LeapFrog Enterprises' (LF) CEO John Barbour on Q1 2015 Results - Earnings Call Transcript

Aug. 4.14 | About: LeapFrog Enterprises (LF)

LeapFrog Enterprises (NYSE:LF)

Q1 2015 Results Earnings Conference Call

August 4, 2014, 5:00 p.m. ET


Karen Sansot – Senior Director-Investor Relations

John Barbour – Chief Executive Officer

Ray Arthur – Chief Financial Officer


Sean McGowan - Needham & Company

Steph Wissink - Piper Jaffray

Drew Crum - Stifel

Dave King - Roth Capital Partners

Michael A. Swartz - SunTrust Robinson Humphrey

Edward Woo - Ascendiant Capital

Gerrick Johnson - BMO Capital Markets

Lee Giordano - CRT Capital


At this time, I would like to welcome everyone to the LeapFrog Enterprises first quarter fiscal 2015 results call. [Operator instructions.] Thank you. Karen Sansot, please go ahead, ma’am.

Karen Sansot

Thank you. Good afternoon and welcome to the LeapFrog Enterprises conference call to review our results for the first fiscal quarter ended June 30, 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 couple of items to go over. In May, we announced that we were changing our fiscal year end from a calendar year end to a March 31 year-end. As a result, this past June quarter is the first quarter of our new fiscal year.

Our closed communication period during which we will be unavailable to talk with investors or analysts about our business will begin on Tuesday, September 30, and will last until we announce our second fiscal quarter results, which we expect to announce in early November.

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 fiscal quarter financial results for the quarter ending September 30, 2014 and full year fiscal 2015 financial results for the fiscal year ending March 31, 2015.

In addition, we expect the questions posed 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 August 4, 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, and good afternoon everyone. Technology is continuing to play a larger and more important role in young children’s lives. For nearly 20 years, LeapFrog has been a leader and a pioneer in leveraging new technologies to deliver content that entertains and educates children.

As we prepare to ship some really exciting new lines and products in high-growth categories, we are managing our business and product lifecycles tightly. In fiscal 2015, we are focused on rightsizing retail inventory levels in our key markets, building on our leadership in children’s learning content and tablets, successfully launching new educational entertainment lines in new categories, and aggressively pursuing new opportunities which will fuel our growth in the coming years.

For the first part of this year, we have been working with our retail partners to clear excess retail [carryover] inventory of multimedia platforms and bundles from holiday 2013. While much of this inventory has been discounted, it is still at prices that are significantly higher than the average consumer prices for chidlren’s products sold during spring and summer, and it’s been selling in retail environments around the world that are filled with competitive [unintelligible] products which are a lot of times at far deeper discount prices. As a result, it’s taking us a bit longer than we expected to work through this retail inventory.

The second half of fiscal 2015 should be much brighter, and we expect solid double digit sales growth in the December and March quarters. We expect this growth to be driven by shipments of our exciting new product introductions for the year, which include lots of great new educational games and content, new feature-filled tablets, and two new exciting new product lines in new high-growth categories not currently being addressed for younger children.

While our net sales for the quarter were slightly worse than forecasted, our progress introducing [unintelligible] retailer inventory levels and initial success in launching our major new product categories position us for a strong holiday season and long term profitable growth.

I’ll first talk about financial performance and outlook for a few minutes, and then talk about the progress we’ve made against our growth initiatives. We had a very challenging net sales comp in the June quarter.

Last year, we delivered exceptional June quarter results with sales up over 16%, driven by the continued high post-holiday demand for our LeapPad tablets and content following an exceptional holiday 2012 performance when our tablets held three of the top 10 sellign toys slots in the U.S. and our Explorer assortment of software was the number one selling toy in the U.S. according to MPD.

In late June last year, we also shipped three significant new platforms: LeapPad 2 Power, LeapPad Ultra, and LeapReader. This year, with higher competitive and LeapFrog carry-forward retail inventories, and the planned shipment of our key new products in the September and December quarters, we announced at our last earnings call that our net sales would decline year over year in the June quarter, and you could expect that our sales for the year would be significantly more back end loaded.

Our net sales declined 43% in the quarter, which was slightly more than expected. The retail environment in our key markets was tougher than we forecasted, and as you also heard from some of our toy competitors, they also had a tough time. We opted to provide additional support to our retail partners to discount our carryover tablets to help reduce inventory levels. This support and the lower retail prices that ensued had a negative impact on our net sales and gross margins.

