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Executives

Karen Sansot

John Barbour - Chief Executive Officer, Director and Member of Non-Executive Officer Stock Award Committee

Mark A. Etnyre - Executive Officer

Analysts

Gerrick L. Johnson - BMO Capital Markets U.S.

Scott W. Hamann - KeyBanc Capital Markets Inc., Research Division

Lee J. Giordano - Imperial Capital, LLC, Research Division

Elizabeth O. Pierce - Roth Capital Partners, LLC, Research Division

Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division

Edward M. Woo - Ascendiant Capital Markets LLC, Research Division

LeapFrog Enterprises (LF) Q2 2012 Earnings Call August 1, 2012 5:00 PM ET

Operator

Good afternoon. My name is David, and I will be your conference operator today. At this time, I would like to welcome everyone to the LeapFrog Q2 2012 Conference Call. [Operator Instructions] Thank you. I would now like to turn the call over to Ms. Karen Sansot, Senior Director of Investor Relations. Ma'am, 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 second quarter ended June 30, 2012. I'm Karen Sansot, Senior Director of Investor Relations. Today on the call, we have John Barbour, our Chief Executive Officer; Mark Etnyre, our departing Chief Financial Officer; and Ray Arthur, our new Chief Financial Officer, who joined the LeapFrog team a couple of weeks ago.

Before we begin, we wish to remind you that our statements today will include forward-looking statements about management's expectations, including expectations regarding anticipated 2012 financial results, such as expected sales and earnings per share. 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 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, everyone, and thank you for joining us today. As the CEO and a shareholder of LeapFrog, I'm very pleased with our performance in the first half of the year and the progress that we're making on our 2012 initiatives.

The LeapFrog team's dedication to developing life-changing educational entertainment is helping millions of children achieve their potential, while also creating significant value for our shareholders and our business partners. As a result of high demand for our leading products that both entertain and educate children, we achieved exceptional sales growth in the first half of the year and delivered a terrific financial performance.

Net sales increased 52% in the first half of the year and was strong worldwide, with sales up 55% in the U.S., and up 47% in International markets. This sales strength, along with a higher mix of content, has driven gross margin expansion, with gross margins increasing 790 basis points in the first half of the year. Given our disciplined operating expense management, we're also benefiting from operational leverage. As a result, we reduced our first half -- seasonal first half loss per share by $0.29 or 53%. And our cash balance more than doubled to $127 million compared to $58 million a year ago.

Consumer demand for LeapPad1 and its rich educational content has remained very high even into the summer months. Retail partner sales have exhibited solid double-digit growth in every major market that we're in. This speaks to the incredible educational and entertainment value of the LeapFrog experience, which transcends many different cultures and demographics.

Since its launch, LeapPad1 has been one of the hottest and most in demand children's products. It is the #1 kid's learning tablet and has received lots of prestigious awards and significant praise from parents, educators and the industry. Building upon our success, in August, we will start to ship the next generation of breakthrough educational entertainment platforms, content and toys. We are introducing a significantly enhanced new version of our #1 kid's learning tablet, the LeapPad2, which features a far faster processor, double the memory, higher resolution front and back cameras and video recorders, music player, reduced energy consumption and a battery recharging option.

We have hundreds of learning game cartridges and apps, music, videos and eBooks, with lots more new ones to come through the rest of this year. Pre-sell orders of LeapPad2 have been very strong. Pre-selling as many units in 2 days as the LeapPad1 presale sold an entire week of last year.

We're also launching LeapsterGS, which is our revolutionary learning video game system that offers fast action game play, packed with rich learning. We all know that lots of kids love to play fast action video games, while many parents prefer that their children spend their time doing something more enriching. LeapsterGS is the perfect solution. It's the portable video game system that parents and kids can agree on. LeapsterGS is a massive improvement over the current Leapster Explorer, which was launched in 2010, and is the current #1 selling learning game handheld. LeapsterGS has a new thinner, sleek design, larger screen, built-in motion sensor, camera and video recorder, far faster processor and 4x the memory. LeapsterGS will be compatible with hundreds of digital contents that can also be played on the LeapPad2.

LeapFrog is quickly transforming from a company that just develops and sells its own content into a company that creates, as well as curates, aggregates and distributes all that is best in children's educational entertainment. Our key competitive advantage and what differentiates us from others is our LeapFrog experience, which provides complete, curated learning solutions for children that are age-appropriate, entertaining and life-changing. Our robust library is a cornerstone of this experience and includes a combination of award-winning LeapFrog content that is created by our in-house development teams, as well as the content that's been carefully selected by our learning experts from some of the biggest names in children's entertainment such as Nickelodeon, Sesame Street, HIT Entertainment, Hasbro, Discovery Education, Lionsgate, Ludorum, Kidz Bop and more.

