S-1 1 ds1.htm FORM S-1 Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on May 27, 2010

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

 

TOYS “R” US, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   5945   22-3260693
(State or other jurisdiction of incorporation or organization)   (Primary Standard Industrial Classification Code Number)  

(I.R.S. Employer

Identification Number)

 

One Geoffrey Way

Wayne, New Jersey 07470

(973) 617-3500

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

David J. Schwartz, Esq.

Executive Vice President and General Counsel

Toys “R” Us, Inc.

One Geoffrey Way

Wayne, New Jersey 07470

(973) 617-3500

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

With copies to:

Michael D. Nathan, Esq.

Simpson Thacher & Bartlett LLP

425 Lexington Avenue

New York, New York 10017-3954

(212) 455-2000

 

James J. Clark, Esq.

Noah B. Newitz, Esq.

William J. Miller, Esq.

Cahill Gordon & Reindel LLP

80 Pine Street

New York, New York 10005-1702

(212) 701-3000

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement is declared effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨     Accelerated filer   ¨
Non-accelerated filer  x (Do not check if a smaller reporting company)   Smaller reporting company   ¨

 

 

CALCULATION OF REGISTRATION FEE

 

 
Title of Each Class of Securities to be Registered   Proposed Maximum
Aggregate Offering
Price(1)(2)
  Amount of
Registration Fee

Common Stock, par value $0.001 per share

  $800,000,000   $57,040
 
 
(1) Includes shares of common stock that the underwriters have an option to purchase. See “Underwriting.”
(2) Estimated solely for the purpose of calculating the amount of the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.

The registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion. Dated May 27, 2010.

Shares

LOGO

TOYS “R” US, INC.

Common Stock

 

 

This is an initial public offering of the common stock of Toys “R” Us, Inc.

Since July 2005 and prior to this offering, there has been no public market for our common stock. It is currently estimated that the initial public offering price per share will be between $             and $            . Toys “R” Us, Inc. intends to list the common stock on the New York Stock Exchange under the symbol “TOYS.”

 

 

See “Risk Factors” beginning on page 14 of this prospectus to read about factors you should consider before buying shares of the common stock.

 

 

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

 

     Per Share    Total

Initial public offering price

   $                 $             

Underwriting discount

   $      $  

Proceeds, before expenses, to us

   $      $  

To the extent that the underwriters sell more than              shares of common stock, the underwriters have the option to purchase up to an additional              shares from us at the initial offering price less the underwriting discount.

 

 

The underwriters expect to deliver the shares against payment in New York, New York on or about              , 2010.

Joint Book-Running Managers

 

Goldman, Sachs & Co.    J.P. Morgan    BofA Merrill Lynch    Credit Suisse

 

Deutsche Bank Securities    Citi    Wells Fargo Securities

Co-Managers

 

Needham & Company, LLC   Mizuho Securities USA Inc.

 

 

Prospectus dated                    , 2010.


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You should rely only on the information contained in this prospectus or in any free writing prospectus that we authorize be delivered to you. Neither we nor the underwriters have authorized anyone to provide you with additional or different information. If anyone provides you with additional, different or inconsistent information, you should not rely on it. We and the underwriters are not making an offer to sell these securities in any jurisdiction where an offer or sale is not permitted. You should assume that the information in this prospectus is accurate only as of the date on the front cover, regardless of the time of delivery of this prospectus or of any sale of our common stock. Our business, prospects, financial condition and results of operations may have changed since that date.

 

 

TABLE OF CONTENTS

 

     Page

Industry, Ranking and Market Data

   ii

Prospectus Summary

   1

Risk Factors

   14

Forward-Looking Statements

   30

Use of Proceeds

   31

Dividend Policy

   32

Capitalization

   33

Dilution

   35

Selected Historical Financial and Other Data

   37

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   39

Business

   70

Management

   85

Principal Shareholders

   112

Certain Relationships and Related Party Transactions

   114

Description of Indebtedness

   117

Description of Capital Stock

   125

Shares Eligible for Future Sale

   129

Material United States Federal Income and Estate Tax Consequences to Non-U.S. Holders

   132

Underwriting

   136

Legal Matters

   141

Experts

   141

Where You Can Find More Information

   141

Index to Consolidated Financial Statements

   F-1

 

 

Through and including                     , 2010 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

 

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INDUSTRY, RANKING AND MARKET DATA

Information included in this prospectus about the toy and juvenile products industry and ranking and brand awareness, including our general expectations concerning this industry, the size of certain markets and our position and the position of our competitors within these markets, are based on estimates prepared using data from various sources and on assumptions made by us. While we believe our internal estimates and industry data are reliable and generally indicative of the toy and juvenile products industry and market, neither such data nor these estimates have been verified by any independent source. Our estimates, in particular as they relate to our general expectations concerning this industry and market, involve risks and uncertainties and are subject to change based on various factors, including those discussed under the caption “Risk Factors” in this prospectus.

 

 

We use a 52-53 week fiscal year ending on the Saturday nearest to January 31. Unless otherwise stated, in this prospectus, references to “fiscal year 2009” or “fiscal 2009” refer to the fiscal year ended January 30, 2010 (consisting of 52 weeks); references to “fiscal year 2008” or “fiscal 2008” refer to the fiscal year ended January 31, 2009 (consisting of 52 weeks); and references to “fiscal year 2007” or “fiscal 2007” are to the fiscal year ended February 2, 2008 (consisting of 52 weeks).

 

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PROSPECTUS SUMMARY

This summary highlights significant aspects of our business and this offering, but it is not complete and does not contain all of the information that you should consider before making your investment decision. You should carefully read the entire prospectus, including the information presented under the section entitled “Risk Factors” and the historical financial and other data and related notes, before making an investment decision. This summary contains forward-looking statements that involve risks and uncertainties. Our actual results may differ significantly from the results discussed in the forward-looking statements as a result of certain factors, including those set forth in “Risk Factors” and “Forward Looking Statements.” As used herein, references to the “Company,” “we,” “us,” “our,” and, where applicable, “Toys “R” Us” are to Toys “R” Us, Inc., the issuer of the common stock, a Delaware corporation, and its subsidiaries.

We refer to Adjusted EBITDA in this prospectus summary and elsewhere in this prospectus. For the definition of Adjusted EBITDA, an explanation of why we present it and a description of the limitations of this non-GAAP measure, as well as a reconciliation to net earnings, see “—Summary Historical Financial and Other Data.”

Our Company

We are the leading global specialty retailer of toys and juvenile products as measured by net sales. For over 50 years, Toys “R” Us has been recognized as the toy and baby authority. In the U.S., in fiscal 2009, approximately 70% of households with kids under 12 shopped at our Toys “R” Us stores, and 84% of all new mothers shopped at our Babies “R” Us stores. We believe we offer the most comprehensive year-round selection of toys and juvenile products, including a broad assortment of private label and exclusive merchandise unique to our stores.

As of January 30, 2010, we operated 1,363 stores and licensed an additional 203 stores. These stores are located in 34 countries and jurisdictions around the world under the Toys “R” Us, Babies “R” Us and FAO Schwarz banners. In addition to these stores, during the fiscal 2009 holiday season, we opened 91 Toys “R” Us Holiday Express stores (“pop-up stores”), a temporary store format located in high-traffic shopping areas, 30 of which remained open as of January 30, 2010. We also sell merchandise through our websites at Toysrus.com, Babiesrus.com, eToys.com, FAO.com and babyuniverse.com. For the fiscal year ended January 30, 2010, we generated net sales of $13.6 billion, net earnings of $312 million and Adjusted EBITDA of $1,130 million.

We operate in an attractive industry that has proven to be resilient due to the demand for toys (including video games and video game systems) and juvenile (including baby) products, driven by the desire of families to spend on their children and by population growth.

We believe that several factors have allowed us to achieve strong financial performance and will enable us to continue to strengthen our position in the marketplace, including our:

 

  Ÿ  

Position as the leading global specialty retailer of toys and juvenile products;

 

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Global footprint and established multi-channel distribution capabilities;

 

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Expertise in managing the seasonal nature of our business;

 

  Ÿ  

Significant growth opportunities, including: the integration of our Toys “R” Us and Babies “R” Us stores, the opening of new stores, the expansion of our on-line presence, the improvement of our sales productivity and the expansion of our operating profit margin; and

 

  Ÿ  

Experienced management team with a proven track record.

 

 

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Our History

Our Company was founded in 1948 when Charles Lazarus opened a baby furniture store, Children’s Bargain Town, in Washington, D.C. The Toys “R” Us name made its debut in 1957. In 1978, we completed an initial public offering of our common stock. When Charles Lazarus retired as our Chief Executive Officer in 1994, the Company operated or licensed over 1,000 stores in 17 countries and jurisdictions. In 1996, we established the Babies “R” Us brand, further solidifying our reputation as a leading consumer destination for children and their families.

On July 21, 2005, we were acquired by an investment group led by entities advised by or affiliated with Bain Capital Partners, LLC, Kohlberg Kravis Roberts & Co., L.P., and Vornado Realty Trust. We refer to this collective ownership group as our “Sponsors”. Upon the completion of this acquisition, we became a private company.

Progress Since Our 2005 Acquisition

Strengthening our management team was our top priority following the 2005 acquisition. The rebuilding effort began with the hiring of Gerald L. Storch, our Chairman and Chief Executive Officer, who joined the Company in February 2006 from Target Corporation, where he was most recently Vice Chairman. He assembled the Company’s leadership team, recruiting seasoned executives with significant retail experience in key areas such as merchandising, store operations, e-commerce, finance, human resources and information technology.

Our new management team has made significant improvements to the business, producing strong results to date and laying the foundation for continued improvement. Over the past five years, we achieved the following:

 

  Ÿ  

Streamlined the organizational structure of the Company.    We harnessed the collective strength of the Toys “R” Us and Babies “R” Us brands by combining their respective corporate, merchandising and field operation functions. In addition, we established a common global culture for our business by more closely aligning and sharing best practices across markets. We also refined capital management processes, which assisted us in identifying and closing unprofitable stores, commencing a remodeling and relocation strategy for our stores, and improving our site selection for new stores.

 

  Ÿ  

Developed and launched our juvenile integration strategy.    We designed and implemented new integrated store formats that combine the Toys “R” Us and Babies “R” Us merchandise offerings under one roof, providing a “one stop shopping” environment for our guests. These formats are side-by-side stores and “R” Superstores. Side-by-side stores are a combination of Toys “R” Us and Babies “R” Us stores, which may be the result of either a conversion or a relocation of a standalone store. Our “R” Superstores are conceptually similar to side-by-side stores, except that they are larger in size and may result from a relocation and/or closure of one or more existing stores. In addition, side-by-side stores and “R” Superstores may also be constructed in a new location and market.

These co-branded formats have become powerful vehicles for remodeling and updating our existing store base, generating significant improvements in store-level net sales and profitability. For example, in the first 12 months after conversion, without any increase in square footage, the aggregate store sales for our 53 domestic and 52 of our international side-by-side stores converted during fiscal years 2006, 2007 and 2008, increased, on a weighted average basis (based on net sales) by 20% and 13%, respectively, as compared to the 12 month period prior to commencement of construction for the conversion. The aggregate store sale increases described above are reduced by our estimate of net sales that were transferred from existing stores (generally Babies “R” Us standalone stores) in the vicinity to the new converted stores.

 

 

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Improved the shopping experience for our guests.    We developed and implemented store standards focused on store cleanliness, store signage and customer service, and we enhanced our merchandise selection. In addition, we integrated our on-line business with our retail stores. From 2005 to 2009, Toys “R” Us and Babies “R” Us guest service scores increased by 9% and 5%, respectively.

 

  Ÿ  

Improved marketing strategies to reach our guests.    We created processes to determine the effectiveness of our marketing initiatives and improved our marketing strategies based on these analyses. We reinvigorated existing marketing programs, including our “Big Book” promotional catalog, which we distribute during the holiday selling season and consider to be our most significant piece of advertising. In addition, we launched new loyalty programs and modernized our baby and gift registries to create a stronger bond with our customers. In 2009, approximately 39% of our global net sales were to customers who are members of our loyalty programs.

 

  Ÿ  

Focused on optimizing our store portfolio.    We have opened 105 of our Company operated stores, closed 111 of our Company operated stores and converted 146 of our Company operated stores to our integrated store format since the end of fiscal year 2005. In addition, the number of licensed stores increased from 173 to 203 during the same time period. In the fiscal year ended January 30, 2010, 98% of our operated stores were store-level EBITDA positive.

 

  Ÿ  

Grew our on-line business.    In 2006, we began selling through our Toysrus.com and Babiesrus.com websites. In 2009, we acquired several URLs including eToys.com, babyuniverse.com, FAO.com and toys.com, that further increased our presence on the Internet. Additionally, our baby registry, birthday club and loyalty programs all offer on-line functionality which we believe deepens our relationship with our guests and complements the in-store experience. Through these business initiatives and acquisitions, we have expanded our on-line business from $486 million in net sales in 2005 to $602 million in net sales in 2009.

These initiatives, along with other operating improvements, have delivered strong financial results, with Adjusted EBITDA growing by 55% from fiscal 2005 to fiscal 2009.

Our Competitive Strengths

We believe that the following key competitive strengths differentiate our business:

We are the leading specialty retailer of toys and juvenile products.    We have brand names that are highly recognized around the world, strong relationships with our guests and vendors and we believe we have the broadest year-round product assortment. We also believe our focus on quality of products, service and safety is a competitive strength. In the U.S., in fiscal 2009, approximately 70% of households with kids under 12 shopped at Toys “R” Us, and 84% of all new mothers shopped at our Babies “R” Us stores.

 

  Ÿ  

Highly recognized brand names.    In the U.S., Toys “R” Us and Babies “R” Us maintain a 98% and 86% brand awareness, respectively. We also own other valuable brand names such as FAO Schwarz.

 

 

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Long-lasting relationships with our guests.    Our product assortment allows us to capture new parents as customers during pregnancy, helping them prepare for the arrival of their newborn. We then become a resource for infant products such as formula, diapers and solid foods, as well as baby clothing and learning aids. We believe this opportunity to establish first contact with new parents enables us to develop long-lasting customer relationships with them as their children age and they transition to becoming consumers of our toy products. We continue to build on these relationships as these children grow and eventually become parents themselves.

 

  Ÿ  

Strong relationships with vendors.    Given our market leadership position, we have been able to develop strategic partnerships with many of our vendors. We provide vendors with a year-round platform for their brand and let them use our stores to test their products. We use our New York City flagship stores, notably our Toys “R” Us Times Square store, our FAO Schwarz 5th Avenue store and our Babies “R” Us Union Square store, as venues to introduce new products. We support our vendors by buying a broader range of their products than any other retailer. In return, we obtain greater access to products in demand, support for advertising and marketing efforts and exclusive access to merchandise.

 

  Ÿ  

Broad and deep product assortment.    We believe we offer our guests the most comprehensive year-round selection of toys and juvenile products. Our merchandise breadth, which ranges from action figures to Zhu-Zhu Pets™, and from cribs to car seats, enables us to command a reputation as the shopping destination for toys and juvenile products.

We have a global footprint and multi-channel distribution capabilities.    We have a global presence and reach children and their families in 34 countries and jurisdictions around the world.

 

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Global footprint.    We are one of the few hardlines specialty retailers with a global footprint with 39% of our consolidated net sales generated outside the U.S. in fiscal 2009. As of January 30, 2010, we operated 1,363 stores and licensed an additional 203 stores in 34 countries and jurisdictions throughout North America, Europe, Asia, the Middle East, Australia and Africa. Our international presence enhances our ability to identify trends in diverse markets and introduce newness and novelty in all our markets. Our global presence allows us to test new products in select markets before rolling them out more broadly. We believe that operating as a global and geographically diverse company enhances the stability of our business by exposing us to growth opportunities in different markets and across a broad customer base.

 

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Multiple retail store formats.    We operate a variety of store formats, which enable us to reach our customers in many different ways. Our big box formats include standalone Toys “R” Us stores, standalone Babies “R” Us stores and integrated formats which combine our Toys “R” Us and Babies “R” Us merchandise offerings under one roof. In addition to these formats, we have recently tested 91 pop-up stores that enabled us to reach more customers during the holiday season.

 

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Differentiated real estate strategy with attractive underlying portfolio.    We own stores on land we own and on properties we long-term ground lease located in 11 countries, representing approximately 47% of our entire store base, which differentiates us from other specialty retailers that operate within similar size stores. We believe these properties are desirable assets located in key areas, in generally proven retail corridors along major thoroughfares with good access, ample parking, frontage and visibility. Additionally, the significant ownership level of our real estate, as well as the ongoing effective management of our leases, provides substantial flexibility to execute our juvenile integration strategy in a capital-efficient manner.

 

 

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  Ÿ  

Leading on-line position.    We also sell merchandise through our Internet sites Toysrus.com and Babiesrus.com, as well as our newly acquired eToys.com, FAO.com and babyuniverse.com Internet sites. In 2009, our on-line businesses generated $602 million of net sales.

We have significant experience in managing the seasonal nature of our business.    Over the past 60 years, we have developed substantial expertise in managing the increased demand during the holiday season. From warehousing and distribution, to hiring and training a seasonal workforce and promotional planning, we have invested in the technology and infrastructure to handle the seasonal surge in a cost effective manner.

We have an experienced management team with a proven track record.    Our senior management team has an average of approximately 20 years of retail experience across a broad range of disciplines in the specialty retail industry, including merchandising, finance and real estate. This management team has made significant improvements to the business, producing strong results to date and laying the foundation for continued improvement.

Our Growth Strategy

We intend to strengthen our position in the marketplace, increase revenues and grow profits primarily through the following initiatives:

Continue juvenile integration strategy across the existing store base.    Converting and/or relocating our standalone Toys “R” Us stores into our side-by-side and our “R” Superstore formats has generated significant improvements in our comparable store net sales and store-level profitability. With only 12% of our global stores in an integrated format today, we believe we have the potential to convert and/or relocate another 60% to 70% of our standalone stores globally into our side-by-side and “R” Superstore formats. As such, we expect our juvenile integration strategy to continue to be a significant driver of our revenue and profit growth going forward.

Expand our store-base.    We have the potential to open new stores in existing and new markets both domestically and internationally, virtually all of which will be in the integrated format, either as side-by-side stores or “R” Superstores. We believe we have the potential to increase our retail square footage, net of closures globally in excess of 15% over the next several years, through our new store growth and relocations of existing stores to “R” Superstores. In addition, we expect to open a significant number of pop-up stores in the upcoming holiday season and believe that we have the opportunity to continue this strategy in future years.

Expand our on-line presence.    We believe our recent acquisitions of eToys.com, Toys.com, babyuniverse.com and FAO.com, combined with our Toysrus.com and Babiesrus.com sites, will drive growth of our on-line business. We plan to further expand our on-line business by continuing to integrate our Internet capabilities with our traditional stores. In addition to our existing online presence in Canada, United Kingdom and Japan, we are planning to introduce websites in countries where we have physical stores but lack a web presence, such as Austria, France, Germany, Spain and Switzerland. Our global e-commerce platform also provides the potential to enter new international markets where we do not have any physical stores.

Improve sales productivity in our base business.    We believe our juvenile integration strategy described above will be an important driver of our store productivity. We also intend to continue to improve space utilization, in-stock positions and store standards, flex our toys and juvenile products categories seasonally and optimize store hours to accommodate our guests’ lifestyles to increase our sales in our existing stores.

 

 

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Execute strategies to expand our operating profit margin.    We will continue to focus on expanding our gross margins primarily through optimizing pricing, improving vendor allowances, increasing our private label penetration and increasing our use of direct sourcing. We will also continue to optimize our cost structure and enhance efficiencies throughout the organization to manage our selling, general and administrative expenditures.

 

 

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Risk Factors

Investing in our common stock involves substantial risk, and our ability to successfully operate our business is subject to numerous risks, including those that are generally associated with operating in the retail industry. Any of the factors set forth under “Risk Factors” may limit our ability to successfully execute our business strategy. You should carefully consider all of the information set forth in this prospectus and, in particular, should evaluate the specific factors set forth under “Risk Factors” in deciding whether to invest in our common stock. Among these important risks are the following:

 

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our business is highly seasonal and our financial performance depends on the results of the fourth quarter of each fiscal year;

 

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our industry is highly competitive and competitive conditions may adversely affect our revenues and overall profitability;

 

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our revenues may decline due to general economic weakness or a reduction in consumer spending on toys and juvenile (including baby) products;

 

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we may not successfully gauge trends and changing consumer preferences;

 

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our results of operations are subject to risks arising from the international scope of our operations including fluctuations in foreign currency exchange rates;

 

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our substantial debt makes us especially vulnerable to adverse trends in general economic and industry conditions;

 

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our operations have significant liquidity and capital requirements and depend on the availability of adequate financing on reasonable terms;

 

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our debt agreements contain restrictions that limit our flexibility in operating our business;

 

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the loss of key personnel could adversely impact our business; and

 

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we may not successfully implement our plans to continue our juvenile integration strategy, expand our store-base, expand our on-line presence, improve our sales productivity and operating profit margin, broaden our product offerings or expand our sales channels.

 

 

Our principal executive offices are located at One Geoffrey Way, Wayne, New Jersey 07470, and our telephone number is (973) 617-3500. Our website address is www.toysrusinc.com. The information on our website is not part of this prospectus.

 

 

 

 

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The Offering

 

Common stock offered by Toys “R” Us, Inc..

            shares

 

Common stock to be outstanding after this offering

            shares (            shares if the underwriters exercise their option in full)

 

Use of proceeds

We estimate that the net proceeds to us from this offering, after deducting underwriting discounts and estimated offering expenses, will be approximately $             million, assuming the shares are offered at $             per share, which is the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus

We intend to use the anticipated net proceeds to primarily repay certain of our existing indebtedness and for general corporate purposes

 

Underwriters’ option

We have granted the underwriters a 30-day option to purchase up to                  additional shares of our common stock at the initial offering price

 

Dividend policy

We have no current plans to pay dividends on our common stock in the foreseeable future

 

Advisory Agreement fees

Upon the completion of this offering, pursuant to and in connection with the terms of the advisory agreement, we will pay total fees of approximately $             million to affiliates of the Sponsors and terminate the agreement. See “Certain Relationships and Related Party Transactions—Advisory Agreement”

 

Risk Factors

You should carefully read and consider the information set forth under “Risk Factors” beginning on page 14 of this prospectus and all other information set forth in this prospectus before investing in our common stock

 

Proposed NYSE ticker symbol

“TOYS”

 

 

Unless we indicate otherwise or the context requires, all information in this prospectus:

 

  Ÿ  

assumes (1) no exercise of the underwriters’ option to purchase additional shares of our common stock and (2) an initial public offering price of $             per share, the midpoint of the estimated initial public offering range indicated on the cover of this prospectus.

 

  Ÿ  

gives effect to the             -for-one stock split of our common stock, which will occur prior to the consummation of this offering.

 

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does not reflect (on a pre-split basis) (1) 3,748,507 shares of our common stock issuable upon the exercise of 3,748,507 outstanding stock options held by our officers and employees at a

 

 

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weighted average exercise price of $26.29 per share as of January 30, 2010, 2,192,798 of which shares were then exercisable; (2) 252,028 shares of our common stock reserved for future grants under our Management Equity Plan (the “Management Equity Plan”); and (3)             shares of our common stock reserved for future grants under our Toys “R” Us, Inc. 2010 Incentive Plan expected to be entered into in connection with this offering (the “2010 Incentive Plan”).

 

 

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Summary Historical Financial and Other Data

Set forth below is summary historical consolidated financial and other data of Toys “R” Us, Inc. at the dates and for the periods indicated. We derived the summary historical statement of operations data for the fiscal years ended January 30, 2010, January 31, 2009 and February 2, 2008, and balance sheet data as of January 30, 2010 and January 31, 2009 from our historical audited consolidated financial statements included elsewhere in this prospectus. We derived the summary historical statement of operations data for the fiscal years ended February 3, 2007 and January 28, 2006 and the balance sheet data as of February 2, 2008, February 3, 2007 and January 28, 2006 presented in this table from our consolidated financial statements not included in this prospectus.

Our historical results are not necessarily indicative of future operating results. The information set forth below should be read in conjunction with, and is qualified in its entirety by reference to, “Selected Historical Financial and Other Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements and the related notes included elsewhere in this prospectus.

 

    Fiscal Years Ended(1)  

(In millions, except number of stores

and per share data)

  January 30,
2010
    January 31,
2009
    February 2,
2008
    February 3,
2007
    January 28,
2006
 

Statement of Operations Data:

  

       

Net sales

  $ 13,568      $ 13,724      $ 13,794      $ 13,050      $ 11,333 (2) 

Cost of sales

    8,790        8,976        8,987        8,638        7,652   
                                       

Gross margin

    4,778        4,748        4,807        4,412        3,681   
                                       

Selling, general and administrative expenses(3)

    3,730        3,856        3,801        3,506        2,986   

Depreciation and amortization

    376        399        394        409        400   

Other (income) expense, net(4)

    (112 )(5)      (128 )(6)      (84     (152     437 (7) 
                                       

Total operating expenses

    3,994        4,127        4,111        3,763        3,823   
                                       

Operating earnings (loss)

    784        621        696        649        (142

Interest expense

    (447     (419     (503     (537     (394

Interest income

    7        16        27        31        31   
                                       

Earnings (loss) before income taxes

    344        218        220        143        (505

Income tax expense (benefit)

    40        7        65        35        (121
                                       

Net earnings (loss)

    304        211        155        108        (384
                                       

Less: Net (loss) earnings attributable to noncontrolling interest

    (8     (7     2        (1     0   
                                       

Net earnings (loss) attributable to Toys “R” Us, Inc.

    312        218        153        109        (384
                                       

Per Share Data:

         

Earnings (loss) per common share attributable to Toys “R” Us, Inc.(8):

         

Basic

  $                   $                   $                       $                   $                

Diluted

  $        $        $        $        $     

Weighted average shares used in computing per share amounts(8):

         

Basic earnings per common share

         

Diluted earnings per common share

         

Statement of Cash Flow:

         

Net cash provided by (used in)

         

Operating activities

  $ 1,014      $ 525      $ 527      $ 411      $ 671   

Investing activities

    (37     (259     (416     (107     573   

Financing activities

    (626     (223     (152     (566     (1,488

Balance Sheet Data (end of period):

         

Working capital

  $ 619      $ 617      $ 685      $ 347      $ 348   

Property and equipment, net

    4,084        4,187        4,385        4,333        4,175   

Total assets

    8,577        8,411        8,952        8,295        7,863   

Long-term debt(9)

    5,034 (10)      5,447        5,824        5,722        5,540   

 

 

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    Fiscal Years Ended(1)  

(In millions, except number of stores and per
share data)

  January 30,
2010
   January 31,
2009
     February 2,
2008
    February 3,
2007
    January 28,
2006
 

Total stockholders’ equity (deficit)(11)

    117      (152      (235     (540     (723

Other Financial and Operating Data:

           

Number of stores—Domestic (at year end)

    849      846         845        837        901   

Number of stores—International—operated (at year end)

    514      504         504        488        468   

Total operated stores (at year-end)

    1,363      1,350         1,349        1,325        1,369   

Number of stores—International—Licensed (at year end)

    203      209         211        190        173   

Adjusted EBITDA(12)

  $ 1,130    $ 990       $ 1,095      $ 982      $ 730   

Capital expenditures

  $ 192    $ 395       $ 326      $ 285      $ 285   

 

(1) Our fiscal year ends on the Saturday nearest to January 31 of each calendar year. With the exception of fiscal 2006, which included 53 weeks, all other fiscal years presented are based on a 52 week period.

 

(2) Toys–Japan was consolidated beginning in fiscal 2006. Toys–Japan Net sales of $1.6 billion for fiscal 2005 were not included in our Net sales.

 

(3) Includes the impact of restructuring and other charges. See Note 10 to our consolidated financial statements entitled “Restructuring and Other Charges” for further information.

 

(4) Includes $20 million, $78 million, $17 million and $15 million of pre-tax gift card breakage income in fiscals 2009, 2008, 2007 and 2006, respectively. Also includes $11 million and $12 million of pre-tax gift card dormancy income in fiscals 2006 and 2005, respectively. See Note 1 to our consolidated financial statements entitled “Summary of Significant Accounting Policies” for further details.

Includes the pre-tax impact of net gains on sales of properties of $6 million, $5 million, $33 million, $110 million and a loss of $3 million in fiscals 2009, 2008, 2007, 2006 and 2005, respectively. See Note 5 to our consolidated financial statements entitled “Property and Equipment” for further details.

Includes pre-tax impairment losses on long-lived assets of $7 million, $33 million, $13 million, $5 million and $22 million in fiscals 2009, 2008, 2007, 2006 and 2005. See Note 1 to our consolidated financial statements entitled “Summary of Significant Accounting Policies” for further details.

 

(5) Includes a $51 million pre-tax gain related to the litigation settlement with Amazon. See Note 15 to our consolidated financial statements entitled “Litigation and Legal Proceedings” for further details.

 

(6) Includes a $39 million pre-tax gain related to the substantial liquidation of the operations of TRU (HK) Limited, our wholly-owned subsidiary. See Note 1 to our consolidated financial statements entitled “Summary of Significant Accounting Policies” for further details.

 

(7) Includes $410 million of transaction and related costs and $22 million of contract settlement and other fees related to the 2005 acquisition.

 

(8) All share and per share amounts reflect a              -for-one stock split of our common stock, which will occur prior to the consummation of this offering.

 

(9) Excludes current portion of long-term debt.

 

(10) Includes the impact of the issuance of $950 million and $725 million of debt on July 9, 2009 and November 20, 2009, respectively, the proceeds from which were used, together with other funds, to repay the outstanding loan balance of $1,267 million and $800 million plus accrued interest and fees. See Note 2 to our consolidated financial statements entitled “Long-Term Debt” for further details.

 

(11) On February 1, 2009, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 160, “Noncontrolling Interests in Consolidated Financial Statements—An Amendment of ARB No. 51” which is now codified under ASC Topic 810 (“ASC 810”). ASC 810 requires a company to clearly identify and present ownership interest in subsidiaries held by parties other than the company in the consolidated financial statements within the equity section but separate from the company’s equity. Therefore, we have included our noncontrolling interest in Toys–Japan within the Total stockholders’ equity (deficit) line item.

 

(12) Adjusted EBITDA is defined as EBITDA (earnings 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. Although the nature of many of these income and expense items is recurring, we have historically excluded such impact from internal performance assessments. We believe that excluding items such as sponsors’ management and advisory fees, asset impairment charges, restructuring charges, gain on settlement of litigation, non-controlling interest, gain (loss) on sale of properties, gift card breakage accounting change and the other charges specified below, helps investors compare our operating performance with our results in prior periods. We believe it is appropriate to exclude these items as they are not related to ongoing operating performance and, therefore, limit comparability between periods and between us and similar companies.

We believe Adjusted EBITDA is useful to investors because it is frequently used by securities analysts, investors and other interested parties in the evaluation of companies in our industry. Investors of the Company regularly request

 

 

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Adjusted EBITDA as a supplemental analytical measure to, and in conjunction with, the Company’s GAAP financial data. We understand that these investors use Adjusted EBITDA, among other things, to assess our period-to-period operating performance and to gain insight into the manner in which management analyzes operating performance.

