LeapFrog hopes pain will lead to gain

By Brent Felgner -- Playthings, 3/2/2007 8:39:00 PM

EMERYVILLE, Calif. — In the midst of a painful turnaround effort, LeapFrog Enterprises reported plunging sales and a net loss for the fourth quarter and full year, as margins continued to shrink and expenses rose. But losses will slow in 2007, company executives predicted, and they are placing their hopes on a healthier 2008.

Last year, 2006, was a financial train wreck by any standard. The company reported a 26.3 percent drop in Q4 sales, to $182.8 million, compared with $248 million the year before. It posted a $46 million loss for the quarter, $0.73 per share, against a $14.4 million profit, $0.23 a share, in same quarter in 2005.

For the full year, it recorded a 22.7 percent decline in net sales, to $502.3 million, compared with $649.8 million in 2005. The full year net loss was $145.1 million, a loss $2.31 a share, versus a profit of $17.5 million and $0.28 per share the year before.

All divisions recorded sales declines, the company said.

Margins also suffered, falling 13.8 percentage points to 29.3 percent for the year, compared to 43 percent for all of 2005 — impacted by reserves for excess and obsolete inventories combined with higher sales discounts and allowances.

At the same time, operating expenses soared to $271.7 million — a 5 percentage point increase.

The ‘fix’
In a conference call with investors, Jeffery Katz, president and CEO, said the company remains true to its three-step turnaround plan unveiled last November—fix, reload and grow—beginning with clearing old inventories from its warehouses and its retailers’ shelves.

“With the actions we took in 2006, the ‘fix’ portion of our operating plan is substantially behind us,” he said. “We reduced inventories faster than we had planned, but spent more in advertising and allowances in order to do so.”

The effort cut net stocks by 57 percent to the lowest levels since 2001 and doubled the company’s cash position to $148 million at year end. Currently, LeapFrog has more than $200 million in cash. Retailer inventories were cut by 40 percent during 2006. Part of that effort involved the phase out of The Fly PenTop computer in anticipation of the introduction of the Fly Fusion later this year.

“Our 2007 marketing plan also calls for the first phase of what we call, ‘Get out of the clutter,’” Katz explained in the call. “The market we compete in is rife with products offering learning benefits from brands that basically stand for fun, to be sure, or affordable, for sure, but learning? Not so much. We could do better based on what our products do and what goes into them. So this year we’ll start getting ourselves out of the muck. Part of this involves improved in-store marketing with the rollout of improved displays and, in some stores, in-store kiosks.”

He said there will be several hundred kiosks in select stores over the course of the year.

Katz also pointed to the company’s new management team, which has been put in place over the past several months, offering that it is focused on execution of the marketing plans.

But the year ahead will bring more pain, Katz added.

“We expect a modest sales decline for the year,” he said. “Sales for the first half of 2007 will be weaker than the second half since our new products will not ship until the fall.”

He said gross margins will improve and expenses will decline from 2006 levels. But the company will continue to “invest heavily in building the LeapFrog brand” as well as in R&D for 2008 product rollouts.

“We have a long way to go and a lot to do but we’re excited about where we are headed,” Katz said.

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