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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended January 31, 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)

Securities registered pursuant to Section 12(b) of the Act:

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 check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    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 aggregate market value of common stock held by non-affiliates was $2,348,710,188 based on the closing sales price of the common stock on the New York Stock Exchange on August 2, 2003, the last business day of the registrant’s most recently completed second fiscal quarter.

The number of shares of common stock, $0.10 par value per share, outstanding as of March 15, 2004 was 213,859,552.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Proxy Statement for the Annual Meeting of Stockholders to be held June 2, 2004 and portions of the Registrant’s Annual Report for the year ended January 31, 2004 are incorporated by reference into Parts II and III of this Form 10-K.

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INDEX

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PART I

ITEM 1.    BUSINESS

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 toys, baby products and children’s apparel. As of January 31, 2004, we operated 1,501 retail stores worldwide. These consisted of 927 locations in the United States, comprised of 685 toy stores, including four Geoffrey stores, which are discussed further in the section “Growth Initiatives;” 198 specialty baby-juvenile stores under the name “Babies “R” Us;” and 44 children’s clothing stores under the name “Kids “R” Us.” All of the Kids “R” Us stores will close in the first half of 2004. Refer to the section entitled “Closing of Kids “R” Us and Imaginarium Free-standing Stores” below for further details. Internationally, as of January 31, 2004, we operated, licensed or franchised an aggregate of 574 stores. We also sell merchandise through our Internet sites at www.toysrus.com, www.babiesrus.com, www.imaginarium.com, www.sportsrus.com, and www.personalizedbyrus.com. Toys “R” Us, Inc. is incorporated in the state of Delaware.

Our retail business began in 1948 when founder Charles Lazarus opened a baby furniture store, Children’s Bargain Town, in Washington D.C. The Toys “R” Us name made its debut in 1957. Since inception, Toys “R” Us has built its reputation as a leading consumer destination for toys and children’s products, including apparel. We opened our first Babies “R” Us stores in 1996, expanding our presence in the specialty baby-juvenile market. We are among the market share leaders in most of the largest markets in which “R” Us retail stores operate, including the United States, the United Kingdom, and Japan.

This Form 10-K reports on our last three fiscal years, ended as follows: for the year ended January 31, 2004 (our 2003 fiscal year end), for the year ended February 1, 2003 (our 2002 fiscal year end), and for the year ended February 2, 2002 (our 2001 fiscal year end). References to 2003, 2002 and 2001 are to our fiscal years unless otherwise specified or the context otherwise requires.

Toys “R” Us – U.S.

We operated toy stores in 49 states and Puerto Rico as of January 31, 2004 and we sell toys, clothing, plush, games, bicycles, sporting goods, VHS and DVD movies, electronic and video games, small pools, books, educational and development products, infant and juvenile furniture, and electronics, as well as educational and entertainment computer software for children. Our toy stores offer approximately 8,000 to 10,000 distinct items year-round, which we believe is more than twice the number of items found in other discount or specialty stores selling toys.

As of January 31, 2004, we operated 685 toy stores in the United States, including four Geoffrey stores and 387 combo stores, which combine our toy offering with approximately 5,500 square feet of children’s apparel. These stores conform to the prototypical designs consisting of approximately 30,000 to 45,000 square feet of space and are typically free-standing units or located in shopping centers. We did not open any new toy stores in 2003, although we did relocate certain stores to nearby locations and incorporated certain elements of our Geoffrey format into 13 other stores.

We seek to differentiate ourselves from competitors in several key areas, including product selection, product presentation, service, in-store experience, and marketing. In the last several years, we have taken a number of actions in our attempt to strengthen our franchise. These actions included:

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Each of these actions is discussed in more detail below.

U.S. Toy Store Product Offering

We offer a wide selection of popular national toy brands including many products that are unique to, or launched at, Toys “R” Us. Over the past few years, we have entered into exclusive branded product agreements with Animal Planet, Cabbage Patch, Home Depot, and Scholastic, among others, enabling us to offer products that our guests will not find elsewhere. In addition to exclusive vendor alliances, we offer a broad assortment of private label merchandise under names such as Animal Alley^®, Fast Lane^®, Fun Years^®, Especially for Baby^®, and Dream Dazzlers^® in our toy stores. We attempt to continually strengthen our “core merchandise” content (our top 1,500 selling items). By focusing on core merchandise, we believe that we can maintain strong relationships with our vendors and allow them to better plan production and meet delivery timetables. We believe this approach helps to ensure our stores have a sufficient supply of core merchandise items, allowing us to satisfy our guests’ demand for these items.

Apparel

Approximately 387 of our domestic toy stores now carry apparel; we plan to add apparel to approximately 35 additional toy stores this year following the closing of the free-standing Kids “R” Us stores. Apparel is also a key product line in Babies “R” Us stores.

Physical Renovation of U.S. Toy Stores

Between 2000 and 2002, we renovated a substantial portion of our toy store network in the United States to our “Mission Possible” format. The Mission Possible format enhances store layout by creating a racetrack design, lowering merchandise displays, widening the aisles, and reorganizing merchandise in logical categories to improve shopping patterns. We believe this format enables us to present our merchandise in a more dynamic selling environment and to create a more enjoyable shopping experience for both adults and children.

Imaginarium

Imaginarium was acquired in 1998 to expand the learning and educational toy categories in the “R” Us family of retail stores. Prior to the acquisition of Imaginarium, we did not have the vendor relationships necessary to compete effectively in the learning, creativity and educational toy segments, some of the fastest growing areas of the toy industry in recent years. The addition of an Imaginarium boutique inside of our toy stores was also a key component of the Mission Possible format. We believe these Imaginarium in-store boutiques have enabled us to establish a leadership position in the learning and educational categories. Although we made a decision in 2003 to close the remaining free-standing Imaginarium stores, we intend to continue strengthening and expanding the product offering of the Imaginarium boutiques within our toy stores. In addition, our Toy Box format also includes Imaginarium products. Refer to the section “Growth Initiatives” below for a further discussion of Toy Box.

Merchandise “Worlds” and Customer Service

To further enhance the shopping experience of our guests, we use a merchandise “World” concept in our toy stores in the United States. In 2003, the Worlds consisted of the following:

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In the past two years, we have provided our store associates with additional training to deepen their product knowledge and enhance their targeted selling skills in order to improve customer service in our stores.

Flagship Store in Times Square

In November 2001, we opened our Times Square flagship store in New York City. This 110,000 square foot, multi-level store offers guests a vast array of toys and dramatic retail attractions, including a 60-foot tall, indoor Ferris Wheel. We believe that our flagship store provides us with an effective platform for new product launches, increased visibility for the “R” Us brands, and serves to further strengthen our standing with the vendor community.

Although we believe the steps we have taken have strengthened our domestic toy store franchise in several respects, the financial impact of these actions has not been as favorable as we had hoped. Operating income from our toy stores in the United States has declined for a number of years and 2003 results were disappointing. Our recent financial performance was a catalyst for the Strategic Evaluation that the company is currently conducting. This Strategic Evaluation is discussed in further detail on Page 6.

Toys “R” Us – International

Toys “R” Us – International (“International”) operates, licenses and franchises toy stores in 30 foreign countries. These stores generally conform to traditional prototypical designs similar to those used by Toys “R” Us – U.S., typically consisting of approximately 30,000 square feet of space. International utilizes proprietary brands and shopping Worlds within some store locations that have been successful in the United States. The worlds include Imaginarium boutiques, which are known in some countries as “World of Imagination,” and Babies “R” Us boutiques.

