Toys R Us Loss Widens

The company misses estimates on a 27% plunge in video-game sales, saying the market is saturated.
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Updated from 12:07 p.m. EDT

Toys R Us

(TOY)

said its first-quarter loss widened from a year ago, missing forecasts, as a plunge in video-game sales and liquidations by its competitors ate into the top line while an accounting change hurt the bottom line.

The retail chain lost $28 million, or 13 cents a share, in the latest quarter, compared with a loss of $26 million, or 12 cents a share, last year. Overall sales were $2.058 billion in the three months ended May 1, 2004, compared with $2.113 billion a year ago. There was a pretax restructuring charge of $15 million in the latest quarter.

In a conference call with analysts today, company executives said they expected video-game sales to pick up in the second half of the year when new merchandise hits the market. They also said much of the first-quarter loss could be attributed to EITF 03-10, a new accounting regulation that affects the way losses are calculated. Ursula Moran, executive vice president of investor relations, said the change fell disproportionately in the first quarter, and accounted for $19 million of the net loss, or 9 cents a share. Without the change, she said the company loss would have been about 3 cents a share.

Analysts surveyed by Thomson First Call were forecasting a loss of 1 cent a share on sales of $2.185 billion in the most recent quarter.

Toys R Us ended the quarter with about $1 billion of cash and equivalents on its balance sheet. The company saw its debt rating cut to junk status in late March by Moody's, citing the difficulty of competing with discount behemoths like

Wal-Mart

(WMT) - Get Report

and

Target

(TGT) - Get Report

.

John Eyler, the company's chairman and chief executive, said Toys R Us was still in the process of a comprehensive strategic review of its business. Despite questions from analysts on the subject, he declined to elaborate on when the review would be finished or if it had focused on any particular aspects of the business.

"We've tried to signal in our last couple of calls that this is a complex process and that we would take an extended period of time to do it thoughtfully and professionally, and not to expect a substantive declaration of our conclusions in this time frame or in the next couple of months," he said.

Rating agency Standard & Poor's recently said Toys R Us will remain on "credit watch with negative implications" as the company continues its strategic review, adding it is in an "intensely competitive" industry and has failed to find a specific niche within toy retailing.

Despite that, Moody's analyst Charles O'Shea said Toy R Us was making the right moves, unloading its Kids R Us business and expanding Babies R Us, a business with less seasonal vulnerability than the flagship toy retail operation, which makes most of its money in fourth-quarter holiday sales. While Wal-Mart and Target won't go away, the company can still compete, he said.

"The things they can do, they have done a pretty decent job of doing," he said. "They went to the capital markets while they were still investment grade, they have no maturities coming due immediately, and they got rid of Kids R Us at, I would say, lightning speed. They're making decisions and they're executing."

Ray Arthur, the company's new chief financial officer, said the baby business would be particularly important going forward. Two Babies R Us stores opened last quarter, the first of about 20 planned for the year. Twenty current stores will be fully renovated, he said.

The company said its U.S. toy division saw same-store sales fall 5.6% in the quarter from a year ago, including a 27% decline in video-game sales. Still, the company was able to improve margin and inventory in the division and kept its operating loss to $14 million, compared with $11 million last year.

O'Shea said the video-slump had affected all toy retailers, because manufacturers such as

Sony

(SNE) - Get Report

and

Microsoft

(MSFT) - Get Report

have not unveiled new console machines in three years. Prices have dropped and the market is saturated, he said.

"It's more of nuisance than anything else with video -- they're in the business, it's going to be soft and there's not a whole heck of a lot anyone can do about it," he said.

O'Shea said Toys R Us management could only control how it reacts to the current video-game market as retailers await the successors to Sony's PlayStation and Microsoft's Xbox.

"We effectively improved margins and controlled expenses and inventory levels during the quarter to offset most of the impact of the sales decline in our toy and video-game businesses," the company said.

Additionally, the video-game market itself is expected to pick up in the last half of the year, as are other toy manufacturers, who have increased their budgets for advertising, Eyler said.

He also said the company's cash-rich balance sheet should prevent it from having to draw on revolving debt facilities when it increases inventory for the seasonal pickup in business. "We believe this will be liquid enough," he said.

Recently, the stock was up 35 cents, or 2.5%, to $14.11.