenses, as well as certain other centrally managed expenses, which are not fully allocated to our reportable segments. The significant categories of expenses include salaries, benefits and related expenses, professional fees, corporate facility depreciation and amortization and insurance. Salaries, benefits and related expenses include salaries, bonus, payroll taxes and health insurance expenses for corporate office employees. Professional fees include costs related to internal control compliance, financial statement audits, legal, information technology and other consulting fees, which are engaged and managed through the corporate office. Depreciation and amortization includes depreciation of leasehold improvements for properties occupied by corporate office employees. Corporate insurance expense includes the cost of fire, liability and automobile premiums.
(1)
Includes cash and cash equivalents, deferred tax assets and other corporate assets.
Our Net sales, inclusive of each country’s respective Internet operations, and long-lived assets by country or region are as follows:
(1)
Includes our wholly-owned operations in Puerto Rico.
(2)
Includes our wholly-owned operations in Germany, Austria, Switzerland, France, Spain, Portugal and Poland.
(3)
Represents licensing fees from unaffiliated third parties.
(1)
Includes our wholly-owned operations in Puerto Rico.
(2)
Includes our wholly-owned operations in Germany, Austria, Switzerland, France, Spain, Portugal and Poland.
NOTE 12 - DEFINED BENEFIT PENSION PLANS
We sponsor defined benefit pension plans covering certain international employees in the UK, Japan, Germany and Austria, with such benefits accounted for on an accrual basis using actuarial assumptions. For our pension plans, we use a measurement date matching the end of our fiscal years.
The following tables provide information regarding our pension plans:
Obligation and Funded Status at End of Fiscal Year:
Of the $9 million of unrecognized net actuarial losses, net of tax, in Accumulated other comprehensive (loss) income as of February 1, 2014, less than $1 million is expected to be amortized into net periodic benefit cost in fiscal 2014.
Information for Pension Plans with Accumulated Benefit Obligations in Excess of Plan Assets:
Components of Net Periodic Benefit Cost During Each Fiscal Year:
Contributions
For fiscal 2014, we expect to contribute $7 million to our pension plans.
Estimated Future Payments
Pension benefit payments, including amounts to be paid from our assets, and reflecting expected future service, as appropriate, are expected to be paid as follows:
Weighted-average Assumptions Used to Determine Net Periodic Benefit Costs at Fiscal Year End:
Weighted-average Assumptions Used to Determine Benefit Obligations at Fiscal Year End:
Determination of Discount Rate
The discount rate used to determine benefit obligations for our pension plans has been developed based on the AA corporate bond yield curve.
Determination of Expected Return on Assets
The expected return on assets is the rate of return expected to be achieved on pension fund assets in the long term, net of investment expenses. More than 90% of the plan assets relate to the UK and Japan pension plans. The UK and Japan pension plans expected return on assets assumption for fiscal 2014 has been determined by considering the return on the actual asset classes held as of the measurement date and our expectations of future rates of return on each asset class. For the UK and Japan pension plans, we determine the expected rate of return by utilizing the current return available on stocks, and government and corporate bonds and applying suitable risk premiums that consider historical market returns and current market expectations. The estimate of the expected rate of return is based on a long term view and considers the impact of economic conditions in the evaluation of historical market returns.
Plan Assets
Investment policies and strategies
Our overall investment policy and strategic management of the plan assets are the responsibility of the trustees (acting based on advice as they deem appropriate) and are driven by investment objectives as set out below. The remaining elements of our investment policy are part of the day-to-day management of the assets, which is delegated to a professional investment manager. The trustees of our defined benefit pension plans are guided by an overall objective of achieving, over the long-term, a return on the investments, which is consistent with the long-term assumptions made by the actuaries in determining funding of the plans.
The investment returns that the trustees expect to achieve are those that are broadly in line with or above the returns of the respective market indices and performance targets against which the investment manager is benchmarked. Over the longer term, the trustees expect to achieve an investment return in excess of the consumer price index.
Weighted-average asset allocation by asset category
The primary investment goal for our plans’ assets is to maximize total asset returns while ensuring the plans’ assets are available to fund the plans’ liabilities as they become due. A change in the overall investment strategy could significantly impact the expected rate of return on plan assets.
The following represents our pension plan target asset allocations for fiscal 2014, as well as the actual asset allocations as of February 1, 2014 and February 2, 2013:
Risk management
In managing the Company’s plan assets, our investment managers evaluate and manage risk associated with funded status risk, interest rate risk, market risk, counterparty risk, liquidity risk and operational risk. Cash flow management and asset class diversification are central to our risk management strategy and are critical to the overall investment strategy of our pension plan assets.
Fair value of plan assets
The following tables present our plan assets by fair value hierarchy in accordance with ASC Topic 820, “Fair Value Measurements and Disclosures” as of February 1, 2014 and February 2, 2013. The fair value hierarchy is comprised of three levels based on the reliability of inputs used to determine fair value. Level 1 refers to fair values determined based on quoted prices in active markets for identical assets. Level 2 refers to fair values estimated using significant other observable inputs, while Level 3 includes the fair values estimated using significant non-observable inputs. The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement of the instrument.
There have been no changes in valuation technique or related inputs for the fiscal years ended February 1, 2014 and February 2, 2013.
(1)
Domestic and international equity securities categorized as Level 2 are valued using the Net Asset Value (“NAV”) per fund share, which is derived from quoted prices in active markets of the underlying securities.
(2)
Domestic and international fixed-income securities categorized as Level 2 are valued using the NAV per fund share, which is derived using a market approach with inputs that include broker quotes, benchmark yields, base spreads and reported trades.
(3)
Insurance contracts contain a minimum guaranteed return and are categorized as Level 2 as the fair value of the assets is equal to the total amount of all individual technical reserves plus the non allocated employer’s financing fund reserves at the valuation date. The individual technical and financing fund reserves are equal to the accumulated paid contributions taking into account the insurance ratification and any allocated profit sharing return.
(4)
Cash and cash equivalents include highly liquid investments with an original maturity of three months or less at acquisition. Due to the nature and short maturity of these investments, their carrying amount approximates fair value. Therefore, we have determined that our cash and cash equivalents in their entirety are classified as Level 1 within the fair value hierarchy.
NOTE 13 - OTHER EMPLOYEE RETIREMENT AND COMPENSATION BENEFITS
We offer other employee retirement and compensation benefits for eligible employees. The Supplemental Executive Retirement Plan (“SERP”) provides supplemental retirement benefits to certain executive officers in excess of the limitations that are imposed by Section 401(a)(17) of the Internal Revenue Code of 1986, as amended, on contributions to our TRU Partnership Employees’ Savings and Profit Sharing Plan (the “Savings Plan”). Participants are generally 100% vested in their SERP accounts after completing 5 years of employment with the Company. During fiscal 2013 we recorded SERP expenses of $1 million. During fiscals 2012 and 2011, we recorded SERP expenses of less than $1 million, respectively. As of February 1, 2014 and February 2, 2013, the SERP liability was $3 million, respectively.
Included in our Savings Plan, we have a 401(k) salary deferral feature, company-matching contributions and a profit sharing component for eligible U.S.-based employees. Under the terms of the Savings Plan, annual employer profit sharing contributions are made at the discretion of the Board of Directors, subject to certain limitations. The Savings Plan may be terminated at our discretion. Employee eligibility for participation in the 401(k) savings account portion of the Savings Plan requires 12 months of service and completion of 1,000 hours. In addition, the Company makes a matching contribution in an amount equal to 100% of the first 4%, of the participant’s contribution. We also have various defined contribution and other foreign government sponsored retirement plans for foreign employees, which are managed by each respective foreign location. Expenses related to the Savings Plan, other foreign defined contribution plans and other foreign government sponsored retirement plans were $24 million, $25 million and $26 million in fiscals 2013, 2012 and 2011, respectively. The Board of Directors did not elect to contribute to the profit sharing portion of the Savings Plan in fiscals 2013, 2012 and 2011.
NOTE 14 - LITIGATION AND LEGAL PROCEEDINGS
On July 15, 2009, the United States District Court for the Eastern District of Pennsylvania (the “District Court”) granted the class plaintiffs’ motion for class certification in a consumer class action commenced in January 2006, which was consolidated with an action brought by two Internet retailers that was commenced in December 2005. Both actions allege that Babies “R” Us agreed with certain baby product manufacturers (collectively, with the Company, the “Defendants”) to impose, maintain and/or enforce minimum price agreements in violation of antitrust laws. In addition, in December 2009, a third Internet retailer filed a similar action and another consumer class action was commenced making similar allegations involving most of the same Defendants. In January 2011, the parties in the consumer class actions referenced above entered into a settlement agreement, which was approved by the District Court in a final approval order in December 2011. In January 2012, certain parties who objected to the District Court’s final approval of the settlement filed Notices of Appeal with the Third Circuit Court of Appeals. As part of the settlement, in March 2011, the Company made a payment of $17 million towards the overall settlement. In February 2013, the Third Circuit Court of Appeals vacated the District Court’s final approval order and remanded the case to the District Court. The Company does not reasonably believe that it will need to make any further payments in connection with any future settlement. In addition, in January 2011, the plaintiffs, the Company and certain other Defendants in the Internet retailer actions referenced above entered into a settlement agreement pursuant to which the Company made a payment of $5 million towards the overall settlement. In addition, on or about November 23, 2010, the Company entered into a Stipulation with the Federal Trade Commission (“FTC”) ending the FTC’s investigation related to the Company’s compliance with a 1998 FTC Final Order and settling all claims in full. Pursuant to the settlement, in May 2011, the Company paid $1 million as a civil penalty.
In December 2011, the Japan Fair Trade Commission (the “JFTC”) issued a cease and desist order in connection with an investigation of Toys-Japan’s potential violation of anti-monopoly laws and assessed a surcharge against Toys-Japan in the amount of $5 million, which was recorded in SG&A. We have appealed this decision to the JFTC.
In October 2012, the Massachusetts Supreme Judicial Court granted the Company’s request for direct appellate review of a judgment in the amount of $20 million, including $18 million in punitive damages, that was entered against the Company in a wrongful death products liability case entitled Aleo v. SLB Toys USA, Inc., et al. (Superior Court of Massachusetts, Essex County, No. 2008-02149-A) (the “Judgment”). Oral argument concerning this appeal was held on May 6, 2013. On September 13, 2013, the Massachusetts Supreme Judicial Court issued its decision affirming the Judgment. During fiscal 2013, we accrued an additional $20 million related to this matter which was recorded in SG&A. In October 2013, the Company paid $25 million to satisfy the Judgment.
In addition to the litigation discussed above, we are, and in the future, may be involved in various other lawsuits, claims and proceedings incident to the ordinary course of business. The results of litigation are inherently unpredictable. Any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in diversion of significant resources. We are not able to estimate an aggregate amount or range of reasonably possible losses for those legal matters for which losses are not probable and estimable, primarily for the following reasons: (i) many of the relevant legal proceedings are in preliminary stages, and until such proceedings develop further, there is often uncertainty regarding the relevant facts and circumstances at issue and potential liability; and (ii) many of these
proceedings involve matters of which the outcomes are inherently difficult to predict. However, based upon our historical experience with similar matters, we do not expect that any such additional losses would be material to our consolidated financial position, results of operations or cash flows.
NOTE 15 - COMMITMENTS AND CONTINGENCIES
We are subject to various claims and contingencies related to lawsuits as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. For claims and contingencies related to income taxes, see Note 10 entitled “INCOME TAXES.” Refer to Note 9 entitled “LEASES” for minimum rental commitments under non-cancelable operating leases having a term of more than one year as of February 1, 2014.
As of February 1, 2014, we remain contingently liable for amounts due or amounts that may become due under certain real estate lease agreements that have been assigned to third parties. In the event of default by the assignees, we could be liable for payment obligations associated with these leases which have future lease related payments (not discounted to present value) of $82 million through September 2032. The impact of these obligations is not material to our Consolidated Financial Statements.
NOTE 16 - RELATED PARTY TRANSACTIONS
The Sponsors provide management and advisory services to us pursuant to an advisory agreement executed at the closing of the merger transaction effective as of July 21, 2005 and amended June 10, 2008 and February 1, 2009 (“Advisory Agreement”). The initial term of the Advisory Agreement is ten years. After ten years, it extends annually for one year unless we or the Sponsors provide notice of termination to the other. The management and advisory fees paid to the Sponsors (the “Advisory Fees”) increase 5% per year during the ten-year term of the agreement with the exception of fiscal 2009. We recorded Advisory Fees of $22 million, $21 million and $20 million for fiscals 2013, 2012 and 2011, respectively. During fiscals 2013, 2012 and 2011, we also paid the Sponsors fees of less than $1 million, respectively, for out-of-pocket expenses.
Additionally, the Advisory Agreement provides that affiliates of the Sponsors will be entitled to receive a fee equal to 1% of the aggregate transaction value in connection with certain financing, acquisition, disposition and change of control transactions (“Transaction Fees”). The Advisory Agreement includes customary exculpation and indemnification provisions in favor of the Sponsors and their affiliates. In the event that the Advisory Agreement is terminated by the Sponsors or us, the Sponsors will receive all unpaid Advisory Fees, all unpaid Transaction Fees and expenses due under the Advisory Agreement with respect to periods prior to the termination date plus the net present value of the Advisory Fees that would have been payable for the remainder of the applicable term of the Advisory Agreement.
In connection with the Propco I Term Loan Facility entered into on August 21, 2013, we incurred Transactions Fees of $10 million pursuant to the terms of the Advisory Agreement. Investment funds or accounts advised by KKR owned an aggregate of $17 million of the Propco I Term Loan Facility as of February 1, 2014.
In connection with the New UK Propco Facility Agreement entered into on March 25, 2013, we incurred Transactions Fees of $4 million pursuant to the terms of the Advisory Agreement.
In connection with the France Propco Facility Agreement entered into on February 27, 2013, we incurred Transactions Fees of $1 million pursuant to the terms of the Advisory Agreement.
