Leapfrog Enterprises (LF)

Headquartered in California, LeapFrog Enterprises (LF) is a leading provider of technology-based learning products and proprietary content. The company designs and develops educational products, as well as related interactive software and content, under multiple product platforms, including the LeapFrog, LeapPad, Leapster, and Quantum Leap brands. The company's product lines include (1) learning platforms (affordable hardware devices), (2) educational software-based content (interactive books and cartridges), and (3) stand-alone educational products. The products are sold through national, regional, and specialty retailers in the U.S. and are distributed in over 25 countries worldwide. In addition to home use, LeapFrog also develops instructional materials for classroom use through its School segment. LeapFrog operates in three business segments: (1) U.S. Consumer, (2) International, and (3) School. In the U.S. Consumer segment, the company markets and sells its products directly to national and regional mass-market and specialty retailers as well as to other retail stores through sales representatives. In the International division, the company sells its products outside the U.S. directly to retailers and through various distribution and strategic arrangements. The School division is focused on the pre-kindergarten through 8th grade school market in the United States and sells directly to educational institutions, teacher supply stores, and educational product catalogs. In 2007, the U.S. Consumer segment accounted for 71% of the company's net sales. The International segment and School segment accounted for 23% and 6% of net sales, respectively.

LeapFrog is experiencing an ongoing decline in shipments of the company's family of LeapPad products as the company's primary retail customers continue to work down inventory of older LeapPad products. Although the management is looking to revitalize sales of LeapPad products through the release of new platforms, new software titles for existing platforms, and new marketing initiatives, the company will have to improve product sell-through significantly.

In 2006 and 2007, overall weakness of the LeapPad product of family and inventory liquidation led to a 27% and 10.8% (respectively) decline in sales of the U.S. consumer business. Also, during the last two tears, International segment sales declined 13% and 9.8% from the prior years, primarily due to the phase out of several products, especially LeapPad. Also in 2007, the International segment experienced a decline in sales in the markets managed by distributors, which has resulted in an inventory build-up. Moreover, with an ongoing transition in management and the attrition of key sales personnel, revenue for the School segment (formerly known as SchoolHouse) declined 29.7% in 2007. Top-line growth and operating results for the School segment should continue to be negatively impacted by the budget constraints and deficits that continue to negatively impact the availability of public school funding throughout the U.S. Lastly, the sales cycle should lengthen, particularly in light of the management's increased focus on pursuing larger orders.

The retail environment for the company's products remains difficult. While overall retail sales growth for the holiday season was in line with market expectations, U.S. toy sales declined for a fourth consecutive year. Toy manufacturers have been negatively impacted by age compression as children are growing up faster. In addition, toy manufacturers face competition from a broad array of alternative activities, including video games, MP3 players, computers, and other electronic devices. While specialty toy retailers have lost market share to mass merchants in recent years, the retail market has also shrunk due to industry-wide consolidation and bankruptcy filings. In addition, Toys R Us went private in 2005, following its agreement to be bought by private equity firms and a real estate group. Toys R Us closed 75 of its U.S. stores and converted 12 others into Babies "R" Us stores. Wal-Mart, the world's largest toy retailer, recorded only a 1.6% same store sales gain in the U.S during the all-important month of December 2006, which was the smallest December monthly gain for the company in five years, despite deep discounting and heavy marketing throughout the holiday selling season. Gasoline prices are high, which will further crimp consumer discretionary spending.

The company depends on very few customers for a large proportion of its sales. In 2007, three retailers (Wal-Mart, Toys R Us, and Target) accounted for 54% (21%, 20%, and 13% respectively) of the company's consolidated sales. The company does not have long-term agreements with any of the retailers hence, loss of any one of the customers would negatively impact the company.

One stockholder controls a majority voting power of LeapFrog. Lawrence J. Ellison controls approximately 16.6 million shares of Class B common stock (super-voting shares with ten votes per share). Therefore, Lawrence Ellison controls the composition of the Board of Directors and the company's future in terms of mergers, business combinations, and acquisitions.

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