We're significantly increasing the number of new, internally-developed pieces of content including many more apps and more than doubling the number of new cartridges since last year. This content will cover learning solutions for a wide range of skills such as creativity, reading, phonics, vocabulary, math, science, music and more.

We're particularly excited to offer Kindergarten Readiness content, designed specifically by our expert learning team for ages 3 to 5 that will help parents prepare their children for kindergarten. This summer, in our toy category, we're launching an exciting new breakthrough product line and expanding our core toys with innovative new products. Just hitting the shelves now is our Touch Magic line-up, which is a super cool magical toy line that turns the softest of touches into big learning moments. With these innovative capacitive touch toys, kids can learn their alphabet, phonics, numbers, music and more with our learning book, Counting Train and the super fun Rockin' Guitar.

We also have a bunch of fun and educational new toys such as My Talking LapPups, which offer a new spin on laptops with our adorable Scout and Violet characters for our youngest consumers. We're also launching the new Letter Factory Phonics, which introduces classic letter telephonics play in a portable phone factor.

Learn to Read continues to be an important pillar of our product line-up. This year, in our Tag reading system, which is the #1 learn-to-read platform for kids, we'll be introducing more than double the number of new books and innovative activity products as last year, including the Human Body Discovery Pack, which teaches human body facts, along with health and nutrition. And the Get Ready for Kindergarten book, which prepares kids with reading, math and social studies skills.

We're further unlocking the value of the LeapFrog brand with outbound licensing partnerships. This past quarter, we entered partnership with MEGA Brands, who has developed and distributing a newly full branded line of stationery and activity products that includes creativity and dry erase workbooks, flashcards, writing pads, pencils and more. Not only does this partnership provide new revenue opportunities, it also extends the presence of the brand into new stores and different aisles.

There's a lot to be excited about with our first half performance and the progress we've achieved in our journey to create a hardware content ecosystem that provides fun and engaging educational entertainment solutions that help children around the world achieve their potential.

As we discussed in our prior calls this year, we planned this year as a year of 2 distinct halves. The first half, with a low prior comps and lots of fresh LeapPad1 momentum and the second half, where we do most of our sales in POS that we're going against far harder comps than the prior year, and a lot more tablet competition in what looks to be potentially tougher economic climate around the world. As a result, our outlook for the year has increased a bit from the last guidance provided, but we remain cautious about the second half. Mark will provide you with more insight about guidance.

In summary, we had a great first half of the year. We extended our leadership in educational entertainment and position ourselves well for the future. We're carefully managing our growth and building a strong foundation for our long-term opportunities. In a world where millions of parents are looking for quality and effective educational products to supplement what their kids are learning at school, LeapFrog stands out as a brand with strong parental trust and a proven ability in creating engaging and compelling entertainment that's filled with the nutrition and fun education that truly changes children's lives.

I'd now like to turn over the call over to Mark who will discuss our second quarter financial performance.

Mark A. Etnyre

Thank you, and good afternoon. Our second quarter performance, while seasonally insignificant, was solid and exceeded our expectations. The results highlight the growing demand for industry-leading educational entertainment products and validate the tremendous potential of the LeapFrog brand. We're happy with the continued momentum, and we entered the back half of the year in strong financial shape with a number of exciting upcoming product launches.

Let me spend a few minutes providing a bit more detail into our second quarter results. Worldwide net sales for the quarter were $71 million, up 31% compared to a year ago, and were negatively impacted by 1% due to changes in currency exchange rates. The worldwide growth was driven by continued strong LeapPad momentum, including content and accessory sales, as well as share gains in virtually all key markets.

Net sales for our U.S. segment were $49 million, up 26% compared to a year ago. POS for our U.S. segment also remained robust in the quarter, growing largely in line with our selling growth rates. In addition, to strong sales of LeapPad, net sales in the U.S. segment also benefited from lower retail channel inventory levels at the start of the quarter compared to the second quarter of 2011.

In our International segment, the net sales were $22 million, up 46% compared to a year ago and were negatively impacted by 5 percentage points from changing in currency exchange rates. Momentum on our International segment remains very strong in the quarter with robust selling growth and strong double-digit POS growth in all key markets.

