LeapFrog Enterprises' (LF) CEO John Barbour on Q1 2014 Results - Earnings Call Transcript

May. 5.14 | About: LeapFrog Enterprises (LF)

LeapFrog Enterprises, Inc. (NYSE:LF)

Q1 2014 Earnings Conference Call

May 5, 2014 5:00 PM ET

Executives

Karen Sansot – Senior Director-Investor Relations

John Barbour – Chief Executive Officer

Ray Arthur – Chief Financial Officer

Analysts

Drew E. Crum – Stifel, Nicolaus & Co., Inc.

Steph S. Wissink – Piper Jaffray & Co.

Michael A. Swartz – SunTrust Robinson Humphrey

Gerrick L. Johnson – BMO Capital Markets

Joe R. Bess – ROTH Capital Partners LLC

Edward M. Woo – Ascendiant Capital Markets LLC

John Gillman Taylor – Arcadia Investment Corporation

Sean P. McGowan – Needham & Co. LLC

Jim A. Chartier – Monness, Crespi, Hardt & Co., Inc.

Operator

Good afternoon. My name is Sarah, and I will be your conference operator today. At this time, I would like to welcome everyone to the LeapFrog Enterprises First Quarter 2014 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions) Thank you. Ms. Karen Sansot, you may begin your conference.

Karen Sansot

Thank you. Good afternoon and welcome to the LeapFrog Enterprises conference call to review our results for the first quarter ended March 31, 2014. I’m Karen Sansot, Senior Director of Investor Relations. Today on the call, we have John Barbour, our Chief Executive Officer, and Ray Arthur, our Chief Financial Officer.

Before we begin, I have a quick item to go over. Our closed communication period, during which we will be unavailable to talk with investors or analysts about our business will begin on Friday June 27 and will last until we announce our second quarter results, which we expect to announce in early August.

And now the Safe Harbor statement. We wish to remind you that our statements today will include forward-looking statements including management's expectations regarding anticipated second quarter and full-year 2014 financial results. In addition, we expect the questions post in the Q&A portion of this call to prompt answers that contain additional forward-looking statements not included in our prepared remarks. You should be aware that actual results might differ materially from those projected in any forward-looking statements. Some important factors that could cause actual results to differ materially from those in the forward-looking statements are described in our most recent Form 10-K filed with the SEC. LeapFrog makes these statements as of today May 5, 2014, and disclaims any duty to update them.

I would now like to turn the call over to John Barbour.

John Barbour

Thank you, Karen. Good afternoon everybody. As you’ve already heard across a number of first quarter performance announcements and earnings statements; overall retail on the children’s market especially continue to be tough in the U.S. and develop markets around the world. The first quarter is seasonably the smallest in the toy industry, but MPD recently reported a 7% decline in year-over-year in the U.S. toy sales in the quarter. This decline was mainly due to the calendar shift of Easter into quarter two, hot weather in January and February the result of manufacturers and retailers addressing higher ending inventory from Holiday 2013 with extensive cut price clearance activities and overall weak economic trends.

These factors also would have led our first quarter performance. In addition, we face an exceptionally tough sales comparison from last year’s record first quarter sales performance, driven by a high post-season demand for our LeapPads in Spring of 2013 following an exceptional Holiday 2012 performance when our tablets held three of the top 10 selling toy slots in the U.S. and were virtually a total sell-out around the world.

Our worldwide sales for the first quarter of 2014 were $57 million, down 31% compared to last year’s record $83 million in sales. When compared to historical Q1 sales performance in 2009, our 2014 sales ranked better than our average and significantly better than the $40 million of sales we achieved in quarter one 2011 the year I joined the team.

Our net loss is $11 million in the first quarter, a decline of $8 million compared to the $3 million we lost a year ago. In the quarter, we performed slightly better than we expected, but we are continuing to deal with significant headwinds that will probably remain through late summer and the fall, until we begin to ship a major new introductions this fall. Despite the higher carry forward introduced across the overall tablet business and significant clearance activity and greater competition, we continue to be the market leader in the kids’ tablet segment.

According to 2014 year-to-date MPD results, while LeapPad tablets have been purchased by consumers in the U.S. than any other brand of children’s tablets.

On the content front, our quarter one shipments were negatively impacted by carryover inventory issues and lower tablet point of sale in Holiday 2015 than 2012. Our toy business was the least impacted by carryover increase. It was our best performing segment in the quarter.

We reduced our inventory average from $14 million at the end of last year to $7 million to the end of quarter one and our cash position improved by $64 million or 38% to $232 million compared to the end of 2013 and it peaked to $240 million which is a historic high level of cash for the company. With the tough start to the year and our major new product launch is schedule for the second half. We expect our sales to be significantly more backend focused in 2014 than last year.

Our line-up of major new product introductions began shipping in late summer and fall all of which build in our mission to create the very best educational entertainment experiences that deliver life changing learning for children around the world. This year, we plan to extend the market leadership in children’s tablets with the number of innovative new LeapPads including our first tablet that is specifically designed to be merchandised in the consumer electronic section of stores.

Well, the children’s tablet market is certainly more competitive today than it was three years ago. It’s also significantly larger and has more growth potential ahead of it. Tablets are here to stay and parents need a safe, reliable, and educational option as children learn how to use them appropriately. When reviewing what’s available in the market today, the majority of tablets available in stores are quite unsuitable for younger children.

