LeapFrog Enterprises Q2 2008 Earnings Call Transcript

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LeapFrog Enterprises, Inc. (NYSE:LF) Q2 2008 Earnings Call August 4, 2008 5:00 PM ET


Eileen VanEss – Vice President, Investor Relations, Treasurer

Jeffrey G. Katz - President, Chief Executive Officer, Director

William B. Chiasson - Chief Financial Officer and Principal Financial Officer


Sean McGowan - Needham & Company

John Taylor - Arcadia

Drew Crum - Stifel Nicolaus


Good afternoon. My name is Allie and I will be your conference operator today. At this time, I would like to welcome everyone to the LeapFrog second quarter financial results conference call. (Operator Instructions) Ms. VanEss, you may begin your conference.

Eileen VanEss

Thank you, Allie. Good afternoon and welcome to LeapFrog Enterprise’s conference call to review the results of our second quarter ended June 30, 2008. I’m Eileen VanEss, Vice President of Investor Relations and Treasurer.

Before we begin, we wish to remind you that certain statements made today will include forward-looking statements about management’s expectations, including expectations regarding the timing, scope, and success of future product launches, expected benefits of new products and services, anticipated 2008 financial results, including expected net sales, margins, expenses, profitability, cash flow, and cash balances for 2008.

In addition, we expect the questions posed in the Q&A portion of this call may prompt additional answers that contain additional forward-looking statements not included in our prepared remarks. This cautionary language concerns forward-looking statements both in our prepared remarks and our impromptu answers to questions posed.

A variety of factors, many of which are beyond our control, affect our results, performance, business strategy and could affect actual results to differ materially from those projected in such forward-looking statements. Some of these factors are described in our 2007 annual report on Form 10-K, which was filed with the SEC on March 13, 2008, as well as in LeapFrog's other public statements and filings. LeapFrog does not update forward-looking statements and we expressly disclaim any obligation to do so.

With that, I will turn it over to Jeff Katz, President and CEO.

Jeffrey G. Katz

Thanks, Eileen. Welcome to our call today and thanks for joining us. We had a good second quarter. We reported net sales of $68.3 million, up 22% over last year and a net loss of $21 million, or $0.32 per share compared to $28 million, or $0.44 per share in the second quarter of last year. The successful and on-time launch of our new Tag reading system on June 8th was clearly the high point of our second quarter and that launch was closely followed by the launch of our two new web connected educational gaming systems, Leapster 2, the latest handheld from the Leapster family, and the all-new Didj custom gaming system in early July.

We also introduced some great new titles during the quarter, including a strong selling performance from our Leapster title based on Pixar Films’ WALL-E.

Sales for the quarter came in better than we expected due to strong and earlier-than-anticipated shipments of our new products. So far we’ve received excellent feedback and we are seeing strong sell-through at retail for Tag. Leapster 2 and Didj are just being introduced but early indications are promising, particularly at LeapFrog.com.

Gross margins are also improving and stood at 39.3% for the quarter. As we’ve talked about before, we expect gross margins to improve over time but they won’t reach or exceed our 45% new product hurdle rate until products are in the market for a year and we begin to see the benefit of improved software tie ratios.

While it’s still early, the metrics for Tag look good. Tie ratios are better than we had planned, connect rates are great, and customer support issues have been de minimis. Consumers’ willingness and ability to connect have been very good. We are encouraged, for example, to see that about 80% of the people who purchase Tag are connecting within just a few days of their purchase.

There has also been lots of positive buzz about Tag, including some really great reviews. One reviewer said “My kids are getting into reading before bedtime and I came across this product thinking it would enhance their reading experience. It definitely has. My boys love it. It’s truly great for even younger twos and older. The pen is so easy to use and the best part is it has games and sounds like the characters’ voice. We bought almost every book available. We couldn’t download all the books on one pen so we bought two. Go buy it. You will not be disappointed.”

Tag has also received the must-have best educational toy of the year award in France and best toy of the year in Australia.

We are pleased about these reviews and awards because they are good indications that Tag should do well for us not only in the U.S. but we believe it will be appreciated globally as well.

Those of you who have followed us for a while now will recall that the lack of a strong reading product was the root cause of the large decline in sales in recent years at LeapFrog but historically it has also been a source of tremendous growth for this company. So the fact that Tag is going well is significant, we think.

