TOYS R US INC - FORM 8-K - EX-99.1 - TOYS-DELAWARE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - December 13, 2016

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Exhibit 99.1
TOYS “R” US – DELAWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
FOR THE QUARTERLY PERIOD ENDED OCTOBER 29, 2016




TOYS “R” US - DELAWARE, INC. AND SUBSIDIARIES

TABLE OF CONTENTS






Item 1.
Financial Statements

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

(In millions)
 
October 29,
2016
 
January 30,
2016
 
October 31,
2015
ASSETS
 
 
 
 
 
 
Current Assets:
 
 
 
 
 
 
Cash and cash equivalents
 
$
189

 
$
139

 
$
143

Accounts and other receivables
 
95

 
104

 
85

Merchandise inventories
 
2,606

 
1,689

 
2,472

Current deferred tax assets
 
—

 
—

 
27

Prepaid expenses and other current assets
 
77

 
65

 
86

Total current assets
 
2,967

 
1,997

 
2,813

Property and equipment, net
 
1,667

 
1,702

 
1,700

Deferred tax assets
 
3

 
2

 
28

Due from affiliates, net
 
997

 
920

 
897

Other assets
 
53

 
31

 
47

Total Assets
 
$
5,687

 
$
4,652

 
$
5,485

 
 
 
 
 
 
 
LIABILITIES AND STOCKHOLDER’S DEFICIT
 
 
 
 
 
 
Current Liabilities:
 
 
 
 
 
 
Accounts payable
 
$
1,487

 
$
1,135

 
$
1,435

Short-term borrowings from Parent
 
269

 
364

 
327

Accrued expenses and other current liabilities
 
672

 
655

 
631

Income taxes payable
 
123

 
109

 
103

Current portion of long-term debt
 
23

 
25

 
26

Total current liabilities
 
2,574

 
2,288

 
2,522

Long-term debt
 
3,356

 
2,425

 
3,154

Deferred tax liabilities
 
232

 
205

 
293

Deferred rent liabilities
 
382

 
378

 
376

Other non-current liabilities
 
134

 
158

 
134

Total stockholder’s deficit
 
(991
)
 
(802
)
 
(994
)
Total Liabilities and Stockholder’s Deficit
 
$
5,687

 
$
4,652

 
$
5,485

See Notes to the Condensed Consolidated Financial Statements.

1


TOYS “R” US - DELAWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

  
 
13 Weeks Ended
 
39 Weeks Ended
(In millions)
 
October 29,
2016
 
October 31,
2015
 
October 29,
2016
 
October 31,
2015
Net sales
 
$
1,520

 
$
1,561

 
$
4,674

 
$
4,775

Other revenues (1)
 
18

 
21

 
57

 
61

Total revenues
 
1,538

 
1,582

 
4,731

 
4,836

Cost of sales
 
997

 
1,027

 
3,024

 
3,075

Cost of other revenues
 
1

 
1

 
4

 
4

Gross margin
 
540

 
554

 
1,703

 
1,757

Selling, general and administrative expenses (1)
 
603

 
596

 
1,754

 
1,784

Depreciation and amortization
 
47

 
52

 
151

 
167

Other income, net (1)
 
(67
)
 
(27
)
 
(134
)
 
(82
)
Total operating expenses
 
583

 
621

 
1,771

 
1,869

Operating loss
 
(43
)
 
(67
)
 
(68
)
 
(112
)
Interest expense (1)
 
(64
)
 
(73
)
 
(199
)

(207
)
Interest income (1)
 
28

 
33

 
82


81

Loss before income taxes
 
(79
)
 
(107
)
 
(185
)
 
(238
)
Income tax expense
 
4

 
3

 
13

 
7

Net loss
 
$
(83
)
 
$
(110
)
 
$
(198
)
 
$
(245
)
 
 
 
 
 
 
 
 
 
(1) Includes the following income (expenses) resulting from transactions with related parties (see Note 8 entitled “Related party transactions” for further details):
 
 
13 Weeks Ended
 
39 Weeks Ended
(In millions)
 
October 29,
2016
 
October 31,
2015
 
October 29,
2016
 
October 31,
2015
Other revenues
 
$
13

 
$
14

 
$
39

 
$
40

Selling, general and administrative expenses
 
(74
)
 
(72
)
 
(229
)
 
(227
)
Other income, net
 
7

 
8

 
21

 
26

Interest expense
 
(2
)
 
(9
)
 
(6
)
 
(20
)
Interest income
 
28

 
33

 
82

 
81

See Notes to the Condensed Consolidated Financial Statements.

2


TOYS “R” US - DELAWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)

  
 
13 Weeks Ended
 
39 Weeks Ended
(In millions)
 
October 29,
2016
 
October 31,
2015
 
October 29,
2016
 
October 31,
2015
Net loss
 
$
(83
)
 
$
(110
)
 
$
(198
)
 
$
(245
)
Other comprehensive (loss) income, net of tax
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 
(3
)
 
—

 
1

 
(4
)
Total other comprehensive (loss) income, net of tax
 
(3
)
 
—

 
1

 
(4
)
Comprehensive loss, net of tax
 
$
(86
)
 
$
(110
)
 
$
(197
)
 
$
(249
)
See Notes to the Condensed Consolidated Financial Statements.

3


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

  
 
39 Weeks Ended
(In millions)
 
October 29,
2016
 
October 31,
2015
Cash Flows from Operating Activities:
 
 
 
 
Net loss
 
$
(198
)
 
$
(245
)
Adjustments to reconcile Net loss to Net cash used in operating activities:
 
 
 
 
Depreciation and amortization
 
151

 
167

Amortization and write-off of debt issuance costs and debt discount
 
15

 
18

Gains on sales of assets
 
(45
)
 
(1
)
Deferred income taxes
 
34

 
1

Unrealized (gains) losses on foreign exchange
 
(6
)
 
3

Other
 
4

 
7

Changes in operating assets and liabilities:
 
 
 
 
Accounts and other receivables
 
7

 
21

Merchandise inventories
 
(913
)
 
(980
)
Prepaid expenses and other operating assets
 
(37
)
 
(20
)
Due from affiliates, net
 
(78
)
 
(62
)
Accounts payable, Accrued expenses and other liabilities
 
356

 
465

Income taxes payable, net
 
16

 
1

Net cash used in operating activities
 
(694
)
 
(625
)
Cash Flows from Investing Activities:
 
 
 
 
Capital expenditures
 
(126
)
 
(100
)
Proceeds from sales of assets
 
45

 
1

Net cash used in investing activities
 
(81
)
 
(99
)
Cash Flows from Financing Activities:
 
 
 
 
Long-term debt borrowings
 
1,007

 
897

Long-term debt repayments
 
(87
)
 
(102
)
Short-term borrowings from Parent
 
229

 
1,145

Repayments of short-term borrowings to Parent
 
(324
)
 
(1,194
)
Net cash provided by financing activities
 
825

 
746

Effect of exchange rate changes on Cash and cash equivalents
 
—

 
—

Cash and cash equivalents:
 
 
 
 
Net increase during period
 
50

 
22

Cash and cash equivalents at beginning of period
 
139

 
121

Cash and cash equivalents at end of period
 
$
189

 
$
143

See Notes to the Condensed Consolidated Financial Statements.

4


TOYS “R” US - DELAWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDER’S DEFICIT
(Unaudited)

  
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Loss
 
Accumulated
Deficit
 
Total
Stockholder’s
Deficit
(In millions)
 
Balance, January 31, 2015
 
$
3,533

 
$
(57
)
 
$
(4,228
)
 
$
(752
)
Net loss
 
—

 
—

 
(245
)
 
(245
)
Total other comprehensive loss, net of tax
 
—

 
(4
)
 
—

 
(4
)
Stock compensation expense
 
(1
)
 
—

 
—

 
(1
)
Contribution arising from tax allocation arrangement
 
8

 
—

 
—

 
8

Balance, October 31, 2015
 
$
3,540

 
$
(61
)
 
$
(4,473
)
 
$
(994
)
 
 
 
 
 
 
 
 
 
Balance, January 30, 2016
 
$
3,511

 
$
(70
)
 
$
(4,243
)
 
$
(802
)
Net loss
 
—

 
—

 
(198
)
 
(198
)
Total other comprehensive loss, net of tax
 
—

 
1

 
—

 
1

Stock compensation expense
 
1

 
—

 
—

 
1

Contribution arising from tax allocation arrangement
 
7

 
—

 
—

 
7

Balance, October 29, 2016
 
$
3,519

 
$
(69
)
 
$
(4,441
)
 
$
(991
)
 See Notes to the Condensed Consolidated Financial Statements.

5


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

1. Basis of presentation
Toys “R” Us – Delaware, Inc. (the “Company,” “we,” “us,” or “our”), a Delaware corporation, is a wholly-owned subsidiary of Toys “R” Us, Inc. (“Parent”), which owns and licenses Toys “R” Us and Babies “R” Us stores in the United States and foreign countries and jurisdictions. We operate Toys “R” Us stores in the United States, Canada, Guam and Puerto Rico; Babies “R” Us stores in the United States; and e-commerce businesses in the United States and Canada.
The Condensed Consolidated Balance Sheets as of October 29, 2016, January 30, 2016 and October 31, 2015, the Condensed Consolidated Statements of Operations and the Condensed Consolidated Statements of Comprehensive Loss for the thirteen and thirty-nine weeks ended October 29, 2016 and October 31, 2015 and the Condensed Consolidated Statements of Cash Flows and the Condensed Consolidated Statements of Stockholder’s Deficit for the thirty-nine weeks ended October 29, 2016 and October 31, 2015, have been prepared by us in conformity with accounting principles generally accepted in the United States of America (“GAAP”) for interim reporting. Our interim Condensed Consolidated Financial Statements are unaudited and are subject to year-end adjustments. In the opinion of management, the financial statements include all known adjustments (which consist primarily of normal, recurring accruals, estimates and assumptions that impact the financial statements) necessary to present fairly the financial position at the balance sheet dates and the results of operations for the thirteen and thirty-nine weeks then ended. The Condensed Consolidated Balance Sheet at January 30, 2016, presented herein, has been derived from our audited balance sheet included in our Annual Financial Statements for the fiscal year ended January 30, 2016, but does not include all disclosures required by GAAP. These financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in our Annual Financial Statements for the fiscal year ended January 30, 2016 included as an exhibit to Parent’s Form 8-K filed on April 8, 2016. The results of operations for the thirteen and thirty-nine weeks ended October 29, 2016 and October 31, 2015 are not necessarily indicative of operating results for the full year.
Adoption of New Accounting Pronouncement
In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2015-03, “Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs” (“ASU 2015-03”).  ASU 2015-03 simplifies the presentation of debt issuance costs by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts.  Under the previous practice, debt issuance costs were recognized as an asset.  In August 2015, the FASB issued ASU 2015-15 “Interest - Imputed Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements” (“ASU 2015-15”), which clarifies that the guidance in ASU 2015-03 does not apply to line-of-credit arrangements.  The Company has retrospectively adopted the amendments of ASU 2015-03 and ASU 2015-15, effective January 31, 2016.  We revised the balance sheet presentation of debt issuance costs from Other assets to a deduction from the carrying amount of Long-term debt on the Condensed Consolidated Balance Sheets and revised the presentation of the carrying amounts of individual debt liabilities in Note 2 entitled “Long-term debt.” The amounts of debt issuance costs that were reclassified as of October 29, 2016, January 30, 2016 and October 31, 2015 totaled $21 million, $28 million and $38 million, respectively.
Subsequent Events
We have performed an evaluation of subsequent events through December 13, 2016, the date these financial statements were issued. Subsequent events, if any, have been disclosed in the related footnotes.


6


    
2. Long-term debt
A summary of the Company’s consolidated Long-term debt as of October 29, 2016, January 30, 2016 and October 31, 2015 is outlined in the table below. The balances below do not include the impact of the Commercial Mortgage-Backed Securities (“CMBS”) and mezzanine financing and subsequent redemption of the Propco II Notes (as defined below) which were completed subsequent to October 29, 2016.
(In millions)
 
October 29,
2016
 
January 30,
2016 (1)
 
October 31,
2015 (1)
8.500% senior secured notes, due fiscal 2017 (2)(3)
 
$
719

 
$
715

 
$
714

Incremental secured term loan facility, due fiscal 2018
 
126

 
129

 
129

Second incremental secured term loan facility, due fiscal 2018
 
63

 
64

 
65

$1.85 billion secured revolving credit facility, expires fiscal 2019
 
1,018

 
80

 
814

Tranche A-1 loan facility, due fiscal 2019
 
271

 
269

 
266

Secured term B-4 loan facility, due fiscal 2020
 
983

 
987

 
982

8.750% debentures, due fiscal 2021 (4)
 
22

 
22

 
22

Finance obligations associated with capital projects
 
167

 
167

 
169

Capital lease obligations
 
10

 
17

 
19

 
 
3,379

 
2,450

 
3,180

Less: current portion
 
23

 
25

 
26

Total Long-term debt (5)
 
