KB Toys, Inc.
KB Toys, Inc.100 West Street
Pittsfield, Massachusetts 01201
Telephone: (413) 496-3000
Fax: (413) 496-3616
Web site: http://www.kbtoys.com
Incorporated: 1922 as Kaufman Brothers
Sales: $1.5 billion (2004 est.)
NAIC: 451120 Hobby, Toy, and Game Shops; 443120 Computer and Computer Software Stores; 454113 Mail-Order Houses
KB Toys Inc. is the nation’s largest mall-based specialty toy retailer, with 640 stores in the United States, Guam, and Puerto Rico. The company emerged from bankruptcy in August 2005 after shedding 4,000 employees and closing nearly 600 stores. Since its stint with bankruptcy, KB Toys has been opening up new stores and remodeling existing locations. With newly renovated stores, the company has focused on stocking more brand-name, top-selling toys and becoming a convenient destination for harried parents looking for a quick purchase.
FROM CANDY WHOLESALER TO TOY RETAILER
KB began as Kaufman Brothers when two brothers in Pittsfield, Massachusetts, opened a wholesale candy business in 1922. Kaufman Brothers provided retailers with candy and soda fountain supplies. The Kaufman brothers got into the toy business by accident. During the 1940s, they acquired a wholesale toy company from a previous client as payment for outstanding debts owed to Kaufman Brothers for purchased candy. It was an opportune moment for Kaufman Brothers to diversify because the cost of producing candy was prohibitive during World War II due to shortages of important ingredients, especially sugar. Kaufman Brothers assumed operation of the toy company, changing its name to Kay-Bee Toy & Hobby Stores. By 1948, the toy business was so much more successful than the confectionary business that the Kaufman brothers decided to focus their energies entirely on toys. Kaufman Brothers opened its first retail toy store in Connecticut in 1959.
It was not until 1973 that the Kaufman brothers, who still owned and operated the company, decided to move once and for all from wholesaling to retailing. They discontinued their wholesale business altogether and concentrated on their 26 retail stores. Suburban malls were popping up across the country, and the Kaufmans wanted to take advantage of the boom. By 1976, only three years after making the decision to focus solely on retail, Kay-Bee Toy & Hobby had more than doubled its number of stores from 26 to 65 across New England, New York, and New Jersey. One year later, in 1977, the company changed its name from Kay-Bee Toy & Hobby to Kay-Bee Toy and Hobby Shops, Inc., primarily to distinguish itself from competitors with initials in their names or logos. In 1981, when the company was operating 210 stores, it changed its name again, this time to Kay-Bee Toy Stores, reflecting a de-emphasis on hobby products. The company was purchased in 1981 by Melville Corporation. As a subsidiary of Melville, Kay-Bee acquired Toy World, with 52 stores, in 1982; Circus World, with 330 stores, in 1990; and K&K Toys, with 133 stores, in 1991. These three acquisitions moved Kay-Bee into the upper echelon of U.S. toy retailers.
Although Melville Corporation already had an impressive list of retail names as part of its corporate family before buying Kay-Bee Toys, the purchase price of $64.2 million represented the greatest expenditure that Melville had ever made. After the sale, Howard Kaufman remained president of Kay-Bee Toys, and the company’s strategy remained essentially the same, exploiting the niche it had developed in malls.
The toy business itself went through enormous structural changes during the period of Kay-Bee’s rise to prominence. The relationship between manufacturers and retailers became much closer, to the detriment of wholesalers, distributors, and smaller retailers. Many small retailers were driven out of business during the 1970s and 1980s; Kay-Bee, however, was large enough and could buy in enough volume to compete with its major competitors. Kay-Bee could also take advantage of its long-standing policy of buying discontinued stock from manufacturers at a favorable rate and selling it at extremely reduced prices. Kay-Bee’s strategy was to pack the entrance of its locations with these bargains to entice shoppers into the store. Once inside, managers reasoned, shoppers would be likely to purchase higher-end products that were priced more conservatively.
In this way, Kay-Bee developed a very different strategy from most of its competitors. Kay-Bee’s main competitors, Toys “R” Us and Wal-Mart, were developed as freestanding stores that customers would make a conscious decision to visit with the intention of making purchases. Kay-Bee, on the other hand, realized that having its stores inside large malls meant that most of its customers probably came to the mall for some other reason, and that Kay-Bee needed to draw this mall traffic in. An important part of this plan was store design. All Kay-Bee outlets were designed with bright, eye-catching colors at the front of the store along with neatly arranged stacks of toys at bargain prices.
