Will Toy Story Turn the Page to Chapter 11?

A day after reporting a net loss of $23.7 million and an operating loss of $20.5 million for its third quarter of 2002, FAO Inc. (King of Prussia, Pa.) warned that it likely would have to seek protection under the bankruptcy code in order to reorganize its operations.

With a deteriorating liquidity situation, the giant toymaker and retailer said it is seeking to have its bank, Wells Fargo Retail Finance LLC, relax recently imposed borrowing restrictions.

The company attributed much of its third-quarter losses to the costs of running both the Zany Brainy and FAO Schwarz operations for the full fiscal year. (Formerly named Right Start bought rival Zany Brainy in 2001 and FAO Schwarz in 2002.) But it has also been troubled in the marketplace. Same-store sales for the roughly 65 Right Start stores were down 8.2 percent in the quarter; for the 23 FAO Schwarz stores, including the Fifth Avenue New York flagship store, down 10 percent; and for the nearly 170 Zany Brainy stores, down 25.1 percent.