$
3,356

 
$
2,425

 
$
3,154

(1)
In accordance with the retrospective adoption of ASU 2015-03 and ASU 2015-15, we have revised the presentation of the carrying amounts of individual debt liabilities as of January 30, 2016 and October 31, 2015.  For further details, refer to Note 1 entitled “Basis of Presentation.”
(2)
Represents obligations of Toys “R” Us Property Company II, LLC (“TRU Propco II”), our indirect wholly-owned subsidiary. TRU Propco II is a single-purpose entity and is a separate entity from the Company. The assets and credit of TRU Propco II and its direct parent Giraffe Junior Holdings, LLC (“Giraffe Junior”) are not available to satisfy the debts or other obligations of the Company or any affiliate.
(3)
On November 3, 2016, we completed $512 million of CMBS financing and $88 million of mezzanine financing. The proceeds and a $51 million rent prepayment from the Company to TRU Propco II in conjunction with an amendment to the master lease agreement, along with cash on hand were used to redeem the aggregate principal amount of $725 million of 8.500% senior secured notes due 2017 of TRU Propco II (the “Propco II Notes”). TRU Propco II entered into a mortgage loan agreement (the “Mortgage Loan Agreement”), providing for a floating-rate loan (the “Propco II Mortgage Loan”) in the initial principal amount of $512 million. Additionally, Giraffe Junior, our indirect wholly-owned subsidiary and the owner of 100% of the equity interest in TRU Propco II, entered into a mezzanine loan agreement (the “Mezzanine Loan Agreement”) providing for a fixed-rate loan (the “Giraffe Junior Mezzanine Loan”) in the initial principal amount of $88 million. The impact of these transactions is not reflected in the balances presented as the transactions occurred after fiscal quarter-end. For further details, refer to the “Subsequent Events” below.
(4)
Our Parent is co-obligor of the outstanding debentures due fiscal 2021. However, all future principal and interest will be funded through the operating cash flows of the Company.
(5)
We may maintain derivative instruments on certain of our long-term debt. Refer to Note 3 entitled “Derivative instruments and hedging activities” for further details. In addition, intercompany loans with our Parent and its other subsidiaries are not included within our long-term debt balances. Refer to Note 8 entitled “Related party transactions” for further details.
Our credit facilities, loan agreements and indentures contain customary covenants that, among other things, restrict our and our subsidiaries’ ability to:
•
incur certain additional indebtedness;
•
transfer money between our Parent, us and our various subsidiaries;
•
pay dividends on, repurchase or make distributions with respect to our or our subsidiaries’ capital stock or make other restricted payments;

7


•
issue stock of subsidiaries;
•
make certain investments, loans or advances;
•
transfer and sell certain assets;
•
create or permit liens on assets;
•
consolidate, merge, sell or otherwise dispose of all or substantially all of our assets;
•
enter into certain transactions with our affiliates; and
•
amend certain documents.
As of October 29, 2016, we did not have any net assets subject to such restrictions. Our agreements also contain various and customary events of default with respect to the indebtedness, including, without limitation, the failure to pay interest or principal when the same is due under the agreements, cross default and cross acceleration provisions, the failure of representations and warranties contained in the agreements to be true and certain insolvency events. If an event of default occurs and is continuing, the principal amounts outstanding thereunder, together with all accrued and unpaid interest and other amounts owed thereunder, may be declared immediately due and payable by the lenders.
We are dependent on the borrowings provided by the lenders to support our working capital needs, capital expenditures and to service debt. As of October 29, 2016, we have funds available to finance our operations under our $1.85 billion secured revolving credit facility (“ABL Facility”) through March 2019, subject to an earlier springing maturity.
Borrowing Availability
Under our ABL Facility which expires on March 21, 2019, subject to an earlier springing maturity, we had outstanding borrowings of $1,018 million, a total of $97 million of outstanding letters of credit and excess availability of $735 million as of October 29, 2016. We are subject to a minimum excess availability covenant of $125 million, with remaining availability of $610 million in excess of the covenant at October 29, 2016. Availability is determined pursuant to a borrowing base, consisting of specified percentages of eligible inventory and credit card receivables and certain Canadian real estate less any applicable availability reserves, and generally peaks in the third quarter of our fiscal year.
Subsequent Events
On November 3, 2016, we completed $512 million of CMBS financing and $88 million of mezzanine financing. The proceeds and a $51 million rent prepayment from the Company to TRU Propco II in conjunction with an amendment to the master lease agreement, along with cash on hand were used to redeem the aggregate principal amount of $725 million of Propco II Notes. TRU Propco II entered into the Mortgage Loan Agreement, providing for the Propco II Mortgage Loan in the initial principal amount of $512 million. The Propco II Mortgage Loan has a three-year initial term expiring on November 9, 2019, and may be extended for two one-year terms at the option of TRU Propco II, subject to certain conditions, including meeting certain ratios at the time of the extension and, in the case of the second extension option, payment of an extension fee. If the Giraffe Junior Mezzanine Loan described below is outstanding, TRU Propco II may only exercise the extension options on the Propco II Mortgage Loan if the term of the Giraffe Junior Mezzanine Loan is also extended.
The Propco II Mortgage Loan has been divided into six separate components, designated as “Loan Component A” through “Loan Component F,” having payment priority in the order of their alphabetical designation, such that amortization payments, voluntary prepayments and other payments of principal will first be applied to the outstanding principal amount of Loan Component A before being applied to the other loan components. TRU Propco II will pay interest on each loan component monthly at a per annum rate equal to the sum of the spread applicable to such loan component, plus one-month U.S. London Interbank Offered Rate (“LIBOR”) (subject to a 0% LIBOR floor). The initial weighted average spread of the loan components is approximately 4.88% assuming no principal prepayments or other reduction of the principal balances.
TRU Propco II is also required to make monthly repayments according to the amortization schedule in the Mortgage Loan Agreement in amounts between $6 million and $7 million per year. The Propco II Mortgage Loan may be prepaid at any time, subject during the first eighteen months of the term to a yield maintenance premium if the aggregate principal balance of the Propco II Mortgage Loan that has been prepaid exceeds a threshold amount. Any voluntary prepayment must be accompanied by a simultaneous and pro-rata prepayment of the Giraffe Junior Mezzanine Loan.
The Propco II Mortgage Loan is secured by, among other things, first mortgage liens on TRU Propco II’s fee simple or leasehold interests in its retail properties (the “Propco II Properties”). The Propco II Properties are leased from TRU Propco II to Toys-Delaware pursuant to an amended and restated master lease agreement, providing for approximately $67 million of master lease rent per year.

8


The Mortgage Loan Agreement requires TRU Propco II to enter into, and maintain in effect, an interest rate cap agreement through the initial term of the Propco II Mortgage Loan and any extension. TRU Propco II has entered into an interest rate cap agreement with an initial notional amount of $512 million, capping LIBOR at 2.50%. For additional information on the interest rate cap, refer to the Subsequent Event disclosure in Note 3 entitled “Derivative instruments and hedging activities”.
The Mortgage Loan Agreement contains representations, warranties, covenants and events of default customary for mortgage loans funded in connection with a CMBS financing.
Our Parent has guaranteed the payment and performance of liabilities of TRU Propco II under the Mortgage Loan Agreement for damages resulting from certain breaches or actions, including, but not limited to, certain intentional abuses or destruction of the Propco II Properties, fraud, intentional misrepresentation, willful misconduct, misappropriation or intentional misapplication of funds, the failure of TRU Propco II to remain a single-purpose entity and certain other violations of the Mortgage Loan Agreement and related loan documents. In addition, our Parent and TRU Propco II have indemnified the lenders and certain other indemnified parties from and against certain environmental losses, liabilities and remediation and other costs with respect to the Propco II Properties.
Substantially concurrent with the closing of the Propco II Mortgage Loan, the Propco II Mortgage Loan was assigned to TRU Trust 2016-TOYS (the “Trust”), which is currently the sole lender of record. The Trust is a New York common law trust, which issued the commercial mortgage pass-through certificates sold to investors under the CMBS facility (the “Certificates”). The Trust is not an affiliate of our Parent or any of its affiliates. The Certificates, which represent beneficial interests in the Trust, are not securities issued by, or obligations of, our Parent or any of its affiliates.
Additionally, as noted above, on November 3, 2016, Giraffe Junior, an indirect wholly-owned subsidiary of the Company and the owner of 100% of the equity interest in TRU Propco II, entered into the Mezzanine Loan Agreement providing for the Giraffe Junior Mezzanine Loan in the initial principal amount of $88 million. The Giraffe Junior Mezzanine Loan has a three-year initial term expiring on November 9, 2019, and may be extended for two one-year terms at the option of Giraffe Junior, subject to certain conditions substantially similar to the conditions to extending the Propco II Mortgage Loan under the Mortgage Loan Agreement. If the Propco II Mortgage Loan is outstanding, Giraffe Junior may only exercise the extension options if the Propco II Mortgage Loan is also extended.
The Giraffe Junior Mezzanine Loan accrues interest at a fixed rate per annum equal to 12.50%. There are no amortization payments. The Giraffe Junior Mezzanine Loan is secured by a first priority pledge of all of Giraffe Junior’s ownership interests in TRU Propco II, together with certain accounts and other related collateral of Giraffe Junior, pursuant to a pledge and security agreement.
The Giraffe Junior Mezzanine Loan may be voluntarily prepaid at any time, subject during the first eighteen months of the term to a yield maintenance premium if the aggregate principal balance of the Giraffe Junior Mezzanine Loan that has been prepaid exceeds a threshold amount. Any voluntary prepayment must be accompanied by a simultaneous and pro-rata prepayment of the TRU Propco II Mortgage Loan. The Mezzanine Loan Agreement also provides for mandatory prepayment in certain circumstances, including prepayment on each monthly payment date of all amounts remaining in the cash management account following payment of monthly debt service and required reserves under the Propco II Mortgage Loan and Giraffe Junior Mezzanine Loan.
The Mezzanine Loan Agreement contains representations, warranties, covenants and events of default customary for mezzanine loans of its type.
Our Parent has guaranteed the payment and performance of certain liabilities of Giraffe Junior under the Mezzanine Loan Agreement. The terms of the guaranty for the Giraffe Junior Mezzanine Loan are substantially similar to the terms of the guaranty for the TRU Propco II Mortgage Loan. In addition, our Parent and Giraffe Junior have indemnified the lenders under the Mezzanine Loan Agreement and certain other indemnified parties from and against certain environmental losses, liabilities and remediation and other costs with respect to the Propco II Properties.

3. Derivative instruments and hedging activities
We are exposed to market risk from potential changes in interest rates and foreign currency exchange rates. We regularly evaluate our exposure and enter into derivative financial instruments to economically manage these risks. We record all derivatives as either assets or liabilities on the Condensed Consolidated Balance Sheets measured at estimated fair value and we do not offset assets and liabilities with the same counterparty. We recognize the changes in fair value as unrealized gains and losses. The recognition of these gains or losses depends on our intended use of the derivatives and the resulting designation. In certain defined conditions, we may designate a derivative as a hedge for a particular exposure.

9


Foreign Exchange Contracts
As of October 29, 2016, January 30, 2016 and October 31, 2015, we had foreign currency forward contracts to economically hedge the U.S. Dollar (“USD”) merchandise purchases of our Canadian subsidiary and our short-term, cross-currency intercompany loans with our subsidiaries. These derivative contracts are not designated as hedges.
As of October 29, 2016, derivative liabilities related to agreements that contain credit-risk related contingent features had fair values of $1 million. As of January 30, 2016 and October 31, 2015, there were no derivative liabilities related to agreements that contain credit-risk related contingent features.
The following table sets forth the net impact of the effective portion of derivatives designated as cash flow hedges on Accumulated other comprehensive loss on our Condensed Consolidated Statements of Stockholder’s Deficit for the thirty-nine weeks ended October 29, 2016 and October 31, 2015:
 
 
39 Weeks Ended
(In millions)
 
October 29,
2016
 
October 31,
2015
Derivatives designated as cash flow hedges:
 
 
 
 
Beginning balance
 
$
1

 
$
1

Reclassifications from Accumulated other comprehensive loss - Interest Rate Contracts
 
—

 
(1
)
Ending balance
 
$
1

 
$
—

The following table sets forth the impact of derivatives on Interest expense on our Condensed Consolidated Statements of Operations for the thirteen and thirty-nine weeks ended October 29, 2016 and October 31, 2015:
 
 
13 Weeks Ended
 
39 Weeks Ended
(In millions)
 
October 29,
2016
 
October 31,
2015
 
October 29,
2016
 
October 31,
2015
Derivatives not designated for hedge accounting:
 
 
 
 
 
 
 
 
Loss on the change in fair value - Intercompany Loan Foreign Exchange Contracts (1)
 
$
(2
)
 
$
—

 
$
(2
)
 
$
—

Gain (loss) on the change in fair value - Merchandise Purchases Program Foreign Exchange Contracts
 
2

 
—

 
(2
)
 
4

Total Interest expense
 
$
—

 
$
—

 
$
(4
)
 
$
4

(1)
Losses related to our short-term intercompany loan foreign exchange contracts are recorded in Interest expense, in addition to the corresponding foreign exchange gains and losses related to our short-term, cross-currency intercompany loans.
The following table contains the notional amounts and related fair values of our derivatives included within our Condensed Consolidated Balance Sheets as of October 29, 2016, January 30, 2016 and October 31, 2015:
  
 
October 29, 2016
 
January 30, 2016
 
October 31, 2015
(In millions)
 
Notional
Amount
 
Fair Value
Assets/
(Liabilities)
 
Notional
Amount 
 
Fair Value
Assets/
(Liabilities)
 
Notional
Amount
 
Fair Value
Assets/
(Liabilities)
Foreign Currency Contracts not designated for hedge accounting:
 
 
 
 
 
 
 
 
 
 
 
 
Prepaid expenses and other current assets
 
$
53

 
$
1

 
$
13

 
$
1

 
$
21

 
$
1

Accrued expenses and other current liabilities
 
80

 
(2
)
 
—

 
—

 
7

 
—

Total derivative contracts outstanding:
 
 
 
 
 
 
 
 
 
 
 
 
Prepaid expenses and other current assets
 
53

 
1

 
13

 
1

 
21

 
1

Total derivative assets (1)
 
$
53

 
$
1

 
$
13

 
$
1

 
$
21

 
$
1

 
 
 
 
 
 
 
 
 
 
 
 
 
Accrued expenses and other current liabilities
 
80

 
(2
)
 
—

 
—

 
7

 
—

Total derivative liabilities (1)
 
$
80

 
$
(2
)
 
$
—

 
$
—

 
$
7

 
$
—

(1)
Refer to Note 4 entitled “Fair value measurements” for the classification of our derivative instruments within the fair value hierarchy.