By business line, worldwide net sales of our multimedia learning platforms and content essentially doubled year-over-year. Sales of LeapPad hardware, content and accessories were particularly strong, offset slightly by declines in gaming platforms, which are nearing the end of their life cycles. Within multimedia learning platforms and content, our traditional reading business, which includes Tag and Tag Junior hardware and the related fiscal books was slightly down, as expected, prior to rolling out our reading solution planogram this fall. However, our holistic reading business, which in addition to the Tag and Tag Junior platforms, also includes eBooks for our gaming and tablet platforms, increased by 11%.

Learning toy net sales declined 24% as we are transitioning product lines. Several of our evergreen products are nearing the end of their life cycle, and we did not ship our new 2012 lines in the second quarter. Additionally, according to NPD's most recent year-to-date toy industry reports for June, many toy categories are experiencing sharp year-to-date declines in the U.S.

Gross profit for the quarter was $29 million, an increase of 50% compared to a year ago. And gross margin was 39.9% for the quarter, up 500 basis points year-over-year due primarily to favorable product mix, fixed cost leverage given our increased sales volume and more efficient promotional spend. The 39.9% gross margin percentage was our highest second quarter gross margin since 2005.

Operating expenses for the quarter were $36 million up 12% compared to the $32 million a year ago, though down more than 8 points as a percentage of net sales. SG&A and R&D both increased due to higher investment. And advertising spend also increased in dollar terms as we tested some new initiatives to drive our sales growth, but advertising, as a percentage of sales, was slightly lower than the same period last year.

So as a result of sales growth, gross margin expansion and operating leverage, we once again drove significant bottom line improvement. Net loss was $8 million, an improvement over $5 million year-over-year, and net loss per share was $0.12, an improvement of $0.09 compared to the $0.21 net loss per share a year ago.

So let me spend a moment on the balance sheet. Our cash and equivalent finished at $127 million, more than double than $58 million a year ago. And operating cash flow improved by $12 million in the quarter. Our accounts receivable balance was $51 million, an increase of 5%, which trailed our 31% net sales increase. Our AR portfolio remained healthy, and our DSO improved over 2 weeks compared to the year-ago period to 65 days.

Our inventory balance was $53 million, down $10 million or 17% compared to a year ago. Retail channel inventory levels are also healthy, down single digits from last year despite the strong sales growth. In summary, our balance sheet is in excellent shape heading into the all-important holiday season.

So I'll finish the prepared remarks with some insight into our outlook. We expect third quarter net sales to increase between 10% and 15% compared to a year ago. Our third quarter outlook has improved as we have greater visibility into the fall. Given the upcoming shipments of LeapPad2, LeapsterGS platforms, Touch Magic and the new toy and Tag Introductions, we expect the higher mix of hardware sales relative to the software sales in the third quarter, which will temper gross margin expansion in the quarter. Additionally, we expect operating expenses to increase year-over-year due to higher headcount-related cost, as well as higher levels of advertising supporting our new fall launches.

As for share count, we expect our weighted average, fully diluted share count for Q3 to be approximately 70 million shares. As a result, we expect third quarter earnings per share to be in the range of $0.36 to $0.41 compared to earnings per share of $0.35 a year ago. For the full year, we now expect net sales growth between 13% and 15%. We expect earnings improvement to be primarily driven by net sales growth, modest growth margin expansion and operating leverage. As a result, we expect net income per share in the range of $0.61 to $0.66 compared to $0.30 in 2011.

So while we're out-of-the-gate strong in the first half and are encouraged with the initial acceptance of our new 2012 product line up, it's important to keep in mind that it's still early in the year with approximately 75% of the year's retail POS ahead of us. Additionally, the economy is still fragile, and competition for kids' tablets is increasing.

With that backdrop we're clearly planning for growth in the second half of the year, but believe it is prudent to have a conservative view of the fourth quarter until we get a better read heading into the holiday season. As we look to the future, we are well-positioned to grow our earnings and deliver strong cash flow. We have good product momentum, the leading children's educational tablet, and exciting new product launches. Most importantly, we are the leader in children's educational entertainment with a brand that both parents and children love.

I'd now like to turn the call back over to JB.

John Barbour

Before we wrap up our prepared remarks, I'd like to say a very big thank you to Mark for his massive contributions to LeapFrog over the past 5 years. We're going to miss Mark, and we wish him all the best.