This clearance activity also contributed to a drop in retail POS dollars. On the other hand, POS units on our LeapPad tablets is up year on year, and they continue to be the top-sellign children’s tablet line in our major markets.

Our loss per share was relatively in line with our forecast, largely due to lower operating expenses. We continue to tightly manage our expenses while investing in selective long term growth initiatives that we believe will drive significant future sales and profitability.

As we look ahead, we expect continued headwinds in the September quarter from the remaining carry-forward inventory and the timing of new product shipments compared to the prior year. As a result, we expect net sales and profit to decline in the September quarter, but we then expect considerable sales growth in both the December and March quarters, led largely by new product shipments.

As I mentioned earlier, we’re making strong progress in our strategic initiatives for the year. This year, we are launching two terrific new lines of products in brand-new entertainment categories for us that will expand and further diversify our business.

All the new lines are incredibly engaging and fun, and filled with life-changing education and they encourage children to get up and get active. Childhood obesity has more than doubled over the last 30 years, and the number of children and adolescents with juvenile diabetes has skyrocketed, prompting the Journal of Diabetes Care to call it an emerging epidemic.

Our mission at LeapFrog is to help children achieve their potential, and to this end, many children desperately need help and encouragement to get more active. Hitting store shelves this month is LeapBand, which was inspired by the Let’s Move Initiative by the First Lady, Michelle Obama.

LeapBand is the first wearable activity tracker created specifically for children that not only tracks activity and encourages and rewards active play and healthy habits with the fun and engagement of nurturing a personalized virtual pet.

LeapBand gets children moving with 50 fun activities and challenges such as walking like a crab, popping like popcorn, or spinning like a helicopter. And it also teaches and encourages children to adopt healthy eating habits.

LeapBand will be launched with a major PR event in early September in Los Angeles, featuring Mia Hamm, the international soccer star and mother of three young children as spokesperson.

Despite greater access to new technologies like tablets and smartphones, the number one screen in children’s lives remains the television. Children continue to consume a significant amount of mindless entertainment on the TV. Most of it is sedentary and lacking in any real learning. With the launch of the new PlayStation 4 and Xbox One consoles, the massive video game market is experiencing a resurgence, yet there isn’t a video game platform designed specifically for younger children.

Our research indicates that many young children would love to play video games, but the vast majority of video games available today have content that is totally inappropriate or too difficult for them to play. We believe this represents a major growth opportunity for LeapFrog. After all, who has had more experience and success than LeapFrog in creating and distributing engaging entertainment content that helps children achieve their potential for pure learning fun.

In October, we will launch LeapTV, an innovative, educational active video game console system for younger children. LeapTV’s radical new transforming controller, simple user interface, and innovative new content, which combines engaging gameplay and learning, have all been designed and thoroughly tested by our design and game experts to make it the best first video game experience for young children.

By year-end, LeapTV will offer more than 100 pieces of content, with games designed to get kids’ minds and bodies moving, and all of this content will be developed or selected by our in-house team of child development and educational experts.

Unlike the children’s mobile gaming market, where very few studios are profitable, and much of the content might amuse children but has little true educational value, we are creating a market for both ourselves and third-party studios to create great educational entertainment for children and be properly rewarded for developing that great content.

We believe that only by providing profitable avenues to deliver content, we will see the true potential of content developers to invest in creating life-changing educational experiences for children.

LeapTV also provides us the opportunity of delivering and distributing digital video content to the TVs in our consumers’ homes. Just a couple of weeks ago, we launched our annual product showcase in New York to launch our new LeapPads for the fall and to demonstrate LeapBand and LeapTV to retail partners, the media, investors, and other industry experts. We are very excited by the feedback received, and we believe LeapTV will be featured in many retailer and media top toy lists this holiday season.

This summer, we’re launching two terrific new versions of our top-sellign LeapPad children’s tablets, the LeapPad 3 and LeapPad Ultra XDI. Quite simply, LeapPads by LeapFrog are the best first tablet for children. They’re kid-tough, kid-safe, and kid-smart, and they provide right out of the box 100% safe internet experience.

And also, we’ll offer a curated content library of about 1,400 apps, games, books, and songs by the year-end, delivering the perfect introduction to tablet play for young children. LeapFrog pioneered the children’s tablet market with the launch of our original LeapPad in 2011. Three years later, LeapPads are still the best first tablets for children, and they continue to be the top-selling children’s tablet line in our major markets.

We will also add more than 370 new pieces of content to our unique multimedia library, where every app, game, video, book, and music track has been developed or reviewed by the LeapFrog learning team, our full-time, in-house team of child development experts and education experts.