As of January 31, 2004, we operated 293 international stores and licensed or franchised 281 international stores. We added 37 new toy stores in 2003, including 31 licensed or franchised stores, and closed seven stores, including five licensed or franchised stores. We intend to add approximately 36 new toy stores in 2004, which includes approximately 27 licensed or franchised stores.

At January 31, 2004, Toys “R” Us – Japan, a licensee of ours, operated three Babies “R” Us stores in Japan. In 2004, Toys “R” Us – Japan intends to open an additional six Babies “R” Us stores.

International has wholly-owned operations in Australia, Austria, Canada, France, Germany, Portugal, Spain, Switzerland, and the United Kingdom. International intends to pursue opportunities that may arise in these and other countries. Net sales in foreign countries (excluding sales by licensees and franchisees) represented approximately 22% of consolidated net sales in 2003. We are subject to the risks inherent in conducting business across national boundaries, many of which are outside of our control. These risks include the following:

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We cannot ensure that one or more of these factors will not negatively affect International and, as a result, our business and financial performance.

On April 24, 2000, we completed the initial public offering in Japan of shares of Toys “R” Us – Japan. As a result of this transaction, our ownership percentage of Toys “R” Us – Japan was reduced from 80% to 48%. We are no longer in a position to exercise control over operations of Toys “R” Us – Japan. Accordingly, we no longer consolidate the financial statements of Toys “R” Us – Japan, and we have accounted for our investment in the common stock of Toys “R” Us – Japan under the equity method of accounting since April 24, 2000. For further discussion of this transaction, refer to the Note to Consolidated Financial Statements beginning on Page 38.

Babies “R” Us

In 1996, we opened our first Babies “R” Us stores. The acquisition of Baby Superstore in 1997 added 76 locations, and the continued expansion of this brand helped Babies “R” Us become a leader in the specialty baby-juvenile market. These stores operate in a prototypical design consisting of approximately 24,000 to 37,000 square feet of space. Babies “R” Us stores target the pre-natal to infant market by offering room settings of juvenile furniture, such as cribs, dressers, bedding and accessories. In addition, we provide baby gear, such as play yards, booster seats, high chairs, strollers, car seats, infant, toddler and infant plush toys, and gifts. As of January 31, 2004, Babies “R” Us operated 198 specialty baby-juvenile retail locations. The Babies “R” Us stores are designed with low profile merchandise displays in the center of the stores, providing a sweeping view of the entire merchandise selection. Most Babies “R” Us stores devote between 3,000 to 5,000 square feet to specialty name brand and private label clothing and offer a wide range of feeding supplies, health and beauty aids, and infant care products.

In addition, we offer a computerized baby registry service and we believe that Babies “R” Us registers more expectant parents than any other retailer in the domestic market. Our computerized baby registry offers a user-friendly printout as well as other features to guide registrants in making their selections.

Based on demographic data used to determine which markets to enter, we opened 16 Babies “R” Us stores in 2003 and closed one Babies “R” Us store location. As part of our long-range growth plan, we plan to open approximately 20 new Babies “R” Us stores in 2004, some of which will be converted from former Kids “R” Us stores.

Toysrus.com

Toysrus.com sells merchandise to the public via the Internet at www.toysrus.com, www.babiesrus.com, www.imaginarium.com, www.sportsrus.com, and www.personalizedbyrus.com. We opened our on-line doors to the public in 1998. In order to provide better customer service and order fulfillment, we entered into a strategic alliance with Amazon.com, Inc. and launched a co-branded toy store in 2000. Under the strategic alliance, this co-branded store offers toys and video games (Toysrus.com), baby products (Babiesrus.com), and learning and educational products (Imaginarium.com). The strategic alliance agreement, which expires in 2010, combines Toysrus.com’s merchandising expertise and trusted brand name with Amazon.com, Inc.’s strengths in website operations, on-line customer service and reliable fulfillment. Toysrus.com is responsible for merchandising and content for the co-branded stores and identifies, purchases, owns, and manages the inventory. Amazon.com, Inc. handles site development, order fulfillment for most items, customer service, and the housing of Toysrus.com’s inventory in Amazon.com, Inc.’s fulfillment centers in the United States.

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Closing of Kids “R” Us and Imaginarium Free-standing Stores

On November 17, 2003, we announced plans 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 supported these stores. These free-standing stores had incurred significant performance declines in the past few years. This accelerated deterioration in financial performance led to our decision to cease operations in these free-standing stores. We continue to expand our apparel business and Imaginarium boutiques within our Toys “R” Us and Babies “R” Us stores, and we continue to convert existing Toys “R” Us stores in the United States into combo stores. However, we believe that ceasing operations in the free-standing Kids “R” Us and Imaginarium stores will benefit future cash flows and net earnings. The majority of the Kids “R” Us facilities were closed on or before January 31, 2004. The remaining 44 Kids “R” Us stores will remain open for a short period of time subsequent to January 31, 2004 in order to liquidate certain apparel inventories. All 36 Imaginarium stores have closed and most of the leases have terminated with the remaining lease terminations under negotiation.

On March 2, 2004, we entered into an agreement with Office Depot, Inc. under which Office Depot, Inc. agreed to acquire 124 of our former Kids “R” Us store locations for $197 million in cash, before commissions and fees, plus the assumption of lease payments and other obligations. The 124 stores include properties owned by us as well as stores with ground or operating leases. This transaction is expected to close in phases during 2004 and will be recorded in our consolidated financial statements at that time. The transaction with Office Depot, Inc. largely completes the disposition of the Kids “R” Us real estate portfolio. We have set aside up to 14 stores for conversion to Babies “R” Us over the next two years. In addition, five of the Kids “R” Us stores had leases that ended on January 31, 2004. Thus, only three leased stores remain and all of these leases expire in less than 48 months.

Details of restructuring and other charges, as well as other strategic initiatives, are described in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations beginning on page 14 and within the Note to Consolidated Financial Statements beginning on Page 35.

Growth Initiatives

Toys “R” Us Toy Box

In 2001, we began testing a concept called Toys “R” Us Toy Box in a limited number of grocery stores. The Toy Box concept consists of approximately 40 to 70 linear feet of space containing an assortment of smaller toy items with price points generally below $25. In 2003, we signed a multi-year deal with Albertson’s, Inc. to become the exclusive toy provider for its food and drug stores. Under the agreement, Toys “R” Us will have a permanent branded and, in some cases, a non-branded presence year-round in these store locations. The branded presence of Toys “R” Us will be executed via this “store-within-a-store” concept. Our goal is to use this concept to offer guests a compelling selection of popular toys at the place where, we believe, they shop most frequently, grocery stores.

At January 31, 2004, we had opened approximately 900 toy sections across Albertson’s, Inc. store locations. We expect to complete the rollout in the first half of 2004, when we expect to have approximately 2,000 toy sections in Albertson’s, Inc. store locations.

Geoffrey Stores

In 2002, we opened four Geoffrey stores in the United States, including conversions of two existing Toys “R” Us stores. These stores combine elements of Toys “R” Us, Babies “R” Us, and apparel in a 40,000 to 45,000 square foot format. These stores also incorporate new concepts such as party rooms, activity centers, haircut and styling salons, photo studios, and play areas. In 2003, we incorporated certain Geoffrey elements into 13 existing Toys “R” Us – U.S. stores. We plan to open one new Geoffrey store in 2004.