Kay-Bee’s corporate image was just as bright and wholesome as the look of its stores, with the company’s public relations philosophy emphasizing family values as much as value for dollars. In 1994, Kay-Bee developed the program Prescribe Reading Early to Kids (pre-K) to help foster literacy in disadvantaged families, providing grants and free books to the program, which was organized in conjunction with local healthcare and community organizations. Kay-Bee was also sensitive to issues of violence in children’s toys. In 1993, Kay-Bee withdrew the Sega product Night Trap, which was controversial for its violence, despite the fact that Kay-Bee had a close relationship with Sega of America and that video sales were one of Kay-Bee’s most important sectors.
Kay-Bee chairman and CEO Ann Iverson took a strong stand against violence when she removed all realistic toy guns from Kay-Bee’s stores in 1994. This decision was prompted by an incident earlier that year in New York City in which a 13-year-old boy was shot and killed by a policeman who mistook his toy weapon for the real thing. Almost 300,000 toy weapons were incinerated as a result of Iverson’s decision, constituting an undetermined loss in revenue for Kay-Bee Toys, but producing enough electricity to light 48 homes for a month. The company also participated in New York’s Goods for Guns program, which offered gift certificates to people who surrendered real firearms. Although Iverson left as chairman in 1994, her policy of not selling look-alike guns was continued by her successor, Alan Fine, who had been senior vice-president before becoming president and CEO.
Since 1922, when the Kaufman Brothers opened the confectionary business that grew into the K-B Family of Stores, our goal has been to give our customers friendly, efficient service, superior selection and great values. Our family is thrilled to share the joy of play and learning with yours.
RESTRUCTURING IN THE EARLY 1990S
In the early 1990s Kay-Bee began a major restructuring process that paralleled that of many other subsidiaries in the Melville Corporation group. Kay-Bee closed nearly 250 less-profitable stores from 1993 to 1994 in what the company described as a strategic realignment program. While Kay-Bee also opened some new, bigger stores during the same period, the chain nevertheless suffered somewhat in overall sales due to the dramatic number of store closings. After having reached the $1 billion mark in 1990, the company fell below that level for the year 1993 with sales of $919,054. The realignment was well managed, however, and, by 1994, the company was back to $1.01 billion in net sales, despite continued store closings.
However, mall construction in the United States slowed during the early 1990s, and Kay-Bee was finding no attractive new malls in need of its outlet. For this reason, Kay-Bee decided to launch a new string of freestanding stores in 1994, under the name Toy Works. Each of the approximately 75 Toy Works stores had a racecourse design with colorful markings and category signage to guide shoppers through the wide aisles of stores averaging 15,000 square feet. Kay-Bee hoped to differentiate itself from competitor Toys “R” Us with this distinctive store design as well as by focusing on improved customer service. At the same time, Kay-Bee began expanding some of its mall-based stores from an average of 3,500 square feet to 5,000 square feet. The bigger stores sold an expanded product line, including sporting goods and toys for adults.
The decision to move into freestanding stores, enlarge floor space, and broaden the product line put Kay-Bee in direct competition with Toys “R” Us for the first time. Additional competition came from the large discount chains, such as Wal-Mart, Kmart, and Target, which in 1995, grabbed 40 percent of the U.S. toy market. Nevertheless, in 1996 Kay-Bee stores managed to increase sales by 6.4 percent over the previous year, to $1.1 billion.
JOINING CONSOLIDATED IN 1996
In 1996, after an aborted attempt in 1995 to spin off Kay-Bee Toys, the Melville Corporation decided to sell the chain of 1,045 stores to Consolidated Stores Corporation for about $300 million. Consolidated already operated Toys Liquidators, Toys Unlimited, and the Amazing Toy Store closeout stores, as well as general retailers Odd Lots, Big Lots, All for One, and the It’s Really $1.00 stores. William Kelley, chief executive officer and chairman of Consolidated’s board, said in a New York Times article that he expected the combined businesses to offer “a great deal of synergy.” Kay-Bee, under the direction of president Michael Glazer, continued to be run as a separate business within Consolidated’s new Toy Division despite talk of its merging with their Toy Liquidators chain. Immediately after the sale, the stock of Consolidated surged upward.
Kay-Bee provided a 50 percent return on Consolidated’s investment in its first nine months of new ownership. In 1997, Kay-Bee’s sales boosted Consolidated’s revenue by about 70 percent after the chain achieved double-digit sales growth during the 1996 Christmas season. The chain closed out fiscal 1997, the best year in the company’s history, with a 10 percent comparable store gain over 1996. In order to meet growing supply needs, Kay-Bee automated its distribution centers and installed a new client/server-based planning system.