Over the last 15 to 20 years, technology has had a dramatic impact on all of our lives. It’s sometimes hard to believe how big an impact it has had, and we know children are engaging with technology earlier and earlier, including beginning to experience the internet and all it has to offer.

Children need to be able to experience all that is great for them on the web, but they need to be protected from the abundance of bad stuff out there on this vast digital superhighway. It’s surprising and scary, and many families let their young children play with tablets with minimal or no internet or email protection.

Protecting children from totally inappropriate content experiences on the internet is critical, but so is protecting families from children mistakenly opening their home computers and parents’ personal mobile devices to the potential of malware and identity theft, which is continuing to be a major global issue.

There has to be a way to give kids a web-based browsing experience made just for them that provides the right level of safety or protection that parents need. Early today, we announced that we acquired KidZui, the leading kid-friendly internet browser that serves as the technology engine for our proprietary kids’ LeapSearch web experience, available on all our wifi-enabled LeapPads.

Through KidZui, LeapSearch is able to provide a 100%-safe internet experience for kids that allows kids to easily find age-appropriate content and explore the web, all in a safe environment where 100% of the content has been reviewed and approved by our team of learning experts. Even kids who can’t read yet can still explore web content in an easy and safe way, since content is categorized under age and topic and uses pictures to help children choose the topics that interest them.

Our acquisition of the KidZui browser and technology allows us to continue to make LeapSearch the best tablet-based web experience made specifically with kids in mind, and to explore additional ways to make this experience available across all channels where kids consume online content.

And finally, our Letter Factory DVD is one of the highest-rated children’s animated movies ever created. Over 2.5 million DVDs and downloads have been sold to date, and our collection of learning videos is very popular on Netflix.

Beyond families, not many people are aware of our success in creating children’s animated movies. A year or so ago, we announced a partnership with Lion’s Gate to produce and distribute a series of four Letter Factory adventure CGI movies featuring the next generation of our popular frog characters. The second movie of this series, Letter Factory Adventures: Counting on Lemonade, will be available in stores and on our download site in September.

We are well-positioned for a robust holiday season, with the strongest product line we’ve ever had. Good momentum with retailers and PR and new product launches, planned national multimedia marketing campaigns for our key drivers in our video gaming, tablet, health and fitness, reading, and toy lines, and exciting off-shelf placement of key products at major retailers.

For nearly 20 years, LeapFrog has been the pioneer and leader in educational entertainment. We are passionate about creating fun, life-changing educational entertainment experiences for children that help them achieve their potential. Over the years, we have developed a very strong brand, consistently developed market-leading solutions, and received more than 1,250 awards and inclusions on top lists from parents, teachers, and industry experts.

We have an amazing library of content assets, from our proprietary education [unintelligible] sequence, to our own characters, artwork, music, stories, and more. We leverage our content assets across many platforms and channels to offer kids a wide variety of educational and entertainment experiences, and we continue to pursue more ways to leverage our content assets even more.

We’re always looking at how children play to identify new ways to deliver innovative experiences and to deliver amazing content, and we provide it in a safe, tough, smart, and perfectly kid-designed way that makes them the best first experiences for children.

We continue to invest heavily in the future, and currently have in development a number of additional new platform initiatives, all with their own unique content distribution opportunities. At the same time, we’re exploring investing in the identification and development of alternative methods and partnerships to distribute our content on other companies’ platforms, including new international markets.

We know that our team is critical to our success. We have an incredible company, filled with world-class people who are passionate about helping children achieve their potential. And we continue to add top-quality talent to our business at senior levels, focused on our key strategic initiatives, including the addition of Craig Relyea, who was SVP of global marketing at Disney Interactive for 10 years, Dan Burns, who was the head of sales at Vtech North America, and Scott Steinberg, who has many years of video game experience gained at Sony and Sega.

In summary, despite a challenging start to the year, I believe we are making the necessary investments to build a strong future for all our stakeholders and the children who play with our products. I’d like to close by thanking all of the LeapFrog team for their incredible passion and commitment to our mission. Now I’ll turn over the call to Ray Arthur, our CFO.

Ray Arthur

Thank you, John, and good afternoon everyone. I’d like to start by reminding you again of our change in fiscal year, from December 31 to March 31, that we announced in May.

Due to this change, our results for the current quarter ended June 30, 2014 constitute the first quarter of our new fiscal year ending March 31, 2015. As John indicated, this was a tough quarter. We continued to work down carry-forward holiday 2013 inventories at retail through increased discount promotional support that had a significant impact on both our sales and margin.

