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Henson posted some more info on Facebook concerning the contest...
1. It is okay to submit a design from another medium than a drawing or painting - a sculpture, puppet, etc. is okay if you submit a high-res photo.
2. Your submission should be art original to you - no clip art or style guide art incorporated directly into your piece.
3. Regarding the merchandising, the winners' art will be potentially incorporated into things like apparel, stationary, mugs, etc.