UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended May 1, 2004

Commission file number 1-11609

TOYS “R” US, INC.

(Exact name of registrant as specified in its charter)

(973) 617-3500

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x    No  ¨

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes   x    No  ¨

The number of shares of common stock, $0.10 par value per share, outstanding as of May 26, 2004 was 213,969,971.

INDEX

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements                                                                                                                              

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TOYS “R” US, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In millions)

See accompanying notes to condensed consolidated financial statements.

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TOYS “R” US, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In millions, except per share data)

See accompanying notes to condensed consolidated financial statements.

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TOYS “R” US, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In millions)

See accompanying notes to condensed consolidated financial statements.

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TOYS “R” US, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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1.  Basis of presentation
Except as expressly indicated or unless the context otherwise requires, as used herein, the “company,” “we,” “us,” or “our” means Toys “R” Us, Inc. and its subsidiaries.  We are a worldwide specialty retailer of children’s products.  Our interim condensed consolidated financial statements are unaudited and are subject to year-end adjustments.  However, in our opinion, all known adjustments (which consist primarily of normal recurring accruals and estimates that impact the carrying values of assets and liabilities) have been made and the interim financial statements present fairly the consolidated financial condition and operating results for the unaudited periods.  However, ultimate outcomes could materially differ from our estimates.  Because of the seasonal nature of our business, results for interim periods are not indicative of results to be expected for a full fiscal year.  The financial statements included herein should be read in conjunction with our 2003 Annual Report on Form 10-K.

2.  Changes in accounting
In the first quarter of 2004, we adopted the provisions of Emerging Issues Task Force (EITF) Issue No. 03-10, “‘Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor,’ by Resellers to Sales Incentives Offered to Consumers by Manufacturers” (EITF 03-10).  Beginning in the first quarter of 2004, sales have been recorded net of coupons that have been redeemed.  Under the provisions of EITF 03-10, when we receive credits and allowances from vendors for coupons related to specific promotional events, we will recognize the related reimbursement as an offset to coupon expense, during the period of redemption, in cost of sales.  Credits and allowances received from vendors that are not for specific promotional events will be recorded as a reduction of product costs in accordance with EITF Issue No. 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor” (EITF 02-16), which we adopted at the beginning of 2003. Our 2003 condensed consolidated financial statements have been restated to the current year’s presentation, as permitted by the provisions of EITF 03-10.  See the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for the details regarding the restatement made to our condensed consolidated statement of operations for the first quarter of 2003.

The following table outlines the unfavorable impact of the adoption of EITF 02-16 and restatement for EITF 03-10 on our 2003 earnings / (loss) before income taxes:

The provisions of EITF 02-16 and EITF 03-10 did not permit adoption through a cumulative effect adjustment at the beginning of 2003.  As noted above, if we had been permitted to record a cumulative effect adjustment at the beginning of 2003, the unfavorable impact on 2003 earnings / (loss) before taxes would have been reduced by $13 million for the first quarter and $74 million for the full year.  The recognition of credits and allowances received from vendors for the current period effect noted above, and for all periods subsequent to 2003, will be driven by changes in vendor agreements, the amount of credits and allowances received from vendors, and changes in sales and inventory levels.  The adoption of EITF 02-16 and EITF 03-10 had no impact on our condensed consolidated statements of cash flows.

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3.  Restructuring and other charges
Our condensed consolidated financial statements for the first quarter of 2004 included the following costs and charges related to restructuring initiatives from prior years and are as follows:

At May 1, 2004, we have total remaining reserves of $117 million to complete all of these restructuring initiatives.  We believe that remaining reserves at May 1, 2004 are adequate to complete these remaining initiatives and commitments.  See below for a further discussion of individual restructuring initiatives and related charges and reserves.

2003 Initiatives
On November 17, 2003, we announced our decision to close all 146 of our free-standing Kids “R” Us stores and all 36 of our free-standing Imaginarium stores, as well as three distribution centers that support these stores.  A majority of these facilities were closed on or before January 31, 2004, and all but 8 closed by May 1, 2004.  The remaining stores will close later this year.

