Hasbro Inc said quarterly sales dropped unexpectedly as demand in the United States petered out at the end of the holiday selling season, and the No. 2 U.S. toy company's shares initially fell more than 5 percent.

The news comes days after smaller rival LeapFrog Enterprises Inc slashed its 2010 earnings forecast after demand for its toys petered out late in the holiday season, too.

The comments from LeapFrog and Hasbro mirror those of many retailers, whose sales slowed late in the holiday season after shoppers flocked to stores to grab bargains right after Thanksgiving.

Target Corp , for example, said toy sales were one of the weaker areas in December.

The slowdown in December sets up a tough environment for toy manufacturers in the first part of 2011 and could lead to stagnation in prices of toy company shares, Gerrick Johnson, analyst at BMO Capital Markets, said

Retailers are going to continue to be cautious. They are going to have some inventory to work through due to the slow December, Johnson said.

Hasbro, which makes toys and games under brands like Nerf, Playskool and G.I. Joe, said it now expected to report fourth-quarter sales of $1.3 billion, down from $1.4 billion a year earlier. Analysts on average forecast $1.4 billion, according to Thomson Reuters I/B/E/S.

Weakness in the United States and in Canada could not be offset by strength internationally, Hasbro said.

Hasbro did not say why sales slowed in December.

But Johnson said that retailers may have gotten overconfident after strong sales in November and raised prices too much in December. Also, cold, snowy weather in the latter part of December hurt sales at some retailers. Consumers who bought toys in November may have chosen to stay home instead of venturing out in frigid temperatures for incremental purchases around Christmas, Johnson said.

Hasbro also estimated only a modest increase in 2010 earnings per share from the $2.48 it reported for 2009, excluding a 14-cent tax benefit in the first quarter of 2010.

Analysts on average had forecast full-year earnings of $2.69, excluding one-time items.

The company said it did expect sales and earnings to increase in 2011.

Hasbro shares were down 91 cents at $43.74 on Friday morning on Nasdaq after falling to as low as $42.54. Rival Mattel Inc fell 33 cents to $23.72.

(Additional reporting by Viraj Nair in Bangalore and Jessica Wohl in Chicago, editing by Dave Zimmerman)

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