In addition, we believe that Adjusted EBITDA is useful in evaluating our operating performance compared to that of other companies in our industry because the calculation of EBITDA and Adjusted EBITDA generally eliminates the effects of financing and income taxes and the accounting effects of capital spending and acquisitions, which items may vary for different companies for reasons unrelated to overall operating performance. We use these non-GAAP financial measures for planning and forecasting and measuring results against the forecast and in certain cases we use similar measures for bonus targets for certain of our employees. Using several measures to evaluate the business allows us and investors to assess our relative performance against our competitors and ultimately monitor our capacity to generate returns for our stockholders.

Although we believe that Adjusted EBITDA can make an evaluation of our operating performance more consistent because it removes items that do not reflect our core operations, other companies, even in the same industry, may define Adjusted EBITDA differently than we do. As a result, it may be difficult to use Adjusted EBITDA or similarly named non-GAAP measures that other companies may use to compare the performance of those companies to our performance. The Company does not, and investors should not, place undue reliance on EBITDA or Adjusted EBITDA as measures of operating performance.

Reconciliation of Net earnings (loss) attributable to Toys “R” Us, Inc. to EBITDA and Adjusted EBITDA is as follows:

 

     Fiscal Years Ended  

(In millions)

   January 30,
2010
    January 31,
2009
    February 2,
2008
    February 3,
2007
    January 28,
2006
 

Net earnings (loss) attributable to Toys “R” Us, Inc.

   $ 312      $ 218      $ 153      $ 109      $ (384

Add:

          

Income tax expense (benefit)

     40        7        65        35        (121

Interest expense, net

     440        403        476        506        363   

Depreciation and amortization

     376        399        394        409        400   
                                        

EBITDA

     1,168        1,027        1,088        1,059        258   

Adjustments:

          

Sponsors management and advisory fees(a)

     15        18        18        20        4   

Impairment on long-lived assets(b)

     7        33        13        5        22   

Restructuring(c)

     5        8        2        9        11   

Gain on settlement of litigation(d)

     (51     —          —          —          —     

Net (loss) earnings attributable to Toys– Japan noncontrolling interest(e)

     (8     (7     2        (1     —     

(Gain) loss on sale of properties(f)

     (6     (5     (33     (110     3   

Gift card breakage accounting change(g)

     —          (59     —          —          —     

McDonald’s Japan contract termination(h)

     —          14        5        —          —     

Gain on liquidation of TRU (HK) Limited(i)

     —          (39     —          —          —     

Transaction and related costs(j)

     —          —          —          —          410   

Contract settlement fees and other(k)

     —          —          —          —          22   
                                        

Adjusted EBITDA

   $ 1,130      $ 990      $ 1,095      $ 982      $ 730   
                                        

 

  (a) Represents the fees paid to the Sponsors in accordance with the advisory agreement. The agreement will be terminated in connection with this offering. See “Certain Relationships and Related Party Transactions.”

 

  (b) These impairments were primarily due to the identification of underperforming stores, the relocation of certain stores and a decrease in real estate market values.

 

  (c) Restructuring and other charges consist primarily of costs incurred from the Company’s 2003 and 2005 restructuring initiatives. The additional charges are primarily due to changes in management’s estimates for events such as lease terminations, assignments and sublease income adjustments.

 

  (d) Represents a $51 million gain recorded in Other (income) expense, net related to the litigation settlement with Amazon in fiscal 2009.

 

  (e) Excludes noncontrolling interest in Toys “R” Us—Japan.

 

  (f)

During fiscal 2009, we sold idle properties which resulted in gains of approximately $6 million. During fiscal 2008, Toys “R” Us Iberia Real Estate S.L., an indirect wholly-owned subsidiary, sold property resulting in a net gain of $14 million. At the time of the sale, Toys “R” Us Iberia S.A., its parent company, leased back a portion of the property. Due to the leaseback, we recognized $4 million of the net gain and deferred the remaining $10 million. During fiscal 2007, we sold our interest in an idle distribution center for gross proceeds of approximately $29

 

 

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million, resulting in a gain of $18 million and sold 4 properties for gross proceeds of $14 million, resulting in a gain of $5 million as part of the agreement with Vornado Surplus 2006 Realty, LLC. In addition, we consummated a lease termination agreement resulting in a net gain of $10 million.

During fiscal 2006, Toys “R” Us-Delaware, Inc. and MAP 2005 Real Estate, LLC, both wholly-owned direct subsidiaries of the Company, consummated the sale of their interest in 38 properties, primarily to an affiliate of Vornado, for gross proceeds of approximately $178 million, resulting in a gain of $91 million. In addition, during fiscal 2006 we sold our interest in and assets related to a leased property, resulting in a gain of $21 million.

 

  (g) During the fourth quarter of fiscal 2008, the Company changed its method for recording gift card breakage income to recognize breakage income and derecognize the gift card liability for unredeemed gift cards in proportion to actual redemptions of gift cards. As a result, the adjustment recorded in fiscal 2008 resulted in an additional $59 million of gift card breakage income.

 

  (h) In fiscal 2008, a settlement was reached in which Toys–Japan and McDonald’s Japan agreed to the termination of the service agreement and the payment by Toys–Japan of ¥2.0 billion ($19 million as of May 13, 2008) to McDonald’s Japan. The Company had previously established a reserve of $5 million in fiscal 2007.

 

  (i) In fiscal 2008, the operations of TRU (HK) Limited, our wholly-owned subsidiary, were substantially liquidated. As a result, we recognized a $39 million gain.

 

  (j) These costs reflect $148 million of expenses related to the 2005 acquisition, compensation expenses associated with the 2005 acquisition related to stock options and restricted stock of $222 million, as well as severance, bonuses and related payroll taxes of $40 million.

 

  (k) This amount resulted from the loss on early extinguishment of debt of $7 million related to the purchase of the notes associated with our equity security units and a contract settlement fee of $15 million related to the early termination of our synthetic lease of our headquarters located in Wayne, New Jersey.

 

 

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RISK FACTORS

An investment in our common stock involves substantial risk. You should carefully consider the following risks as well as the other information included in this prospectus, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and related notes, before investing in our common stock. Any of the following risks could materially and adversely affect our business, financial condition or results of operations. However, additional risks and uncertainties not presently known to us or that we currently believe to be less significant than the following risk factors may also adversely affect our business, financial condition or results of operations. In such a case, the trading price of the common stock could decline and you may lose all or part of your investment in our company.

Risks Relating to Our Business

Our business is highly seasonal, and our financial performance depends on the results of the fourth quarter of each fiscal year.

Our business is highly seasonal. During the last three fiscal years more than 39% of our total Net sales were generated in the fourth quarter. It is typically the case that we incur net losses in each of the first three quarters of the year, with all of our net earnings and cash flows from operations being generated in the fourth quarter. As a result, we depend significantly upon the fourth quarter holiday selling season. If we achieve less than satisfactory sales, operating earnings or cash flows from operating activities during the fourth quarter, we may not be able to compensate sufficiently for the lower sales, operating earnings or cash flows from operating activities during the first three quarters of the fiscal year. Our results in any given period may be affected by dates on which important holidays fall and the shopping patterns relating to those holidays. Additionally, the concentrated nature of our seasonal sales means that the Company’s operating results could be materially adversely affected by natural disasters and labor strikes, work stoppages, terrorist acts or disruptive global political events, prior to or during the holiday season, as described below.

Our industry is highly competitive and competitive conditions may adversely affect our revenues and overall profitability.

The retail industry is highly and increasingly competitive and our results of operations are sensitive to, and may be adversely affected by, competitive pricing, promotional pressures, additional competitor store openings and other factors. We compete with discount and mass merchandisers, such as Wal-Mart and Target, electronics retailers, national and regional specialty chains, as well as local retailers in the geographic areas we serve. We also compete with national and local discount stores, department stores, supermarkets and warehouse clubs, as well as Internet and catalog businesses. Competition is principally based on product variety, quality, availability, price, convenience or store location, advertising and promotion, customer support and service. Some of our competitors have greater sales of toys and juvenile products than us, greater financial resources, lower merchandise acquisition costs and lower operating expenses than we do.

Much of the merchandise we sell is also available from various retailers at competitive prices. Discount and mass merchandisers use aggressive pricing policies and enlarged toy-selling areas during the holiday season to build traffic for other store departments. Our business is vulnerable to shifts in demand and pricing, as well as consumer preferences. Competition in the video game market has increased in recent years as mass merchandisers have expanded their offerings in this market, and as alternative sales channels (such as the Internet) have grown in importance.

The baby registry market is highly competitive, with competition based on convenience, quality and selection of merchandise offerings and functionality. Our baby registry primarily competes with the baby registries of mass merchandisers and other specialty format and regional retailers. Some of our

 

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competitors have been aggressively advertising and marketing their baby registries through national television and magazine campaigns. Within the past few years, the number of multiple registries and on-line registries has steadily increased. These trends present consumers with more choices for their baby registry needs, and as a result, increase competition for our baby registry.

If we fail to compete successfully, we could face lower sales and may decide or be compelled to offer greater discounts to our customers, which could result in decreased profitability.

Our sales may be adversely affected by changes in economic factors and changes in consumer spending patterns.

Many economic and other factors outside our control, including consumer confidence, consumer spending levels, employment levels, consumer debt levels, inflation and deflation, as well as the availability of consumer credit, affect consumer spending habits. A significant deterioration in the global financial markets and economic environment, recessions or an uncertain economic outlook adversely affects consumer spending habits and results in lower levels of economic activity. The domestic and international political situation, including the economic health of various political jurisdictions, also affects economic conditions and consumer confidence. Any of these events and factors could cause consumers to curtail spending and could have a negative impact on our financial performance and position in future fiscal periods.

Since fiscal 2008, there has been a deterioration in the global financial markets and economic environment, which has negatively impacted consumer spending. In response, we have taken steps to drive profitable sales and to curtail capital spending and operating expenses wherever prudent. However, there is a risk that our steps to respond to these economic conditions may be ill-conceived or ineffective. These adverse trends in economic conditions may worsen to the point that even well-conceived responses would not be sufficiently effective to counteract the impacts of these trends. In such cases, there would be a negative impact on our financial performance and position in future fiscal periods.

Our operations have significant liquidity and capital requirements and depend on the availability of adequate financing on reasonable terms.

We have significant liquidity and capital requirements. Among other things, the seasonality of our businesses requires us to purchase merchandise well in advance of the fourth quarter holiday selling season. We depend on our ability to generate cash flows from operating activities, as well as on borrowings under our revolving credit facilities and our credit lines, to finance the carrying costs of this inventory and to pay for capital expenditures and operating expenses. For fiscal 2009, peak borrowings under our various credit lines were $784 million as we purchased merchandise for the fourth quarter holiday selling season. If our lenders are unable to fund borrowings under their credit commitments or we are unable to borrow, it could have a significant negative effect on our business.

Moody’s has assigned Toys “R” Us a corporate rating of B2 with a positive outlook, while Standard & Poor’s has assigned a corporate credit rating of B with a stable outlook. Any adverse change to our credit ratings could negatively impact our ability to refinance our debt on satisfactory terms and could have the effect of increasing our financing costs. While we believe we currently have adequate sources of funds to provide for our ongoing operations and capital requirements for the next 12 months, any inability on our part to have future access to financing, when needed, would have a negative effect on our business.

A loss of, or reduction in, trade credit from our vendors could reduce our liquidity, increase our working capital needs and/or limit our ability to purchase products.

We purchase products for resale from our vendors, who may seek credit insurance to protect against non-payment of amounts due to them. However, as a result of deteriorating economic

 

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conditions and higher claims costs, credit insurers have curtailed or eliminated coverage to vendors (as it was the case in the recent disruptions to the trade credit market in the U.K.) and may continue to do so in the future. If credit insurance is not available to vendors at reasonable terms or at all, vendors may demand accelerated payment of amounts due to them or require advance payments or letters of credit before goods are shipped to us. Such demands could have a significant adverse impact on our inventory levels and operating cash flow and negatively impact our liquidity. Any such disruptions could increase the costs to us of financing our inventory or negatively impact our ability to deliver products to our customers, which could in turn negatively affect our financial performance.

We may not retain or attract customers if we fail to successfully implement our strategic initiatives.

We continue to implement a series of customer-oriented strategic programs designed to differentiate and strengthen our core merchandise content and service levels and to expand and enhance our merchandise offerings. We seek to improve the effectiveness of our marketing and advertising programs for our “R” Us stores. The success of these and other initiatives will depend on various factors, including the implementation of our growth strategy, the appeal of our store formats, our ability to offer new products to customers, our financial condition, our ability to respond to changing consumer preferences and competitive and economic conditions. We continuously endeavor to minimize our operating expenses, without adversely affecting the profitability of the business. If we fail to implement successfully some or all of our strategic initiatives, we may be unable to retain or attract customers, which could result in lower sales and a failure to realize the benefit of the expenditures incurred for these initiatives.

If we cannot implement our juvenile integration strategy or open new stores, our future growth will be adversely affected.

Our growth is dependent on both increases in sales in existing stores and the ability to successfully implement our juvenile integration strategy and open profitable new stores. Increases in sales in existing stores are dependent on factors such as competition, merchandise selection, store operations and other factors discussed in these Risk Factors. Our ability to successfully implement our juvenile integration strategy in a timely and cost effective manner or open new stores and expand into additional market areas depends in part on the following factors, which are in part beyond our control:

 

  Ÿ  

the availability of attractive store locations and the ability to accurately assess the demographic or retail environment and customer demand at a given location;

 

  Ÿ  

the ability to negotiate favorable lease terms and obtain the necessary permits and zoning approvals;

 

  Ÿ  

the absence of occupancy delays;

 

  Ÿ  

the ability to construct, furnish and supply a store in a timely and cost effective manner;

 

  Ÿ  

the ability to hire and train new personnel, especially store managers, in a cost effective manner;

 

  Ÿ  

costs of integration, which may be higher than anticipated;

 

  Ÿ  

general economic conditions; and

 

  Ÿ  

the availability of sufficient funds for the expansion.

Delays or failures in successfully implementing our juvenile integration strategy and opening new stores, or achieving lower than expected sales in integrated or new stores, or drawing a greater than expected proportion of sales in integrated or new stores from existing stores, could materially

 

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adversely affect our growth and/or profitability. In addition, we may not be able to anticipate all of the challenges imposed by the expansion of our operations and, as a result, may not meet our targets for integrating, opening new stores or relocating stores or expanding profitably.

Some of our new stores may be located in areas where we have little or no meaningful experience. Those markets may have different market conditions, consumer preferences and discretionary spending patterns than our existing markets, which may cause our new stores to be less successful than stores in our existing markets. Other new stores may be located in areas where we have existing stores. Although we have experience in these markets, increasing the number of locations may result in unanticipated over-saturation of markets and temporarily or permanently divert customers and sales from our existing stores, thereby adversely affecting our overall financial performance.

Our sales may be adversely affected if we fail to respond to changes in consumer preferences in a timely manner.

Our financial performance depends on our ability to identify, originate and define product trends, as well as to anticipate, gauge and react to changing consumer preferences in a timely manner. Our products must appeal to a broad range of consumers whose preferences cannot be predicted with certainty and are subject to change. Our business fluctuates according to changes in consumer preferences dictated in part by fashion trends, perceived value and season. These fluctuations affect the merchandise in stock since purchase orders are written well in advance of the holiday season and, at times, before fashion trends and high-demand brands are evidenced by consumer purchases. If we overestimate the market for our products, we may be faced with significant excess inventories, which could result in increased expenses and reduced margins associated with having to liquidate obsolete inventory at lower prices. Conversely, if we underestimate the market for our products, we will miss opportunities for increased sales and profits, which would place us at a competitive disadvantage.

Sales of video games and video game systems tend to be cyclical, which may result in fluctuations in our results of operations, and may be adversely affected if products are sold through alternative channels.

Sales of video games and video game systems, which have tended to account for 10% to 15% of our annual net sales, have been cyclical in nature in response to the introduction and maturation of new technology. Following the introduction of new video game systems, sales of these systems and related software and accessories generally increase due to initial demand, while sales of older systems and related products generally decrease. Moreover, competition within the video game market has increased in recent years and, due to the large size of this product category, fluctuations in this market could have a material adverse impact on our sales and profits trends. Additionally, if video game system manufacturers fail to develop new hardware systems, or if new video products are sold in channels other than traditional retail stores, including through direct online distribution to customers, our sales of video game products could decline, which would negatively impact our financial performance.

The success and expansion of our on-line business depends on our ability to provide quality service to our Internet customers.

Our Internet operations are subject to a number of risks and uncertainties which are beyond our control, including the following:

 

  Ÿ  

changes in consumer willingness to purchase goods via the Internet;

 

  Ÿ  

increases in software filters that may inhibit our ability to market our products through e-mail messages to our customers and increases in consumer privacy concerns relating to the Internet;

 

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  Ÿ  

changes in technology;

 

  Ÿ  

changes in applicable federal and state regulation, such as the Federal Trade Commission Act, the Children’s Online Privacy Act, the Fair Credit Reporting Act and the Gramm-Leach-Bliley Act and similar types of international laws;

 

  Ÿ  

breaches of Internet security;

 

  Ÿ  

failure of our Internet service providers to perform their services properly and in a timely and efficient manner;

 

  Ÿ  

failures in our Internet infrastructure or the failure of systems or third parties, such as telephone or electric power service, resulting in website downtime or other problems;

 

  Ÿ  

failure by us to process on-line customer orders properly and on time, which may negatively impact future on-line and in-store purchases by such customers; and

 

  Ÿ  

failure by our service provider to provide warehousing and fulfillment services, which may negatively impact future on-line and in-store purchases by customers.

We depend on key vendors to supply the merchandise that we sell to our customers.

Our performance depends, in part, on our ability to purchase our merchandise in sufficient quantities at competitive prices. We purchase our merchandise from numerous international and domestic manufacturers and importers. We have no contractual assurances of continued supply, pricing or access to new products, and any vendor could change the terms upon which they sell to us or discontinue selling to us at any time. We may not be able to acquire desired merchandise in sufficient quantities on terms acceptable to us in the future. Better than expected sales demand may also lead to customer backorders and lower in-stock positions of our merchandise.

We have approximately 3,700 active vendor relationships through which we procure the merchandise that we offer to our guests. For fiscal 2009, our top 20 vendors worldwide, based on our purchase volume in U.S. dollars, represented approximately 41% of the total products we purchased. An inability to acquire suitable merchandise on acceptable terms or the loss of one or more key vendors could have a negative effect on our business and operating results and could cause us to miss products that we feel are important to our assortment. We may not be able to develop relationships with new vendors, and products from alternative sources, if any, may be of a lesser quality and/or more expensive than those from existing vendors.

In addition, our vendors are subject to various risks, including raw material costs, inflation, labor disputes, union organizing activities, financial liquidity, product merchantability, inclement weather, natural disasters and general economic and political conditions that could limit our vendors’ ability to provide us with quality merchandise on a timely basis and at prices and payment terms that are commercially acceptable. For these or other reasons, one or more of our vendors might not adhere to our quality control standards, and we might not identify the deficiency before merchandise ships to our stores or customers. In addition, our vendors may have difficulty adjusting to our changing demands and growing business. Our vendors’ failure to manufacture or import quality merchandise in a timely and effective manner could damage our reputation and brands, and could lead to an increase in customer litigation against us and an attendant increase in our routine and non-routine litigation costs. Further, any merchandise that does not meet our quality standards could become subject to a recall, which could damage our reputation and brands and harm our business.

The decrease of birth rates in countries where we operate could negatively affect our business.

Most of our end-customers are newborns and children and, as a result, our revenues are dependent on the birth rates in countries where we operate. In recent years, many countries have

 

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experienced a sharp drop in birth rates as their population ages and education and income levels increase. A continued and significant decline in the number of newborns and children in these countries could have a material adverse effect on our operating results.

Current store locations may become unattractive, and attractive new locations may not be available for a reasonable price, if at all.

The success of any store depends in substantial part on its location. There can be no assurance that current locations will continue to be attractive as demographic patterns change. Neighborhood or economic conditions where stores are located could decline in the future, resulting in potentially reduced sales in these locations. If we or our licensees cannot obtain desirable locations at reasonable prices, our ability to implement our growth strategy will be adversely affected.

If we are unable to renew or replace our current store leases or if we are unable to enter into leases for additional stores on favorable terms, or if one or more of our current leases are terminated prior to expiration of their stated term and we cannot find suitable alternate locations, our growth and profitability could be negatively impacted.

We currently have ground and store leasehold interests in approximately 70% of our domestic and international store locations. Most of our current leases provide for our unilateral option to renew for several additional rental periods at specific rental rates. Our ability to re-negotiate favorable terms on an expiring lease or to negotiate favorable terms for a suitable alternate location, and our ability to negotiate favorable lease terms for additional store locations could depend on conditions in the real estate market, competition for desirable properties and our relationships with current and prospective landlords or may depend on other factors that are not within our control. Any or all of these factors and conditions could negatively impact our growth and profitability.

Inflation may adversely affect our business operations in the future.

In recent years, we have experienced certain inflationary conditions in our cost base due primarily to changes in foreign currency exchange rates that have reduced the purchasing power of the U.S. dollar and increases in selling, general and administrative expenses, particularly with regard to employee benefits. Inflation can harm our margins and profitability if we are unable to increase prices or cut costs enough to offset the effects of inflation in our cost base. If inflation in these or other costs worsens, we cannot assure you that our attempts to offset the effects of inflation and cost increases through control of expenses, passing cost increases on to customers or any other method will be successful. Any future inflation could adversely affect our profitability and our business.

Our business, financial condition and results of operations are subject to risks arising from the international scope of our operations.

We conduct a significant portion of our business in many countries around the world. For the 2009 and 2008 fiscal years, approximately 38.7% and 38.2% of our Net sales were generated outside the U.S., respectively. In addition, as of January 31, 2010, approximately 35.3% of our long-lived assets were located outside of the United States. All of our foreign operations are subject to risks inherent in conducting business abroad, including the challenges of different economic conditions in each of the countries, possible nationalization or expropriation, price and currency exchange controls, fluctuations in the relative values of currencies as described below, political instability and restrictive governmental actions.

 

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Our business is subject to fluctuations in foreign currency exchange.

Exchange rate fluctuations may affect the translated value of our earnings and cash flow associated with our international operations, as well as the translation of net asset or liability positions that are denominated in foreign currencies. In countries outside of the United States where we operate stores, we generate revenues and incur operating expenses and selling, general and administrative expenses denominated in local currencies. In many countries where we do not operate stores, our licensees pay royalties in U.S. dollars. However, as the royalties are calculated based on local currency sales, our revenues are still impacted by fluctuations in exchange rates. In fiscal years 2009 and 2008, 38.7% and 38.2% of our Net sales were completed in a currency other than the U.S. dollar, the majority of which were denominated in euros, yen and pounds. In fiscal 2009, our reported operating earnings would have decreased or increased $28 million if all foreign currencies uniformly weakened or strengthened by 10% relative to the U.S. dollar. In addition, our exposure to foreign currency exchange rate fluctuations will grow if the relative contribution of our operations outside the United States increases.

We enter into foreign exchange agreements from time to time with financial institutions to reduce our exposure to fluctuations in currency exchange rates referred to as hedging activities. However, these hedging activities may not eliminate foreign currency risk entirely and involve costs and risks of their own. Although we hedge some exposures to changes in foreign currency exchange rates arising in the ordinary course of business, foreign currency fluctuations may have a material adverse effect on our business, financial condition and results of operations.

Our results may be adversely affected by fluctuations in raw material and energy costs.

Our results may be affected by the prices of the components and raw materials used in the manufacture of our toys and juvenile products. These prices may fluctuate based on a number of factors beyond our control, including: oil prices, changes in supply and demand, general economic conditions, labor costs, competition, import duties, tariffs, currency exchange rates and government regulation. In addition, energy costs have fluctuated dramatically in the past. These fluctuations may result in an increase in our transportation costs for distribution, utility costs for our retail stores and overall costs to purchase products from our vendors.

We may not be able to adjust the prices of our products, especially in the short-term, to recover these cost increases in raw materials and energy. A continual rise in raw material and energy costs could adversely affect consumer spending and demand for our products and increase our operating costs, both of which could have a material adverse effect on our financial condition and results of operations.

A significant disruption to our distribution network or to the timely receipt of inventory could adversely impact sales or increase our transportation costs, which would decrease our profits.

We rely on our ability to replenish depleted inventory in our stores through deliveries to our distribution centers from vendors and then from the distribution centers or direct ship vendors to our stores by various means of transportation, including shipments by sea, rail, air and truck. Unexpected delays in those deliveries or increases in transportation costs (including through increased fuel costs) could significantly decrease our ability to make sales and earn profits. In addition, labor shortages or labor disagreements in the transportation industry or long-term disruptions to the national and international transportation infrastructure that lead to delays or interruptions of deliveries could negatively affect our business.

 

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Product safety issues, including product recalls, could harm our reputation, divert resources, reduce sales and increase costs.

The products we sell in our stores are subject to regulation by the Consumer Product Safety Commission and similar state and international regulatory authorities. Such products could be subject to recalls and other actions by these authorities. Product safety concerns may require us to voluntarily remove selected products from our stores. Such recalls and voluntary removal of products can result in, among other things, lost sales, diverted resources, potential harm to our reputation and increased customer service costs, which could have a material adverse effect on our financial condition.

Our business exposes us to personal injury and product liability claims which could result in adverse publicity and harm to our brands and our results of operations.

We are from time to time subject to claims due to the injury of an individual in our stores or on our property. In addition, we have in the past been subject to product liability claims for the products that we sell. Subject to certain exceptions, our purchase orders generally require the manufacturer to indemnify us against any product liability claims; however, if the manufacturer does not have insurance or becomes insolvent, there is a risk we would not be indemnified. Any personal injury or product liability claim made against us, whether or not it has merit, could be time consuming and costly to defend, resulting in adverse publicity, or damage to our reputation, and have an adverse effect on our results of operations.

Adverse litigation judgments or settlements resulting from legal proceedings in which we may be involved could expose us to monetary damages or limit our ability to operate our business.

We are involved in private actions, investigations and various other legal proceedings by employees, suppliers, competitors, shareholders, government agencies or others. For instance, on July 15, 2009, the United States District Court for the Eastern District of Pennsylvania granted the class plaintiffs’ motion for class certification in a consumer class action commenced in January 2006, which was consolidated with an action brought by two Internet retailers that was commenced in December 2005. Both actions allege that Babies “R” Us agreed with certain baby product manufacturers to impose, maintain and/or enforce minimum price agreements in violation of antitrust laws. In addition, in December 2009, a third internet retailer filed a similar action and another class action was commenced making similar allegations involving most of the same defendants. Additionally, the Federal Trade Commission (“FTC”) notified us in April 2009 that they had opened an investigation related to the issues in those cases and to confirm our compliance with a 1998 FTC Final Order that prohibits us from, among other things, influencing our suppliers to limit sales of products to other retailers, including price club warehouses.

The results of such litigation, investigations and other legal proceedings are inherently unpredictable. Any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and divert significant resources. If any of these legal proceedings were to be determined adversely to us, there could be a material adverse effect on our business, financial condition and results of operations.

We are subject to certain regulatory and legal requirements. If we fail to comply with regulatory or legal requirements, our business and financial results may be adversely affected.

We are subject to numerous regulatory and legal requirements. Our policies, procedures and internal controls are designed to comply with all applicable laws and regulations, including those imposed by the Sarbanes-Oxley Act of 2002 and the Securities and Exchange Commission. In addition, our business activities require us to comply with complex regulatory and legal issues on a

 

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local, national and worldwide basis (including, in some cases, more stringent local labor law or regulations). Failure to comply with such laws and regulations could adversely affect our operations and financial results, involve significant expense and divert management’s attention and resources from other matters, which in turn could harm our business.

Our business operations could be disrupted if our information technology systems fail to perform adequately or we are unable to protect the integrity and security of our customers’ information.

We depend largely upon our information technology systems in the conduct of all aspects of our operations. If our information technology systems fail to perform as anticipated, we could experience difficulties in virtually any area of our operations, including but not limited to replenishing inventories or in delivering our products to store locations in response to consumer demands. Any of these or other systems-related problems could, in turn, adversely affect our sales and profitability.

Additionally, a compromise of our security systems (or a design flaw in our system environment) could result in unauthorized access to certain personal information about our customers which could adversely affect our reputation with our customers and others, as well as our operations, and could result in litigation against us or the imposition of penalties. In addition, a security breach could require that we expend significant additional resources related to our information security systems.

Natural disasters, inclement weather, pandemic outbreaks, terrorist acts or disruptive global political events could cause permanent or temporary distribution center or store closures, impair our ability to purchase, receive or replenish inventory, or decrease customer traffic, all of which could result in lost sales and otherwise adversely affect our financial performance.

The occurrence of one or more natural disasters, such as hurricanes, fires, floods, earthquakes, tornados and volcano eruptions, or inclement weather such as frequent or unusually heavy snow, ice or rain storms, or extended periods of unseasonable temperatures, or the occurrence of pandemic outbreaks, labor strikes, work stoppages, terrorist acts or disruptive global political events, such as civil unrest in countries in which our suppliers are located, or similar disruptions could adversely affect our operations and financial performance. To the extent these events impact one or more of our key vendors or result in the closure of one or more of our distribution centers or a significant number of stores, our operations and financial performance could be materially adversely affected through an inability to make deliveries to our stores and through lost sales. In addition, these events could result in increases in fuel (or other energy) prices or a fuel shortage, delays in opening new stores, the temporary lack of an adequate work force in a market, the temporary or long-term disruption in the supply of products from some local and overseas vendor, the temporary disruption in the transport of goods from overseas, delay in the delivery of goods to our distribution centers or stores, the temporary reduction in the availability of products in our stores and disruption to our information systems. These events also can have indirect consequences such as increases in the costs of insurance if they result in significant loss of property or other insurable damage.

Our results of operations could suffer if we lose key management or are unable to attract and retain experienced senior management for our business.

Our future success depends to a significant degree on the skills, experience and efforts of our senior management team. The loss of services of any of these individuals, or the inability by us to attract and retain qualified individuals for key management positions, could harm our business and financial performance.

 

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Because of our extensive international operations, we could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act and similar worldwide anti-bribery laws.

The U.S. Foreign Corrupt Practices Act, and similar worldwide anti-bribery laws generally prohibit companies and their intermediaries from making improper payments to non-U.S. officials for the purpose of obtaining or retaining business. Our policies mandate compliance with these anti-bribery laws. Despite our training and compliance program, we cannot assure you that our internal control policies and procedures always will protect us from reckless or criminal acts committed by our employees or agents. Violations of these laws, or allegations of such violations, could disrupt our business and result in a material adverse effect on our financial condition, results of operations and cash flows.

International events could delay or prevent the delivery of products to our stores.

A significant portion of products we sell are manufactured outside of the United States, primarily in Asia. As a result, any event causing a disruption of imports, including labor strikes, work stoppages, boycotts, safety issues on materials, the imposition of trade restrictions in the form of tariffs, embargoes or export controls, “anti-dumping” duties, port security or other events that could slow port activities, could increase the cost and reduce the supply of products available to us. In addition, port-labor issues, rail congestion and trucking shortages can have an impact on all direct importers. Although we attempt to anticipate and manage such situations, both our sales and profitability could be adversely impacted by any such developments in the future. These and other international events could negatively affect our sales and profitability.