10


Subsequent Event
On October 31, 2016, in connection with the Propco II Mortgage Loan, TRU Propco II entered into an interest rate cap agreement maturing on November 15, 2019, capping LIBOR at 2.50%, with an initial notional amount of $512 million which amortizes in conjunction with the principal of the Propco II Mortgage Loan.

4. Fair value measurements
To determine the fair value of our assets and liabilities, we utilize the established fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Derivative Financial Instruments
Currently, we use derivative financial arrangements to manage our exposure to foreign currency risk relating to cross-currency intercompany lending and merchandise purchases. The valuation of our foreign currency contracts is determined using market-based foreign exchange rates, which are classified as Level 2 inputs. Any transfer into or out of a level of the fair value hierarchy is recognized based on the value of the instruments at the end of the reporting period. As of October 29, 2016, January 30, 2016 and October 31, 2015, we did not have any outstanding interest rate contracts.
The table below presents our assets and liabilities measured at fair value on a recurring basis as of October 29, 2016, January 30, 2016 and October 31, 2015 aggregated by level in the fair value hierarchy within which those measurements fall.
(In millions)
 
Quoted Prices in
Active Markets for
Identical Assets
and Liabilities
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Balance at
October 29, 2016
Assets
 
 
 
 
 
 
 
 
Derivative financial instruments:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
—

 
$
1

 
$
—

 
$
1

Total assets
 
$
—

 
$
1

 
$
—

 
$
1

Liabilities
 
 
 
 
 
 
 
 
Derivative financial instruments:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
—

 
$
2

 
$
—

 
$
2

Total liabilities
 
$
—

 
$
2

 
$
—

 
$
2

(In millions)
 
Quoted Prices in
Active Markets for
Identical Assets
and Liabilities
(Level 1)
 
Significant Other
Observable Inputs  
(Level 2)
 
Significant
Unobservable    
Inputs
(Level 3)
 
Balance
January 30, 2016
Assets
 
 
 
 
 
 
 
 
Derivative financial instruments:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
—

 
$
1

 
$
—

 
$
1

Total assets
 
$
—

 
$
1

 
$
—

 
$
1

(In millions)
 
Quoted Prices in
Active Markets for
Identical Assets
and Liabilities
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Balance at
October 31, 2015
Assets
 
 
 
 
 
 
 
 
Derivative financial instruments:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
—

 
$
1

 
$
—

 
$
1

Total assets
 
$
—

 
$
1

 
$
—

 
$
1

For the periods ended October 29, 2016, January 30, 2016 and October 31, 2015, we had no derivative financial instruments within Level 3 of the fair value hierarchy.

11


Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Certain of our assets and liabilities are measured at fair value on a nonrecurring basis. We evaluate the carrying value of all long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Impairment of long-lived assets is included in Other income, net on our Condensed Consolidated Statements of Operations.
The fair value measurements related to long-lived assets held and used classified as Level 3 were determined using a discounted cash flow valuation method or a relative, market-based approach based on purchase offers or appraisals we have received from third parties. The inputs we use to calculate discounted cash flows include the projected cash flows for the asset group (generally by store location) and, when significant, a risk-adjusted rate of return we estimate would be used by a market participant in valuing the assets. The projected cash flows are based on the Company’s sales, gross margin and expense forecasts for each asset group, taking into consideration historical cash flows, as well as anticipated costs and/or proceeds from disposal. For our market-based valuations, we use purchase offers we receive from third parties, predominantly for our properties, which are classified as Level 3 because they are not received in an organized market or observable to market participants. Alternatively, when management commits to sell properties and no third party offers exist, we use asset appraisals conducted by external specialists with experience in real estate valuations. These require a significant amount of judgment regarding appropriate comparable properties and their assessment of current market conditions.
There have been no changes in valuation technique or related inputs for long-lived assets for the thirty-nine weeks ended October 29, 2016 and October 31, 2015. The table below presents our long-lived assets evaluated for impairment and measured at fair value on a nonrecurring basis for the thirteen and thirty-nine weeks ended October 29, 2016 and October 31, 2015, aggregated by level in the fair value hierarchy within which those measurements fall. Because these assets are not measured at fair value on a recurring basis, certain carrying amounts and fair value measurements presented in the table may reflect values at earlier measurement dates and may no longer represent their fair values at October 29, 2016 and October 31, 2015. As of October 29, 2016 and October 31, 2015, we did not have any long-lived assets classified as Level 1 or 2 within the fair value hierarchy, respectively.
(In millions)
 
Carrying Value
Prior to
Impairment
 
Significant
Unobservable
Inputs
(Level 3)
 
Impairment
Losses
Long-lived assets held and used
 
$
—

 
$
—

 
$
—

Balance, April 30, 2016
 
—

 
—

 
—

Long-lived assets held and used
 
1

 
—

 
1

Balance, July 30, 2016
 
1

 
—

 
1

Long-lived assets held and used
 
—

 
—

 
—

Balance, October 29, 2016
 
$
1

 
$
—

 
$
1

(In millions)
 
Carrying Value
Prior to
Impairment
 
Significant
Unobservable
Inputs
(Level 3)
 
Impairment
Losses
Long-lived assets held and used
 
$
2

 
$
1

 
$
1

Balance, May 2, 2015
 
2

 
1

 
1

Long-lived assets held and used
 
1

 
—

 
1

Balance, August 1, 2015
 
3


1


2

Long-lived assets held and used
 
—

 
—

 
—

Balance, October 31, 2015
 
$
3

 
$
1

 
$
2

Other Financial Instruments
The fair values of our Long-term debt including current portion are estimated using quoted market prices for the same or similar issues and other pertinent information available to management as of the end of the respective periods. The fair values of debt instruments classified as Level 1 are based on quoted prices in reasonably active markets and Level 2 instruments are valued using market prices we obtain from external third parties. Debt instruments classified as Level 3 are not publicly traded, and therefore we are unable to obtain quoted market prices, and are generally valued using estimated spreads, a present value calculation or a cash flow analysis, as appropriate. There have been no significant changes in valuation technique or related inputs for Long-term debt for the thirty-nine weeks ended October 29, 2016 and October 31, 2015. The table below presents

12


the carrying values and fair values of our Long-term debt including current portion as of October 29, 2016, January 30, 2016 and October 31, 2015, aggregated by level in the fair value hierarchy within which those measurements fall.
 
 
Long-term Debt
(In millions)
 
Carrying Value
 
Fair Value
 
Quoted Prices in Active Markets for Identical Assets and Liabilities
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
October 29, 2016
 
$
3,379

 
$
3,318

 
$
725

 
$
1,398

 
$
1,195

January 30, 2016
 
2,450

 
2,141

 
667

 
1,210

 
264

October 31, 2015
 
3,180

 
3,065

 
723

 
1,341

 
1,001

Other financial instruments that are not measured at fair value on our Condensed Consolidated Balance Sheets include cash and cash equivalents, accounts receivable, accounts payable and accrued expenses. Due to the short-term nature of these assets and liabilities, their carrying amounts approximate fair value.

5. Income taxes
The following table summarizes our Income tax expense and effective tax rates for the thirteen and thirty-nine weeks ended October 29, 2016 and October 31, 2015:
 
 
13 Weeks Ended
 
39 Weeks Ended
($ In millions)
 
October 29,
2016
 
October 31,
2015
 
October 29,
2016
 
October 31,
2015
Loss before income taxes
 
$
(79
)
 
$
(107
)
 
$
(185
)
 
$
(238
)
Income tax expense
 
4

 
3

 
13

 
7

Effective tax rate
 
(5.1
)%
 
(2.8
)%
 
(7.0
)%
 
(2.9
)%
The effective tax rates for the thirteen and thirty-nine weeks ended October 29, 2016 and October 31, 2015 were based on our forecasted effective tax rates, adjusted for discrete items that occurred within the periods presented. Our forecasted effective tax rate was (6.9)% for the thirty-nine weeks ended October 29, 2016 compared to (3.0)% for the same period last year. The difference between our forecasted effective tax rates was primarily due to a change in the mix and level of earnings between jurisdictions.
There were no significant discrete items that impacted our effective tax rate for the thirteen and thirty-nine weeks ended October 29, 2016 and October 31, 2015, respectively.

6. Segments
Our reportable segments are Toys “R” Us – Domestic (“Domestic”), which provides toy and baby product offerings in 49 states in the United States, Puerto Rico and Guam, and Toys “R” Us – Canada (“Canada”), which operates in Canada. Our Domestic and Canada segments also include their respective e-commerce operations. Segment operating (loss) earnings excludes corporate related charges and income. All intercompany transactions between segments have been eliminated. Income tax information by segment has not been included as taxes are calculated at a company-wide level and are not allocated to each segment. Revenues from external customers are derived primarily from merchandise sales and we do not generate material sales from any single customer.

13


Our percentages of consolidated Total revenues by product category for the thirteen and thirty-nine weeks ended October 29, 2016 and October 31, 2015 were as follows:
 
 
13 Weeks Ended
 
39 Weeks Ended
 
 
October 29,
2016
 
October 31,
2015
 
October 29,
2016
 
October 31,
2015
Baby
 
44.6
%
 
44.7
%
 
45.3
%
 
45.3
%
Core Toy
 
16.5
%
 
15.9
%
 
14.8
%
 
14.2
%
Entertainment
 
4.6
%
 
6.4
%
 
4.9
%
 
6.3
%
Learning
 
22.0
%
 
20.9
%
 
19.5
%
 
18.9
%
Seasonal
 
10.8
%
 
10.3
%
 
14.0
%
 
13.4
%
Other (1)
 
1.5
%
 
1.8
%
 
1.5
%
 
1.9
%
Total
 
100
%
 
100
%
 
100
%
 
100
%
(1)
Consists primarily of non-product related revenues, including licensing revenue from Parent’s foreign affiliates and certain third party licensees.
From time to time, we may make revisions to our prior period Total revenues by product category to conform to the current period allocation. These revisions did not have a significant impact to our prior year disclosure.
A summary of financial information by reportable segment is as follows:
 
 
13 Weeks Ended
 
39 Weeks Ended
(In millions)
 
October 29,
2016
 
October 31,
2015
 
October 29,
2016
 
October 31,
2015
Total revenues
 
 
 
 
 
 
 
 
Domestic
 
$
1,367

 
$
1,420

 
$
4,235

 
$
4,353

Canada
 
171

 
162

 
496

 
483

Total revenues
 
$
1,538

 
$
1,582

 
$
4,731

 
$
4,836

Operating (loss) earnings
 
 
 
 
 
 
 
 
Domestic
 
$
(47
)
 
$
(29
)
 
$
5

 
$
30

Canada
 
9

 
10

 
46

 
23

Corporate and other
 
(5
)
 
(48
)
 
(119
)
 
(165
)
Operating loss
 
(43
)
 
(67
)
 
(68
)
 
(112
)
Interest expense
 
(64
)
 
(73
)
 
(199
)
 
(207
)
Interest income
 
28

 
33

 
82

 
81

Loss before income taxes
 
$
(79
)
 
$
(107
)
 
$
(185
)
 
$
(238
)
(In millions)
 
October 29,
2016
 
January 30,
2016
 
October 31,
2015
Merchandise inventories
 
 
 
 
 
 
Domestic
 
$
2,355

 
$
1,559

 
$
2,228

Canada
 
251

 
130

 
244

Total Merchandise inventories
 
$
2,606

 
$
1,689

 
$
2,472


7. Litigation and legal proceedings
We and our Parent are, and in the future may be, involved in various lawsuits, claims and proceedings incident to the ordinary course of business. The results of litigation are inherently unpredictable. Any claims against us and our Parent, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in diversion of significant resources. We and our Parent are not able to estimate an aggregate amount or range of reasonably possible losses for those legal matters for which losses are not probable and estimable, primarily for the following reasons: (i) many of the relevant legal proceedings are in preliminary stages, and until such proceedings develop further, there is often uncertainty regarding the relevant facts and circumstances at issue and potential liability; and (ii) many of these proceedings involve matters of which the outcomes are inherently difficult to predict. However, based upon our and our Parent’s historical experience with similar matters, we do not expect that any such additional losses would be material to our consolidated financial position, results of operations or cash flows.


