LeapFrog Enterprises Inc. (LF)

Richie Hartz, Patrick O’Donnell, Matthew Rasinski

Tuesday, April 2nd 2013

Agenda

Introduction Company Overview Industry Overview Stock Performance Financial Analysis Valuation Recommendation

Introduction

LeapFrog trades on the NYSE with ticker symbol LF Company was founded in 1995 by Micheal Wood

and Robert Lally and headquartered in Emeryville, California USA

Focus: educational entertainment Concept was originally designed to educate

Wood’s son through toys

Company Overview

LeapFrog - designs, develops, and markets technology-based products for the purpose of education

Demographics – infants through 9 years of age Focus on math, reading, writing, science, social studies,

creativity, life skills, and foreign languages In 1995, with the aid of Stanford University Professor Dr. Robert

Calfee, LeapFrog developed their first toy called the LeapFrog Phonics Desk (at a of price $50).

In 2013, the firms top product is the Disney Princess Bundle – a tablet complete with “Disney” apps (price $130)

Product Overview

Learning games, apps, eBooks, videos, music, toys, and more

Currently sell 2 versions of LeapPads, 2 hand held computers (GS and the Explorer), 2 sets of eBooks (Tag and the Tag Junior), learning toys, and iPhone and iPad apps LeapPads -- $120 GS and Explorer -- $70 eBooks -- $25 to $170 bundles Toys -- $10 to $25 Apps -- $0.99

www.LeapFrog.com

LeapFrog Products

Recent News

Leapfrog has won over 80 awards from the Parent’s Choice Foundation

As of 2013 – The new management team has shifted their emphasis from toy development to educational entertainment

Leapfrog has sold more than 100 million books, over 100 million educational toys and over 55 million tablet and gaming platforms.

Transition Period

Toy Development

Educational Entertainment

Transition by Management• Changes the target

market from infant to grade-schooler

• Addition rather then a substitute to current product line

2013 Outlook

New product launches include: Learn-to-read system iPhone and iPad apps New version of LeapPad tablet

Global distribution networks Including 4 interactive languages

Growth Strategy: long term investments in content, international expansion, online communities, systems, and new platforms

Utilize FIFO inventory recognition Emerville, California – Headquarters and Operations

Type of possession: Lease Fontana, California – Distribution Center

Type of possession: Lease Income tax benefits

2012 – ($24,504,000) & 2011 – ($1,137,000) Due to the recognition of previously unrecognized tax

carryforwards

Accounting

Manufacturing

Designed to maximize the use of outsourced services With respect to physical production and distribution

Highly seasonal business

Manufacturers are located in Asia, primarily in China Top three vendors supplied 73%, 65%, and 57% of

LeapFrog’s products in 2012, 2011, and 2010 respectively Largest manufacturers are: Wynnewood Corp. Ltd. & WKK

Technology Limited They are billed by manufacturers in US dollars

Operations

Develop products primarily in the United States Marketing efforts are centered on North America

Lesser extent to Europe and the rest of the world Foreign currency transactions are hedged through

short term futures contracts

EBIT Breakdown by Region

• However, his does not explain the entire picture

LeapFrog 2012 10k Report

EBIT in terms of United States has grown exponentially since 2010

A similar expansion strategy into the foreign market place would lead to enormous economies of scale

United StatesForeign

Figures are in thousands

Domestic Sales

The big three US retailers: Wal-Mart, Toys “R” Us, and Target have historically accounted for a substantial portion of gross sales

Equity Snapshot

Stock Price: $8.33 Beta: 1.26 TTM P/E: 6.72 Forward P/E: 11.11 PEG Ratio (5 year):

0.67 Price/Book: 1.76

Source: www.finance.yahoo.com

Stock Performance

Source: www.finance.yahoo.comHasbro Inc. (HAS)Mattel Inc. (MAT)

Industry Overview

Hasbro Inc.Mattel Inc.

Source www.finance.yahoo.com

Porters 5 Force Analysis

Bargaining Power of Buyers: Moderate Evidence: high profit margins exist Niche market, little direct competiton

Bargaining Power of Suppliers: Moderate Computer components and assembly have become commodities Competitive advantage lies in the programming, not the physical interface They have 3 main manufacturers

Threat of New Substitutes: High Classic teaching methods still dominate the educational market Apple and Samsung tablets can offer “learning” apps that mimic those

offered by Leapfrog.

5 Force Analysis Continued

Competitive Rivalry within the Industry: Moderate There is no definitive market dominance Educational Technology for individual users is a

relatively new industry (use of the “pad”) Threat of New Entrants: High

App market is vast and easy to gain market presence Brand loyalty has yet to be established – users

“children” unable to recognize the difference between a Leapfrog product and an Apple Product.

Macroeconomic Condition

• Consumer confidence has shown slow signs of improvement

Source: www.dailycapitalist.com

SPDR – XLY Performance

Consumer Discretionary Select Sector Consistent growth in discretionary spending

over the 2y

Source: www.finance.yahoo.com

2012 4th Quarter Highlights

Highlights of full year 2012 results compared to full year 2011 results:Consolidated net sales were up 28%.U.S. segment net sales were up 24%, and international segment net sales were up 38%.Income from operations was up 170%.Income from operations as a percentage of net sales was 11.0%, more than double the prior year.Net income was $86.5 million, up 334%.Adjusted EBITDA was $93.1 million, up 89%.Cash and cash equivalents were $120.0 million as of December 31, 2012, up 67% compared to the balance as of December 31, 2011. 

WHAT is Bringing in the Money?

According to management (2012 Annual Report): -”LeapPad” – one of the generally more expensive

items. -“App” sales for iPhone and iPad

In general, sales are increasing for the technology products, however the less technology intensive projects have greater margins.

Revenue/Cost Tradeoffs

Overall Retail Inventory Levels have increased since 2010

Sales increased by 5% while Cost of Goods increased by 6% (as a reflection of the proportionally higher sales of higher cost platforms “pads”)

Decreased Marketing expenditures to offset increased COGS (of technology products) and Operating expenditures.

WHEN is the Money Coming in?

According to 2012 Annual Report: Quarterly Cash Flow

Revenue Cost/Tradeoffs

Financial Analysis - Recent Growth

• Consistent Expansion in Price and Volume Components

432,564 455,140 581,288

• Suggests that LeapFrog is still in a growth stage

Net Sales (in thousands, USD)

Valuation

DCF Suggests 20% Upside

Valuation - Sensitivity

12% 14% 16% 18% 20%2.0% $13.41 $11.22 $9.66 $8.50 $7.602.5% $13.85 $11.50 $9.85 $8.63 $7.693.0% $14.34 $11.80 $10.05 $8.77 $7.793.5% $14.89 $12.14 $10.27 $8.92 $7.904.0% $15.51 $12.50 $10.50 $9.08 $8.01

Discount Rate

Terminal Growth

Rate

Sensitivity Analysis

Valuation

Comparable AnalysisCompetitor Enterprise Value/EBITDA Price/Tangible Book Value Trailing P/E Forward P/EHasbro Inc. (HAS) 8.6 9.1 17.1 13.9Mattel, Inc. (MAT) 11.2 11.6 19.6 14.2

Average Multiple 9.9 10.35 18.35 14.05

Implied Price $5.90 $7.03 $22.75 $18.45Weight 30% 30% 10% 30%

Weighted-Average Price $11.69

- Trailing versus forward P/E

Decision Drivers

GICS Application Clear Management Goals Discounted Cash Flow Comparable Analysis

Recommendation

Buy 2000 Shares at the Current Market Price Current Stock Price of $8.20 Order total: $16,400