While we are pleased with early indications at retail for Tag and at LeapFrog.com for some of our other products, it’s still too early in the game to have a complete read. Leapster 2 and Didj, for example, were just rolled out in a limited number of retail stores in mid-July and our full gaming line won’t be in distribution fully until the end of August. Internationally, we won’t really start shipping until the end of the third quarter.

What’s clear from early data though is that both our gaming line and Tag will be strong product sets for the year. Gaming sales continue to grow and with Tag, we’ve restarted growth in the reading category. And now, we have gaming and reading products which connect to the learning path, which launches in August, and we expect this to be a principal tool to boost sales velocity of our content.

So while the jury is certainly still out on consumer spending trends for the year and we have much work yet to accomplish, we are confident that the second half will show solid growth over the second half of 2007.

Execution of our marketing plans to support robust sell-through of our new products is a core focus for the company right now. We have rolled out a number of our marketing initiatives already and they have contributed nicely to the initial sales of Tag in particular, and to increased traffic and sales online at retailers’ websites and at LeapFrog.com.

We believe we have some of the best micro sites in the industry and they are doing a lot of the marketing work for us, but they will do even more as we hit the fall seasonal period.

We have two remaining launches left for the year -- the LeapFrog Learning Path, which will debut in August, as I alluded to earlier; and Crammer, our study and sound system, which will launch in the early part of the fall. I know I sound like a broken record on this but it’s important -- I am pleased to say that we are now a connected company and the Learning Path will play a critical role in our strategy going forward. In particular, we believe it will clearly distinguish us from the competition in the so-called learning space. It will also provide us a forum to showcase the learning power of our products and give us new and better ways to engage with our customers and consumers to strengthen what is already an awesome brand.

For the remainder of the year, we are going to be heads down focused on continued execution behind our products, our marketing efforts, and supporting our retail customers. We are paying close attention to what is working so we can leverage that but we are also on the lookout for opportunities to make necessary refinements. Given the broad scope of what we are launching this year, a new level of execution across the company is required and we are taking all the preparatory steps to do just that.

So what still needs work? There are certainly areas where more attention is required. International continued to lag in the first half of 2008 but we expect to see a pick-up there in the second half as new product launches, and especially Tag, take hold.

As I mentioned earlier, overseas reception of Tag has been good and that gives us cause for optimism about our international business. We expect growth in international in the back half of the year.

And LeapFrog School -- as you are all aware, schools across America have been hit hard with budget shortfalls and they aren’t buying many products from companies like ours. During the second quarter, we implemented a 15% reduction in force in our school organization to ensure continuing profitability contribution of this division, while still enabling ourselves a chance to sell to those accounts that are ready to buy.

Looking ahead, our goal for school is to make sure it fits well within our core product strategy and that it remains a profitable contributor.

At this point, I would like to turn it over to Bill Chiasson, our Chief Financial Officer, who will go into the financials in some detail.

William B. Chiasson

Thanks, Jeff. As Jeff said, we are pleased with the progress we are making this year on improving our sales performance, strengthening gross margins, and reducing operating expenses. Before I go through the details of the second quarter, there are several key highlights I would like to point out.

First, net sales for the second quarter increased 22% compared to the second quarter last year. This increase was driven by the initial shipments of our new products in the United States, especially the Tag reading system, and also the Leapster 2 and Didj educational gaming systems.

Gross margins were 39.3%. That’s up 3.1 percentage points from last year. Much of the increase is reflective of the positive impact of margins on the new products.

And expense control was good. Combined, selling, general and administrative and research and development costs were down double-digits. All advertising expense increased by $3.6 million to support the new product introductions. Overall, operating expenses were down 3% as compared to the second quarter last year.

As a result of the good sales growth, stronger gross margins and lower operating expenses, the loss on the quarter narrowed as compared to last year. Specifically, the net loss for the quarter was $20.6 million, $7.5 million improved from the second quarter last year.

Now let me run through sales by segment. Net sales in the U.S. consumer business increased 57% to $50 million in the second quarter of 2008, compared to $31.9 million last year. The sales increases were driven by the launch of the Tag reading system and Didj and Leapster 2 electronic gaming systems. The new products accounted for virtually all of the sales increase in the U.S. consumer segment.

We also continue to see increases in Leapster software sales. Some of these increases were associated with the shipments of Leapster 2, but we also saw good sell-through of software to consumers who are using these titles on their classic Leapster models.