In connection with the Spain Propco Facility Agreement entered into on January 29, 2013, we incurred Transaction Fees of $1 million pursuant to the terms of the Advisory Agreement.
In connection with the offering of the 2017 Notes on August 1, 2012, we incurred Transaction Fees of $4 million pursuant to the terms of the Advisory Agreement. Investment funds or accounts advised by KKR owned an aggregate of $9 million and $14 million of the 2017 Notes as of February 1, 2014 and February 2, 2013, respectively.
In connection with the Second Joinder Agreement entered into on April 10, 2012, we incurred Transaction Fees of $2 million pursuant to the terms of the Advisory Agreement. Investment funds or accounts advised by KKR owned an aggregate of $9 million and $8 million of the Second Incremental Secured Term Loan as of February 1, 2014 and February 2, 2013, respectively.
In connection with the issuance of the Incremental Secured Term Loan on May 25, 2011, we incurred Transaction Fees of $4 million pursuant to the terms of the Advisory Agreement. Investment funds or accounts advised by KKR owned an aggregate of $50 million and $63 million of the Incremental Secured Term Loan as of February 1, 2014 and February 2, 2013, respectively.
Investment funds or accounts advised by KKR owned an aggregate of $9 million and $5 million of the Toys-Delaware Secured Notes as of February 1, 2014 and February 2, 2013, respectively. In addition, investment funds or accounts advised by KKR owned an aggregate of $70 million and $67 million of the Secured Term Loan Facility as of February 1, 2014 and February 2, 2013, respectively. Additionally, investment funds or accounts advised by KKR owned an aggregate of $5 million of the Propco II Notes as of February 1, 2014 and February 2, 2013, respectively. For further details, see Note 2 entitled “SHORT-TERM BORROWINGS AND LONG-TERM DEBT.”
From time to time, we and our subsidiaries, as well as the Sponsors or their affiliates, may acquire debt or debt securities issued by us or our subsidiaries in open market transactions, tender offers, exchange offers, privately negotiated transactions or otherwise. During fiscals 2013, 2012 and 2011, affiliates of Vornado and investment funds or accounts advised by KKR held debt and debt securities issued by the Company and its subsidiaries. The interest amounts paid on such debt and debt securities held by related parties were $10 million, $8 million and $14 million in fiscals 2013, 2012 and 2011, respectively.
Additionally, under lease agreements with affiliates of Vornado, we paid an aggregate amount of $8 million, $10 million and $9 million in fiscals 2013, 2012 and 2011, respectively, with respect to 0.8%, 0.9% and 0.9%, respectively, of our operated stores, which include Express stores. Of the aggregate amount paid in fiscals 2013, 2012 and 2011, $2 million, respectively, was allocable to joint-venture parties not otherwise affiliated with Vornado.
Each of the Sponsors, either directly or through affiliates, has ownership interests in a broad range of companies (“Portfolio Companies”) with whom we may from time to time enter into commercial transactions in the ordinary course of business, primarily for the purchase of goods and services. We believe that none of our transactions or arrangements with Portfolio Companies are significant enough to be considered material to the Sponsors or to our business.
Subsequent Event
In connection with the amendment and restatement of the ABL Facility on March 21, 2014, we incurred Transaction Fees of $19 million pursuant to the terms of the Advisory Agreement.
NOTE 17 - ACQUISITIONS
On October 31, 2011, the Company acquired a 70% ownership interest in Labuan from Li & Fung for a purchase price of $79 million (including a $10 million hold back) plus $8 million of contingent consideration. The terms of the agreement provide us with the future option to acquire Li & Fung’s 30% interest in the business and also provide Li & Fung the option to require us to buy their 30% interest in the business at the end of three years from the acquisition date.
During fiscal 2012, the Company paid $5 million of contingent consideration related to the Labuan acquisition. The Company did not make any payments during fiscal 2013. In accordance with the purchase agreement, the remaining $3 million of contingent consideration will be paid out in subsequent periods based on the future financial performance of Labuan and is included within Other long term liabilities in our Consolidated Balance Sheets as of February 1, 2014 and February 2, 2013.
In addition, during fiscal 2012, in accordance with the purchase agreement, the Company paid $10 million of the purchase price related to the Labuan acquisition to Li & Fung as it was determined that the business had been appropriately delivered in the agreed upon financial condition.
The acquisition of Labuan was accounted for under the acquisition method of accounting. As such, the cost to acquire Labuan was allocated to the respective assets acquired and liabilities assumed based on their fair values as of the acquisition date. The following table summarizes our final purchase price allocation of the cost to acquire Labuan:
Of the $64 million allocated to goodwill, none will be deductible for tax purposes. All of the goodwill acquired in connection with the Labuan acquisition has been allocated to the Company’s International segment.
Goodwill represents the excess of fair value of the acquiree over the recognized bases of net identifiable assets acquired and includes the future economic benefits from other assets that could not be individually identified and separately recognized. Specifically, the goodwill recorded as part of the Labuan acquisition includes: the expected synergies resulting from combining the resources of the acquired business with those of the Company; and the value associated with an established retail presence with the potential to further penetrate into emerging international markets.
In connection with the acquisition, the Company recorded $48 million of intangible assets related to a reacquired license right associated with a pre-existing license agreement between the Company and Li & Fung. The reacquired license right has a finite life and will be amortized over the remaining contractual term without consideration to any contractual renewals through 2019.
As a result of the acquisition, the Company recognized Noncontrolling interest in the amount of $24 million which was measured at fair value at the acquisition date. In accordance with the terms of the agreement, the Noncontrolling interest is redeemable for cash or common stock of the Company at the option of the holder. As such, the Noncontrolling interest has been recorded in temporary equity. See Note 1 entitled “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” for a reconciliation of the change in Noncontrolling interest to redemption value as of February 1, 2014 and February 2, 2013.
NOTE 18 - RECENT ACCOUNTING PRONOUNCEMENTS
In July 2013, the FASB issued ASU No. 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” (“ASU 2013-11”). ASU 2013-11 addresses the diversity in practice regarding financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The guidance requires an unrecognized tax benefit, or a portion of, to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. To the extent the deferred tax asset is not available at the reporting date to settle any additional income taxes that would result from the disallowance of a tax position; the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with the deferred tax asset. The amendments in this standard are effective for reporting periods beginning after December 15, 2013, with early adoption permitted. The adoption of ASU 2013-11 is not expected to have a material impact on our Consolidated Financial Statements.
In April 2013, the FASB issued ASU No. 2013-07, “Presentation of Financial Statements (Topic 205): Liquidation Basis of Accounting” (“ASU 2013-07”). ASU 2013-07 clarifies when an entity should apply the liquidation basis of accounting and provides principles for the measurement of associated assets and liabilities, as well as required disclosures. The amendments in this standard are effective prospectively for entities that determine liquidation is imminent for reporting periods beginning after December 15, 2013, with early adoption permitted. The adoption of ASU 2013-07 is not expected to have a material impact on our Consolidated Financial Statements.
In March 2013, the FASB issued ASU No. 2013-05, “Foreign Currency Matters (Topic 830): Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity” (“ASU 2013-05”). ASU 2013-05 provides clarification regarding whether Subtopic 810-10, Consolidation - Overall, or Subtopic 830-30, Foreign Currency Matters - Translation of Financial Statements, applies to the release of cumulative translation adjustments into net income when a reporting entity either sells a part or all of its investment in a foreign entity or ceases to have a controlling financial interest in a subsidiary or group of assets that constitute a business within a foreign entity. The amendments in this ASU are effective prospectively for reporting periods beginning after December 15, 2013, with early adoption permitted. The adoption of ASU 2013-05 is not expected to have a material impact on our Consolidated Financial Statements.
In February 2013, the FASB issued ASU No. 2013-04, “Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date” (“ASU 2013-04”). ASU 2013-04 provides guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this ASU is fixed at the reporting date. The guidance requires an entity to measure those obligations as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors as well as any additional amount the reporting entity expects to pay on behalf of its co-obligors. ASU 2013-04 also requires an entity to disclose the nature and amount of those obligations. The amendments in this ASU are effective for reporting periods beginning after December 15, 2013, with early adoption permitted. Retrospective application is required. The adoption of ASU 2013-04 is not expected to have a material impact on our Consolidated Financial Statements.
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain unaudited quarterly financial information:
(1)
Our Domestic and International businesses are highly seasonal with sales highest in the fourth quarter. During fiscals 2013, 2012 and 2011, 42%, 43% and 43%, respectively, of our total Net sales were generated in the fourth quarter. Our results of operations depend significantly upon the fourth quarter holiday selling season.
(2)
For the fourth quarter of fiscal 2013, our Net loss was impacted by Goodwill impairment of $378 million associated with our Toys-Domestic and Toys-Japan reporting units, the write-down of excess and obsolete inventory of $51 million, long-lived asset impairment of $37 million and a prior period vacation accrual correction of $17 million.
(3)
With the exception of the fourth quarter of fiscal 2012, which included 14 weeks, all other quarters presented include 13 weeks.
(4)
For the fourth quarter of fiscal 2012, our effective tax rate was unfavorably impacted by an increase to our valuation allowance of $22 million for certain state jurisdictions. The increase in our valuation allowance was predominately due to the fact that, as of the end of fiscal 2012, in certain state tax jurisdictions we have incurred a pre-tax cumulative loss (after adjustments required for tax purposes) over the past three fiscal years.
PARENT COMPANY INFORMATION
Toys “R” Us, Inc.
Schedule I - Condensed Statements of Operations and Comprehensive (Loss) Income
See accompanying notes to Condensed Financial Statements.
Toys “R” Us, Inc.
Schedule I - Condensed Balance Sheets
See accompanying notes to Condensed Financial Statements.
Toys “R” Us, Inc.
Schedule I - Condensed Statements of Cash Flows
See accompanying notes to Condensed Financial Statements.
Toys “R” Us, Inc.
Schedule I - Notes to Condensed Financial Statements
NOTE A - BASIS OF PRESENTATION
The Parent Company is a holding company that conducts substantially all of its business operations through its subsidiaries. As specified in certain of its subsidiaries’ debt agreements, there are restrictions on the Parent Company’s ability to obtain funds from certain of its subsidiaries through dividends, loans or advances (refer to Note 2 to our Consolidated Financial Statements entitled “SHORT-TERM BORROWINGS AND LONG-TERM DEBT”). Accordingly, these condensed financial statements have been presented on a “parent-only” basis. Under a parent-only presentation, the Parent Company’s investments in its consolidated subsidiaries are presented under the equity method of accounting. These parent-only financial statements should be read in conjunction with Toys “R” Us, Inc.’s audited Consolidated Financial Statements included elsewhere herein.
In connection with the July 21, 2005 Merger and subsequent reorganization, the Parent Company borrowed $770 million and received a promissory note of $887 million (£509 million) as a dividend from its indirect wholly-owned subsidiary, Toys “R” Us (UK) Limited (“Toys Limited”). On January 25, 2012 the $770 million intercompany note payable to Toys Limited was amended to translate the outstanding principal and accrued interest on that date to pounds sterling.
As of February 1, 2014, Investments in and advances to subsidiaries, net included the outstanding net intercompany receivable balance from Toys Limited of $179 million. Additionally included within Investments in and advances to subsidiaries, net, is an intercompany payable of $381 million to Toys-Delaware, which includes $45 million of accrued interest in fiscal 2013 related to Parent Company’s net intercompany payable balance. As of February 1, 2014, an outstanding short term loan of $316 million to Delaware was recorded in Due from subsidiary.
In addition, the Investments in and advances to subsidiaries, net, included investments in subsidiaries, net, which declined in fiscal 2013 given our subsidiaries’ results of operations.
As of February 2, 2013, Investments in and advances from subsidiaries, net included the outstanding net intercompany receivable balance from Toys Limited of $189 million. Additionally included within Investments in and advances from subsidiaries, net, is an intercompany payable of $631 million to Toys-Delaware, which includes $35 million of accrued interest in fiscal 2012 related to Parent Company’s net intercompany payable balance. As of February 2, 2013, the intercompany payable balance also reflects an outstanding loan of $22 million due from Toys-Delaware. During fiscal 2012, Toys-Delaware advanced us an aggregate of $265 million, which are recorded as long-term loans.
During fiscal 2011, we received a $63 million non-cash dividend from our subsidiary Toys “R” Us - Value, Inc. (“TRU-Value”) of its intercompany receivable due from Toys-Delaware.
For fiscals 2013 and 2012, the income tax expense of $169 million and $53 million, respectively, and income tax benefit for fiscal 2011 of $1 million, represents the Parent Company’s consolidated income tax expense (benefit). Such amounts include income tax expense of $127 million, $105 million and $33 million, respectively, related to our subsidiaries, which have not been consolidated for this presentation. The Parent Company is responsible for cash income tax payments on the separate company income of such subsidiaries for United States Federal and certain state filings.
During fiscal 2011, we acquired from unaffiliated parties $36 million face value debt securities of Vanwall for $26 million which are included in Other assets within the Condensed Balance Sheet of the Parent Company, classified as held-to-maturity debt and reported at amortized cost. These debt securities were repaid during fiscal 2013 in conjunction with the refinancing of the UK senior and junior credit facilities. Refer to Note 2 to our Consolidated Financial Statements entitled “SHORT-TERM BORROWINGS AND LONG-TERM DEBT” for further details.
NOTE B - DEBT
A summary of the Parent Company’s Long-term debt as of February 1, 2014 and February 2, 2013 is outlined in the table below:
(1)
Represents obligations of Toys “R” Us, Inc. and Toys-Delaware.
The total fair values of the Parent Company’s Long-term debt, with carrying values of $872 million at February 1, 2014 and February 2, 2013, respectively, were $687 million and $829 million, respectively. The fair values of the Parent Company’s Long-term debt are estimated using the quoted market prices for the same or similar issues and other pertinent information available to management as of the end of the respective periods.