14


8. Related party transactions
Sponsor Advisory Agreement - Our Parent is owned by an investment group led by entities advised by or affiliated with Bain Capital Partners LLC, Kohlberg Kravis Roberts & Co. L.P. (together with its affiliates, “KKR”) and Vornado Realty Trust (“Vornado”) (collectively, the “Sponsors”). The Sponsors provide management and advisory services to us and our Parent pursuant to an advisory agreement executed at the closing of the merger transaction effective as of July 21, 2005 and amended June 10, 2008, February 1, 2009, August 29, 2014, June 1, 2015 and December 1, 2015 (“Advisory Agreement”). The term of the Advisory Agreement is currently a one-year renewable term unless our Parent or the Sponsors provide notice of termination to the other. Management and advisory fees (the “Advisory Fees”) of $6 million per annum are payable on a quarterly basis. The Advisory Agreement includes customary exculpation and indemnification provisions in favor of the Sponsors and their affiliates. In the event that the Advisory Agreement is terminated by the Sponsors or our Parent, the Sponsors will receive all unpaid Advisory Fees and expenses due under the Advisory Agreement with respect to periods prior to the termination date plus the net present value of the Advisory Fees that would have been payable for the remainder of the then applicable one-year term of the Advisory Agreement.
We recorded Advisory Fees of $2 million and $5 million for the thirteen and thirty-nine weeks ended October 29, 2016, respectively. We recorded Advisory Fees of less than $1 million and $5 million for the thirteen and thirty-nine weeks ended October 31, 2015, respectively. During each of the thirteen and thirty-nine weeks ended October 29, 2016, we also paid the Sponsors for out-of-pocket expenses, which were nominal. During each of the thirteen and thirty-nine weeks ended October 31, 2015, out-of-pocket expenses paid to the Sponsors were less than $1 million.
Other Relationships and Transactions with the Sponsors - From time to time, we and our subsidiaries, as well as the Sponsors or their affiliates, may acquire debt or debt securities issued by us or our subsidiaries in open market transactions, tender offers, exchange offers, privately negotiated transactions or otherwise. During the thirteen and thirty-nine weeks ended October 29, 2016 and October 31, 2015, affiliates of KKR held debt and debt securities issued by us and our subsidiaries. There were no interest amounts on such debt and debt securities held by related parties during the thirteen weeks ended October 29, 2016 and less than $1 million during the thirty-nine weeks ended October 29, 2016. The interest amounts on such debt and debt securities held by related parties were $1 million and $5 million during the thirteen and thirty-nine weeks ended October 31, 2015, respectively.
Additionally, under lease agreements with affiliates of Vornado, we paid an aggregate amount of $1 million and $4 million for the thirteen and thirty-nine weeks ended October 29, 2016, with respect to less than 1% of our operated stores, which include Toys “R” Us Express stores. For the thirteen and thirty-nine weeks ended October 31, 2015, we paid an aggregate amount of $2 million and $4 million, respectively. Of the aggregate amount paid, less than $1 million and $1 million for the thirteen and thirty-nine weeks ended October 29, 2016 and October 31, 2015, respectively, was allocable to joint-venture parties not otherwise affiliated with Vornado.
Each of the Sponsors, either directly or through affiliates, has ownership interests in a broad range of companies (“Portfolio Companies”) with whom our Parent and its subsidiaries may from time to time enter into commercial transactions in the ordinary course of business, primarily for the purchase of goods and services. We believe that none of our transactions or arrangements with Portfolio Companies are significant enough to be considered material to the Sponsors or to our business.
Real Estate Arrangements with Affiliates - We leased 351 and 353 properties from affiliates of Parent as of October 29, 2016 and October 31, 2015, respectively. Selling, general and administrative expenses (“SG&A”) included lease expense of $71 million and $213 million, respectively, which includes reimbursement of expenses of $11 million and $34 million related to these leases for the thirteen and thirty-nine weeks ended October 29, 2016. For the thirteen and thirty-nine weeks ended October 31, 2015, SG&A included lease expense of $71 million and $215 million, respectively, which includes reimbursement expenses of $11 million and $34 million related to these leases.
Other Transactions with Toys “R” Us Property Company I, LLC (“TRU Propco I”) - Under the master lease agreement with our affiliate, TRU Propco I, we may be required to recognize an expense in conjunction with a store closure through the successful execution of a sale of a property by TRU Propco I to a third party or an early store closure prior to the expiration of the master lease agreement. Pursuant to the master lease agreement, the expense is equal to the net present value of the base rent for such property over the remaining term for such property, discounted at 10% per annum, less the sales proceeds for such property received by TRU Propco I or the anticipated sublease income to be received by the Company. For the thirteen and thirty-nine weeks ended October 29, 2016, SG&A included expenses associated with store closures of less than $1 million and $7 million, respectively. For the thirteen and thirty-nine weeks ended October 31, 2015, SG&A included expenses of a nominal amount and $2 million, respectively, related to expenses associated with store closures.
Related Party Finance Obligations Associated with Capital Projects - In fiscal 2012, we were significantly involved in the construction of two leased stores with our affiliate TRU Propco I which included non-standard tenant improvements. As a

15


result of this involvement, we are deemed the “owner” for accounting purposes and are required to capitalize the construction costs on our Consolidated Balance Sheets. Upon completion of these projects, we performed an analysis pursuant to ASC 840 and determined that we were unable to derecognize the assets capitalized during construction. Therefore, in conjunction with these leases, we record related party finance obligations equal to the cash proceeds and fair market value of the assets received. As of October 29, 2016, January 30, 2016 and October 31, 2015, we had related party financing obligations of $9 million, respectively. These amounts are included in Other non-current liabilities on our Condensed Consolidated Balance Sheets. The rental payments to TRU Propco I are recognized as a reduction of the financing obligation and interest expense.
Management Service Fees and Other - We provide a majority of the centralized corporate functions including accounting, human resources, legal, tax and treasury services to Parent and other affiliates under the Domestic Services Agreement (“DSA”). The amounts charged are allocated based on a formula for each affiliate, as defined in the DSA, and are recorded in Other income, net on our Condensed Consolidated Statements of Operations. The amounts we charged to Parent and other affiliates for the thirteen and thirty-nine weeks ended October 29, 2016 for these services were $1 million and $3 million, respectively, and $1 million and $4 million for the thirteen and thirty-nine weeks ended October 31, 2015, respectively.
In addition, we incurred service fees associated with our China sourcing office of $2 million and $8 million for the thirteen and thirty-nine weeks ended October 29, 2016, respectively. We incurred $4 million and $11 million of service fees for the thirteen and thirty-nine weeks ended October 31, 2015, respectively. These costs are recorded within SG&A on our Condensed Consolidated Statements of Operations.
Information Technology and Administrative Support Services Agreement (“ITASSA”) - We provide information technology services, store operations services, internal audit services and financial services to a number of our international affiliates under the ITASSA. These affiliates are charged 108% of the costs we incur to administer such services. For the thirteen and thirty-nine weeks ended October 29, 2016, we charged our affiliates $6 million and $18 million, respectively, for these services, which are recorded in Other income, net on our Condensed Consolidated Statements of Operations. For the thirteen and thirty-nine weeks ended October 31, 2015, we charged our affiliates $7 million and $22 million, respectively, for these services.
Licensing Arrangements with Affiliates - We own intellectual property used by us and Parent’s foreign affiliates in the toy and baby businesses. In consideration for the use of our intellectual property, we charge a license fee based on a percentage of net sales, which management believes represents fair value. For the thirteen and thirty-nine weeks ended October 29, 2016, we charged Parent’s foreign affiliates license fees of $13 million and $39 million, respectively, which are classified on our Condensed Consolidated Statements of Operations as Other revenues. For the thirteen and thirty-nine weeks ended October 31, 2015, we charged Parent’s foreign affiliates license fees of $14 million and $40 million, respectively.
Stock Compensation Expense - For the thirteen and thirty-nine weeks ended October 29, 2016, we recorded a nominal amount and $1 million, respectively, of Parent’s total stock-based compensation expense, which related to awards issued to participants, in SG&A. For the thirteen and thirty-nine weeks ended October 31, 2015, we recorded $3 million and $1 million, respectively, of Parent’s total stock-based compensation net, benefit.
Due from Affiliates, Net - As of October 29, 2016, January 30, 2016 and October 31, 2015, Due from affiliates, net, of $997 million, $920 million and $897 million, respectively, primarily consisted of receivables from Parent and affiliates. In connection with loans to and from Parent, we recognize related party interest expense and related party interest income.
As of October 29, 2016, January 30, 2016 and October 31, 2015, $18 million, $12 million and $16 million, respectively, of receivables from affiliates related primarily to license fees and are included in Prepaid expenses and other current assets on our Condensed Consolidated Balance Sheets.
Additionally, we are obligated to reimburse our affiliates for certain expenses, which primarily include rent and property taxes under lease agreements. As of October 29, 2016, January 30, 2016 and October 31, 2015, the net amount owed to our affiliates was $9 million, $5 million and $9 million, respectively. These amounts are included in Accrued expenses and other current liabilities on our Condensed Consolidated Balance Sheets.
Short-term Borrowings from Parent - From time to time, we have short-term intercompany loans outstanding with Parent. As of October 29, 2016, January 30, 2016 and October 31, 2015, we maintained balances of $269 million, $364 million and $327 million, respectively, in short-term intercompany loans from Parent. For the thirteen and thirty-nine weeks ended October 29, 2016 and October 31, 2015, we incurred $1 million and $4 million, respectively, of related party interest expense associated with our short-term intercompany loans from Parent.
Income Taxes Payable to Parent - We make income tax payments to Parent based on certain tax-sharing agreements made with Parent regarding our consolidated tax filings.  As of October 29, 2016, Income taxes payable to Parent were $119 million. As of January 30, 2016 and October 31, 2015, Income taxes payable to Parent were $101 million, respectively.

16



9. Dispositions
During the thirteen and thirty-nine weeks ended October 29, 2016, we sold intellectual property related to the FAO Schwarz brand for proceeds of $45 million, resulting in a net gain of $45 million, respectively. Net gains on sales are included in Other income, net on our Condensed Consolidated Statements of Operations.

10. Accumulated other comprehensive loss
Total other comprehensive (loss) income, net of tax is included in our Condensed Consolidated Statements of Comprehensive Loss and Condensed Consolidated Statements of Stockholder’s Deficit. Accumulated other comprehensive loss is reflected in Total stockholder’s deficit on our Condensed Consolidated Balance Sheets, as follows:
(In millions)
 
Foreign currency
translation
adjustments,
net of tax
 
Unrealized gain
on hedged
transactions,
net of tax
 
Accumulated
other
comprehensive
loss
Balance, January 31, 2015
 
$
(58
)
 
$
1

 
$
(57
)
Change
 
7

 
(1
)
 
6

Balance, May 2, 2015
 
(51
)
 
—

 
(51
)
Change
 
(10
)
 
—

 
(10
)
Balance, August 1, 2015
 
$
(61
)
 
$
—

 
$
(61
)
Change
 
—

 
—

 
—

Balance, October 31, 2015
 
$
(61
)
 
$
—

 
$
(61
)
 
 
 
 
 
 
 
(In millions)
 
Foreign currency
translation
adjustments,
net of tax
 
Unrealized gain
on hedged
transactions,
net of tax
 
Accumulated
other
comprehensive
loss
Balance, January 30, 2016
 
$
(71
)
 
$
1

 
$
(70
)
Change
 
7

 
—

 
7

Balance, April 30, 2016
 
(64
)
 
1

 
(63
)
Change
 
(3
)
 
—

 
(3
)
Balance, July 30, 2016
 
$
(67
)
 
$
1

 
$
(66
)
Change
 
(3
)
 
—

 
(3
)
Balance, October 29, 2016
 
(70
)
 
1

 
(69
)

11. Recent accounting pronouncements
In November 2016, the FASB issued ASU No. 2016-18 “Statement of Cash Flows (Topic 230), Restricted Cash” (“ASU 2016-18”). ASU 2016-18 provides guidance on the presentation of restricted cash and restricted cash equivalents in the statement of cash flows. Restricted cash and restricted cash equivalents should now be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts shown on the statements of cash flows. The amendments of this ASU are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. Other than the revised statement of cash flows presentation of restricted cash, the adoption of ASU 2016-16 is not expected to have an impact on our Condensed Consolidated Financial Statements.
In October 2016, the FASB issued ASU No. 2016-17 “Consolidation (Topic 810), Interests Held Through Related Parties That Are Under Common Control” (“ASU 2016-17”). ASU 2016-17 changes how a single decision maker will consider its indirect interests when performing the primary beneficiary analysis under the variable interest entity (“VIE”) model. Under ASU 2015-02 “Consolidation (Topic 810), Amendments to the Consolidation Analysis,” a single decision maker was required to consider an indirect interest held by a related party under common control in its entirety. Under ASU 2016-17, the single decision maker will consider the indirect interest on a proportionate basis. ASU 2016-17 does not change the characteristics of a primary beneficiary in the VIE model. The amendments of ASU 2016-17 are effective for reporting periods beginning after December 15, 2016, with early adoption permitted. The adoption of ASU 2016-17 is not expected to have an impact on our Condensed Consolidated Financial Statements.

17


In October 2016, the FASB issued ASU No. 2016-16 “Income Taxes (Topic 740), Intra-Entity Transfers of Assets Other Than Inventory” (“ASU 2016-16”). ASU 2016-16 requires companies to account for income tax effects of intercompany transactions other than inventory in the period in which the transfer occurs. This is a change from current GAAP, which requires companies to defer the income tax effects of intercompany transfers of assets until the asset has been sold to an outside party or otherwise recognized (i.e. depreciation, amortization, impaired). ASU 2016-16 will still require companies to defer the income tax effects of intercompany inventory transactions. The amendments of this ASU are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The adoption of ASU 2016-16 is not expected to have a material impact on our Condensed Consolidated Financial Statements.
In August 2016, the FASB issued ASU No. 2016-15 “Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”). ASU 2016-15 provides guidance on the following eight specific cash flow classification issues: (1) debt prepayment or debt extinguishment costs; (2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; (3) contingent consideration payments made after a business combination; (4) proceeds from the settlement of insurance claims; (5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; (6) distributions received from equity method investees; (7) beneficial interests in securitization transactions; and (8) separately identifiable cash flows and application of the predominance principle. Current GAAP does not include specific guidance on these eight cash flow classification issues. The amendments of this ASU are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. Management is currently assessing the impact the adoption of ASU 2016-15 will have on our Condensed Consolidated Financial Statements.
In March 2016, the FASB issued ASU No. 2016-09 “Compensation-Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). Under ASU 2016-09, companies will no longer record excess tax benefits and certain tax deficiencies in additional paid-in capital (“APIC”). Instead, they will record all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement and the APIC pools will be eliminated. In addition, ASU 2016-09 eliminates the requirement that excess tax benefits be realized before companies can recognize them. ASU 2016-09 also requires companies to present excess tax benefits as an operating activity on the statement of cash flows rather than as a financing activity. Furthermore, ASU 2016-09 will increase the amount an employer can withhold to cover income taxes on awards and still qualify for the exception to liability classification for shares used to satisfy the employer’s statutory income tax withholding obligation. An employer with a statutory income tax withholding obligation will now be allowed to withhold shares with a fair value up to the amount of taxes owed using the maximum statutory tax rate in the employee’s applicable jurisdiction(s). ASU 2016-09 requires a company to classify the cash paid to a tax authority when shares are withheld to satisfy its statutory income tax withholding obligation as a financing activity on the statement of cash flows. Under current GAAP, it was not specified how these cash flows should be classified. In addition, companies will now have to elect whether to account for forfeitures on share-based payments by (1) recognizing forfeitures of awards as they occur or (2) estimating the number of awards expected to be forfeited and adjusting the estimate when it is likely to change, as is currently required. The amendments of this ASU are effective for reporting periods beginning after December 15, 2016, with early adoption permitted but all of the guidance must be adopted in the same period. Management is currently assessing the impact the adoption of ASU 2016-09 will have on our Condensed Consolidated Financial Statements.
In March 2016, the FASB issued ASU No. 2016-06 “Derivatives and Hedging (Topic 815), Contingent Put and Call Options in Debt Instruments” (“ASU 2016-06”). ASU 2016-06 clarifies the requirements for assessing whether contingent put or call options that can accelerate the payment of principal on debt instruments are clearly and closely related. Under current GAAP, two divergent approaches developed. Under the first approach, the assessment of whether contingent put or call options are clearly and closely related to the debt host only requires an analysis of the four-step decision sequence of ASC 815-15-25-42. Under the second approach, in addition to the four-step decision sequence of ASC 815-15-2-42, some entities evaluate whether the ability to exercise the put or call options are triggered by the entities interest rates or credit risk. ASU 2016-06 clarifies that an entity is required to assess whether the economic characteristics and risks of embedded put or call options are clearly and closely related to those of their debt hosts only in accordance with the four-step decision sequence of ASC 815-15-2-42. An entity should not assess whether the event that triggers the ability to exercise a put or call option is related to interest rates or credit risk of the entity. ASU 2016-06 does not change the existing criteria for determining when bifurcation of an embedded put or call option in a debt instrument is required. The amendments of this ASU are effective for reporting periods beginning after December 15, 2016, with early adoption permitted. Entities are required to apply the guidance to existing debt instruments using a modified retrospective transition method as of the period of adoption. Management is currently assessing the impact the adoption of ASU 2016-06 will have on our Condensed Consolidated Financial Statements.
In March 2016, the FASB issued ASU No. 2016-05 “Derivatives and Hedging (Topic 815), Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships” (“ASU 2016-05”). ASU 2015-05 provides guidance clarifying that the novation of a derivative contract (i.e. a change in counterparty) in a hedge accounting relationship does not, in and of itself, require de-designation of that hedge accounting relationship. This ASU amends ASC 815 to clarify that such a change does

