eToys at the Crossroads

eToys, Inc. (Nasdaq: ETYS) was a nearly ubiquitous presence in the news this week, as the online toy seller launched a splashy, summer-themed marketing campaign in advance of a mixed quarterly report.

The e-tailer announced Thursday that net sales for its fiscal year ended March 31st reached $151 million (US$) — up five-fold from $30 million one year earlier — and that customer accounts over the same period grew from 365,000 to 1.9 million.

Sales were buoyed by a robust holiday selling period. Customer accounts nearly tripled, and revenue rose 366 percent to $107 million during the last quarter of 1999. The wave carried into 2000, as net sales for the fourth fiscal quarter ended March 31st were $23.0 million, nearly four times greater than net sales of $6.1 million for the year-earlier period.

Excluding certain charges, the company also reported a fiscal year loss of $148.1 million, or $1.29 per share, compared with a loss of $22.4 million or 27 cents per share a year ago.

These results have left investors pondering whether a summertime splash — designed to attract new customers “during the traditionally overlooked summer selling period” — will be enough to nudge eToys closer to profitability.

Toys of Summer

At first glance, eToys appears to be playing with fewer cards than other companies in the toy trade. Strong brand awareness helps, but the company is scrambling to outfit its distribution centers, does not have intellectual property rights in the toys its sells, and does not offer a place — either virtual or real-world — where kids can play.

Also, according to many analysts, eToys is quickly running out of cash. Estimates put its current bankroll at about $180 million, which detractors believe is not enough to see the company through the end of the year at current burn rates.

Where Toys Come From

While the company is putting on a happy face, it is looking inward to correct its distribution problems. The e-tailer has phased out its third party distribution agreement with Fingerhut, and is now going it alone on the warehouse front, with its existing center in Commerce, California and a new center being built in Danville, Virginia.

Although eToys did not face the same level of holiday chaos that traditional retailer Toys “R” Us experienced at its Toysrus.com site, eToys also had some late deliveries and was missing stock items in the crush of overwhelming interest in its online store in December. Toys “R” Us had technical glitches as it joined the e-commerce realm, but is many warehouses ahead of eToys.

Not All Fun and Games

Virtually all of the leading brick-and-mortar toy stores, such as Toys “R” Us, KB Toys and FAO Schwartz, have online stores that compete head-to-head with eToys. Moreover, newcomer destination-style toy stores are starting to join forces and compete — both online and off.

For instance, Zany Brainy, the trendy location store that features educational toys, in-store play spaces and special events, is buying rival Noodle Kidoodle, Inc. for $35 million. The deal, announced Monday, will create a 163-store chain that will sell a wide-range of educational toys under the Zany Brainy name.

Combined sales for Zany Brainy alone topped more than $370 million last year.

The Original Toy Companies

eToys is also facing pressure from leading original brand toy manufacturers who own the rights to their own products.

Mattel, the number one toymaker in the U.S., has an online store featuring historical content along with sales of its leading brands and licensed products, including Barbie, Winnie-the-Pooh, Sesame Street, Hot Wheels, Matchbox, American Girl, and Cabbage Patch Kids.

Hasbro, Inc. does not yet have an e-commerce Web site, but does have best-selling toys in its intellectual property vault and, more importantly, a demonstrated ability to show a profit.

Hasbro, whose lineup includes Pokemon cards, Star Wars action figures, and the board game Monopoly, announced Tuesday that its first quarter profits for 2000 reached $15.1 million, up from $13.8 million in the year-earlier quarter, according to research firm First Call/Thomson Financial.

This summer, Hasbro plans to launch an online game portal, Games.com, where visitors will be able to play Monopoly, Clue, Battleship, and many other globally branded games before buying those games in the Games.com online store.

Additionally, with challenges from such price-conscious retailers as Wal-Mart and Target, eToys faces formidable pressure from all sides.

No One Has All the Toys

Despite uncertainty for toy retailers in the online space, the toy business overall is a happy place. According to Peter Eio, chairman of the Toy Manufacturers of America (TMA), toy sales soared to $16.9 billion as last year came to a close, representing an 8.8 percent increase over 1998 figures. What’s more, the number of units sold in 1999 increased by 9.3 percent to a total of $3.83 billion.

Ultimately, eToys is going to have to gauge the industry better if it is going to survive. While no one company has all the toys, a recognizable name, waves of new customers, and a cute marketing initiative are probably not enough of a game plan to keep up with changes in a very competitive marketplace.