The annual maturities of the Parent Company’s Long-term debt at February 1, 2014 are as follows:
The Parent Company is a co-obligor of the outstanding debentures due fiscal 2021, and these debt securities are included in Long-term debt within the Parent Company Condensed Balance Sheets for stand-alone reporting purposes. However, it is expected all future principal and interest payments will be funded through the operating cash flows of Toys-Delaware. During fiscals 2013, 2012 and 2011, Toys-Delaware recorded interest expense related to the outstanding debentures due fiscal 2021 of $2 million, respectively, which is reflected as part of (Deficit) Equity in pre-tax (loss) earnings of consolidated subsidiaries in the Parent Company Condensed Statements of Operations and Comprehensive (Loss) Income.
The Parent Company currently guarantees 80% of one of Toys-Japan’s installment loans, totaling ¥120 million ($1 million at February 1, 2014). This loan has an annual interest rate of 2.6%. In addition, the Parent Company has an agreement with McDonald’s Japan, in which the Parent Company promises to reimburse McDonald’s Japan for any amounts it may be required to pay in connection with its guarantees of the remaining 20% of the loan. Additionally, the Parent Company provides guarantees related to the uncommitted credit lines of Labuan in an aggregate amount up to HK$288 million ($37 million at February 1, 2014) for future borrowings. During fiscal 2012, the Parent Company provided the lenders of the Spain Propco Facility Agreement entered into on January 29, 2013 with a deficiency guarantee with respect to certain losses the lenders may suffer in certain circumstances.
For a discussion of the debt obligations of the Parent Company and its subsidiaries, see Note 2 to the Consolidated Financial Statements entitled “SHORT-TERM BORROWINGS AND LONG-TERM DEBT.”
NOTE C - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
We are exposed to market risk from potential changes in interest rates and foreign currency exchange rates. We regularly evaluate our exposure and enter into derivative financial instruments to economically manage these risks. We record all derivatives as either assets or liabilities on the Parent Company Condensed Balance Sheets measured at estimated fair value and we do not offset assets and liabilities with the same counterparty. We recognize the changes in fair value as unrealized gains and losses. The recognition of these gains and losses depends on our intended use of the derivatives and the resulting designation. In certain defined conditions, a derivative may be specifically designated as a hedge for a particular exposure.
Interest Rate Contracts
We and our subsidiaries have a variety of fixed and variable rate debt instruments and are exposed to market risks resulting from interest rate fluctuations. We enter into interest rate swaps and/or caps to reduce our exposure to variability in expected future cash outflows attributable to the changes in LIBOR rates. Some of our interest rate contracts may contain credit-risk related contingent features and are subject to master netting arrangements. As of February 1, 2014, our interest rate contracts have maturity dates through April 2015.
At February 1, 2014 and February 2, 2013, we had no derivative liabilities related to agreements that contain credit-risk related contingent features. As of February 1, 2014 and February 2, 2013, we were not required to post collateral with any derivative counterparties.
The following table presents our outstanding interest rate contracts as of February 1, 2014 and February 2, 2013:
(1) These interest rate caps are not designated as cash flow hedges in accordance with ASC 815.
Foreign Exchange Contracts
We occasionally enter into foreign currency forward contracts to economically hedge our short-term, cross-currency intercompany loans with our foreign subsidiaries. We enter into these contracts in order to reduce our exposure to the variability in expected cash outflows attributable to changes in foreign currency rates. These derivative contracts are not designated as hedges and are recorded on the Parent Company Condensed Balance Sheets at fair value with a gain or loss recorded on the Parent Company Condensed Statements of Operations and Comprehensive (Loss) Income in Interest expense, net. At February 1, 2014 and February 2, 2013, we had no outstanding foreign exchange contracts.
Our foreign exchange contracts typically mature within 12 months. Some of these contracts may contain credit-risk related contingent features and are subject to master netting arrangements. Some of these agreements contain provisions where we could be declared in default on our derivative obligations if we default on certain specified indebtedness. At February 1, 2014 and February 2, 2013, derivative liabilities related to agreements that contain credit-risk related contingent features had a fair value of less than $1 million, respectively. We are not required to post collateral for these contracts.
The following table sets forth the net impact of the effective portion of Parent Company’s derivatives on Accumulated other comprehensive (loss) income for the fiscal years ended February 1, 2014, February 2, 2013 and January 28, 2012:
The following table sets forth the impact of derivatives on Interest expense, net on the Parent Company Condensed Statements of Operations and Comprehensive (Loss) Income for the fiscal years ended February 1, 2014, February 2, 2013 and January 28, 2012:
(1)
Gains and losses related to our short-term, intercompany loan foreign exchange contracts are recorded in Interest expense, net, in addition to the corresponding foreign exchange gains and losses related to our short-term, cross-currency intercompany loans. For further details related to gains and losses resulting from foreign currency transactions, refer to Note 1 to our Consolidated Financial Statements entitled “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.”
The following table contains the notional amounts and fair values of Parent Company’s outstanding derivative contracts as of February 1, 2014 and February 2, 2013:
Refer to Note 3 to our Consolidated Financial Statements entitled “DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES” for further details on derivative instruments.
Offsetting of Derivatives
We present our derivatives at gross fair values in the Parent Company Condensed Balance Sheets. However, some of our interest rate and foreign exchange contracts are subject to master netting arrangements which allow net settlements under certain conditions. As of February 1, 2014 and February 2, 2013, the aggregate gross fair value of derivative liabilities which could be net settled against our derivative assets were nominal, respectively, and the aggregate gross fair value of derivative assets which could be net settled against our derivative liabilities were nominal, respectively. As of February 1, 2014 and February 2, 2013, none of the master netting arrangements involved collateral.
NOTE D - COMMITMENTS AND CONTINGENCIES
Although the Parent Company does not currently have material legal proceedings pending against us, we may be subject to various claims and contingencies related to lawsuits, as well as commitments under contractual and other obligations. Refer to Note 14 to our Consolidated Financial Statements entitled “LITIGATION AND LEGAL PROCEEDINGS” for further information. Additionally, the Parent Company is a guarantor on certain leases entered into by its subsidiaries. For a discussion of the lease obligations of the Parent Company and its subsidiaries, see Note 9 to our Consolidated Financial Statements entitled “LEASES.”
NOTE E - DISTRIBUTIONS AND CAPITAL CONTRIBUTIONS
Distributions
The Parent Company received cash distributions (inclusive of returns of capital) from certain of its subsidiaries of $202 million, $203 million and $680 million during fiscals 2013, 2012 and 2011, respectively. The cash distributions received included $79 million, $129 million and $616 million, in fiscals 2013, 2012 and 2011, respectively, from our subsidiary Toys-Delaware. During fiscal 2011, the cash distributions received from Toys-Delaware included $519 million for the repayment of the 7.625% notes due in fiscal 2011. Additionally, during fiscal 2011, TRU-Value issued a $63 million non-cash distribution of a portion of its intercompany receivable due from Toys-Delaware to Parent Company.
The cash distributions received also included $123 million, $72 million and $64 million, in fiscals 2013, 2012 and 2011, respectively, from certain of our property subsidiaries, which included returns of capital of $109 million, $10 million and $4 million, respectively. The cash distributions received during fiscals 2013, 2012 and 2011 from our property subsidiary TRU Propco I were $115 million, $64 million and $58 million, respectively.
Capital Contributions
During fiscal 2013, Parent Company made a capital contribution of $274 million to Toys Europe, which it used in connection with the refinancing of the UK real estate credit facility. Additionally, during fiscal 2013, Parent Company made a capital contribution of $10 million to Toys Europe to assist in the funding of the new Spain Propco Facility Agreement debt repayment for the fourth quarter of fiscal 2013. During fiscal 2012, Parent Company made a capital contribution of $30 million to Toys Europe, which it used in connection with the refinancing of the Spain Propco Facility. Refer to Note 2 to our Consolidated Financial Statements entitled “SHORT-TERM BORROWINGS AND LONG-TERM DEBT” for further details.
Additionally, during fiscal 2012, Parent Company made a capital contribution of $5 million to TRU Asia, Ltd., which it used to pay contingent consideration related to the Labuan acquisition. During fiscal 2011, Parent Company made a capital contribution of $79 million to TRU Asia, Ltd., which it used to acquire a 70% interest in Labuan. Refer to Note 17 to our Consolidated Financial Statements entitled “ACQUISITIONS” for further details.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
(a) Disclosure Controls and Procedures
Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including the principal executive and principal financial officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.
We have evaluated, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act as of the end of the fiscal year covered by this annual report.
Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of the end of the fiscal year covered by this Annual Report on Form 10-K to accomplish their objectives at the reasonable assurance level.
(b) Management’s Annual Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Securities Exchange Act Rule 15d-15(f). Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements for external purposes in accordance with United States Generally Accepted Accounting Principles.
Under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, we conducted an assessment of the design and effectiveness of our internal control over financial reporting as of the end of the fiscal year covered by this report based on the framework issued by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission in Internal Control-Integrated Framework (1992).
Based on this assessment, management concluded that, as of February 1, 2014, the Company’s internal control over financial reporting was effective.
Deloitte & Touche LLP, an independent registered public accounting firm which has audited and reported on the financial statements contained in this Annual Report on Form 10-K, has issued its written attestation report on the Company’s internal control over financial reporting which is included in this Annual Report on Form 10-K.
(c) Change in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during our fourth quarter of fiscal 2013 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Toys “R” Us, Inc.:
We have audited the internal control over financial reporting of Toys “R” Us, Inc. and subsidiaries (the “Company”) as of February 1, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of February 1, 2014, based on the criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended February 1, 2014 of the Company and our report dated March 31, 2014 expressed an unqualified opinion on those financial statements and financial statement schedule.
/s/ Deloitte & Touche LLP
New York, New York
March 31, 2014
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors
The following persons were members of our Board of Directors (the “Board”) as of March 1, 2014. Each elected director will hold office until a successor is duly elected and qualified or until his or her earlier death, resignation or removal from office by our stockholders.
In appointing Mr. Urcelay to the Board, the Board considered the intimate knowledge of the Company’s global business and operations that Mr. Urcelay brings to the Board from his experience as the Chief Executive Officer of the Company. In addition, the Board considered his significant experience and expertise in the retail industry gained over his more than 30 years of retail and consumer goods experience, including in his various roles at Toys “R” Us over a 17 year career. In his most recent role as President of Europe, he was responsible for the successful operation of more than 250 Toys “R” Us and Babies “R” Us
stores in eight European countries: the United Kingdom, Austria, France, Germany, Poland, Portugal, Spain and Switzerland. This included providing leadership in asserting the company’s global status as the toy and juvenile products authority through marketing, merchandising, e-commerce, store support and customer service excellence. In 2011, Mr. Urcelay directed the company’s market entry into Poland, providing the gateway for potential further expansion in Europe.
In electing Mr. Markee to the Board, the Board considered his significant experience and expertise in the retail industry including his prior service as Chief Executive Officer of the Vitamin Shoppe and his prior service with the Company in which he served in a number of capacities, including serving as Vice Chairman from 2004 to 2006 and interim Chief Executive Officer from 2005 to 2006.
Other than Messrs. Urcelay, Goodman and Markee, each of the Directors was elected to the Board pursuant to a stockholders agreement dated July 21, 2005 by and among the Company, Bain, KKR and Vornado (collectively, the “Sponsors”) and a private investor (the “Stockholders’ Agreement”). Pursuant to such agreement, Messrs. Bekenstein, Levin and Why were appointed to the Board as a consequence of their respective relationships with Bain; Messrs. Calbert, Waglay and Taylor were appointed to the Board as a consequence of their respective relationships with KKR; and Ms. Silverstein and Messrs. Macnow and Guglielmone were appointed to the Board as a consequence of their respective relationships with Vornado. Mr. Goodman was appointed to the Board based upon his significant business experience including his extensive knowledge of financial statements and reporting.
Executive Officers
The following persons were our Executive Officers as of March 1, 2014, having been elected to their respective offices by the Board:
Name
Age
Position with the Registrant
Antonio Urcelay (1)
Chairman of the Board; Chief Executive Officer
F. Clay Creasey, Jr.
Executive Vice President - Chief Financial Officer
Richard Barry
Executive Vice President - Chief Merchandising Officer
Deborah Derby
Vice Chairman and Executive Vice President
Dr. Wolfgang Link
President - Toys “R” Us, Europe
Monika M. Merz
President - Toys “R” Us, Asia Pacific
Harry J. Mullany III
President - Toys “R” Us, U.S.
David J. Schwartz
Executive Vice President - General Counsel & Corporate Secretary
(1)
See “Directors” above for Mr. Urcelay’s biography.
The following is a brief description of the business experience of each of our Executive Officers:
Mr. Creasey has served as our Executive Vice President - Chief Financial Officer since May 2006. From July 2005 to April 2006, Mr. Creasey served as Chief Financial Officer of Zoom Systems, an automated retailer. Prior to that, Mr. Creasey served in various roles at Mervyn’s, a subsidiary of Target, from 1992 to 2005, most recently as Senior Vice President, Finance and Chief Financial Officer from 2000 to 2005.
Mr. Barry has served as our Executive Vice President - Chief Merchandising Officer since October 2012. From January 2012 to October 2012, Mr. Barry served as Senior Vice President - Chief Merchandising Officer. From March 2010 to January 2012, Mr. Barry served as Vice President - General Merchandising Manager and from September 2006 to March 2010, he served as Vice President - Divisional Merchandising Manager.
Ms. Derby has served as our Vice Chairman and Executive Vice President since March 2013. From September 2012 to March 2013, Ms. Derby served as a consultant at Kenneth Cole Productions, Inc. From February 2009 to February 2012, Ms. Derby served as our Chief Administrative Officer. Prior to that she served as the President of Babies “R” Us from May 2006 to February 2009. Ms. Derby currently serves as a member of the Board of Directors of the Vitamin Shoppe, Inc.