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Strategic Evaluation

We are currently in the process of conducting a thorough strategic evaluation of all of our worldwide assets and operations to determine the optimal configuration and use of our resources. We have retained Credit Suisse First Boston LLC as our financial advisor to assist us in this process. We have also retained experts in appropriate disciplines to provide appraisals of our real estate assets and other holdings.

The fact-finding phase of the evaluation is underway. Once we have gathered all of the necessary valuations and other relevant information, management will begin a process of reviewing all of the strategic alternatives and make its recommendations to the Board of Directors. We anticipate that this review process will be completed later in 2004.

Financial Information About Industry Segments

Information about industry segments is set forth within the Note to the Consolidated Financial Statements entitled “SEGMENTS” beginning on Page 52.

Distribution Centers

In the United States, our stores are supported by 12 distribution centers, which average approximately 750,000 square feet in size, and are strategically located throughout the United States to efficiently support our stores. We also operate eight International distribution centers that support our International toy stores.

These distribution centers employ warehouse management systems and material handling equipment that help to minimize overall inventory levels and distribution costs. Certain product processing and ticketing activities are performed at the distribution centers in order to improve store labor efficiency, thereby allowing store employees to concentrate on guest service and store presentation.

We believe the flexibility afforded by our warehouse/distribution system and by the ownership of a majority of our fleet of trucks used to distribute merchandise provides us with operating efficiencies and the ability to maintain a better in-stock inventory position at our stores. We are currently implementing initiatives to improve our supply chain management and to optimize our inventory assortment. We are also expanding our automated replenishment system to improve inventory turnover.

Trademarks

“TOYS “R” US”^®, “BABIES “R” US” ^®, “IMAGINARIUM” ^®, and “GEOFFREY” ^®, 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 foreign countries. We believe that our rights to these properties are adequately protected.

Risks Associated with Our Business

Seasonality

Our worldwide toy business is highly seasonal with net sales and earnings highest in the fourth quarter. During the last three fiscal years, more than 45% of the net sales from our worldwide toy business and a substantial portion of the operating earnings and cash flows from operations were generated in the fourth quarter. Our results of operations depend significantly upon the holiday selling season in the fourth quarter. If less than satisfactory net sales, operating earnings or cash flows from operations are achieved during the key fourth quarter, we may not be able to compensate sufficiently for the lower net sales, operating earnings, or cash flows from operations during the first three quarters of the fiscal year. Our Babies “R” Us business is not significantly impacted by seasonality.

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For further detail regarding the seasonal nature of our business, refer to the tabular presentation in the “Quarterly Results of Financial Operations” section at the end of Item 8 on Page 57.

Liquidity and Capital Requirements

We have significant liquidity and capital requirements. Among other things, the seasonality of our toy business requires us to purchase merchandise well in advance of the holiday selling season. We depend on our ability to generate cash flow from operations as well as borrowings from our unsecured revolving credit facilities to finance the carrying costs of this inventory, to pay for capital expenditures, and to maintain operations. Standard & Poor’s and Moody’s rate our debt as non-investment grade. There is a risk that these ratings may be lowered again in the future. Our current credit ratings could (1) negatively impact our ability to finance our operations on satisfactory terms; (2) have the effect of increasing our financing costs; and (3) have the effect of slightly increasing our insurance premiums and collateral requirements necessary for our self-insured programs. We currently have adequate sources of funds to provide for our ongoing operations and capital requirements; however, any inability to have future access to financing, when needed, could have a negative effect on the financial condition and results of our operations.

For a discussion of our liquidity and capital resource requirements, refer to Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations beginning on Page 20.

Competition

The retailing industry is highly competitive and our results of operations are sensitive to, and may be adversely affected by, competitive pricing, promotional pressures, additional competitor store openings, and other factors. We compete with discount and mass merchandisers, such as Wal-Mart, Target, and Kmart; electronic retailers, such as Best Buy and Circuit City; national and regional chains; as well as local retailers in the market areas we serve. Competition is principally based on price, store location, advertising and promotion, product selection, quality, and service. Some of our competitors may have greater financial resources, lower merchandise acquisition costs, and lower operating expenses than our company. If we fail to compete successfully, we could face lower net sales and may decide to offer greater discounts to our guests, which could result in decreased profitability.

Most 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 build traffic for other store departments. We seek to address these competitive tactics and attract more guests by continually building brand image and by offering exclusive products, high value items, and the best available selection of toys and toy-related products relative to the discount and mass merchandisers.

In addition, competition in the retail apparel business consists of national and local department stores, specialty and discount store chains, as well as Internet and catalog businesses. Our apparel business is vulnerable to demand and pricing shifts and to less than optimal selection as a result of these factors. We review our merchandise assortments in order to identify slow-moving items and use markdowns to clear such inventory.

Strategic Initiatives

We continue to implement a series of guest-oriented strategic programs designed to differentiate and strengthen our core merchandise content and service levels. We are also continuing with plans to reduce and optimize our operating expense structure. The success of these plans will depend on various factors including the appeal of renovated store formats, our ability to offer new products to guests, and competitive and economic conditions. If we are unsuccessful at implementing some or all of our strategic initiatives, we may be unable to retain or attract guests, which could result in lower net sales and a failure to realize the benefit of the sizeable expenditures incurred for these initiatives. Also refer to the section entitled “Strategic Evaluation” on Page 6.

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Consumer Preferences

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 demands in a timely manner. Our toy and other products must appeal to a broad range of consumers whose preferences cannot be predicted with certainty and are subject to change. We cannot guarantee our ability to continue to meet changing consumer demands in the future. If we misjudge the market for our products, we may be faced with significant excess inventories for some products and missed opportunities for other products. In addition, because we place orders for products well in advance of purchases by guests, we could experience excess inventory if our guests purchase fewer products than anticipated. The retail apparel business fluctuates according to changes in consumer preferences dictated in part by fashion, perceived value, and season. These fluctuations affect the merchandise in stock since purchase orders are made well in advance of the season and, at times, before fashion trends and high-demand brands are evidenced by consumer purchases.

Consumer Spending

Sales of toys and other products may depend upon discretionary consumer spending, which may be affected by general economic conditions, consumer confidence, and other factors beyond our control. A decline in consumer spending could, among other things, negatively affect our net sales and could also result in excess inventories, which could in turn lead to increased inventory financing expenses. As a result, changes in consumer spending patterns could adversely affect our profitability.

Age Compression Trend

Toy sales may be negatively impacted by “age compression,” which is the acceleration of children abandoning traditional toy categories at increasingly younger ages for more sophisticated products, such as cell phones, DVD players, CD players, MP3 devices, and other electronic products. The age compression pattern tends to decrease consumer demand for traditional toys. To the extent that we cannot offer guests more sophisticated products or that the more sophisticated items are also available at a wider range of retailers than our traditional competitors, our sales and profitability could be detrimentally affected and we could experience excess inventories.

Vendor Relationships

We have more than 2,000 vendor relationships through which we procure the merchandise that we offer to guests. For 2003, our top 20 vendors, based on our purchase volume, represented approximately 45% of the total products we purchased. The concentration of goods coming from a limited number of vendors could negatively affect our business if our relationship deteriorated with this group of vendors. If we were unable to negotiate reasonable terms to acquire merchandise from this group of vendors and then fail to obtain similar products from alternative sources, our net sales and profitability would be negatively affected.

