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The $23 billion toy industry heads into its biggest product showcase amid chaos in the toy store.

Most toy marketers racked up strong holiday sales as families stuck closer to home post-Sept. 11 and parents spent heavily on toys despite the anemic economy. But the industry goes into the American International Toy Fair Feb. 10-14 facing a bankruptcy filing by Kmart Corp. and hard times for Toys `R' Us, which together account for almost a quarter of industry sales.

"With Kmart closing stores and the bad debt [concerns], there are still some issues that will hurt toy sales in the first half of the year," said Hayley Kissel, analyst at Merrill Lynch. Mattel, the world's largest toy company, said it recorded fourth-quarter pretax bad debt expense of $22.1 million "related to the write-down of receivables as a result of Kmart Corp.'s bankruptcy filing."

But Ms. Kissel said, "It's fortunate for toys that [the retail turmoil] is happening in the first half of the year" rather than during the peak holiday sales period.

Toys "R" Us-whose share of toy sales grew to 16.5% in 2000 from 15.6% in 1999, according to the NPD Toy Market Index-lost money for the past three quarters and recently said it would shutter 64 underperforming stores-including 27 toy stores. Kmart controlled 7.4% of toy-market sales in 2000, up from 7.2% in 1999. Retail goliath Wal-Mart Stores, meanwhile, became even more powerful for toymakers, with 19% of industry sales, up from 17.4%.

To insulate themselves from the turmoil, toy marketers are proceeding carefully with new licensed lines. Many for holiday 2002 are based on hit TV shows like "Dora the Explorer" and "Blues Clues" on Viacom's Nickelodeon, and Sesame Street's Elmo character.

They're also expecting more momentum from toys based on AOL Time Warner-owned Warner Bros.' "Harry Potter and the Sorcerer's Stone," Walt Disney Co.'s and Pixar's "Monsters, Inc.," Viacom-owned Paramount Pictures' "Jimmy Neutron Boy Genius" and AOL Time Warner-owned New Line Cinema's "Lord of the Rings: The Fellowship of the Rings."


But there is a danger in becoming over-reliant on a small group of entertainment licenses. "It's a case of trying not to oversaturate the market," said Chris Cox, securities analyst at Goldman Sachs. "For the people that own the licenses, the challenge is not to divide the pie too finely."

Mattel reported 2001 sales of $4.8 billion, up 3%, on net income of $298.9 million; global ad spending declined 3% to $661 million.

"Conservatism is setting the tone for how much [toy vendors] manufacture," Mr. Cox said. "Full-year `Harry Potter' sales for Mattel were $160 million. That isn't that much. ... The name of the game recently has been keeping inventories as clean as possible." He expects Mattel's sales for "Harry Potter" toys in 2002 to be flat to slightly up.

Mattel rakes in 25% of sales from Wal-Mart, 22% from Toys "R" Us and 10% from Target Stores, according to a recent report from Morgan Stanley analyst Brian McGough.

As for Hasbro, Ms. Kissel projects its 2001 licensed toy sales from "Monsters, Inc." will come in at $75 million. Hasbro is also ramping up plans for a full toy line based on Fox/Lucasfilms' "Star Wars Episode II," set for a May release. Hasbro executives declined to comment, citing a quiet period until the company releases earnings Feb. 7.

Compounding toymakers' challenges is a worrisome trend they say has been around for the last few years-the kids are "getting older younger phenomenon," according to Jerry Perez, exec VP-marketing and design for Mattel's Fisher-Price. "Kids are leaving the traditional toy industry earlier than they ever have," he said, making it a challenge for marketers to come up with compelling products.

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