Dr. Link has served as President, Toys “R” Us, Europe since October 2013. From August 2007 to October 2013, Dr. Link served as Managing Director, Toys “R” Us, Central Europe.
Ms. Merz has served as President - Toys “R” Us, Asia Pacific since November 2011. She served as the President and Chief Executive Officer of Toys “R” Us - Japan Ltd. (“Toys Japan”) from November 2007 to November 2011. From January 2000
until November 2007, Ms. Merz served as the President of Toys “R” Us Canada, Ltd. (“Toys Canada”). Prior to that, from October 1996 until January 2000, Ms. Merz served as Vice President and General Merchandise Manager for Toys Canada.
Mr. Mullany has served as President - Toys “R” Us, U.S. since November 2013. From February 2011 to March 2013, he served as Chief Executive Officer of Servicemaster Company, a provider of various services to residences and firms including home cleaning and maintenance, pest control and lawn fertilization. From January 2010 to November 2010, Mr. Mullany served as Executive Vice President and President, Wal-Mart North. From January 2006 to December 2009, he served as Senior Vice President and President, Northeast Division of Wal-Mart Stores Inc.
Mr. Schwartz has served as our Executive Vice President - General Counsel since October 2009 and has served as Corporate Secretary since April 2006. From September 2003 until October 2009, Mr. Schwartz served as Senior Vice President - General Counsel. From January 2002 until September 2003, Mr. Schwartz served as our Vice President - Deputy General Counsel, and served as Assistant Corporate Secretary from that time until April 2006. From February 2001 to January 2002, Mr. Schwartz served as our Vice President - Corporate Counsel and Assistant Corporate Secretary.
Section 16(a) Beneficial Ownership Reporting Compliance
As our equity securities are not registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), none of our directors, officers or ten percent holders were subject to Section 16(a) of the Exchange Act for the past fiscal year or the filing requirements thereof.
Code of Ethics
We have adopted a code of ethics that applies to our principal executive officer, principal financial officer and principal accounting officer or any person performing similar functions (the “Code of Ethics”). The Code of Ethics is available on the Corporate Governance page of our website at www.Toysrusinc.com. If we ever were to amend or waive any provision of our Code of Ethics, we intend to satisfy our disclosure obligations with respect to any such waiver or amendment by posting such information on our Internet website set forth above rather than by filing a Form 8-K. The Code of Ethics is also available in print, free of charge, to any investor who requests it by writing to: Toys “R” Us, Inc., One Geoffrey Way, Wayne, New Jersey 07470, Attention: Investor Relations.
Audit Committee
Our Board of Directors has a separately designated audit committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. The Audit Committee consists of Joseph Macnow, Nathaniel H. Taylor and Richard Goodman, who serves as Chairman of the Audit Committee. Our Board of Directors has determined that each member of the Audit Committee is financially literate and that Mr. Goodman is an “audit committee financial expert” within the meaning of the regulations adopted by the Securities and Exchange Commission. The Board has not made a determination as to whether any Audit Committee members are independent.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
We refer to the persons included in the Summary Compensation Table below as our “named executive officers.” References to “2013,” “2012,” and “2011” mean, respectively, our fiscal years ended February 1, 2014, February 2, 2013 and January 28, 2012, respectively.
COMPENSATION DISCUSSION AND ANALYSIS
The following Executive Compensation discussion and analysis discusses our compensation policies and decisions regarding our named executive officers and describes the material elements of compensation for our named executive officers. Our named executive officers are:
•
Antonio Urcelay, Chairman of the Board and Chief Executive Officer;
•
F. Clay Creasey, Jr., Executive Vice President - Chief Financial Officer;
•
Deborah Derby, Vice Chairman and Executive Vice President;
•
Monika M. Merz, President - Toys “R” Us, Asia Pacific;
•
Harry J. Mullany III, President - Toys “R” Us, U.S.; and
•
Gerald L. Storch, Former Chairman of the Board and Chief Executive Officer1
1 Mr. Storch transitioned from his role as Chief Executive Officer in February 2013 and continued to serve as Chairman of the Board until November 2013.
Role of Our Board of Directors in Compensation Decisions
Our Board of Directors acting through the Executive Committee pursuant to delegated authority has historically been ultimately responsible for approving both our compensation program and the specific compensation paid to each of our named executive officers. The Executive Committee, which is currently comprised of one designee from each of the three Sponsors, has discharged this responsibility pursuant to a charter approved by the Board.
Objective of Our Executive Compensation Program
The overall objective of our executive compensation program is to provide compensation opportunities that will allow us to attract and retain executive officers of a caliber and level of experience necessary to effectively manage our global business and motivate such executive officers to increase the value of our Company. We believe that, in order to achieve that objective, our program must:
•
provide each executive officer with compensation opportunities that are competitive with the compensation opportunities available to executives in comparable positions at companies with whom we compete for talent;
•
tie a significant portion of each executive officer’s compensation to our financial performance and his or her individual performance; and
•
align the interests of our executive officers with those of our equity holders.
Summary of Significant 2013 Compensation Decisions
Personnel Changes
Mr. Urcelay was promoted to Interim Chief Executive Officer in May 2013 and pursuant to a Letter Agreement between the Company and Mr. Urcelay, his salary was increased by €31,039 per month ($41,307 per month based on the Company’s average annual conversion rate in fiscal 2013) for so long as Mr. Urcelay continued to serve as head of the Company’s operating committee. In October 2013, Mr. Urcelay was appointed the Chief Executive Officer of the Company and in connection with this appointment, his annual base salary was increased to €1,000,000. In addition, Mr. Urcelay was awarded a one-time signing bonus of €250,000, was granted a one-time award of restricted stock units having a grant date fair value of $8,001,400, 50% of which will vest on the earlier of October 16, 2014 or the termination of his employment other than for cause and the remainder of which will vest in equal installments at the end of each fiscal quarter commencing January 31, 2015, with the last portion vesting on October 31, 2015, subject to continued employment through the applicable vesting dates. Mr. Urcelay will become eligible for an additional award of restricted stock units with a value of $4,000,000 in the event the Company extends his employment term from October 31, 2015 to October 31, 2016. Mr. Urcelay’s employment agreement also provides that Mr. Urcelay is eligible to earn an annual bonus award in a target amount of up to 150% of his base salary. Mr. Urcelay also became entitled to additional severance benefits and perquisites in connection with his promotion.
In November 2013, Mr. Mullany joined the Company as President - Toys “R” Us, U.S. Pursuant to his employment agreement, Mr. Mullany will be paid an annual base salary of $1,000,000 and he will be eligible to earn an annual bonus award in a target amount of up to 125% of his base salary. Mr. Mullany was also awarded a one-time signing bonus of $300,000 subject to repayment as further described in “POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL-EMPLOYMENT AGREEMENTS” below. Pursuant to the terms of his employment agreement, he received a one-time award of stock options and restricted stock units under the 2010 Incentive Plan with grant date fair values of $4,687,500 and $2,000,020, respectively, as further described in “ELEMENTS OF OUR EXECUTIVE COMPENSATION PROGRAM-LONG TERM INCENTIVES-2010 INCENTIVE PLAN” below. The restricted stock units and stock options will vest in four equal annual installments beginning on the first anniversary of the grant date, with one half of the options subject to additional performance criteria. Additionally, Mr. Mullany purchased 22,728 shares of stock under the 2010 Incentive Plan.
In March 2013, Ms. Derby rejoined the Company as Vice Chairman and Executive Vice President. She previously served as the Company’s Chief Administrative Officer from February 2009 to February 2012. Pursuant to her employment agreement, Ms. Derby’s annual salary is $700,000 and she was awarded a one-time signing bonus of $115,000. Ms. Derby’s employment agreement also provides that Ms. Derby is eligible to earn an annual bonus award in a target amount of up to 110% of her base salary. In addition, Ms. Derby was granted certain option awards as further described in “ELEMENTS OF OUR EXECUTIVE COMPENSATION PROGRAM-LONG TERM INCENTIVES-2010 INCENTIVE PLAN” below.
Mr. Storch transitioned from his role as Chief Executive Officer in February 2013 and continued to serve as Chairman of the Board until November 2013.
Transition Bonuses
In connection with the transition of Mr. Storch from his role as Chief Executive Officer of the Company, on March 11, 2013 the Company granted special transition bonuses (the “Transition Bonuses”) to senior management of the Company, including Mr.
Creasey ($1,200,000), Ms. Merz (CAD $1,298,000 ($1,300,856 based on the Company’s average annual conversion rate in fiscal 2012)) and Mr. Urcelay (€1,164,000 ($1,500,047 based on the Company’s average annual conversion rate in fiscal 2012)), payable by the Company in lump sum payments on March 11, 2015. The Executive Committee determined these awards to be advisable in promoting retention and incentivizing senior management during the transition period. A pro rata portion of the bonus will be paid to an executive officer whose employment is terminated by the Company for any reason other than “cause” (as defined in the bonus agreement) between September 11, 2014 and March 11, 2015, based on the number of full months that have elapsed since the date of grant. No special Transition Bonus will be paid to an executive officer if such executive officer’s employment is terminated by the Company for any reason prior to September 11, 2014, by the Company for “cause” (as defined in the bonus agreement) at any time, or by the executive officer prior to the payment date.
Option Exchange and Option Extensions
Commencing in November 2013, certain participants under the 2010 Incentive Plan, including the named executive officers, were offered an opportunity to exchange certain of their outstanding stock options (“Old Options”) and all outstanding performance shares or units for a grant of one new stock option (“New Options”) for every two Old Options canceled, which New Options have an exercise price of $22.00. The Executive Committee determined these awards to be advisable in promoting retention and incentivizing senior management. On December 23, 2013, the Company closed its offer and a total of 919,599 and 104,240 Old Options and performance shares or units were canceled, respectively, and a total of 459,805 New Options were issued under the 2010 Incentive Plan. See “ELEMENTS OF OUR EXECUTIVE COMPENSATION PROGRAM-2013 OPTION EXCHANGE AND OPTION EXTENSION” below for further details.
Additionally, we extended the expiration dates of certain outstanding option awards, which were originally scheduled to expire in fiscals 2015 and 2016, to August 6, 2017.
Elements of Our Executive Compensation Program
Our executive compensation program consists of the following components:
•
base salary;
•
annual incentive awards;
•
long-term incentives;
•
perquisites;
•
other benefits; and
•
benefits upon termination or change of control.
Mix of Total Compensation
Cash compensation includes base salary and annual incentive awards which, for top executive officers, are targeted to approach or exceed base salaries to emphasize performance-based compensation. Stock compensation includes long-term incentives, which provide a long-term capital appreciation opportunity to our executive compensation program. Perquisites and other types of non-cash benefits are used on a limited basis and represent a small portion of total compensation for our executive officers.
Base Salary
Base salary provides fixed compensation and is designed to reward core competence in the executive officer’s role relative to his or her skills, experience and contributions to the Company.
The Executive Committee reviews the base salary of each of our executive officers annually as part of the Company’s performance review process described below, as well as upon a promotion or other change in job responsibility. On an annual basis, the Executive Committee determines the range, if any, for merit-based increases for eligible employees of the Company (including our executive officers) based upon the recommendation of the Company’s human resources department, after taking into account a variety of factors, including the Company’s internal financial projections, the general economy and the Sponsors’ practices at companies in their investment portfolios. In formulating a proposed range of merit-based increases, the Company’s human resources department considers a number of different factors, including the Company’s budget for the year, internal financial projections and historical practice, and also reviews a number of broad-based third party surveys to gain a general background understanding of the current compensation practices and trends and a sense of the reasonableness of the proposed range.
Merit-based increases to the base salary of an executive officer are based on the Executive Committee’s assessment that the executive officer performed at or above his or her established goals. Increases in base salary due to a promotion or change in
job responsibilities are based on the Executive Committee’s assessment of the responsibilities and importance of the executive officer’s new position compared to the executive officer’s prior position.
At the beginning of each fiscal year, each of our executive officers is required to establish his or her personal business goals for the year. For fiscal 2013, the key priority was to drive relentless focus on prioritization and execution, and to put the consumer at the core of all we do. This focus is at the core of our strategic priorities for 2013, which are as follows:
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Drive Product Differentiation;
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Optimize eCommerce;
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Focus on Service and Operational Excellence;
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Design Store of the Future;
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Change Value Perception;
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Foundational Improvements; and
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Reinvigorate Juvenile.
We believe that the above criteria, when considered together, provide an appropriate method of measuring our executive officers’ personal performance.
At the beginning of each fiscal year, our Chairman and Chief Executive Officer, reviews and approves the goals developed by each of our executive officers, other than himself, and the Executive Committee reviews and approves our Chairman and Chief Executive Officer’s goals. In connection with the departure of Mr. Storch, Mr. Urcelay, as head of the Company’s operating committee, coordinated the review and approval of the goals with the Executive Committee of the Board. At the end of each fiscal year, our Chairman and Chief Executive Officer reviews the individual performance of each executive officer against his or her personal goals. Mr. Urcelay will also prepare a self-evaluation of his own performance. He then presents his conclusions and recommendations with respect to base salary adjustments to the Executive Committee. The Executive Committee considers these conclusions and recommendations when determining any adjustments to our executive officers’ base salaries.
The following table sets forth the personal business goals of our named executive officers for fiscal 2013:
Name
Personal Business Goals
Mr. Urcelay
President of Europe (February 2013 - October 2013)
• Identify and leverage potential synergies within Europe (and globally) to reduce costs and/or improve results.
• Lead the successful execution of the European strategic initiatives including; expansion into new product categories, Loyalty Card price differentiation, optimize eCommerce and Customer Relationship Management (“CRM”).
Interim Chief Executive Officer and Chief Executive Officer
• Provide day to day support and strategic direction to the Company’s senior leadership team and overall organization, including; fostering a more “guest centric” culture, stabilizing the team and optimizing the alignment of existing talent, support the successful execution of the U.S. and Asian strategic priorities.
• Explore and present to the Board of Directors, as appropriate, future potential growth/expansion opportunities.