18


not, in and of itself, represent a termination of the original derivative instrument or a change in the critical terms of the hedge relationship. ASU 2016-05 allows the hedging relationship to continue uninterrupted if all of the other hedge accounting criteria are met, including the expectation that the hedge will be highly effective when the creditworthiness of the new counterpart to the derivative contract is considered. The amendments of this ASU are effective for reporting periods beginning after December 15, 2016, with early adoption permitted. Entities may adopt the guidance prospectively or use a modified retrospective approach. Management is currently assessing the impact the adoption of ASU 2016-05 will have on our Condensed Consolidated Financial Statements.
In March 2016, the FASB issued ASU No. 2016-04 “Liabilities - Extinguishment of Liabilities (Subtopic 405-20), Recognition of Breakage for Certain Prepaid Stored-Value Products” (“ASU 2016-04”). ASU 2015-04 requires entities that sell prepaid stored-value products redeemable for goods, services or cash at third-party merchants to recognize breakage (i.e. the value that is ultimately not redeemed by the consumer) in a way that is consistent with how it will be recognized under the new revenue recognition standard. Under current GAAP, there is diversity in practice in how entities account for breakage that results when a consumer does not redeem the entire product balance. Some entities view liabilities for prepaid stored-value products that can be redeemed only for goods or services from a third-party as nonfinancial because the issuer’s obligation to the consumer will be settled by the transfer of goods or services (albeit by a third-party), not cash. Others view these liabilities as financial, given that the issuer is ultimately obligated to transfer cash to a third-party. This ASU clarifies that an entity’s liability for prepaid stored-value products within its scope meets the definition of a financial liability. The amendments of this ASU are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. Entities will apply the guidance using either a modified retrospective approach or a full retrospective approach. The adoption of ASU 2016-04 is not expected to have an impact on our Condensed Consolidated Financial Statements.
In February 2016, the FASB issued ASU No. 2016-02 “Leases (Topic 842)” (“ASU 2016-02”). The FASB issued ASU 2016-02 to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. Under ASU 2016-02, a lessee will recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-to-use asset representing its right to use the underlying asset for the lease term. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee have not significantly changed from current GAAP. ASU 2016-02 retains a distinction between finance leases (i.e. capital leases under current GAAP) and operating leases. The classification criteria for distinguishing between finance leases and operating leases will be substantially similar to the classification criteria for distinguishing between capital leases and operating leases under current GAAP. The accounting applied by the lessor is largely unchanged from that applied under current GAAP. The amendments of this ASU are effective for reporting periods beginning after December 15, 2018, with early adoption permitted. An entity will be required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. Management is currently assessing the impact the adoption of ASU 2016-02 will have on our Condensed Consolidated Financial Statements.
In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”). ASU 2014-09 amends the guidance for revenue recognition to replace numerous, industry-specific requirements and converges areas under this topic with those of the International Financial Reporting Standards. The ASU implements a five-step process for customer contract revenue recognition that focuses on transfer of control, as opposed to transfer of risk and rewards. The amendment also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenues and cash flows from contracts with customers. Other major provisions include the capitalization and amortization of certain contract costs, ensuring the time value of money is considered in the transaction price, and allowing estimates of variable consideration to be recognized before contingencies are resolved in certain circumstances. The amendments of ASU 2014-09 were effective for reporting periods beginning after December 15, 2016, with early adoption prohibited. Entities can transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption.
Subsequent to issuing ASU 2014-09, the FASB issued the following amendments concerning the adoption and clarification of ASU 2014-09. In August 2015, the FASB issued ASU No. 2015-14 “Revenue from Contracts with Customers (Topic 606), Deferral of the Effective Date” (“ASU 2015-14”), which deferred the effective date one year. As a result, the amendments of ASU 2014-09 are effective for reporting periods beginning after December 15, 2017, with early adoption permitted only as of annual reporting periods beginning after December 15, 2016. In March 2016, the FASB issued ASU No. 2016-08 “Revenue from Contracts with Customers (Topic 606), Principal versus Agent Considerations (Reporting Revenue versus Net)” (“ASU 2016-08”), which clarifies the implementation guidance on principal versus agent considerations in the new revenue recognition standard. ASU 2016-08 clarifies how an entity should identify the unit of accounting (i.e. the specified good or service) for the principal versus agent evaluation and how it should apply the control principle to certain types of arrangements. In April 2016, the FASB issued ASU No. 2016-10 “Revenue from Contracts with Customers (Topic 606), Identifying Performance Obligations and Licensing” (“ASU 2016-10”), which reduces the complexity when applying the guidance for identifying performance obligations and improves the operability and understandability of the license implementation guidance. In May 2016, the FASB issued ASU No. 2016-12 “Revenue from Contracts with Customers (Topic 606), Narrow-

19


Scope Improvements and Practical Expedients” (“ASU 2016-12”), which amends the guidance on transition, collectability, noncash consideration and the presentation of sales and other similar taxes. ASU 2016-12 clarifies that, for a contract to be considered completed at transition, all (or substantially all) of the revenue must have been recognized under legacy GAAP. In addition, ASU 2016-12 clarifies how an entity should evaluate the collectability threshold and when an entity can recognize nonrefundable consideration received as revenue if an arrangement does not meet the standard’s contract criteria. Management is currently assessing the adoption methodology and the impact the adoption of these ASUs will have on our Condensed Consolidated Financial Statements.

20


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
As used herein, the “Company,” “we,” “us,” or “our” means Toys “R” Us – Delaware, Inc., a Delaware corporation, and its subsidiaries, except as expressly indicated or unless the context otherwise requires. The Company is a wholly-owned subsidiary of Toys “R” Us, Inc. (“Parent”). The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help facilitate an understanding of our financial condition and our historical results of operations for the periods presented. This MD&A should be read in conjunction with our Annual Financial Statements for the fiscal year ended January 30, 2016, included as an exhibit to Parent’s Form 8-K filed on April 8, 2016 and the Condensed Consolidated Financial Statements and the accompanying notes thereto, and contains forward-looking statements that involve risks and uncertainties. See “Forward-Looking Statements” below.

Our Business
We generate sales, earnings and cash flows by retailing a variety of toy and baby products worldwide through our omnichannel offerings that leverage the synergies between our brick-and-mortar stores and e-commerce. Our reportable segments are Toys “R” Us – Domestic (“Domestic”), which operated 880 stores in 49 states in the United States, Puerto Rico and Guam; and Toys “R” Us – Canada (“Canada”), which operated 82 stores as of October 29, 2016. Our Domestic and Canada segments also include their respective e-commerce operations.

Financial Performance
As discussed in more detail in this MD&A, the following financial data presents an overview of our financial performance for the thirteen and thirty-nine weeks ended October 29, 2016 compared to the thirteen and thirty-nine weeks ended October 31, 2015:
  
 
13 Weeks Ended
 
39 Weeks Ended
($ In millions)
 
October 29,
2016
 
October 31,
2015
 
October 29,
2016
 
October 31,
2015
Total revenues
 
$
1,538

 
$
1,582

 
$
4,731

 
$
4,836

Same store sales
 
(1.1
)%
 
0.7
%
 
0.1
%
 
(0.6
)%
Gross margin
 
$
540

 
$
554

 
$
1,703

 
$
1,757

Gross margin as a percentage of Total revenues
 
35.1
 %
 
35.0
%
 
36.0
%
 
36.3
 %
Selling, general and administrative expenses (“SG&A”)
 
$
603

 
$
596

 
$
1,754

 
$
1,784

SG&A as a percentage of Total revenues
 
39.2
 %
 
37.7
%
 
37.1
%
 
36.9
 %
Net loss
 
$
(83
)
 
$
(110
)
 
$
(198
)
 
$
(245
)
Non-GAAP Financial Measure:
 
 
 
 
 
 
 
 
Adjusted EBITDA (1)
 
$
(28
)
 
$
(15
)
 
$
64

 
$
81

(1) For an explanation of Adjusted EBITDA as a measure of the Company’s operating performance and a reconciliation to Net loss, see “Non-GAAP Financial Measure - Adjusted EBITDA”.
Third quarter 2016 financial highlights:
•
Total revenues decreased by $44 million compared to the prior year period, predominantly due to a decrease in Domestic same store sales and Domestic store closures.
•
Consolidated same store sales decreased by 1.1 percentage points driven by a decline in our Domestic segment.
•
Gross margin, as a percentage of Total revenues, (“Gross margin rate”) increased in Canada and decreased slightly in our Domestic segment.
•
SG&A increased by $7 million primarily due to an increase in advertising, partially offset by a decrease in occupancy costs.
•
Net loss decreased by $27 million.
Year-to-date 2016 financial highlights:
•
Total revenues decreased by $105 million compared to the prior year period, primarily due to Domestic store closures.
•
Consolidated same store sales increased by 0.1 percentage point driven by growth in our Canada segment.
•
Gross margin rate declined in our Domestic segment and increased in Canada.
•
SG&A decreased by $30 million primarily due to a reduction in occupancy costs, partially offset by an increase in advertising.

21


•
Net loss decreased by $47 million.

Same Store Sales
In computing same store sales, we include stores that have been open for at least 56 weeks from their “soft” opening date. A soft opening is typically two weeks prior to the grand opening. Express stores that have a cumulative lease term of at least two years (“Permanent Express”) and have been open for at least 56 weeks from their soft opening date are also included in the computation of same store sales.
Our same store sales computation includes the following:
•
stores that have been remodeled while remaining open;
•
stores that have been relocated and/or expanded to new buildings within the same trade area, in which the new store opens at about the same time as the old store closes;
•
stores that have expanded within their current locations; and
•
sales from our e-commerce businesses.
By measuring the year-over-year sales of merchandise in the stores that have been open for 56 weeks or more and online, we can better gauge how the core store base and e-commerce business is performing since same store sales excludes the impact of store openings and closings, as well as foreign currency translation.
Various factors affect same store sales, including the number of and timing of stores we open, close, convert, relocate or expand, the number of transactions, the average transaction amount, the general retail sales environment, current local and global economic conditions, consumer preferences and buying trends, changes in sales mix among distribution channels, our ability to efficiently source and distribute products, changes in our merchandise mix, competition, the timing of the release of new merchandise and our promotional events, the success of marketing programs and the cannibalization of existing store net sales by new stores. Among other things, weather conditions, terrorism and catastrophic events can affect same store sales because they may discourage travel or require temporary store closures, thereby reducing customer traffic. These factors have caused our same store sales to fluctuate significantly in the past on a monthly, quarterly and annual basis and, as a result, we expect that same store sales will continue to fluctuate in the future.
The changes in our same store sales for the thirteen and thirty-nine weeks ended October 29, 2016 and October 31, 2015 are as follows:
 
 
13 Weeks Ended
 
39 Weeks Ended
 
 
October 29, 2016
vs. 2015
 
October 31, 2015
vs. 2014
 
October 29, 2016
vs. 2015
 
October 31, 2015
vs. 2014
Domestic
 
(1.9
)%
 
(0.9
)%
 
(0.6
)%
 
(1.8
)%
Canada
 
4.9
 %
 
14.0
 %
 
6.0
 %
 
10.4
 %
Toys “R” Us - Delaware
 
(1.1
)%
 
0.7
 %
 
0.1
 %
 
(0.6
)%

Percentage of Total Revenues by Product Category
 
 
13 Weeks Ended
 
39 Weeks Ended
 
 
October 29,
2016
 
October 31,
2015
 
October 29,
2016
 
October 31,
2015
Baby
 
44.6
%
 
44.7
%
 
45.3
%
 
45.3
%
Core Toy
 
16.5
%
 
15.9
%
 
14.8
%
 
14.2
%
Entertainment
 
4.6
%
 
6.4
%
 
4.9
%
 
6.3
%
Learning
 
22.0
%
 
20.9
%
 
19.5
%
 
18.9
%
Seasonal
 
10.8
%
 
10.3
%
 
14.0
%
 
13.4
%
Other (1)
 
1.5
%
 
1.8
%
 
1.5
%
 
1.9
%
Total
 
100
%
 
100
%
 
100
%
 
100
%
(1)
Consists primarily of non-product related revenues, including licensing revenue from Parent’s foreign affiliates and certain third party licensees.
From time to time, we may make revisions to our prior period Total revenues by product category to conform to the current period allocation. These revisions did not have a significant impact to our prior year disclosure.

