While today's headlines of widening losses don't exactly inspire much confidence, all is not gloom and doom at Toys "R" Us (NYSE: TOY ) . The nation's second-largest toy retailer posted a first-quarter loss of $0.13 per share, a penny wider than the year before, on a 2.6% drop in revenues to $2.06 billion. The news sent investors scurrying for the exits, with the stock retreating 8% to $13.23 in morning trading.
Mounting losses at Toys "R" Us are by no means encouraging, but shouldn't be alarming, either. Excluding the impact of foreign currency fluctuations and the costs associated with closing the remaining Kids "R" Us stores, sales only fell by 1.7%. Furthermore, changes in the way the company accounts for promotional payments received from vendors were enacted in the first quarter, and represented $19 million, or $0.09 of the loss.
Most of the domestic weakness was the result of sluggish sales of video games, which fell by 27%. Toys "R" Us is not alone in this respect, as a lack of new video game consoles has created a slowdown for other retailers as well. First-quarter sales were also negatively affected by inventory liquidations at the now bankrupt KB Toys and FAO Schwarz chains.
Ongoing competition from discounters such as Wal-Mart (NYSE: WMT ) and Target (NYSE: TGT ) is an ever-present threat. Toys "R" Us has countered by slowly evolving. It has renovated the once cavernous interiors of their stores, closed underperforming Kids "R" Us locations, and stockpiled exclusive private-label merchandise. Management is also expanding the rapidly growing Babies "R" Us division. The thriving segment has helped offset flagging sales elsewhere, with comps and operating earnings rising 4.6% and 17, respectively. Plans are under way to open 20 new stores and remodel another 20.
Toys "R" Us has weathered the price-war storm intact, and now has fewer rivals to contend with. Though costly renovations have left the company leveraged, management at least dipped into the capital markets before the firm's debt was downgraded to junk status, and over $1 billion in cash now sits on the balance sheet. Ultimately, the renovation should help attract more shoppers.
More importantly, the company has made progress in cost containment, lifting gross margins from 34% to 35.3%. If Toys "R" Us can reduce its dependence on the holiday shopping season (all net income is currently earned in the fourth quarter alone), and find a way to plug leaking market share, the struggling retailer should deliver solid results when not confronted with an array of unfavorable onetime conditions.
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Fool contributor Nathan Slaughter likes the new-look Toys "R" Us stores, but owns none of the shares mentioned.
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