Letting a young chap play with a tablet with open Internet access is just irresponsible and dangerous. And just adding more screen tempt to a child today is particularly productive, if all the child does is watch streamed TV and play mindless games. Our LeapPads are the best established for children. Right out of box 100% safe Internet experience, and curative content a library of about 1,400 apps, games, books and songs by year end delivering the perfect introduction to tablet play for young children. And our marketplace that’s overflowing with content that is very little learning or education, we have the only app store where every piece of content has been developed or curated by child development experts.

But also adding a variety of new toys to our line-up in the fall, we’re especially excited about Kindergarten Readiness playset. Nearly half the children have found Kindergarten, get off the right level of skills and are now prepared for the social and emotional transitions of going to school for the first time.

For many children, the first few days of school can be quite traumatic, our Kindergarten Readiness playset will be the first in the market that’s been specifically designed to help children develop the right skills and be better prepared socially for starting their educational journey.

On the diversification front, LeapFrog has a terrific track record of identifying hot new children’s play categories especially in areas where children really need help, and increasing innovative fun learning products that satisfy those needs.

These innovations have resulted in many best sellers that have driven overall category growth. Good examples of this ability with our LeapPad, the Leapster, will bring and of course a current line of market leading LeapPad tablets. Last week, we continue to enhance this track record of innovation by introducing LeapBand, the first wearable activity tracker created for children that encourages active play and healthy habits while they nurture their own personalized virtual pets.

Child obesity and juvenile diabetes are epidemic that are hurting children in many of the developed countries around the world. In the U.S., obesity has more than doubled in children and quadrupled in adolescents in the past 30 years. Healthy lifestyle habits, including healthy eating and physical activity can lower the risk of children becoming obese and developing related diseases. Unlike the majority of adult activity brands that solely measure activity level, the LeapBand has been software designed not only to track, but to motivate children’s activity. It's so much fun watching children getting exercised when they have fun jumping like a Kangaroo, waddling like a duck or popping like popcorn.

Playing with the LeapBand, also teaches and encourages children to adopt healthy eating habits. The response to our consumer announcements just last week in New York City had been very positive, as have the holiday planning meetings with our current retail partners and potential new partners like sporting good retailers. LeapBand will hit store shelves in late summer and is a great example of our strategy to diversify our business by creating unique play experiences that have children achieve their potential through pure learning fun.

It is interesting to note that despite great access to new technologies like tablet and smartphones the number one screen in children’s lives those remains the television. Children continue to consume a significant amount of entertainment on the TV but unfortunately most of it is sedentary and lacking in any learning.

With the launch of a new PlayStation 4 and Xbox One Consoles, the massive video game market is experiencing a resurgence and many of the children are spending more time playing console video games again. With the bulk of the investment our new product innovations in video game industry over the last few years have been targeted at children over the age, teenagers and above there are now very few games available in the market today that are suitable for younger children.

The younger children are smart to play games in a TV. Unfortunately these gaming systems today are not made for young kids and very few games are appropriate for them based on the number of easy rated games available in the market today. Across the video games landscape of thousands of games we can only find 17 titles across all consoles that are ESRB rated, EC for early childhood. This is a very large potential market segment that no one has been focused on for years.

In the fall we are going to capitalize on this opportunity with the massive launch of our exciting new LeapTV platform, an innovative kids active video game console system made specifically for younger children with educationally focused content for kids, that gets minds and bodies moving.

We will support the launch with the range of over 100 pieces of content developed and selected by our in-house learning experts for LeapTV by the end of the year. We are very excited about the response the new platform and products have received from our retail partners and other industrial experts.

I’m going to look forward to revealing more information about these platforms and products later in the year. Hopefully, it’s now clear to everybody that our vision for LeapFrog goes way beyond being a toy company or a tablet company. We have far greater aspirations. We aim to become the leader in children’s educational entertainment.

As I said, many times the true magic of LeapFrog is its unique ability to create engaging and compelling entertainment experiences for children that are filled with life changing learning. Both LeapBand and LeapTV not only fit that vision perfectly, they have significant investments in diversifying our product portfolio to provide us with a more solid foundation for growth.

We also continue to invest heavily in content development. Over the last three years, we have made nearly twice as much investment in content as we have in hardware. No toy company has won more independent awards for its Children’s educational content. In 2014, we’ll add over 370 content titles to our portfolio and even in a tough year like 2013, our Explorer cartridges were still the number two selling toy in the U.S. according to MPD.

And in 2014 with the launch of LeapTV, we will add to distribution of physical and digital video game software and children’s video entertainment for the TV to our content business. We view bringing LeapFrog Education Entertainment and Gaming to the TV as a substantial new business opportunity for the Company.

We also continue to invest heavily in the future and currently have in development, three additional new platform initiatives. All with their own unique content distribution opportunities for potential launch in 2015, 2016 and beyond. At the same time, what exploring and investing and identifying alternative roots in partnerships to distribute our content on other company’s platforms. And then we added to national expansion in 2015 to our mix its clear we have a lot of opportunities ahead of us.

So while we are preparing for business to be tough for the next couple of quarters we’re also energized for the future potential of LeapFrog. There are few companies that showed us market that have grown in the rate we’ve achieved over the last few years that have consistently delivered innovative new products and have such a positive impact on millions of children around the world.

In summary despite a challenging start to the year I believe that we’re making the necessary investments to build a strong future for all of our stakeholders and the children who play with our products. I’d like to close by thanking all the LeapFrog for their incredible passion and commitment to our mission.