Mr. Creasey
• Manage the optimization of inventory purchases.
• Help drive the achievement of the Company’s 2013 key initiatives focusing on reducing expenses through critical IT improvements, refinancing savings opportunities and achieving expense control totals.
• Drive real estate reviews globally to identify opportunities for profitable restructuring where appropriate.
Ms. Derby
• Manage executive transition issues working directly with our Chief Executive Officer and our Sponsors in providing support to the U.S. based Executive team.
• Partner with Sponsors on critical senior leadership changes and development opportunities.
• Partner with U.S. team to deliver the 2013 strategic initiatives and priorities.
• Stabilize organization and foster a better, more “guest centric” culture.
Ms. Merz
• Drive loyalty and CRM for all countries in Asia Pacific to implement competitive loyalty programs, improved communications through targeted marketing and expand digital marketing efforts to drive repeat purchases.
• Focus on service and operational excellence by creating interactive stores, implementing in shop special events and partnerships with third parties.
• Focus on improving real estate portfolio by opening in high traffic locations and maximize internet sales.
• Promote synergies for all countries in Asia Pacific by sharing cross functional best practices and implementing cooperation in merchandising to drive product differentiation through private label and exclusive products and lines.
As Mr. Mullany started in November 2013, there were no formal goals set for Mr. Mullany other than to oversee the U.S. operations for the holiday season and to begin developing the 2014 business strategy plan for the U.S. operations.
In fiscal 2013 and based upon performance during fiscal 2012, effective as of March 24, 2013, Mr. Creasey received an increase in salary of $20,000 from $580,000 to $600,000, and effective April 1, 2013, Ms. Merz received an increase in salary of CAD $22,000 from CAD $627,000 to CAD $649,000. In addition, Mr. Urcelay’s compensation was increased to €1,000,000 in connection with his appointment to Chief Executive Officer of the Company. Pursuant to their employment agreements, Mr. Mullany and Ms. Derby’s annual base salaries are $1,000,000 and $700,000, respectively. Due to the transitional nature of his services, Mr. Storch did not receive an increase in base salary for fiscal 2013.
In March 2014, and based upon fiscal 2013 performance, the Executive Committee determined that there would be no increase in the annual base salaries of our named executive officers.
Annual Incentive Awards
Annual incentive awards are an important part of the overall compensation we pay our executive officers. Unlike base salary, which is fixed, the annual incentive awards are paid only if specified performance levels are achieved during the year. We believe that annual incentive awards encourage our executive officers to focus on specific short-term business and financial goals of the Company. Our executive officers receive annual cash incentive awards under the Toys “R” Us, Inc. Management Incentive Plan (the “Management Incentive Plan”).
Under the Management Incentive Plan, each executive officer has an annual incentive target payout expressed as a percentage of his or her base salary. The target bonus payouts as a percentage of base salary for our named executive officers were established in their employment agreements and may be subsequently adjusted based upon performance and/or a promotion in responsibility. Our named executive officers’ 2013 annual incentive award target payouts, expressed as a percentage of base salary, are as follows: for Mr. Urcelay 110% (February 2013 - October 2013) and 150% (November 2013 - January 2014), for Ms. Derby and Ms. Merz, 110%; and for Mr. Creasey, 100%. Mr. Mullany was hired in November 2013 and is not eligible for an annual incentive award in fiscal 2013. Due to the transitional nature of his services, Mr. Storch was not eligible for an annual incentive award in fiscal 2013.
The 2013 annual incentive target payout was weighted 80% on the Company’s financial performance (“Financial Component”) and 20% on the executive officer’s personal performance (“Personal Component”). We believe that weighting the executive officers’ annual incentive awards in this way aligns the interests of our executive officers with the interests of our equity holders by motivating the executive officers to increase the shareholder value of the Company as a whole, while also rewarding each of the executive officers for his or her individual performance.
The Financial Component is based on a combination of both: (i) the Adjusted Compensation EBITDA results for the Company as a whole and for one or more segments or business units of the Company and (ii) cash flow for the Company as a whole and for one or more segments or business units of the Company (for purposes of France, the financial component utilizes the metric return on invested capital (“ROIC”) instead of cash flow). We calculate Adjusted Compensation EBITDA for this purpose, as earnings before interest, income taxes, depreciation and amortization, further adjusted for the effects of specified period charges and gains or losses, including, among others, changes in foreign currency, noncontrolling interest, gains or losses on liquidations of subsidiaries or sales of properties, asset impairments and accounting changes. More detail about the calculation of Adjusted Compensation EBITDA is set forth below. Cash Flow is defined as EBITDA less Capital Expenditure and the change in Working Capital. We calculate ROIC by dividing Adjusted Compensation EBITDA (minus annual depreciation and amortization) by our average invested capital (which includes the aggregate of Net Property, Plant and Equipment, Inventory, Accounts Receivable, Prepaid Expenses and Goodwill minus the aggregate of Accounts Payable and Accrued Expenses).
We believe that focusing the Financial Component on Adjusted Compensation EBITDA and Cash Flow closely aligns the executive officers’ interests with those of our equity holders. The Adjusted Compensation EBITDA and Cash Flow targets for the Company as a whole and each segment or business unit are established by the Executive Committee when it establishes our business plan as part of our annual financial planning process, during which we assess the future operating environment and build projections of anticipated results.
The specific combination of Adjusted Compensation EBITDA measures that make up the Financial Component for a particular named executive officer relates to his or her primary job responsibilities as indicated in the chart below:
(1)During this time, Mr. Urcelay served as President of Europe. His adjusted compensation EBITDA included United Kingdom, Iberia, France, Central Europe and Canada; all weighted equally at 11.25%. International Cash Flow also included United Kingdom, Iberia, Central Europe and Canada; all weighted equally at 3.75%. In the case of France, ROIC was weighted at 3.75%.
(2)Mr. Mullany was hired in November 2013 and was not eligible for an annual incentive payout for fiscal 2013.
(3)Ms. Merz’s Adjusted Compensation EBITDA includes Japan, Toys (Labuan) Holding Limited (“Labuan”) and Australia weighted at 42.19%, 8.44% and 5.63%, respectively. International Cash Flow also includes Japan, Labuan and Australia, weighted at 14.06%, 2.81% and 1.88%, respectively. For purposes of fiscal 2013, the Company did not
utilize the Cash Flow of Labuan in determining the Cash Flow metric but rather utilized the Adjusted Compensation EBITDA.
(4)Other than Mr. Urcelay (for the period of February 2013 to October 2013) and Ms. Merz, all other named executive officers were subject to the Domestic metrics for EBITDA and Cash Flow.
We believe that these Financial Component weightings motivate our executive officers to work to improve the Company with appropriate emphasis on business unit results as the executive’s job responsibilities merit.
The Executive Committee sets the threshold, target and maximum payout levels for the Financial Component of the Management Incentive Plan. Achievement at the respective levels would result in a payout at, above or below the target level (that is, 80% (the portion based on the Financial Component) of the executive officer’s annual incentive target payout in fiscal 2013). If the actual Adjusted Compensation EBITDA and Cash Flow (or in the case of France, ROIC) performance is less than the minimum threshold, no amount will be earned with respect to that portion of the Financial Component of the Management Incentive Plan. If the actual Adjusted Compensation EBITDA and Cash Flow (or in the case of France, ROIC) performance is greater than 100% of the target, the executive officer’s total payout with respect to that portion of the Financial Component of the Management Incentive Plan will be greater than target (that is, 80% for all officers) and is capped at 300% of target of that portion of the Financial Component target. Straight interpolation determines the bonus payout for performance which falls between the threshold and target or between the target and maximum.
The Personal Component of the annual incentive under the Management Incentive Plan is based on each executive officer’s individual performance measured against his or her personal business goals (as further described in the “-BASE SALARY” section above), as assessed as part of the Company’s performance review process described under “-BASE SALARY” above. The Executive Committee sets the threshold and maximum payout levels for the Personal Component of the Management Incentive Plan. The Executive Committee typically first determines an average payout percentage of the Personal Component of the annual incentive target for all eligible employees at the Company (including our executive officers) and then determines the actual payout of the Personal Component portion of each executive officer’s annual incentive target, after considering the conclusions and recommendations provided by Mr. Urcelay with respect to executive officers other than himself. An executive officer’s payout with respect to the Personal Component of the Management Incentive Plan (that is, 20% of his or her annual incentive target payout) is capped at 200% of target. The Executive Committee also considers how the payouts to the executive officers will affect the payouts for all eligible employees because percentage payouts to employees (including our executive officers) must equal the average payout percentage determined by the Executive Committee. If 80% of the Financial Component target is not met, the Board has the discretion to fund the Personal Component at a level they determine appropriate. For fiscal 2013, the Board used its discretion in funding the Personal Component at 90% for markets that met or exceeded the targets for their financial metrics of Country EBITDA and Country Cash Flow. In the United States, we did not fund the Personal or Financial Components.
Notwithstanding the formulas described above for the Management Incentive Plan, the Executive Committee has the discretion to adjust the Personal Component and/or Financial Component payouts for all participants (which includes our executive officers) of the Management Incentive Plan. For fiscal 2013, the Executive Committee set the Personal Component payout ranges based upon the respective performance rating that each executive officer received.
The Adjusted Compensation EBITDA targets for fiscal 2013 were: $953,000,000 for the Company as a whole; $751,700,000 for our Domestic segment; $451,700,000 for our International segment; $54,300,000 for the United Kingdom, $64,000,000 for Central Europe; $53,900,000 for France; $40,200,000 for Iberia; $(5,400,000) for Australia, $110,000,000 for Canada; $32,736,000 for Labuan and $95,800,000 for Japan (in each case using the budgeted conversion rate of 1 GBP = $1.5693, 1 EURO = $1.3640, 1 AUD = $1.0407, 1 CAD = $1.0035, 1 CNY = $0.1605 and 1 JPY = $0.01078).
In fiscal 2013, the actual consolidated Adjusted Compensation EBITDA for the Company as a whole was higher than our Adjusted EBITDA due to adjustments of $20 million primarily related to the difference between the previous year’s period-end foreign currency translation rates and the actual foreign currency translation impact on our results of operations and fixed assets write-offs. In fiscal 2013, the actual consolidated Adjusted Compensation EBITDA results were $464,600,000 for our Domestic segment; and $380,600,000 for our International segment. The following businesses of our International segment had the following Adjusted Compensation EBITDA results: $42,200,000 for the United Kingdom, $60,200,000 for Central Europe, $41,700,000 for France, $38,100,000 for Iberia, $(2,700,000) for Australia, $100,400,000 for Canada, $34,388,000 for Labuan and $57,800,000 for Japan. For more information on calculation of our Adjusted EBITDA, see Note 5 of Item 6 entitled “SELECTED FINANCIAL DATA” of this Annual Report on Form 10-K.
The Cash Flow targets for fiscal 2013 were: $720,100,000 for the Company as a whole; $638,300,000 for our Domestic segment; $248,200,000 for our International segment; $58,600,000 for the United Kingdom, $31,400,000 for Central Europe; $41,100,000 for Iberia; $(11,700,000) for Australia, $75,400,000 for Canada and $75,600,000 for Japan (in each case using the
budgeted conversion rate of 1 GBP = $1.5693, 1 EURO = $1.3640, 1 AUD=$1.0407, 1 CAD=$1.0035 and 1 JPY = $0.01078). The ROIC target for France in fiscal 2013 was 17.9%.
In fiscal 2013, the actual consolidated Cash Flow results were $431,000,000 for our Domestic segment and $272,700,000 for our International segment. The following businesses of our International segment had the following Cash Flow results: $50,800,000 for the United Kingdom, $48,500,000 for Central Europe, $41,500,000 for Iberia, $(1,400,000) for Australia, $72,900,000 for Canada and $72,200,000 for Japan. The actual ROIC result for France in fiscal 2013 was 13.7%.
In addition, the Executive Committee approved the following percentage payouts for fiscal 2013 with respect to the Personal Component for each of the named executive officers: 120.5% for Mr. Urcelay for his time spent as President of Europe and 0% for his time as CEO and 0% for Mr. Creasey, Ms. Derby and Ms. Merz.
The following table illustrates the calculation of each named executive officer’s annual incentive payouts for fiscal 2013, if any, in light of the performance results and decisions discussed above:
(1)Mr. Urcelay’s bonus target payout is weighted to reflect the period from February 2013 to October 2013 at a bonus target of 110% and the period from November 2013 to January 2014 at a bonus target of 150%.
(2)Mr. Mullany was hired in November 2013 and was not eligible for an annual incentive payout for fiscal 2013. Due to the transitional nature of his services, Mr. Storch was not eligible for an annual incentive award in fiscal 2013.
The “Grants of Plan-Based Awards in Fiscal 2013” table shows the threshold, target and maximum Management Incentive Plan awards that each of our named executive officers was eligible to receive in fiscal 2013. The actual payouts under the Management Incentive Plan awards actually earned by our named executive officers in fiscal 2013 are shown above and in the “Non-Equity Incentive Plan Compensation” column of the “SUMMARY COMPENSATION TABLE” below.
For fiscal 2014, the Executive Committee of the Board has modified the methodology for determining the amount of the pay-out for both the Financial Component and the Personal Component, which will continue to be weighted at 80% and 20%, respectively. The funding for the Financial Component (based on the actual financial performance achievement) will now be combined with any individual performance funding for all officers to create a bonus pool that will be discretionarily awarded to officers based on their individual performance.
Long-Term Incentives
We believe that providing long-term incentives as a component of compensation helps us to attract and retain our executive officers. These incentives also align the financial rewards paid to our executive officers with the Company’s long-term performance, thereby encouraging our executive officers to focus on the Company’s long-term goals. Since the Merger, the Executive Committee has offered long-term incentives under the Toys “R” Us, Inc. Management Equity Plan (the “Management Equity Plan”) and the Toys “R” Us, Inc. 2010 Incentive Plan (the “2010 Incentive Plan”), as further described below. For a description of awards made in fiscal 2013 under the 2010 Incentive Plan, see “-THE 2010 INCENTIVE PLAN” section and “GRANTS OF PLAN-BASED AWARDS IN FISCAL 2013” table below.