We may experience fluctuations in our tax obligations and effective tax rate.

We are subject to taxes in the United States and numerous international jurisdictions. We record tax expense based on our estimates of future tax payments, which include reserves for estimates of probable settlements of international and domestic tax audits. At any one time, many tax years are subject to audit by various taxing jurisdictions. The results of these audits and negotiations with taxing authorities may affect the ultimate settlement of these issues. As a result, we expect that throughout the year there could be ongoing variability in our quarterly tax rates as taxable events occur and exposures are re-evaluated. Further, our effective tax rate in a given financial statement period may be materially impacted by changes in the mix and level of earnings by taxing jurisdiction or by changes to existing accounting rules or regulations.

Changes to accounting rules or regulations may adversely affect our results of operations.

Changes to existing accounting rules or regulations may impact our future results of operations or cause the perception that we are more highly leveraged. Other new accounting rules or regulations and varying interpretations of existing accounting rules or regulations have occurred and may occur in the future. For instance, accounting regulatory authorities have indicated that they may begin to require lessees to capitalize operating leases in their financial statements in the next few years. If adopted, such change would require us to record significant capital lease obligations on our balance sheet and make other changes to our financial statements. This and other future changes to accounting rules or regulations could adversely affect our results of operations and financial position.

Our total assets include goodwill and substantial amounts of property and equipment. Changes to estimates or projections related to such assets, or operating results that are lower than our current estimates at certain store locations, may cause us to incur impairment charges.

Our total assets include substantial amounts of property, equipment and goodwill. We make certain estimates and projections in connection with impairment analyses for these assets, in

 

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accordance with “FASB Accounting Standards Codification” (“Codification” or “ASC”) Topic 360 (“ASC 360”), formerly Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” and ASC Topic 350 (“ASC 350”), formerly SFAS No. 142, “Goodwill and Other Intangible Assets”. We also review the carrying value of these assets for impairment whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable in accordance with ASC 360 or ASC 350. We will record an impairment loss when the carrying value of the underlying asset, asset group or reporting unit exceeds its fair value. These calculations require us to make a number of estimates and projections of future results. If these estimates or projections change, we may be required to record additional impairment charges on certain of these assets. If these impairment charges are significant, our results of operations would be adversely affected.

Risks Related to Our Substantial Indebtedness

Our substantial indebtedness could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industries, expose us to interest rate risk to the extent of our variable rate debt and prevent us from meeting our obligations under our various debt instruments.

We are highly leveraged. As of January 30, 2010, our total indebtedness was $5,196 million, of which $2,588 million was secured indebtedness and $1,964 million of which matures before the end of fiscal 2012. Our substantial indebtedness could have significant consequences, including, among others, the following:

 

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increasing our vulnerability to general economic and industry conditions;

 

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requiring a substantial portion of cash flows from operating activities to be dedicated to the payment of principal and interest on our indebtedness, and as a result, reducing our ability to use our cash flows to fund our operations and capital expenditures, capitalize on future business opportunities and expand our business and execute our strategy;

 

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increasing the difficulty for us to make scheduled payments on our outstanding debt, as our business may not be able to generate sufficient cash flows from operating activities to meet our debt service obligations;

 

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exposing us to the risk of increased interest expense due to changes in borrowing spreads and short-term interest rates;

 

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causing us to make non-strategic divestitures;

 

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limiting our ability to obtain additional financing for working capital, capital expenditures, debt service requirements and general, corporate or other purposes; and

 

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limiting our ability to adjust to changing market conditions and reacting to competitive pressure and placing us at a competitive disadvantage compared to our competitors who are less highly leveraged.

We may be able to incur additional indebtedness in the future, including under our current revolving credit agreements, subject to the restrictions contained in our debt instruments. If new indebtedness is added to our current debt levels, the related risks that we now face could intensify.

We may not be able to generate sufficient cash to service all of our indebtedness and may not be able to refinance our indebtedness on favorable terms. If we are unable to do so, we may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial condition and operating performance, our lenders’ financial stability, which are subject to

 

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prevailing global economic and market conditions and to certain financial, business and other factors beyond our control. Even if we were able to refinance or obtain additional financing, the costs of new indebtedness could be substantially higher than the costs of our existing indebtedness.

If our cash flows and capital resources are insufficient to fund our debt service obligations or we are unable to refinance our indebtedness, we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital or restructure our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. If our operating results and available cash are insufficient to meet our debt service obligations, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. We may not be able to consummate those dispositions, or the proceeds from the dispositions may not be adequate to meet any debt service obligations then due. If we were unable to repay amounts when due, the lenders could proceed against the collateral granted to them to secure that indebtedness.

Our debt agreements contain covenants that limit our flexibility in operating our business.

Toys “R” Us, Inc. is a holding company and conducts its operations through its subsidiaries, certain of which have incurred their own indebtedness. As specified in certain of our subsidiaries’ debt agreements, there are restrictions on our ability to obtain funds from our subsidiaries through dividends, loans or advances. The agreements governing our indebtedness contain various covenants that limit our ability to engage in specified types of transactions, and may adversely affect our ability to operate our business. Among other things, these covenants limit our and our subsidiaries’ ability to:

 

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incur additional indebtedness;

 

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transfer money between the parent company and our various subsidiaries;

 

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pay dividends on, repurchase or make distributions with respect to our capital stock or make other restricted payments;

 

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issue stock of subsidiaries;

 

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make certain investments, loans or advances;

 

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transfer and sell certain assets;

 

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create or permit liens on assets;

 

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consolidate, merge, sell or otherwise dispose of all or substantially all of our assets;

 

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enter into certain transactions with our affiliates; and

 

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amend certain documents.

A breach of any of these covenants could result in default under one or more of our debt agreements, which could prompt the lenders to declare all amounts outstanding under the debt agreements to be immediately due and payable and terminate all commitments to extend further credit. If we were unable to repay those amounts, the lenders could proceed against the collateral granted to them to secure that indebtedness. If the lenders under the debt agreements accelerate the repayment of borrowings, we may not have sufficient assets and funds to repay the borrowings under our debt agreements.

Risks Related to this Offering and Ownership of Our Common Stock

An active, liquid trading market for our common stock may not develop.

After our 2005 acquisition and prior to this offering, there has not been a public market for our common stock. We cannot predict the extent to which investor interest in our company will lead to the

 

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development of a trading market on the New York Stock Exchange or otherwise or how active and liquid that market may become. If an active and liquid trading market does not develop, you may have difficulty selling any of our common stock that you purchase. The initial public offering price for the shares will be determined by negotiations between us and the underwriters and may not be indicative of prices that will prevail in the open market following this offering. The market price of our common stock may decline below the initial offering price, and you may not be able to sell your shares of our common stock at or above the price you paid in this offering, or at all.

You will incur immediate and substantial dilution in the net tangible book value of the shares you purchase in this offering.

Prior investors have paid substantially less per share of our common stock than the price in this offering. The initial public offering price of our common stock is substantially higher than the net tangible book value per share of outstanding common stock prior to completion of the offering. Based on our net tangible book value as of January 30, 2010 and upon the issuance and sale of             shares of common stock by us at an assumed initial public offering price of $             per share (the midpoint of the estimated initial public offering price range indicated on the cover of this prospectus), if you purchase our common stock in this offering, you will pay more for your shares than the amounts paid by our existing shareholders for their shares and you will suffer immediate dilution of approximately $             per share in net tangible book value after giving effect to the sale of             shares of our common stock in this offering assuming an initial public offering price of $             per share, less the underwriting discounts and commissions and the estimated offering expenses payable by us, and without taking into account any other changes in such net tangible book value after January 30, 2010. We also have a large number of outstanding stock options to purchase common stock with exercise prices that are below the estimated initial public offering price of our common stock. To the extent that these options are exercised, you will experience further dilution. See “Dilution.”

Our stock price may change significantly following the offering, and you could lose all or part of your investment as a result.

We and the underwriters will negotiate to determine the initial public offering price. You may not be able to resell your shares at or above the initial public offering price due to a number of factors such as those listed in “—Risks Relating to Our Business” and the following, most of which are beyond our control:

 

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quarterly variations in our results of operations;

 

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results of operations that vary from the expectations of securities analysts and investors;

 

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results of operations that vary from those of our competitors;

 

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changes in expectations as to our future financial performance, including financial estimates by securities analysts and investors;

 

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announcements by us, our competitors or our vendors of significant contracts, acquisitions, joint marketing relationships, joint ventures or capital commitments;

 

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announcements by third parties of significant claims or proceedings against us;

 

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increases in prices of raw materials for our products, fuel or our goods;

 

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future sales of our common stock; and

 

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general domestic and international economic conditions.

Furthermore, the stock market recently has experienced extreme volatility that in some cases has been unrelated or disproportionate to the operating performance of particular companies. These broad market and industry fluctuations may adversely affect the market price of our common stock, regardless of our actual operating performance.

 

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In the past, following periods of market volatility, shareholders have instituted securities class action litigation. If we were involved in securities litigation, it could have a substantial cost and divert resources and the attention of executive management from our business regardless of the outcome of such litigation.

Our operating results may fluctuate in future periods which could cause the market price of our common stock to be volatile or to decline.

Our operating results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year, and sales and profits for any future period may decrease. Our operating results may fall below our expectations or the expectations of investors or industry analysts in one or more future periods. Any such shortfall could results in a significant decline in the price of our common stock.

If we or our existing investors sell additional shares of our common stock after this offering, the market price of our common stock could decline.

The market price of our common stock could decline as a result of sales of a large number of shares of common stock in the market after this offering, or the perception that such sales could occur. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. After the completion of this offering, we will have             shares of common stock outstanding (                 if the underwriters exercise their option to purchase additional shares in full). This number includes             shares being sold in this offering, which may be resold immediately in the public market.

We, our directors and officers and the Sponsors have agreed not to offer, sell, dispose of or hedge, directly or indirectly, any common stock without the prior written consent of the representatives of the Underwriters for a period of 180 days from the date of this prospectus, subject to certain exceptions and automatic extension in certain circumstances. In addition, pursuant to the Registration Rights Agreement, we have granted certain shareholders the right to cause us, in certain instances, at our expense, to file registration statements under the Securities Act of 1933, as amended (the “Securities Act”) covering resales of our common stock held by them or to piggyback on a registration statement in certain circumstances. This right will not be exercisable during the 180 day restricted period described above. These shares will represent approximately     % of our common stock after this offering or     % if the underwriters exercise their option to purchase additional shares in full. These shares may also be sold pursuant to Rule 144 under the Securities Act, depending on their holding period and subject to restrictions in the case of shares held by persons deemed to be our affiliates. As restrictions on resale end or if these stockholders exercise their registration rights, the market price of our common stock could decline if the holders of restricted shares sell them or are perceived by the market as intending to sell them. See “Certain Relationships and Related Party Transactions—Registration Rights Agreement” and “Shares Eligible for Future Sales” and “Underwriting.”

As of January 30, 2010, 48,951,836 shares of our common stock were outstanding (353,696 of which are held by our employees and are subject to restrictions on transfer), 3,748,507 shares were issuable upon the exercise of outstanding stock options under our Management Equity Plan, and 252,028 shares were reserved for future grant under our Management Equity Plan. Prior to the completion of this offering, our Board of Directors and our shareholders will approve our new 2010 Incentive Plan, which will increase the number of shares authorized for issuance to             , effective upon the closing of this offering. Subject to the lapse of applicable transfer restrictions, these shares will first become eligible for resale      days after the date of this prospectus. Sales of a substantial number of shares of our common stock could cause the market price of our common stock to decline.

 

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Because we have no current plans to pay cash dividends on our common stock for the foreseeable future, you may not receive any return on investment unless you sell your common stock for a price greater than that which you paid for it.

We may retain future earnings, if any, for future operation, expansion and debt repayment and have no current plans to pay any cash dividends for the foreseeable future. Any decision to declare and pay dividends in the future will be made at the discretion of our Board of Directors and will depend on, among other things, our results of operations, financial condition, cash requirements, contractual restrictions and other factors that our Board of Directors may deem relevant. In addition, our ability to pay dividends may be limited by covenants of any existing and future outstanding indebtedness we or our subsidiaries incur, including our credit facilities and the indentures governing the notes (each as described in “Description of Indebtedness”). As a result, you may not receive any return on an investment in our common stock unless you sell our common stock for a price greater than that which you paid for it.

Some provisions of Delaware law and our governing documents could discourage a takeover that shareholders may consider favorable.

In addition to the Sponsors’ ownership of a controlling percentage of our common stock, Delaware law and provisions contained in our charter and bylaws as we expect them to be in effect upon completion of this offering could make it difficult for a third party to acquire us, even if doing so might be beneficial to our shareholders. For example, our charter authorizes our Board of Directors to determine the rights, preferences, privileges and restrictions of unissued preferred stock, without any vote or action by our shareholders. As a result, our Board of Directors could authorize and issue shares of preferred stock with voting or conversion rights that could adversely affect the voting or other rights of holders of our common stock or with other terms that could impede the completion of a merger, tender offer or other takeover attempt. In addition, as described under “Description of Capital Stock—Delaware Anti-Takeover Statutes” elsewhere in this prospectus, we are subject to certain provisions of Delaware law that may discourage potential acquisition proposals and may delay, deter or prevent a change of control of our company, including through transactions, and, in particular, unsolicited transactions, that some or all of our shareholders might consider to be desirable. As a result, efforts by our shareholders to change the direction or management of our company may be unsuccessful.

The Sponsors will continue to have significant influence over us after this offering, including control over decisions that require the approval of shareholders, which could limit your ability to influence the outcome of key transactions, including deterring a change of control.

We are controlled, and after this offering is completed will continue to be controlled, by the Sponsors. The Sponsors will have an indirect interest in approximately     % of our common stock (or     % if the underwriters exercise their option to purchase additional shares in full) after the completion of this offering. In addition, the Sponsors will have the right to designate a majority of the seats on our Board of Directors. As a result, the Sponsors will have control over our decisions to enter into any corporate transaction (and the terms thereof) and the ability to prevent any change in the composition of our Board of Directors and any transaction that requires stockholder approval regardless of whether others believe that such change or transaction is in our best interests. So long as the Sponsors continue to have an indirect interest in a majority of our outstanding common stock, they will have the ability to control the vote in any election of directors, amend our certificate of incorporation or bylaws or take other actions requiring the vote of our stockholders. In addition, pursuant to our Stockholder Agreement with the Sponsors and certain other investors, the Sponsors have a consent right over certain significant corporate actions and have certain rights to appoint directors to our board and its committees. See “Certain Relationships and Related Party Transactions—Stockholders Agreement.”

 

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The Sponsors are also in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us. The Sponsors may also pursue acquisition opportunities that are complementary to our business and, as a result, those acquisition opportunities may not be available to us. So long as the Sponsors, or other funds controlled by or associated with the Sponsors, continue to indirectly own a significant amount of our outstanding common stock, even if such amount is less than 50%, the Sponsors will continue to be able to strongly influence or effectively control our decisions. The concentration of ownership may have the effect of delaying, preventing or deterring a change of control of our company, could deprive shareholders of an opportunity to receive a premium for their common stock as part of a sale of our company and might ultimately affect the market price of our common stock.

We are a “controlled company” within the meaning of the New York Stock Exchange rules and, as a result, will qualify for, and intend to rely on, exemptions from certain corporate governance requirements. You will not have the same protections afforded to shareholders of companies that are subject to such requirements.

After completion of this offering, the Sponsors will continue to control a majority of the voting power of our outstanding common stock. As a result, we are a “controlled company” within the meaning of the New York Stock Exchange corporate governance standards. Under these rules, a company of which more than 50% of the voting power is held by an individual, group or another company is a “controlled company” and may elect not to comply with certain corporate governance requirements, including:

 

  Ÿ  

the requirement that a majority of the Board of Directors consist of independent directors;

 

  Ÿ  

the requirement that we have a nominating/corporate governance committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities;

 

  Ÿ  

the requirement that we have a compensation committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities; and

 

  Ÿ  

the requirement for an annual performance evaluation of the nominating/corporate governance and compensation committees.

Following this offering, we intend to utilize these exemptions. As a result, we will not have a majority of independent directors in our executive committee, which performs the functions of a compensation committee and such committee will not be subject to annual performance evaluations. In addition, we will not have a separate nominating/corporate governance committee. Accordingly, you will not have the same protections afforded to shareholders of companies that are subject to all of the corporate governance requirements of the New York Stock Exchange.

 

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FORWARD-LOOKING STATEMENTS

This prospectus 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. 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, store openings, integration and remodeling, future financial or operational performance, projected sales or earnings per share for certain periods, comparable 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, nature and allocation of future capital expenditures, growth initiatives, inventory levels, cost of goods, future financings 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, competition in the retail industry and changes in our product distribution mix and distribution channels, seasonality of our business, changes in consumer preferences and consumer spending patterns, product safety issues including product recalls, general economic conditions in the United States and other countries in which we conduct our business, our ability to implement our strategy, our substantial level of indebtedness and related debt-service obligations, restrictions imposed by covenants in our debt agreements, availability of adequate financing, changes in laws that impact our business, changes in employment legislation, our dependence on key vendors for our merchandise, 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, political and other developments associated with our international operations, existence of adverse litigation and other risks, uncertainties and factors set forth under “Risk Factors” herein. 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 SEC rules and regulations. Actual results may differ materially from anticipated results or outcomes discussed in any forward-looking statement.

 

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USE OF PROCEEDS

We estimate that the net proceeds we will receive from this offering of shares of our common stock after deducting underwriter discounts and commissions and estimated expenses payable by us, will be approximately $             million (or $             million if the underwriters exercise their option to purchase additional shares in full). This estimate assumes an initial public offering price of $             per share, the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus.

We intend to use the anticipated net proceeds primarily to repay certain of our existing indebtedness and also for general corporate purposes.

A $1.00 increase (decrease) in the assumed initial public offering price of $             per share would increase (decrease) the net proceeds to us from this offering by $             million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated expenses payable by us. In the event of any such increase in net proceeds to us, we would apply such additional net proceeds to further reduce our indebtedness and for general corporate purposes.

 

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DIVIDEND POLICY

During fiscal years 2009, 2008 and 2007, no dividends were paid out to shareholders. We do not currently anticipate paying any cash dividends on our common stock for the foreseeable future and instead may retain earnings, if any, for future operations and expansion and debt repayment. Any decision to declare and pay dividends in the future will be made at the discretion of our Board of Directors and will depend on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions and other factors that our Board of Directors may deem relevant. In addition, our and our subsidiaries’ ability to pay dividends is limited by covenants in agreements related to our indebtedness. See “Description of Indebtedness” for restrictions on our ability to pay dividends.

 

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CAPITALIZATION

The following table sets forth our capitalization as of January 30, 2010:

 

  Ÿ  

on an actual basis; and

 

  Ÿ  

on an as adjusted basis to give effect to (1) the issuance of common stock in this offering and the application of proceeds from the offering as described in “Use of Proceeds” as if each had occurred on January 30, 2010 and (2) the payment of approximately $             million in fees under our Advisory Agreement with the Sponsors. See “Certain Relationships and Related Party Transactions—Advisory Agreement.”

You should read this table in conjunction with “Use of Proceeds,” “Selected Historical Financial and Other Data,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and notes thereto, included elsewhere in this prospectus.

 

     January 30, 2010

(amounts in millions, except share-amounts)

   Actual     As Adjusted

Cash and cash equivalents

   $ 1,126     
          

Long-term debt:

    

Revolving credit facilities(1)

   $ —       

Notes and credit facilities

     5,048     

Finance obligations associated with capital projects and capital lease obligations

     148     

Total long-term debt

     5,196     
              

Stockholders’ Equity:

    

Common stock; $0.001 par value, shares authorized 55,000,000, shares issued and outstanding 48,951,836 actual and              as adjusted

     —       

Treasury stock

     (7  

Additional paid-in capital

     25     

Retained earnings

     112     

Accumulated other comprehensive loss

     (45  
              

Toys “R” Us, Inc. stockholders’ equity

     85     

Noncontrolling interest

     32     
              

Total stockholders’ equity(2)

     117     

Total capitalization

   $ 5,313      $             
              

 

(1) At January 30, 2010, we had no outstanding borrowings under our $2.1 billion secured revolving credit facility, a total of $109 million of outstanding letters of credit and had excess availability of $874 million. In addition, at January 30, 2010, we had no outstanding borrowings under the European ABL and had availability of $71 million. At January 30, 2010, we had no outstanding debt under Tranche 1 and Tranche 2 of our Toys–Japan unsecured credit lines and had availability of $222 million under Tranche 1, and $140 million under Tranche 2. On February 26, 2010, Toys–Japan entered into an agreement with a syndicate of financial institutions to refinance Tranche 2. Additionally, on March 29, 2010, Toys–Japan modified Tranche 2 to include an additional lender. As a result, Tranche 2 became available in amounts of up to ¥14.0 billion ($149 million at May 1, 2010), expiring on March 28, 2011.
(2) A $1.00 increase (decrease) in the assumed initial public offering price of $             per share would (decrease) increase our total long-term obligations and would increase (decrease) equity by $             and $            , respectively, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated expenses payable by us. To the extent we raise more proceeds in this offering, we may repay additional indebtedness. To the extent we raise less proceeds in this offering, we may reduce the amount of indebtedness that will be repaid.

 

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The table set forth above is based on the number of shares of our common stock outstanding as of January 30, 2010. This table does not reflect:

 

  Ÿ  

3,748,507 shares of our common stock issuable upon the exercise of outstanding stock options under our Management Equity Plan at a weighted average exercise price of $26.29 per share as of January 30, 2010, 2,192,798 of which were then exercisable;

 

  Ÿ  

252,028 shares of our common stock reserved for future grants under our Management Equity Plan;

 

  Ÿ  

             shares of our common stock to be reserved for future grants under our 2010 Incentive Plan; and

 

  Ÿ  

             shares of common stock subject to the Underwriters’ overallotment option.

 

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DILUTION

If you invest in our common stock, your interest will be diluted to the extent of the difference between the initial public offering price per share of our common stock and the net tangible book value per share of our common stock after this offering. Dilution results from the fact that the initial public offering price per share of common stock is substantially in excess of the net tangible book value per share of our common stock attributable to the existing shareholders for our presently outstanding shares of common stock. We calculate net tangible book value per share of our common stock by dividing the net tangible book value (total consolidated tangible assets less total consolidated liabilities) by the number of outstanding shares of our common stock.

Our net tangible book value as of January 30, 2010 was $             billion, or $             per share of our common stock, based on             shares of our common stock outstanding immediately prior to the closing of this offering. Net tangible book value represents the amount of total tangible assets less total liabilities. Dilution is determined by subtracting net tangible book value per share of our common stock from the assumed initial public offering price per share of our common stock.

After giving effect to the sale of             shares of our common stock in this offering assuming an initial public offering price of $             per share, less the underwriting discounts and commissions and the estimated offering expenses payable by us, and without taking into account any other changes in such net tangible book value after January 30, 2010, our pro forma as adjusted net tangible book value at January 30, 2010 would have been $             billion, or $             per share. This represents an immediate increase in net tangible book value of $             per share of our common stock to the existing shareholders and an immediate dilution in net tangible book value of $             per share of our common stock, or     % of the estimated offering price of $            , to investors purchasing shares of our common stock in this offering. The following table illustrates such per share of our common stock dilution:

 

Assumed initial public offering price per share

   $             
      

Actual net tangible book value per share as of January 30, 2010

  

Pro forma net tangible book value per share before the change attributable to new investors

  
      

Increase in pro forma net tangible book value per share attributable to new investors

  

Pro forma as adjusted net tangible book value per share after this offering dilution per share to new investors

   $  
      

If the underwriters exercise their option to purchase additional shares in full, the adjusted net tangible book value per share of our common stock after giving effect to the offering would be $             per share of our common stock. This represents an increase in adjusted net tangible book value of $             per share of our common stock to existing stockholders and dilution in adjusted net tangible book value of $             per share of our common stock to new investors.

A $1.00 increase (decrease) in the assumed initial public offering price of $             per share of our common stock would increase (decrease) our net tangible book value after giving to the offering by $             million, or by $             per share of our common stock, assuming no change to the number of shares of our common stock offered by us as set forth on the cover page of this prospectus, and after deducting the estimated underwriting discounts and estimated expenses payable by us.

The following table summarizes, on a pro forma basis as of January 30, 2010, the total number of shares of our common stock purchased from us, the total cash consideration paid to us and the

 

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average price per share of our common stock paid by purchasers of such shares and by new investors purchasing shares of our common stock in this offering.

 

     Shares of our Common
Stock purchased
  Total
Consideration
Amount
(in millions)
   Average
Price
Percent
  Per Share of our
Common Stock
     Number
(in millions)
   Percent       

Existing Stockholders

          %   $                    %   $            

New investors

          %   $                    %   $            

Total

          %   $                    %   $            

If the underwriters were to fully exercise the underwriters’ option to purchase additional shares of our common stock from us, the percentage of shares of our common stock held by existing shareholders who are directors, officers or affiliated persons would be     %, and the percentage of shares of our common stock held by new investors would be     %.

To the extent that we grant options or other equity awards to our employees or directors in the future, and those options or other equity awards are exercised or become vested or other issuances of shares of our common stock are made, there will be further dilution to new investors.

 

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Selected Historical Financial and Other Data

The following table sets forth selected consolidated financial and other data of Toys “R” Us, Inc. as of the dates and for the periods indicated. We derived the selected historical statement of operations data for the fiscal years ended January 30, 2010, January 31, 2009 and February 2, 2008, and selected historical balance sheet data as of January 30, 2010 and January 31, 2009, from our historical audited consolidated financial statements included elsewhere in this prospectus. We derived the selected historical statement of operations data for the fiscal years ended February 3, 2007 and January 28, 2006 and selected historical balance sheet data as of February 2, 2008, February 3, 2007 and January 28, 2006 presented in this table from our consolidated financial statements not included in this prospectus.

Our historical results are not necessarily indicative of future operating results. The information set forth below should be read in conjunction with, and is qualified in its entirety by reference to, “Prospectus Summary—Summary Historical Financial and Other Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this prospectus.

 

     Fiscal Years Ended(1)  

(In millions, except number

of stores and per share data)

   January 30,
2010
    January 31,
2009
    February 2,
2008
    February 3,
2007
    January 28,
2006
 

Statement of Operations Data:

          

Net sales

   $ 13,568      $ 13,724      $ 13,794      $ 13,050      $ 11,333 (2) 

Cost of sales

     8,790        8,976        8,987        8,638        7,652   
                                        

Gross margin

     4,778        4,748        4,807        4,412        3,681   
                                        

Selling, general and administrative expenses(3)

     3,730        3,856        3,801        3,506        2,986   

Depreciation and amortization

     376        399        394        409        400   

Other (income) expense, net(4)

     (112 )(5)      (128 )(6)      (84     (152     437 (7) 
                                        

Total operating expenses

     3,994        4,127        4,111        3,763        3,823   
                                        

Operating earnings (loss)

     784        621        696        649        (142

Interest expense

     (447     (419     (503     (537     (394

Interest income

     7        16        27        31        31   
                                        

Earnings (loss) before income taxes

     344        218        220        143        (505

Income tax expense (benefit)

     40        7        65        35        (121
                                        

Net earnings (loss)

     304        211        155        108        (384
                                        

Less: Net (loss) earnings attributable to noncontrolling interest

     (8     (7     2        (1     0   
                                        

Net earnings (loss) attributable to Toys “R” Us, Inc.

   $ 312      $ 218      $ 153      $ 109      $ (384
                                        

Per Share Data:

          

Earnings (loss) per common share attributable to Toys “R” Us, Inc.(8):

          

Basic

   $                   $                   $                   $                   $                

Diluted

   $        $        $        $        $     

Weighted average shares used in computing per share amounts(8):

          

Basic earnings per common share

          

Diluted earnings per common share

          

Statement of Cash Flow:

          

Net cash provided by (used in)

          

Operating activities

   $ 1,014      $ 525      $ 527      $ 411      $ 671   

Investing activities

     (37     (259     (416     (107     573   

Financing activities

     (626     (223     (152     (566     (1,488

Balance Sheet Data (end of period):

          

Working capital

   $ 619      $ 617      $ 685      $ 347      $ 348   

Property and equipment, net

     4,084        4,187        4,385        4,333        4,175   

 

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    Fiscal Years Ended(1)  

(In millions, except number of stores and per share
data)

  January 30,
2010
    January 31,
2009
    February 2,
2008
    February 3,
2007
    January 28,
2006
 

Total assets

    8,577        8,411        8,952        8,295        7,863   

Long-term debt(9)

    5,034 (10)      5,447        5,824        5,722        5,540   

Total stockholders’ equity (deficit)(11)

    117        (152     (235     (540     (723

Other Financial and Operating Data:

         

Number of stores—Domestic (at year end)

    849        846        845        837        901   

Number of stores—International—operated
(at year end)

    514        504        504        488        468   

Total operated stores (at year-end)

    1,363        1,350        1,349        1,325        1,369   

Number of stores—International—Licensed
(at year end)

    203        209        211        190        173   

Capital expenditures

  $ 192      $ 395      $ 326      $ 285      $ 285   

 

(1) Our fiscal year ends on the Saturday nearest to January 31 of each calendar year. With the exception of fiscal 2006, which included 53 weeks, all other fiscal years presented are based on a 52 week period.

 

(2) Toys–Japan was consolidated beginning in fiscal 2006. Toys–Japan Net sales of $1.6 billion for fiscal 2005 were not included in our Net sales.

 

(3) Includes the impact of restructuring and other charges. See Note 10 to our consolidated financial statements entitled “Restructuring and Other Charges” for further information.

 

(4) Includes $20 million, $78 million, $17 million and $15 million of pre-tax gift card breakage income in fiscals 2009, 2008, 2007 and 2006, respectively. Also includes $11 million and $12 million of pre-tax gift card dormancy income in fiscals 2006 and 2005, respectively. See Note 1 to our consolidated financial statements entitled “Summary of Significant Accounting Policies” for further details.

Includes the pre-tax impact of net gains on sales of properties of $6 million, $5 million, $33 million, $110 million and a loss of $3 million in fiscals 2009, 2008, 2007, 2006 and 2005, respectively. See Note 5 to our consolidated financial statements entitled “Property and Equipment” for further details.

Includes pre-tax impairment losses on long-lived assets of $7 million, $33 million, $13 million, $5 million and $22 million in fiscals 2009, 2008, 2007, 2006 and 2005. See Note 1 to our consolidated financial statements entitled “Summary of Significant Accounting Policies” for further details.

 

(5) Includes a $51 million pre-tax gain related to the litigation settlement with Amazon. See Note 15 to our consolidated financial statements entitled “Litigation and Legal Proceedings” for further details.

 

(6) Includes a $39 million pre-tax gain related to the substantial liquidation of the operations of TRU (HK) Limited, our wholly-owned subsidiary. See Note 1 to our consolidated financial statements entitled “Summary of Significant Accounting Policies” for further details.

 

(7) Includes $410 million of transaction and related costs and $22 million of contract settlement and other fees related to the 2005 acquisition.

 

(8) All share and per share amounts reflect a             -for-one stock split of our common stock, which will occur prior to the consummation of this offering.

 

(9) Excludes current portion of long-term debt.