I'd like to welcome Ray Arthur as our new CFO. Ray and I have worked together before, and he's a seasoned executive with a proven track record of building excellent organizations and helping grow industry-leading companies. In addition to Ray, over the past few weeks, we've strengthened our leadership team with the addition of 2 world-class product marketing digital and consumer experienced executives, Greg Ahearn and Brad Rodrigues.

I am super excited about the impact that Brad, Greg and Ray are going to have in our business through the end of 2012 and beyond. I'd like to finish by giving a really big thank you to the talented team members of the LeapFrog team around the world for their incredible commitment and passion for helping children achieve their potential.

That concludes the prepared remarks. And we'd now like to open the call for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Gerrick Johnson of BMO Capital Markets.

Gerrick L. Johnson - BMO Capital Markets U.S.

So your guidance for the back half assumes a 4% growth in the back half. If demand ends up being stronger than that, do you guys have the capacity to fill that demand?

John Barbour

It really depends what that demand is, but we're still planning to have some capacity to -- certainly, if the demand increases, to go above that number, yes.

Gerrick L. Johnson - BMO Capital Markets U.S.

Okay. And then this quarter, were there any shipments of LeapPad2 or LeapsterGS or are they entirely third quarter?

John Barbour

No, entirely third quarter. And I think -- I mean, if you look, Gerrick, at the second half, the fact is that we haven't shipped one piece of any of our new products into the marketplace. We've had a great response from trade and we got good promotion set-up, and a bunch of other stuff that we feel positive about. But we're still very early on. 75% of our POS is ahead of us, and none of us really know what's going to happen with the economy. So we're trying to do the business the best way we do, and that is by keeping a conservative outlook, but also be prepared for any upside -- well, hopefully, some upside that comes our way.

Operator

Your next question comes from the line of Scott Hamann of KeyBanc Capital Market.

Scott W. Hamann - KeyBanc Capital Markets Inc., Research Division

Just in terms of the gross margin profit in the first half. I mean, I know you typically don't break out the content, but could you kind of give us a feel for how heavy content was? You guys were kind of thinking about in the back half here?

Mark A. Etnyre

Sure. I mean, content was clearly a driver, Scott, in the first half. We mentioned, I think, on our first quarter call that a lot of the surprise upside both on sales and margin was content. And we saw that strength continuing in the second quarter as well. When we look to the back half though, it's kind of in our prepared remarks, it's very clear that we're expecting that we're going to have a higher shipment of hardware in the back half. That's going to temper our growth, not to say that we could see further software attached to that, but generally, our experience shows it lags a quarter or 2 before we'll see that benefit.

Scott W. Hamann - KeyBanc Capital Markets Inc., Research Division

So in your guidance right now, you're kind of assuming that we see the same thing we saw last year where one of the content and accessories came in first quarter this year versus around the holiday season even though you already have a lot of hardware out in circulation right now?

Mark A. Etnyre

That's been typically our experience, particularly as you're selling a fair amount of that in the back of the year, which for the most part, doesn't get opened until the last week of December.

Scott W. Hamann - KeyBanc Capital Markets Inc., Research Division

Okay. And then just on the International business, can you kind of give us a feel for what you're seeing in some of the different markets in terms of the current trends? And then just what was the appetite for ordering product heading into the holiday season?

John Barbour

Yes, I mean, I think -- I've been in a number of the International markets over the last month or so, and know our business in the U.K. continues to dramatically outperform the rest of the marketplace. The launch of LeapPad2 and GS has gone exceptionally well. And France, where we've launched the LeapPad1, we're getting a very strong sell-in as well. And in Canada, LeapPad2 and GS have had a good response in their pre-sell and pre-launch and then there are International markets similar to that result, I mean we're fortunate. We are experiencing, as you can see from our numbers, good growth across virtually all of the markets we're playing in.

Operator

Your next question comes from the line of Lee Giordano of Imperial Capital.

Lee J. Giordano - Imperial Capital, LLC, Research Division

Can you talk a little more about the advertising strategy for the LeapsterGS and the LeapPad2 in the back half of the year? And then also, how should we think about marketing spend versus last year?

John Barbour

Yes, and we will be creating dedicated new ads for both the LeapsterGS and the LeapPad2. And we will be planning to support them with strong campaigns through the holiday season. And the strength of those campaigns will be a little bit dependent upon our ability, like last year, to drive dramatic PR and social network response for the product. So we've kind of bought our TV and invested upfront on TV in a little bit more flexible way this year so that if we do get that dramatic push, we will have the flexibility to move that TV around on to other products as well.