Glazer, quoted in Discount Stores News in July 1997, attributed the chain’s outstanding performance to closing underperforming stores and writing off lots of obsolete inventory prior to the sale to Consolidated. Consolidated also established a specific identity for the 1,200 stores and brushed up the chain’s image with a new logo reading simply KB. It integrated Kay-Bee with its core closeout business, and was boosting the chain’s higher-margin closeout items from 25 to about 30 percent of its business.
- The Kaufman brothers open a wholesale candy business.
- The brothers exit the candy business to focus exclusively on their toy stores.
- Kaufman Brothers opens its first retail toy store in Connecticut.
- The company moves from wholesaling to retailing toys, calling itself Kay-Bee Toy & Hobby.
- The company is purchased by Melville Corporation and becomes a division of that company.
- Company launches a new string of freestanding stores under the name Toy Works.
- The Melville Corporation sells the chain to Consolidated Stores Corporation.
- KBkids.com is started to market KB merchandise online.
- KB Toys becomes a private company in management-led buyout in partnership with Bain Capital, Inc.
- KB starts a wholesale division, supplying toys to Sears, Safeway, and CVS stores.
- KB Toys files for bankruptcy.
- KB Toys emerges from bankruptcy under new ownership and management.
By 1998, KB had annual sales of $1.6 million despite a somewhat difficult year in the toy industry. To combat the slowing trend, KB came up with some creative merchandising alternatives, such as working closely with vendors on promotions and preselling select toys in hot demand. The following June, Consolidated’s Toy Division announced the formation of a new subsidiary developed in partnership with BrainPlay.com. KBkids.com LLC took advantage of the well-established KB brand name to launch its online retail business offering toys, video games, software, and videos. That fall, KBkids.com entered into a major partnership agreement with America Online, Inc., which provided the Web toy business access as one of the premier toy retailers featured on AOL. In 1999, KBkids.com received top points from an e-commerce market research firm, the Gomez Advisors, in the categories of customer confidence, overall cost, and bargain shopping. Softletter named the site one of the Ten Best Online Software Stores of 1999 in its October 15 issue. Even the Wall Street Journal dubbed the site the “best overall” online toy retailer. In a little more than four months online, KBkids.com increased its business more than 400 percent and twice ranked among the five biggest gainers on the NextCard eCommerce Movers index.
It seemed nothing could stop KB Toys from challenging its rivals in the toy industry. Operating profit for 1999 was up 51 percent from 1998. The company, seeking to capitalize on its growth, decided to hold an initial public offering in the spring of 2000, then postponed trading due to unfavorable market conditions. Notwithstanding this delay, KB was more focused than ever on fine-tuning its position in the very fashion-forward toy industry.
PRIVATE STATUS IN THE NEW CENTURY
By December of that year, KB’s managers, with the support of Boston-based Bain Capital, a venture capital firm, bought out the 1,300-store chain from Consolidated Stores for $300 million. The deal, however, involved Bain paying just $18 million in cash, with the remaining purchase price funded by loading the company with debt.
After two decades of being a subsidiary, KB believed its status as a private company would enable it to focus on long-term goals instead of being beholden to near term month-to-month composite sales. At the time, KB was trying to build its Internet presence to keep pace with the profound changes in the toy industry with increasing sales of video games—20 percent of KB’s business—and children showing an earlier preference for teen and adult products. Such giant discounters as Wal-Mart, Target, and Kmart were also moving aggressively into the toy market. Even though KB was pursuing online retailing, it lagged behind Toys “R” Us and Amazon.com, which struck a deal in 2000 to sell toys together and were dominating the Internet toy market.
In April 2001, KB launched KBwholesale.com to boost its niche position in the wholesale and closeout market. The new site offered convenient, online access to low-priced items in case pack quantities. Customers could choose from a variety of toys including action figures, Barbie dolls, arts and crafts kits, electronics, sporting goods, and collectible toys. KB further improved its Internet presence during this time when it bought the trademark, logos, and Web address of eToys for $3.35 million. In a meteoric four-year history, eToys had risen to the top of the online toy market and then imploded with astonishing speed amid the dot-com bust. The company had raised $160 million in start-up funding, and its shares had peaked at $80 per share. For the 1999 holiday season, in fact, eToys had a customer base of two million and sold more toys than chief rival Toys “R” Us. The economical addition of eToys offered to invigorate KB’s money losing online site, KBkids. com.