 

(10) Includes the impact of the issuance of $950 million and $725 million of debt on July 9, 2009 and November 20, 2009, respectively, the proceeds from which were used, together with other funds, to repay the outstanding loan balance of $1,267 million and $800 million plus accrued interest and fees. See Note 2 to our consolidated financial statements entitled “Long-Term Debt” for further details.

 

(11) On February 1, 2009, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 160, “Noncontrolling Interests in Consolidated Financial Statements—An Amendment of ARB No. 51” which is now codified under ASC Topic 810 (“ASC 810”). ASC 810 requires a company to clearly identify and present ownership interest in subsidiaries held by parties other than the company in the consolidated financial statements within the equity section but separate from the company’s equity. Therefore, we have included our noncontrolling interest in Toys–Japan within the Total stockholders’ equity (deficit) line item.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

You should read the following Management’s Discussion and Analysis of our Financial Condition and Results of Operations (“MD&A”) with “Selected Historical Financial and Other Data” and the audited historical financial statements and related notes included elsewhere in this prospectus. This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited, to those described in the “Risk Factors” section of this prospectus. Actual results may differ materially from those contained in any forward-looking statements. You should read “Forward-Looking Statements” and “Risk Factors.”

Our MD&A includes the following sections:

 

  Ÿ  

Executive Overview provides an overview of our business.

 

  Ÿ  

Results of Operations provides an analysis of our financial performance and of our consolidated and segment results of operations for fiscal 2009 compared to fiscal 2008 and fiscal 2008 compared to fiscal 2007.

 

  Ÿ  

Liquidity and Capital Resources provides an overview of our financing, capital expenditures, cash flows and contractual obligations.

 

  Ÿ  

Critical Accounting Policies provides a discussion of our accounting policies that require critical judgment, assumptions and estimates.

 

  Ÿ  

Recently Adopted Accounting Pronouncements provides a brief description of significant accounting standards which were adopted during fiscal 2009. See Note 21 to our consolidated financial statements included elsewhere in this prospectus entitled “Recent Accounting Pronouncements” for accounting standards which we have not yet been required to implement and may be applicable to our future operations.

Executive Overview

Our Business

We are the leading global specialty retailer of toys and juvenile products as measured by net sales. For over 50 years, Toys “R” Us has been recognized as the toy and baby authority. In the U.S., in fiscal 2009, approximately 70% of households with kids under 12 shopped at our Toys “R” Us stores and 84% of all new mothers shopped at our Babies “R” Us stores. We believe we offer the most comprehensive year-round selection of toys and juvenile products, including a broad assortment of private label and exclusive merchandise unique to our stores.

As of January 30, 2010, we operated 1,363 stores and licensed an additional 203 stores. These stores are located in 34 countries and jurisdictions around the world under the Toys “R” Us, Babies “R” Us and FAO Schwarz banners. In addition to these stores, during the fiscal 2009 holiday season, we opened 91 pop-up stores, 30 of which remained open as of January 30, 2010. We also sell merchandise through our websites at Toysrus.com, Babiesrus.com, eToys.com, FAO.com and babyuniverse.com. For the fiscal year ended January 30, 2010, we generated net sales of $13.6 billion, net earnings of $312 million and Adjusted EBITDA of $1,130 million.

As of the end of fiscal 2009, we operated all of the “R” Us branded retail stores in the United States and Puerto Rico. Internationally, we operate 514 of the 717 “R” Us branded retail stores. The balance of the “R” Us branded retail stores outside the United States are operated by licensees. The fees from these licensees did not have a material impact on our Net sales. During fiscal 2009, the Company acquired certain business assets of FAO Schwarz, and began selling merchandise through our FAO Schwarz retail store in New York City. We also sell merchandise through our Internet sites in

 

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the United States at Toysrus.com and Babiesrus.com, as well as through other Internet sites internationally. In addition, commencing in fiscal 2009, we sell merchandise through our newly acquired eToys.com, FAO.com and babyuniverse.com Internet sites.

We developed several new store formats with an integrated “one-stop shopping” environment for our guests by combining the Toys “R” Us and Babies “R” Us merchandise offerings under one roof. We call these formats “side-by-side” or “SBS”, and “‘R’ Superstores” or “SSBS”, depending on the store size. Side-by-side stores are a combination of Toys “R” Us stores and Babies “R” Us stores which may be the result of either conversion or relocation of a standalone store. Our “R” Superstores are conceptually similar to SBS stores, except that they are larger in size and may result from a relocation and/or closure of one or more existing stores. In addition, side-by-side stores and “R” Superstores may also be constructed in a new location and market.

The integration of juvenile (including baby) merchandise with toy and entertainment offerings has allowed us to create a “one-stop shopping” experience for our guests, and enabled us to obtain the sales and operating benefits associated with combining product lines under one roof. Our juvenile product assortment allows us to capture new parents as customers during pregnancy, helping them prepare for the arrival of their newborn. We then become a resource for infant products such as formula, diapers and solid foods, as well as baby clothing and learning aids. We believe this opportunity to establish first contact with new parents enables us to develop long-lasting customer relationships with them as their children age and they transition to becoming consumers of our toy products. We continue to build on these relationships as these children grow and eventually become parents themselves. Additionally, juvenile merchandise such as baby formula, diapers and infant clothing provide us with a mitigant to the inherent seasonality in the toy business.

In connection with our juvenile integration strategy, we continue to increase the number of SBS and SSBS stores both domestically and internationally. Since implementing the integrated store format over three years ago, we have converted 129 existing stores into SBS store formats and have constructed 38 new SBS and SSBS stores (19 of which were relocations of existing stores). We expect that our integrated store formats will continue to be a significant driver of our revenue and profit growth going forward. In 2010, we plan to open seven new SSBS stores (six of which are relocations of existing stores), open 12 new SBS stores and convert an additional 78 stores to the SBS stores format, all within our existing markets. As a result, we expect capital expenditures incurred in connection with store conversion projects and relocations to increase in 2010. In addition, we expect Selling, General and Administrative Expenses (“SG&A”) to increase due to additional expenses in connection with our conversions, expansion of online business, costs associated with additional labor for our Babies “R” Us stores and the opening of a sourcing office in China. See “—Capital Expenditures” below for further details on budgeted capital expenditure for 2010.

In addition to our SBS and SSBS store formats, we continue to enhance our integrated strategy with our Babies “R” Us Express (“BRU Express”) and Juvenile Expansion formats which devote additional square footage to our juvenile products within our traditional Toys “R” Us stores. Since implementing this integrated store format, we have augmented 79 existing Toys “R” Us stores with these formats.

Our extensive experience in retail site selection has resulted in a portfolio of stores that include attractive locations in many of our chosen markets. Markets for new stores and formats are selected on the basis of proximity to other “R” Us branded stores, demographic factors, population growth potential, competitive environment, availability of real estate and cost. Once a potential market is identified, we select a suitable location based upon several criteria, including size of the property, access to major commercial thoroughfares, proximity of other strong anchor stores or other destination superstores, visibility and parking capacity.

 

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As of January 30, 2010, we operated 1,363 retail stores and licensed an additional 203 retail stores worldwide in the following formats:

 

Format

  

Description

  Number
of Stores
 

Approximate Store
Size (sq. ft.)

     Operated Stores        
Traditional Toys “R” Us stores    The majority of square footage is devoted to traditional toy categories, with approximately 5,500 square feet devoted to boutique areas for juvenile products (BRU Express and Juvenile Expansion formats devote approximately an additional 4,500 square feet and 1,000 square feet, respectively, for juvenile - including baby - products).   911   30,000 to 50,000
Traditional Babies “R” Us stores    Predominantly juvenile (including baby) products, with approximately 2,000 to 5,000 square feet devoted to specialty name brand and private label clothing.   282   30,000 to 45,000
Side-by-Side (SBS) stores    Devote approximately 20,000 to 30,000 square feet to traditional toy products and 9,000 to 15,000 square feet to juvenile (including baby) products.   141   30,000 to 50,000
“R” Superstores (SSBS)    Combine a traditional toy store of approximately 34,000 square feet with a juvenile (including baby) store of approximately 30,000 square feet.   26   55,000 to 70,000
Flagship stores (all in
New York City)
   The Toys “R” Us store in Times Square, the FAO Schwarz store on 5th Avenue near Central Park, and the Babies “R” Us store in Union Square.   3   55,000 to 100,000
          
     1,363  
Total operated stores    Licensed Stores    
Traditional Toys “R” Us stores    The majority of square footage is devoted to traditional toy categories, with approximately 5,500 square feet devoted to boutique areas for juvenile (including baby) products.   203   30,000 to 50,000
          
Total operated and licensed stores      1,566  

In addition to these stores, during the fiscal 2009 holiday season, we opened 91 Toys “R” Us Holiday Express stores or pop-up stores a temporary store format located in high-traffic shopping areas, 30 of which remained open as of January 30, 2010.

 

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Our Business Segments

Our business has two reportable segments: Domestic and International. The following is a brief description of our segments:

 

  Ÿ  

Domestic—Our Domestic segment sells a variety of products in the core toy, entertainment, juvenile (including baby), learning and seasonal categories through 849 stores that operate in 49 states in the United States and Puerto Rico and through the Internet. Domestic Net sales are derived from 496 traditional toy stores (including 77 BRU Express and Juvenile Expansion formats), 260 juvenile stores, 64 SBS stores, 26 SSBS stores and our 3 flagship stores in New York City. Additionally, we also generate sales through our pop-up store locations. On average, our stores offer approximately 10,000 active items year-round. Based on sales, we are the largest specialty retailer of toys in the United States and Puerto Rico as well as the only specialty juvenile and baby retailer that operates on a national scale in the United States. Domestic Net sales were $8.3 billion for the fiscal year ended January 30, 2010, which accounts for 61% of our consolidated Net sales.

 

  Ÿ  

International—Our International segment sells a variety of products in the core toy, entertainment, juvenile (including baby), learning and seasonal categories through 514 operated and 203 licensed stores that operate in 33 countries and jurisdictions, and through the Internet. Net sales (including fees received from licensed stores) in our International segment are derived from 618 traditional toy stores, 415 of which are operated by us, including 2 BRU Express formats, as well as 77 SBS stores and 22 juvenile stores. Our wholly-owned operations are in Australia, Austria, Canada, France, Germany, Portugal, Spain, Switzerland and the United Kingdom. We also consolidate the results of Toys “R” Us–Japan, Ltd. (“Toys–Japan”) of which we owned approximately 91% at January 30, 2010 and, as of April 15, 2010, we now own 100%. On average, our stores offer approximately 8,500 active items year-round. International Net sales were $5.3 billion for the fiscal year ended January 30, 2010, which accounts for 39% of our consolidated Net sales.

In order to properly judge our business performance, it is necessary to be aware of the following challenges and risks:

 

  Ÿ  

Seasonality—Our business is highly seasonal with sales and earnings highest in the fourth quarter. During the last three fiscal years, more than 39% of the Net sales from our worldwide business and a substantial portion of the operating earnings and cash flows from operations were generated in the fourth quarter. Our results of operations depend significantly upon the fourth quarter holiday selling season.

 

  Ÿ  

Spending patterns and product migration—Many economic and other factors outside our control, including consumer confidence, consumer spending levels, employment levels, consumer debt levels and inflation, as well as the availability of consumer credit, affect consumer spending habits. Since fiscal 2008, there has been a deterioration in the global financial markets and economic environment, which has negatively impacted consumer spending. In response, we have taken steps to increase opportunities to drive profitable sales and curtailed capital spending and operating expenses wherever prudent. If these adverse trends in economic conditions worsen, or if our efforts to counteract the impacts of these trends are not sufficiently effective, there would be a negative impact on our financial performance and position in future fiscal periods.

 

  Ÿ  

Increased competition—Our businesses operate in a highly competitive retail market. We compete on the basis of product variety, quality, safety, availability, price, advertising and

 

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promotion, convenience or store location and customer service. We face strong competition from discount and mass merchandisers, national and regional chains and department stores, local retailers in the market areas we serve and Internet and catalog businesses. Price competition in our retailing business continued to be intense during the 2009 fourth quarter holiday season.

 

  Ÿ  

Video games and video game systems—Video games and video game systems represent a significant portion of our entertainment category. Video games and video game systems have tended to account for 10% to 15% of our annual Net sales. The video game market remains competitive with significant competition from Wal-Mart, Amazon, Target, Kmart, Best Buy and GameStop. Due to the intensified competition as well as the maturation of this category, sales of video games and video game systems will periodically experience volatility that may impact our financial performance.

Results of Operations

Financial Performance

As discussed in more detail in this MD&A, the following financial data represents an overview of our financial performance for fiscals 2009, 2008 and 2007:

 

     Fiscal Years Ended  

($ In millions)

   2009     2008     2007  

Net sales

   $ 13,568      $ 13,724      $ 13,794   

Gross margin as a percentage of Net sales

     35.2     34.6     34.8

Selling, general and administrative expenses as a percentage of Net sales

     27.5     28.1     27.6

Net earnings attributable to Toys “R” Us, Inc.

   $ 312      $ 218      $ 153   

Net sales for fiscal 2009 decreased by $156 million primarily as a result of decreased comparable store net sales across both of our segments driven by a slowdown in demand for certain video game systems and related accessories, as well as a lower average transaction amount at both of our segments and a decrease in the number of transactions at our International segment. Partially offsetting this decrease was the positive impact of stores that were recently opened or converted to our SBS and SSBS store formats.

Gross margin as a percentage of Net sales for fiscal 2009 increased primarily as a result of improvements in sales mix away from lower margin products. Partially offsetting this increase were increased sales of lower margin commodities within the juvenile category at our Domestic segment.

SG&A as a percentage of Net sales for fiscal 2009 decreased primarily as a result of strong initiatives to reduce overall operating expenses. This includes decreases in advertising and promotional expenses, travel and transportation costs, store labor and other compensation expenses and professional fees. Additionally, SG&A decreased by $14 million at our International segment due to the contract termination fee paid by the Company in fiscal 2008 related to the settlement between Toys–Japan and McDonald’s Holding Company (Japan), Ltd. (“McDonald’s Japan”).

Net earnings attributable to Toys “R” Us, Inc. for fiscal 2009 increased primarily due to a reduction in SG&A and an increase in Gross margin, partially offset by an increase in net interest expense and Income tax expense.

 

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Comparable Store Net Sales

We include, in computing comparable store net sales, stores that have been open for at least 56 weeks (1 year and 4 weeks) from their “soft” opening date. A soft opening is typically two weeks prior to the grand opening.

Comparable stores include the following:

 

  Ÿ  

stores that have been remodeled while remaining open (including conversions);

 

  Ÿ  

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;

 

  Ÿ  

stores that have expanded within their current locations; and

 

  Ÿ  

sales from our Internet businesses.

By measuring the year-over-year sales of merchandise in the stores that have been open for a full comparable 56 weeks or more, we can better gauge how the core store base is performing since it excludes store openings and closings.

Various factors affect comparable store net sales, including the number of stores we open or close, the number of transactions, the average transaction amount, the general retail sales environment, current local and global economic conditions, consumer preferences and buying trends, changes in sales mix among distribution channels, our ability to efficiently source and distribute products, changes in our merchandise mix, competition, the timing of the release of new merchandise and our promotional events, the success of marketing programs and the cannibalization of existing store net sales by new stores. Among other things, weather conditions can affect comparable store net sales because inclement weather may discourage travel or require temporary store closures, thereby reducing customer traffic. These factors have caused our comparable store net sales to fluctuate significantly in the past on an annual, quarterly and monthly basis and, as a result, we expect that comparable store net sales will continue to fluctuate in the future.

The following table discloses our comparable store net sales for the fiscal years ended January 30, 2010, January 31, 2009 and February 2, 2008:

 

     Fiscal Years Ended  
     January 30,
2010
    January 31,
2009
    February 2,
2008
 

Domestic

   (3.0 )%    (0.1 )%    2.7

International

   (2.8 )%    (3.4 )%    2.9

Percentage of Net Sales by Product Category(1)

 

     Fiscal Years Ended  
     January 30,
2010
    January 31,
2009
    February 2,
2008
 

Core Toy

   17.0   16.1   16.8

Entertainment

   15.5   18.0   17.8

Juvenile(2)

   30.8   31.2   29.8

Learning

   22.4   20.6   21.1

Seasonal

   13.2   13.0   13.4

Other(3)

   1.1   1.1   1.1
                  

Total

   100   100   100
                  

 

(1) See “—Business—Product Selection and Merchandise” for a description of the product categories.
(2) As a result of our juvenile integration strategy, the total square footage allocable to our juvenile products category in our domestic and international stores increased in each of the fiscal years ended January 30, 2010, January 31, 2009 and February 2, 2008, respectively, from the prior fiscal year.
(3) Consists primarily of shipping and other non-product related revenues.

 

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Store Count by Segment

 

    January 30,
2010
  Fiscal 2009     January 31,
2009
  Fiscal 2008     February 2,
2008
    Opened     Closed       Opened     Closed    

Domestic(1)

  849   6      (3   846   6      (5   845

International—Operated(2)

  514   10      —        504   5      (5   504

International—Licensed

  203   16 (3)    (22 )(3)    209   36 (3)    (38 )(3)    211
                                   

Total(4)

  1,566   32      (25   1,559   47      (48   1,560
                                   

 

(1) Store count as of January 30, 2010 included 64 SBS stores, 26 SSBS stores, 13 BRU Express stores and 64 Juvenile Expansions. As of January 31, 2009 store count included 53 SBS stores, 19 SSBS stores, 12 BRU Express stores and 63 Juvenile Expansions. As of February 2, 2008, there were 28 SBS stores, 4 SSBS stores and 4 BRU Express stores.
(2) Store count includes 77, 66 and 31 SBS stores as of January 30, 2010, January 31, 2009 and February 2, 2008, respectively. As of January 30, 2010, there were 2 BRU Express stores.
(3) Closed stores in fiscal 2009 include the closure of 17 stores in the Netherlands due to the expiration of our license agreement in the Netherlands. Opened stores include new licensed stores primarily in China and Israel. Closed stores in fiscal 2008 include the closure of 35 stores related to the termination of our license agreement in Turkey. Opened stores include new licensed stores primarily in China, Malaysia and South Africa.
(4) Does not include 29 pop-up stores Domestically and 1 Internationally that remained open as of January 30, 2010 due to the temporary nature of these locations. At the peak of this initiative, there were 89 Domestic and 2 International pop-up stores open. Certain pop-up stores may remain in operation and become permanent locations.

Fiscal 2009 Compared to Fiscal 2008

Net Earnings Attributable to Toys “R” Us, Inc.

 

(In millions)

   Fiscal
2009
   Fiscal
2008
   Change

Net earnings attributable to Toys “R” Us, Inc.

   $ 312    $ 218    $ 94

We generated Net earnings attributable to Toys “R” Us, Inc. of $312 million in fiscal 2009 compared to $218 million in fiscal 2008. The increase in Net earnings attributable to Toys “R” Us, Inc. was primarily due to a reduction in SG&A of $126 million resulting primarily from initiatives to reduce our operating expenses, and an increase in Gross margin of $30 million due to improvements in sales mix away from lower margin products, partially offset by an increase in net interest expense of $37 million and Income tax expense of $33 million. Each of these changes includes the effect of foreign currency translation, which accounted for approximately $28 million of the increase in Net earnings attributable to Toys “R” Us, Inc. Additionally, for a discussion of the impact of Other income, net on Net earnings attributable to Toys “R” Us, Inc. refer to the section below entitled “Other income, net.”

 

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Net Sales

 

($ In millions)

   Fiscal
2009
   Fiscal
2008
   $
Change
    %
Change
    Percentage of Net
Sales
 
             Fiscal
2009
    Fiscal
2008
 

Domestic

   $ 8,317    $ 8,480    $ (163   (1.9 )%    61.3   61.8

International

     5,251      5,244      7      0.1   38.7   38.2
                                        

Total Net sales

   $ 13,568    $ 13,724    $ (156   (1.1 )%    100.0   100.0
                                        

Net sales decreased by $156 million, or 1.1%, to $13,568 million in fiscal 2009, compared with $13,724 million in fiscal 2008. Net sales for fiscal 2009 included the impact of foreign currency translation that increased Net sales by approximately $83 million.

Excluding the impact of foreign currency translation, the decrease in Net sales for fiscal 2009 was primarily due to decreased comparable store net sales across both our segments. Comparable store net sales were primarily impacted by the overall slowdown in the global economy, a lower average transaction amount at both of our segments and a decrease in the number of transactions at our International segment. Partially offsetting this decrease was an increase in comparable store net sales attributable to stores that were recently opened or converted to our SBS and SSBS store formats.

Domestic

Net sales for the Domestic segment decreased by $163 million, or 1.9%, to $8,317 million in fiscal 2009, compared with $8,480 million in fiscal 2008. The decrease in Net sales was primarily a result of a decrease in comparable store net sales of 3.0%.

The decrease in comparable store net sales resulted primarily from a decrease in our entertainment, juvenile (including baby) and seasonal categories, which were all affected by the overall slowdown in the economy. The decrease in our entertainment category was driven by a slowdown in demand for certain video game systems and related accessories as well as fewer new software releases. The juvenile category decreased primarily as a result of the phasing out of certain size apparel offerings, along with declines in sales of baby gear, furniture and bedding. Sales of seasonal products, such as outdoor play equipment, decreased primarily due to cooler weather. These decreases were partially offset by increases in our learning and core toy categories. The learning category increased as a result of strong sales of construction toys, while increased sales in the core toy category were primarily driven by an increase in sales of collectibles and dolls.

International

Net sales for the International segment increased by $7 million, or 0.1%, to $5,251 million in fiscal 2009, compared with $5,244 million in fiscal 2008. Excluding an $83 million increase in Net sales due to foreign currency translation, there was a decrease in Net sales at our International segment which was primarily a result of a decrease in comparable store net sales of 2.8%.

The decrease in comparable store net sales resulted primarily from a decrease in our entertainment and juvenile (including baby) categories, which were both affected by the slowdown in the global economy. The entertainment category decreases were primarily attributable to a slowdown in demand for certain video game systems and related accessories as well as fewer new software releases. The juvenile category decreased primarily from declines in sales of nursery equipment and apparel. These decreases were partially offset by increases in our learning and core toy categories.

 

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The increase in the learning category was primarily a result of strong sales of educational products and construction toys. The increase in the core toy category was primarily attributable to increased sales of action figures.

Cost of Sales and Gross Margin

We record the costs associated with operating our distribution networks as a part of SG&A, including those costs that primarily relate to transporting merchandise from distribution centers to stores. Therefore, our consolidated Gross margin may not be comparable to the gross margins of other retailers that include similar costs in their cost of sales.

The following costs are included in “Cost of sales”:

 

  Ÿ  

the cost of merchandise acquired from vendors;

 

  Ÿ  

freight in;

 

  Ÿ  

provision for excess and obsolete inventory;

 

  Ÿ  

shipping costs;

 

  Ÿ  

provision for inventory shortages; and

 

  Ÿ  

credits and allowances from our merchandise vendors.

 

($ In millions)

   Fiscal
2009
   Fiscal
2008
   $
Change
    Percentage of Net sales  
           Fiscal
2009
    Fiscal
2008
    %
Change
 

Domestic

   $ 2,893    $ 2,910    $ (17   34.8   34.3   0.5

International

     1,885      1,838      47      35.9   35.0   0.9
                                        

Total Gross margin

   $ 4,778    $ 4,748    $ 30      35.2   34.6   0.6
                                        

Gross margin increased by $30 million to $4,778 million in fiscal 2009, compared with $4,748 million in fiscal 2008. Gross margin, as a percentage of Net sales, for fiscal 2009 increased by 0.6 percentage points. Foreign currency translation accounted for approximately $15 million of the increase in Gross margin. The increase in Gross margin, as a percentage of Net sales, was primarily the result of improvements in sales mix away from lower margin products.

Domestic

Gross margin decreased by $17 million to $2,893 million in fiscal 2009, compared with $2,910 million in fiscal 2008. Gross margin, as a percentage of Net sales, for fiscal 2009 increased by 0.5 percentage points.

The increase in Gross margin, as a percentage of Net sales, resulted primarily from improvements in sales mix away from lower margin products such as video game systems, and overall improvements in margin on full price sales and promotional sales in the learning and core toy categories. These increases were partially offset by increased sales of lower margin commodities within the juvenile category.

International

Gross margin increased by $47 million to $1,885 million in fiscal 2009, compared with $1,838 million in fiscal 2008. Foreign currency translation accounted for approximately $15 million of the increase. Gross margin, as a percentage of Net sales, for fiscal 2009 increased by 0.9 percentage points.

 

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The increase in Gross margin, as a percentage of Net sales, resulted primarily from improvements in sales mix toward sales of higher margin learning and core toy products as well as decreased sales of lower margin video game systems compared to fiscal 2008.

Selling, General and Administrative Expenses

The following are the types of costs included in SG&A:

 

  Ÿ  

store payroll and related payroll benefits;

 

  Ÿ  

rent and other store operating expenses;

 

  Ÿ  

advertising and promotional expenses;

 

  Ÿ  

costs associated with operating our distribution network, including costs related to transporting merchandise from distribution centers to stores;

 

  Ÿ  

restructuring charges; and

 

  Ÿ  

other corporate-related expenses.

 

     Fiscal
2009
   Fiscal
2008
   $
Change
    Percentage of Net sales  

($ In millions)

           Fiscal
2009
    Fiscal
2008
    %
Change
 

Toys “R” Us—Consolidated

   $ 3,730    $ 3,856    $ (126   27.5   28.1   (0.6 )% 

SG&A decreased $126 million to $3,730 million in fiscal 2009 compared to $3,856 million in fiscal 2008. As a percentage of Net sales, SG&A decreased by 0.6 percentage points. Foreign currency translation accounted for approximately $5 million of the decrease.

Excluding the impact of foreign currency translation, the decrease in SG&A was primarily from strong initiatives to reduce overall operating expenses, which includes decreases of $29 million in advertising and promotional expenses, $23 million in travel and transportation costs, $17 million in store labor and other compensation expenses and $17 million in professional fees at our Domestic and International segments. Additionally, SG&A decreased at our International segment due to the contract termination fee paid by the Company related to the settlement between Toys–Japan and McDonald’s Japan, which increased SG&A by $14 million in fiscal 2008.

Depreciation and Amortization

 

(In millions)

   Fiscal
2009
   Fiscal
2008
   Change  

Toys “R” Us—Consolidated

   $ 376    $ 399    $ (23

Depreciation and amortization decreased by $23 million to $376 million in fiscal 2009 compared to $399 million in fiscal 2008. The decrease was primarily due to a decrease of $11 million in accelerated depreciation related to store relocations and disposals in fiscal 2008, a decrease of $8 million related to assets which became fully amortized during the first half of fiscal 2009, as well as the addition of fewer new Company operated stores due to the curtailment of capital spending during fiscal 2009. Additionally, foreign currency translation accounted for approximately $1 million of the decrease.

Other Income, Net

Other income, net includes the following:

 

  Ÿ  

gain on litigation settlement;

 

  Ÿ  

credit card program income;

 

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  Ÿ  

gift card breakage income;

 

  Ÿ  

net gains on sales of properties;

 

  Ÿ  

impairment losses on long-lived assets;

 

  Ÿ  

gain on liquidation of a foreign subsidiary; and

 

  Ÿ  

other operating earnings and expenses.

 

(In millions)

   Fiscal
2009
   Fiscal
2008
   Change  

Toys “R” Us—Consolidated

   $ 112    $ 128    $ (16

Other income, net decreased by $16 million to $112 million in fiscal 2009 compared to $128 million in fiscal 2008. The decrease was primarily due to the recognition of an additional $59 million of gift card breakage income in fiscal 2008 resulting from the change in estimate effected by a change in accounting principle, and a $39 million gain recognized in fiscal 2008 on the liquidation of our Hong Kong subsidiary representing a cumulative translation adjustment. These decreases were partially offset by a $51 million litigation settlement with Amazon in fiscal 2009 and a decrease in impairment losses on long-lived assets of $26 million compared to the same period last year.

See Note 1 to our consolidated financial statements included elsewhere in this prospectus entitled “Summary of Significant Accounting Policies” for further details.

Interest Expense

 

(In millions)

   Fiscal
2009
   Fiscal
2008
   Change

Toys “R” Us—Consolidated

   $ 447    $ 419    $ 28

Interest expense increased by $28 million for fiscal 2009 compared to fiscal 2008. The increase was largely due to an increase of $20 million primarily as a result of the write-off of fees related to the repayment of our $1.3 billion unsecured credit agreement and our $800 million secured real estate loans. In addition, there was an increase of $5 million related primarily to higher effective interest rates, partially offset by a reduction in average debt balances.

Interest expense will increase in the future due to the issuance of $950 million of 10.75% Senior Notes by Toys “R” Us Property Company I, LLC (“TRU Propco I”) on July 9, 2009 and the issuance of $725 million of 8.50% Senior Secured Notes by Toys “R” Us Property Company II, LLC (“TRU Propco II”) on November 20, 2009. These increases will be partially offset by the repayment of approximately $2.0 billion in real estate loans which had a lower effective interest rate of LIBOR plus margin.

Interest Income

 

(In millions)

   Fiscal
2009
   Fiscal
2008
   Change  

Toys “R” Us—Consolidated

   $ 7    $ 16    $ (9

Interest income decreased by $9 million for fiscal 2009 compared to fiscal 2008 primarily due to lower effective interest rates in fiscal 2009.

 

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Income Tax Expense

 

(In millions)

   Fiscal
2009
    Fiscal
2008
    Change  

Toys “R” Us—Consolidated

   $ 40      $ 7      $ 33   

Consolidated effective tax rate

     11.6     3.2     8.4

The net increase in income tax expense of $33 million in fiscal 2009 compared to fiscal 2008 was principally due to the increase in pre-tax earnings. Other increases due to a change in the mix of pre-tax earnings, an increase in permanent items, and a net increase in valuation allowances and liabilities for unrecognized tax benefits, were offset by a benefit for the reversal of deferred tax liabilities associated with the undistributed earnings of two of our subsidiaries as it is management’s intention to permanently reinvest those earnings, as well as benefits associated with a change in the tax classification of certain foreign entities.

The U.S. Federal statutory tax rate is 35%. Our income tax expense in fiscal 2009 materially benefited from certain non-recurring items, including items related to our Foreign operations. As these non-recurring items may not provide a benefit in future periods, our income tax expense may be materially higher in these future periods. See Note 11 to our consolidated financial statements included elsewhere in this prospectus entitled “Income Taxes” for further details.

Fiscal 2008 Compared to Fiscal 2007

Net Earnings Attributable to Toys “R” Us, Inc.

 

(In millions)

   Fiscal
2008
   Fiscal
2007
   Change

Net earnings attributable to Toys “R” Us, Inc.

   $ 218    $ 153    $ 65

We generated Net earnings attributable to Toys “R” Us, Inc. of $218 million in fiscal 2008 compared to $153 million in fiscal 2007. Net earnings attributable to Toys “R” Us, Inc. increased primarily as a result of a decrease in Interest expense of $84 million, a decrease in Income tax expense of $58 million and an increase in Other income, net of $44 million (primarily due to $59 million of additional gift card breakage income—see Note 1 to our consolidated financial statements included elsewhere in this prospectus entitled “Summary of Significant Accounting Policies”), partially offset by a decrease in Gross margin of $59 million and an increase in SG&A of $55 million. Each of these changes includes the effect of foreign currency translation, which accounted for an approximate $17 million decrease in Net earnings attributable to Toys “R” Us, Inc.