22



Store Count by Segment
Store Type
 
Domestic
 
Canada
 
Toys “R” Us - Delaware
 
October 29,
2016
 
October 31,
2015
 
October 29,
2016
 
October 31,
2015
 
October 29,
2016
 
October 31,
2015
Traditional Toy
 
359

 
367

 
26

 
26

 
385

 
393

Side by Side
 
213

 
213

 
56

 
56

 
269

 
269

Baby
 
223

 
224

 
—

 
—

 
223

 
224

Permanent Express/Outlet
 
85

 
61

 
—

 
—

 
85

 
61

Total Operated
 
880

 
865

 
82

 
82

 
962

 
947

 
 
 
 
 
 
 
 
 
 
 
 
 
Excluded from store count:
 
 
 
 
 
 
 
 
 
 
 
 
Temporary Express
 
26

 
73

 
—

 
—

 
26

 
73


Net Loss
 
 
13 Weeks Ended
 
39 Weeks Ended
(In millions)
 
October 29,
2016
 
October 31,
2015
 
Change
 
October 29,
2016
 
October 31,
2015
 
Change
Toys “R” Us - Delaware
 
$
(83
)
 
$
(110
)
 
$
27

 
$
(198
)
 
$
(245
)
 
$
47

Net loss decreased by $27 million to $83 million for the thirteen weeks ended October 29, 2016, compared to $110 million for the same period last year. The decrease was primarily due to a $40 million increase in Other income, net, partially offset by a $14 million decline in Gross margin.
Net loss decreased by $47 million to $198 million for the thirty-nine weeks ended October 29, 2016, compared to $245 million for the same period last year. The decrease was primarily due to a $52 million increase in Other income, net, a $30 million reduction in SG&A and a $16 million decrease in Depreciation and amortization. Partially offsetting these amounts was a $54 million decline in Gross margin.

Total Revenues
 
 
13 Weeks Ended
 
 
 
 
 
 
 
 
 
 
Percentage of Total revenues
($ In millions)
 
October 29,
2016
 
October 31,
2015
 
$ Change
 
% Change
 
October 29,
2016
 
October 31,
2015
Domestic
 
$
1,367

 
$
1,420

 
$
(53
)
 
(3.7
)%
 
88.9
%
 
89.8
%
Canada
 
171

 
162

 
9

 
5.6
 %
 
11.1
%
 
10.2
%
Toys “R” Us - Delaware
 
$
1,538

 
$
1,582

 
$
(44
)
 
(2.8
)%
 
100.0
%
 
100.0
%
Total revenues decreased by $44 million or 2.8%, to $1,538 million for the thirteen weeks ended October 29, 2016, compared to $1,582 million for the same period last year. Foreign currency translation increased Total revenues by $1 million for the thirteen weeks ended October 29, 2016.
Excluding the impact of foreign currency translation, the decrease in Total revenues was due to a decline in Domestic same store sales driven by a decrease in the number of transactions and Domestic store closures, including our Times Square flagship store. Partially offsetting the decrease was an increase in Canada same store sales driven by higher average transaction amounts and an increase in the number of transactions. Consolidated e-commerce sales increased 8% for the thirteen weeks ended October 29, 2016, compared to the same period last year.
Total revenues included $13 million and $14 million of licensing revenue charged to our Parent’s foreign affiliates for the thirteen weeks ended October 29, 2016 and October 31, 2015, respectively.

23


 
 
39 Weeks Ended
 
 
 
 
 
 
 
 
 
 
Percentage of Total revenues
($ In millions)
 
October 29,
2016
 
October 31,
2015
 
$ Change
 
% Change
 
October 29,
2016
 
October 31,
2015
Domestic
 
$
4,235

 
$
4,353

 
$
(118
)
 
(2.7
)%
 
89.5
%
 
90.0
%
Canada
 
496

 
483

 
13

 
2.7
 %
 
10.5
%
 
10.0
%
Toys “R” Us - Delaware
 
$
4,731

 
$
4,836

 
$
(105
)
 
(2.2
)%
 
100.0
%
 
100.0
%
Total revenues decreased by $105 million or 2.2%, to $4,731 million for the thirty-nine weeks ended October 29, 2016, compared to $4,836 million for the same period last year. Foreign currency translation decreased Total revenues by $15 million for the thirty-nine weeks ended October 29, 2016.
Excluding the impact of foreign currency translation, the decrease in Total revenues was due to Domestic store closures, including our Times Square and FAO Schwarz flagship stores. Additionally contributing to the decrease was a decline in Domestic same store sales driven by a decrease in the number of transactions. Partially offsetting the decrease was an increase in Canada same store sales primarily driven by an increase in the number of transactions. Consolidated e-commerce sales increased 12% for the thirty-nine weeks ended October 29, 2016, compared to the same period last year.
Total revenues included $39 million and $40 million of licensing revenue charged to our Parent’s foreign affiliates for the thirty-nine weeks ended October 29, 2016 and October 31, 2015, respectively.
Domestic
Total revenues for our Domestic segment decreased by $53 million or 3.7%, to $1,367 million for the thirteen weeks ended October 29, 2016, primarily due to a decline in same store sales of 1.9% and store closures.
The decrease in same store sales resulted primarily from decreases in our entertainment and baby categories. The decline in our entertainment category was mainly due to “toys to life” video game products. The decline in our baby category was predominantly due to infant care products and baby gear. Partially offsetting these decreases were increases in our learning and core toy categories. The increase in our learning category was primarily due to preschool toys and trading cards and accessories. The increase in our core toy category was mainly due to dolls.
Total revenues for our Domestic segment decreased by $118 million or 2.7%, to $4,235 million for the thirty-nine weeks ended October 29, 2016, primarily due to store closures and a decline in same store sales of 0.6%.
The decrease in same store sales resulted primarily from decreases in our entertainment and baby categories. The decline in our entertainment category was mainly due to “toys to life” products and video game software and systems. The decline in our baby category was predominantly due to infant care products and commodities. Partially offsetting these decreases were increases in our seasonal and core toy categories. The increase in our seasonal category was primarily due to sports and water toys. The increase in our core toy category was mainly due to dolls.
Canada
Total revenues for our Canada segment increased by $9 million or 5.6%, to $171 million for the thirteen weeks ended October 29, 2016. Excluding a $1 million increase in Total revenues due to foreign currency translation, Canada Total revenues increased primarily as a result of a 4.9% increase in same store sales.
The increase in same store sales resulted primarily from improvements in our learning and baby categories. The increase in our learning category was primarily due to preschool and construction toys. The increase in our baby category was predominantly due to baby gear and infant care products. Partially offsetting the increase was a decrease in our entertainment category due to video game software and “toys to life” products.
Total revenues for our Canada segment increased by $13 million or 2.7%, to $496 million for the thirty-nine weeks ended October 29, 2016. Excluding a $15 million decrease in Total revenues due to foreign currency translation, Canada Total revenues increased primarily as a result of a 6.0% increase in same store sales.
The increase in same store sales resulted primarily from improvements in our learning, baby and core toy categories. The increase in our learning category was primarily due to preschool toys. The increase in our baby category was predominantly due to baby gear, apparel and infant care products. The increase in our core toy category was primarily due to collectibles. Partially offsetting the increase was a decrease in our entertainment category due to “toys to life” products and video game software.


24


Gross Margin
The following are reflected in “Cost of sales”:
•
the cost of merchandise acquired from vendors;
•
freight in;
•
provision for excess and obsolete inventory;
•
shipping costs to consumers;
•
provision for inventory shortages; and
•
credits and allowances from our merchandise vendors.
We record the costs associated with operating our distribution networks as a part of SG&A, including those costs that primarily relate to transporting merchandise from distribution centers to stores. Therefore, our consolidated Gross margin may not be comparable to the gross margins of other retailers that include similar costs in their cost of sales.
 
 
13 Weeks Ended
 
 
 
 
 
 
 
 
Percentage of Total revenues
($ In millions)
 
October 29,
2016
 
October 31,
2015
 
$ Change
 
October 29,
2016
 
October 31,
2015
 
Change
Domestic
 
$
476

 
$
495

 
$
(19
)
 
34.8
%
 
34.9
%
 
(0.1
)%
Canada
 
64

 
59

 
5

 
37.4
%
 
36.4
%
 
1.0
 %
Toys “R” Us - Delaware
 
$
540

 
$
554

 
$
(14
)
 
35.1
%
 
35.0
%
 
0.1
 %
Gross margin decreased by $14 million to $540 million for the thirteen weeks ended October 29, 2016, compared to $554 million for the same period last year.
Gross margin rate increased by 0.1 percentage point for the thirteen weeks ended October 29, 2016 compared to the same period last year. The increase in Gross margin rate was primarily the result of a prior year increase in costs of USD denominated merchandise purchases in our Canada segment.
 
 
39 Weeks Ended
 
 
 
 
 
 
 
 
Percentage of Total revenues
($ In millions)
 
October 29,
2016
 
October 31,
2015
 
$ Change
 
October 29,
2016
 
October 31,
2015
 
Change
Domestic
 
$
1,514

 
$
1,574

 
$
(60
)
 
35.7
%
 
36.2
%
 
(0.5
)%
Canada
 
189

 
183

 
6

 
38.1
%
 
37.9
%
 
0.2
 %
Toys “R” Us - Delaware
 
$
1,703

 
$
1,757

 
$
(54
)
 
36.0
%
 
36.3
%
 
(0.3
)%
Gross margin decreased by $54 million to $1,703 million for the thirty-nine weeks ended October 29, 2016, compared to $1,757 million for the same period last year. Foreign currency translation decreased Gross margin by $6 million.
Gross margin rate decreased by 0.3 percentage points for the thirty-nine weeks ended October 29, 2016 compared to the same period last year. The decrease in Gross margin rate was primarily due to an increase in shipping costs from higher e-commerce sales coupled with a reduction in our free shipping purchase minimum in our Domestic segment, partially offset by a prior year increase in costs of USD denominated merchandise purchases in our Canada segment.
Domestic
Gross margin decreased by $19 million to $476 million for the thirteen weeks ended October 29, 2016. Gross margin rate decreased by 0.1 percentage point for the thirteen weeks ended October 29, 2016, compared to the same period last year.
Gross margin decreased by $60 million to $1,514 million for the thirty-nine weeks ended October 29, 2016. Gross margin rate decreased by 0.5 percentage points for the thirty-nine weeks ended October 29, 2016, compared to the same period last year.
The decrease in Gross margin rate for the thirty-nine weeks ended October 29, 2016 was primarily from higher shipping costs due to an increase in e-commerce sales coupled with a reduction in our free shipping purchase minimum from $49 to $19 launched in September 2015.
Canada
Gross margin increased by $5 million to $64 million for the thirteen weeks ended October 29, 2016. Gross margin rate increased by 1.0 percentage point for the thirteen weeks ended October 29, 2016, compared to the same period last year.

25


The increase in Gross margin rate resulted from a prior year increase in costs of USD denominated merchandise purchases. Additionally contributing to the increase were margin rate improvements in our core toy and entertainment categories and sales mix away from lower margin entertainment products.
Gross margin increased by $6 million to $189 million for the thirty-nine weeks ended October 29, 2016. Foreign currency translation decreased Gross margin by $6 million. Gross margin rate increased by 0.2 percentage points for the thirty-nine weeks ended October 29, 2016, compared to the same period last year.
The increase in Gross margin rate resulted from a prior year increase in costs of USD denominated merchandise purchases.

Selling, General and Administrative Expenses
The following table presents expenses as a percentage of consolidated SG&A:
 
 
13 Weeks Ended
 
39 Weeks Ended
 
 
October 29,
2016
 
October 31,
2015
 
October 29,
2016
 
October 31,
2015
Payroll and related benefits
 
42.7
%
 
43.6
%
 
43.4
%
 
43.0
%
Occupancy costs
 
32.7
%
 
34.0
%
 
33.1
%
 
34.8
%
Advertising and promotional expenses
 
7.5
%
 
6.2
%
 
6.8
%
 
6.0
%
Professional fees
 
3.7
%
 
3.1
%
 
3.3
%
 
3.7
%
Transaction fees (1)
 
3.4
%
 
3.5
%
 
3.6
%
 
3.4
%
Other (2)
 
10.0
%
 
9.6
%
 
9.8
%
 
9.1
%
Total
 
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
(1)
Primarily consists of credit card fees.
(2)
Includes costs related to website hosting, transporting merchandise from distribution centers to stores, store related supplies and signage and other corporate-related expenses.
 
 
13 Weeks Ended
 
 
 
 
 
 
 
 
Percentage of Total revenues
($ In millions)
 
October 29,
2016
 
October 31,
2015
 
$ Change
 
October 29,
2016
 
October 31,
2015
 
Change
Toys “R” Us - Delaware
 
$
603

 
$
596

 
$
7

 
39.2
%
 
37.7
%
 
1.5
%
SG&A increased by $7 million to $603 million for the thirteen weeks ended October 29, 2016, compared to $596 million for the same period last year. As a percentage of Total revenues, SG&A increased by 1.5 percentage points.
The increase in SG&A was primarily due to an $8 million increase in advertising and promotional expenses, mainly related to the timing of our “Big Book” holiday catalog release. Partially offsetting the increase was a $5 million decrease in occupancy costs, predominantly as a result of the closure of our Times Square flagship store.
 