In addition, as planned, our new products will be launched later this year than in the previous year. This later introduction of new products is the drive for more than about a third of our decrease in sales quarter on quarter. Also, please keep in mind that the prior year quarterly performance was exceptionally strong for LeapFrog.

These factors contributed to a significant decline in our year over year performance. With that said, I will move on to a more detailed discussion of our first quarter results.

Worldwide net sales for the quarter were $47 million, down 43% compared to $83 million in the same period last year. Net sales faced a challenging comparison to the prior year due to the timing of new product launches and very high post-season demand for our LeapPad tablets and content in spring 2013, following an exceptional holiday 2012 performance.

Again, net sales for the first quarter were negatively impacted by high inventory levels at retail entering the fiscal year that were carried over from the 2013 holiday season, which drove retailers to discount products, cut replenishment orders, and acquire higher trade discounts.

Net sales in our U.S. segment were $31 million, down 47%, compared to $58 million last year. In our international segment, net sales were $16 million, down 34% compared to $25 million last year, but were not materially impacted by changes in currency exchange rates.

Worldwide net sales of multimedia learning platforms and content, which includes tablets, gaming systems, reading systems, content, and accessories, decreased 55% year over year. Worldwide net sales of our learning toy line also declined, but at a lower rate of 9%.

Gross margin was 18.8%, down 18.4 percentage points year over year. The decline in gross margin was driven by higher trade discounts associated with the continued retail support and clearing high inventory levels, an unfavorable shift in product mix, higher royalty payments due to a higher mix of licensed content, and a greater impact of fixed logistics costs due to the lower sales volume.

Gross profit for the quarter was $9 million, a decrease of 71% compared to the $31 million reported for the prior year. Operating expenses for the quarter were $35 million, flat to a year ago. SG&A decreased by $1 million or 4%, driven by lower incentive compensation expense, partially offset by higher employee payroll and higher expenses to pursue our strategic initiatives.

R&D expenses decreased $1 million, or 12% due to higher capitalization of web developing costs and lower incentive compensation expense.

Advertising, including our marketing and retail programs, increased $1 million, or 60%, due the a one-time settlement of a dispute with a supplier of our point of sale purchase displays in the prior year period, higher cooperative advertising spending during the current period, partially offset by lower media-based advertising spend.

Net loss was $16 million, a decline of $13 million over the $3 million loss reported for the prior year. Net loss per basic and diluted share was $0.23, compared to a $0.05 loss a year ago.

Adjusted EBITDA, which is EBITDA adjusted for stock based compensation, was a $16 million loss, compared to a $3 million gain a year ago.

Cash used in operations increased by $23 million to $21 million, compared to cash provided by operations of $2 million a year ago, primarily due to an increase in the net loss resulting from the timing of our sales, increased discounts and promotional support, and investments in our infrastructure.

Moving on to the balance sheet, cash and cash equivalents finished at $199 million, an increase of $18 million, or 10% compared to a year ago. Our accounts receivable balance was $32 million, down $30 million on lower sales volume. Our portfolio is in good shape, and our DSO improved year over year by 6 days to 61.

Our inventory balance was $64 million, down $2 million or 4% compared to a year ago, primarily due to the timing of product launches.

Deferred taxes increased $64 million due to the reversal of a valuation allowance against our deferred tax assets in the December quarter of last year.

In accounts payable, we were $33 million down, $13 million compared to $46 million a year ago, due to a reduction in inventory purchases. So, in summary, our balance sheet is in excellent shape.

I’ll finish my prepared remarks with our outlook. In the second quarter of fiscal 2015, which is the September quarter, we expect our results to be impacted by the timing of new product launches as we expect to ship more of our new products in the December and March quarters this year, compared to the June and September quarters last year.

Specifically, we expect net sales in the second quarter to be in the range of $125 million to $130 million, down 38% to 35% as compared to a year ago. The decline is largely due to the timing of new product launches, with our major new launch, LeapTV, which we will begin shipping at the end of September.

In addition, our sales projections have declined with the deferral until next year of our consumer electronics tablet, as we focus more of our current year efforts on LeapTV.

Additionally, we expect an increase in operating expenses year over year due to higher headcount related costs supporting our strategic initiatives, including platform and content development, international expansion, and information system upgrades. As a result, we expect the September quarter net income per diluted share to be in the range of a loss of $0.03 per share to income of $0.01, compared to net earnings per diluted share of $0.37 a year ago.