Net Sales

 

     Fiscal
2008
   Fiscal
2007
   $
Change
    Percentage of Net sales  

($ In millions)

           %
Change
    Fiscal
2008
    Fiscal
2007
 

Domestic

   $ 8,480    $ 8,450    $ 30      0.4   61.8   61.3

International

     5,244      5,344      (100   (1.9 )%    38.2   38.7
                                        

Total Net sales

   $ 13,724    $ 13,794    $ (70   (0.5 )%    100.0   100.0
                                        

Net sales decreased by $70 million, or 0.5%, to $13,724 million in fiscal 2008 from $13,794 million in fiscal 2007. Net sales for fiscal 2008 included the impact of foreign currency translation that increased Net sales by approximately $47 million.

 

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Excluding the impact of foreign currency translation, the decrease in Net sales for fiscal 2008 was primarily due to decreased comparable store net sales across both of our segments, resulting primarily from the slowdown in the global economy which contributed to a decrease in the number of transactions in both of our segments and a lower average transaction amount at our International segment. Partially offsetting this decrease was Net sales from new Company operated stores and a higher average transaction amount at our Domestic segment.

Domestic

Net sales for the Domestic segment increased by $30 million, or 0.4%, to $8,480 million in fiscal 2008 from $8,450 million for fiscal 2007. The increase in Net sales was primarily a result of new wholly-owned stores, partially offset by a decrease in comparable store net sales of 0.1%.

The comparable store net sales decrease in fiscal 2008 was primarily a result of lower sales in our core toy, learning and seasonal categories, which were all affected by the overall slowdown in the economy. Core toys and learning also experienced declines in sales of mature product lines as well as poor performance of certain new product releases. These decreases were partially offset by increases in our entertainment category as a result of strong demand for video game systems, new video game software releases and related accessories. Our juvenile category was positively impacted by the conversion of certain stores to our SBS and SSBS store formats along with increased square footage devoted to juvenile products in our traditional toy stores, partially offset by decreases in baby gear and furniture sales.

International

Net sales for the International segment decreased by $100 million, or 1.9%, to $5,244 million for fiscal 2008, compared to $5,344 million for fiscal 2007. Excluding a $47 million increase in Net sales due to foreign currency translation, Net sales of our International segment decreased primarily due to a decrease in comparable store net sales of 3.4%, partially offset by increased Net sales from the addition of new Company operated stores.

The comparable store net sales decrease in fiscal 2008 was primarily impacted by decreases in our entertainment, core toy and seasonal categories, which we believe were affected by the slowdown in the global economy. Entertainment decreased primarily due to strong prior year sales of video game systems. Core toys decreased primarily due to strong prior year sales of licensed products. Sales of seasonal products decreased primarily due to a decrease in sales of outdoor products. Partially offsetting these decreases were increased sales in our juvenile category from the conversion of certain stores to our SBS store format along with increased square footage devoted to juvenile products in our traditional toy stores.

Cost of Sales and Gross Margin

 

                     Percentage of Net sales  

($ In millions)

   Fiscal
2008
   Fiscal
2007
   $
Change
    Fiscal
2008
    Fiscal
2007
    %
Change
 

Domestic

   $ 2,910    $ 2,902    $ 8      34.3   34.3   —     

International

     1,838      1,905      (67   35.0   35.6   (0.6 )% 
                                        

Total Gross margin

   $ 4,748    $ 4,807    $ (59   34.6   34.8   (0.2 )% 
                                        

Gross margin, as a percentage of Net sales, decreased by 0.2 percentage points and decreased $59 million in fiscal 2008 compared to fiscal 2007. The decrease in Gross margin, as a percentage of

 

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Net sales, was primarily due to price reductions taken in light of the slowdown in the global economy. Partially offsetting these decreases was a change in accounting method for valuing merchandise inventory at our Domestic segment, which contributed an approximate $30 million increase to our Gross margin. Additionally, Gross margin in fiscal 2008 included the impact of foreign currency translation that increased Gross margin by approximately $11 million.

Domestic

Gross margin increased by $8 million to $2,910 million in fiscal 2008 compared to $2,902 million in fiscal 2007. Gross margin, as a percentage of Net sales, in fiscal 2008 remained unchanged compared to fiscal 2007.

Gross margin, as a percentage of Net sales, was impacted by increases in allowances from vendors, and the change in accounting method for valuing merchandise inventory which contributed an approximate $30 million increase to our Gross margin, offset by increased sales of lower margin products, such as electronics and commodities.

International

Gross margin decreased by $67 million to $1,838 million in fiscal 2008 compared to $1,905 million in fiscal 2007. Gross margin in fiscal 2008 included the impact of foreign currency translation that increased Gross margin by approximately $11 million. Gross margin, as a percentage of Net sales, in fiscal 2008 decreased by 0.6 percentage points compared to fiscal 2007.

The decrease in Gross margin, as a percentage of Net sales, was primarily due to price reductions in light of the slowdown in the global economy, reduced discounts and allowances from vendors resulting from a reduction in inventory purchases. Partially offsetting these decreases were improvements in our sales mix toward higher margin products.

Selling, General and Administrative Expenses

 

                    Percentage of Net sales  

($ In millions)

   Fiscal
2008
   Fiscal
2007
   $
Change
   Fiscal
2008
    Fiscal
2007
    %
Change
 

Toys “R” Us—Consolidated

   $ 3,856    $ 3,801    $ 55    28.1   27.6   0.5

SG&A increased $55 million to $3,856 million in fiscal 2008 compared to $3,801 million in fiscal 2007. As a percentage of Net sales, SG&A increased by 0.5 percentage points. Foreign currency translation accounted for approximately $31 million of the increase.

In addition to the impact of foreign currency translation, the increase in SG&A was primarily due to increases in advertising and store occupancy expenses at our Domestic and International segments. Advertising expenses increased due to increases in print advertising and promotional activities to drive customer traffic to our stores, with a focus on the holiday shopping season. Store occupancy expenses increased primarily due to increased costs to support our new integrated strategy of constructing and converting existing stores to our SBS and SSBS store formats. Additionally, SG&A increased at our International segment due to a contract termination payment to McDonald’s Japan, which increased SG&A by $14 million. Partially offsetting these increases were decreases in Domestic store payroll, company-wide bonuses and corporate professional fees, as a result of cost-saving initiatives.

 

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Depreciation and Amortization

 

(In millions)

   Fiscal
2008
   Fiscal
2007
   Change
      

Toys “R” Us—Consolidated

   $ 399    $ 394    $ 5

Depreciation and amortization increased by $5 million to $399 million in fiscal 2008 compared to $394 million in fiscal 2007, primarily due to foreign currency translation.

Other Income, Net

 

(In millions)

   Fiscal
2008
   Fiscal
2007
   Change

Toys “R” Us—Consolidated

   $ 128    $ 84    $ 44

Other income increased by $44 million to $128 million in fiscal 2008 compared to $84 million in fiscal 2007. The increase was primarily due to the recognition of an additional $59 million of gift card breakage income as a result of the change in estimate effected by a change in accounting principle. In addition, the operations of TRU (HK) Limited, our wholly-owned subsidiary, were substantially liquidated in fiscal 2008. As a result, we recognized a $39 million gain representing a cumulative translation adjustment. Partially offsetting these increases was a decrease of $28 million in net gains on sales of properties, primarily due to a gain of $18 million on the sale of an idle distribution center and a $10 million gain on the consummation of a lease termination agreement during fiscal 2007. In addition, we recognized $20 million of additional impairment losses on long-lived assets as compared to the same period in the prior year.

See Note 1 to our consolidated financial statements included elsewhere in this prospectus entitled “Summary of Significant Accounting Policies” for further details.

Interest Expense

 

(In millions)

   Fiscal
2008
   Fiscal
2007
   Change  

Toys “R” Us—Consolidated

   $ 419    $ 503    $ (84

Interest expense decreased by $84 million for fiscal 2008 compared to fiscal 2007. The decrease in Interest expense was primarily due to lower average interest rates on our debt and a reduction of charges related to the changes in the fair values of our derivatives which are not designated for hedge accounting. See Note 2 to the consolidated financial statements included elsewhere in this prospectus entitled “Long-Term Debt” and Note 3 to our consolidated financial statements entitled “Derivative Instruments and Hedging Activities.”

Interest Income

 

(In millions)

   Fiscal
2008
   Fiscal
2007
   Change  

Toys “R” Us—Consolidated

   $ 16    $ 27    $ (11

Interest income decreased by $11 million for fiscal 2008 compared to fiscal 2007 primarily due to lower average interest rates in fiscal 2008.

 

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Income Tax Expense

 

(In millions)

   Fiscal
2008
    Fiscal
2007
    Change  

Toys “R” Us—Consolidated

   $ 7      $ 65      $ (58

Consolidated effective tax rate

     3.2     29.5     (26.3 )% 

The decrease in income tax expense of $58 million in fiscal 2008 compared to fiscal 2007 was due to a change in the mix of pre-tax earnings, a reduction in permanent items and net reductions in valuation allowances and liabilities for unrecognized tax benefits. See Note 11 to our consolidated financial statements included elsewhere in this prospectus entitled “Income Taxes” for further details.

Liquidity and Capital Resources

As of January 30, 2010, we were in compliance with all of our covenants related to our outstanding debt. On June 24, 2009, we amended and restated the credit agreement for our $2.1 billion secured revolving credit facility, which extended the maturity date on a portion of the facility and amended certain other provisions. As amended, the facility is bifurcated into two tranches, $517 million of which matures on July 21, 2010 with the remainder maturing on May 21, 2012 and with a current total credit availability of $2,148 million. Borrowings under this credit facility are secured by tangible and intangible assets of Toys “R” Us–Delaware, Inc. (“Toys–Delaware”), subject to specific exclusions stated in the credit agreement. Availability is determined pursuant to a borrowing base, consisting of specified percentages of eligible inventory and eligible credit card receivables less any applicable availability reserves. At January 30, 2010, we had no outstanding borrowings, a total of $109 million of outstanding letters of credit and had excess availability of $874 million. This amount is also subject to a minimum availability covenant, which was $125 million at January 30, 2010, with remaining availability of $749 million in excess of the covenant. See Note 2 to our consolidated financial statements included elsewhere in this prospectus entitled “Long-Term Debt” for further details regarding the borrowing base calculation.

Toys–Japan has credit agreements with a syndicate of financial institutions, which established two unsecured loan commitment lines of credit (“Tranche 1” and “Tranche 2”, respectively). Under the agreement, Tranche 1 is available in amounts of up to ¥20 billion ($222 million at January 30, 2010), and expires in fiscal 2011. At January 30, 2010, we had no outstanding debt under Tranche 1 with $222 million of availability. On March 30, 2009, Toys–Japan refinanced Tranche 2 resulting in amounts of up to ¥12.6 billion ($140 million at January 30, 2010), expiring in fiscal 2010. At January 30, 2010, we had no outstanding debt under Tranche 2 with $140 million of availability. This agreement contains covenants, including, among other things, covenants that require Toys–Japan to maintain a certain minimum level of net assets and profitability during the agreement terms. The agreement also restricts us from reducing our ownership percentage in Toys–Japan.

On February 26, 2010, Toys–Japan entered into an agreement with a syndicate of financial institutions to refinance Tranche 2. Additionally, on March 29, 2010, Toys–Japan modified Tranche 2 to include an additional lender. As a result, Tranche 2 became available in amounts of up to ¥14.0 billion ($149 million at May 1, 2010), expiring on March 28, 2011.

In fiscal 2009, certain of our foreign subsidiaries entered into a European and Australian secured revolving credit facility (“European ABL”), which provides for a three-year £124 million ($198 million at January 30, 2010) senior secured asset-based revolving credit facility and which expires on October 15, 2012. Borrowings under the European ABL are secured by and subject to, among other things, the terms of a borrowing base derived from the value of eligible inventory and eligible accounts receivable of certain of Toys “R” Us Europe, LLC’s (“Toys Europe”) and Toys “R” Us Australia Holdings, LLC’s (“Toys Australia”) subsidiaries. The European ABL contains covenants that, among

 

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other things, restrict the ability of Toys Europe and Toys Australia and their respective subsidiaries to incur certain additional indebtedness, create or permit liens on assets, repurchase or pay dividends or make certain other restricted payments on capital stock, make acquisitions and investments or engage in mergers or consolidations. At January 30, 2010, we had no outstanding borrowings and $71 million of availability under the European ABL. See Note 2 to our consolidated financial statements included elsewhere in this prospectus entitled “Long-Term Debt” for further details regarding the borrowing base calculation.

Due to the deterioration in the credit markets, some financial institutions have reduced and, in certain cases, ceased to provide funding to borrowers. We are dependent on the borrowings provided by the lenders to support our working capital needs and capital expenditures. Currently we have funds available to finance our operations under our $2.1 billion secured revolving credit facility through May 2012, our European ABL through October 2012 and our Toys–Japan unsecured credit lines through March 2011. Our lenders may be unable to fund borrowings under their credit commitments to us if a lender faces bankruptcy, failure, collapse or sale. If our cash flow and capital resources do not provide the necessary liquidity, such an event could have a significant negative effect on our results of operations.

In general, our primary uses of cash are providing for working capital, which principally represents the purchase of inventory, servicing debt, financing construction of new stores, remodeling existing stores, and paying expenses, such as payroll costs, 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. Peak borrowings under our revolving credit facilities and credit lines amounted to $784 million and have been repaid as of January 30, 2010. Our largest source of operating cash flows is cash collections from our customers. We have been able to meet our cash needs principally by using cash on hand, cash flows from operations and borrowings under our revolving credit facilities and credit lines.

Although we believe that cash generated from operations along with existing cash, revolving credit facilities and credit lines will be sufficient to fund expected cash flow requirements and planned capital expenditures for at least the next 12 months, continued world-wide financial market disruption may have a negative impact on our financial performance and financial position in the future. Our minimum projected obligations for fiscal 2010 and beyond are set forth below under “—Contractual Obligations.”

Capital Expenditures

A component of our long-term strategy is our capital expenditure program. Our capital expenditures are primarily for financing construction of new stores, remodeling existing stores, as well as improving and enhancing our information technology systems. Throughout 2009 we curtailed our capital spending due to the prevailing economic environment. For fiscal 2010, we plan to increase our capital spending to grow our business through a continued focus on our integrated strategy, recognizing the synergies between our toy and juvenile (including baby) categories.

During fiscal 2009 we invested $192 million in property and equipment, including opening 16 new stores, expanding and remodeling existing stores, and upgrading our information technology systems and capabilities. Capital expenditures are funded primarily through cash provided by operating activities, as well as available cash.

 

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The following table presents our capital expenditures for each of the past three fiscal years:

 

(In millions)

   Fiscal
2009
   Fiscal
2008
   Fiscal
2007

New stores(1)

   $ 39    $ 98    $ 67

Conversion projects(2)

     28      109      63

Other store-related projects(3)

     53      95      99

Information technology

     45      72      70

Distributions centers

     27      21      27
                    

Total capital expenditures

   $ 192    $ 395    $ 326
                    

 

(1) Includes SSBS relocations.
(2) Includes SBS conversions and other remodels pursuant to our juvenile integration strategy.
(3) Includes other store-related maintenance projects (other than conversion projects) such as store updates and expenses incurred in connection with the maintenance of our stores.

In addition, in fiscal 2010, we have budgeted approximately $396 million for capital expenditures. We expect to spend approximately $135 million on SBS conversion projects and other remodeling efforts and approximately $88 million on other store-related projects and $68 million on opening new stores including relocations to SSBS. The SBS conversion projects in 2010 for our side-by-side stores in the U.S. are budgeted on average at $2.1 million; our conversion projects in 2010 for our side-by-side stores internationally are budgeted on average at approximately $1.2 million; and new stores are budgeted on average at approximately $2.8 million, approximately $2.2 million, and approximately $4.2 million for domestic SBS stores, international SBS stores and “R” Superstores, respectively.

Cash Flows

 

(In millions)

   Fiscal
2009
    Fiscal
2008
    Fiscal
2007
 

Net cash provided by operating activities

   $ 1,014      $ 525      $ 527   

Net cash used in investing activities

     (37     (259     (416

Net cash used in financing activities

     (626     (223     (152

Effect of exchange rate changes on cash and cash equivalents

     (8     (11     27   
                        

Net increase (decrease) during period in cash and cash equivalents

   $ 343      $ 32      $ (14
                        

Cash Flows Provided by Operating Activities

Net cash provided by operating activities for fiscal 2009 was $1,014 million, an increase of $489 million compared to fiscal 2008. The increase in net cash provided by operating activities was primarily the result of decreased payments on accounts payable due to the timing of vendor payments at year-end, a reduction in SG&A primarily attributable to initiatives to reduce overall operating expenses and decreased payments for income taxes.

Net cash provided by operating activities for fiscal 2008 was $525 million, a decrease of $2 million compared to fiscal 2007. The decrease in cash provided by operating activities was primarily the result of increased payments on accounts payable due to the timing of vendor payments, increased payments for income taxes and decreased gross margins from operations. The decrease was partially offset by decreased purchases of merchandise inventories due to the slowdown in the global economy and lower interest payments due to lower average interest rates.

Cash Flows Used in Investing Activities

Net cash used in investing activities for fiscal 2009 was $37 million, a decrease of $222 million compared to fiscal 2008. The decrease in net cash used in investing activities was primarily due to a decrease of $214 million in restricted cash primarily as a result of the repayment of our $1,267 million

 

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unsecured credit agreement and our $800 million secured real estate loans, and a reduction in capital expenditures of $203 million due to the curtailment of capital spending as a result of the slowdown in the economy. These changes were partially offset by a decrease of $167 million from the sale of short-term investments in fiscal 2008.

Net cash used in investing activities for fiscal 2008 was $259 million, a decrease of $157 million compared to fiscal 2007. The decrease in net cash used in investing activities was primarily related to the purchase of $168 million of short-term investments in fiscal 2007 and subsequent sale in fiscal 2008 of $167 million of those investments resulting in a net decrease of $335 million. The decrease was partially offset by an $81 million increase in the change in restricted cash and increases in capital expenditures of $69 million.

Cash Flows Used in Financing Activities

Net cash used in financing activities was $626 million for fiscal 2009, an increase of $403 million compared to fiscal 2008. The increase in net cash used in financing activities was primarily due to the repayment of our $1,267 million unsecured credit agreement, the repayment of $800 million of our secured real estate loans, an increase of $104 million in debt issuance costs and an increase of $32 million related to purchases of Toys–Japan common stock. These increases were partially offset by the proceeds of $925 million received from the offering of senior unsecured 10.75% notes due 2017, the proceeds of $715 million received from the offering of senior secured 8.50% notes due 2017 and the reduced repayments on our Toys–Japan credit lines of $147 million as compared to the prior year.

See the description of changes to our debt structure below, as well as Note 2 to our consolidated financial statements included elsewhere in this prospectus entitled “Long-Term Debt” for more information.

Net cash used in financing activities was $223 million for fiscal 2008, an increase of $71 million from fiscal 2007. The increase in net cash used in financing activities was primarily due to increased repayments of our Toys–Japan unsecured credit lines of $119 million, due to the timing of merchandise payments and purchase of $34 million of additional shares of Toys–Japan. These increases were partially offset by a repayment of $44 million of our $200 million asset sale facility in fiscal 2007 and increased finance obligations of $33 million associated with capital project financing.

Debt

Our credit facilities, loan agreements and indentures contain customary covenants, including, among other things, covenants that restrict our ability to incur certain additional indebtedness, create or permit liens on assets, engage in mergers or consolidations, and place restrictions on the ability of certain of our subsidiaries to provide funds to us through dividends, loans or advances. The amount of net assets that were subject to these restrictions was approximately $709 million as of January 30, 2010. Certain of our agreements also contain various and customary events of default with respect to the loans, including, without limitation, the failure to pay interest or principal when the same is due under the agreements, cross default provisions, the failure of representations and warranties contained in the agreements to be true and certain insolvency events. If an event of default occurs and is continuing, the principal amounts outstanding thereunder, together with all accrued unpaid interest and other amounts owed thereunder, may be declared immediately due and payable by the lenders. Were such an event to occur, we would be forced to seek new financing that may not be on as favorable terms as our current facilities or be available at all. As of January 30, 2010, our total indebtedness of $5,196 million, of which $2,588 million was secured indebtedness, and included three facilities: our $2.1 billion secured revolving credit facility, our European ABL and our Toys–Japan unsecured credit lines. We had no outstanding borrowings on any of the three facilities as of January 30, 2010. Our

 

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ability to refinance our indebtedness on favorable terms, or at all, is directly affected by the current global economic and financial conditions and other economic factors that may be outside our control. In addition, our ability to incur secured indebtedness (which may enable us to achieve better pricing than the incurrence of unsecured indebtedness) depends in part on the covenants in our credit facilities and indentures and the value of our assets, which depends, in turn, on the strength of our cash flows, results of operations, economic and market conditions and other factors. We are currently in compliance with our financial covenants relating to our debt. See Note 2 to our consolidated financial statements included elsewhere in this prospectus entitled “Long-Term Debt” for more information regarding our debt covenants.

During fiscal 2009, we made the following significant changes to our debt structure:

 

  Ÿ  

On March 30, 2009, Toys–Japan entered into an agreement with a syndicate of financial institutions to refinance Tranche 2. As a result, Tranche 2 is available in amounts of up to ¥12.6 billion ($140 million at January 30, 2010), and expires in fiscal 2010. Tranche 2 was subsequently refinanced, as described below.

 

  Ÿ  

On June 24, 2009, Toys–Delaware and certain of its subsidiaries amended and restated the credit agreement for their $2.0 billion five-year secured revolving credit facility in order to extend the maturity date of a portion of the facility and amend certain other provisions. As amended, the facility was bifurcated into two tranches, $517 million of which matures on July 21, 2010 with the remainder maturing on May 21, 2012. On November 13, 2009, we partially exercised the accordion feature of this secured revolving credit facility, increasing the credit available, subject to borrowing base restrictions, from $2,043 million to $2,148 million.

 

  Ÿ  

On July 9, 2009, TRU Propco I, formerly known as TRU 2005 RE Holding Co. I, LLC, one of our wholly-owned subsidiaries, completed the offering of $950 million aggregate principal amount of senior unsecured 10.75% notes due 2017 (the “Notes”). The Notes were issued at a discount of $25 million, which resulted in the receipt of proceeds of $925 million. The proceeds of $925 million from the offering of the Notes, together with $263 million of cash on hand and $99 million of restricted cash released from restrictions were used to repay the outstanding loan balance under TRU Propco I’s unsecured credit agreement of $1,267 million plus accrued interest of approximately $1 million and fees at closing of approximately $19 million.

 

  Ÿ  

On October 15, 2009, certain of our foreign subsidiaries entered into a European ABL, which provides for a three-year £112 million ($179 million at January 30, 2010) secured revolving credit facility which expires October 15, 2012. On November 19, 2009, we partially exercised the accordion feature of the European ABL increasing the credit available, subject to borrowing base restrictions, from £112 million to £124 million ($198 million at January 30, 2010).

 

  Ÿ  

On November 20, 2009, TRU Propco II, formerly known as Giraffe Properties, LLC, an indirect wholly-owned subsidiary of ours, completed the offering of $725 million aggregate principal amount of senior secured 8.50% notes due 2017 (the “Secured Notes”). The Secured Notes were issued at a discount of $10 million which resulted in the receipt of proceeds of $715 million. The proceeds of $715 million, together with $93 million in cash on hand and the release of $22 million in cash from restrictions, were used to repay TRU Propco II’s outstanding loan balance under a secured real estate loan agreement of $600 million, plus accrued interest of approximately $1 million and fees paid or accrued at closing of approximately $29 million, inclusive of fees payable to the Sponsors pursuant to their advisory agreement. In addition, in connection with the offering, MPO Properties, LLC an indirect wholly-owned subsidiary, repaid its secured real estate loans of $200 million plus accrued interest and fees.

 

  Ÿ  

Three of the multiple Toys–Japan bank loans, representing $127 million in aggregate, mature in January 2011. As such, these amounts were classified as Current portion of long-term debt on our consolidated balance sheet as of January 30, 2010.

 

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On February 26, 2010, Toys–Japan entered into an agreement with a syndicate of financial institutions to refinance Tranche 2, which was previously available in amounts of up to ¥12.6 billion ($140 million at January 30, 2010). Additionally, on March 29, 2010, Toys–Japan modified Tranche 2 to include an additional lender. As a result, Tranche 2 became available in amounts of up to ¥14.0 billion ($149 million at May 1, 2010), expiring on March 28, 2011.

We and our subsidiaries, as well as the Sponsors or their affiliates, may from time to time acquire debt or debt securities issued by us or our subsidiaries in open market transactions, tender offers, 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. See Note 17 to our consolidated financial statements included elsewhere in this prospectus entitled “Related Party Transactions.”

Contractual Obligations

Our contractual obligations consist mainly of payments related to Long-term debt and related interest, operating leases related to real estate used in the operation of our business and product purchase obligations. The following table summarizes our contractual obligations associated with our Long-term debt and other obligations as of January 30, 2010:

 

     Payments Due By Period

(In millions)

   Fiscal
2010
   Fiscals
2011 & 2012
   Fiscals
2013 & 2014
   Fiscals
2015 and
thereafter
   Total

Operating leases

   $ 556    $ 1,010    $ 806    $ 1,683    $ 4,055

Less: sub-leases to third parties

     18      27      17      15      77
                                  

Net operating lease obligations

     538      983      789      1,668      3,978

Capital lease obligations

     33      46      32      95      206

Long-term debt(1)

     145      1,780      1,053      2,070      5,048

Interest payments(2)

     413      683      415      571      2,082

Purchase obligations(3)

     1,280      —        —        —        1,280

Other(4)

     137      149      73      57      416
                                  

Total contractual obligations(5)

   $ 2,546    $ 3,641    $ 2,362    $ 4,461    $ 13,010
                                  

 

(1) Reflects the issuance of $950 million of 10.75% Senior Notes by TRU Propco I on July 9, 2009 and the issuance of $725 million of 8.50% Senior Secured Notes by TRU Propco II on November 20, 2009, the proceeds of which were used to repay the outstanding loan balance of $1,267 million and $800 million plus accrued interest and fees, respectively. See Note 2 to our consolidated financial statements entitled “Long-Term Debt” for further details.
(2) In an effort to manage interest rate exposures, we periodically enter into interest rate swaps and interest rate caps.
(3) Purchase obligations consist primarily of open purchase orders for merchandise as well as an agreement to purchase fixed or minimum quantities of goods that are not included in our consolidated balance sheet as of January 30, 2010.
(4) Includes pension obligations, risk management liabilities, and other general obligations and contractual commitments.
(5) The above table does not reflect liabilities for uncertain tax positions of $97 million, which includes $10 million of current liabilities. The amount and timing of payments with respect to these items are subject to a number of uncertainties such that we are unable to make sufficiently reliable estimates of the timing of future payments.

 

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Obligations under our operating leases and capital leases in the above table do not include contingent rent payments, payments for maintenance and insurance, or real estate taxes. The following table presents these amounts which were recorded in SG&A in our consolidated statement of operations for fiscals 2009, 2008 and 2007:

 

(In millions)

   Fiscal
2009
   Fiscal
2008
   Fiscal
2007

Real estate taxes

   $ 67    $ 62    $ 60

Maintenance and insurance

     62      55      47

Contingent rent

     10      9      10
                    

Total

   $ 139    $ 126    $ 117
                    

Off-balance Sheet Arrangements

We have an off-balance sheet arrangement as a result of the February 2006 credit agreement between Toys “R” Us Properties (UK) Limited (“Toys U.K. Properties”) and Vanwall Finance PLC (“Vanwall”), a special purpose entity established with the limited purpose of issuing notes, and entering into the credit agreement with Toys Properties. On February 9, 2006, Vanwall issued $620 million of multiple classes of commercial mortgage backed floating rate notes to third party investors, which are publicly traded on the Irish Stock Exchange Limited. The proceeds from the floating rate notes issued by Vanwall were used to fund the Senior Loan to Toys U.K. Properties. Pursuant to the credit agreement, Vanwall is required to maintain an interest rate swap which effectively fixes the variable LIBOR rate at 4.56%, the same as the fixed interest less the applicable credit spread paid by Toys U.K. Properties to Vanwall. The fair value of this interest rate swap at January 30, 2010 and January 31, 2009 was a liability of approximately $40 million and $39 million, respectively. Management performed an analysis in accordance with ASC Topic 810 (“ASC 810”), formerly Financial Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” and concluded that Vanwall should not be consolidated. The Company has not identified any subsequent changes to Vanwall’s governing documents or contractual arrangements that would change the characteristics or adequacy of the entity’s equity investment at risk in accordance with reconsideration guidance of ASC 810. See Note 2 to our consolidated financial statement included elsewhere in this prospectus entitled “Long-Term Debt” for further details.

Credit Ratings

As of May 27, 2010, our current credit ratings, which are considered non-investment grade, were as follows:

 

     Moody’s    Standard and Poor’s

Long-term debt

   B2    B

Outlook

   Positive    Stable

On November 9, 2009, Moody’s and Standard & Poor’s revised its outlook on the Company from Stable to Positive and Negative to Stable, respectively. The outlook revision reflects reduced refinancing risk, effective execution of our merchandising strategies, cost-control measures, and management success with its initiatives, including the store conversion strategy.

Other credit ratings for our debt are available; however, we have disclosed only the ratings of the two leading nationally recognized statistical rating organizations.

 

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Our current credit ratings, as well as any adverse future actions taken by the rating agencies with respect to our debt ratings, could negatively impact our ability to finance our operations on satisfactory terms and could have the effect of increasing our financing costs. Our debt instruments do not contain provisions requiring acceleration of payment upon a debt rating downgrade.

The rating agencies may, in the future, revise the ratings on our outstanding debt.

The above information regarding credit ratings and ratings outlook assigned to our indebtedness by Moody’s and Standard & Poor’s are opinions of our ability to meet our ongoing obligations. Credit ratings are not recommendations to buy, sell or hold securities and are subject to revision or withdrawal at any time by the assigning rating agency. Each agency’s rating should be evaluated independently of any other agency’s rating.

Critical Accounting Policies

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The Financial Accounting Standards Board (“FASB”) finalized the Codification or ASC, which is effective for periods ending on or after September 15, 2009. The ASC does not change how we account for our transactions or the nature of the related disclosures made. Any references to guidance issued by the FASB in this prospectus are to the ASC, in addition to the other legacy standards.

The preparation of these financial statements requires us to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosures of contingent assets and liabilities as of the date of the consolidated financial statements and during the applicable periods. We base these estimates on historical experience and on other factors that we believe are reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions and could have a material impact on our consolidated financial statements.

We believe the following are our most critical accounting policies that include significant judgments and estimates used in the preparation of our consolidated financial statements. We consider an accounting policy to be critical if it requires assumptions to be made that were uncertain at the time they were made, and if changes in these assumptions could have a material impact on our consolidated financial condition or results of operations.