Management Equity Plan
During fiscal 2013, no named executive officer was granted an equity award pursuant to the Management Equity Plan. In fiscal 2012, we amended the Management Equity Plan to (i) provide for, among other things, a longer exercise period, expiring no later than the original term of the option, and the right to a cashless exercise of options held by a participant who is terminated without cause after four or more years of continuous service and (ii) allow any plan participant, as long as he or she remains employed by the Company or its affiliates, the right to put up to 25%, calculated as provided in the amendment, of his or her
Original Investment Shares, the number of shares that would be equal to the value of their original investment to us, during permitted transaction windows, until the occurrence of an initial public offering of the Company. In early fiscal 2013, we further amended the Management Equity Plan to allow certain plan participants the right to put to the Company (i) in 2013, up to 50%, calculated as provided in the amendment, of his or her Original Investment Shares held at March 1, 2013 and (ii) in 2014, any or all of the participant’s then remaining Original Investment Shares, in each case, during permitted transaction windows, until the occurrence of an initial public offering of the Company. For more information about the Management Equity Plan, see “NARRATIVE SUPPLEMENT TO THE SUMMARY COMPENSATION TABLE AND THE GRANTS OF PLAN-BASED AWARDS IN FISCAL 2013 TABLE” below.
The 2010 Incentive Plan
In fiscal 2010, our Board adopted the 2010 Incentive Plan. The purpose of the 2010 Incentive Plan is to promote our success, and enhance our value, by providing us with the flexibility to motivate, attract, and retain the services of our employees, officers, directors, and consultants and linking the interests of such persons to those of our stockholders through the granting of incentive awards from time to time to such persons and by providing them with an incentive for outstanding performance.
The 2010 Incentive Plan is an omnibus plan that provides for the granting of stock options, stock appreciation rights, restricted stock, restricted and deferred stock units, performance awards, dividend equivalents and other stock or stock based awards. The 2010 Incentive Plan provides that the total number of shares of our common stock that may be issued is 3,750,000 and the maximum number of such shares of our common stock for which incentive stock options may be granted is 500,000. Shares of common stock covered by awards that are terminated, canceled, forfeited or settled in cash, lapse without the payment of consideration, or are otherwise withheld, repurchased or not issued, may be granted again under the 2010 Incentive Plan. Generally, an unexercised or restricted award will not be transferable or assignable by a participant other than to the Company or an affiliate or by will or by the laws of descent and distribution.
Fiscal 2013
In December 2012, our management retained the services of the Hay Group to provide us insight regarding market practice including base salary competitiveness, bonus target and actual awards eligibility and long term incentive award targets and eligibility. Management reviewed the prevalent practice based upon a peer group consisting of the following 20 retailers: Amazon.com, Best Buy Co., Inc., Dick’s Sporting Goods, Inc., Dollar General Corporation, The Gap, Inc., The Home Depot, Inc., J.C. Penney Company, Inc., Kohl’s Corporation, Limited Brands, Inc., Lowe’s Companies, Inc., Macy’s, Inc., Michaels Stores, Inc., Nordstrom, Inc., Office Depot, Inc., OfficeMax Incorporated, PetSmart, Inc., Ross Stores, Inc., Staples, Inc., Target and The TJX Companies, Inc. Based upon the recommendations of our Human Resources Department, which included information contained in the Hay Group analysis, management presented its recommendation to the Executive Committee of the Board, which resulted in changes to our Long Term Incentive Program for fiscal 2013 including the types of long-term incentive awards and the vesting schedule of awards. For certain participants, including our named executive officers, we ceased granting performance shares and began granting time vesting restricted stock units (“RSUs”) for retention purposes. For further information see “NARRATIVE SUPPLEMENT TO THE SUMMARY COMPENSATION TABLE AND GRANTS OF PLAN-BASED AWARDS IN FISCAL 2013 TABLE-2010 INCENTIVE PLAN”.
In May 2013, we made certain equity grants of common stock options (“Stock Options”) and RSUs under the 2010 Incentive Plan to our executive officers, including our named executive officers, as set forth in the “Grants of Plan-Based Awards in Fiscal 2013” table. The named executive officers received approximately fifty percent (50%) of their grant date fair value in Stock Options and fifty percent (50%) of their grant date fair value in RSUs. This allocation was based on the aggregate grant date estimated fair value of the awards based on a formula that valued each option to purchase a share of common stock at one-half of the value of a share of common stock.
The RSUs and Stock Options will generally vest based on continuous service over a four year period at 50% on the second anniversary of the award and 25% on each of the third and fourth anniversary of the award. We believe that a four year vesting period provides us with the necessary retention incentive while at the same time providing our named executive officers with the ability to vest in a portion of the RSUs and Stock Options during the four year vesting period, which we believe will properly motivate our named executive officers.
Mr. Urcelay
In October 2013 and in connection with his appointment to Chief Executive Officer, we made to Mr. Urcelay a one-time award of restricted stock units under the 2010 Incentive Plan, having a grant date value of $8,001,400, 50% of which will vest on October 31, 2014 and the remainder of which will vest in equal installments at the end of each fiscal quarter between October 31, 2014 and October 31, 2015, subject to continued employment through the applicable vesting dates. Pursuant to the terms of his employment agreement, Mr. Urcelay is eligible for an additional award of restricted stock units having a grant date value of
$4,000,000 if the Company chooses to extend the employment term for the one-year period through October 31, 2016, which award would vest in four equal quarterly installments at the end of each fiscal quarter from October 31, 2015 through October 31, 2016, subject to Mr. Urcelay’s continued employment through the applicable vesting dates. Exercisable commencing 6 months after the earlier of the expiration of the employment term or the effective date of his retirement and prior to the occurrence of an IPO, Mr. Urcelay has the right to sell back to the Company at fair market value his shares of the Company’s common stock received upon vesting or exercise of any current or future awards under the Company’s long-term incentive plans, subject to certain other terms and conditions.
Mr. Mullany
In connection with his employment agreement, Mr. Mullany received a one-time award of stock options and restricted stock units under the 2010 Incentive Plan with grant date fair values of $4,687,500 and $2,000,020, respectively. 250,000 of the options will vest in four equal annual installments beginning on the first anniversary of the grant date. The remaining 250,000 option awards will be subject to performance and time vesting. For the performance component, (i) 125,000 options will satisfy the performance vesting contingency upon the occurrence, on or before the tenth anniversary of the grant date, of certain liquidity events for the Sponsors as described in Mr. Mullany’s employment agreement in which the consideration received by Sponsors reflects a price of the Company’s common stock of at least $33.50 per share and (ii) the remaining 125,000 options will satisfy the performance vesting contingency based upon the same criteria except that the price of the Company’s common stock shall be at a per share price of at least $40.00. For the options that satisfy the performance contingency criteria, such options will vest in equal annual installments over a four year period commencing with the first anniversary of the grant date. The shares underlying stock options are subject to certain call rights, by the Company and the Sponsors upon termination of his employment. The restricted stock units will vest in four equal annual installments beginning on the first anniversary of the grant date.
Ms. Derby
In connection with her employment agreement, Ms. Derby received the following option awards: (x) an option to purchase 26,667 shares of the Company’s common stock, with an exercise price equal to $60.00 per share, and (y) an option to purchase 21,014 shares of the Company’s common stock, with an exercise price equal to $44.00 per share. These Options were granted pursuant to the 2010 Incentive Plan, and were scheduled to vest over a three-year period, subject to Ms. Derby’s continued employment with the Company through the applicable vesting date. The intent of these awards was to replace the option awards that Ms. Derby forfeited at the time she had previously left the Company in February 2012. These options were subsequently canceled in exchange for the receipt of New Options as described below in “-2013 OPTION EXCHANGE AND OPTION EXTENSION”.
Perquisites
We provide our executive officers with perquisites that we believe are reasonable and consistent with the perquisites that would be available to them at other potential employers. We provide each of our executive officers with a car allowance or company-leased car; financial planning, accounting and tax preparation services; legal services; an annual executive physical; and reimbursement of relocation expenses. In addition, in connection with Mr. Urcelay’s appointment to Chief Executive Officer, he has been granted additional perquisites as described in footnote 4 of the “SUMMARY COMPENSATION TABLE.” Also, in connection with Ms. Merz’s assignment in Japan, she has been granted additional perquisites as described in footnote 10 of the “SUMMARY COMPENSATION TABLE.” We believe that providing Mr. Urcelay and Ms. Merz with these additional perquisites was necessary in order to facilitate a smooth transition and allow them to focus on their respective new business assignment. Perquisites are valued at the aggregate incremental cost to the Company.
For more information regarding perquisites for our executive officers, see the “SUMMARY COMPENSATION TABLE.”
Other Benefits
Other benefits for our executive officers include retirement benefits and health and insurance benefits. Based upon annual surveys sponsored by the Retail Benefits Group in which we have participated, we believe that our retirement program, including the amount of benefits, is comparable to those offered by other companies in the retail industry and, as a result, is needed to ensure that our executive compensation program remains competitive. The Retail Benefits Group consists of 34 member companies in which organizations must have $2 billion in annual retail revenue and employ at least 20,000 retail employees. The Retail Benefits Group provides a forum for the exchange of ideas and information so that member companies are better able to improve the efficiency and competitiveness of their benefit plans.
We maintain the “TRU” Partnership Employees’ Savings and Profit Sharing Plan (the “Savings Plan”) in which our U.S. named executive officers who have at least one year of employment with the Company are eligible to participate, along with a substantial majority of our employees. The Savings Plan is a 401(k) plan, which is qualified under tax rules applicable to
retirement plans, under which the Company matches 100% up to the first 4% of each plan participant’s (including our executive officers) earnings up to the Internal Revenue Code limit for each respective year in which the executive officer participates in the Savings Plan. The Company match is 100% vested on the funding date.
We also maintain the Supplemental Executive Retirement Plan (the “SERP”) for U.S. officers of the Company, including executive officers, who have one year of employment with the Company. Participants are generally 100% vested in their SERP accounts after completing five years of employment with the Company. The SERP provides supplemental retirement benefits that restore benefits to individuals whose retirement benefits are affected by the Internal Revenue Code limit on the maximum amount of compensation that may be taken into account under the Savings Plan. We intend the SERP to constitute an unfunded deferred compensation plan that is a “top-hat” plan under the Employee Retirement Income Security Act of 1974. We believe the SERP gives our executive officers parity in terms of retirement benefits with our other employees whose benefits are not subject to these limitations. In addition, the SERP supports the financial security component of compensation by providing a level of retirement benefits that is based on the actual level of compensation earned by our named executive officers during their employment rather than only a portion of such compensation.
Ms. Merz participates in the Toys Canada Deferred Profit Sharing Plan (“Deferred Profit Sharing Plan”). The Company contributes 8% of her earnings each year, and she is fully vested since participants are fully vested after 2 years. Ms. Merz is eligible to, but does not currently, participate in the Toys Canada Registered Retirement Savings Plan (“RRSP”), a defined contribution plan available to all employees, in which she can contribute between two percent and ten percent of her earnings annually and the Company will match 50% of such contribution up to two percent of her earnings.
Pursuant to his employment agreement, Mr. Urcelay is entitled to receive annual contributions equal to 15% of his base salary (the “Contribution Amount”). The Contribution Amount is utilized to purchase certain additional annuity products from MAPFRE Vida (the “MAPFRE Policies”), which provide certain payments to Mr. Urcelay upon maturity of each policy and prior to maturity, in the event of Mr. Urcelay’s disability or death.
Benefits Upon Termination or Change of Control
Pursuant to their employment agreements, our executive officers are entitled to benefits upon termination or change of control. We believe these benefits play an important role in attracting and retaining high caliber executive officers and permit our executive officers to focus on their responsibilities for the Company without distractions caused by uncertainties in the context of an actual or threatened change of control. We also believe these benefits play an important role in protecting the Company’s highly competitive business by restricting our executive officers from working for a competitor during the severance period. These benefits and restrictions are described in more detail below under the section “POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL.”
2013 Option Exchange and Option Extension
Commencing in November 2013, certain participants, including the named executive officers, under the 2010 Incentive Plan were offered an opportunity to exchange certain of their outstanding stock options (“Old Options”) and all outstanding performance shares or units for a grant of one new stock option (“New Options”) for every two Old Options canceled, which New Options have an exercise price of $22.00. On December 23, 2013, the Company closed its offer and a total of 919,599 and 104,240 Old Options and performance shares or units were canceled, respectively, and a total of 459,805 New Options were issued under the 2010 Incentive Plan. In connection with the option exchange, the Executive Committee removed the stockholder approval requirement for certain option modifications under the 2010 Incentive Plan.
The New Options have an exercise price of $22.00 per share and will vest 50% on the second anniversary of the grant date and 25% on each of the third and fourth anniversaries of the grant date (subject to earlier expiration in accordance with the new option award agreement). Consistent with the Old Options, the New Options will vest automatically upon a change in control of the Company or upon the employee’s earlier termination due to death, disability or retirement (as each such term is defined in the 2010 Incentive Plan).
The following named executive officers elected to participate in the award exchange and the table below sets forth the number of canceled securities and New Options received in the award exchange:
(1)Mr. Mullany did not own any Old Options or performance shares and therefore was not eligible to participate in the award exchange.
Additionally, we extended the expiration dates of certain outstanding option awards, which were originally scheduled to expire in fiscal 2015, to August 6, 2017. For Mr. Urcelay, expiration dates for 122,841 option awards were extended to August 6, 2017.
Tax and Accounting Considerations
In making decisions about executive compensation, we take into account certain tax and accounting considerations. For example, we consider Section 409A of the Internal Revenue Code regarding non-qualified deferred compensation and Section 280G of the Internal Revenue Code with regard to change-in-control provisions. In making decisions about executive compensation, we also consider how various elements of compensation will affect our financial reporting. For example, we consider the impact of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 718, “Compensation-Stock Compensation” (“ASC 718”), which requires us to recognize the cost of employee services received in exchange for awards of equity instruments based upon the grant date fair value of those awards.