Product Sourcing

A significant portion of the toys and other products sold by us are manufactured outside of the United States, primarily in Asia. As a result, any event causing a disruption of imports, including the imposition of import restrictions or trade restrictions in the form of tariffs or otherwise, acts of war, or terrorism could increase the cost and reduce the supply of products available to us, which could, in turn, negatively affect our net sales and profitability.

Internet Operations

The success of our on-line business depends on our ability to provide quality service to our Internet guests and on our strategic alliance with Amazon.com, Inc. If our relationship with Amazon.com, Inc. deteriorated in a material way, it could have a negative impact on our on-line business. If our strategic alliance ended and we were

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unable to provide the same level of website and fulfillment services ourselves or through another third party, our net sales and profitability would be negatively affected.

Information Technology Systems

We depend upon our information technology systems in the conduct of our operations. We are in the process of upgrading the inventory management, distribution and supply chain management systems, our point of sale systems, as well as other essential information technology. We spent approximately $100 million in each of the last three years on information technology. Implementation of new systems and enhancements to existing systems could cause disruptions in our operations. If our major information systems fail to perform as anticipated, we could experience difficulties in replenishing inventories or in delivering toys and other products to store locations in response to consumer demands. Any of these or other systems related problems could, in turn, adversely affect our net sales and profitability.

Employees

At January 31, 2004, we employed approximately 65,000 full-time and part-time individuals. Due to the seasonality of our business, we employed approximately 113,000 full-time and part-time employees during the 2003 holiday season.

Available Information

Our investor relations website is www.toysrusinc.com. We make available on this website under “INVESTOR RELATIONS, SEC Filings,” 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 or furnish such material to the United States Securities and Exchange Commission.

Our Corporate Governance Guidelines and the charters for our Audit Committee, Corporate Governance and Nominating Committee, Compensation and Organizational Development Committee and Executive Committee may also be found on our investor relations website at www.toysrusinc.com. In addition, our website contains the Toys “R” Us, Inc. and Subsidiaries Code of Ethical Standards and Business Practices and Conduct (Code of Ethics), which is our code of ethics and conduct for our directors, officers and employees. Any waivers to our Code of Ethics for our directors and officers will be promptly disclosed on our website. These materials are also available in print to any stockholder who requests them by writing to: Toys “R” Us, Inc., One Geoffrey Way, Wayne, New Jersey 07470, Attention: Investor Relations.

Forward Looking Statements

This Form 10-K contains “forward looking” statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created thereby. All statements herein that are not historical facts, including statements about our beliefs or expectations, are forward-looking statements. We generally identify these statements by words or phrases, such as “anticipate,” “estimate,” “plan,” “expect,” “believe,” “intend,” “foresee,” “will,” “may,” and similar words or phrases. These statements discuss, among other things, our strategy, store openings and renovations, future financial or operational performance, anticipated cost savings, results of store closings and restructurings, anticipated domestic or international development, and other goals and targets. These statements are subject to risks, uncertainties, and other factors, including, among others, competition in the retail industry, seasonality of our business, changes in consumer preferences and consumer spending patterns, general economic conditions in the United States and other countries in which we conduct our business, our ability to implement our strategy, availability of adequate financing, our dependence on key vendors for our merchandise, international events affecting the delivery of toys and other products to our stores, economic, political and other developments associated with our international operations, and risks, uncertainties and factors set forth in our

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reports and documents filed with the United States Securities and Exchange Commission. We believe that all forward-looking statements are based on reasonable assumptions when made; however, we caution that it is impossible to predict actual results or outcomes or the effects of risks, uncertainties or other factors on anticipated results or outcomes and that, accordingly, one should not place undue reliance on these statements. Forward-looking statements speak only as of the date they were made, and we undertake no obligation to update these statements in light of subsequent events or developments. Actual results may differ materially from anticipated results or outcomes discussed in any forward-looking statement.

ITEM 2.    PROPERTIES

The following summarizes our worldwide operating store and distribution center facilities as of January 31, 2004 (excluding International licensed and franchised stores):

In 2003, we consolidated five New Jersey store support center facilities into our Global Store Support Center facility in Wayne, New Jersey, which is financed under a lease arrangement commonly referred to as a “synthetic lease.” Further details of the recent consolidation of these store support facilities into the Global Store Support Center facility and the “synthetic lease” are described within the Notes to Consolidated Financial Statements on Pages 36 and 46. We also utilize other facilities worldwide for administrative and store support purposes.

We have former stores and distribution centers that are no longer part of our operations. Approximately 50% of these locations are owned and the rest are leased. We have tenants in about half of these locations, and for those without tenants, we continue to market the facilities for disposition. The net costs associated with these locations are reflected in our consolidated financial statements, but are not listed above.

For further information regarding properties, refer to the Note to Consolidated Financial Statements entitled “LEASES” included on Page 46 and Exhibit No. 13.

ITEM 3.    LEGAL PROCEEDINGS

From time to time, in the ordinary course of business, we are involved in various legal proceedings, including commercial disputes, personal injury claims and employment issues. We do not believe that any of these proceedings will have a material adverse effect on our financial condition, results of operations, or cash flows.

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ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted for a vote of stockholders during the fourth quarter of the fiscal year ending January 31, 2004.

Executive Officers of the Registrant

Information with respect to our directors is incorporated herein by reference to the section, “Directors’ Proposal to Elect Directors,” in our 2004 Proxy Statement.

a) The following persons are our Executive Officers, having been elected to their respective offices by our Board of Directors:

b) The following is a brief description of the business experience during the past five years for each of our Executive Officers:

We have employed Mr. Eyler since January 2000. Effective June 2001, he became Chairman of the Board in addition to President and Chief Executive Officer. From January 2000 to June 2001, he was President and Chief Executive Officer. Prior to his employment with us, he served as Chairman and Chief Executive Officer of FAO Schwarz. He had held this position since prior to January 2000.

We have employed Mr. Arthur since January 1999. In January 2002, he was appointed President – Toysrus.com, Inc. From October 2000 through January 2002, he served as Senior Vice President – Chief Financial Officer of Toysrus.com, Inc. From May 2000 to October 2000, he was Vice President – Finance and Administration of Toysrus.com, Inc. From April 2000 to May 2000, he was Vice President – Controller of Toysrus.com, Inc. From January 1999 to April 2000, he was Vice-President – Controller of Toys “R” Us, Inc.

We have employed Mr. Barbour since August 1999. Effective January 2002, he was appointed Executive Vice President – President – Toys “R” Us International. From August 1999 to January 2002, he served as President and Chief Executive Officer of Toysrus.com, Inc. From January 1999 to August 1999, he served as Chief Executive Officer of OddzOn, a division of Hasbro, Inc.

We have employed Ms. Brockett since September 1998. Effective October 2000, she was appointed Executive Vice President – Strategic Planning / Business Development. From September 1998 to October 2000, she was Senior Vice President – Strategic Planning / Business Development.

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We have employed Ms. Derby since June 2000. Effective May 2003, she was appointed as Executive Vice President – Human Resources. From November 2002 to May 2003, she served as Senior Vice President, Associate Relations and Organizational Development. From January 2002 to November 2002, she was Vice President, Associate Relations. From June 2000 to January 2002, she was Vice President – Human Resources for Babies “R” Us. From 1999 to May 2000, she was Corporate Director, Compensation and Benefits at Whirlpool Corporation.