On March 2, 2004, we entered into an agreement under which Office Depot, Inc. agreed to acquire 124 of the former Kids “R” Us stores for $197 million in cash, before commissions and fees, plus the assumption of lease payments and other obligations.  Certain properties have subsequently been excluded from this agreement and are being marketed for disposition. We currently expect to receive approximately $180 million in cash, before commissions and fees, from Office Depot, Inc. (or its designee) plus the assumption of lease payments and other obligations.  The transaction is closing in phases and we anticipate that the majority of these closings will occur over the next several months. Those stores that will not be acquired by Office Depot, Inc. (or its designee) either had leases that ended, will be converted to Babies “R” Us stores, or are being marketed for disposition.

We recorded costs and charges of $147 million in the fourth quarter of 2003 relating to the closing of these facilities.  These costs and charges included $49 million of inventory markdowns recorded in cost of sales and $24 million of depreciation that was accelerated through the closing periods of the Kids “R” Us stores.  The remaining $74 million of costs and charges were included in restructuring and other charges.

As outlined in the summary table above, we recorded costs and charges of $15 million (pre-tax) in the first quarter of 2004 for the closing of the free-standing Kids “R” Us stores, which included $5 million of costs for those facilities that were closed.  We expect to record additional costs and charges for the remaining stores that will close later this year, as well as for vacancy related costs for closed facilities until their disposition.

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Details on the activity of charges and reserves for the first quarter of 2004 are as follows:

2001 Initiatives
In 2001, we recorded costs and charges to close a number of stores, to eliminate a number of staff positions, and to consolidate five store support center facilities into our Global Store Support Center facility in Wayne, New Jersey.  These actions resulted in total pre-tax charges of $237 million, which were partially offset by the reversal of $24 million of previously accrued charges ($11 million from the 1998 charge and $13 million from the 1995 charge) that we determined to no longer be needed.  Therefore, we recorded net charges of $213 million in the fourth quarter of 2001, of which $27 million were recorded in cost of sales.

Details on the activity of charges and reserves for the first quarter of 2004 are as follows:

1998 and 1995 Initiatives
We had $32 million of reserves remaining at May 1, 2004 from charges previously recorded in 1998 and 1995, primarily for long-term lease commitments, that will be utilized in 2004 and thereafter.  In addition, we have recorded additional charges of $5 million in the first quarter of 2004 related to properties included in these restructuring initiatives.

Net property assets held for sale
We have included certain real estate assets as current assets in our condensed consolidated balance sheets, as they are being held for sale.  Net property assets held for sale at May 1, 2004 included former Kids “R” Us real estate assets as discussed above, as well as our former store support center facility in Montvale, New Jersey.

4.  Stock-based compensation
We account for stock options in accordance with the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Options Issued to Employees” (APB 25).  We have adopted the disclosure-only provisions of SFAS No. 123, “Accounting for Stock Based Compensation” (SFAS No. 123), issued in 1995.

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In accordance with the provisions of SFAS No. 123, we apply APB 25 and related interpretations in accounting for our stock option plans and, accordingly, do not recognize compensation expense.  If we had elected to recognize compensation expense based on the fair value of the options granted at grant date as prescribed by SFAS No. 123, net earnings and earnings per share would have been reduced to the pro forma amounts indicated in the following table:

The weighted-average fair value at the date of grant for options granted in the first three months of 2004 and 2003 was $4.95 per option and $2.74 per option, respectively.  The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model.

As there were a number of options granted during the quarters ended May 1, 2004 and May 3, 2003, a range of assumptions are provided below:

The effects of applying SFAS No. 123 and the results obtained through the use of the Black-Scholes option-pricing model are not necessarily indicative of future values.

5.  Credits and allowances received from vendors
We receive credits and allowances from vendors that are related to formal agreements negotiated with such vendors.  These credits and allowances are predominantly for cooperative advertising, promotions, and volume-related purchases, are recognized in cost of sales, and have a positive impact on our consolidated gross margin.

Credits and allowances from vendors for coupons related to events that meet the direct offset requirements of EITF 03-10 are recognized in the same period that the related coupon expense is recognized (see Note 2 to the condensed consolidated financial statements for a further discussion about EITF 03-10).

Credits and allowances from vendors not meeting the direct offset requirements of EITF 03-10, along with other credits and allowances from vendors, are recorded as a reduction of product costs that are recognized when the related merchandise inventories are sold.

