Toys "R" Us posts Q2 profit, says balance sheet in good shape

By Paul Deckelman

New York, Aug. 23 - Toys "R" Us Inc. reported a fiscal second-quarter profit Monday - although it also had a sales decline and a swing to a sizable operating loss for the quarter - and says its balance sheet and liquidity are in good shape.

Moreover, although the Wayne, N.J.,-based toy retailer recently expressed the intention of separating its core toy-retailing business, beset by increased competition and low profit margins, from its lucrative Babies "R" Us division, the company's chief executive officer took pains during a short conference call that followed release of the results to stress that - for the moment, at least - Toys "R" Us still views its toy-selling business as valuable and viable, and is certainly not yet rolling over and running up the white flag against competitors such as Wal-Mart Stores Inc. as it approaches the all-important end-of-year holiday selling season.

Far from wanting to slink away from the toy wars a bloodied and beaten loser, as some media accounts have lately suggested, Toys "R" Us continues to believe, CEO John Eyler declared, that "there remains clear demand in the market for a specialty retailer that can deliver the widest assortment of toys possible, including exclusive products - and we intend to answer that demand."

The next 120 days, he said - which includes the holiday season, traditionally the boom time of the year in the toy industry - "are key for our global toy business."

He said that Toys "R" Us "continues to expect that we will generate significant cash from our global toy operations [for the remainder of] this [fiscal] year and going forward."

"Exceptionally strong" balance sheet

Addressing the company's financial picture, Eyler, who also serves as chairman and president, said that "maintaining an exceptionally strong balance sheet, ample liquidity and significant financial flexibility continue to be among our highest priorities.

"We are confident our financial flexibility gives us the ability to meet all of our outstanding and ongoing financial commitments to all of our constituents - our shareholders, our vendors, our bondholders, and of course, our employees."

For the fiscal second quarter ended July 31, Toys "R" Us had net earnings of $61 million (28 cents a share) versus a year-earlier loss of $11 million (five cents a share). The net results included the reversal of $200 million of income tax reserves as a result of the conclusion of the Internal Revenue Service's review of proposed adjustments to the company's tax filings for 1997 through 1999.

But total sales for the quarter were $2 billion, down 3.9% from $2.1 billion for the second quarter of 2003, and excluding the impact of currency translation that increased 2004 second quarter sales by $30 million, and a $68 million decline in sales associated with the previously announced closings of the company's underperforming Kids "R" Us division's stores, total sales decreased 2.2% for the second quarter.

That translated into an operating loss for the second quarter of $192 million versus operating earnings of $14 million for the prior year. The 2004 quarterly operating results included pre-tax charges totaling $228 million, of which $38 million were included in restructuring and other charges, while $154 million were included in cost of sales and $36 million were included in selling, general and administrative expenses.

$1.1 billion of cash

The company's chief financial officer, Raymond Arthur, told the conference call that as of the end of the quarter, Toys "R" Us had $1.1 billion of cash and cash equivalents, with no outstanding short-term borrowing. He said the company had $685 million of revolving credit facility availability, but said the company's expectation was that it would use "none or very little" of its revolver capacity for the rest of its fiscal year, which will end on Jan. 31, 2005, just as the company did not tap its revolver at all in the previous fiscal year, ended this past Jan. 31.

The company did not release further debt-related information on its latest quarter, although that information is expected to be included when the company files its quarterly 10-Q report with the Securities and Exchange Commission. A call to the company Monday by Prospect News seeking further details on Toys "R" Us' debt and leverage picture was not returned. According to the 10-Q filed after the end of the fiscal first quarter, the company had $2.253 billion of long-term debt on its balance sheet at that time.

In November 2003, Toys "R" Us announced plans to close all 146 of its free-standing Kids "R" Us stores, which primarily sold children's clothing and other accessories, and its 36 Imaginarium stores, as well as the three distribution centers that supported those stores. Virtually all of those stores have since been closed. It subsequently announced plans for Office Depot Inc. to acquire 124 of the former Kids "R" Us store locations for a total of $197 million in cash, before commissions and fees, plus the assumption of lease payments and other obligations, with the other locations to be disposed of later, either by sales to other buyers or conversion to the Babies "R" Us format.

Arthur told the conference call that as of the end of the second quarter, the sales of more than half of the stores slated to go to Office Depot had been closed, generating cash proceeds to Toys "R" Us of over $100 million. "We currently anticipate that the remaining closing will be completed, and the resulting gain reported, over the next several months, as the [Office Depot] transaction is concluded," the CFO said.