For the full fiscal year ending March 31, 2015, we expect net sales to be in the range of $480 million to $505 million, which is down 4% to 9% as compared to a year ago. We expect net income per diluted share, GAAP and normalized, to be in the range of a loss per share of $0.04 to income per share of about $0.10, compared to GAAP net income per diluted share of $1.07 and normalized net income per diluted share of $0.18 in the prior year.

Lastly, we expect capital expenditures to be in the range of $30 million to $40 million for the full fiscal year as we make long term strategic investments in our business, particularly in our information technology systems. Capital expenditures also include purchases of property and equipment and capitalization of product costs.

In closing, we believe that we are very well-positioned for a strong holiday season with a new lineup of tablets, fantastic new products in LeapTV and LeapBand set to enter the market, and even more great content in our library. And we expect solid growth in our third and fourth fiscal quarters.

That concludes our prepared remarks, and we’d now like to open up the call for questions. Operator, who would like to ask the first question?

Question-and-Answer Session


[Operator instructions.] Your first question comes from the line of Sean McGowan with Needham.

Sean McGowan - Needham & Company

I have a couple of questions. But first, just to clarify, the consumer electronics tablet, is that delayed until next calendar year, but it might be in your fiscal year? Or are you saying it’s out of the fiscal year entirely?

John Barbour

It will be out of our fiscal year entirely.

Sean McGowan - Needham & Company

At this point, we’re talking about retail inventory carry-over affecting sales all the way through September. How could the inventory be that high if the shipments are down that much, and the stuff is selling? Can you help us with that? How is it not getting cleared out fast enough to allow for shipments?

Ray Arthur

Retail POS has been challenged in the first quarter of the calendar year. I think we told you that before. And that trend has improved somewhat, but it’s still carried over into the second quarter. And even with our discounted price, these are pretty expensive units for the average consumer purchase in these slow first and second quarters of the calendar year. So we’ve made some good progress on bringing down the amount of carry-over inventory, but we’re probably just past halfway through it at this point in time.

That being said, I think we’ve given all the discounting and promotional offers we’ve needed to give during this quarter, and taken the pain so that those units will now clear out more quickly.

John Barbour

I think the other thing that’s there is that we also, a little bit, got ahead of that, and that’s why we’ve also delayed the launch of our new products coming into the marketplace. So we try and flush through. We’ve kind of discussed a lot over the last two or three calls about what caused that carry-forward of inventory from last year, but the other big impact in the quarter was the fact that we launched the new platforms in the quarter last year that we’re not launching this year.

Sean McGowan - Needham & Company

Can you comment on the degree to which the declining gross profit that we saw overall, was that fairly consistent North America versus international? Or was it much more significantly pronounced in the North American market?

Ray Arthur

I would say it’s a little worse in the North American market, but not significantly so.


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

Steph Wissink - Piper Jaffray

I was wondering if you could talk a little bit about, I think you mentioned that the hardware unit sales have continued to be up, but it’s really the pricing that’s dropping? So can you give us some sensibility around the unit sales relative to price, and maybe the pass-through, the [unintelligible] rates on software? It doesn’t seem like you’re getting as much benefit from that software life cycle tail.

And then second, if you could talk a little bit about the guidance. I’m trying to reconcile your prior guidance, which was on a December year-end, versus your current guidance, and it implies a pretty substantial step-up in the September quarter, specifically, both in sales and margin. So Ray, if you could just walk us through the P&L for what we should be thinking about as we kind of look into that holiday quarter, that would be helpful.

John Barbour

Let’s talk first of all about tablet sales. You know, tablet sales have been discounted in price to try and move through predominantly LeapPad Powers and the LeapPad tablets, which were left over at the end of last year, because of some of the pricing things that happened during the fourth quarter.

So as I said, what happens there is that of course the unit sales are actually up in terms of POS, but they’re down in terms of dollars, because of those discounted prices. The other thing that happens is that once you move beyond the holiday season and the first month after the holidays, then people’s content purchases are just a little bit lower, because when you think about it, the added price of the tablet plus much content is a significant price, higher than most people are spending at that time on product for their kids.

When you think about it, you’ve got a situation where, when you’re talking about spending $100 or more on children, over the spring and summer period, unless that’s really a kid’s birthday or something special, or you’re buying a big swing set or something, the average price point in terms of purchase for kids is quite lower at that time. So we’re not really seeing the full [unintelligible] ratio for those tablets at the moment. We’ll see how that develops as we go up through the fall.

And Ray, do you want to talk a little bit about the guidance?