Now, I’ll the turn the call over to Ray Arthur, LeapFrog’s, CFO.

Ray Arthur

Thank you, John and good afternoon everyone. Our first quarter results were slightly ahead of our expectations. However it was a tough first quarter. The overall children’s retail environment was weaker than expected being impacted by significant industry wide discounting, increase competition and harsh weather conditions in a January and February.

In addition retailers entered the first quarter with higher levels of retail inventory carried over from the holidays compared to last year. All of these factors contributed to a significant decline in our year-over-year performance. Worldwide net sales for the quarter were $57 million down 31% compared to last year’s record high $83 million in sales.

As John mentioned we faced an exceptionally tough sales comparison from last year’s record first quarter sales performance. Driven by high post season demand for our LeapPads in the spring of 2013. Following an exceptional Holiday 2012 performance when our tablets held three of the top 10 selling toys in the U.S. and virtually sold out around the world.

The worldwide decline in sales was also driven by high retail inventory levels entering the quarter that resulted in reduced replenishment orders from our retailers. Sales were also impacted by our efforts to help reduced inventory levels of retail. And lastly the effect on net sales from changes in currency exchange rates was immaterial.

Net sales for our U.S. segment were $39 million, down 33% compared to the $58 million reported a year-ago. And sales for our international segment were $18 million down 29% compared to the $25 million reported a year-ago. Drivers for the declines in both segments were inline those that drove the consolidated decline. In addition changes in currency exchange rates had a 1% negative impact on net sales in our international segment.

Turing to business line, worldwide net sales of multimedia learning platforms and content, which includes tablets, gaming systems, reading systems, content and accessories decreased 38% year-over-year. Worldwide net sales of our learning toy line also declined, at a lower rate of 7% and that was in line with overall toy industry declines as reported by MPD.

Gross margin rates was 37.1% down 3.1 percentage points year-over-year. The decline in gross margin was driven by higher inventory allowances and content development amortization, higher royalty costs as a percentage of sales due to proportionately higher sales of license content, and lower sales volume, which increased the impact of fixed logistic costs. These decreases were partially offset by improvements in product mix with proportionately higher sales of higher margin software and learning toys.

Gross profit for the quarter was $21 million, a decrease of 37%, compared to the $33 million reported for the prior year, due to the aforementioned and the decline in sales volume. Operating expenses for the quarter were $40 million, up 5% compared to the $38 million reported a year ago.

SG&A increased $2.8 million or 13%, driven by higher expenses due to an increase in headcount and the higher spending related to service providers and consultants supporting our strategic initiatives. R&D expenses increased to $100,000, or 1% driven by higher expenses associated with headcount to support our strategic initiatives, largely offset by capitalization of web developing costs.

Advertising including our marketing and retail programs decreased $900,000, or 21% year-over-year as Easter occurred in the second quarter of 2014, compared to the first quarter of 2013. Net loss was $11 million, a decline of $8 million over the $3 million loss reported from the prior year. Net loss per basic and diluted share was $0.16, compared to $0.04 net loss per share a year ago.

Normalized net loss per basic and diluted share was $0.17 compared to a loss of $0.05 a year ago. Normalized earnings have been adjusted to reflect an effective 37.5% tax rate. In the first quarter of 2014, normalized net loss per share was different than GAAP net loss per share by $0.01, primarily due to a discrete tax benefit related to an expiring statute of limitation. Adjusted EBITDA, which is EBITDA adjusted for stock-based compensation was a $10 million loss compared to a $2 million gain a year ago. Operating cash flow was $71 million, down 6% year-over-year.

Now let me take a minute to go over the balance sheet, cash and cash equivalents, which peaked to $240 million during the quarter finished at $232 million, an increase of $42 million, or 22%, compared to the year-ago period. Our accounts receivable balance was $30 million, down $27 million on lower sales volume. Our portfolio is in good shape and our DSO improved over the year-ago period by 15 days to 47 days, due to proportionately higher direct to consumer sales.

Our inventory balance was $52 million, up $7 million or 16%, compared to a year ago, primarily due to the reduction in sales period-on-period. However, this increase is down by $7 million from the year-over-year increase as of December 31, 2013. Deferred taxes increased $57 million due to the reversal of a valuation allowance, I guess our deferred tax assets in the fourth quarter of last year. And lastly, accounts payable was flat to a year-ago at $19 million.

In summary, our balance sheet is in excellent shape. I’ll finish prepared remarks with our outlook. In the second quarter of 2014, we expect our results to continue to be impacted by high retail inventory levels from the beginning of the year. Additionally, our second quarter results will also be impacted by the timing of new product launches as we expect to shift more of our new products in the third and fourth quarters of 2014 compared to the second and third quarters of 2013.

Specifically, we expect net sales in the second quarter to be in the range of $52 million to $48 million, down 37% to 42% as compared to a year ago. Additionally, we expect an increase in operating expenses year-over-year due to higher headcount related costs supporting our strategic initiatives. As a result, we expect second quarter GAAP and normalized net loss per basic and diluted share to be in the range of $0.21 to $0.24 compared to a GAAP net loss per basic and diluted share of $0.05 a year ago and a normalized net loss per basic and diluted share of $0.04 a year ago.