Merchandise Inventories

We value our merchandise inventories at the lower of cost or market, as determined by the weighted average cost method. Cost of sales under the weighted average cost method represents the weighted average cost of the individual items sold. Cost of sales under the weighted average cost method is also affected by adjustments to reflect current market conditions, merchandise allowances from vendors, expected inventory shortages and estimated losses from obsolete and slow-moving inventory.

Merchandise inventories and related reserves are reviewed on an interim basis and adjusted, as appropriate, to reflect management’s current estimates. These estimates are derived using available data, our historical experience, estimated inventory turnover and current purchase forecasts. Various types of negotiated allowances received from our vendors are generally treated as adjustments to the purchase price of our Merchandise inventories. We adjust our estimates for vendor allowances and our provision for expected inventory shortage to actual amounts at the completion of our physical inventory counts and finalization of all vendor allowance agreements. In addition, we perform an inventory-aging

 

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analysis for identifying obsolete and slow-moving inventory. We establish a reserve to reduce the cost of our inventory to its estimated net realizable value based on certain loss indicators which include aged inventory and excess supply on hand, as well as specific identification methods.

Our estimates may be impacted by changes in certain underlying assumptions and may not be indicative of future activity. For example, factors such as slower inventory turnover due to changes in competitors’ tactics, consumer preferences, consumer spending and inclement weather could cause excess inventory requiring greater than estimated markdowns to entice consumer purchases. Such factors could also cause sales shortfalls resulting in reduced purchases from vendors and an associated reduction in vendor allowances. Based on our inventory aging analysis for identifying obsolete and slow-moving inventory, a 10% change in our reserve would have impacted pre-tax earnings by approximately $4 million for fiscal 2009.

Store Closures and Long-lived Asset Impairment

Based on an overall analysis of store performance and expected trends, management periodically evaluates the need to close underperforming stores. Reserves are established at the time of closing for the present value of any remaining operating lease obligations, net of estimated sublease income, and at the communication date for severance, as prescribed by ASC Topic 420, formerly SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” A key assumption in calculating the reserves is the estimation of sublease income. If actual experience differs from our estimates, the resulting reserves could vary from recorded amounts. Reserves are reviewed periodically and adjusted when necessary.

We also evaluate the carrying value of all long-lived assets, such as property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable, in accordance with ASC 360. We will record an impairment loss when the carrying value of the underlying asset group exceeds its estimated fair value.

In determining whether long-lived assets are recoverable, our estimate of undiscounted future cash flows over the estimated life or lease term of a store is based upon our experience, historical operations of the store, an estimate of future store profitability and economic conditions. The future estimates of store profitability and economic conditions require estimating such factors as sales growth, inflation and the overall economics of the retail industry. Since we forecast our future undiscounted cash flows for up to 25 years, our estimates are subject to variability as future results can be difficult to predict. If a long-lived asset is found to be non-recoverable, we record an impairment charge equal to the difference between the asset’s carrying value and fair value. We estimate the fair value of a reporting unit or asset using a valuation method such as discounted cash flow or a relative, market-based approach.

In fiscal 2009, we recorded $7 million of impairment charges related to non-recoverable long-lived assets. These impairments were primarily due to the identification of underperforming stores, the relocation of certain stores and a decrease in real estate market values. In the future, we plan to relocate additional stores which may result in additional asset impairments.

Goodwill Impairment

Goodwill is evaluated for impairment annually or whenever we identify certain triggering events or circumstances that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Events or circumstances that might indicate an interim evaluation is warranted include, among other things, unexpected adverse business conditions, economic factors, unanticipated competitive activities, loss of key personnel and acts by governments and courts.

 

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In accordance with ASC 350, we test for goodwill impairment by comparing the fair values and carrying values of our reporting units as of the first day of the fourth quarter of each fiscal year, or November 1, 2009 for fiscal 2009. Our Domestic reporting unit had $361 million of goodwill at January 30, 2010. Our Toys–Japan reporting unit (included in our International segment) had $21 million of goodwill at January 30, 2010.

We estimate the fair values of our reporting units by blending results from the market multiples approach and the income approach. These valuation approaches consider a number of factors that include, but are not limited to, expected future cash flows, growth rates, discount rates, and comparable multiples from publicly traded companies in our industry, and require us to make certain assumptions and estimates regarding industry economic factors and future profitability of our business. It is our policy to conduct impairment testing based on our most current business plans, projected future revenues and cash flows, which reflect changes we anticipate in the economy and the industry. The cash flows are based on five-year financial forecasts developed internally by management and are discounted to a present value using discount rates that properly account for the risk and nature of the respective reporting unit’s cash flows and the rates of return market participants would require to invest their capital in our reporting units. If the carrying value exceeds the fair value, we would then calculate the implied fair value of our reporting unit goodwill as compared to its carrying value to determine the appropriate impairment charge. Although we believe our assumptions are reasonable, actual results may vary significantly and may expose us to material impairment charges in the future. Our methodology for determining fair values remained consistent for the periods presented.

At November 1, 2009, we determined that none of the goodwill associated with our reporting units were impaired. The estimated fair value of our Domestic reporting unit substantially exceeded its carrying value at the date of testing. The estimated fair value of our Toys–Japan reporting unit exceeded the carrying value. We believe it is unlikely that we are at risk for material impairment charges if further decreases in Toys–Japan’s fair value occur in the foreseeable future. In addition, we applied a hypothetical 10% decrease to the fair values of each reporting unit, which at November 1, 2009, would not have triggered additional impairment testing and analysis.

Self-Insured Liabilities

We self-insure a substantial portion of our workers’ compensation, general liability, auto liability, property, medical, prescription drug and dental insurance risks, in addition to maintaining third party insurance coverage. We estimate our provisions for losses related to self-insured risks using actuarial techniques and estimates for incurred but not reported claims. We record the liability for workers’ compensation on a discounted basis. We also maintain insurance coverage to limit the exposure related to certain risks. The assumptions underlying the ultimate costs of existing claim losses can vary, which can affect the liability recorded for such claims.

Although we feel our reserves are adequate to cover our estimated liabilities, changes in the underlying assumptions and future economic conditions could have a considerable effect upon future claim costs, which could have a material impact on our consolidated financial statements. Our reserve for self-insurance was $93 million as of January 30, 2010. A 10% change in the value of our self-insured liabilities would have impacted pre-tax earnings by approximately $10 million for the fiscal year ended January 30, 2010.

Revenue Recognition

We recognize revenue in accordance with ASC Topic 605, formerly SEC Staff Accounting Bulletin No. 104 “Revenue Recognition.” Revenue related to merchandise sales, which is approximately 99.4% of total revenues, is generally recognized for retail sales at the point of sale in the store and when the

 

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customer receives the merchandise shipped from our websites. Discounts provided to customers are accounted for as a reduction of sales. We record a reserve for estimated product returns in each reporting period based on historical return experience and changes in customer demand. Actual returns may differ from historical product return patterns, which could impact our financial results in future periods.

Gift Cards and Breakage

We sell gift cards to customers in our retail stores, through our websites and through third parties and, in certain cases, provide gift cards for returned merchandise and in connection with promotions. We recognize income from gift card sales when the customer redeems the gift card, as well as an estimated amount of unredeemed liabilities (“breakage”). Gift card breakage is recognized proportionately, based on management estimates and assumptions of redemption patterns, the useful life of the gift card and an estimated breakage rate of unredeemed liabilities. Our estimated gift card breakage represents the remaining unused portion of the gift card liability for which the likelihood of redemption is remote and for which we have determined that we do not have a legal obligation to remit the value to the relevant jurisdictions. Income related to customer gift card redemption is included in Net sales, whereas income related to gift card breakage is recorded in Other income, net in the consolidated statements of operations.

During fiscal 2009, we recognized $20 million of net gift card breakage income. A change of 10% in the estimated gift card breakage rate would have impacted our pre-tax earnings by approximately $2 million for the fiscal year ended January 30, 2010.

Income Taxes

We account for income taxes in accordance with ASC Topic 740 (“ASC 740”), formerly SFAS No. 109, “Accounting for Income Taxes.” Our provision for income taxes and effective tax rates are calculated by legal entity and jurisdiction and are based on a number of factors, including our income tax planning strategies, differences between tax laws and accounting rules, statutory tax rates and credits, uncertain tax positions, and valuation allowances. We use significant judgment and estimates in evaluating our tax positions.

Tax law and accounting rules often differ as to the timing and treatment of certain items of income and expense. As a result, the tax rate reflected in our tax return (our current or cash tax rate) is different from the tax rate reflected in our consolidated financial statements. Some of the differences are permanent, while other differences are temporary as they reverse over time. We record deferred tax assets and liabilities for any temporary differences between the assets and liabilities in our consolidated financial statements and their respective tax bases. We establish valuation allowances when we believe it is more likely than not that our deferred tax assets will not be realized. For example, we would establish a valuation allowance for the tax benefit associated with a loss carryforward in a tax jurisdiction if we did not expect to generate sufficient taxable income to utilize the loss carryforward. Changes in future taxable income, tax liabilities and our tax planning strategies may impact our effective tax rate, valuation allowances and the associated carrying value of our deferred tax assets and liabilities.

At any one time our tax returns for various tax years are subject to examination by U.S. Federal, foreign, and state taxing jurisdictions. We establish tax liabilities in accordance with FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” also codified under ASC 740. ASC 740 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold and measurement attributes for income tax positions taken or expected to be taken on a tax return. Under ASC 740, the impact of an uncertain tax position taken or expected to be taken on an income tax return must be recognized in the financial

 

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statements at the largest amount that is more-likely-than-not to be sustained. An uncertain income tax position will not be recognized in the financial statements unless it is more-likely-than-not to be sustained. We adjust these tax liabilities, as well as the related interest and penalties, based on the latest facts and circumstances, including recently published rulings, court cases, and outcomes of tax audits. To the extent our actual tax liability differs from our established tax liabilities for unrecognized tax benefits, our effective tax rate may be materially impacted. While it is often difficult to predict the final outcome of, the timing of, or the tax treatment of any particular tax position or deduction, we believe that our tax balances reflect the more-likely-than-not outcome of known tax contingencies.

Recently Adopted Accounting Pronouncements

On August 2, 2009, we adopted ASC Topic 105 (“ASC 105”), formerly SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles—A Replacement of FASB Statement No. 162.” ASC 105 establishes the FASB Accounting Standards Codification, which officially launched July 1, 2009, as the source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. The subsequent issuances of new standards will be in the form of Accounting Standards Updates (“ASU”) that will be included in the Codification. The Codification does not change how we account for our transactions or the nature of the related disclosures made. Any references to guidance issued by the FASB in this prospectus are to the Codification, in addition to the other legacy standards.

On May 3, 2009, we adopted ASC Topic 855 (“ASC 855”), formerly SFAS No. 165, “Subsequent Events.” ASC 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This pronouncement is effective for interim or annual financial periods ending after June 15, 2009, and shall be applied prospectively. The adoption of ASC 855 did not have a material impact on the consolidated financial statements.

On February 1, 2009, we adopted SFAS No. 161 “Disclosures about Derivative Instruments and Hedging Activities—An Amendment of FASB Statement No. 133,” which has been incorporated into the Codification under ASC Topic 815 (“ASC 815”). ASC 815 establishes the disclosure requirements for derivative instruments and for hedging activities with the intent to provide financial statement users with an enhanced understanding of the entity’s use of derivative instruments, the accounting of derivative instruments and related hedged items under Statement 133 and its related interpretations, and the effects of these instruments on the entity’s financial position, financial performance, and cash flows. Other than the enhanced disclosures, the adoption of the amendment to ASC 815 had no impact on the consolidated financial statements. See Note 3 of our consolidated financial statements included elsewhere in this prospectus entitled “Derivative Instruments and Hedging Activities” for further details.

On February 1, 2009, we adopted ASC Topic 810 (“ASC 810”), formerly SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—An Amendment of ARB No. 51.” ASC 810 requires a company to clearly identify and present ownership interests in subsidiaries held by parties other than the company in the consolidated financial statements within the equity section but separate from the company’s equity. ASC 810 also requires the amount of consolidated net earnings attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income; changes in ownership interest be accounted for similarly, as equity transactions; and when a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary and the gain or loss on the deconsolidation of the subsidiary be measured at fair value. The presentation and disclosure requirements of ASC 810 were applied retrospectively.

 

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In February 2010, the FASB issued ASU No. 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements” (“ASU 2010-09”). The amendments remove the requirement for an SEC filer to disclose a date through which subsequent events have been evaluated in both issued and revised financial statements. ASU 2010-09 was effective upon issuance. Its adoption did not have a material impact on the consolidated financial statements.

In January 2010, the FASB issued ASU No. 2010-02, “Consolidation (Topic 810)—Accounting and Reporting for Decreases in Ownership of a Subsidiary—A Scope Clarification” (“ASU 2010-02”). This ASU provides amendments to ASC 810 to clarify the scope of the decrease in ownership provisions of the Subtopic and related guidance as it applies to a subsidiary or group of assets that is a business, a subsidiary that is a business and is transferred to an equity method investee or joint venture, and an exchange of a group of assets that constitutes a business for a noncontrolling interest in an entity. The amendments in this update also clarify that the decrease in ownership guidance does not apply to certain transactions, such as sales of in substance real estate, even if they involve businesses. ASU 2010-02 is effective beginning in the period that an entity adopts ASC 810 and should be applied retrospectively to the first period that an entity adopts ASC 810. Its adoption did not have a material impact on the consolidated financial statements.

On November 1, 2009, we adopted ASU No. 2009-05, “Fair Value Measurements and Disclosures (Topic 820)—Measuring Liabilities at Fair Value” (“ASU 2009-05”) which represents an update to ASC Topic 820 (“ASC 820”). ASU 2009-05 provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the following techniques: 1) a valuation technique that uses either the quoted price of the identical liability when traded as an asset or quoted prices for similar liabilities or similar liabilities when traded as an asset; or 2) another valuation technique that is consistent with the principles in ASC 820 such as the income and market approach to valuation. The amendments in this update also clarify that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. This update further clarifies that if the fair value of a liability is determined by reference to a quoted price in an active market for an identical liability, that price would be considered a Level 1 measurement in the fair value hierarchy. Similarly, if the identical liability has a quoted price when traded as an asset in an active market, it is also a Level 1 fair value measurement if no adjustments to the quoted price of the asset are required. This update is effective for the first reporting period (including interim periods) beginning after issuance. The adoption of ASU 2009-05 did not have an impact on the consolidated financial statements.

In August 2009, the FASB issued ASU No. 2009-04, “Accounting for Redeemable Equity Instruments” (“ASU 2009-04”), which represents an update to ASC Topic 480, “Distinguishing Liabilities from Equity,” and provides guidance on what type of instruments should be classified as temporary versus permanent equity, as well as guidance regarding measurement. ASU 2009-04 is effective for the first reporting period, including interim periods, beginning after issuance. The adoption of ASU 2009-04 did not have an impact on the consolidated financial statements.

In April 2009, SFAS No. 107, “Disclosures about Fair Value of Financial Instruments” and Accounting Principles Board (“APB”) Opinion 28, “Interim Financial Reporting” were amended by FASB Staff Position (“FSP”) SFAS 107-1 and APB Opinion 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” and incorporated into the Codification under ASC Topic 825 (“ASC 825”) and ASC Topic 270 (“ASC 270”), respectively. These amendments enhance the consistency in financial reporting by increasing the frequency of fair value disclosures. We adopted the disclosure requirements for fair value of financial instruments, as prescribed by ASC 825 and ASC 270 on May 3, 2009. The adoption did not have a material impact on the consolidated financial statements.

 

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On February 1, 2009, we adopted SFAS No. 141(R) “Business Combinations,” as amended by FSP SFAS 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies” (“FSP SFAS 141 (R)-1”), which have been incorporated into the Codification under ASC Topic 805 (“ASC 805”). ASC 805 states that all business combinations (whether full, partial or step acquisitions) will result in all assets and liabilities of an acquired business being recorded at their fair values. Certain forms of contingent consideration and certain acquired contingencies will be recorded at fair value at the acquisition date. ASC 805 also states acquisition costs will generally be expensed as incurred and restructuring costs will be expensed in periods after the acquisition date. FSP SFAS 141(R)-1 addresses application issues, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. Its adoption did not have a material impact on the consolidated financial statements.

On February 1, 2009, we adopted FSP SFAS 142-3, “Determination of the Useful Life of Intangible Assets,” (“FSP SFAS 142-3”), which has been incorporated into the Codification under ASC 350. FSP SFAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under ASC 350. The adoption of FSP SFAS 142-3 did not have a material impact on the consolidated financial statements.

On February 1, 2009, we adopted the fair value guidance related to nonfinancial assets and liabilities, as prescribed by ASC 820, formerly SFAS No. 157, “Fair Value Measurements,” as amended by the following: FSP SFAS 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Its Related Interpretive Accounting Pronouncements That Address Leasing Transactions,” FSP SFAS 157-2, “Effective Date of FASB Statement No. 157: Fair Value Measurements,” FSP SFAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for that Asset is Not Active” and FSP SFAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” The guidance in the FSP’s discussed above are now codified under ASC 820. Assumptions made regarding the adoption of ASC 820 will impact any accounting standards that include fair value measurements. See Note 4 to our consolidated financial statements included elsewhere in this prospectus entitled “Fair Value Measurements” for the impact to the consolidated financial statements and further details.

In December 2008, ASC Topic 715, formerly SFAS No. 132 (Revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” was amended by FSP SFAS 132 (R)-1 “Employers’ Disclosures about Postretirement Benefit Plan Assets.” This FSP provides guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan and is effective for financial statements issued for fiscal years ending after December 15, 2009. See Note 13 to our consolidated financial statements included elsewhere in this prospectus entitled “Defined Benefit Pension Plans” for the impact to our consolidated financial statements and further details.

See Note 21 to our consolidated financial included elsewhere in this prospectus entitled “Recent Accounting Pronouncements” for a discussion of accounting standards which we have not yet been required to implement and may be applicable to our future operations, and their impact on our consolidated financial statements.

Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risk from potential changes in interest rates and foreign currency exchange rates. We regularly evaluate our exposure to these risks and take measures to mitigate these risks on our consolidated financial results. We enter into derivative financial instruments to

 

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economically manage our market risks related to interest rate and foreign currency exchange. We do not participate in speculative derivative trading. The analysis below presents our sensitivity to selected hypothetical, instantaneous changes in market interest rates and foreign currency exchange rates as of January 30, 2010.

Foreign Exchange Exposure

Our foreign currency exposure is primarily concentrated in the United Kingdom, Continental Europe, Canada, Australia and Japan. We believe the countries in which we own assets and operate stores are politically stable. We face currency translation exposures related to translating the results of our worldwide operations into U.S. dollars because of exchange rate fluctuations during the reporting period.

We face foreign currency exchange transaction exposures related to short-term, cross-currency intercompany loans and merchandise purchases:

 

  Ÿ  

We enter into short-term, cross-currency intercompany loans with our foreign subsidiaries. This exposure is economically hedged through the use of foreign currency exchange forward contracts. Our exposure to foreign currency risk related to exchange forward contracts on our short-term, cross-currency intercompany loans has not materially changed from fiscal 2008 to fiscal 2009. As a result, a 10% change in foreign currency exchange rates against the U.S. dollar would not have an impact on our pre-tax earnings related to our short-term, cross-currency intercompany loans.

 

  Ÿ  

In addition, our foreign subsidiaries make U.S. dollar denominated merchandise purchases through the normal course of business. From time to time, we enter into foreign exchange forward contracts under our merchandise import program. As of January 30, 2010, a 10% change in foreign currency exchange rates against the U.S. dollar would impact our earnings by $11 million related to our forward contracts under our merchandise import program.

The above sensitivity analysis on our foreign currency exchange transaction exposures related to our short-term, cross-currency intercompany loans assumes our mix of foreign currency-denominated debt instruments and derivatives and all other variables will remain constant in future periods. These assumptions are made in order to facilitate the analysis and are not necessarily indicative of our future intentions.

Changes in foreign exchange rates affect interest expense recorded in relation to our foreign currency-denominated derivative instruments and debt instruments. As of January 30, 2010 and January 31, 2009, we estimate that a 10% hypothetical change in foreign exchange rates would impact our pre-tax earnings due to the effect of foreign currency translation on interest expense related to our foreign currency-denominated derivative instruments and debt instruments by $9 million.

See “Risk Factors—Our business is subject to fluctuations in foreign currency exchange.”

Interest Rate Exposure

We have a variety of fixed and variable rate debt instruments and are exposed to market risks resulting from interest rate fluctuations. In an effort to manage interest rate exposures, we periodically enter into interest rate swaps and interest rate caps. A change in interest rates on variable rate debt impacts our pre-tax earnings and cash flows, whereas a change in interest rates on fixed rate debt impacts the fair value of debt. A portion of our interest rate contracts are designated for hedge accounting as cash flow hedges. Therefore, for designated cash flow hedges, the effective portion of the changes in the fair value of derivatives are recorded in other comprehensive (loss) income and subsequently recorded in the consolidated statements of operations at the time the hedged item affects earnings.

 

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The following table illustrates the estimated sensitivity of a 1% change in interest rates to our future pre-tax earnings and cash flows on our derivative instruments and variable rate debt instruments at January 30, 2010:

 

(In millions)

   Impact of
1% Increase
    Impact of
1% Decrease
 

Interest rate swaps/caps(1)

   $ 34      $ (30

Variable rate debt

     (14     14   
                

Total pre-tax income exposure to interest rate risk

   $ 20      $ (16
                

 

(1) The difference of $4 million related to a 1% hypothetical change in interest rates is due to interest rate caps which manage the variable cash flows associated with changes in the one month LIBOR above a stated contractual interest rate. Therefore, a hypothetical change in interest rates may not result in a uniform impact.

The above sensitivity analysis assumes our mix of financial instruments and all other variables will remain constant in future periods. These assumptions are made in order to facilitate the analysis and are not necessarily indicative of our future intentions. As of January 31, 2009, we estimated that a 1% hypothetical increase or decrease in interest rates could potentially have caused either a $10 million increase or a $10 million decrease on our pre-tax earnings, respectively. The difference in our exposure to interest rate risk in fiscal 2009 from fiscal 2008 is primarily due to the reduction in market exposure as a result of the repayment of approximately $2.1 billion of variable rate debt and subsequent issuance of approximately $1.7 billion of fixed rate debt. See our consolidated financial statements for further discussion of our debt in Note 2 to our consolidated financial statements included elsewhere in this prospectus entitled “Long-Term Debt” and our derivative instruments in Note 3 to our consolidated financial statements included elsewhere in this prospectus entitled “Derivative Instruments and Hedging Activities.” At this time, we do not anticipate material changes to our interest rate risk exposure or to our risk management policies. We believe that we could mitigate potential losses on pre-tax earnings through our risk management objectives, if material changes occur in future periods.

 

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BUSINESS

Our Business

Our Company

We are the leading global specialty retailer of toys and juvenile products as measured by net sales. For over 50 years, Toys “R” Us has been recognized as the toy and baby authority. In the U.S., in fiscal 2009, approximately 70% of households with kids under 12 shopped at our Toys “R” Us stores, and 84% of all new mothers shopped at our Babies “R” Us stores. We believe we offer the most comprehensive year-round selection of toys and juvenile products, including a broad assortment of private label and exclusive merchandise unique to our stores.

As of January 30, 2010, we operated 1,363 stores and licensed an additional 203 stores. These stores are located in 34 countries and jurisdictions around the world under the Toys “R” Us, Babies “R” Us and FAO Schwarz banners. In addition to these stores, during our fiscal 2009 holiday season, we opened 91 pop-up stores, 30 of which remained open as of January 30, 2010. We also sell merchandise through our websites at Toysrus.com, Babiesrus.com, eToys.com, FAO.com and babyuniverse.com. For the fiscal year ended January 30, 2010, we generated net sales of $13.6 billion, net earnings of $312 million and Adjusted EBITDA of $1,130 million.

Our History

Our Company was founded in 1948 when Charles Lazarus opened a baby furniture store, Children’s Bargain Town, in Washington, D.C. The Toys “R” Us name made its debut in 1957. In 1978, we completed an initial public offering of our common stock. When Charles Lazarus retired as our Chief Executive Officer in 1994, the Company operated or licensed over 1,000 stores in 17 countries and jurisdictions. In 1996, we established the Babies “R” Us brand, further solidifying our reputation as a leading consumer destination for children and their families.

On July 21, 2005, we were acquired by an investment group led by entities advised by or affiliated with Bain Capital Partners, LLC, Kohlberg Kravis Roberts & Co., L.P., and Vornado Realty Trust. We refer to this collective ownership group as our “Sponsors.” Upon the completion of this acquisition, we became a private company.

Progress Since Our 2005 Acquisition

Strengthening our management team was our top priority following the 2005 acquisition. The rebuilding effort began with the hiring of Gerald L. Storch, our Chairman and Chief Executive Officer, who joined the Company in February 2006 from Target Corporation, where he was most recently Vice Chairman. He assembled the Company’s leadership team, recruiting seasoned executives with significant retail experience in key areas such as merchandising, store operations, e-commerce, finance, human resources and information technology.

Our new management team has made significant improvements to the business, producing strong results to date and laying the foundation for continued improvement. Over the past five years, we achieved the following:

 

  Ÿ  

Streamlined the organizational structure of the Company.    We harnessed the collective strength of the Toys “R” Us and Babies “R” Us brands by combining their respective corporate, merchandising and field operation functions. In addition, we established a common global culture for our business by more closely aligning and sharing best practices across markets. We also refined capital management processes, which assisted us in identifying and closing unprofitable stores, commencing a remodeling and relocation strategy for our stores, and improving our site selection for new stores.

 

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  Ÿ  

Developed and launched our juvenile integration strategy.    We designed and implemented new integrated store formats that combine the Toys “R” Us and Babies “R” Us merchandise offerings under one roof, providing a “one stop shopping” environment for our guests. The side-by-side store and “R” Superstore co-branded formats have become powerful vehicles for remodeling and updating our existing store base, generating significant improvements in store-level net sales and profitability. For example, in the first 12 months after conversion, without any increase in square footage, the aggregate store sales for our 53 domestic and 52 of our international side-by-side stores converted during fiscal years 2006, 2007 and 2008, increased on a weighted average basis (based on net sales) by 20% and 13%, respectively, as compared to the 12 month period prior to commencement of construction for the conversion. The aggregate store sale increases described above are reduced by our estimate of net sales that were transferred from existing stores (generally Babies “R” Us standalone stores) in the vicinity to the new converted stores. For more information on our juvenile integration strategy, see “—Our Stores”.

 

  Ÿ  

Improved the shopping experience for our guests.    We developed and implemented store standards focused on store cleanliness, store signage and customer service, and we enhanced our merchandise selection. We integrated our on-line business with our retail stores and instituted processes related to customer satisfaction measurement and tracking and improved in-stock levels and processes. In addition, we developed better labor scheduling, more disciplined processes relating to tracking store performance and operating metrics, and implemented a disciplined pricing strategy. From 2005-2009, Toys “R” Us and Babies “R” Us guest service scores increased by 9% and 5%, respectively.

 

  Ÿ  

Improved marketing strategies to reach our guests.    We created processes to determine the effectiveness of our marketing initiatives and improved our marketing strategies based on these analyses. We reinvigorated existing marketing programs, including our “Big Book” promotional catalog, which we distribute during the holiday selling season and consider to be our most significant piece of advertising. In addition, we launched new loyalty programs and modernized our baby and gift registries to create a stronger bond with our customers. In 2009, approximately 39% of our net sales were to customers who are members of our loyalty programs. For more information on our marketing strategy, see “—Marketing”.

 

  Ÿ  

Focused on optimizing our store portfolio.    Since the 2005 acquisition, we designed and implemented more sophisticated processes for site selection of new stores and prioritization and ranking of opportunities for new stores, remodels and relocations. We have opened 105 of our Company operated stores, closed 111 of our Company operated stores and converted 146 of our Company operated stores to our integrated store format since the end of fiscal year 2005. In addition, the number of licensed stores increased from 173 to 203 during the same time period. In the fiscal year ended January 30, 2010, 98% of our operated stores were store-level EBITDA positive.

 

  Ÿ  

Grew our on-line business.    In 2006, we separated our on-line business from Amazon and launched our separate Toysrus.com and Babiesrus.com websites. In 2009, we acquired several URLs including eToys.com, babyuniverse.com, FAO.com and toys.com, that further increased our presence on the Internet. Additionally, our baby registry, birthday club and loyalty programs all offer on-line functionality which we believe deepens our relationship with our guests and complements the in-store experience. Through these business initiatives and acquisitions, we have expanded our on-line business from $486 million in net sales in 2005 to $602 million in net sales in 2009.

These initiatives, along with other operating improvements, have delivered strong financial results, with Adjusted EBITDA growing by 55% from fiscal 2005 to fiscal 2009.

 

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Our Competitive Strengths

We are the leading specialty retailer of toys and juvenile products

We have brand names that are highly recognized around the world, strong relationships with our guests and vendors and we believe we have the broadest year-round product assortment. We also believe our focus on quality of products, service and safety is a competitive strength. In the U.S., in fiscal 2009, approximately 70% of households with kids under 12 shopped at Toys “R” Us, and 84% of all new mothers shopped at our Babies “R” Us stores.

Highly recognized brand names

In the U.S., Toys “R” Us and Babies “R” Us maintain a 98% and 86% brand awareness, respectively. We also own other valuable brand names such as FAO Schwarz.

Long-lasting relationships with our guests

Our product assortment allows us to capture new parents as customers during pregnancy, helping them prepare for the arrival of their newborn. We then become a resource for infant products such as formula, diapers and solid foods, as well as baby clothing and learning aids. We believe this opportunity to establish first contact with new parents enables us to develop long-lasting customer relationships with them as their children age and they transition to becoming consumers of our toy products. We continue to build on these relationships as these children grow and eventually become parents themselves.

Strong relationships with vendors

We have approximately 3,700 active vendors relationships. Given our market leadership position, we have been able to develop strategic partnerships with many of these vendors. We provide vendors with a year-round platform for their brand and let them use our stores to test their products. We use our New York City flagship stores, notably our Toys “R” Us Times Square store, our FAO Schwarz 5th Avenue store and our Babies “R” Us Union Square store, as venues to introduce new products. We support our vendors by buying a broader range of their products than any other retailer. In return, we obtain greater access to products in demand, support for advertising and marketing efforts and exclusive access to merchandise.

Broad and deep product assortment

We believe we offer our guests the most comprehensive year-round selection of toys and juvenile (including baby) products. Our merchandise breadth which ranges from action figures to Zhu-Zhu Pets™, and from cribs to car seats enables us to command a reputation as the shopping destination for toys and juvenile (including baby) products.

We have a global footprint and multi-channel distribution capabilities

Global footprint

We are one of the few hardlines specialty retailers with a global footprint with 39% of our consolidated net sales generated outside the U.S. in fiscal 2009. As of January 30, 2010, we operated 1,363 stores and licensed an additional 203 stores in 34 countries and jurisdictions throughout North America, Europe, Asia, the Middle East, Australia and Africa.

 

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Our international presence enhances our ability to identify trends in diverse markets and introduce newness and novelty in all our markets. Our global presence allows us to test new products in select markets before rolling them out more broadly. We believe that operating as a global and geographically diverse company enhances the stability of our business by exposing us to growth opportunities in different markets and across a broad customer base.