Ray Arthur

Sure. Definitely the third quarter of our fiscal year is a big quarter for us, bigger than it’s been for a long time. I think that’s primarily the result of LeapTV starting to ship at the end of September. So most of the channel fill is going to occur in Q3, even with LeapBand, which is going to come out a little earlier. A lot of the channel fill is going to come in Q3. And also, the new tablet lineups.

So the response we’ve gotten to LeapTV is just incredibly exciting, and we anticipate that it’s going to be a really good quarter in terms of sales there and channel fill for our other products that are going into retail. And then we expect, as we get into our fourth quarter, that we’re going to see some good follow-on software sales for LeapTV in the new platforms, in terms of LeapPads.

And fortunately for us, the LeapTV space is an area where we don’t see competition in our age bracket. It allows a little better margin rates in both the platforms themselves and in terms of the margin.

Steph Wissink - Piper Jaffray

And just a follow up, if I could, on the gross margin. Your guidance would imply a pretty significant lift to the last two fiscal quarters. Could you help us just reconcile that gross margin rate? How should we be thinking about that?

Ray Arthur

We’ve gotten through all the discounting we believe we’ve had to get through to now get all that clearance product at an appropriate price at retail. So I think if you were to go into retailers today and see bundles from 2013, they’re probably $49.99. When we clear through that product, we’ll be selling LeapTV and LeapBand both at higher margin rates. And we’re also expecting to get some good follow-on attachment rate from the new Ultra that’s coming out, as well as LeapPad 3.

Your next question comes from Drew Crum with Stifel.

Drew Crum - Stifel

Just a follow up to Sean’s question on the inventory, when do you expect to clear the excess inventory?

John Barbour

I think it will be interesting. I think that if you think about it, we’re probably right now just over halfway for clearing the product that was there. My sense is that bulk of it will be cleared as we move into probably the late fall, into the early part of the season. And you know, the challenge that is there is that, as tends to happen with inventory, is it tends to clog up in the slower-sellign stores.

So it’s interesting in the fact that the retailers have it on their books, but much of it is in the smaller, slow-sellign stores. So it does restrict open to buy, but unfortunately, it’s been the smaller, worse-performing stores. So again, our sense is that the bulk of it will be gone as we get close to Thanksgiving, as people are looking for really incredible value gifts to put away for the holiday season.

Drew Crum - Stifel

And then Ray, if you look at the midpoint of your guidance range for fiscal 2015, just kind of using some rough numbers here, it looks like the EBITDA margins are mid-single digits. That’s about half of what they were versus recent calendar years where the revenue was $30 million to $40 million lower than what you’re forecasting for 2015. So I just want to get a sense of if there’s any anomalies in fiscal 2015. You’ve referenced higher investment spending as a factor. Or is there some type of permanent mix shift in the business that leads to a lower margin profile going forward?

Ray Arthur

I don’t think there’s been a fundamental shift in the business. There is quite a bit of spending on additional people cost to support our strategic initiatives. There’s specific spending against those initiatives, and we’re also re-implementing an ERP system, which is costing us quite a bit of money, as well as relaunching our digital website. The digital website relaunch will hopefully be a revenue driver for us and be lower-cost as we go forward. And hopefully, our ERP system will provide us some efficiencies to be able to work to reduce our cost structure.

And I think we’re all very cognizant here that we need to keep our cost structure in line, and we will make that happen over the coming years as we pursue lower cost of sales as well as lower SG&A.

John Barbour

And also, I think it’s important to recognize that we’re not the first company in the world that’s had to deal with a challenging inventory situation because of something happening and getting carry-forward into next year. It doesn’t take away from the incredible opportunity this company has ahead of it. You know, we’re dealing with a one-off situation here, which as I said, we’ve explained many times on the calls in the past, where we’re trying to deal with it as quickly as possible.

But I’ll be frank, we are totally energized about the response we’ve had to LeapBand and LeapTV. I think it does a great job of demonstrating to the world that we’re more than a toy and a tablet company. You know, if you look at the scale of the video marketplace, and there’s nothing like this product out there for young children, and the potential to deliver content to those video game systems including, for the first time, video content to people’s TV, I mean, don’t be mistaken. We are incredibly energized, and we are investing still in the future of this business.

And while at the same time, we deal with our one-off situation here. And as we get through this, and our tablet business starts to get back onto a growth curve, and then we launch these new diversification opportunities, we’re still big believers in the opportunity ahead of us.


Your next question comes from the line of Dave King with Roth Capital Partners.