Remember our annual business cycle really consist of two halves; the first half of the year is seasonally very small, while the second half benefits from holiday shipments and holiday sales, in the first half of the year small fluctuations in the timing of shipments or expenditures between quarters can have a big impact on our results. Therefore, we suggest you’ll look at our results on a first half and second half basis.

We expect net sales and earnings declines in the first half of the year largely due to a tough comp to Q1 2013 and beginning retail inventory levels while we expect net sales and earnings growth in the second half of the year largely due to new product introductions. Within the second half of this year, our results will be much more backend loaded with some new product shipping for the first time in September. For the full year, we are reiterating our guidance for sales between $554 million and $580 million and net income per diluted share to be in the range of $0.18 to $0.25 for both GAAP and normalized net income per diluted share excluding any potential discrete tax adjustment related to our valuation allowances. This will be compared to GAAP and normalized EPS for 2013 over $1.19 and $0.30 respectively.

However, if current retail trends continue we do believe we will see ourselves coming in at the low end of this guidance range. That concludes our prepared remarks. And we now like to open the call for questions. Operator, who would like to ask the first question?

Question-and-Answer Session

Operator

And your first question comes from the line of Drew Crum with Stifel.

Drew E. Crum – Stifel, Nicolaus & Co., Inc.

Good afternoon, guys. I want to ask about point of sales. Can you tell us what it was for the quarter and then the progression you saw or experienced through the quarter. Some of your competitors talked about POS getting better in March as you approached Easter, did you see any improvement?

John Barbour

Yes, we did. I think where the trends are very similar, I think with the Easter shipment, we’ll see a shift of Easter into the second quarter. There is no question first point-of-sale was always going to be challenged. But it’s also challenged by the fact that a year-ago, we were living on the demand from the end of a holiday season. We were virtually the total seller, the holiday season, so our point-of-sale was certainly then in the first quarter, but it improved with the Easter period through the moment and that’s kind of where we stand right now.

Drew E. Crum – Stifel, Nicolaus & Co., Inc.

Okay. And, JB, you mentioned the tablet that is going to be merchandised in the consumer electronics section. Having that leadership position in the kids' tablet category or in the toy aisle, can you talk about the rationale behind shifting focus or putting a product in a new category, a new part of the store for you guys?

John Barbour

Yes, I mean I think, we – since the day we launched, we’ve been a significant market leader in the electronic learning part of the store and one of things that we saw was we got some imbalance from some electronics buyers over the last 12 months or so. Asking about, potential having a LeapPad that we could sell in the electronic section of the store as well, a number of consumers immediately go to the tablet section sometimes don't think about going to the LE section. So the idea of having a version of the best first tablets for children, electronics is a pretty good strategy.

So we’ve been developing a new tablet that we could sell in electronics, that we could sell there for the last 12 months and it’s a LeapPad, it’s branded LeapPad. It’s got all of the great qualities of the existing LeapPads, you can drop it on the ground, it's kid robust. It’s got a really cool 100% safe, Internet experience for LeapSearch and it can play all of the content that we have here right now, and it’s a really nice alternative, that a bunch of tablets that in our electronics at the moment that are really quite suitable, unsuitable for young children.

Drew E. Crum – Stifel, Nicolaus & Co., Inc.

Got it, okay, thank guys.

John Barbour

Yes. Thanks.

Operator

Your next question comes from the line of Steph Wissink with Piper Jaffray.

Steph S. Wissink – Piper Jaffray & Co.

Hi good afternoon everyone.

John Barbour

Good afternoon.

Steph S. Wissink – Piper Jaffray & Co.

We have a few questions. Ray, a couple for you just to start. I think you mentioned the SG&A rate was up because of higher headcount aligned with the strategic initiatives. If you could just give us some insights into where that headcount might be focused within the company.

And then secondly, related to inventory exiting the second quarter down about $7 million from year in, how should we think about that Q2 ending balance? And then, JB, if I could just one throw one out for you as well, if you think about the back half of this year, the inventory carryover coming out of 2013 wasn't necessarily that you had too much inventory but that it was dislocated. So, can you talk about some of the new product introductions and what you're doing from a merchandising standpoint to ensure that those new products are adequately replenished as we kind of move through the holiday cycle this year?

Ray Arthur

Sure, I’ll start. This is Ray. We have some more SG&A, it’s primarily around international expansion plans and producing business plans to support moving forward in those markets. We do think that we’re going to be entering some international markets in 2015. So we want to make sure that we enter the curve in getting ready and getting product ready to go there and we also have other folks that are in various stages of helping with product planning and strategic planning to make that all happen.

The question about inventory levels at the end of Q2, I anticipate that they will come down somewhat but it will depend to some extent on what happens with POS. And then I think it's over to you, is it John?

John Barbour

Yes. I think a couple of things, I think – and if you look at the inventory that we’ve been dealing with this year, the bulk of it is really two products, which is the Power, LeapPad and the LeapPad Bundles. And if you remember the reason that we’ve – that we had carryover of those products was the significant discounting that happened on the LeapPad2, which some ways took away from the value of those products. So as I said, it was quite unique situation and we’re working our way through that inventory right now, but as you can imagine, these are higher priced products and they take a bit of time to move at this time of year.

As we look to next – to the end of this year, we have to say we’re super-excited, the bunch of new products we’ve got for this year, I think we have better products this year than we’ve had since I joined the company. Not only do we have a host of new LeapPads, including the one is going to go in the electronic section. LeapBand has already been seen by the response it’s had since we launched it last week, has a terrific opportunity for us, and at a lower price point are being $40. and then of course, we’ve got LeapTV where you used to say that my guess is it’s going to be in a significant demand by the end of the year. It’s not shipping until late and I think we felt likelihood, that was the product of seller, just like the original LeapPad did, it’s a major innovation in the marketplace.