Equity Ownership Guidelines
We do not have formal equity ownership guidelines, although we have historically strongly encouraged our executive officers to invest in the Company through the Management Equity Plan and the 2010 Incentive Plan. We believe equity ownership aligns our executive officers’ interests with our equity holders’ interests. The equity ownership of our named executive officers is set forth in the beneficial ownership table in Item 12
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table presents information regarding beneficial ownership of our Common Stock, as of March 1, 2014, by the named executive officers, each of our directors, all of our directors and executive officers as a group and each person who is known by us to beneficially own more than 5% of our Common Stock:
*
For purposes of this table, “beneficial ownership” is determined in accordance with Rule 13d-3 under the Exchange Act pursuant to which a person or group of persons is deemed to have “beneficial ownership” of any shares of Common Stock with respect to which such person has (or has the right to acquire within 60 days, i.e., by April 30, 2014 in this case) sole or shared voting power or investment power.
(1)
Total Beneficial Ownership includes shares and options exercisable within 60 days, of which Mr. Urcelay and Mr. Creasey have 122,841.
(2)
Unless otherwise indicated, the beneficial ownership of any named person does not exceed, in the aggregate, one percent of our outstanding equity securities on March 1, 2014, as adjusted as required by applicable rules.
(3)
Includes shares held by Bain Capital (TRU) VIII, L.P., Bain Capital (TRU) VIII-E, L.P., Bain Capital (TRU) VIII Coinvestment, L.P., Bain Capital Integral Investors, LLC and BCIP TCV, LLC (collectively, the “Bain Capital Entities”). Bain Capital Investors, LLC (“BCI”) is the general partner of Bain Capital Partners VIII, L.P. which is the general partner of Bain Capital (TRU) VIII, L.P. and Bain Capital (TRU) VIII Coinvestment, L.P. BCI is also the general partner of Bain Capital Partners VIII E, L.P. which is the general partner of Bain Capital (TRU) VIII-E, L.P. BCI is also the Administrative Member of Bain Capital Integral Investors, LLC and BCIP TCV, LLC. By virtue of the relationships described above, each of the foregoing entities may be deemed to beneficially own the shares held by the Bain Capital Entities. Each such entity disclaims beneficial ownership of the shares held by the Bain Capital Entities except to the extent of its pecuniary interest therein. The address of each of the Bain entities is c/o BCI at 111 Huntington Avenue, Boston, MA 02199. Each of Joshua Bekenstein, Matthew S. Levin and Gregory R. Why is a managing director of BCI and a director of our Company. As a result, and by virtue of the relationships described in this footnote (3), each of Messrs. Bekenstein, Levin and Why may be deemed to be the beneficial owner of the shares held by the Bain Capital Entities. Each of Messrs. Bekenstein, Levin and Why disclaims beneficial ownership of the shares held by the Bain Capital Entities.
(4)
Shares owned of record by Toybox Holdings, LLC are also beneficially owned by its majority member, KKR Millennium Fund L.P. As the sole general partner of KKR Millennium Fund L.P., KKR Associates Millennium L.P. may be deemed to be the beneficial owner of such securities beneficially owned by KKR Millennium Fund L.P. As the sole general partner of KKR Associates Millennium L.P., KKR Millennium GP LLC also may be deemed to be the beneficial owner of such securities beneficially owned by KKR Millennium Fund L.P. Each of KKR Fund Holdings L.P. (as the designated member of KKR Millennium GP LLC); KKR Fund Holdings GP Limited (as a general partner of KKR Fund Holdings L.P.); KKR Group Holdings L.P. (as a general partner of KKR Fund Holdings L.P. and the sole shareholder of KKR Fund Holdings GP Limited); KKR Group Limited (as the sole general partner of KKR Group Holdings L.P.); KKR & Co. L.P. (as the sole shareholder of KKR Group Limited) and KKR Management LLC (as the sole general partner of KKR & Co. L.P.) may also be deemed to be the beneficial owner of the securities beneficially owned by KKR Millennium Fund L.P. As the designated members of KKR Management LLC, Henry R. Kravis and George R. Roberts may also be deemed to beneficially own the securities beneficially owned by KKR Millennium Fund L.P. Messrs. Kravis and Roberts have also been designated as managers of KKR Millennium GP LLC by KKR Fund Holdings L.P. Messrs. Taylor and Waglay are members of our Board of Directors and are each an executive of Kohlberg Kravis Roberts & Co. L.P. and/or one or more of its affiliates. Each of Messrs. Taylor and Waglay disclaim beneficial ownership of the securities held by Toybox Holdings, LLC. For a description of material relationships between KKR and us over the last three years, see Item 13
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Advisory Agreement
Certain affiliates of the Sponsors provide management and advisory services to us pursuant to an advisory agreement executed at the closing of the merger transaction effective as of July 21, 2005 and amended June 10, 2008 and February 1, 2009 (“Advisory Agreement”). The initial term of the Advisory Agreement is ten years. After ten years, it extends annually for one year unless we or the affiliates of the Sponsors provide notice of termination to the other. The management and advisory fees paid to the affiliates of the Sponsors (the “Advisory Fees”) increase 5% per year during the ten-year term of the agreement with the exception of fiscal 2009. We recorded Advisory Fees of $22 million, $21 million and $20 million for fiscals 2013, 2012
and 2011, respectively. During fiscals 2013, 2012 and 2011, we also paid the Sponsors fees of less than $1 million, respectively, for out-of-pocket expenses.
Additionally, the Advisory Agreement provides that affiliates of the Sponsors will be entitled to receive a fee equal to 1% of the aggregate transaction value in connection with certain financing, acquisition, disposition and change of control transactions (“Transaction Fees”). The Advisory Agreement includes customary exculpation and indemnification provisions in favor of the Sponsors and their affiliates. In the event that the Advisory Agreement is terminated by the affiliates of the Sponsors or us, the affiliates of the Sponsors will receive all unpaid Advisory Fees, all unpaid Transaction Fees and expenses due under the Advisory Agreement with respect to periods prior to the termination date plus the net present value of the Advisory Fees that would have been payable for the remainder of the applicable term of the Advisory Agreement.
Other Relationships and Transactions with our Sponsors
In connection with the Propco I Term Loan Facility entered into on August 21, 2013, we incurred Transactions Fees of $10 million pursuant to the terms of the Advisory Agreement. Investment funds or accounts advised by KKR owned an aggregate of $17 million of the Propco I Term Loan Facility as of February 1, 2014.
In connection with the New UK Propco Facility Agreement entered into on March 25, 2013, we incurred Transactions Fees of $4 million pursuant to the terms of the Advisory Agreement.
In connection with the France Propco Facility Agreement entered into on February 27, 2013, we incurred Transactions Fees of $1 million pursuant to the terms of the Advisory Agreement.
In connection with the Spain Propco Facility Agreement entered into on January 29, 2013, we incurred Transaction Fees of $1 million pursuant to the terms of the Advisory Agreement.
In connection with the offering of the 2017 Notes on August 1, 2012, we incurred Transaction Fees of $4 million pursuant to the terms of the Advisory Agreement. Investment funds or accounts advised by KKR owned an aggregate of $9 million and $14 million of the 2017 Notes as of February 1, 2014 and February 2, 2013, respectively.
In connection with the Second Joinder Agreement entered into on April 10, 2012, we incurred Transaction Fees of $2 million pursuant to the terms of the Advisory Agreement. Investment funds or accounts advised by KKR owned an aggregate of $9 million and $8 million of the Second Incremental Secured Term Loan as of February 1, 2014 and February 2, 2013, respectively.
In connection with the issuance of the Incremental Secured Term Loan on May 25, 2011, we incurred Transaction Fees of $4 million pursuant to the terms of the Advisory Agreement. Investment funds or accounts advised by KKR owned an aggregate of $50 million and $63 million of the Incremental Secured Term Loan as of February 1, 2014 and February 2, 2013, respectively.
Investment funds or accounts advised by KKR owned an aggregate of $9 million and $5 million of the Toys-Delaware Secured Notes as of February 1, 2014 and February 2, 2013, respectively. In addition, investment funds or accounts advised by KKR owned an aggregate of $70 million and $67 million of the Secured Term Loan Facility as of February 1, 2014 and February 2, 2013, respectively. Additionally, investment funds or accounts advised by KKR owned an aggregate of $5 million of the Propco II Notes as of February 1, 2014 and February 2, 2013, respectively. For further details, see Note 2 to the Consolidated Financial Statements entitled “SHORT-TERM BORROWINGS AND LONG-TERM DEBT.”
From time to time, we and our subsidiaries, as well as the Sponsors or their affiliates, may acquire debt or debt securities issued by us or our subsidiaries in open market transactions, tender offers, exchange offers, privately negotiated transactions or otherwise. During fiscals 2013, 2012 and 2011, affiliates of Vornado and investment funds or accounts advised by KKR held debt and debt securities issued by the Company and its subsidiaries. The interest amounts paid on such debt and debt securities held by related parties were $10 million, $8 million and $14 million in fiscals 2013, 2012 and 2011, respectively.
In connection with the closing of the 2005 acquisition, we entered into a Stockholders Agreement with the Sponsors and certain other investors, and members of our management are bound by certain of the provisions of such agreement. The Stockholders Agreement and management stockholder addendum are each filed as an exhibit to this Annual Report on Form 10-K.
Additionally, under lease agreements with affiliates of Vornado, we paid an aggregate amount of $8 million, $10 million and $9 million in fiscals 2013, 2012 and 2011, respectively, with respect to 0.8%, 0.9% and 0.9%, respectively, of our operated stores, which include Express stores. Of the aggregate amount paid in fiscals 2013, 2012 and 2011, $2 million, respectively, was allocable to joint-venture parties not otherwise affiliated with Vornado.
Each of the Sponsors, either directly or through affiliates, has ownership interests in a broad range of companies (“Portfolio Companies”) with whom we may from time to time enter into commercial transactions in the ordinary course of business, primarily for the purchase of goods and services. We believe that none of our transactions or arrangements with Portfolio Companies are significant enough to be considered material to the Sponsors or to our business.
Subsequent Event
In connection with the amendment and restatement of the ABL Facility on March 21, 2014, we incurred Transaction Fees of $19 million pursuant to the terms of the Advisory Agreement.
Management Equity Plan and the 2010 Incentive Plan
Since the 2005 acquisition, the Executive Committee has offered long-term incentives under the Management Equity Plan. We expect to issue any future equity awards pursuant to the 2010 Incentive Plan. Since the 2005 acquisition, our officers and certain employees participate in the Management Equity Plan. The Management Equity Plan provides for the granting of non-qualified stock options (including “rollover options” (as defined in the Management Equity Plan)) to purchase shares of common stock, as well as restricted stock to our officers, directors, employees, consultants and advisors. In fiscal 2010, our Board adopted the 2010 Incentive Plan. The 2010 Incentive Plan is an omnibus plan that provides for the granting of stock options, restricted stock, restricted and deferred stock units, performance awards, dividend equivalents and other stock awards. The 2010 Incentive Plan provides that the total number of shares of our common stock that may be issued under the 2010 Incentive Plan is 3,750,000 and the maximum number of such shares of our common stock for which incentive stock options may be granted under the 2010 Incentive Plan is 500,000. For a description of the Management Equity Plan and the 2010 Incentive Plan, see Item 11 entitled “EXECUTIVE COMPENSATION” of this Annual Report on Form 10-K.
Review, Approval or Ratification of Transactions with Related Persons
Our Board has adopted written policies and procedures for the review of any transaction, arrangement or relationship in which the Company is a participant, the amount involved exceeds $120,000, and one of our executive officers, directors, director nominees (or their immediate family members) or 5% stockholders or an employee serving in the capacity of an executive officer of a 5% stockholder or any consultant or an advisor of a 5% stockholder who participates in meetings of our management or Board, each of whom we refer to as a “related person,” has a direct or indirect material interest.
If a related person proposes to enter into such a transaction, arrangement or relationship, which we refer to as a “related person transaction,” the related person must report the proposed related person transaction to our General Counsel. The policy calls for the proposed related person transaction to be reviewed and, if deemed appropriate, approved by our Board’s Audit Committee. The policy also permits the Chairman of the Audit Committee to review and, if deemed appropriate, approve proposed related person transactions that arise between meetings, subject to providing notice to the other members of the Audit Committee at the next meeting of the Audit Committee. Any related person transactions that are ongoing in nature will be reviewed annually. A related person transaction reviewed under the policy will be considered approved or ratified if it is authorized by the Audit Committee (or its Chairman) after full disclosure of the related person’s interest in the transaction. The Audit Committee (or its Chairman) will review and consider such information regarding the related person transaction as it deems appropriate under the circumstances.
The Audit Committee (or its Chairman) may approve or ratify the transaction only if the Audit Committee or its Chairman, as applicable, determines that, under all of the circumstances, the transaction is not inconsistent with the Company’s best interests. The Audit Committee (or its Chairman) may impose any conditions on the related person transaction that it deems appropriate.
Director Independence
Each of the members of our Board of Directors, other than Mr. Urcelay, our Chief Executive Officer, and Messrs. Goodman and Markee, is affiliated with the Sponsors as further described in Item 10 entitled “DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE” of this Annual Report on Form 10-K and our Board of Directors has not made a determination as to whether any of our directors are independent.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
Appointment of Independent Registered Public Accounting Firm
The Audit Committee appointed Deloitte & Touche LLP (“D&T”) as the Company’s independent registered public accounting firm to conduct the audit of the Company’s Consolidated Financial Statements for fiscals 2013 and 2012.