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6.  Cost of sales and selling, general and administrative expenses
The following table illustrates types of costs included in each category:

7.  Comprehensive income
Comprehensive income is calculated in accordance with SFAS No. 130, “Reporting Comprehensive Income” (SFAS No. 130).  SFAS No. 130 requires that comprehensive income include net income, foreign currency translation adjustments, unrealized gains / (losses) on hedged transactions, and minimum pension liability adjustments, which are reported separately on the consolidated statements of stockholders’ equity in our 2003 Annual Report on Form 10-K.  The components of comprehensive loss are as follows:

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8.  Segments
A summary of operations by reportable segment is as follows:

 

 ⁽¹⁾  The remaining free-standing stores will close in 2004.  See Note 3 to the condensed consolidated financial
        statements for a further discussion.
 ⁽²⁾  Includes corporate expenses, and the equity in net earnings of Toys “R” Us – Japan, a licensee of ours.

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9.  Merchandise inventories
Merchandise inventory for our domestic stores, excluding apparel, is stated at the lower of LIFO (Last-In, First Out) cost or market.  If inventories had been valued at the lower of FIFO (First-In, First-Out) cost or market, inventories would show no change at May 1, 2004, May 3, 2003, or January 31, 2004.  Apparel inventory and inventory for our International and Toysrus.com divisions are stated at the lower of FIFO cost or market.  Details on the components of our consolidated merchandise inventories are as follows:

10.  Long-term debt
On February 13, 2004, we paid a total of $506 million, including interest, for our 500 million euro-denominated bond bearing an original interest rate of 6.375% per annum.  In 2001, this obligation was swapped into a $466 million fixed rate obligation with an effective interest rate of 7.43% per annum, interest payments due annually, and principal due on February 13, 2004.

In March 2003, we filed a “shelf” registration statement with the Securities and Exchange Commission giving us the capability to sell up to $800 million of debt securities.  In April 2003, we sold and issued $400 million in notes bearing interest at a coupon rate of 7.875% per annum, maturing on April 15, 2013.  The notes were sold at a price of 98.3% of the principal amount, resulting in an effective yield of 8.125% per annum, and we received net proceeds of $390 million.  Simultaneously with the sale of the notes, we entered into interest rate swap agreements.  As a result of these swap agreements, interest accrues at the rate of LIBOR plus 3.6% per annum.  Interest is payable semi-annually and commenced on October 15, 2003.  In September 2003, we sold an additional $400 million in notes bearing interest at a coupon rate of 7.375% per annum, maturing on October 15, 2018, which fully utilized our capacity to issue debt under the “shelf” registration statement.  The notes were sold at a price of 99.6% of the principal amount, resulting in an effective yield of 7.424% per annum, and we received net proceeds of $395 million.  Simultaneously with the sale of the notes, we entered into interest rate swap agreements.  As a result of these swap agreements, interest accrues at the rate of LIBOR plus 2.3% per annum.  Interest is payable semi-annually and commenced on April 15, 2004.  We used the net proceeds from these notes for the repayment of debt that matured in 2004 and for other general corporate purposes.  These swaps are designated as highly effective fair value hedges, as defined by SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS No. 133).  Changes in the fair value of the interest rate swap offset changes in the fair value of the fixed rate debt due to changes in market interest rates.

11.  Commitments and contingencies
Our condensed consolidated balance sheets contain carrying amounts for certain assets and liabilities that are based on estimates and assumptions.  Certain of these estimates are related to loss contingencies, recoverability of assets, and to other potential obligations for which we are contingently liable. Such estimates include reserves for self-insured risks, litigation reserves, reserves for disputed amounts with vendors, and tax reserves.  We believe that our related reserves are adequate to cover all probable and estimable loss exposures at May 1, 2004.

In the past year, the Internal Revenue Service proposed, and we have agreed to, several adjustments to certain deductions claimed in our 1997 to 1999 federal income tax returns. If these proposed adjustments become final, we will be able to reverse a significant amount of reserves associated with these deductions that had been set up in prior years to cover these items and to recognize the tax benefits associated with those items that were resolved on a favorable basis.

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We file unclaimed property returns as required by law.  In certain jurisdictions, the rules concerning proper treatment of unclaimed properties are ambiguous.  In 2003, four states commenced an audit of our unclaimed property returns using contingent fee, third-party auditors.  We are not yet able to estimate the magnitude or determine the probability of the potential unclaimed property liabilities, if any.

We are exposed to other claims and litigation arising out of the ordinary course of business.  We believe the currently identified claims and litigation will not have a material adverse effect on our condensed consolidated financial statements.