Dave King - Roth Capital Partners

Just piggybacking a little bit off that last question, when we think about the capex guidance of $30 million to $40 million, can you talk a little bit about how much of that is maintenance versus some of the initiatives you guys have for the ERP system and web platform?

Ray Arthur

It’s probably the low $20 million that is maintenance, updating the content library and probably near $15 million is probably like a lot of strategic initiatives, ERP. I think I told you before, ERP is about $14 million estimated, and website development.

Dave King - Roth Capital Partners

And then kind of thinking again about, with your tablet launches, when we look at the Ultra XDI, it seems to be fairly similar to the previous Ultra. Can you talk a little bit about the rationale for the launch of that, and any kind of plans you have for selling it this holiday?

John Barbour

You know as well as we do that we had some issues when we launched the Ultra, when we launched it at first. But you know, we’ve progressively fixed those issues, and Ultra, since then, has been selling exceptionally well. So an updated version of it is really in the cards. The other thing is for this holiday season, it’s going to be selling at retail prices of $129 versus last year’s $149. So it’s super competitive in the marketplace.

So we’re excited about the launch of our two new tablets. The LeapPad 3 has just got some really great ratings online. People like it a lot. And then the other advantage is with both LeapPad 3 and the XDI, both are wifi enabled tablets, where we progressively sell more content to them. So both of them are really good [unintelligible] for us to expand and grow our content and our tablet business.

Dave King - Roth Capital Partners

And then thinking about the LeapTV, and not starting to ship until September, is this kind of where you guys were planning to start shipping? Or is this a little bit later than expected?

John Barbour

I think if you look at the video game marketplace, and you look at POS, there aren’t that many people in the marketplace to buy a $150 video game system before Thanksgiving. So the fact that it’s been launched at that time, and getting into the marketplace, we see it hitting the bulk of the POS opportunity for this year. So we’re excited about it. Technologically, there’s a lot of technology in it. This wasn’t a simple product to develop. There’s a lot of really cool technology in it, and we’re very excited about it.

Ray Arthur

It will get to stores when we plan to get it to stores.

Dave King - Roth Capital Partners

And then just one last question on, thinking about the point of sales trends, and how they’ve been challenging over the last quarter or so, is this really the main driver for the reduction in guidance? Or is there anything else that we should be thinking about?

Ray Arthur

I think deferring our CE tablet to next year, challenging POS trends and the carry-over inventory are the real drivers, as well as the discounts we’ve given, although we should be done with the discounting. But I think the thing that you should take away is POS trends did improve from the beginning of the year to the first quarter. So never say never, but maybe things will improve.

John Barbour

The thing is that, you know, we’re not the only company to slightly miss guidance in the quarter in our space.


The next question comes from the line of Michael Swartz with SunTrust.

Michael Swartz - SunTrust Robinson Humphrey

Maybe you could provide us a brief update, I know you’ve talked about the LeapBand and the LeapTV products maybe getting into some new distribution channels. Could you maybe fill us in there? Any progress you’ve had there? And do you expect any of those gains to be seen this fiscal year?

John Barbour

We are, at the moment, talking to other people about expanding our distribution across those products. So far, things are looking very promising, but we’re not at the stage where we probably want to disclose any of that, just from a competitive standpoint. But you know, as you probably read across the press, and a lot of the writeups there, I think that people were very surprised and positive about our launch on our LeapTV.

I think the other thing that’s exciting about it is that unlike the mobile marketplace where, when you’re developing content for kids under the age of eight years old, there’s actually very little profitability opportunity there. Most of the people who are developing mobile content for kids under the age of eight aren’t making any money. That’s very different than the video game marketplace, where the prices tend to be higher, the content’s more immersive, and I think there’s a greater profitability opportunity. So again, the response we’ve had from people has been terrific.

Michael Swartz - SunTrust Robinson Humphrey

And then just with the KidZui transaction that was announced today, are there any financial implications in terms of revenue or earnings? Any of that embedded in guidance?

Ray Arthur

There’s a small incremental cost to running the site versus what we used to pay for the service, but this technology allows us to support LeapSearch and provide a 100% kid-safe browser experience, because all the content that is served up on our platforms is curated by our team of learning experts. And it is categorized by age and by topic, with pictures, so that even children who can’t read can have a web experience without opening up the possibility of getting inappropriate content off the web, or being hacked into by nefarious people.

John Barbour

I think one of the points there is that when you think about the amount of families out there right now who hand their family tablet to a young kid -- young kids are kids. They go explore. That’s all part of what they do. And they go and open up something on it, which has got a potential virus within it. I think protecting families and protecting our personal data is really important.