Multiple retail store formats

We operate a variety of store formats, which enable us to reach our customers in many different ways. Our big box formats include standalone Toys “R” Us stores, standalone Babies “R” Us stores and integrated formats which combine our Toys “R” Us and Babies “R” Us merchandise offerings under one roof. In addition to these formats, we have recently tested 91 pop-up stores that enabled us to reach more customers during the holiday season. These locations typically range in size from approximately 3,000 square feet to 5,000 square feet. Pop-up stores are temporary locations and, as such, are not included in our overall store count. As of January 30, 2010, 30 pop-up stores remained open. Certain pop-up stores may remain in operation and become permanent locations.

Differentiated real estate strategy with attractive underlying portfolio

We own stores on land we own and on properties we long-term lease located in 11 countries, representing approximately 47% of our entire store base, which differentiates us from other specialty retailers that operate within similar size stores. We believe these properties are desirable assets located in key areas, in generally proven retail corridors along major thoroughfares with good access, ample parking, frontage and visibility. Additionally, the significant ownership level of our real estate, as well as the ongoing effective management of our leases, provides substantial flexibility to execute our juvenile integration strategy in a capital-efficient manner.

Leading on-line position

We also sell merchandise through our Internet sites Toysrus.com and Babiesrus.com, as well as our newly acquired eToys.com, FAO.com and babyuniverse.com Internet sites. In 2009, our on-line businesses generated $602 million of net sales.

We believe our guests expect multi-channel retailers to offer seamless shopping experiences between their websites and their stores. Our websites allow guests to determine if an item is in-stock at a particular store and we expect to offer in-store pick-up of on-line purchases in the near future. Additionally, our baby registry, birthday club and loyalty programs all offer on-line functionality which deepens our relationship with our guests and complements the in-store experience.

We have significant experience in managing the seasonal nature of our business

Over the past 60 years, we have developed substantial expertise in managing the increased demand during the holiday season. From warehousing and distribution, to hiring and training a seasonal workforce and promotional planning, we have invested in the technology and infrastructure to handle the seasonal surge in a cost effective manner.

We have an experienced management team with a proven track record

Our senior management team has an average of approximately 20 years of retail experience across a broad range of disciplines in the specialty retail industry, including merchandising, finance and

 

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real estate. This management team has made significant improvements to the business, producing strong results to date and laying the foundation for continued improvement.

Our Growth Strategy

Continue juvenile integration strategy across the existing store base

Converting and/or relocating our standalone “Toys “R” Us stores into our side-by-side and our “R” Superstore formats has generated significant improvements in our comparable store net sales and store-level profitability.

With only 12% of our global stores in an integrated format today, we believe we have the potential to convert and/or relocate another 60% to 70% of our standalone stores globally into our side-by-side and “R” Superstore formats. As such, we expect our juvenile integration strategy to continue to be a significant driver of our revenue and profit growth going forward.

Expand our store-base

We have the potential to open new stores in existing and new markets both domestically and internationally, virtually all of which will be in the integrated format, either as side-by-side stores or “R” Superstores. We believe we have the potential to increase our retail square footage, net of closures globally in excess of 15% over the next several years, through our new store growth and relocations of existing stores to “R” Superstores. In addition, we expect to open a significant number of pop-up stores in the upcoming holiday season and believe that we have the opportunity to continue this strategy in future years.

Expand our on-line presence

We believe our recent acquisitions of eToys.com, Toys.com, babyuniverse.com and FAO.com, combined with our Toysrus.com and Babiesrus.com sites, will drive growth of our on-line business. We plan to further expand our on-line business by continuing to integrate our Internet capabilities with our traditional stores. In addition to our existing online presence in Canada, United Kingdom and Japan, we are planning to introduce websites in countries where we have physical stores but lack a web presence, such as Austria, France, Germany, Spain and Switzerland. Our global e-commerce platform also provides the potential to enter new international markets where we do not have any physical stores.

Improve sales productivity in our base business

We believe our juvenile integration strategy described above will be an important driver of our store productivity. We also intend to continue to improve space utilization, in-stock positions and store standards, flex our toys and juvenile products categories seasonally and optimize store hours to accommodate our guests’ lifestyles to increase our sales in our existing stores.

Execute strategies to expand our operating profit margin

We will continue to focus on expanding our gross margins primarily through optimizing pricing, improving vendor allowances, increasing our private label penetration and increasing our use of direct sourcing. We will also continue to optimize our cost structure and enhance efficiencies throughout the organization to manage our selling, general and administrative expenditures.

Our Stores

In the U.S., we sell a variety of products in the core toy, entertainment, juvenile (including baby), learning and seasonal categories through 849 stores that operate in 49 states and Puerto Rico and

 

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through the Internet. Domestic Net sales in fiscal 2009 were derived from 496 traditional toy stores (including 77 BRU Express and Juvenile Expansion formats), 260 juvenile stores, 64 SBS stores, 26 SSBS stores, 89 pop-up stores and our 3 flagship stores in New York City. We operated all of the “R” Us branded retail stores in the United States and Puerto Rico. Domestic Net sales were $8.3 billion for the fiscal year ended January 30, 2010, which accounts for 61% of our consolidated Net sales.

Internationally, we operate 514 of the 717 “R” Us branded retail stores. The balance of the “R” Us branded retail stores outside the United States are operated by licensees. The fees from these licensees did not have a material impact on our Net sales. We sell a variety of products in the core toy, entertainment, juvenile (including baby), learning and seasonal categories through these stores that operate in 33 countries and jurisdictions and through the Internet. International Net sales in fiscal 2009 (including fees received from licensed stores) were derived from 618 traditional toy stores (including 2 BRU Express formats), as well as 77 SBS stores, 22 juvenile stores and two pop-up stores. International Net sales were $5.3 billion for the fiscal year ended January 30, 2010, which accounts for 39% of our consolidated Net sales.

We developed several new store formats with an integrated “one-stop shopping” environment for our guests by combining the Toys “R” Us and Babies “R” Us merchandise offerings under one roof. We call these formats side-by-side and “R” Superstore. Side-by-side stores are typically former single-format Toys “R” Us stores between 30,000 and 50,000 square feet of which have been converted to a combination Toys “R” Us and Babies “R” Us store format. “R” Superstores are conceptually similar to SBS stores, except they are typically newly-constructed facilities with store footprints in the 55,000 to 70,000 square foot range.

The integration of juvenile merchandise (including baby products) with toy and entertainment offerings has allowed us to create a “one-stop shopping” experience for our guests, and enabled us to obtain the sales and operating benefits associated with combining product lines under one roof. Our juvenile product assortment allows us to capture new parents as customers during pregnancy, helping them prepare for the arrival of their newborn. We then become a resource for infant products such as formula, diapers and solid foods, as well as baby clothing and learning aids. We believe this opportunity to establish first contact with new parents enables us to develop long-lasting customer relationships with them as their children age and they transition to becoming consumers of our toy products. We continue to build on these relationships as these children grow and eventually become parents themselves. Additionally, juvenile merchandise such as baby formula, diapers and infant clothing provide us with a mitigant to the inherent seasonality in the toy business.

In connection with our juvenile integration strategy, we continue to increase the number of SBS and SSBS stores both domestically and internationally. Since implementing the integrated store format over three years ago, we have converted 129 existing stores into SBS store formats and have constructed 38 new SBS and SSBS stores (19 of which were relocations of existing stores). We expect that our integrated store formats will continue to be a significant driver of our revenue and profit growth going forward.

In addition to our SBS and SSBS store formats, we continue to enhance our integrated strategy with our Babies “R” Us Express BRU Express and Juvenile Expansion formats which devote additional square footage to our juvenile (and baby) products within our traditional Toys “R” Us stores. Since implementing this integrated store format, we have augmented 79 existing Toys “R” Us stores with these formats.

Our extensive experience in retail site selection has resulted in a portfolio of stores that include attractive locations in many of our chosen markets. Markets for new stores and formats are selected

 

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on the basis of proximity to other “R” Us branded stores, demographic factors, population growth potential, competitive environment, availability of real estate and cost. Once a potential market is identified, we select a suitable location based upon several criteria, including size of the property, access to major commercial thoroughfares, proximity of other strong anchor stores or other destination superstores, visibility and parking capacity.

As of January 30, 2010, we operated 1,363 retail stores and licensed an additional 203 retail stores worldwide in the following formats:

 

Format

  

Description

   Number
of Stores
   Approximate
Store Size
(sq. ft.)
   Operated Stores      
Traditional Toys “R” Us stores   

The majority of square footage is devoted to traditional toy categories, with approximately 5,500

square feet devoted to boutique areas for juvenile products (BRU Express and Juvenile Expansion formats devote approximately an additional 4,500 square feet and 1,000 square feet, respectively, for juvenile – including baby - products).

   911    30,000 to
50,000
Traditional Babies “R” Us stores    Predominantly juvenile (including baby) products, with approximately 2,000 to 5,000 square feet devoted to specialty name brand and private label clothing.    282    30,000 to
45,000
Side-by-Side (SBS) stores    Devote approximately 20,000 to 30,000 square feet to traditional toy products and 9,000 to 15,000 square feet to juvenile (including baby) products.    141    30,000 to
50,000
“R” Superstores (SSBS)    Combine a traditional toy store of approximately 34,000 square feet with a juvenile (including baby) store of approximately 30,000 square feet.    26    55,000 to
70,000
Flagship stores (all in New York City)    The Toys “R” Us store in Times Square, the FAO Schwarz store on 5th Avenue near Central Park, and the Babies “R” Us store in Union Square.    3    55,000 to
100,000
            

Total operated stores

      1,363   
   Licensed Stores      
Traditional Toys “R” Us stores    The majority of square footage is devoted to traditional toy categories, with approximately 5,500 square feet devoted to boutique areas for juvenile (including baby) products.    203    30,000 to
50,000
            

Total operated and licensed stores

      1,566   

In addition to these stores, during the fiscal 2009 holiday season, we opened 91 Toys “R” Us Holiday Express stores, or pop-up stores, a temporary store format located in high-traffic shopping areas, 30 of which remained open as of January 30, 2010.

 

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Geographic Distribution of Domestic Stores

The following table sets forth the location of our Domestic stores as of January 30, 2010:

 

Location

   Number of Stores

Alabama

   9

Alaska

   1

Arizona

   15

Arkansas

   5

California

   106

Colorado

   10

Connecticut

   14

Delaware

   3

Florida

   57

Georgia

   28

Hawaii

   2

Idaho

   3

Illinois

   38

Indiana

   17

Iowa

   7

Kansas

   6

Kentucky

   10

Louisiana

   10

Maine

   3

Maryland

   19

Massachusetts

   20

Michigan

   32

Minnesota

   11

Mississippi

   5

Missouri

   16

Montana

   1
  

 

Location

   Number of Stores
Nebraska    4
Nevada    9
New Hampshire    7
New Jersey    41
New Mexico    3
New York    56
North Carolina    21
North Dakota    1
Ohio    37
Oklahoma    7
Oregon    8
Pennsylvania    45
Rhode Island    2
South Carolina    10
South Dakota    2
Tennessee    17
Texas    60
Utah    8
Vermont    1
Virginia    27
Washington    16
West Virginia    4
Wisconsin    11
Puerto Rico    4
    
  

Total(1)

   849
    

 

(1) Overall store count does not include 29 pop-up stores that remained open as of January 30, 2010 due to the temporary nature of these locations. At the peak of this initiative, there were 89 pop-up stores open Domestically. Certain pop-up stores may remain in operation and become permanent locations.

 

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Geographic Distribution of International Stores

The following table sets forth the location of our International operated stores as of January 30, 2010:

 

Location

   Number of Stores
Operated

Australia

   35

Austria

   14

Canada

   69

France

   39

Germany

   57

Japan

   167

Portugal

   8

Spain

   44

Switzerland

   6

United Kingdom

   75
    

Total(1)

   514
    

 

(1) Overall store count does not include 1 pop-up store that remained open as of January 30, 2010 due to the temporary nature of these locations. At the peak of this initiative, there were 2 pop-up stores open Internationally. Certain pop-up stores may remain in operation and become permanent locations.

The following table sets forth the location of our International licensed stores as of January 30, 2010:

 

Location

   Number of
Stores Licensed
  

Location

   Number of
Stores Licensed

Bahrain

   1    Norway    8

China

   15    Oman    1

Denmark

   13    Philippines    8

Egypt

   4    Qatar    1

Finland

   4    Saudi Arabia    10

Hong Kong

   11    Singapore    6

Iceland

   3    South Africa    24

Israel

   27    Sweden    15

Korea

   5    Taiwan    16

Kuwait

   1    Thailand    8

Macau

   1    United Arab Emirates    6
          

Malaysia

   15   

Total

   203
          

Financial information about our segments and our operations in different geographical areas for the last three fiscal years is set forth in Note 12 to the consolidated financial statements entitled “Segments.”

 

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Product Selection and Merchandise

Our product offerings are:

 

Category

  

Description

   FY2009 %
of net sales
 
Core Toy    Boys and girls toys, such as dolls and doll accessories, action figures, role play toys and vehicles, games, plush toys and puzzles.    17.0
Entertainment    Video game systems and software, electronics, computer software, DVDs and other related products.    15.5
Juvenile    Focused on serving newborns and children up to four years of age. Offer a broad array of products, such as baby gear, infant care products, apparel, commodities, furniture, bedding, room décor and infant toys.    30.8
Learning    Educational electronics and developmental toys, such as our Imaginarium products in the United States and World of Imagination products at our International locations, and pre-school merchandise which includes pre-school learning products, activities and toys.    22.4
Seasonal   

Toys and other products geared toward holidays (including Christmas, Hannukah, Three Kings, Carnival, Easter, Golden Week

and Halloween) and summer activities, as well as bikes, sporting goods, play sets and other outdoor products.

   13.2
Other    Consists primarily of shipping and other non-product related revenues.    1.1
Total       100.0

We offer a wide selection of popular national toy and juvenile brands including many products that are exclusively offered at, or launched at, our stores. Over the past few years, we have worked with key resources to obtain exclusive products and expand our private label brands enabling us to earn higher margins and offer products that our customers will not find elsewhere. We offer a broad selection of private label merchandise under names such as IMAGINARIUM , ESPECIALLY FOR BABY, BRUIN JUVENILE, KOALA BABY, FAST LANE, YOU & ME, JUST LIKE HOME and FAO SCHWARZ in our stores. We believe these private label brands provide a platform on which we can expand our product offerings in the future and will further differentiate our products and allow us to enhance our profitability.

Marketing

We believe that we have achieved our leading market position largely as a result of building a highly recognized brand names and delivering superior service to our customers. We use a variety of broad-based and targeted marketing and advertising strategies to reach consumers. These strategies include mass marketing programs such as direct mail, e-mail marketing, targeted magazine advertisements, catalogs/rotos and other inserts in national or local newspapers, national television and radio broadcasts, targeted door-to-door distribution, direct mailings to loyalty card members and in-store marketing. Our most significant single piece of advertising is the “Big Book” promotional catalog release, which is distributed through direct mail, newspapers and in-stores during the fourth quarter holiday selling season. Through the “Big Book” release we promote deals and discounts on our merchandise.

Our direct marketing program for the specialty juvenile market includes mailings to expecting and new parents. In addition, we offer unique benefits such as loyalty programs to our customers, including the Rewards “R” Us program, which provides customers with a variety of exclusive one-time offers and ongoing benefits, and Geoffrey’s Birthday Club, which provides members with exciting birthday surprises.

 

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Our comprehensive baby registry offered in our stores and on the Internet allows an expectant parent to list desired products and enables gift-givers to tailor purchases to the expectant parent’s specific needs and wishes. Our baby registry also facilitates our direct marketing and customer relationship initiatives.

The merchandising and marketing teams work closely to present the products in an engaging and innovative manner and we are focused on enhancing our in-store signage, which is carefully coordinated so that it is consistent with the current television, radio and print advertisements. We regularly change our banners and in-store promotions, which are advertised throughout the year, to attract consumers to visit the stores, to generate strong customer frequency and to increase average sales per customer. Our websites are used to support and supplement the promotion of products in “R” Us branded stores.

Management has developed a comprehensive strategy to strengthen its competitive position and deliver profitable growth. To increase store traffic, we have expanded our commodities offering selection in both of our segments, and we are continuing to build on the successes of our organic product offering selection within our Domestic segment. To improve the value offering for our customers, we introduced more opening price point products and private label items and utilized strategies such as loyalty programs.

Customer Service

Compared with multi-line mass merchandisers, we believe we are able to provide superior service to our customers through our highly trained sales force. We train our store associates extensively to deepen their product knowledge and enhance their targeted selling skills in order to improve customer service in our stores. We are continually working to improve the allocation of products within our stores and reduce waiting times at checkout counters. For the added convenience of our customers, we offer a layaway program and in select stores we provide a home delivery program.

In addition to our baby registry, we offer a variety of helpful publications and innovative programs and services for the expectant parent, including frequent in-store product demonstrations.

Corporate Citizenship

In addition to providing quality goods and services, we believe great brands are built by adopting responsible business practices. We believe commercial success and good corporate citizenship are closely linked. Our efforts to be responsible corporate citizens are manifested in the following ways:

Safety Focus

We have taken a leadership position on safety. We believe that we have put in place industry-leading product safety standards that meet or exceed U.S. federally mandated and/or global regulatory requirements in the countries in which we operate. In addition, through our dedicated safety micro site, safety boards in stores, e-mail blasts and partnerships with noted safety experts and organizations, we provide resources that are used by parents, grandparents and childcare providers to ensure they have the most up-to-date information on product safety and recalls.

Corporate Philanthropy and Community Service

We are proud to have a long tradition at Toys “R” Us of supporting numerous children’s charities. Toys “R” Us Children’s Fund Inc., a non-profit organization, and Toys “R” Us, Inc. have contributed

 

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millions of dollars to charities that help keep children safe and help them in times of need. We actively support charities such as the Marine Toys For Tots Foundation, Autism Speaks and Save the Children, among others. Each year the Company also produces a special toy selection guide for differently-abled children. The Company encourages its employees to become active in charitable endeavors by matching contributions they make to charities of their choice. The Company also manages the Geoffrey Fund, Inc., a non-profit organization. The Geoffrey Fund’s sole purpose is to provide assistance to employees affected by natural and personal disasters and relies on donations from employees and funds from the Company to carry out its mission.

In addition, in April, 2010, the Reputation Institute has ranked us #36 in the U.S., among the top 50 “Most Reputable U.S. Companies,” with a score of 75.36. The Reputation Institute considers companies with scores between 70 and 79 to have strong/robust reputations.

Our Vendors

We procure the merchandise that we offer to our customers from a wide variety of domestic and international vendors. We have approximately 3,700 active vendor relationships. For fiscal 2009, our top 20 vendors worldwide, based on our purchase volume in U.S. dollars, represented approximately 41% of the total products we purchased. In 2010, we opened a sourcing office in China to work with our vendors.

Given our market leadership position, we have been able to develop strategic partnerships with many of our vendors. We provide vendors with a year-round platform for their brand and let them use our stores to test their products, giving vendors a meaningful opportunity to display new merchandise and reach consumers throughout the year. We use our New York City flagship stores, notably our Toys “R” Us Times Square store, our FAO Schwarz 5th Avenue store and our Babies “R” Us Union Square store, as venues to introduce new products. We support our vendors by buying a broader range of their products than any other retailer. In addition, we are able to provide our vendors with a wide variety of data on global sales trends and marketing guidance and support, as well as early feedback on their product development initiatives through the depth and longevity of our experienced merchandising team. In return, we obtain greater access to products in demand, support for advertising and marketing efforts and exclusive access to merchandise.

Distribution

We operate 18 distribution centers including 9 that support our Domestic retail stores and 9 that support our International “R” Us branded stores (excluding licensed operations). These distribution centers employ warehouse management systems and material handling equipment that help to minimize overall inventory levels and distribution costs. We believe the flexibility afforded by our warehouse/distribution system and by our operation of the fleet of trucks used to distribute merchandise provide us with operating efficiencies and the ability to maintain a superior in-stock inventory position at our stores. We continuously seek to improve our supply chain management, optimize our inventory assortment and upgrade our automated replenishment system to improve inventory turnover.

To support delivery of products sold through our websites, we have a multi-year agreement with Exel, Inc., a leading North American contract logistics provider, who provides warehousing and fulfillment services for our Internet operations in the United States. We utilize various third party providers who furnish similar services in our international markets.

 

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Market and Competition

We are the leading global specialty retailer of toys and juvenile products as measured by net sales. As a specialty retailer, we are able to focus solely on the toys and juvenile products market. We operate in an attractive industry that has proven to be resilient due to the demand for toys (including video games and video game systems) and juvenile (including baby) products, driven by the desire of families to spend on their children and by population growth.

In these markets, we compete with mass merchandisers, such as Wal-Mart, Target and Kmart; consumer electronics retailers, such as Best Buy and GameStop; Internet and catalog businesses, such as Amazon; national and regional specialty, department and discount store chains; as well as local retailers in the geographic areas we serve. Our baby registry competes with baby registries of mass merchandisers, other specialty retail formats and regional retailers.

In the International toy and electronics markets, we compete with mass merchandisers, discounters and specialty retailers such as Argos, Auchan, Bic Camera, Carrefour, El Corte Ingles, King Jouet, Mother Care, Spielmax, Wal-Mart, Yamada Dinky, Yodobashi, and Zellers. The mass merchandisers and discounters aggressively price items in the traditional toy and electronic product categories with larger dedicated selling space during the holiday season in order to build traffic for other store departments.

We believe the principal competitive factors in the specialty toy, juvenile (including baby) and video game products markets are product variety, quality, safety, availability, price, advertising and promotion, convenience or store location and customer support and service. We believe we are able to compete by providing a broader range of merchandise, maintaining in-stock positions, as well as convenient locations, superior customer service and competitive pricing.

Seasonality

Our global business is highly seasonal with sales and earnings highest in the fourth quarter due to the fourth quarter holiday selling season. During the last three fiscal years more than 39% of our total Net sales were generated in the fourth quarter. It is typically the case that we incur net losses in each of the first three quarters of the year, with all of our net earnings and cash flows from operations being generated in the fourth quarter. We seek to continuously improve our ability to manage the numerous demands of a highly seasonal business, from the areas of product sourcing and distribution, to the challenges of delivering high sales volumes and excellent customer service during peak business periods. Over the past 60 years, we have developed substantial experience and expertise in managing the increased demand during the holiday season which favorably differentiates us from our competition. See also “—Our Competitive Strengths”.

License Agreements

We have license agreements with unaffiliated third party operators located outside the United States. The agreements are largely structured with royalty income paid as a percentage of sales for the use of the Toys “R” Us trademark, trade name and branding. While this business format remains a small piece of our overall International business operations, we continue to look for opportunities for market expansion. Our preferred approach is to open stores in our successful Company operated format, but we may choose partnerships or licensed arrangements where we believe business climate and risks may dictate.

 

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Employees

As of January 30, 2010, we employed approximately 68,000 full-time and part-time individuals worldwide, with approximately 44,000 in the United States and 24,000 internationally. These numbers do not include the individuals employed by licensees of our stores. In the U.S., none of our employees is subject to any collective bargaining agreement, except for employees in one store in Pennsylvania. Due to the seasonality of our business, we employed approximately 114,000 full-time and part-time employees during the fiscal 2009 holiday season. We consider the relationships with our employees to be positive. We believe that the benefits offered to our employees are competitive in relation to those offered by other companies in the retail sector.

Trademarks and Licensing

“TOYS “R” US®”, “BABIES “R” US®”, “IMAGINARIUM®”, “GEOFFREY®”, “KOALA BABY®”, “ANIMAL ALLEY®”, “FAST LANE®”, “DREAM DAZZLERS®”, “ESPECIALLY FOR BABY®”, “YOU AND ME®”, the reverse “R” monogram logo and the Geoffrey character logo, as well as variations of our family of “R” Us marks, either have been registered, or have trademark applications pending, with the United States Patent and Trademark Office and with the trademark registries of many other countries. These trademarks are material to our business operations. We believe that our rights to these properties are adequately protected. In addition, during fiscal 2009, we purchased the U.S. trademarks associated with eToys.com, babyuniverse.com, ePregnancy.com, KB Toys and certain trademark rights in other countries. In May 2009, we acquired the exclusive right and license to use the FAO SCHWARZ trademarks.

Properties

The following summarizes our worldwide operating stores and distribution centers as of January 30, 2010 (excluding licensed operations in our International segment):

 

     Owned    Ground
Leased(1)
   Leased(2)    Total

Stores:

           

Domestic

   300    231    318    849

International

   79    26    409    514
                   
   379    257    727    1,363

Distribution Centers:

           

Domestic

   7    —      2    9

International

   5    —      4    9
                   
   12    —      6    18
                   

Total Operating Stores and Distribution Centers

   391    257    733    1,381
                   

 

(1) Owned buildings on leased land.
(2) Does not include 29 pop-up stores Domestically and 1 pop-up store Internationally that remained open as of January 30, 2010 due to the temporary nature of these locations. At the peak of this initiative, there were 89 Domestic and 2 International pop-up stores open. Certain pop-up stores may remain in operation and become permanent locations.

We maintain our headquarters in approximately 585,000 square feet of space in Wayne, New Jersey.

We also maintain 124 former stores that are no longer part of our operations. Approximately half of these surplus facilities are owned and the remaining locations are leased. We have tenants in more

 

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than half of these facilities, and we continue to market those facilities without tenants for disposition. The net costs associated with these facilities are reflected in our consolidated financial statements, but the number of surplus facilities is not included above.

Portions of our debt are secured by direct and indirect interests in certain of our properties. See Note 2 to the consolidated financial statements entitled “Long-Term Debt” for further details.

We believe that our current operating stores and distribution centers are adequate to support our business operations.

Legal Proceedings

On July 15, 2009, the United States District Court for the Eastern District of Pennsylvania granted the class plaintiffs’ motion for class certification in a consumer class action commenced in January 2006, which was consolidated with an action brought by two Internet retailers that was commenced in December 2005. Both actions allege that Babies “R” Us agreed with certain baby product manufacturers (collectively, with the Company, the “Defendants”) to impose, maintain and/or enforce minimum price agreements in violation of antitrust laws. In addition, in December 2009, a third Internet retailer filed a similar action and another class action was commenced making similar allegations involving most of the same Defendants. We intend to vigorously defend all of these cases. Additionally, the FTC notified the Company in April 2009 that they had opened an investigation related to the issues in those cases and to confirm the Company’s compliance with a 1998 FTC Final Order that prohibits the Company from, among other things, influencing suppliers to limit sales of products to other retailers, including price club warehouses. The Company believes it has complied with the FTC Final Order and is currently cooperating with the FTC.

In addition to the litigation discussed above, we are, and in the future, may be involved in various other lawsuits, claims and proceedings incident to the ordinary course of business. The results of litigation are inherently unpredictable. Any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in diversion of significant resources. The results of these lawsuits, claims and proceedings cannot be predicted with certainty. However, we believe that the ultimate resolution of these current matters will not have a material adverse effect on our consolidated financial statements taken as a whole.

 

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MANAGEMENT

Set forth below are the names, ages as of the date of this prospectus and positions with our company of the persons who will serve as our directors and executive officers upon the consummation of this offering.

Executive Officers

The following persons were our Executive Officers as of May 17, 2010, having been elected to their respective offices by our Board of Directors:

 

Name

   Age(1)   

Position with the Registrant

Gerald L. Storch

   53    Chairman of the Board; Chief Executive Officer

F. Clay Creasey, Jr.

   61    Executive Vice President—Chief Financial Officer

Deborah M. Derby

   46    Executive Vice President—Chief Administrative Officer

Antonio Urcelay

   58    President—Continental Europe

David Rurka

   63    Managing Director of Toys “R” Us Holdings, Limited

Daniel Caspersen

   57    Executive Vice President—Human Resources

David J. Schwartz

   42    Executive Vice President—General Counsel & Corporate Secretary

 

(1) As of May 17, 2010.

The following is a brief description of the business experience of each of our Executive Officers:

Mr. Storch has been our Chairman of the Board and Chief Executive Officer since February 2006. Mr. Storch was Vice Chairman of Target Corporation (“Target”) from 2001 to 2005 and held various other positions at Target from 1993 (then Dayton-Hudson) to 2001. Prior to joining Target, Mr. Storch was a Principal of McKinsey & Company where he served from 1982 to 1993.

Mr. Creasey has served as our Executive Vice President—Chief Financial Officer since May 2006. From July 2005 to April 2006, Mr. Creasey served as Chief Financial Officer of Zoom Systems, an automated retailer. Prior to that, Mr. Creasey served in various roles at Mervyn’s, a subsidiary of Target, from 1992 to 2005, most recently as Senior Vice President, Finance and Chief Financial Officer from 2000 to 2005. Prior to that, Mr. Creasey served in various roles at Lucky Stores, Inc. from 1981 to 1992, most recently as Vice President, Operations Accounting.

Ms. Derby has served as our Executive Vice President—Chief Administrative Officer since February 2009. From May 2006 to February 2009, Ms. Derby served as Executive Vice President—President—Babies “R” Us. From September 2005 until May 2006, Ms. Derby served as our Executive Vice President—Human Resources, Legal and Corporate Communications and Secretary. From May 2003 until September 2005, Ms. Derby served as our Executive Vice President—Human Resources. From November 2002 to May 2003, Ms. Derby served as our Senior Vice President, Associate Relations and Organizational Effectiveness. From January 2002 to November 2002, Ms. Derby was our Vice President, Associate Relations. From June 2000 (when she first joined the Company) to January 2002, Ms. Derby was our Vice President—Human Resources, Babies “R” Us.

Mr. Urcelay has served as our President—Continental Europe (Germany, Switzerland, Austria, France, Spain and Portugal) since August 2004. Mr. Urcelay served as the Managing Director of Toys “R” Us Iberia, S.A. from October 2006 until February 2009. From August 2003 through August 2004, Mr. Urcelay was President of Southern Europe (France, Spain and Portugal).

Mr. Rurka has served as the Managing Director of Toys “R” Us Holdings, Limited, a United Kingdom subsidiary of the Company, since 1984.

 

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Mr. Caspersen has served as our Executive Vice President—Human Resources since May 2006. From September 2004 until April 2006, Mr. Caspersen served as Vice President—Stores—Human Resources of Target. Prior to that, from September 2001 to September 2004, Mr. Caspersen was Vice President—Headquarters—Human Resources at Target.

Mr. Schwartz has served as our Executive Vice President—General Counsel since October 2009 and has served as Corporate Secretary since April 2006. From September 2003 until October 2009, Mr. Schwartz served as Senior Vice President—General Counsel. From January 2002 until September 2003, Mr. Schwartz served as our Vice President—Deputy General Counsel, and has served as Assistant Corporate Secretary from that time until April 2006. From February 2001 to January 2002, Mr. Schwartz served as our Vice President—Corporate Counsel and Assistant Corporate Secretary. Mr. Schwartz is a Director of Toys “R” Us Japan, Ltd.

Directors

The following persons were members of our Board of Directors as of May 17, 2010. Each elected director will hold office until a successor is duly elected and qualified or until his or her earlier death, resignation or removal from office by our stockholders.