Audit Fees and Non-audit Fees
The aggregate fees billed by D&T and their respective affiliates for professional services rendered for the audit of the annual Consolidated Financial Statements for fiscals 2013 and 2012 and for the reviews of the financial statements included in our Quarterly Reports on Form 10-Q for those fiscal years, and for other services rendered during those fiscal years on our behalf were as follows:
(1)
For fiscals 2013 and 2012, the audit fees consist of fees for professional services performed in connection with the audit of the Company’s annual consolidated financial statements, review of financial statements included in our 10-Q filings, the Sarbanes-Oxley Section 404 audit and services that are normally provided in connection with statutory and regulatory filings or engagements.
(2)
For fiscal 2013, audit-related fees consist primarily of fees related to special purpose audits. For fiscal 2012, audit-related fees consist primarily of fees related to the 144A offering and Toys “R” Us, Inc. Form S-4 for the issuance of the 2017 Notes and fees related to special purpose audits.
(3)
For fiscals 2013 and 2012, tax fees consist of a variety of U.S. Federal, state and non-U.S. tax consultation services.
Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Registered Public Accounting Firm
The Audit Committee has adopted a policy for the pre-approval of all audit and permissible non-audit services provided by D&T. These services may include audit services, audit-related services, tax services and other services. Under the policy, pre-approval is generally provided for up to one year and any pre-approval is detailed as to the particular service or category of services and is subject to a specific budget. In addition, the Audit Committee may also pre-approve particular services on a case-by-case basis. The Audit Committee may delegate pre-approval authority to one or more of its members. Such member or members must report any decision to the Audit Committee at its next scheduled meeting.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements and financial statement schedules
(1) and (2) The financial statements and financial statement schedules required to be filed as part of this report are set forth in Item 8 entitled “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of this Annual Report on Form 10-K.
(3) Exhibits. See Item 15(b) below.
(b) Exhibits required by Item 601 of Regulation S-K
The information required by this item is incorporated herein by reference from the Index to Exhibits beginning on page 157 of this Annual Report on Form 10-K. We will furnish to any security holder, upon written request, any exhibit listed in the accompanying Index to Exhibits upon payment by such security holder of our reasonable expenses in furnishing any such exhibit. Written requests should be sent to Investor Relations, Toys “R” Us Inc., One Geoffrey Way, Wayne, New Jersey 07470.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
TOYS “R” US, INC.
(Registrant)
/S/ ANTONIO URCELAY
Antonio Urcelay
Chairman of the Board and
Chief Executive Officer
Date: March 31, 2014
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 31st day of March 2014.
Signature
Title
/s/ ANTONIO URCELAY
Antonio Urcelay
Chairman of the Board, Chief Executive Officer and Director
(Principal Executive Officer)
/s/ F. CLAY CREASEY, JR.
F. Clay Creasey, Jr.
Executive Vice President - Chief Financial Officer
(Principal Financial Officer)
/s/ CHARLES D. KNIGHT
Charles D. Knight
Senior Vice President - Corporate Controller
(Principal Accounting Officer)
*
Joshua Bekenstein
Director
*
Michael M. Calbert
Director
*
Richard Goodman
Director
*
Daniel Guglielmone
Director
*
Matthew S. Levin
Director
*
Joseph Macnow
Director
*
Richard L. Markee
Director
*
Wendy Silverstein
Director
*
Nathanial H. Taylor
Director
*
Adam Waglay
Director
*
Gregory R. Why
Director
The foregoing constitutes all of the Board of Directors and the Principal Executive, Financial and Accounting Officers of the Registrant.
*By
/S/ ANTONIO URCELAY
Antonio Urcelay
Attorney-In-Fact
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT
We have not sent a copy of our annual report or proxy statement to our security holders.
INDEX TO EXHIBITS
The following is a list of all exhibits filed as part of this Report:
Exhibit No.
Document
4.13
Security Agreement, dated August 24, 2010, among Toys “R” Us - Delaware, Inc., the Guarantors named therein and The Bank of New York Mellon, as Collateral Agent (filed as Exhibit 4.3 to the Registrant’s Quarterly Report on Form 10-Q, filed on September 10, 2010 and incorporated herein by reference).
4.14
First Lien Intercreditor Agreement, dated as of August 24, 2010, among Toys “R” Us - Delaware, Inc., the Guarantors named therein, Bank of America, N.A., as Term Loan Collateral Agent and The Bank of New York Mellon, as Notes Collateral Agent (filed as Exhibit 4.4 to the Registrant’s Quarterly Report on Form 10-Q, filed on September 10, 2010 and incorporated herein by reference).
4.15
Amended and Restated Intercreditor Agreement, dated as of August 24, 2010, among Toys “R” Us - Delaware, Inc., the Guarantors named therein, Bank of America, N.A., as ABL Agent and as Term Agent and The Bank of New York Mellon, as Notes Agent (filed as Exhibit 4.5 to the Registrant’s Quarterly Report on Form 10-Q, filed on September 10, 2010 and incorporated herein by reference).
4.16
Indenture for the 10.375% Senior Notes due 2017, dated August 1, 2012, between the Registrant and The Bank of New York Mellon, as Trustee (filed as Exhibit 4.1 to the Registrant’s Quarterly Report on Form 10-Q, filed on December 7, 2012 and incorporated herein by reference).
4.17
Form of the 10.375% Senior Notes (included in Exhibit 4.16).
4.18
Registration Rights Agreement, dated August 1, 2012, among the Registrant, and the Initial Purchasers named therein, of the Registrant’s 10.375% Senior Notes due 2017 (filed as Exhibit 4.3 to the Registrant’s Quarterly Report on Form 10-Q, filed on December 7, 2012 and incorporated herein by reference).
4.19
Substantially all other long-term debt of the Registrant (which other debt does not exceed on an aggregate basis 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis) is evidenced by, among other things, (i) industrial revenue bonds issued by industrial development authorities and guaranteed by the Registrant, (ii) mortgages held by third parties on real estate owned by the Registrant and (iii) stepped coupon guaranteed bonds held by a third party and guaranteed by the Registrant, any of which the Registrant will furnish to the Commission upon request.
10.1
Second Amended and Restated Credit Agreement, dated as of August 10, 2010, among Toys “R” Us - Delaware, Inc., as the Lead Borrower, Toys “R” Us (Canada) Ltd., Toys “R” Us (Canada) Ltee, as the Canadian Borrower, and certain other subsidiaries of Toys “R” Us - Delaware, Inc., as Facility Guarantors, Bank of America N.A., as Administrative Agent, as Canadian Agent and Co-Collateral Agent, Wells Fargo Retail Finance, LLC, as Co-Collateral Agent, and the Lenders named therein, Wells Fargo Retail Finance, LLC and JPMorgan Chase Bank, N.A., as Co-Syndication Agents, Citigroup Global Markets Inc., and Deutsche Bank AG New York Branch, as Co-Documentation Agents, Banc of America Securities LLC, Wells Fargo Capital Finance, LLC, JPMorgan Securities, Inc., as Joint Lead Arrangers and Banc of America Securities LLC, Wells Fargo Capital Finance, LLC, JPMorgan Securities, Inc., Citigroup Global Markets Inc. and Deutsche Bank Securities Inc., as Joint Bookrunners (filed as Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q, filed on September 10, 2010 and incorporated herein by reference).
10.2
Security Agreement, dated as of July 21, 2005, among Toys “R” Us, Inc., and the borrowers named therein, the guarantors named therein, and Bank of America, N.A., as Administrative Agent (filed as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed on July 27, 2005 and incorporated herein by reference).
10.3
Syndicated Facility Agreement, dated as of October 15, 2009, among Toys “R” Us Europe, LLC, TRU Australia Holdings, LLC, Toys “R” Us (UK) Limited, Toys “R” Us Limited, Toys “R” Us (Australia) Pty Ltd, Toys “R” Us GmbH, Toys “R” Us SARL, Toys “R” Us Iberia, S.A., the other Obligors party thereto from time to time, the Lenders party thereto from time to time, Deutsche Bank AG New York Branch, as Administrative Agent and Security Agent, Deutsche Bank AG, London Branch, as Facility Agent and Deutsche Bank AG New York Branch and Bank of America, N.A., as Co-Collateral Agents (filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed on October 16, 2009 and incorporated herein by reference).
Exhibit No.
Document
10.4
Amended and Restated Syndicated Facility Agreement, dated as of October 15, 2009 and amended and restated as of March 8, 2011, among Toys “R” Us Europe, LLC, TRU Australia Holdings, LLC, Toys “R” Us (UK) Limited, Toys “R” Us Limited, Toys “R” Us (Australia) Pty Ltd, Toys “R” Us GmbH, Toys “R” Us SARL, Toys “R” Us Iberia, S.A., the other Obligors party thereto from time to time, the Lenders party thereto from time to time, Deutsche Bank AG, New York Branch, as Administrative Agent and Security Agent, Deutsche Bank AG, London Branch, as Facility Agent, Deutsche Bank AG, New York Branch and Bank of America, N.A., as Co-Collateral Agents, Deutsche Bank Securities Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, as Joint Lead Arrangers, Deutsche Bank Securities Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, as Joint Book-Runners, Bank of America, N.A., as Syndication Agent and Citibank, N.A. and Goldman Sachs Lending Partners LLC, as Documentation Agents. (filed as Exhibit 10.4 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended January 29, 2011, filed on March 24, 2011 and incorporated herein by reference).
10.5
Incremental Commitment Agreement, dated as of April 28, 2011, to the Amended and Restated Syndicated Facility Agreement, dated as of October 15, 2009 and amended and restated as of March 8, 2011, among Toys “R” Us Europe, LLC, TRU Australia Holdings, LLC, Toys “R” Us (UK) Limited, Toys “R” Us (Australia) Pty Ltd., and other Obligors party thereto from time to time, the Lenders party thereto, Deutsche Bank AG, New York Branch, as Administrative Agent and Security Agent, Deutsche Bank AG, London Branch, as Facility Agent, Deutsche Bank AG, New York Branch and Bank of America, N.A., as Co-Collateral Agents, Deutsche Bank Securities Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, as Joint Lead Arrangers, Deutsche Bank Securities Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, as Joint Book-Runners, Bank of America, N.A., as Syndication Agent and Citibank, N.A. and Goldman Sachs Lending Partners LLC, as Documentation Agents (filed as Exhibit 10.5 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended January 28, 2012, filed on March 21, 2012 and incorporated herein by reference).
10.6
Amendment and Restatement Agreement, dated as of July 24, 2013, relating to the UK Propco Facility Agreement, dated as of March 25, 2013, among Toys “R” Us Properties (UK) Limited, as borrower, Debussy DTC PLC, as original lender, Elavon Financial Services Limited, as facility agent and U.S. Bank Trustees Limited, as security agent (filed as Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q, filed on September 17, 2013 and incorporated herein by reference).
10.7
Amended and Restated Credit Agreement (the “New Secured Term Loan”), dated as of August 24, 2010 by and among Toys “R” Us - Delaware, Inc., as Borrower, Banc of America, N.A., as Administrative Agent and as Collateral Agent, Goldman Sachs Credit Partners L.P. and JPMorgan Chase Bank, N.A., as Syndication Agents, the Lenders named therein, Credit Suisse Securities (USA) LLC and Wells Fargo Bank, N.A., as Documentation Agents, Banc of America Securities LLC, J.P. Morgan Securities, Inc. and Goldman Sachs Lending Partners LLC, as Joint Lead Arrangers and Banc of America Securities LLC, J. P. Morgan Securities Inc., Wells Fargo Securities, LLC, Goldman Sachs Lending Partners LLC, Credit Suisse Securities (USA) LLC, Citigroup Global Markets Inc. and Deutsche Bank Securities Inc., as Joint Bookrunning Managers (filed as Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q, filed on September 10, 2010 and incorporated herein by reference).
10.8
Amendment No. 1, dated as of September 20, 2010, to the New Secured Term Loan (filed as Exhibit 10.7 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended January 29, 2011, filed on March 24, 2011 and incorporated herein by reference).
10.9
Term Loan Credit Agreement, dated as of August 21, 2013, among Toys “R” Us Property Company I, LLC, as Borrower, the Lenders named therein, Goldman Sachs Lending Partners LLC, as Administrative Agent, Joint Lead Arrangers and Bookrunners, Deutsche Bank Securities, Inc., J.P. Morgan Securities LLC, and Merrill Lynch, Pierce, Fenner & Smith Incorporated, as Joint Lead Arrangers and Bookrunners, Citigroup Global Markets Inc. and Wells Fargo Securities, LLC, as Joint Lead Arrangers, Goldman Sachs Lending Partners LLC, Deutsche Bank Securities Inc., J.P. Morgan Securities LLC and Merrill Lynch, Pierce, Fenner & Smith Incorporated, as Co-Syndication Agents, Citigroup Global Markets Inc. and Wells Fargo Securities, LLC, as Co-Documentation Agents (filed as Exhibit 10.4 to the Registrant’s Quarterly Report on Form 10-Q, filed on September 17, 2013 and incorporated herein by reference).
10.10
Incremental Joinder Agreement, dated as of May 25, 2011, to the New Secured Term Loan, dated as of August 24, 2010 by and between, among others, Toys “R” Us - Delaware, Inc., as the Borrower, Bank of America, N.A. as Administrative Agent, and the other agents and the lenders party thereto (filed as Exhibit 10.1 to the Registrant’s Quarterly Report of Form 10-Q, filed on June 10, 2011 and incorporated herein by reference).
10.11
Incremental Joinder Agreement No. 2, dated as of April 10, 2012, to the New Secured Term Loan, dated as of August 24, 2010 by and between, among others, Toys “R” Us - Delaware, Inc., as the Borrower, Bank of America, N.A. as Administrative Agent, and the other agents and the lenders party thereto (filed as Exhibit 10.4 to the Registrant’s Quarterly Report on Form 10-Q, filed on June 8, 2012 and incorporated herein by reference).
*
Management contract or compensatory plan, contract or arrangement.
(i)
The provisions of this Amendment are only applicable to those participants under the Management Equity Plan who consented to be bound by this Amendment.