LeapFrog Positions For The Future

The global toy market was around $78.09 billion in 2008. Sixty-five percent of the toy business comes from ten countries, with North America contributing 30% and Europe 29% of global sales. Asia’s contribution was 27% in 2008. The United States is the largest market for toys with sales of $21.7 billion. The toy market is expected to continue to grow as a result of strong demand in the emerging markets like Brazil, China, Russia, and India. Market research firm NPD expects the worldwide toy sales to be approximately $80.3 billion in 2012. The major players in the industry are Mattel, JAKKS Pacific, LeapFrog and Hasbro.

LeapFrog (NYSE:LF) declared its Q309 results on November 2, 2009. Net sales for the quarter ended September 30 were $111.9 million, down 42.5% compared to $194.6 million in the same quarter a year ago. Gross margin in Q309 was 42.7%, compared to 43.8% in Q308. Income from operations for the quarter was $9.1 million, compared to $29.4 million a year ago. Net income for the quarter was $7.2 million, or $0.11 per share, compared to $24.1 million, or $0.38 per share, a year ago.

Cash and cash equivalents were $29.5 million at September 30, 2009, representing an increase of $5.9 million compared with $23.6 million at September 30, 2008. Inventories were $71.6 million at September 30, 2009, compared with $95.7 million at September 30, 2008.

Net sales were down year over year primarily because of fewer new platform launches, lower product shipments to retailers due to high retailer inventory levels at the end of 2008, and more conservative sales expectations for the holidays compared to the prior year. Net sales from the United States segment for the quarter were $89.9 million, down 42.5% compared to $156.4 million a year ago. Net sales from the international segment were $22.0 million, down 42.3% compared to $38.2 million a year ago.

The company has been focusing on reducing inventory over the past nine months. Inventory is over 30% lower than a year ago and nearly 10% lower than two years ago. Retail point-of-sale (POS), dollars continue to be higher year over year and were up 2% for the 39 weeks ended October 3, 2009 compared to the 39 weeks ended October 4, 2008.

Though sales declined substantially in Q309, LeapFrog had some positives to report, such as growth in retail point-of-sales dollars year over year, increased market share, and lower operating expenses since the company went public in 2002. LeapFrog expects sales to grow in the fourth quarter of 2009.

LeapFrog’s products are available in four languages at major retailers in more than 44 countries and in more than 100,000 classrooms in the US. Currently, it is focused on the developed markets and its presence in the emerging markets is small. LeapFrog is present in the emerging markets through international distributors.

LeapFrog’s Learning Path strategy, through which it attempts to build one-to-one relationships with consumers, seems to be bearing fruit. POS and tie ratios of software for Tag, LeapFrog’s first connected product, are well beyond those of the highly successful LeapPad at the same point in its life cycle. The company currently has over one million connected consumers, and it has the capability to market to these consumers in a personalized way based on information it has through the Learning Path. Management expects that by the end of the holiday season, it will have a substantially greater number of connected consumers and will see earnings benefits grow as a result.

For the fourth quarter of 2009, LeapFrog expects net sales to be between $155 million and $170 million, compared to $138 million in the fourth quarter of 2008. Gross margin is expected to be between 40% and 45%. Operating expenses to be down approximately 40% compared to the fourth quarter of 2008.

Though LeapFrog had a bad quarter, it seems to be well positioned as the market recovers.  With lean retail inventory levels along with lower cost structure, a leading brand, strong product portfolio and its Learning Path strategy, LeapFrog seems set for growth in the coming quarters. This stock is definitely not for the short term, but I expect that it will yield good returns over a longer horizon.