 
39 Weeks Ended
 
 
 
 
 
 
 
 
Percentage of Total revenues
($ In millions)
 
October 29,
2016
 
October 31,
2015
 
$ Change
 
October 29,
2016
 
October 31,
2015
 
Change
Toys “R” Us - Delaware
 
$
1,754

 
$
1,784

 
$
(30
)
 
37.1
%
 
36.9
%
 
0.2
%
SG&A decreased by $30 million to $1,754 million for the thirty-nine weeks ended October 29, 2016, compared to $1,784 million for the same period last year. Foreign currency translation decreased SG&A by $5 million. As a percentage of Total revenues, SG&A increased by 0.2 percentage points.
Excluding the impact of foreign currency translation, the decrease in SG&A was primarily due to a $39 million decline in occupancy costs, predominantly as a result of the closure of our Times Square and FAO Schwarz flagship stores. Partially offsetting the decrease was a $13 million increase in advertising and promotional expenses.


26


Depreciation and Amortization
 
 
13 Weeks Ended
 
39 Weeks Ended
(In millions)
 
October 29,
2016
 
October 31,
2015
 
Change
 
October 29,
2016
 
October 31,
2015
 
Change
Toys “R” Us - Delaware
 
$
47

 
$
52

 
$
(5
)
 
$
151

 
$
167

 
$
(16
)
Depreciation and amortization decreased by $5 million and $16 million for the thirteen and thirty-nine weeks ended October 29, 2016, respectively, compared to the same periods last year. The decrease for both periods was primarily due to fully depreciated assets and closed stores.

Other Income, Net
Other income, net includes the following:
•
net gains on sales;
•
credit card program income;
•
gift card breakage income;
•
information technology and administrative support service income;
•
foreign exchange gains and losses;
•
management service fees income;
•
impairment of long-lived assets; and
•
other operating income and expenses.
 
 
13 Weeks Ended
 
39 Weeks Ended
(In millions)
 
October 29,
2016
 
October 31,
2015
 
Change
 
October 29,
2016
 
October 31,
2015
 
Change
Toys “R” Us - Delaware
 
$
67

 
$
27

 
$
40

 
$
134

 
$
82

 
$
52

Other income, net increased by $40 million to $67 million for the thirteen weeks ended October 29, 2016. Other income, net increased by $52 million to $134 million for the thirty-nine weeks ended October 29, 2016. The increase in both periods was primarily due to the sale of the FAO Schwarz brand for a net gain of $45 million.

Interest Expense
 
 
13 Weeks Ended
 
39 Weeks Ended
(In millions)
 
October 29,
2016
 
October 31,
2015
 
Change
 
October 29,
2016
 
October 31,
2015
 
Change
Toys “R” Us - Delaware
 
$
64

 
$
73

 
$
(9
)
 
$
199

 
$
207

 
$
(8
)
Interest expense decreased by $9 million to $64 million for the thirteen weeks ended October 29, 2016, compared to $73 million for the same period last year, primarily due to a decrease in interest expense on borrowings with Parent. Refer to Note 8 to the Condensed Consolidated Financial Statements entitled “Related party transactions” for further details
Interest expense decreased by $8 million to $199 million for the thirty-nine weeks ended October 29, 2016, compared to $207 million for the same period last year. The decrease was primarily due to a decrease in interest expense on borrowings with Parent, partially offset by the change in value of foreign exchange contracts.
As a result of the CMBS and mezzanine debt refinancing in November 2016 described further below, we expect that our annual cash interest paid will decrease by approximately $22 million, based on LIBOR rates as of October 29, 2016, primarily due to a lower rate of interest on the Propco II Mortgage Loan (as defined below in Liquidity and Capital Resources - Debt).

Interest Income
 
 
13 Weeks Ended
 
39 Weeks Ended
(In millions)
 
October 29,
2016
 
October 31,
2015
 
Change
 
October 29,
2016
 
October 31,
2015
 
Change
Toys “R” Us - Delaware
 
$
28

 
$
33

 
$
(5
)
 
$
82

 
$
81

 
$
1

Interest income decreased by $5 million to $28 million for the thirteen weeks ended October 29, 2016, compared to $33 million for the same period last year. The decrease was primarily due to a decrease in interest income on loans receivable from Parent. Refer to Note 8 to the Condensed Consolidated Financial Statements entitled “Related party transactions” for further details.

27


Interest income increased by $1 million to $82 million for the thirty-nine weeks ended October 29, 2016, compared to the same period last year.

Income Tax Expense
The following table summarizes our Income tax expense and effective tax rates for the thirteen and thirty-nine weeks ended October 29, 2016 and October 31, 2015:
 
 
13 Weeks Ended
 
39 Weeks Ended
($ In millions)
 
October 29,
2016
 
October 31,
2015
 
October 29,
2016
 
October 31,
2015
Loss before income taxes
 
$
(79
)
 
$
(107
)
 
$
(185
)
 
$
(238
)
Income tax expense
 
4

 
3

 
13

 
7

Effective tax rate
 
(5.1
)%
 
(2.8
)%
 
(7.0
)%
 
(2.9
)%
The effective tax rates for the thirteen and thirty-nine weeks ended October 29, 2016 and October 31, 2015 were based on our forecasted effective tax rates, adjusted for discrete items that occurred within the periods presented. Our forecasted effective tax rate was (6.9)% for the thirty-nine weeks ended October 29, 2016 compared to (3.0)% for the same period last year. The difference between our forecasted effective tax rates was primarily due to a change in the mix and level of earnings between jurisdictions.
There were no significant discrete items that impacted our effective tax rate for the thirteen and thirty-nine weeks ended October 29, 2016 and October 31, 2015, respectively.

Non-GAAP Financial Measure - Adjusted EBITDA
We believe Adjusted EBITDA is useful to investors because it is frequently used by securities analysts, investors and other interested parties in the evaluation of companies in our industry. Investors in the Company regularly request Adjusted EBITDA as a supplemental analytical measure to, and in conjunction with, the Company’s financial data prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). We understand that investors use Adjusted EBITDA, among other things, to assess our period-to-period operating performance and to gain insight into the manner in which management analyzes operating performance.
In addition, we believe that Adjusted EBITDA is useful in evaluating our operating performance compared to that of other companies in our industry because the calculation of EBITDA and Adjusted EBITDA generally eliminates the effects of financing and income taxes and the accounting effects of capital spending and acquisitions, which items may vary for different companies for reasons unrelated to overall operating performance. We use the non-GAAP financial measures for planning and forecasting and measuring results against the forecast and in certain cases we use similar measures for bonus targets for certain of our employees. Using several measures to evaluate the business allows us and investors to assess our relative performance against our competitors.
Although we believe that Adjusted EBITDA can make an evaluation of our operating performance more consistent because it removes items that do not reflect our core operations, other companies, even in the same industry, may define Adjusted EBITDA differently than we do. As a result, it may be difficult to use Adjusted EBITDA or similarly named non-GAAP measures that other companies may use to compare the performance of those companies to our performance. The Company does not, and investors should not, place undue reliance on EBITDA or Adjusted EBITDA as measures of operating performance.

28


A reconciliation of Net loss to EBITDA and Adjusted EBITDA is as follows:
 
 
13 Weeks Ended
 
39 Weeks Ended
(In millions)
 
October 29,
2016
 
October 31,
2015
 
October 29,
2016
 
October 31,
2015
Net loss
 
$
(83
)
 
$
(110
)
 
$
(198
)
 
$
(245
)
 
 
 
 
 
 
 
 
 
Add:
 
 
 
 
 
 
 
 
Income tax expense
 
4

 
3

 
13

 
7

Interest expense, net
 
36

 
40

 
117

 
126

Depreciation and amortization
 
47

 
52

 
151

 
167

EBITDA
 
4

 
(15
)
 
83

 
55

 
 
 
 
 
 
 
 
 
Adjustments:
 
 
 
 
 
 
 
 
Certain transaction costs (a)
 
5

 
—

 
13

 
—

Foreign currency re-measurement (b)
 
4

 
—

 
(5
)
 
3

Severance
 
2

 
3

 
3

 
11

Sponsors’ management and advisory fees (c)
 
2

 
1

 
5

 
5

Net gains on sales (d)
 
(45
)
 
(1
)
 
(45
)
 
(1
)
Store closure costs (e)
 
—

 
1

 
7

 
8

Compensation expense (f)
 
—

 
(3
)
 
2

 
(1
)
Impairment of long-lived assets
 
—

 
—

 
1

 
2

Property losses, net of insurance recoveries
 
—

 
(1
)
 
—

 
(1
)
Adjusted EBITDA (g)
 
$
(28
)
 
$
(15
)
 
$
64

 
$
81

(a)
Represents expenses associated with the transition of our U.S. e-commerce operations and other transaction costs.
(b)
Represents the unrealized loss (gain) on foreign exchange related to the re-measurement of the portion of the Tranche A-1 loan facility attributed to Toys-Canada.
(c)
Represents the fees expensed to our Sponsors in accordance with the advisory agreement.
(d)
Represents sales of properties and intellectual property.
(e)
Represents store closure costs, net of lease surrender income.
(f)
Represents the incremental compensation expense related to certain one-time awards and modifications, net of forfeitures of certain officers’ awards.
(g)
Adjusted EBITDA is defined as EBITDA (earnings (loss) before net interest income (expense), income tax expense (benefit), depreciation and amortization), as further adjusted to exclude the effects of certain income and expense items that management believes make it more difficult to assess the Company’s actual operating performance including certain items which are generally non-recurring. We have excluded the impact of such items from internal performance assessments. We believe that excluding items such as Sponsors’ management and advisory fees, asset impairment charges, severance, impact of litigation, store closure costs, net gains on sales and other charges, helps investors compare our operating performance with our results in prior periods. We believe it is appropriate to exclude these items as they are not related to ongoing operating performance and, therefore, limit comparability between periods and between us and similar companies.

Liquidity and Capital Resources
Overview
As of October 29, 2016, we were in compliance with all of the covenants related to our outstanding debt. Under the $1.85 billion secured revolving credit facility (“ABL Facility”), we had outstanding borrowings of $1,018 million, a total of $97 million of outstanding letters of credit and excess availability of $735 million as of October 29, 2016. We are subject to a minimum excess availability covenant of $125 million, with remaining availability of $610 million in excess of the covenant at October 29, 2016. Availability is determined pursuant to a borrowing base, consisting of specified percentages of eligible inventory among other assets, and generally peaks in the third quarter of our fiscal year. As of October 29, 2016, we had total liquidity of $799 million, which included cash and cash equivalents of $189 million.

29


We are dependent on borrowings to support our working capital needs, capital expenditures and to service debt. As of October 29, 2016, we have funds available to finance our operations under our ABL Facility through March 2019, subject to an earlier springing maturity. If our cash flow and capital resources do not provide the necessary liquidity, it could have a significant negative effect on our results of operations.
In general, our primary uses of cash are providing for working capital purposes (which principally represents the purchase of inventory), servicing debt, remodeling existing stores, financing construction of new stores and paying expenses, such as payroll costs and rental expense, to operate our stores. Our working capital needs follow a seasonal pattern, peaking in the third quarter of the year when inventory is purchased for the fourth quarter holiday selling season. For the thirty-nine weeks ended October 29, 2016, peak borrowings under our revolving credit facilities and credit lines amounted to $1,018 million, with remaining availability of $610 million in excess of the ABL Facility covenant.
In addition, from time to time, we may have short-term intercompany loans outstanding from Parent. As of October 29, 2016, January 30, 2016 and October 31, 2015, we had outstanding balances of $269 million, $364 million and $327 million, respectively, in short-term intercompany loans from Parent.
Our largest source of operating cash flows is cash collections from our customers. We have been able to meet our cash needs principally by using cash on hand, cash flows from operations and borrowings under our ABL Facility and from our Parent. From time to time, we may enter into intercompany loans with Parent or pay dividends to Parent as permitted under our debt instruments. The funds provided to Parent may be used for general purposes, including, without limitation, for paying interest, repaying, refinancing, repurchasing, redeeming, defeasing or otherwise satisfying indebtedness of our Parent or of its subsidiaries.
Although we believe that cash generated from operations along with our existing cash and ABL Facility will be sufficient to fund our expected cash flow requirements and planned capital expenditures for at least the next 12 months, financial market disruption could have a negative impact on our ability to refinance our maturing debt and available resources in the future.

Capital Expenditures
A component of our long-term strategy is our capital expenditure program. Our capital expenditures are primarily for enhancing our e-commerce and other information technology and logistics systems, as well as improving existing stores and construction of new stores. Capital expenditures are funded primarily through cash provided by operating activities, as well as available cash.
The following table presents our capital expenditures for the thirty-nine weeks ended October 29, 2016 and October 31, 2015:
  
 
39 Weeks Ended
(In millions)
 
October 29,
2016
 
October 31,
2015
Information technology
 
$
60

 
$
51

Store improvements (1)
 
22

 
19

Distribution centers
 
13

 
8

New stores
 
7

 
1

Other store-related projects (2)
 
24

 
21

Total capital expenditures
 
$
126

 
$
100

(1)
Includes expenditures related to the “Clean and Bright” initiative.
(2)
Includes remodels and other store updates.

Cash Flows
  
 
39 Weeks Ended
(In millions)
 
October 29,
2016
 
October 31,
2015
 
Change      
Net cash used in operating activities
 
$
(694
)
 
$
(625
)
 
$
(69
)
Net cash used in investing activities
 
(81
)
 
(99
)
 
18

Net cash provided by financing activities
 
825

 
746

 
79

Effect of exchange rate changes on Cash and cash equivalents
 
—

 
—

 
—

Net increase during period in Cash and cash equivalents
 
$
50

 
$
22

 
$
28


30


Cash Flows Used in Operating Activities
Net cash used in operating activities increased by $69 million to $694 million for the thirty-nine weeks ended October 29, 2016, compared to $625 million for the thirty-nine weeks ended October 31, 2015. The increase was primarily due to higher Domestic vendor payments in fiscal 2016 for merchandise purchased in fiscal 2015 as part of our continued focus to maintain stronger in-stock positions.
Cash Flows Used in Investing Activities
Net cash used in investing activities decreased by $18 million to $81 million for the thirty-nine weeks ended October 29, 2016, compared to $99 million for the thirty-nine weeks ended October 31, 2015, primarily due to a $45 million increase in proceeds received from sales of assets, partially offset by a $26 million increase in capital expenditures.
Cash Flows Provided by Financing Activities
Net cash provided by financing activities increased by $79 million to $825 million for the thirty-nine weeks ended October 29, 2016, compared to $746 million for the thirty-nine weeks ended October 31, 2015, due to the increase in total net borrowings to finance our increased purchases of merchandise inventories. Refer to Note 2 to the Condensed Consolidated Financial Statements entitled “Long-term debt” for further details regarding our debt.