Operator

Your next question comes from the line of Liz Pierce of Roth Capital Partners.

Elizabeth O. Pierce - Roth Capital Partners, LLC, Research Division

Just kind of following up on Lee's question on advertising. So, do you feel like you're about 1 year out before you can start to level that down when you get some leverage in the model with social media, et cetera?

John Barbour

I think, actually, if you look at our advertising spend as a percent of sale, we're probably, today, one of the lower of the big branded companies out there. And that's because we've got these new interconnected consumers that we have a relationship with that allows us to be a little bit more focused on how we invest our money in terms of advertising. And I think as the brand develops, and we are still moving at a pretty big there [ph], we'll certainly keep on looking at that. The hope would be that as we continue to expand our ecosystem and we bring more people into, and we're delivering this life-changing content to millions more consumers out there, that we will be able to get greater leverage across our marketing investment. And -- but I think as I said, this year's a little bit unique because of just the incredible PR and support and success we got last year, we'd like to hope that we're going to get that again this year. We're certainly looking that way early on, and you can't plan for that. We've got to be prepared that if we don't get that level of support, if something else super exciting new comes along that everybody wants to talk about then, we got to be prepared to support our brand with the right piece of TV that keeps it right in the mind of the consumer.

Elizabeth O. Pierce - Roth Capital Partners, LLC, Research Division

Got it. And then just a second question, JB, in terms of how fast you can get content to market, I mean, are you in a position at this point where you you've got things teed up that you could bring in faster or is that going to be more methodical because you had quite a few announcements in the quarter, and I'm just wondering if that we should look for something similar patterns in the back half of the year and into next year?

John Barbour

The answer to that is yes. We are aggressively adding more content to our platform. We were ready to -- when we talk about the stuff that we've developed and created and the product that our learning team are getting out there and curating and aggregating, we've got hundreds of pieces of content on our platform today, both in download and digital, that really is filled with the top of the top world-class educational entertainment. We are not sitting on our laurels on that. We're going to add hundreds more as we go forward over the next 6 to 12 months and actively looking to fill in little gaps that are there and be at the forefront of what's all that is great in educational entertainment. So you're going to see more announcements, more investment in content as we drive this business forward.

Operator

[Operator Instructions] Your next question is from the line of Drew Crum of Stifel, Nicolaus.

Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division

A couple of questions from me. First, can you talk about your planned shelf space on the hardware side? You've got a couple of new products coming in, and a couple that you're phasing out. How are you thinking about shelf space at retail? Secondly, I think you mentioned that the learning toy category for your business was down 24% in the quarter. It sounds like it's somewhat timing-related. But some of your competitors noted tepid performance during the second quarter and preschool overall seems to be a little softer. How are you thinking about that for the second half? And then finally, can you talk about the pricing strategy on the content side for LeapPad and LeapPad2?

John Barbour

What was the first one?

Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division

Planned shelf space.

John Barbour

Yes. As you look at our shelf space across our major customers for the holiday season, across the board, we've got increases in shelf support in the marketplace and support for LeapsterGS, LeapPad2 and our new Touch Magic line. So we're feeling pretty good about the shelf support that our great partners are giving us. In addition, we've got more promotional support this holiday season across our lines, across our content, across our accessories. So again, we -- it's really early on in the game, but our sales and marketing teams, I think, have done a terrific job this year, setting up our stall and getting ready for the holiday season. What was the second question?

Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division

Second question is just your thoughts on the preschool category?

John Barbour

Preschool is tough, you can see in the NPD numbers and what -- we're going to be impacted in that, the same as everybody else. We’re excited about the new launches we've put into the marketplace, which some of them we're just starting to ship right now. Early in the season, we've had some transition of products, but I think that's a combination of that and some tough headwinds in preschool at the moment. And the hope is the market turns around a little bit and starts to increase. We're planning our business relatively conservatively at the moment. We're excited about the new products, and we're prepared to chase inventory if we have to.

Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division

Just the last question was on the pricing strategy with your content for some of your new hardware devices?

John Barbour

Our pricing strategy is consistent with our strategy in the past, which is that we believe we create the best educational entertainment out in the marketplace, that we believe offers incredible life-changing value. And that's why I think it's been so successful in the past and successful now. We don't see any dramatic changes in our pricing going forward. We are going to be doing some testing. We are going be trying some new things as we always are. I mean, we're always trying to learn new stuff and looking at pricing list [ph], let's say, in a bunch of other stuff. And if those test shows that we're missing an opportunity or there's chance to do something definite, we'll certainly do that. But I wouldn't be looking for any dramatic changes in our pricing strategy going forward.