We have employed Mr. Feldt since March 1999. Effective March 2000, he was appointed Executive Vice President – President – Merchandising and Marketing, Toys “R” Us U.S. From March 1999 to March 2000, he was Executive Vice President – Merchandising of Toys “R” Us U.S.

We have employed Mr. Holohan since February 1999. Effective May 2002, he was appointed Executive Vice President – Chief Information Officer. From February 1999 to May 2002, he served as Senior Vice President – Chief Information Officer.

We have employed Mr. Kay since September 2000. Effective September 2003, he was appointed Executive Vice President – Operations and Corporate Secretary. From January 2002 to September 2003, he served as Executive Vice President – Operations and General Counsel in addition to Corporate Secretary. From September 2000 to January 2002, he served as Executive Vice President – General Counsel and Corporate Secretary. Prior to September 2000, he was a partner in the law firm of Kay, Gronek & Latham.

We have employed Mr. Kornblum since January 1999. Effective January 2002, he was appointed Executive Vice President – Chief Marketing Officer. From March 2000 to January 2002, he served as Executive Vice President – Worldwide Marketing and Brand Management. From January 1999 to March 2000, he was Senior Vice President and Chief Marketing Officer.

We have employed Mr. Markee since 1990. Effective May 2003, he became Vice Chairman of Toys “R” Us, Inc.; President – Toys “R” Us U.S. From January 2002 to May 2003, he was Executive Vice President – President – Specialty Businesses and International Operations. From October 1999 to January 2002, he served as Executive Vice President, President of Babies “R” Us and Chairman of Kids “R” Us. From prior to 1999 to October 1999, he served as Executive Vice President, President of the Babies “R” Us Division and President of the Kids “R” Us Division.

We have employed Mr. Wahle since December 2000. Effective March 2003, he was appointed President – Babies “R” Us and Kids “R” Us. From September 2002 to March 2003, he served as President – Babies “R” Us. From December 2000 until September 2002, he served as Vice President and General Manager – Times Square, Toys “R” Us U.S. From August 1995 until February 2000, he was President and Chief Executive Officer of Dylex Limited.

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PART II

ITEM 5.    MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Market Information

Our common stock is listed on the New York Stock Exchange under the symbol “TOY.” The following table sets forth, for the periods indicated, the high and low sales prices (rounded to the nearest hundredth) as reported on the New York Stock Exchange composite tape since February 2, 2002.

We have not paid any cash dividends on our common stock. Our Board of Directors periodically reviews whether to pay dividends and any decision to pay dividends will depend upon our earnings, financial condition, and other factors.

We had approximately 31,820 stockholders of record on March 15, 2004.

Information regarding our equity compensation plans is hereby incorporated by reference to the section “Equity Compensation – Plan Information” in our 2004 Proxy Statement.

ITEM 6.    SELECTED FINANCIAL DATA

Selected financial data is hereby incorporated by reference to Exhibit No. 13.

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The following Management’s Discussion and Analysis is intended to provide the reader of our financial statements with a narrative discussion about our business, and is presented in five sections: Overview, Results of Operations, Restructuring and Other Charges, Liquidity and Capital Resources, and Critical Accounting Policies.

OVERVIEW

Our Business

Our company generates sales, earnings and cash flows by retailing specialty children’s products worldwide. We operate all of our retail stores in the United States, as well as approximately 50% of our branded retail stores internationally. As of January 31, 2004, there were 1,501 “R” Us branded retail stores operating worldwide in the following formats:

In addition to the above, we sell merchandise through our Internet sites at www.toysrus.com, www.babiesrus.com, www.imaginarium.com, www.sportsrus.com, and www.personalizedbyrus.com.

Opportunities, Challenges, and Risks

As a worldwide retailer of specialty goods, we are faced with significant opportunities, as well as challenges and risks.

We believe our major opportunities are as follows:

We believe the following are our principal challenges and risks, predominantly for our Toys “R” Us – U.S. division:

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RESULTS OF OPERATIONS

Consolidated net earnings were $88 million, or $0.41 per diluted share, for the year ended January 31, 2004, $229 million, or $1.09 per diluted share, for the year ended February 1, 2003, and $67 million, or $0.33 per diluted share, for the year ended February 2, 2002.

Our 2003 consolidated financial statements were impacted by the implementation of Emerging Issues Task Force Issue No. 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor” (EITF 02-16). Under this new guidance, amounts received from vendors are considered a

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reduction of product cost, unless certain restrictive provisions are met. EITF 02-16 was effective for all new arrangements, and modifications to existing arrangements, entered into after December 31, 2002. Beginning in 2003, we began to treat cooperative advertising arrangements as a reduction of product cost. Our 2002 consolidated financial statements have not been restated as part of the adoption of EITF 02-16 since the provisions of EITF 02-16 did not permit restatement.

Our consolidated financial statements for 2003 and 2001 also include restructuring and other charges, some of which are recorded in cost of sales. In addition, our consolidated financial statements for 2003 include depreciation that was accelerated during the closing periods of the Kids “R” Us stores. Refer to the Note to Consolidated Financial Statements entitled “RESTRUCTURING AND OTHER CHARGES” beginning on Page 35 for further details.

To better understand how EITF 02-16 impacted our results, we adjusted our 2003 reported results, including our results by segment, to a non-GAAP presentation below to be comparable with our reported results for 2002 and 2001:

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Comparable Store Sales Performance

Sales

Consolidated net sales increased 2.3% in 2003 and 2.6% in 2002. Excluding the impact of foreign currency translation, consolidated net sales decreased 0.6% to $11.23 billion in 2003 following a 1.2% increase to $11.16 billion in 2002. The decrease in consolidated net sales in 2003, after excluding the impact of foreign currency translation, was primarily due to the decrease in sales in the Toys “R” Us – U.S. division, which was partially offset by increases from our Babies “R” Us and International divisions. The decline in sales for 2003 and 2002 in the Toys “R” Us – U.S. division was primarily due to a decrease in net sales of video game products which decreased 20% in 2003 and 12% in 2002.

The decline in our video game business for both 2003 and 2002 is the result of price deflation of video game hardware, as well as the maturation of the most current video game platforms released in 2001: Microsoft X-Box,

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Nintendo Gamecube, and Nintendo Gameboy Advance. We expect the next video game platforms, such as the Sony Playstation 3 and the Sony handheld PSP, to be introduced in 2005.

The increase in consolidated net sales in 2002, after excluding the impact of foreign currency translation, was primarily the result of increased comparable store sales, in local currency, from our International division, as well as the addition of new Babies “R” Us stores.

Below are selected items from our consolidated statements of earnings, as a percentage of net sales:

Cost of Sales and Gross Margin

Consolidated gross margin, as a percentage of sales, increased by 1.1 percentage points during 2003 and remained unchanged in 2002. Consolidated gross margin for 2003 was impacted by the implementation of EITF 02-16. In addition, consolidated cost of sales included store closing inventory markdowns of $49 million in 2003, and $27 million in 2001. Consolidated gross margin as a percentage of sales for 2003, excluding the impact of EITF 02-16, decreased by 0.4 percentage points. Gross margin for the Toys “R” Us – U.S. division increased by 0.8 percentage points to 30.1% of net sales and was impacted by the implementation of EITF 02-16, which increased gross margin by 1.5 percentage points. Gross margin for the Toys “R” Us – U.S. division, excluding the impact of EITF 02-16, decreased by 0.7 percentage points to 28.6% of net sales. For 2002, the Toys “R” Us – U.S. division reported a decline of 0.8% in gross margin, to 29.3% of net sales.

