Toy Story's Unhappy Twist

FAO, the parent company of venerable toy retailer FAO Schwarz, soon could find itself in bankruptcy.

The company on Tuesday said it is facing a "liquidity crisis." FAO (FAOO Quote - Cramer on FAOO - Stock Picks), which operates the Zany Brainy and Right Start retail chains, is working with Wells Fargo, its bank, to relax its credit restrictions, but said it can't promise that it will succeed in securing new funds.

"In the event Wells were to refuse, FAO warned that it likely would have to seek protection under the bankruptcy code in order to reorganize its operations," FAO said in a statement.

An FAO representative declined to comment on Tuesday about when the company might file for bankruptcy or if it had had any success in its talks with Wells Fargo. Wells Fargo representatives did not return calls seeking comment.

FAO, then known as The Right Start, bought FAO Schwarz in January from the Netherlands-based Royal Vendex KBB. The acquisition was the second in four months for the company; Right Start bought the assets of educational toy retailer Zany Brainy in September 2001.

Although the acquisition brought with it two high-profile brands, FAO has struggled to get its financial footing. In its third fiscal quarter, which ended Nov. 2, the company lost $23.7 million, or 66 cents per share, on $88 million in revenue. FAO lost $9.9 million, or $4.07 per share, on $57 million in revenue last year. FAO's outstanding shares ballooned from 7.2 million to 35.8 million over the last year as it issued stock for acquisitions and to fund its working capital.

The company's troubles were even more stark at its individual stores. Same-store sales for the company were down nearly 20% in the third quarter, compared with the same period last year. At the company's Zany Brainy unit, which comprises the bulk of FAO's 253 retail outlets, comparable-store sales dropped 25%. Same-store sales compare results of stores open more than one year.

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