No one else there has the educational activity based gaming system to watch in the TV that targeted the kids five, six, seven years old. So it’s a not only a very big marketplace, it’s a very big empty marketplace at the moment. So I feel at this stage, pretty good about the response we’ve had from the trade in terms of these products.

and I think that’s going to be in super demand this year. And regarding overstocks that we experienced last year across the rest of our products, I think the holiday season is going to be a less compressed than a year-ago. I think our retail partners are going to have seen that the mix of business that they’ve had last year because of some of their problems and they are going to execute better and we’re going to end up investing more money I believe, making sure those products are pulled out and put on shelf. I think we all saw opportunity disappear last year because of some of these educational issues and I’m sure none of us want it to happen again this year. So we’re all investing a lot of time and money, making sure that we are properly planned for this holiday season.

Steph S. Wissink – Piper Jaffray & Co.

All right. thanks, guys.

Operator

Your next question comes from the line of Mike Swartz with SunTrust

Michael A. Swartz – SunTrust Robinson Humphrey

All right, good evening everyone.

Karen Sansot

Hi, Mike.

Michael A. Swartz – SunTrust Robinson Humphrey

I just wanted to talk about some of the new products that are coming out this year. Do any of these, including LeapBand, LeapTV, and the new tablet for the electronics aisles, do any of these open you up to any new retailers that maybe you didn't work with before?

John Barbour

Yes, they did. And then also extend the relationship with some of the retailers that we are working with. An activity band, I have to tell you, I mean when you see the product, you’ve probably seen photographs of it, I’m fortunate, I’ve actually seen kids playing with it. but when you say to a child, jump like a kangaroo, or waddle like a duck, it is really funny how they can get engaged with it. So it’s again, the important of both is not just about tracking activity; it’s about stimulating activity and giving the kids fun. And then all the healthy tips and the way that we built out into the games in it. I think it’s really special, and we’re certainly talking to sporting goods chains, as to that opportunity. And then when you look at LeapTV, again, a major innovation, you haven’t seen photographs of it yet, but we will show some photographs over the next few months. And I think that opens up some opportunities more in video game part of the business around the world as well.

So, yes I think it will be an opportunity to expand distribution for us and also an opportunity for us as well in terms of the ability to deliver. A LeapFrog education entertainment experience on the TV, we are continuing looking at new ways to deliver this incredible content we create. As I said earlier, no one has won more awards for quality educational entertainment content in the toy space than we have.

And the opportunity that deliver that content to TVs around the world, it’s also I think a really exciting opportunity for this year and beyond. So I think what we’ve done in terms of product offers us a whole gamut of new distribution opportunities for this year and beyond.

Michael A. Swartz – SunTrust Robinson Humphrey

Thanks, JB. Just with the – the first-quarter revenue came in a little ahead of your expectations. Were there any discrete items or discounting timing of shipments that impacted that, anything can you really point out?

John Barbour

A lot of this, the quarters are so small in the beginning of the year that just having reorders hit at one week as opposed to the next week can have you go over or under just because the numbers are so small. But there's nothing of significance.

Michael A. Swartz – SunTrust Robinson Humphrey

Okay, and then just finally can you maybe talk about just inventory levels at retail at the end of the quarter?

John Barbour

Sure. Inventories retail have come down from where they were at year-end by a fair amount. I would say that we don’t get great information outside of the U.S. on retail inventories. And so we don’t know from a consolidated perspective, but we still believe that retail inventories are higher than what we would like them to be at the end of Q1.

Ray Arthur

Yes, the important factor, this isn’t across the board, I think we’ve made that clear on a number of statements we made, we don’t have higher inventories across the board. We have some pockets of inventory, and we are working with our retail partners to move the inventory?

Michael A. Swartz – SunTrust Robinson Humphrey

All right, thanks a lot guys.

Ray Arthur

Thank you.

Operator

And your next question comes from the line of Gerrick Johnson with BMO Capital Markets.

Gerrick L. Johnson – BMO Capital Markets

Good afternoon. So those pockets of inventory you are referring to that you're working with the retailers to move, are you guys fully reserved for that or should we anticipate further allowances to hit margin in the future quarter?

John Barbour

There will probably be some cost associated with the clearance, but I don’t think it’s going to be incredibly significant.

Gerrick L. Johnson – BMO Capital Markets

Okay. On your own inventory, if we exclude the $7 million of carryover from last year, you are still flat year-over-year, but expecting 40%-ish declines in sales in the next quarter. So it seems even excluding the carryover of your inventory, it seems too high. Just tell me why that assessment would be wrong.

John Barbour

It depends on what the ultimate disposition of that inventory is going to be. It may be too high for this, you may not be wrong but that inventory may be used for special promotions at different times of the year. So it’s good inventory it’s going to get sold. It may not get sold in the second quarter, it may get sold in the third quarter. But clearly from our perspective we believe it’s good in marketable inventory that's going to get sold through before the end of the year.

Gerrick L. Johnson – BMO Capital Markets

Okay. And then my last one on software sales, are you guys generating the level of software sales that you had originally anticipated or expected given the installed base of LeapPad that's out there after two or three years of that being on the market?