The declines in gross margin for the Toys “R” Us – U.S. division for 2003 and 2002 were primarily attributable to higher inventory markdowns, both for competitive purposes during the highly promotional and competitive fourth quarters of both years, and to manage inventory levels during these periods. The declines in gross margin for the Toys “R” Us – U.S. division in 2003 and 2002 were offset by increases in gross margin from other divisions in both years. Babies “R” Us reported a 0.8 percentage point increase in gross margin in 2003, after excluding the impact of EITF 02-16, and a 1.0 percentage point increase in 2002, which was primarily driven by favorable shifts in the sales mix. Toysrus.com reported a 2.3 percentage point increase in gross margin in 2003 and a 2.7 percentage point increase in 2002, due to a favorable shift in the sales mix.

We record the costs associated with operating our distribution network as a part of consolidated selling, general, and administrative expenses (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 margin of other retailers that include similar costs in their cost of sales. Credits and allowances received from vendors are recognized in consolidated cost of sales and have a positive impact on our consolidated gross margin.

Selling, General and Administrative Expenses

Consolidated SG&A expense as a percentage of sales for 2003 increased 2.1 percentage points, but was impacted by the implementation of EITF 02-16. Consolidated SG&A, excluding the impact of EITF 02-16, increased by 0.2 percentage points in 2003, and decreased by 0.7 percentage points in 2002. The increase in

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2003, as a percentage of net sales, was primarily driven by the sales decrease of $279 million versus 2002 in the Toys “R” Us – U.S. division, which was partially offset by continued emphasis on expense control, such as the implementation of shared services in a variety of functions in 2002. SG&A as a percentage of sales for 2001 reflects the impact of strategic investments we made in our businesses, including the renovation of our toy stores to the Mission Possible format in the United States, and various guest-focused initiatives.

Depreciation and Amortization

The increase in depreciation and amortization of $31 million for 2003 included $24 million of depreciation during the fourth quarter of 2003 that was accelerated through the closing periods for the free-standing Kids “R” Us stores. Depreciation and amortization for 2001 included $13 million related to the amortization of goodwill. We ceased amortizing goodwill on February 3, 2002 when we adopted the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” (SFAS No. 142). Refer to the Note to Consolidated Financial Statements entitled “GOODWILL” on Page 38 for further details on the adoption of SFAS No. 142. Therefore, excluding the 2001 goodwill amortization, depreciation and amortization increased by $22 million for 2002. This increase was primarily due to our Mission Possible store remodeling program, new store openings, and strategic investments to improve our information technology systems. These increases were partially offset by the impact of closed stores.

Interest Expense

Interest expense increased by $23 million for 2003 and by $2 million for 2002. The increases in interest expense are mainly attributable to the increased long-term debt borrowings as a result of our initiative to refinance shorter-term debt. Refer to the section “LIQUIDITY AND CAPITAL RESOURCES” for further details.

Income Taxes

Our effective tax rate was 36.5% for 2003, 36.5% for 2002, and 26.9% for 2001. The 2001 effective tax rate reflects the impact of the reversal of restructuring reserves that had previously provided no tax benefit. Our effective tax rate includes reserves for items that we believe could be challenged by taxing authorities. Refer to the section “CRITICAL ACCOUNTING POLICIES – Income Taxes” and the Note to Consolidated Financial Statements entitled “INCOME TAXES” beginning on Page 47 for further details.

Other

Foreign currency translation had a 4% favorable impact on our consolidated net earnings for 2003 and 2002 and had a favorable impact on our operating earnings for the International Division of 14% in 2003 and 12% in 2002. Inflation did not have a significant impact on our consolidated net earnings in 2003, 2002 or 2001.

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. These free-standing stores incurred significant performance declines in the past few years. This accelerated deterioration in financial performance led to our decision to cease operations in these free-standing stores. While we continue to expand our apparel business and Imaginarium boutiques within our Toys “R” Us and Babies “R” Us stores, we believe that ceasing operations in the free-standing Kids “R” Us and Imaginarium stores will have a favorable impact on future cash flows and net earnings.

As of January 31, 2004, all of the free-standing Imaginarium stores were closed. Most of the leases have been terminated, with the remaining terminations under negotiation. 102 of the Kids “R” Us facilities were closed on or before January 31, 2004, and the remaining 44 locations will close during the first half of 2004. We plan to convert up to 14 of the former Kids “R” Us locations to Babies “R” Us stores over the next two years. In addition, five former Kids “R” Us stores had leases that ended on January 31, 2004. On March 2, 2004, we entered into an agreement with Office Depot, Inc. under which Office Depot, Inc. has agreed to acquire 124 of the former Kids “R” Us stores for $197 million in cash, before commissions and fees, plus the assumption of

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lease payments and other obligations. This transaction is expected to close in phases throughout 2004 and will be recorded in our consolidated financial statements upon closing. We are currently marketing the remaining three former Kids “R” Us store properties for disposition.

We recorded costs and charges of $147 million in the fourth quarter of 2003 for the closing of the free-standing Kids “R” Us and Imaginarium stores, and we expect to record additional charges of approximately $25 million during 2004.

In 2001, we recorded charges to close 27 Toys “R” Us stores and 37 Kids “R” Us stores, all of which have closed. In conjunction with most of the Kids “R” Us store closings, we converted the nearest Toys “R” Us store into a Toys “R” Us combo store, which combines our toy offering with approximately 5,500 square feet of apparel offering. Also, as part of this plan, we eliminated approximately 1,700 staff positions in our stores and headquarters and consolidated five of our store support center facilities into our current Global Store Support Center facility in Wayne, New Jersey. We have obtained a signed letter of intent to sell our former store support center facility in Montvale, New Jersey to a third party, and we continue to aggressively pursue a sub-tenant for our former store support center facilities in Paramus and Fort Lee, New Jersey. We recorded net charges of $213 million in the fourth quarter of 2001 for these initiatives and have recorded additional net charges of $13 million in 2003 and $10 million in 2002, primarily related to the disposition of the real estate properties discussed above.

Refer to the Note to Consolidated Financial Statements entitled “RESTRUCTURING AND OTHER CHARGES” beginning on Page 35 for further details.

LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of liquidity are cash flow provided from operations, our existing cash balances, and our revolving credit facilities. The seasonal nature of our business typically causes cash balances to decline from the beginning of the fiscal year through October as inventory increases for the holiday selling season and funds are used for construction of new stores, as well as remodeling and other initiatives that normally occur in this period. Our revolving credit facilities are available for seasonal borrowings and general corporate purposes. Additionally, we have lines of credit with various banks to meet certain of the short-term financing needs of our foreign subsidiaries. We had no short-term borrowings outstanding at either January 31, 2004 or February 1, 2003. We had cash and cash equivalents of $2,003 million at January 31, 2004, of which $506 million was used to repay a euro-denominated bond plus accrued interest on February 13, 2004. We have generated positive cash flow from operations of $789 million in 2003, $574 million in 2002 and $504 million in 2001.

We believe that cash flow from our operations in 2004, along with our existing cash and our revolving credit facilities, will be adequate to meet our expected 2004 cash flow requirements. In addition, our next significant debt maturity will occur in 2006 and we believe that we will be able to either repay or refinance this maturing debt.

Selected Statements of Cash Flows Highlights:

For further details on our cash flow data, refer to the consolidated statements of cash flows on Page 30.