You’ve got to remember, we’re talking about kids here that are three, four, through six, seven years old. So you want to give them an experience of the internet, because the internet is changing everybody’s lives, but you want to make sure it’s super safe for kids. And there’s nobody out there with a service just like we’ve got here with KidZui, and LeapSearch. And therefore, my viewpoint is you can’t create the best first tablet for kids unless you’ve got a super safe, out of the box web experience for kids.


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

Edward Woo - Ascendiant Capital

I had question in terms of the initial response to the LeapBand. I know it’s been out a couple of weeks.

John Barbour

Yes, it’s been out a couple of weeks, and it’s been strong. We’re excited about it. I was in some stores in the U.K. last week, and you know, it’s getting exciting. We’re getting a good response to it from people.

Edward Woo - Ascendiant Capital

This is in the U.K. as well as in the U.S.?

John Barbour

Yeah, in the U.K., it’s very much still from retailers. It’s hitting shelves right now. But in the U.S., it’s starting to hit shelves. I saw it in some stores in Chicago. And it’s available online right now. And early sales response has been strong.

Edward Woo - Ascendiant Capital

And then going on to the LeapPads for this holiday, how many LeapPads will be on the retail shelves? And is there any concern that some of the lower-priced products will cannibalize the higher priced products?

John Barbour

You know, I think what we’re trying to do here is offer the best first tablet for children at a variety of access price points. So there will be a smaller five-inch tablet without wifi, right up to a super seven-inch tablet with wifi. So the nice thing about this space is that people will tend to pick the tablet that best suits their income and their children. And we feel that we’ve got the bases covered. It’s the best line of first tablets in the marketplace.


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

Gerrick Johnson - BMO Capital Markets

We’ve heard a lot about hardware and the [unintelligible] out there and the impact on margin shipments, but how about software? Are we pleased with software sales? And are you seeing follow-through there that you had expected given the large installed base of LeapPads out there?

Ray Arthur

I think we’ve been encouraged by the new wireless units that we’ve put in there, and we’re actually seeing some improvement in the attachment rates there. I’d say that software does, to some extent, follow the sales of tablets into market. And so with the reduction in fourth quarter sales of tablets, there’s been a little less in terms of software activity, but I would say overall, we’re very encouraged by the conversion to wireless, because we get more engagement with the units. But, you know, we have another 370-plus pieces of content that are going to be available this year, and we just continue to strive to drive that attachment rate up.

John Barbour

The advantage of wifi is we have a far stronger connection with the consumer. We get a lot more link to them in terms of delivering them the content.

Gerrick Johnson - BMO Capital Markets

So if you’re selling more digitally, then, the glut of inventory retail has no bearing on what you sell software-wise, really. So is it safe to say that your software is up year over year?

Ray Arthur

No. And I think what you have to understand is people also buy cartridges and digitally. They don’t buy just one or the other. So it’s typical to see somebody buy a wireless unit but also buy a cartridge.

John Barbour

The cartridge sales for this year are impacted more by the fact that we actually put less tablets into the marketplace in the fourth quarter than we did the year before.


Your final question comes from Lee Giordano with CRT Capital.

Lee Giordano - CRT Capital

Can you talk a little more about the competitive environment for kids’ tablets going into this holiday season? Do you anticipate being in a similarly promotional environment as it was last year? And anything new out there that kind of catches your eye, that could be a potential game-changer in the category?

John Barbour

You know, it’s interesting, we track POS through MPD every week in the tablet space. It’s something we’re actively looking at. We look at children’s tablet sales in the toy section of the store, and we look at tablet sales in the CE section of the store as well. So we have an immense amount of time into tracking tablet sales.

The spring this year has been impacted by some price discounts across excess inventory, not just in our tablets, but across the board in tablets. In fact, in some of the competitors’ tablets, the price discounts have been even greater than the price discounts on ours.

At the same time, the tablet POS is actually slightly up. So we’re competing head-to-head with these cheaper tablets fairly successfully. And the growth in the CE segment, in terms of tablets, has started to slow, and therefore we’re looking at that marketplace really, really tightly. But as I say, in terms of unit sales, we’re holding our own against the competition.

There’s been some innovation in the tablet space. You can see it in some stores. Some of the big innovation doesn’t look to be performing in the marketplace, so we’ll keep an eye on it. But right now, we haven’t really seen anything out there that we feel is going to have a dramatic impact on the momentum we have through the holiday season.


And this concludes 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.


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