12.  Investment in Toys “R” Us – Japan
We have accounted for our 48% ownership investment in the common stock of Toys “R” Us – Japan, a licensee of ours, using the “equity method” of accounting since the initial public offering of Toys “R” Us – Japan in April 2000.  Our policy is to account for the sale of subsidiaries’ stock by recognizing gains or losses for value received in excess of, or less than, our basis in such subsidiary.

At May 1, 2004, the quoted market value of our investment was $372 million, which exceeds our carrying value.  The valuation is derived from a mathematical calculation based on the closing quotation published by the Tokyo over-the-counter market and is not necessarily indicative of the amount that could be realized upon sale.  We are the guarantor of 80% of a 10 billion yen ($90 million) loan to Toys “R” Us – Japan from third parties in Japan.  The loan has an annual interest rate of 6.47% and is due in 2012.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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General
Toys “R” Us, Inc. and its subsidiaries generate sales, earnings, and cash flow by retailing specialty children’s products worldwide.  We operate all of the “R” Us branded stores in the United States, as well as approximately 50% of the “R” Us branded stores internationally, the balance of which are either licensed or franchised.  Our operating segments include: Toys “R” Us – U.S., Toys “R” Us – International, our Babies “R” Us specialty baby-juvenile stores, Toysrus.com, our Internet subsidiary, and Kids “R” Us.

The Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to provide information to help you better understand and evaluate our financial condition and results of operations.  We recommend that you read this section along with our condensed consolidated financial statements in Item 1 and with our 2003 Annual Report on Form 10-K.

Results of Operations
Consolidated net loss was $28 million, or $0.13 per share, for the first quarter ended May 1, 2004 versus a consolidated net loss of $26 million, or $0.12 per share for the first quarter ended May 3, 2003.  As discussed in Note 2 to the condensed consolidated financial statements, we adopted the provisions of EITF 03-10 beginning in the first quarter of 2004.  Our 2003 condensed consolidated financial statements have been restated for comparability purposes, as permitted by the provisions of EITF 03-10.  Also, as discussed in Note 2 to the condensed consolidated financial statements, we adopted the provisions of EITF 02-16 beginning in the first quarter of 2003.

The following tables present our first quarter 2003 condensed consolidated and segment results, as previously reported and as restated for comparability to the 2004 presentation, as permitted by the provisions of EITF 03-10:

⁽¹⁾ The provisions of EITF 02-16 and EITF 03-10 did not permit adoption through a cumulative effect adjustment at the beginning of 2003. Our results for the first quarter of 2003, as restated, were unfavorably impacted by $13 million ($8 million after-tax), or $0.04 per share, resulting from the initial implementation of both EITF 02-16 and EITF 03-10.  For all periods subsequent to 2003, the recognition of credits and allowances received from vendors will be driven by changes in vendor agreements, the amount of credits and allowances received from vendors, and changes in sales and inventory levels. The adoption of EITF 02-16 and EITF 03-10 had no impact on our cash flows. See note 2 to the consolidated financial statements for a further discussion about the adoption of EITF 02-16 and EITF 03-10.

⁽²⁾ Includes the adoption of EITF 02-16.

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Sales
Consolidated net sales for the first quarter of 2004 were $2.06 billion and $2.11 billion for the first quarter of 2003, representing a decrease of $55 million, or 2.6%, from the first quarter of 2003.  Excluding the impact of foreign currency translation of $51 million, consolidated net sales decreased by $106 million, or 5.0%, to $2.0 billion.  Excluding both the impact of foreign currency translation and a $72 million decline in net sales due to the previously announced Kids “R” Us store closings (see Note 3 to the condensed consolidated financial statements), consolidated net sales decreased by $34 million, or 1.6%. This decrease was due to a 5.5% decrease in net sales in the Toys “R” Us – U.S. division, which was primarily driven by a 27% decrease in net sales of video game products in the first quarter of 2004 and was partially offset by an increase of 9.6% in the net sales from our Babies “R” Us division.

The decline in our video game business in the United States is the result of the continued maturation from the last significant video game platform releases in 2001, increased competition, and price deflation of video game products.  We do not expect that any significant video game platforms will be released in 2004.  The Babies “R” Us increase was driven by a 4.6% comparable store sales increase, as well as revenues from new stores sales.  The Babies “R” Us sales’ increases were primarily due to strong sales within the Juvenile and Apparel product categories.

