Toys R Us Inc. said yesterday that its second-quarter profit fell 14 percent, mainly because it has increased spending on its online store to meet competition from Internet toy retailers.

The nation's No. 2 toy merchant also announced that it has split with its online retail partner, investment firm Benchmark Capital, after a dispute over ownership of the Internet store, Toys R Us declined to explain the split.

Benchmark Capital, known for its investments in eBay Inc., Ariba Inc. and other up-and-coming technology firms, had been willing to invest about $10 million in But it wanted a piece of the online venture--something Toys R Us officials opposed, it said.

"Toys R Us decided the online venture was a business they wanted to own, which was inconsistent with our return objectives," said Bob Kagle, a general partner with Menlo Park, Calif.-based Benchmark.

"We felt it was in the best interests of both companies to part ways before we were too far down the track."

In the second quarter ended July 31, Toys R Us net income dropped to $12 million, or 5 cents a share, from $14 million (also 5 cents, with more shares outstanding) in the year-ago period, including one-time charges. Sales at the Paramus, N.J.-based company rose 9 percent, to $2.2 billion, from $2.02 billion.

Company officials said they were not concerned about the decline in second-quarter net income.

The retailer spent about $4 million during the period trying to boost its performance on the World Wide Web before the critical Christmas shopping season.

"You have to make an investment in order to establish a business," said Louis Lipschitz, the retailer's chief financial officer.

After the announcements, Toys R Us shares climbed 62 1/2 cents on the New York Stock Exchange to close at $15.81 1/4.

Toys R Us has experienced several setbacks over the past year.

Wal-Mart Stores Inc. surpassed Toys R Us in retail toy sales for the first time ever in 1998, according to Toy Manufacturers of America. Wal-Mart's online store, which is now being redeveloped, is being closely watched by toy retailers.

"Wal-Mart is a very formidable competitor in traditional retail," said Sally Wallick, an analyst with Legg Mason Wood Walker Inc. in Baltimore. "We'll have to see what they're going to do online."

So far, Internet-only retailers have the lead. EToys Inc. has established itself as the dominant toy merchant in cyberspace. It faces new competition from Inc., an online bookselling giant that recently added toys to its arsenal.

"There's no model for a brick-and-mortar company going online and being wildly successful," said Seema Williams, an analyst with Forrester Research Inc. "There's nobody you can point to."

Earlier this month, Toys R Us named John Barbour as president and chief executive of the online division. Barbour has been president and CEO of OddzOn, a unit of the toy manufacturer Hasbro Inc.

Toys R Us initially announced the hiring of Bruce Moog, founder and chairman of University Games Inc., to lead its online campaign. But Moog told the Wall Street Journal in July that he had declined the job after having business disagreements over how the online venture would function.


Toys R Us, once the leader in market share for toys, lost its spot to Wal-Mart last year.

Estimated dollar share, U.S. toy industry

* 1997

Toys R Us: 18.3%

Wal-Mart: 16.3%

Kmart: 8.2%

Target: 7.1%

KB Toys /Toy Works: 4.9%

* 1998

Wal-Mart: 17.4%

Toys R Us: 16.8%

Kmart: 8.0%

Target: 6.9%

KB Toys /Toy Works: 4.9%

NOTE: Includes online sales.

SOURCE: Toy Market Index