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Operating activities

Net cash flow from operating activities increased by $215 million in 2003 and increased by $70 million in 2002. The increase in net cash flow from operating activities in 2003 was driven primarily by lower consolidated merchandise inventories, which accounted for $204 million of the year-over-year increase and was partially offset by a decrease in net earnings, as adjusted for non-cash items. Inventories at Kids “R” Us decreased by $83 million to $4 million at January 31, 2004, and will be liquidated as the remaining free-standing stores close during the first half of 2004. The increase in 2002 was driven by a year over year increase in net earnings, as adjusted for non-cash items of $225 million, and was partially offset by the change in operating assets and liabilities.

Investing Activities

Capital expenditures, net of dispositions, decreased by $142 million in 2003 and decreased by $307 million in 2002. Capital expenditures in 2003 included the opening of 16 new Babies “R” Us stores in the United States and six new wholly-owned international toy stores. Capital expenditures in 2002 included the opening of 19 new Babies “R” Us stores, two new Geoffrey stores in the United States, and 10 new wholly-owned international toy stores. Capital expenditures for 2002 and 2001 included costs to reformat existing toy stores in the United States into the Mission Possible format, costs to convert certain existing toy stores in the United States into the combo format, and costs to reformat certain Kids “R” Us stores. In addition, we opened 20 new Babies “R” Us stores in the United States and five new wholly-owned international toy stores in 2001. During 2004, we plan to invest approximately $340 million in capital expenditures. These plans include opening approximately 20 new Babies “R” Us stores in the United States, approximately nine new wholly-owned international Toys “R” Us stores and to convert approximately 35 Toys “R” Us stores in the United States into combo stores. In addition, our capital expenditures in each of the preceding three years included costs to improve and enhance our information technology systems.

Financing Activities

Net cash flow from financing activities in 2003 include the net proceeds of $792 million from notes issued under a “shelf” registration statement filed with the United States Securities and Exchange Commission (“SEC”). Long-term debt repayments in 2003 include $342 million to retire our 475 million Swiss Franc note that matured on January 28, 2004. Net cash flow from financing activities in 2002 was driven by the net proceeds from the issuance of common stock and equity security units, which were used to refinance short-term borrowings and for other general corporate purposes. Refer to the Note to Consolidated Financial Statements entitled “ISSUANCE OF COMMON STOCK AND EQUITY SECURITY UNITS” beginning on Page 42 for further details. Net cash flow from financing activities in 2001 included the issuance of $750 million of notes, the proceeds of which were used to reduce outstanding commercial paper obligations. Also in 2001, we issued a 500 million euro-denominated bond that was swapped into a $466 million fixed rate obligation.

Refer to the Note to Consolidated Financial Statements entitled “SEASONAL FINANCING AND LONG-TERM DEBT” beginning on Page 39 for further details regarding debt issuances and outstanding obligations.

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Contractual Obligations and Commitments

Our contractual obligations consist mainly of operating leases related to real estate used in the operation of our business, and long-term debt. Below are the operating leases and principal amounts due under long-term debt issuances, as well as other obligations:

Contractual Obligations at January 31, 2004

We are in compliance with all covenants associated with the above contractual obligations. The covenants include, among other things, requirements to provide financial information and public filings and to comply with specified financial ratios. We also are in compliance with covenants associated with our unsecured revolving credit facilities. One covenant requires our total debt to capital ratio to be less than 58%. This ratio was 42% as of January 31, 2004. The other covenant requires our fixed charge ratio to be greater than 1.8. This ratio is calculated by dividing earnings before interest, income tax, depreciation, and rent expense, by the total of interest and rent expense, and was 2.3 at January 31, 2004. Non-compliance with associated covenants could give rise to accelerated payments, requirements to provide collateral, or changes in terms contained in the respective agreements.

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We currently have $885 million in unsecured committed revolving credit facilities from a syndicate of financial institutions. However, $200 million of this $885 million will expire in May 2004. We do not plan to renew this expiring facility since we do not believe that we will need this additional facility given our current liquidity position. The credit facilities are available for seasonal borrowings and other general corporate purposes. There were no outstanding balances under these credit facilities at the end of 2003, 2002 or 2001. Additionally, we have lines of credit with various banks to meet certain of the short-term financing needs of our foreign subsidiaries. The following table shows our commercial commitments with their related expirations and availability:

Commercial Commitments at January 31, 2004

In addition to the above, we had $61 million of outstanding letters of credit related to import merchandise at January 31, 2004.

Credit Ratings

On March 10, 2004, Standard & Poor’s revised our long-term debt credit rating to BB, a one level downgrade from BB+. On March 24, 2004, Moody’s revised our long-term debt credit rating to Ba2, a two level downgrade from Baa3. These current credit ratings are considered non-investment grade. Our current credit ratings are as follows:

Other credit ratings for our debt are available; however, we have disclosed only the ratings of the two largest nationally recognized statistical rating organizations because we believe these are the most relevant to our business.

Our current credit ratings, as well as future rating agency actions, could (1) negatively impact our ability to finance our operations on satisfactory terms; (2) have the effect of increasing our financing costs; and (3) have the effect of slightly increasing our insurance premiums and collateral requirements necessary for our self-insured programs. Our debt instruments do not contain provisions requiring acceleration of payment upon a debt rating downgrade.

CRITICAL ACCOUNTING POLICIES

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosures of contingent assets and liabilities as of the date of the financial statements and during the

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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 estimate to be critical if it requires assumptions to be made that were uncertain at the time they were made, and if changes in these estimates could have a material impact on our consolidated financial condition or results of operations:

Merchandise Inventories:

Merchandise inventories for the Toys “R” Us – U.S. division, other than apparel, are stated at the lower of LIFO (last-in, first-out) cost or market value, as determined by the retail inventory method and represent approximately 64% of total merchandise inventories. All other merchandise inventories are stated at the lower of FIFO (first-in, first-out) cost or market value as determined by the retail inventory method.

We receive various types of merchandise and other types of allowances from our vendors based on negotiated terms. We use estimates at interim periods to record our provisions for inventory shortage, to adjust certain inventories to a LIFO basis, and to record merchandise allowances from our vendors. These estimates are based on the development of the cost-to-retail ratios (estimated average markup percentages for product categories), consumer price index data, estimated inventory turnover, and the accounting for retail price adjustments. These estimates are based on available data and are adjusted to actual amounts at the completion of our physical inventories, finalization of all vendor allowance agreements, and the closing of our books at the end of our fiscal year. In addition, we perform an inventory-aging analysis for the establishment of markdown reserves for inventory items that have been on hand for more than one year at the end of our fiscal year. We also establish markdown reserves for items that will soon be obsolete due to anticipated developments in technology or products that are updated each year. Specific reserves are established based on the above and anticipated turnover of specific items based on planned marketing events and negotiated vendor support for reduced pricing of the identified items.

Factors such as slower inventory turnover due to changes in competitors’ tactics, consumer preferences, consumer spending and unseasonable weather patterns, among other factors, could cause excess inventory requiring greater than estimated markdowns to entice consumer purchases, resulting in an unfavorable impact on our consolidated financial statements. Sales shortfalls due to the above factors could cause reduced purchases from vendors and associated vendor allowances that would also result in an unfavorable impact on our consolidated financial statements.