Cost of Sales and Gross Margin
Consolidated gross margin, as a percentage of sales, increased by 1.3 percentage points during the first quarter of 2004.  Consolidated gross margin for the first quarter of 2003 reflects the unfavorable non-recurring impact of the initial implementation of the provisions of EITF 03-10 and EITF 02-16 of $13 million, as discussed previously.  The initial implementation impact represents 0.6 percentage points of the total increase, primarily affecting the Toys “R” Us – U.S. division.

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After excluding the initial implementation impact of EITF 03-10 and EITF 02-16 in the first quarter of 2003, consolidated gross margin, as a percentage of sales, increased by 0.7 percentage points.  Gross margin for the Toys “R” Us – U.S. division was 33.2% for the first quarter of 2004 and 32.3% for the first quarter of 2003.  The increase of 0.9 percentage points reflects the initial implementation impact of EITF 03-10 and EITF 02-16.  Excluding the implementation effects, gross margin for the Toys “R” Us – U.S. division was in line with that of the prior year.  Babies “R” Us reported a 1.3 percentage point increase in gross margin to 38.1% of net sales.  Of this increase, 0.3 percentage points are due to the implementation effects of EITF 03-10 and EITF 02-16.  The International division reported an increase of 1.6 percentage points to 38.0%.  Of this increase, 0.6 percentage points represent the implementation effects of EITF 03-10 and EITF 02-16.  Toysrus.com reported an increase of 5.6 percentage points to 30.2%.  The implementation of EITF 03-10 and EITF 02-16 did not affect the gross margin at Toysrus.com.

The increase in gross margin for the Babies “R” Us division for the first quarter was primarily due to a more favorable sales mix.  The increase in margin at the International division is predominantly related to a favorable sales mix of higher Baby, Learning and owned brands, and lower sales of video product.  The increase in gross margin for Toysrus.com reflects a favorable shift of business from lower margin video game products to higher margin Baby and Toy products, as well as lower markdowns.

Selling, General and Administrative Expenses
Consolidated SG&A expenses, as a percentage of sales, for 2004 increased 0.5 percentage points, which was primarily attributable to the net sales decrease discussed above, and was partially offset by cost reduction efforts related to the closing of the Kids “R” Us free-standing stores.

Foreign Currency Exchange
Operating loss for the first quarter of 2004 was $15 million and included a $3 million unfavorable foreign exchange impact.  Excluding this impact of foreign currency translation, operating losses were $12 million for both the first quarters of 2004 and 2003.  Operating losses for the Toys “R” Us – International division were $14 million for the first quarter of 2004 and $12 million for the first quarter of 2003. Excluding the impact of foreign currency translation, operating loss for the Toys “R” Us – International division was $11 million for the first quarter of 2004 and $12 million for the first quarter of 2003.

Strategic Review
We are continuing with the process of conducting a thorough strategic review of all of our assets and operations in order to determine the optimal configuration and use of these resources.

Restructuring and Other Charges
On November 17, 2003, we announced our decision to close all 146 of our free-standing Kids “R” Us stores and all 36 of our free-standing Imaginarium stores, as well as three distribution centers that support these stores.  On March 2, 2004, we entered into an agreement under which Office Depot, Inc. agreed to acquire 124 of the former Kids “R” Us stores.  Certain properties have subsequently been excluded from the agreement with Office Depot, Inc. and these properties are being marketed for disposition.  We currently expect to receive approximately $180 million in cash, before commissions and fees, from Office Depot, Inc. (or its designee) plus the assumption of lease payments and other obligations.  We recorded costs and charges of $15 million (pre-tax) in the first quarter of 2004 for the closing of the free-standing Kids “R” Us stores, which included $5 million of costs for those facilities that were closed.  These costs and charges included $3 million that was recorded in cost of sales and $3 million of depreciation that was accelerated through the closing periods of the stores.  The remaining $9 million of costs and charges were included in restructuring and other charges.  We expect to record additional costs and charges for the remaining stores that will close later this year, as well as for vacancy related costs for closed facilities until their disposition.  Those stores that will not be acquired by Office Depot, Inc. (or its designee) either had leases that ended, will be converted to Babies “R” Us stores, or are being marketed for disposition.

See Note 3 to the condensed consolidated financial statements for a further discussion about restructuring and other charges.

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