 

Name

   Age(1)   

Position with the Registrant

Gerald L. Storch(2)

   53    Chairman of the Board; Chief Executive Officer

Joshua Bekenstein

   51    Director

Michael M. Calbert

   47    Director

Michael D. Fascitelli

   53    Director

Matthew S. Levin

   44    Director

Sanjay Morey

   38    Director

John Pfeffer

   41    Director

Steven Roth

   68    Director

Wendy Silverstein

   49    Director

Michael Ward

   46    Director

 

(1) As of May 17, 2010.
(2) See “Executive Officers” above, for Mr. Storch’s biography.

Mr. Bekenstein has been our director since September 2005. Mr. Bekenstein is a Managing Director of Bain Capital, LLC, which he helped found in 1984. Mr. Bekenstein serves as a member of the Board of Directors of several corporations, including Bombardier Recreational Products, Bright Horizons Family Solutions, Burlington Coat Factory, Dollarama, Michaels Stores and Waters Corporation. In addition, he is active in a variety of community and educational organizations such as New Profit, City Year, the Dana-Farber Cancer Institute, Horizons for Homeless Children and New Leaders for New Schools. He also serves on the Yale Corporation Investment Committee.

Mr. Calbert has been our director since July 2005. Mr. Calbert has been with Kohlberg Kravis Roberts & Co., L.P. for over ten years and during that time has been directly involved with several portfolio companies. He heads the Retail industry team. Mr. Calbert is currently on the board of directors of Dollar General, U.S. Foodservice and Pets at Home. He joined Randall’s Food Markets as the Chief Financial Officer in 1994, ultimately taking the company private through a transaction with Kohlberg Kravis Roberts & Co., L.P. in June 1997. He left Randall’s Food Markets after the company was sold in September 1999 and joined Kohlberg Kravis Roberts & Co., L.P. Mr. Calbert started his professional career as a consultant with Arthur Andersen Worldwide, where his primary focus was on the retail/consumer industry.

Mr. Fascitelli has been our director since July 2005. Mr. Fascitelli has been President and a Trustee of Vornado Realty Trust since December 1996 and Chief Executive Officer of Vornado Realty

 

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Trust since May 2009. Mr. Fascitelli has also been President of Alexanders, Inc. since August 2000 and a director since December 1996. Mr. Fascitelli was on the Board of Directors of GMH Communities Trust (a real estate investment trust) from August 2005 until June 2008.

Mr. Levin has been our director since July 2005. Mr. Levin joined Bain Capital in 1992, where he has been a Managing Director since 2000. Prior to joining Bain Capital, he was a consultant at Bain & Company where he consulted in the consumer products and manufacturing industries. Mr. Levin serves as a board member of several corporations, including Bombardier Recreational Products, Dollarama L.P., Guitar Center, Inc., Lilliput Kidswear Ltd., Michaels Stores, Inc. and Unisource Worldwide.

Mr. Morey has been our director since June 2008. Mr. Morey has been an executive of Kohlberg Kravis Roberts & Co., L.P. since 2006. Mr. Morey was a Vice President of Fenway Partners from August 2001 through February 2006. Mr. Morey is a director of U.S. Foodservice.

Mr. Pfeffer has been our director since September 2005. Mr. Pfeffer has been an executive of Kohlberg Kravis Roberts & Co., L.P. since 2000, heading the European Retail Sector Team. Mr. Pfeffer is a director of Pets at Home, U.N. Ro-Ro, Maxeda and ATU.

Mr. Roth has been our director since September 2005. Mr. Roth has been Chairman of the Board of Vornado Realty Trust since May 1989. Mr. Roth was Chief Executive Officer of Vornado Realty Trust from May 1989 to May 2009 and has been Chairman of the Executive Committee of the Board of Vornado Realty Trust since April 1980. Mr. Roth is currently the Managing General Partner of Interstate Properties, an owner of shopping centers and investor in securities and partnerships. Mr. Roth has been a general partner of Interstate Properties since 1968. He has also been the Chief Executive Officer of Alexander’s, Inc. since March 1995 and Chairman of the Board of Alexander’s, Inc. since 2004 and a director since 1989.

Ms. Silverstein has been our director since September 2005. Ms. Silverstein has been Executive Vice President—Capital Markets of Vornado Realty Trust since 1998.

Mr. Ward has been our director since September, 2007. Mr. Ward joined Bain Capital in January 2003 and has been a Managing Director since 2004. He has worked closely with several portfolio companies including Houghton Mifflin, Burger King, Warner Music Group, and Toys “R” Us. He is on the Board of Directors of Sensata Technologies, Inc. and The Weather Channel. He also serves on the Board of Directors of the Boston Public Library Foundation and the MBA Advisory Board at the Amos Tuck School of Business Administration. Previously, Mr. Ward was the President and Chief Operating Officer of Digitas.

With respect to Mr. Storch, the Board considered his experience as CEO of the Company and his significant experience and expertise in the retail industry. Other than Mr. Storch, each of the Directors was elected to the Board pursuant to the stockholders agreement dated July 21, 2005 by and among the Company, the Sponsors and a private investor (the “Stockholders Agreement”). Pursuant to such agreement, Messrs. Bekenstein, Levin and Ward were appointed to the Board as a consequence of their respective relationships with Bain Capital Partners, LLC; Messrs. Calbert, Morey and Pfeffer were appointed to the Board as a consequence of their respective relationships with Kohlberg Kravis Roberts & Co., L.P.; and Messrs. Fascitelli and Roth and Ms. Silverstein were appointed to the Board as a consequence of their respective relationships with Vornado Realty Trust.

Upon completion of this offering, we intend to appoint new members to our Board of Directors.

Controlled Company Exception

After completion of this offering, the Sponsors will continue to control a majority of our outstanding common stock and voting power. As a result, (1) under the terms of the Stockholders Agreement, each of the Sponsors is entitled to nominate three members of the board of directors and (2) we are a “controlled company” within the meaning of the New York Stock Exchange corporate governance standards. Under the New York Stock Exchange rules, a company of which more than

 

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50% of the voting power is held by an individual, group or another company is a “controlled company” and may elect not to comply with certain New York Stock Exchange corporate governance standards, including:

 

  Ÿ  

the requirement that a majority of the Board of Directors consist of independent directors;

 

  Ÿ  

the requirement that we have a nominating/corporate governance committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities;

 

  Ÿ  

the requirement that we have a compensation committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities; and

 

  Ÿ  

the requirement for an annual performance evaluation of the nominating/corporate governance and compensation committees.

Following this offering, we intend to utilize these exemptions. As a result, we will not have a majority of independent directors, our nominating/corporate governance committee and compensation committee will not consist entirely of independent directors and such committees will not be subject to annual performance evaluations. Accordingly, you will not have the same protections afforded to shareholders of companies that are subject to all of the New York Stock Exchange corporate governance requirements.

Committees of the Board of Directors

Audit Committee.    Our Board of Directors has a separately designated audit committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. Our Audit Committee is currently composed of Sanjay Morey, Michael Ward and Wendy Silverstein. Upon completion of this offering, the current Audit Committee members will resign and we intend to appoint                      to our Audit Committee. Our Board of Directors has determined that each nominee is financially literate and will determine which members will qualify as an “audit committee financial expert” within the meaning of the regulations adopted by the Securities and Exchange Commission. All of our Audit Committee nominees qualify as independent directors under the corporate governance standards of the New York Stock Exchange and the independence requirements of Rule 10A-3 of the Exchange Act.

The purpose of the Audit Committee will be to assist our Board of Directors in overseeing and monitoring (1) the quality and integrity of our financial statements, (2) our compliance with legal and regulatory requirements, (3) our independent registered public accounting firm’s qualifications and independence, (4) the performance of our internal audit function and (5) the performance of our independent registered public accounting firm.

Our Board of Directors will update its written charter for the audit committee which will be available on our website.

Executive Committee.    The function of the Compensation Committee is and will continue to be performed by the Executive Committee of the Board of Directors (the “Executive Committee”) consisting of Messrs. Calbert, Fascitelli and Levin. Upon completion of this offering, we intend to appoint                     , and                      to the Executive Committee. The Executive Committee assists the Board in discharging this responsibility as further described below. The Executive Committee takes action pursuant to a charter approved by the Board.

 

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Communications with the Board of Directors

Stockholders, employees and other interested parties may communicate with any of our directors by writing to such director(s) c/o Board of Directors, Toys “R” Us, Inc., One Geoffrey Way, Wayne, NY 07470, Attention: Corporate Secretary. All communications from stockholders, employees and other interested parties addressed in that manner will be forwarded to the appropriate director.

Executive Compensation

We refer to the persons included in the Summary Compensation Table below as our “named executive officers.” References to “2009,” “2008,” and “2007” mean, respectively, our fiscal years ended January 30, 2010, January 30, 2009 and February 1, 2008.

Compensation Discussion and Analysis

The following Executive Compensation discussion and analysis discusses our compensation policies and decisions regarding our named executive officers and describes the material elements of compensation for our named executive officers. Our named executive officers are:

 

  Ÿ  

Chairman of the Board and Chief Executive Officer, Gerald L. Storch;

 

  Ÿ  

Executive Vice President—Chief Financial Officer, F. Clay Creasey, Jr.;

 

  Ÿ  

Former Executive Vice President—Chief Operating Officer, Claire Babrowski;

 

  Ÿ  

Executive Vice President—Chief Administrative Officer, Deborah M. Derby; and

 

  Ÿ  

President of Continental Europe—Antonio Urcelay.

Role of Our Board of Directors in Compensation Decisions

Our Board of Directors bears the ultimate responsibility for approving both our compensation program and the specific compensation paid to each of our named executive officers. The Executive Committee assists the Board in discharging this responsibility as further described below. The Executive Committee takes action pursuant to a charter approved by the Board. The Executive Committee is currently comprised of three members, one designee from each of our Sponsors.

Objective of Our Compensation Program

The overall objective of our compensation program is to provide compensation opportunities that will allow us to attract and retain executive officers of a caliber and level of experience necessary to effectively manage our global business and motivate such executive officers to increase the value of our Company. We believe that, in order to achieve that objective, our program must:

 

  Ÿ  

provide each executive officer with compensation opportunities that are competitive with the compensation opportunities available to executives in comparable positions at companies with whom we compete for talent;

 

  Ÿ  

tie a significant portion of each executive officer’s compensation to our financial performance and his or her individual performance; and

 

  Ÿ  

align the interests of our executive officers with those of the Sponsors.

Elements of Our Compensation Program

Our executive compensation program consists of the following integrated components:

 

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  Ÿ  

base salary;

 

  Ÿ  

annual incentive awards;

 

  Ÿ  

long-term incentives;

 

  Ÿ  

perquisites;

 

  Ÿ  

other benefits; and

 

  Ÿ  

benefits upon termination without cause or change of control.

Mix of Total Compensation

No formula or specific weightings or relationships are used with regard to the allocation of the various pay elements within the total compensation program. Cash compensation includes base salary and annual incentive awards which, for top executive officers, are targeted to approach or exceed base salaries to emphasize performance-based compensation. Perquisites and other types of non-cash benefits are used on a limited basis and represent only a small portion of total compensation for our executive officers. Stock compensation includes long-term incentives, which provide a long-term capital appreciation element to our executive compensation program. The bulk of deferred compensation is provided through our “TRU” Partnership Employees’ Savings and Profit Sharing Plan (the “Savings Plan”) and Supplemental Executive Retirement Plan (the “SERP”) for the U.S. officers. For Mr. Urcelay, the bulk of his deferred compensation is provided through his retirement plans, the Plan de Pensiones CajaMadrid Rent (the “Spain Savings Plan”) and certain annuity products from MAPFRE Vida (the “MAPFRE Policies”).

Initial Determination of Compensation

Prior to hiring a new executive officer to fill a vacant position, we typically describe the responsibilities of the position and the skills and level of experience required for the position to one or more national executive search firms. The search firms inform us about the compensation ranges of executives in positions with similar responsibilities at comparable companies and provide us with guidance as to how different skills and levels of experience impact those compensation ranges. In addition, the Sponsors inform us about the compensation ranges paid by their portfolio companies to executive officers with similar skills and experiences. By using the information obtained from the search firms and our Sponsors, we determine target compensation ranges for the positions we are seeking to fill, taking into account the individual candidate’s particular skills and levels of experience. In specific circumstances, when making an offer to a potential new executive officer, we also consider other factors such as the amount of unvested compensation that the executive officer has with his or her former employer. By using information provided by one or more search firms, we seek to ensure that the compensation information we consider is both comprehensive and reliable. We believe this process has enabled us to attract superior individuals for key positions by providing for reasonable and competitive compensation. Each of our named executive officer’s initial base salary, annual incentive award target and, in some instances, long-term incentives was determined through this process.

Base Salary

Base salary provides fixed compensation and is designed to reward core competence in the executive officer’s role relative to his or her skills, experience and contribution to the Company.

The Executive Committee reviews the base salary of each of our executive officers annually as part of the Company’s performance review process described below, as well as upon a promotion or other change in job responsibility. On an annual basis, the Executive Committee determines the range,

 

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if any, for merit-based increases for eligible employees of the Company (including our executive officers). In developing the range for merit-based increases, the Executive Committee will often look at broad-based industry surveys to determine the reasonableness of the proposed range of merit-based increases. Merit-based increases to the base salary of an executive officer are based on the Executive Committee’s assessment that the executive officer performed at or above his or her established goals. Increases in base salary due to a promotion or change in job responsibilities are based on the Executive Committee’s assessment of the responsibilities and importance of the executive officer’s new position compared to the executive officer’s prior position.

At the beginning of each fiscal year, each of our executive officers is required to establish his or her personal business goals for the year, using some or all of the following five criteria:

 

  Ÿ  

Financial—focuses on financial metrics that we believe are good indicators of whether the Company and our business segments are achieving their annual and long-term business objectives;

 

  Ÿ  

Operational Efficiency—focuses on operational efficiencies and cost reduction, such as supply chain optimization and reducing selling, general and administrative expenses;

 

  Ÿ  

Team Work—focuses on people individually and as a team, such as the hiring, development and retention of employees, compensation initiatives, team building, conflict resolution, communication and succession planning activities;

 

  Ÿ  

Customer Satisfaction—focuses on operational execution, such as improving customer satisfaction and testing new business initiatives and new product lines; and

 

  Ÿ  

Future Development—focuses on growing our business, such as implementing new business strategies, accelerating new store rollouts and developing financial strategies.

We believe that these five criteria, when considered together, provide an appropriate method of measuring our executive officers’ personal performance.

At the beginning of each fiscal year, Mr. Storch, our Chairman and CEO, reviews and approves the goals developed by each of our executive officers, other than himself, and the Executive Committee reviews and approves Mr. Storch’s goals. At the end of each fiscal year, Mr. Storch reviews the individual performance of each executive officer against his or her personal goals. Mr. Storch also prepares a self-evaluation of his own performance. He then presents his conclusions and recommendations with respect to base salary adjustments to the Executive Committee. The Executive Committee considers these conclusions and recommendations when determining any adjustments to our executive officers’ base salaries. Based upon the economic conditions and the resulting impact on our business, the Executive Committee decided that no named executive officers would receive an increase in salary for fiscal 2009.

Annual Incentive Awards

Annual incentive awards are an important part of the overall compensation we pay our executive officers. Unlike base salary, which is fixed, the annual incentive awards are paid only if specified performance levels are achieved during the year. We believe that annual incentive awards encourage our executive officers to focus on specific short-term business and financial goals of the Company. Our executive officers receive annual cash incentive awards under the Toys “R” Us, Inc. Management Incentive Plan (the “Management Incentive Plan”).

Under the Management Incentive Plan, each executive officer has an annual incentive target expressed as a percentage of his or her salary. The target bonus percentages for our named executive

 

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officers were established in their employment agreements and may be subsequently adjusted based upon performance and/or a promotion in responsibility. Our named executive officers’ annual incentive award targets, expressed as a percentage of base salary, are as follows: 200% for Mr. Storch; 110% for Ms. Derby; and 100% for Messrs. Creasey and Urcelay. The annual incentive award and target for Ms. Babrowski, our former Chief Operating Officer, was 110%. Each executive officer’s annual incentive target is weighted 70% on the Company’s financial performance (“Financial Component”) and 30% on the executive officer’s personal performance (“Personal Component”). We believe that weighting the executive officers’ annual incentive targets in this way aligns the interests of our executive officers with the interests of the Sponsors by motivating the executive officers to increase the shareholder value of the Company as a whole, while also rewarding each of the executive officers for his or her individual performance.

The Financial Component is based on a combination of the Adjusted Compensation EBITDA results for the total Company and for one or more business units of the Company. We calculate Adjusted Compensation EBITDA for this purpose, as earnings before interest tax depreciation and amortization, further adjusted for the effects of certain period charges and gains or losses, including, among others, changes in foreign currency, noncontrolling interest, gains or losses on liquidations of subsidiaries or sales of properties, asset impairments and accounting changes. More detail about the calculation of Adjusted Compensation EBITDA is set forth in the narrative after the “- Summary Compensation Table”, including actual Adjusted Compensation EBITDA results. We believe that focusing the Financial Component solely on Adjusted Compensation EBITDA closely aligns the executive officers’ interests with those of the Sponsors. The Adjusted Compensation EBITDA goals for the Company and each business unit are established at the beginning of each year by the Executive Committee. The Adjusted Compensation EBITDA goals for fiscal 2009 were $976,300,000 for the consolidated Company, $841,500,000 for our Domestic segment, $335,800,000 for our International segment, $28,209,000 for Central Europe (using the budgeted conversion rate of 1 EURO = 1.2813 USD), $44,847,000 for France (using the budgeted conversion rate of 1 EURO = 1.2813 USD) and $56,630,000 for Iberia (using the budgeted conversion rate of 1 EURO = 1.2813 USD).

The specific combination of Adjusted Compensation EBITDA measures that make up the Financial Component for a particular named executive officer relates to his or her primary job responsibilities. For example, corporate officers generally have a financial target based 50% on consolidated Adjusted Compensation EBITDA and 50% on Adjusted Compensation EBITDA of the Domestic segment and International segment, weighted two-thirds for the Domestic segment and one-third for the International segment. However, if the named executive officer has primary responsibility for one business unit, the Financial Component of his or her annual bonus is based 25% on consolidated Adjusted Compensation EBITDA and 75% on Adjusted Compensation EBITDA for that particular business unit (except for Mr. Urcelay, whose annual bonus is based 25% on consolidated EBITDA, and 25% on the Adjusted Compensation EBITDA for each of Iberia, France and Central Europe). We believe that these Financial Component weightings motivate our executive officers to work to improve the Company as a whole with appropriate emphasis on business unit results as the executive’s job responsibilities merit.

The Executive Committee sets the threshold, target and maximum payout levels for the Financial Component of the Management Incentive Plan. The Executive Committee generally sets the target levels of achievement under the Management Incentive Plan at the Adjusted Compensation EBITDA targets for the Company and its business units, as applicable, which the Executive Committee determines when it establishes our business plan as part of our annual financial planning process whereby we assess the future operating environment and build projections of anticipated results. Achievement at the respective levels would result in a payout at the target level (i.e., 70% of the executive officer’s annual incentive target in fiscal 2009). If the applicable Adjusted Compensation EBITDA performance is less than the minimum threshold of the particular Adjusted Compensation

 

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EBITDA target, no bonus will be earned with respect to that portion of the Financial Component of the Management Incentive Plan. If Adjusted Compensation EBITDA performance is greater than 100% of any particular Adjusted Compensation EBITDA target, the executive officer’s total payout with respect to the Financial Component of the Management Incentive Plan (i.e., 70% of his or her annual incentive target) is capped at 300% of the Financial Component target (which means 210% of his or her annual incentive target).

The Personal Component of the annual incentive under the Management Incentive Plan is based on each executive officer’s individual performance measured against his or her personal business goals (as further described in the “—Base Salary” section above), as assessed as part of the Company’s performance review process described under “—Base Salary” above. The Executive Committee sets the threshold and maximum payout levels for the Personal Component of the Management Incentive Plan. The Executive Committee will first determine an average payout percentage of the annual incentive target for all eligible employees at the Company (including our executive officers) and will then determine the actual payout of the Personal Component portion of each executive officer’s annual incentive target, after considering the conclusions and recommendations provided by Mr. Storch with respect to executive officers other than himself. An executive officer’s payout with respect to the Personal Component of the Management Incentive Plan (i.e., 30% of his or her annual incentive target) is capped at 200% (which means 60% of his or her annual incentive target). The Executive Committee also considers how the payouts to the executive officers will affect the payouts for all eligible employees, as all percentage payouts to employees (including our executive officers) must equal the average payout percentage determined by the Executive Committee.

Notwithstanding the formulas described above for the Management Incentive Plan, the Executive Committee has the discretion to adjust the Personal Component and/or Financial Component payouts for all participants (which includes our executive officers) of the Management Incentive Plan.

The “—Grants of Plan-Based Awards in Fiscal 2009” table below shows the threshold, target and maximum Management Incentive Plan awards that each of our named executive officers was eligible to receive in fiscal 2009. The Management Incentive Plan awards actually earned by our named executive officers in fiscal 2009 are shown in the “Non-Equity Incentive Plan Compensation” column of the “Summary Compensation Table” below.

The 2010 Incentive Plan

We expect that the 2010 Incentive Plan will be adopted and approved by our Board of Directors and our stockholders prior to the completion of this offering. We intend that the awards made under the 2010 Incentive Plan will be deductible as performance based compensation (as defined under Section 162(m) of the Code). Whether or not such awards would otherwise qualify as performance based compensation, we still expect them to be fully tax deductible due to the transitional relief described in “Considerations Associated with Regulatory Requirements.” The purpose of the 2010 Incentive Plan will be to aid us in recruiting, retaining and motivating key employees and directors, and to align their interests to the interests of our stockholders by providing long-term incentives through the granting of options, stock appreciation rights and other stock-based awards. There will be             shares of our common stock that may be granted under our 2010 Incentive Plan.

Long-Term Incentives

We believe that providing long-term incentives as a component of compensation helps us to attract and retain our executive officers. These incentives also align the financial rewards paid to our executive officers with the Company’s long-term performance, thereby encouraging our executive officers to focus on the Company’s long-term goals. We offer long-term incentives under the Management Equity Plan and will offer long-term incentives under our 2010 Incentive Plan.

 

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Under the Management Equity Plan, executive officers are eligible to purchase (or in some instances to receive without payment) restricted shares of our common stock, par value $.001 per share (“Common Stock”) and to receive stock options to purchase such Common Stock. Restricted shares of Common Stock may be purchased at a price equal to the fair value of the Common Stock. When the shares of Common Stock are purchased for fair value, they are fully vested upon purchase and are “restricted” in that the Common Stock is subject to certain transfer restrictions, as well as, in some cases, a put right exercisable in certain circumstances by the holder and a call right exercisable by us (and, if not exercised by us, by the Sponsors in the event the holder is no longer employed by us or any of our subsidiaries). When the shares of Common Stock are granted without consideration, they generally have a vesting period designed to encourage retention of the executive officer. Stock options granted under the Management Equity Plan have an exercise price equal to the fair value of the underlying Common Stock on the grant date. Unless special vesting conditions are approved in an individual case, stock options granted under the Management Equity Plan vest over five years based on continued service (“service-based options”) or (ii) after eight years (“performance-based options”). The service-based stock options are designed to encourage retention, while the performance-based stock options combine retention with reward for achieving designated levels of return on investment for the Sponsors. In June 2009, the Management Equity Plan was amended in order to remove the performance-based requirements and have all of the options to purchase our Common Stock vest upon continued service of five years. More detail about the restricted stock and stock options held by our named executive officers (including the vesting provisions related to these grants) are shown in the tables that follow this discussion, including the “—Outstanding Equity Awards at 2009 Fiscal Year-End” table.

Our executive officers who were employed at the time of the 2005 acquisition (including Ms. Derby and Mr. Urcelay) were offered the opportunity at that time to invest in the Company along with the Sponsors, by either making a cash investment to purchase restricted shares of Common Stock under the Management Equity Plan or rolling over previously existing options into the Management Equity Plan. Our executive officers, who were hired after the 2005 acquisition, are provided the option of making a cash investment to purchase restricted shares of Common Stock. The equity ownership of our named executive officers is set forth in the Beneficial Ownership table in “Principal Shareholders.”

During Fiscal 2009, no named executive officer was granted an equity award. For more information on our practice for granting equity awards, see the section below entitled “—Equity Grant Practices.”

Perquisites

We provide our executive officers with perquisites that we believe are reasonable and consistent with the perquisites that would be available to them at other potential employers. We provide each of our executive officers with a car allowance or company-leased car; financial planning, accounting and tax preparation services; legal services; an annual executive physical; and reimbursement of relocation expenses. In addition to these perquisites, pursuant to her employment agreement, Ms. Derby is entitled to tax gross-up payments if and to the extent that a change in control of the Company causes her to incur an excise tax under Section 4999 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”). Perquisites are valued at aggregate incremental cost to the Company.

For more information regarding perquisites for our executive officers, see “—Summary Compensation Table”. For information on the incremental costs of these perquisites, see the footnotes to the Summary Compensation Table.

Other Benefits

Other benefits for our executive officers include retirement benefits and health and insurance benefits. Retirement benefits play an important role within our overall executive compensation program

 

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by facilitating retention and encouraging our employees to accumulate assets for retirement. Based upon annual surveys sponsored by the Retail Benefits Group in which we have participated, we believe that our retirement program, including the amount of benefits, is comparable to those offered by other companies in the retail industry and, as a result, is needed to ensure that our executive compensation program remains competitive.

We maintain the Savings Plan in which our U.S. named executive officers who have at least one year of employment with the Company are eligible to participate, along with a substantial majority of our employees. The Savings Plan is a traditional 401(k) plan, under which the Company matches 100% up to the first 4% of each plan participant’s (including our executive officers) earnings up to the Internal Revenue Code limit for each respective year in which the executive officer participates in the Savings Plan.

We also maintain the SERP for U.S. officers of the Company, including executive officers, who have one year of employment with the Company. Participants are generally 100% vested in their SERP accounts after completing five years of employment with the Company. The SERP provides supplemental retirement benefits that restore benefits to individuals whose retirement benefits are affected by the Internal Revenue Code limit on the maximum amount of compensation that may be taken into account under the Savings Plan. We intend the SERP to constitute an unfunded deferred compensation plan that is a “top-hat” plan under the Employee Retirement Income Security Act of 1974. We believe the SERP gives our executive officers parity in terms of retirement benefits with our other employees whose benefits are not subject to these limitations. In addition, the SERP supports the financial security component of compensation by providing a level of retirement benefits that is based on the actual level of compensation earned by our named executive officers during their employment rather than only a portion of such compensation.

We currently offer an executive life insurance coverage benefit to certain of our officers. This benefit, however, is in the process of being phased out and Ms. Derby is the only current named executive officer entitled to this benefit. This plan has been a closed population, with no new members, since March 2005. This plan entitles executive officers’ beneficiaries or estates to receive an amount equal to five times their annual salary and target annual cash incentive as of May 2006, net of any principal amounts paid by the Company (i.e., a “split dollar plan”). This plan will remain in place until July 2010.

Mr. Urcelay, along with certain other management employees in Spain, participated in the Spain Savings Plan, which is a defined contribution pension plan. This plan is a product offered by CajaMadrid, a Spanish bank, and participation in this plan is not limited to our management employees but rather is available to other companies and investors who elect to participate. Mr. Urcelay will be eligible to receive this benefit at age 65, or a reduced benefit beginning at age 60. The benefit is paid either as a lump sum or as an annuity. Pursuant to his employment agreement, Mr. Urcelay is entitled to receive annual contributions equal to 15% of his base salary (the “Contribution Amount”). Spanish regulations limit company contributions to the Spain Savings Plan. The remaining balance of the Contribution Amount is utilized to purchase certain additional annuity products under the MAPFRE Policies, which provide certain payments to Mr. Urcelay upon maturity of each policy and prior to maturity, in the event of Mr. Urcelay’s disability or death. On July 23, 2009, Mr. Urcelay’s Spain Savings Plan account was cancelled and the balance was moved into the MAPFRE Policies. His entire 2009 contribution was made into the MAPFRE Policies.

Benefits Upon Termination or Change of Control

Pursuant to their employment agreements, our executive officers are entitled to benefits upon termination or change of control. We believe these benefits play an important role in attracting and

 

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retaining high caliber executive officers and permit our executive officers to focus on their responsibilities for the Company without distractions caused by uncertainties in the context of an actual or threatened change of control. We also believe these benefits play an important role in protecting the Company’s highly competitive business by restricting our executive officers from working for a competitor during the severance period. These benefits and restrictions are described in more detail below.

Tax and Accounting Considerations

In making decisions about executive compensation, we take into account certain tax and accounting considerations. For example, we consider Section 409A of the Internal Revenue Code regarding non-qualified deferred compensation and Section 280G of the Internal Revenue Code with regard to change-in-control provisions. In making decisions about executive compensation, we also consider how various elements of compensation will affect our financial reporting. For example, we consider the impact of FASB Accounting Standards Codification (“Codification” or “ASC”) Topic 718, “Compensation—Stock Compensation” (“ASC 718”), which requires us to recognize the cost of employee services received in exchange for awards of equity instruments based upon the grant date fair value of those awards.

Considerations Associated with Regulatory Requirements

After the consummation of this offering, Section 162(m) of the Internal Revenue Code would limit the deductibility of the annual compensation of our named executive officers (other than our chief financial officer) to $1,000,000 per individual to the extent that such compensation is not “performance-based” (as defined in Section 162(m)). We intend to rely on transitional relief that is available under Section 162(m) of the Internal Revenue Code that exempts compensation plans adopted prior to a company’s initial public offering from the deductible limit under that Section. This transitional relief for our compensation plans will be available to us until the date of our annual meeting that occurs after the third calendar year following the year of our initial public offering, unless prior to that date, we materially modify the plan or use up the shares or compensation that is subject to that transitional relief earlier (at which point, the transitional relief will expire). We will continue to consider the implications of Section 162(m) and the limits of deductibility of compensation in excess of $1,000,000, as we design our compensation programs going forward.

Equity Ownership Guidelines

Although as a privately held company we do not have formal equity ownership guidelines, we strongly encourage our executive officers to invest in the Company through the Management Equity Plan. We believe equity ownership aligns our executive officers’ interests with the Sponsors’ interests. The equity ownership of our named executive officers is set forth in the Beneficial Ownership Table in “Principal Shareholders”.

Equity Grant Practices

We intend to only issue equity under the Management Equity Plan twice a year to eligible new hires and eligible promoted individuals, although we may decide to issue equity at other times. Each grant date will coincide with a re-valuation of the stock price. After the stock price has been determined and our Executive Committee of the Board has approved the grant, there will be a limited investment window, during which eligible individuals will be able to purchase Common Stock and/or be granted stock options. These stock valuations will not be performed without considering all relevant public and non-public information. The number of options granted to these individuals will generally be determined by a multiple of the amount of their investment in restricted stock divided by the stock price, although the Board may grant options to persons who do not invest in the Common Stock at that time. The multiple is fixed and is based on the experience of the Sponsors in similar transactions.

 

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Summary Compensation Table

The following table summarizes the compensation awarded to, earned by or paid to the named executive officers for fiscals 2009, 2008 and 2007.

 

Name and Principal
Position                     

  Fiscal
Year
  Salary   Bonus   Stock
Awards
  Option
Awards(1)
    Non-Equity
Incentive Plan
Compensation
  Change in