Operator

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

Edward M. Woo - Ascendiant Capital Markets LLC, Research Division

How comfortable are you with your visibility into the manufacturing and supply chain heading into this holiday?

John Barbour

I would say pretty comfortable. I was in the new factory that we have that's making LeapPads in China about 3 weeks ago. And I was super impressed. I was incredibly impressed with the job that our team has done to help set that factory and help set those lines up. And I was very impressed with the new partner we have for making LeapPad2s. And so I'm -- again, I'm feeling reasonably good about the quality of the manufacturing support that we will have going through this holiday season. I mean, like anything, our capacity is going to be limited by our purchasing of componentry and purchasing on a product, I mean, supply isn't just related to whether the factory can make it. Some of it is also related to the amount of risk we want to take as a company. And this marketplace is pretty tough when people would make a mistake there and go too high in terms of product as well. So we work very closely with our partners. Our teams spend spent a lot of time modeling our business. We try and get a really good sense of what we got ahead of us. We work with our partners to get that level of capacity in terms of both components and products, and then we give it our best shot, but you know as well as I did, if things change dramatically, we do the bulk of our sale through consumer sell-through from Thanksgiving onwards. And if anything changes dramatically over that period, there's not a lot you can do about it.

Edward M. Woo - Ascendiant Capital Markets LLC, Research Division

Okay. And my other question is for the LeapPad2, do you expect that to be rolled out in most International markets in the current quarter?

John Barbour

That will be rolled out in the major English-speaking markets in the current quarter, yes.

Edward M. Woo - Ascendiant Capital Markets LLC, Research Division

What about the non-English-speaking countries, because we know they have to learn their languages as well?

John Barbour

Yes -- no, it's not a case of learning the languages. It's just the case -- and we have the hardware. We don't have the software developed for some of those market places. And we'll launch into some of those markets next year because we want to expand the amount of games and content available in those markets.

Edward M. Woo - Ascendiant Capital Markets LLC, Research Division

Great. And would you continue -- what's your plan for the LeapPad1? Do you expect to continue selling it alongside the LeapPad2?

John Barbour

We will continue to sell LeapPad1, alongside LeapPad2 through the end of this year.

Operator

[Operator Instructions] Your next question is a follow-up from Gerrick Johnson of BMO Capital.

Gerrick L. Johnson - BMO Capital Markets U.S.

Mark, could you go over your accounts receivable being only up 5%? Why would that lag sales growth so significantly?

Mark A. Etnyre

Well, there's a couple of factors. I mean, one most importantly is the team has, from an operational perspective, done a really nice job working on the collection side. So we've certainly put efforts there, and you can see that payback on our numbers. There's some element of channel mix that impacts that as well. But by and large, the majority of it is just the heavy lifting by the LeapFrog teams here on the collection side.

Gerrick L. Johnson - BMO Capital Markets U.S.

Okay. And did you go over the ratio of downloadable content to cartridge-based content in the quarter yet?

Mark A. Etnyre

No.

Gerrick L. Johnson - BMO Capital Markets U.S.

Can you?

Mark A. Etnyre

No.

Gerrick L. Johnson - BMO Capital Markets U.S.

Okay. And lastly, the inventory looked down rather significant. And now kind of similar to my original question, if you have the opportunity for incremental sales, do you have the inventory to support those deliveries in the back half?

John Barbour

We're -- again, one of the interesting things about our business, Gerrick, as you know, is that once we start moving into probably even September or so, people are going to be starting buying a bunch of our hardware systems and putting them away because the likelihood is, they're going to be hard to get again this holiday season and people don't want to disappoint their kids. So we're planning for a pretty heavy content business in the post-holiday and into January season just like we saw this year. And therefore, we are looking at that inventory of cartridge and product and looking at it and being a little bit more aggressive on that this year versus last year.

Gerrick L. Johnson - BMO Capital Markets U.S.

Okay. And I guess downloadable content creates no inventory, right?

John Barbour

No. We're fortunate that way it doesn't.

Operator

And there are no additional questions in queue at this time. Are there any final comments?

Karen Sansot

Yes, thank you. Thank you, everyone, for joining us on our call today. Please feel free to contact Ray or me with any follow-up questions. Thanks, and goodbye.

Operator

Ladies and gentlemen, this does conclude today's conference. Thank you for your participation. You may now disconnect.

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