No details on review

Eyler told the conference call - which consisted only of the formal company presentation and which did not include the customary question-and-answer period with analysts and portfolio managers due to SEC disclosure regulations triggered by the company's strategic review announcement on Aug. 11 - that the company had no further information for release at this time on that review. During the Aug. 11 announcement, the company startled much of Wall Street when it broached the notion of leaving its increasingly competitive and difficult flagship toy retailing business to focus solely on Babies "R" Us.

He said that when the decision is made about separating Babies "R" Us and the global toy-selling operation into discrete entities and how that will be accomplished more detailed information would be forthcoming. But he added: "We do not anticipate that that decision will be made for a number of months."

Toys "R" Us' once-dominant position as the leading retail outlet for toys and games has been increasingly undercut in recent years by Wal-Mart's emergence as the retailing industry's fearsome 800-pound gorilla. Specialty retailers in all kinds of businesses - toy sellers, electronics stores and supermarkets to name but a few - are scrambling to get out of the way of Wal-Mart and its smaller but also quite-potent rivals like Target Stores Corp. and Costco Wholesale Corp. as these discounters steamroller across the U.S. retailing landscape with their awesome buying power and their ability to undercut the traditional specialty retailers in reselling to price-conscious consumers through their far-flung store networks.

In doing this, they improve on the formula that Toys "R" Us itself pioneered back in the 1970s and 80s, when it drove most of the traditional local mom-and-pop toy retailers out of business with its network of sprawling big-box stores located in large regional shopping plazas. Victims of the discounter juggernaut have already included two Toys "R" Us rivals, FAO Inc., the parent of the venerable FAO Schwartz upscale toy emporium, and mall-based toy seller KB Toys Inc.

But while much has been made about Toys "R" Us' loss of market share to the discounters, especially Wal-Mart, Eyler's tone Monday almost seemed to soft-pedal the idea, widely reported at the time of the Aug. 11 strategic review announcement, that Toys "R" Us would completely abandon the toy retailing battlefield to a victorious Wal-Mart and its imitators.

That Aug. 11 announcement had seemed to definitively stress that ownership of the toy-selling operation and Babies "R" Us would surely be separated - "Board of Directors has decided to pursue the separation of the global toy and Babies 'R' Us businesses," it said, "in a manner designed to enhance shareholder value, and the Board is continuing to evaluate various means of effecting this separation." The company's decree further declared that the two divisions would in the meantime be operated "as separate entities within the existing Toys 'R' Us, Inc. corporate structure."

Toy business sale "a possibility"

Eyler's phrasing on the conference call, with no analysts aboard to seek clarification, seemed almost to take a step back from that hard-core declaration of intent just a little, noting that when the strategic review announcement was made, "there was a significant media focus placed on the part of the announcement which mentioned plans to explore a possible sale of our toy business," and saying that such a sale remains "a possibility."

In the meantime, he asserted, the company's focus "remains on running our company and taking advantage of our place in the market as the world's largest specialty toy retailer."

Profitable, generating cash

He seemed to even scold elements of the media and the financial community who have been singing the "Toys 'R' Us is finished as a toy retailer" chorus, especially since Aug. 11, defiantly proclaiming "indeed, although the toy retail environment has been highly competitive in recent years, particularly in the United States, sometimes, observers of our company tend to lose sight of the fact that this business is profitable and cash-generating."

He noted that "despite the difficult environment, our U.S. toy stores generated about $6.5 billion in sales last year and had operating income in excess of $100 million, and contributed more than $300 of EBITDA in 2003." He also remarked that "all of our U.S. toy stores are cash flow-positive on a four-wall basis."

But a trader in the company's bonds, in discussing whether Eyler's statements represented any kind of very subtle retreat from what seems to many in the market an already foregone conclusion - that Toys "R" Us will indeed ultimately walk away from the business it once ruled - or whether they were just so much bombastic window-dressing aimed at boosting employee morale heading into the holiday season, shoring up the company's stock price and enhancing the value of the toy business in the eyes of potential buyers, leaned toward the latter opinion.

"I get the impression that they're ultimately going to look to do it [sell the toy retailing operation] . . . I think he's talking up the toy business to try to find a potential buyer of the business."

As the toy retailing industry is currently structured, he opined, "to me, this business is not a good business to still be in. I don't see how they are going to stay in," with Wal-Mart continually encroaching on Toys "R" Us' traditional turf.

While he acknowledged that "it's hard to decipher" the nuances of statements issued by companies and their executives, to him it seemed, whether Toys "R" Us will pull out of the toy retailing business "is not a matter of 'if' - but a matter of 'when'."

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.