Retailer KB Toys Inc. filed for Chapter 11 bankruptcy on Thursday, citing a “sharp decline” in sales during its critical holiday season.

This is the second time the privately-held KB Toys, a Massachusetts-based company, has filed for bankruptcy. But this time the company said it intends to shut down operations in order help pay creditors.

The 86-year old toy seller is majority owned by the private equity firm Prentice Capital Management. In addition to its 277 primary stores, mostly located in malls, KB Toys operates 40 “KB Toy Works,” 114 outlet stores and 30 temporary holiday season sites.

The filing was made in the U.S. Bankruptcy Court for the District of Delaware.

KB Toys said its sales were mostly flat for much of 2008, with comparable same-store sales up 0.36% from a year ago. However in early October when the economy soured and credit markets froze up, the company experienced a massive drop in sales. Since Oct. 4, sales fell by nearly 20% from a year ago, according to the company's bankruptcy filing.

Revenue deteriorated and the company was unsuccessful in its efforts to find alternative access to additional capital or liquidity, according to filings.

KB Toys said it intends to “immediately” liquidate its inventory and initiate going out of business sales, with the intent to close its stores. As of Dec. 6 the company had approximately 10,850 employees, 6,515 of them seasonal hires.

KB Toys listed as its biggest creditors: $27.2 million to Hong Kong-based toy manufacturer Li & Fung; $1.3 million in accounts with Mattel (MAT); $728,127 in accounts with Energizer Battery, part of Energizer Holdings (ENR); and $424,625 in accounts with Hasbro (HAS).  The company reported up to $500 million in liabilities and up to $500 million in assets.

Law firms Young Conaway Stargatt & Taylor and Wilmer Cutler Pickering Hale and Dorr were retained as advisers for the bankruptcy, and FTI Consulting was hired to provide restructuring and financial advice.