Financial Problems at EToys Bode Ill for Retailing Sector

EToys Inc.’s announcement Friday that sharply weaker sales are forcing the once highflying company to reexamine its viability is a bad omen for other online-only sellers as well as for the rest of the retailing sector.

A slowing economy, vicious competition from bricks-and-mortar retailers and the unpredictable habits of new Internet users have conspired to cause trouble much sooner than expected for online retailers, even for companies once thought to have enough cash for a short-term reprieve into 2001.

“I wouldn’t say this is unique to EToys,” said company spokesman Gary Gerdemann. “We certainly had hopes sales would be better, and people in this building worked their hearts out to make EToys as good as it is and arguably the best in Internet retailing.”

EToys said sales for its crucial holiday quarter could be off by as much as $100 million, reaching between $120 million and $130 million, rather than the $210 million to $240 million the company had anticipated. The revised figure is just barely above last year’s holiday net sales of $106.8 million, in spite of millions of new online users and sales that increased steadily throughout the year.

EToys also said it has hired investment banking firm Goldman, Sachs & Co. to explore options, including merger possibilities and asset sales.

The Los Angeles-based company said it was taking steps to cut expenses and will announce layoffs in January. In the meantime, it said it would have no problem filling holiday orders and accepting returns or exchanges.

EToys’ sales outlook partly reflects the broader picture for U.S. retailers in general. Overall, U.S. retail sales tumbled in November, the start of the key holiday sales season, which analysts forecast will be flat or lower compared with last year.

A host of major retail chains, including Home Depot and Circuit City, have lowered their sales forecasts for the second half of the year. Even the venerable Wal-Mart Inc., the world’s biggest retailer, said its third-quarter sales would fall sharply from the previous period. And on Sunday, Natural Wonders Inc., a chain of shopping mall-based stores selling gifts with science themes, said it filed for bankruptcy protection from its creditors as holiday sales were less than the Fremont, Calif.-based company expected.

The problems with EToys’ sales, though, could signal serious problems for other online sellers with strong brands and marketing budgets, analysts said.

“Last year, the brick-and-mortars didn’t count on the ‘dot-coms’ being so competitive and this year the dot-coms didn’t count on the brick-and-mortars being so competitive,” said David Copperstein, director of online research for Forrester Research.

Although the year’s dwindling number of e-tailers seemed to lessen competition for the biggest online players, most of the competition is coming from the traditional offline retailers with online operations funded by deep pockets and strong resources.

For EToys, that meant last year’s crowded field of would-be Internet toy sellers had been whittled down to a handful.

But now behemoth Toys R Us Inc. is better prepared for online selling; in August, Toys R Us announced a joint site with Amazon.com, with the Internet retailer taking care of Web operations and fulfillment.

The traditional retailers, having learned from last year’s experience online, would be a formidable competitor in any event.

But working even more in their favor has been the nature of the newest online users, whose presence was expected to boost all Web sales.

Shoppers buying online for the first time this year are, by definition, nontechies, which contrasts sharply with the online buyers of last year and prior who were generally more technologically savvy and open to the concept of doing business with online-only sellers.

And nontech-minded shoppers, aware of various problems and glitches of last year, seem more inclined to buy at familiar stores, a windfall for the traditional retailers that have gone online.

“Earlier users were going for easy-to-find things,” Cooperstein said. “New users are going for easy-to-ship, easy-to-return and easy-to-trust.”

Still, analysts say it is the slowing of the economy, combined with the Internet-only sellers’ need to boost sales, that will most haunt the online sector.

Even after April’s Nasdaq decline, when a number of dot-coms started to nose dive, most of the financial community’s concerns revolved around costs more than revenue.

At the time, economists warned that for many companies, sales growth might not be enough to offset the still-high price of gaining customers and making sales--especially as investors began demanding a quicker route to profitability.

Even so, those concerns seemed mostly to threaten companies that had to gain sales while dramatically reducing ad campaigns and other costs.

EToys, with enough money to spend significant dollars and still keep afloat through the important holiday selling period, seemed to have a bit more breathing room to make it into the black.

However, EToys’ stock has fallen about 96% so far this year and now trades at about $1 on Nasdaq.

EToys and other companies with strong brand identity and sales, however, planned capital expenditures as if last year’s record-setting consumer buying would continue, spending tens of millions of dollars on expansion and new distribution centers with costly state-of-the-art equipment.

Many analysts were supportive of such expenditures for the top online companies, arguing that millions of new Web users were bound to ratchet up the sales figures for the most well-known of the e-tailers.

According to the most recent statistics from Nielsen/-NetRatings, the number of people with Web access in November increased 30%, from 118 million a year ago to 153 million this year--more than half the U.S. population.

But even though e-tailers’ selling models have always called into question their long-term success, online experts were not anticipating serious threats this soon for the surviving online-only retailers.

Indeed, Internet pundits have been warning that after the holiday sales season many of the stress fractures in online retailing would grow into full-blown fissures, but now some of the problems are emerging earlier than expected.

EToys said operating losses could be more than double the amount it had anticipated.

Rather than the 22% to 28% of revenue, excluding charges, the company had forecast, those losses could hit a whopping 55% to 65%. The company’s losses last year hit 59%.

And perhaps most significant, a cash infusion in June of $100 million, which EToys had said would give it enough cash to fund operations through the end of June 2001, will now dry up far sooner, perhaps as early as March.

EToys also said rather than increase cash reserves as a result of holiday sales, the company now expects them to be far lower than anticipated.

At the end of December, the company’s cash and cash equivalents are likely to be between $50 million and $60 million, far short of the $100 million to $120 million the company anticipated. EToys ended its second quarter Sept. 30 with cash and cash equivalents of $111.4 million.

Gross margin, the company said, also will miss forecasts, at roughly 21% to 23% rather than the 22% to 24% previously expected. Last year’s holiday gross margins were 19% of revenue.

“This is pretty bad,” said one analyst who asked not to be identified.

“Last year, either Amazon or Toys R Us might have been interested in the company. This year, EToys might only be able to sell off assets at fire-sale prices.”