John Barbour

What we’re seeing high ratios go up which is good, that installed base actually goes down a little bit from what we had hoped last year because fourth quarter tablet sales weren’t as high, as we had hoped they would be I think that’s a result of the whole bundling strategy and distraction of value that was perceived in those bundles at the end of last year. But I would say we are happy with our direction of our content.

Ray Arthur

Yes, I would say those things are little bit different – we are never truly happy because we always want more. But it’s certainly growing, and that's the main thing for us.

Gerrick L. Johnson – BMO Capital Markets

All right. I just want to dig into software with one more question. Let's say for every 100 software titles you release, because we release a lot of titles, how many of those 100 software titles end up covering their development costs, if you look at each individual one?

Ray Arthur

I don’t have the exact numbers here, but I would guess that virtually every software title we make, we make money on.

Gerrick L. Johnson – BMO Capital Markets

Okay.

John Barbour

A lot of the software titles are not as robust as the full game might be as well, Gerrick, so they don't cost as much to develop.

Gerrick L. Johnson – BMO Capital Markets

Okay all right. Thank you guys.

Operator

Your next question comes from the line of Dave King with ROTH Capital partner.

Joe R. Bess – ROTH Capital Partners LLC

Good afternoon, everybody. This is Joe Bess for David, as well. The first question I have is that you have a number of exciting product launches scheduled for this year. And I guess when we think about the LeapPad, can you talk a little bit more about what necessarily defines it to be able to be in the consumer electronics section in the store? And then did you happen to say the retail price for it?

John Barbour

We’re not announcing it today. Bottom line is, so I would say it’s actually quite simple. It is, without question, the best first tablet for children. If you actually step back and look at a tablet for a kid aged four, five, six years old, what are you really looking for, what are moms looking for. Moms are looking for a tablet that doesn’t break when it hits the ground unlike most of the Android or expensive tablets out there.

They’re looking for a tablet with super safe Internet. When you are really think about if anybody with a five or six-year old child actually want a kid surfing the Internet without any type of security, so having super safe out-of-the-box Internet, and then to be frank, making sure that that tablet isn’t just another extension of the TV.

So kids spend more time just watching TV in their room or playing mindless games and we’ve got the best educational content library with every piece of content selected or developed by educational experts. So when it comes to tablets, nobody has got a better first tablet in the marketplace than we have. And for people who want to shop those tablets, wherever they want to

shop them – in ELA, ordinary electronics section, it fits beautifully.

Ray Arthur

And it’s going to have competitive speed and screens and it’s going to be – it belongs there.

Joe R. Bess – ROTH Capital Partners LLC

Okay. Great. And then, as we think about the guidance for the new products, how much should we be thinking about it in terms of contribution in this year, or was it included in the previous guidance?

Ray Arthur

It’s in the previous guidance.

Joe R. Bess – ROTH Capital Partners LLC

And then any color around what we should be thinking about the contribution for the year?

John Barbour

I’m sorry. I’m missed that.

Joe R. Bess – ROTH Capital Partners LLC

Any color on what the contribution could be from the new products this year?

Ray Arthur

No.

Joe R. Bess – ROTH Capital Partners LLC

Okay. And then I guess just on the margin side, how should we be thinking about it in terms of gross margin? Will these products be selling kind of at a higher gross margin, or will they be somewhat dilutive this year?

Ray Arthur

They will help our overall results.

Joe R. Bess – ROTH Capital Partners LLC

Okay, great. That’s it. Thank you.

John Barbour

Thank you.

Operator

Your next question comes from the line of Ed Woo with Ascendiant Capital.

Edward M. Woo – Ascendiant Capital Markets LLC

Yes, thank you. I had a question in terms of the LeapBand you introduced last week and the LeapTV. Have you talked about what your international plans are for those products?

John Barbour

We haven’t. No. And we’ll announce that later.

Edward M. Woo – Ascendiant Capital Markets LLC

Okay. Then talk about the performance for U.S. versus international, was there any big differences that you saw this quarter versus last quarter?

John Barbour

No, really. One thing that’s there is the international markets certainly had a tougher quarter this year, but I mean everybody was impacted by the shift of Easter. And interestingly, everybody was impacted by weather. This seemed to be a bad winter in most of the developed marketplaces. We can look at the storms affected right across America for much of the first couple of months of this year. But, you know, it snowed last week in Canada, although it may snow in Canada right through the summer. But the bottom line is – and there were floods right through the UK and England for a bunch of period.

So a lot of the fact was it was actually a really interesting start this year, a lot of the facts were similar across the marketplaces. The one thing I would say is a little bit different is that the other markets didn’t have as much an impact in terms of the power and the bundles because they didn’t have a situation in their marketplaces of a retailer just slashing the price of LeapPad2 in the marketplace and causing that problem. So the big difference between our international markets and U.S. marketplace are just those pockets of those products that we’ve talked about.

Edward M. Woo – Ascendiant Capital Markets LLC

Well, that sounds good. Hopefully, there’s no weather issues in China when you produce the stuff. Do you see any potential roadblocks in getting these new products out to the, I guess, retailers in the U.S. and Europe for this holiday?

Ray Arthur

Whenever you’re developing new products – every development process has its speed bumps, but we’re super excited about the products. We’ve had them in tests. We’ve had the games in test and we’re getting a really good response from the consumers that are playing them and trying them. So we feel good about it.