KB also entered several partnerships as an alternative way to grow besides opening new stores. First, KB agreed to operate toy departments in 29 Sears, Roebuck Company stores, a deal that included 77 stores in 2002. The store-within-a store arrangement allowed the toy retailer to operate in high traffic areas, one of the tenets of its business strategy, while enabling Sears to add a wider range of products in its department stores. KB also signed a deal in October with CVS/pharmacy, the nation’s leading pharmacy chain, to be the exclusive toy supplier for CVS’ more than 4,000 locations.
Next KB entered into an agreement with Safeway Inc. for seasonal toy displays in more than 1,000 of the grocery chain’s stores. After having neared maximum mall growth with over 1,000 storefronts, 120 express stores, and 29 test boutiques within select Sears stores, KB saw the grocery niche as a viable growth strategy.
In September 2002, KB announced that it would open a superstore on New York’s Fifth Avenue in time for the holidays. The move represented a sense of growing confidence in the company’s future. The giant KB store was unlike any of its traditional mall stores, occupying over 20,000 square feet, more than five times larger than the average KB Toy store. KB said it planned to open other superstores if the Fifth Avenue location proved to be a success.
REVERSAL OF FORTUNES
Despite KB’s efforts to carve out a distinctive market niche, the company faced stiffening competition from Wal-Mart and other giant discount chains that could offer lower priced items. By the end of 2003, competition among the discount stores and consumer electronic chains that sold popular video games were shaking up the $21 billion toy market. With more than 1,200 outlets, most of them in malls, KB became a casualty of a price war that was initiated by Wal-Mart in late September. As a result, KB’s sales dropped precipitously, leading it to file for Chapter 11 bankruptcy protection in January 2004 with the U.S. Bankruptcy Court for the District of Delaware. In its filing with the court, KB said it planned to close between 400 and 500 stores, including mostly mall-based units. KB also obtained a $350 million loan from FleetBoston Financial to finance its operations while it reorganized. In addition, the company sold its Internet assets to D. E. Shaw, a private equity firm, for $7.4 million, in order to focus on its core retail store and wholesale operations.
By the end of August 2005, KB had emerged from bankruptcy with 640 stores under new ownership and management. The reorganization put the 80-year-old toy retailer under the control of a subsidiary of New York investment firm, Prentice Capital Management, and replaced KB’s chief executive, Michael L. Glazer. Taking over as CEO and president was Gregory R. Staley, a former president of Toys “R” Us’s U.S. and international divisions. The reorganization provided that an affiliate of Prentice Management invest $20 million in the company and extend credit of up to $25 million for 90 percent of its common stock and 100 percent of its preferred stock.
In March 2006, a Delaware court dismissed a $45 million lawsuit filed by the Consolidated Stores’ subsidiary Big Lots Inc. against Bain Capital. Big Lots, the biggest creditor of KB Toys prior to the bankruptcy, alleged that, during the 2000 sale to Bain, Bain and top KB executives who assumed ownership of the toy company drained cash out of the chain of stores, leaving it unable to pay its debts. The toy retailer collapsed into bankruptcy less than two years after Bain and the KB executives took $120 million in cash out of the company in a dividend recapitalization transaction. The court ruled that the right to sue Bain and the executives belonged to those seeking money to pay all creditors in the bankruptcy, and that Big Lots did not have special legal grounds to go after the private equity fund.
By the end of 2006, KB and Toys “R” Us were the last surviving national toy chains. Still facing intense competition from mass discounters such as Wal-Mart, KB strove to improve the product line, selling more electronics and working closely with manufacturers to design innovative products for its stores. According to KB chief executive Greg Staley, the company needed to attract new customers as quickly as it could. Toward that end, KB introduced a KBtronics section in its stores that stocked about 60 electronics products including some high-tech exclusives. KB moved away from the cutthroat competition of the closeout market to more upscale and full-price toys, and it also redesigned its stores, making them brighter and easier to shop for mall visitors.
As more and diverse retailers, from bookstores to gas stations, were selling toys, KB sought to extend its reach, striking a deal with Bed Bath & Beyond to supply toys for retail at the home furnishings stores. KB also entered partnership agreements with other chains, including 7-Eleven, to sell its gift cards, and sought to woo the baby boomer generation, now grandparents and accounting for about $4.5 billion of the traditional toy market, with special discount programs. While management was optimistic, it remained to be seen whether the leaner and more focused KB Toys was back on track.
Hilary Gopnik and Donald McManus
Updated, Carrie Rothburd; Bruce P. Montgomery
Toys “R” Us, Inc.; Target Corporation; Wal-Mart Stores, Inc.
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