Debt
As of October 29, 2016, we had total indebtedness (excluding Short-term borrowings from Parent) of $3,379 million, of which $3,180 million was secured indebtedness. During the thirty-nine weeks ended October 29, 2016, there were no significant events that occurred with respect to our debt structure. Refer to Note 2 to the Condensed Consolidated Financial Statements entitled “Long-term debt” for further details regarding our debt.
Our ability to refinance our indebtedness on favorable terms, or at all, is directly affected by global economic and financial market conditions and other economic factors that may be outside our control. In addition, our ability to incur secured indebtedness (which may enable us to achieve better pricing than the incurrence of unsecured indebtedness) depends in part on the covenants in our credit facilities and our Parent’s indentures and the value of our assets, which depends, in turn, on the strength of our cash flows, results of operations, economic and market conditions and other factors.
We, Parent and its subsidiaries, as well as the Sponsors or their affiliates, may from time to time prepay, repurchase, refinance or otherwise acquire debt or debt securities issued by us or our subsidiaries in open market transactions, tender offers, exchange offers, privately negotiated transactions or otherwise. Any such transactions, and the amounts involved, will depend on prevailing market conditions, liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. Refer to Note 8 to the Condensed Consolidated Financial Statements entitled “Related party transactions” and Note 15, entitled “RELATED PARTY TRANSACTIONS,” to our Annual Financial Statements for the fiscal year ended January 30, 2016, included as an exhibit to Parent’s Form 8-K filed on April 8, 2016.
Subsequent Refinancings
On November 3, 2016, we completed the $512 million of Commercial Mortgage-Backed Securities (“CMBS”) financing and $88 million of mezzanine financing. The proceeds and a $51 million rent prepayment from the Company to Toys “R” Us Property Company II, LLC (“TRU Propco II”) in conjunction with an amendment to the master lease agreement, along with cash on hand were used to redeem the aggregate principal amount of $725 million of 8.500% senior secured notes due 2017 of TRU Propco II. TRU Propco II entered into a mortgage loan agreement (the “Mortgage Loan Agreement”), providing for a floating-rate loan (the “Propco II Mortgage Loan”) in the initial principal amount of $512 million. The Propco II Mortgage Loan has a three-year initial term expiring on November 9, 2019, and may be extended for two one-year terms at the option of TRU Propco II, subject to certain conditions, including meeting certain ratios at the time of the extension and, in the case of the second extension option, payment of an extension fee. If the Giraffe Junior Mezzanine Loan described below is outstanding, TRU Propco II may only exercise the extension options on the Propco II Mortgage Loan if the term of the Giraffe Junior Mezzanine Loan is also extended.
Additionally, as noted above, on November 3, 2016, Giraffe Junior Holdings, LLC (“Giraffe Junior”), our indirect wholly-owned subsidiary and the owner of 100% of the equity interest in TRU Propco II, entered into a mezzanine loan agreement (the “Mezzanine Loan Agreement”) providing for a fixed-rate loan (the “Giraffe Junior Mezzanine Loan”) in the initial principal amount of $88 million. The Giraffe Junior Mezzanine Loan has a three-year initial term expiring on November 9, 2019, and may be extended for two one-year terms at the option of Giraffe Junior, subject to certain conditions substantially similar to the conditions to extending the Propco II Mortgage Loan under the Mortgage Loan Agreement. If the Propco II Mortgage Loan is outstanding, Giraffe Junior may only exercise the extension options if the Propco II Mortgage Loan is also extended. Refer to Note 2 to the Condensed Consolidated Financial Statements entitled “Long-term debt” for further details on the CMBS and

31


mezzanine financings.

Contractual Obligations
Our contractual obligations consist mainly of payments for operating leases related to real estate used in the operation of our business, Long-term debt and related interest and product purchase obligations. There were no significant changes to our contractual obligations as of October 29, 2016. Refer to the “Subsequent Events” section in Note 2 to the Condensed Consolidated Financial Statements entitled “Long-term debt” for a discussion of certain changes that occurred after October 29, 2016. Refer to the “Contractual Obligations” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Financial Statements for the fiscal year ended January 30, 2016 included as an exhibit to Parent’s Form 8-K filed on April 8, 2016, for details on our contractual obligations.

Critical Accounting Policies
Our Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosures of contingent assets and liabilities as of the date of the financial statements and during the applicable periods. We base these estimates on historical experience and on other factors that we believe are reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions and could have a material impact on our Condensed Consolidated Financial Statements. Refer to our Annual Financial Statements for the fiscal year ended January 30, 2016 included as an exhibit to Parent’s Form 8-K filed on April 8, 2016, for a discussion of critical accounting policies.

Recently Adopted Accounting Pronouncements
In September 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2015-16 “Business Combinations (Topic 805), Simplifying the Accounting for Measurement-Period Adjustments” (“ASU 2015-16”). ASU 2015-16 eliminates the requirement that an acquirer in a business combination account for measurement-period adjustments retrospectively. Under the previous guidance, an acquirer must recognize adjustments to provisional amounts during the measurement period retrospectively (i.e. as if the accounting for the business combination had been completed at the acquisition date). That is, the acquirer must revise comparative information on the income statement and balance sheet for any prior periods affected. Under ASU 2015-16, acquirers must recognize measurement-period adjustments in the period in which they determine the amounts, including the effect on earnings of any amounts they would have recorded in previous periods if the accounting had been completed at the acquisition date. The amendments in ASU 2015-16 require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earning by line item that would have been in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. ASU 2015-16 did not change the criteria for determining whether an adjustment qualifies as a measurement-period adjustment and does not change the length of the measurement period. The Company has adopted the amendments of ASU 2015-16, effective January 31, 2016. The adoption did not have an impact on our Condensed Consolidated Financial Statements.
In April 2015, the FASB issued ASU No. 2015-05, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement” (“ASU 2015-05”). Existing GAAP does not include explicit guidance about a customer’s accounting for fees paid in a cloud computing arrangement. The amendments in this ASU provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software licenses element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. As a result of the amendments, all software licenses within the scope of Subtopic 350-40 will be accounted for consistent with other licenses of intangible assets. An entity can elect to adopt the amendments either (1) prospectively to all arrangements entered into or materially modified after the effective date; or (2) retrospectively. The Company adopted the amendments of ASU 2015-05 as of January 31, 2016 on a prospective basis. The adoption did not have an impact on our Condensed Consolidated Financial Statements.
In April 2015, the FASB issued ASU No. 2015-03, “Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs” (“ASU 2015-03”). ASU 2015-03 simplifies the presentation of debt issuance costs by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. Under the previous practice, debt issuance costs were recognized as a deferred charge (that is, an asset). This ASU will create consistencies with the guidance in International Financial Reporting Standards as well as the guidance in FASB Concepts Statement No. 6, “Elements of Financial Statements”,

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which states that debt issuance costs are similar to debt discounts and in effect reduce the proceeds of borrowing, thereby increasing the effective interest rate. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. In August 2015, the FASB issued ASU No. 2015-15 “Interest - Imputed Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements” (“ASU 2015-15”), which clarifies that the guidance in ASU 2015-03 does not apply to line-of-credit arrangements. According to ASU 2015-15, line-of-credit arrangements will continue to defer and present debt issuance costs as an asset and subsequently amortize the deferred debt costs ratably over the term of the arrangement. Upon transition, an entity is required to comply with the applicable disclosures for a change in an accounting principle. The Company has adopted the amendments of ASU 2015-03 and ASU 2015-15, effective January 31, 2016. Other than the revised balance sheet presentation of debt issuance costs from an asset to a deduction from the carrying amount of the debt liability and related disclosures, the adoption of ASU 2015-03 and ASU 2015-15 did not have an impact on our Condensed Consolidated Financial Statements.
In February 2015, the FASB issued ASU No. 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis” (“ASU 2015-02”). ASU 2015-02 is intended to improve targeted areas of consolidation guidance for reporting organizations that are required to evaluate whether they should consolidate certain legal entities. This ASU simplifies consolidation accounting by reducing the number of consolidation models and improves current GAAP by (1) placing more emphasis on risk of loss when determining a controlling financial interest; (2) reducing the frequency of the application of related-party guidance when determining a controlling financial interest in a VIE; and (3) changing consolidation conclusions for public and private companies in several industries that typically make use of limited partnerships or VIEs. Entities can transition to the standard either retrospectively or as a cumulative effect adjustment as of the date of adoption. The Company adopted the amendments of ASU 2015-02, effective January 31, 2016. The adoption did not have an impact on our Condensed Consolidated Financial Statements.
In January 2015, the FASB issued ASU No. 2015-01, “Income Statement - Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items” (“ASU 2015-01”). ASU 2015-01 eliminates from U.S. GAAP the concept of extraordinary items. Under the previous practice, an entity was required to separately classify, present, and disclose extraordinary events and transactions. The FASB issued this ASU as part of its initiative to reduce complexity in accounting standards. This ASU will also align more closely U.S. GAAP income statement presentation guidance with IAS 1, “Presentation of Financial Statements,” which prohibits the presentation and disclosure of extraordinary items. The Company adopted the amendments of ASU 2015-01, effective January 31, 2016. The adoption did not have an impact on our Condensed Consolidated Financial Statements.
In June 2014, the FASB issued ASU No. 2014-12, “Compensation-Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period” (“ASU 2014-12”).  ASU 2014-12 provides specific guidance on this Topic, requiring that performance targets that affect vesting and that could be achieved after the requisite service period be treated as a performance condition.  A reporting entity should apply existing guidance in ASC Topic 718 as it relates to awards with performance conditions that affect vesting to account for such awards.  This varies from the previous practice, as such provisions were also accounted for as non-vesting restrictions which affect the determination of grant-date fair value and required expense recognition over the requisite service period regardless of whether the performance condition is met.  The Company adopted the amendments of ASU 2014-12 as of January 31, 2016 on a prospective basis.  The adoption did not have an impact on our Condensed Consolidated Financial Statements.

Forward-Looking Statements
This Management’s Discussion and Analysis of Financial Condition and Results of Operations, the other reports and documents that our Parent has filed or may in the future file with the Securities and Exchange Commission and other publicly released materials and statements, both oral and written, that we have made or may make in the future, may contain “forward looking” statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and such disclosures are intended to be covered by the safe harbors created thereby. These forward looking statements reflect our current views with respect to, among other things, our operations and financial performance. All statements herein or therein that are not historical facts, including statements about our beliefs or expectations, are forward-looking statements. We generally identify these statements by words or phrases, such as “anticipate,” “estimate,” “plan,” “project,” “expect,” “believe,” “intend,” “foresee,” “forecast,” “will,” “may,” “outlook” or the negative version of these words or other similar words or phrases. These statements discuss, among other things, our strategy, our “Strategic Pillars,” store openings, integration and remodeling, the development, implementation and integration of our e-commerce business, the continued benefit of the “Fit for Growth” process improvements, future financial or operational performance, projected sales for certain periods, same store sales from one period to another, cost savings, results of store closings and restructurings, outcome or impact of pending or threatened litigation, domestic or international developments, amount and allocation of future capital expenditures, growth initiatives, inventory levels, cost of goods, selection and type of

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merchandise, marketing positions, implementation of safety standards, access to trade credit, future financings, refinancings including exchange offers, debt repayments, estimates regarding future effective tax rates, future interest payments, and other goals and targets and statements of the assumptions underlying or relating to any such statements.
These statements are subject to risks, uncertainties and other factors, including, among others, the seasonality of our business, competition in the retail industry, changes in our product distribution mix and distribution channels, general economic factors in the United States and other countries in which we conduct our business, consumer spending patterns, birth rates, our ability to implement our strategy including implementing initiatives for season, our ability to recognize cost savings, implementation and operation of our new e-commerce platform, marketing strategies, the availability of adequate financing, ability to repatriate cash from Toys-Canada, access to trade credit, changes in consumer preferences, changes in employment legislation, our dependence on key vendors for our merchandise, political and other developments associated with our international operations, costs of goods that we sell, labor costs, transportation costs, domestic and international events affecting the delivery of toys and other products to our stores, product safety issues including product recalls, the existence of adverse litigation, changes in laws that impact our business, our substantial level of indebtedness and related debt-service obligations, restrictions imposed by covenants in our debt agreements and other risks, uncertainties and factors set forth under Item 1A entitled “RISK FACTORS” of our Parent’s Annual Report on Form 10-K filed on March 24, 2016, as well as our Parent’s other reports and documents filed with the Securities and Exchange Commission. In addition, we typically earn a disproportionate part of our annual operating earnings in the fourth quarter as a result of seasonal buying patterns and these buying patterns are difficult to forecast with certainty. These factors should not be construed as exhaustive, and should be read in conjunction with the other cautionary statements that are included in this report. We believe that all forward-looking statements are based on reasonable assumptions when made; however, we caution that it is impossible to predict actual results or outcomes or the effects of risks, uncertainties or other factors on anticipated results or outcomes and that, accordingly, one should not place undue reliance on these statements. Forward-looking statements speak only as of the date they were made, and we undertake no obligation to update these statements in light of subsequent events or developments unless required by the Securities and Exchange Commission’s rules and regulations. Actual results and outcomes may differ materially from anticipated results or outcomes discussed in any forward-looking statement.


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TOYS R US INC Reports