John Barbour

We’ll just hope there is not an extended port strike from the West Coast this year.

Edward M. Woo – Ascendiant Capital Markets LLC

All right. That’s sounds good. Well, good luck guys.

Ray Arthur

Thank you.

Operator

The next question comes from the line of John Taylor with Arcadia Investment.

John Gillman Taylor – Arcadia Investment Corporation

I’ve got a couple of questions. So you are going into a couple of big categories here with the younger-oriented segments. I’m wondering about two things. Number one, I guess is sort of the – you may not want to answer any of this, but I’m kind of wondering how you’re thinking about the merchandising, placement of this, particularly in the mass-market stores where the videogame department fights against the toy department for Skylanders and that kind of thing.

So there’s even – sporting goods, there’s all kinds of stuff here where you could create some conflict amongst merchants. So I’m wondering about that. And on top of that, to launch these guys in these big categories, again, you do have the low-age position, I think. That’s super. But I wonder how you are going to get the word out? Is it going to be a TV flight, is it going to be point-of-sale, how are you going to do that? It seems to me this is going to be kind of expensive to do. So maybe talk around some of those issues, and then I’ve got a question for Ray on capitalized stuff. Thanks.

John Barbour

Well, I think we all know that all it all starts with having great products, all right. And the two segments we’re going into that you’ve just referred to, are really pretty hard segments for the moment. The all-activity band wearable segment is pretty hot news in the marketplace. So the fact that we’ve got the first activity band here for children that not only tracks their activity, but encourages them to be active and teaches them things. You know as well as I do, we’re going to get an immense amount of publicity for that product as soon as it hits the marketplace. And at anytime I put my money in PR support as effectiveness, versus TV any day.

Ray Arthur

And just, in addition to that, I mean, the retailers that have seen this, I think I would bet you that we’re going to get plenty of end caps and feature space for this product this year.

John Barbour

And then we’ll also be TVing it. So the fact is in both of those products, same in LeapTV, right, there is not a videogame system as there are right now. They have been specifically designed for five and six-year old kids there. If you look at ESRB rating, there are only 17 pieces of content out there that rated EC and below, right.

So a lot of the young kids are seeing their brothers, their sisters, their cousins playing video games at home and there is nothing for them. An activity game system that again gets the kids up, gets them active and is filled with education – I believe as well is going to get a lot of publicity when we launch into the marketplace. And again we’ll be TVing the product as well.

And when you look at it from a distribution standpoint, every retailer at the moment is desperate for innovation, right. Everybody is looking for hot new products, right. Everybody is looking for new ways to drive traffic and drive incremental sales. So we’re fortunate in both of these products. We’ve had a very, very positive response from our retail partners. And in some cases, we’ll be looking for display space on the racetrack, out at front store. And in some cases we’ll be discussing what is best between video game and toy. And as we develop that and we negotiate where we’re going to be as we go through the next few months. Your guys will hear about it.

But I think you’re right in saying that they are somewhat challenges, but I would say and step back and say, I really believe when you see these products in the flesh you will understand why we’ve had such a great response from the trade on it, and also why just like the original LeapPad, right, where – you know what, we have a similar situation. We went into marketplace. We had the first tablet specifically designed for children.

Many of the same things we’re talking about right here. And you know what? It was phenomenally successful in its first and second year, right. It’s still hard. It’s still hard to comprehend that in 2012 we had three tablets in the top 10 selling toys in the U.S. So as I like to say to the guys, this is not our first rodeo. We’ve been here before. Everyone has got a whole set of challenges to it. We don’t minimize it.

But we think we’ve got the team here. We know we have the products and we’ll invest behind them if necessary. We’re not just selling the product this year. We see these products as being good platforms going into next year and beyond and help diversify our business. You know, everybody has been saying to us for quite some, hey, you’ve got to find ways to distribute this great content you’ve got on other platforms, right.

We are taking on the TV, the biggest platform above here right now, right. More kids are entertained by their TV than any other screen out there. And we feel we got some really good stuff there. As I say, I’m fortunate. I’ve seen kids playing with both products and I’m super excited about both introductions.

John Gillman Taylor – Arcadia Investment Corporation

So let me ask this about the band. I don’t know if you announced this, but what’s the screen that I look at the performance on? Or what does the kid watch when he’s jumping like a kangaroo?

John Barbour

You’ll have to wait and see.

John Gillman Taylor – Arcadia Investment Corporation

Okay. We don’t know that. Okay. And then, Ray, for you. So I think you mentioned the increase in capitalized expenses, which related to the IT investment you are doing. so as you’re marching towards the release of both fuel band and the TV console or TV whatever it is – LeapTV and building out all the software that goes with it, all the content, are we likely to see that number expand even faster and contain some elements or some of those things?

John Barbour

I think, yes. There’s going to be additional content. Amortization, there will be additional amortization of IT systems that are developed for product, but that will be more than offset by the revenue and margin potential that will be generated from these new platforms.

John Taylor – Arcadia Investment Corporation

Okay, all right. And let me ask one other thing about LeapTV, and then I’ll yield. Is this a single player thing or can multiple kids play?

John Barbour

We’ll let you know soon.

John Taylor – Arcadia Investment Corporation

Okay, all right. Thank you.

John Barbour

Sure.

Operator

Your next question comes from the line of Sean McGowan with Needham & Company.