Insurance Risks:

We insure a substantial portion of our general liability and workers’ compensation risks through a wholly-owned insurance subsidiary, in addition to third party insurance coverage. Provisions for losses related to self-insured risks are based upon independent actuarially determined estimates. We maintain stop-loss coverage to limit the exposure related to certain 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. For example, variability in inflation rates of health care costs inherent in these claims can affect the amounts realized. Similarly, changes in legal trends and interpretations, as well as a change in the nature and method of how claims are settled can impact ultimate costs.

Although our estimates of liabilities incurred do not anticipate significant changes in historical trends for these variables, any changes could have a considerable effect upon future claim costs and currently recorded liabilities and could have a material impact on our consolidated financial statements.

Impairment of Assets:

We periodically review the carrying value of long-lived assets, other than goodwill, for indicators of impairment, and we test goodwill for impairment annually. Indicators of impairment for long-lived assets, other

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than goodwill, include current period losses combined with a history of losses or a projection of continuing losses, and a significant decrease in the fair market value of an asset. In addition, plans and intentions of management, such as a decision to close stores, which could impact the future cash flows associated with long-lived assets could indicate impairment. Goodwill is evaluated for impairment annually under the provisions of SFAS No. 142, which requires us to estimate future cash flows to measure the recoverability of goodwill assets.

Future indicators of impairment for long-lived assets, other than goodwill, could result in asset impairment charges. In addition, while we have concluded that our net goodwill of $348 million as of January 31, 2004 will be fully recoverable in future periods, changes in estimated future cash flows could require us to record impairment charges on these assets.

Income Taxes:

As part of the process of preparing our consolidated financial statements, we are required to estimate the amount of income and withholding tax in each of the jurisdictions in which we operate. In certain jurisdictions, the rules concerning the tax treatment of various items of income, expense, and credits are ambiguous. On a regular basis, these items, and others, are reviewed by various federal, state, and foreign taxing authorities. As such, we routinely provide reserves for items that we believe could be challenged by these taxing authorities. In addition, we routinely provide valuation allowances for deferred tax assets that we believe may not be realized, e.g., the tax benefits of certain foreign tax loss carryovers.

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 and when these proposed adjustments become final, we will be able to reverse a significant amount of reserves 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.

Derivatives and Hedging Activities:

We enter into derivative financial arrangements to hedge a variety of risk exposures, including interest rate and currency risks, associated with our long-term debt, as well as foreign currency risk relating to import merchandise purchases. We account for these hedges in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and we record the fair value of these instruments within our consolidated balance sheets.

Gains and losses from derivative financial instruments are largely offset by gains and losses on the underlying transactions. The ineffective portion of an instrument’s change in fair value will be immediately recognized in earnings. Generally, the contract terms of hedge instruments closely mirror those of the item being hedged, providing a high degree of risk reduction and correlation. At January 31, 2004, we increased the carrying amount of our long-term debt by $238 million, representing the fair value of debt in excess of the carrying amount on that date. Also at January 31, 2004, we recorded derivative assets of $239 million and derivative liabilities of $26 million.

We intend to continue to meet the conditions for hedge accounting. However, if hedges were not to be highly effective in offsetting cash flows attributable to the hedged risk, the changes in the fair value of the derivatives used as hedges could have a significant impact on our consolidated financial statements. Assuming that all derivatives at January 31, 2004 were deemed ineffective, our consolidated financial statements would be favorably impacted by $213 million.

RECENT ACCOUNTING PRONOUNCEMENTS

Refer to the Note to Consolidated Financial Statements entitled “RECENT ACCOUNTING PRONOUNCEMENTS” for a discussion of recent accounting pronouncements and their impact on our consolidated financial statements, beginning on Page 53. Included in this discussion is the issuance of EITF 03-10, which we will adopt at the beginning of our 2004 fiscal year. EITF 03-10 will impact our consolidated financial statements in 2004 as well as the restatement of our consolidated financial statements for 2003, when reported for comparative purposes.

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ITEM 7a.    QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk from potential changes in interest rates and foreign exchange rates. The countries in which we own assets and operate stores are politically stable. We regularly evaluate these risks and have taken the following measures to mitigate these risks: our foreign exchange risk management objectives are to stabilize cash flow from the effects of foreign currency fluctuations; we do not participate in speculative hedges; and we will, whenever practical, offset local investments in foreign currencies with liabilities denominated in the same currencies. We also enter into derivative financial instruments to hedge a variety of risk exposures including interest rate and currency risks.

Our foreign currency exposure is primarily concentrated in the United Kingdom, Europe, Canada, Australia, and Japan. We face currency exposures that arise from translating the results of our worldwide operations into U.S. dollars from exchange rates that have fluctuated from the beginning of the period. We also face transactional currency exposures relating to merchandise that we purchase in foreign currencies. We enter into forward exchange contracts to minimize and manage the currency risks associated with these transactions. The counter-parties to these contracts are highly rated financial institutions and we do not have significant exposure to any single counter-party. Gains or losses on these derivative instruments are largely offset by the gains or losses on the underlying hedged transactions. For foreign currency derivative instruments, market risk is determined by calculating the impact on fair value of an assumed one-time change in foreign exchange rates relative to the U.S. dollar. Fair values were estimated based on market prices, where available, or dealer quotes. With respect to derivative instruments outstanding at January 31, 2004, a 10% appreciation of the U.S. dollar would have had no impact on pre-tax earnings and would have increased comprehensive income in 2003 by $19 million, while a 10% depreciation of the U.S. dollar would have decreased comprehensive income in 2003 by $19 million. Comparatively, considering our derivative instruments outstanding at February 1, 2003, a 10% appreciation of the U.S. dollar would have increased comprehensive income in 2002 by $39 million, while a 10% depreciation of the U.S. dollar would have decreased comprehensive income in 2002 by $42 million. Considering our derivative instruments outstanding at February 2, 2002, a 10% appreciation of the U.S. dollar would have increased comprehensive income in 2001 by $13 million, while a 10% depreciation of the U.S. dollar would have decreased comprehensive income in 2001 by $13 million.

We are faced with interest rate risks resulting from interest rate fluctuations. We have a variety of fixed and variable rate debt instruments. In an effort to manage interest rate exposures, we strive to achieve an acceptable balance between fixed and variable rate debt and have entered into interest rate swaps to maintain that balance. For interest rate derivative instruments, market risk is determined by calculating the impact to fair value of an assumed one-time change in interest rates across all maturities. Fair values were estimated based on market prices where available or dealer quotes. A change in interest rates on variable rate debt impacts earnings, cash flow, and the fair value of debt. A change in interest rates on fixed rate debt does not impact the fair value of debt, earnings, or cash flow. Based on our overall interest rate exposure related to floating rate debt outstanding at January 31, 2004, February 1, 2003 and February 2, 2002, a 1% increase in interest rates would have an unfavorable annualized impact on pre-tax earnings of $20 million in 2003, $15 million in 2002, and $11 million in 2001. A 1% decrease in interest rates would have a favorable annualized impact on pre-tax earnings of $20 million in 2003, $15 million in 2002, and $11 million in 2001. A 1% increase in interest rates would decrease the fair value of our long-term debt at January 31, 2004 and February 1, 2003 by approximately $101 million and $90 million, respectively. A 1% decrease in interest rates would increase the fair value of our long-term debt at January 31, 2004 and February 1, 2003 by approximately $93 million and $98 million, respectively.

Refer to the Note to Consolidated Financial Statements entitled “DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES” for a discussion of recent accounting pronouncements and their impact on our consolidated financial statements, beginning on Page 41.

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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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Toys “R” Us, Inc. and Subsidiaries

Consolidated Statements of Earnings