Sean P. McGowan – Needham & Co. LLC

Hi, guys. How are you? Wanted to first start with tacking on to Gerrick’s question earlier. The hardware may have declined, but it’s still higher – the installed base is still higher going into the first quarter than it was a year ago. So, I’m a little puzzled as to why the software content would be down when you have a higher installed base going into the quarter than a year ago.

John Barbour

Well, one thing of course is that the software sales are done in the first quarter because we come into this year with more inventory of software on shelf.

Sean P. McGowan – Needham & Co. LLC

Is the point of sales on that software up then?

John Barbour

We don’t break it in that way, but I think it’s important to say – I’m just trying to think what that number would be at the moment. We didn’t get back to on that. We don’t break it out, I don’t think.

Sean P. McGowan – Needham & Co. LLC

Okay. You don’t talk about it this way anymore like you used to, but with the decline in multimedia educational content hardware versus content, are they both down about the same in the quarter?

Ray Arthur

We don’t break it out.

Sean P. McGowan – Needham & Co. LLC

Okay. A couple of other questions then. In terms of LeapTV, I know there’s only so much you want to talk about what this product will be, but can you talk about how much development effort went into it compared to, let’s say, starting with a completely new LeapPad system? I mean is this more like tweaks on the existing technology that you have? Or is it a radically new platform?

John Barbour

I think whenever you’re delivering digital and physical content onto a system, there’s a lot of expertise that you’ve got and there’s technology that we use that definitely go into that. So it’s not like we’ve suddenly decided to get into a totally different business, the soda business, for example, right. There’s a lot of similarities to what we’re doing, but there’s also a significant amount of differences as well. And so again, this is something we’ll be working on quite sometime.

Again, it’s important to recognize that from the very early days when a bunch of us came here, we were pretty open to everybody that our vision was beyond a toy company. And then we had success in tablets, and we kind of changed from being a toy company to kind of being a tablet company and we’ve said to people then, you know what, tablets are really cool. They’re changing the world, and we’ve got the best first tablet for kids out there.

But we have visions way beyond tablets as well. And I think it’s important, I mean I think probably no, when you see the products, it will start to come together what we’re talking about for the last three years, which is we believe that LeapFrog has a very unique position. We make the best entertainment experiences for children that are compelling, engaging and filled with the nutrition of education. We’ve been saying it for three years, and we’re continually looking at other platforms as we go forward.

So right now, for example, we had line reviews last week, and we saw three additional brand new platforms that we’re going to start working on for the next two to three years to keep building as we go forward. And I believe that the people are following our business are going to be sitting in three, four years time and see that we’ve got this multi-faceted platform business where we’re taking the essence of our business, which is content that changes lives, and we are distributing it across multiple platforms. And again, I think it’s important that we’re consistent with a vision of this business that we’ve had for three years.

Sean P. McGowan – Needham & Co. LLC

Okay. It’s possible to conceive of LeapTV as being, at the base case, nothing more than just projecting your LeapPad images onto a TV, which would kind of be boring. It’s also possible to imagine…

John Barbour

I would say to you this, Sean, when we came into the tablet space, we just didn’t take an Android tablet and throw (indiscernible). We started and we developed the best first tablet for kids, and we’ve proven over the last three years.

I can promise you we’re just not taking a LeapPad product now and projecting some grid on to a TV screen. We have stated from scratch here with everything we’ve learned over the last three years, and some new stuff we’re learning right now and we’ve created what we believe is the best starting video game experience by young kids that’s filled with activity and filled with learning and is a lot of fun.

Sean P. McGowan – Needham & Co. LLC

And will the content be in any way integrated with what the kids may have already bought on the LeapPad?

John Barbour

No.

Sean P. McGowan – Needham & Co. LLC

Okay. So it’s a completely new system.

John Barbour

We are going to launch this by the end of this year. We will have about 100 pieces of content that will work on LeapTV that will be unique to LeapTV.

Sean P. McGowan – Needham & Co. LLC

Okay. All right. thank you.

John Barbour

Anytime.

Operator

Your next question comes from the line from Jim Chartier with Monness, Crespi and Hardt.

Jim A. Chartier – Monness, Crespi, Hardt & Co., Inc.

Good evening. My first question – just to clarify the comment that if current trends continue you’ll be at the low end of your guidance, are you talking about year-to-date trends, first quarter trends, just clarify that for us.

Ray Arthur

It’s the first quarter trends. So like we said, POS was not very robust in the first quarter. Some of that may be attributable to the weather, some of them may be due to the flooding in Europe, but we think that if we’re going to get better than the bottom end of the guidance we’re going to have to see POS improve and then replenishment improve.

Jim A. Chartier – Monness, Crespi, Hardt & Co., Inc.

Okay. And just curious, you guys seem to be very excited about the product for the back half of the year and have a robust pipeline for the next three years. What does it take to get you to start buying back stock?

Ray Arthur

We’ll evaluate what’s in the marketplace, what prices are out there, where we are in terms of our cash position and buyback stock under the current plan that exists today when we think it’s appropriate.

Jim A. Chartier – Monness, Crespi, Hardt & Co., Inc.

Okay. Thanks. Best of luck.

Ray Arthur

Thanks.

John Barbour

Thank you.

Operator

I’ll now turn the call back over to Ms. Karen Sansot for closing remarks.

Karen Sansot

Thank you, every one for joining us today. And if have any follow-up questions, please feel free to give Ray or me a call. Thank you.

Operator

Thank you for joining today’s conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!