In dollar terms, we saw increases across platforms, software, and standalone products. However, the introduction of our new platforms impacted our product mix. The mix of net sales of platform, software, and standalone products as a percentage of the U.S. consumer segment’s net sales were as follows: platforms were about $23.8 million, or 48% of net sales in the second quarter this year compared to being 38% last year. Platforms typically carry a lower margin than software, so this higher percentage of platforms tempered the improvement in our overall gross margin for the quarter. We expect the third quarter to be a big platform quarter as well, given our continuing shipments of new products in the United States and overseas.

Software was about $12.7 million, or 25% of net sales in the second quarter this year compared to 24% last year. So while the absolute dollars of software sales increased significantly from last year, as a percent of the total mix for the quarter they were essentially unchanged. And that leaves net sales of our standalone products at $13.5 million, or 27% of net sales in the second quarter this year, down 11 points from the 38% of net sales recorded last year.

Net sales in our international segment declined 12% to $12.3 million in the second quarter, from $13.9 million last year. Excluding the positive impact of a weaker U.S. dollar, our international segment sales would have declined by 14% for the quarter.

We are still phasing out some of the retiring products in our international markets and these markets are not yet benefiting from the introduction of new products. Unlike the U.S., where shipments of new products including Tag, Leapster 2, and Didj began in the second quarter, availability of these products begins in the third quarter for our international business. In addition, the installed base of our gaming products in our international markets lags that of the U.S. As a result, unlike the U.S. the international segment did not benefit from as much strong Leapster business in the second quarter.

With the introduction of the new products starting in the third quarter, we expect sales for the back half of the year to increase for our international segment as compared to the same period last year.

Sales in our school segment decreased 41% to $6 million in the second quarter, from $10.2 million last year, primarily driven by increased competition and budgetary issues facing school funding.

We are managing the cost structure of this business so that it will continue to provide a positive contribution margin, despite the decline in revenues. For the quarter, the school segment contributed $1 million to earnings.

As Jeff commented, we’ll have more to say about the school segment later in the year. In the meantime, know that we are focusing on profitability and making sure that this business is aligned to our core strategies.

On to gross profit and gross margin -- overall, gross margin improved to 39.3% of sales in the second quarter of 2008. That’s up 3.1 percentage points from the 36.2% margin in the second quarter last year. The improved gross margin was aided by the introduction of new products in the U.S., which carried higher margins as compared to last year’s product portfolio, where we were discounting to move old product.

However, as I mentioned to you earlier, we also saw an increased percentage of hardware sales. As you know, some of our hardware carries lower margin than software. As a result, the high percentage of hardware sales had a dampening effect on our overall improvement in gross margin. We expect to continue to see relatively strong hardware shipments this year as we introduce our new platforms.

While these new systems should ultimately achieve our gross margin hurdle of 45%, this will occur as we increase our tie ratios on new products and we generate a great percentage of sales from software.

By segment, gross margins were as follows: for the U.S. consumer segment, the gross margin was 39.6% for the quarter, up 9.2 points from last year, reflecting the impact of the new products and the significantly reduced discounting.

For international, gross margin was 30.1%, up two percentage points from last year, and the school segment’s gross margin fell to 56.3%, down 9.4 points from last year, due I part to product mix.

Our selling, general and administrative expense for the quarter was $26 million, a decrease of $3.9 million or 13% from 2007. The decrease reflects the workforce reductions over the last year, as well as our lowered legal and audit fees.

Our research and development expense for the quarter was $12.9 million, a decrease of $1.1 million or 8% over the second quarter of 2007, reflecting reduced headcount and the move to more cost effective and more flexible third-party content development.

For the first half of the year, the combined R&D and selling, general, and administrative spending was down 10% as compared to last year. We expect full-year spending for these two expense categories to be down 10% to 15%.

Turning to advertising, our advertising expense for the quarter was $7.8 million, nearly double last year’s $4.2 million. We increased advertising this quarter in support of the consumer launch of Tag in June.

For all of 2008, we expect advertising dollars to increase from 2007 levels as we continue to launch and promote new products. We expect this increase to be consistent with the increase in net sales.

Operating income and loss by segment -- higher sales, improved gross margin expense control, were all factors in reducing the operating loss for the quarter to $22.2 million from $30.4 million for the second quarter of 2007.

The U.S. consumer segment had an operating loss of $19.7 million for the second quarter 2008, compared to a loss of $31.4 million for the same quarter last year. Driving the improvement was the increase in sales due to the shipment of new products, as well as continued strength in the Leapster software.

The operating loss for the international segment was $3.5 million for the second quarter of 2008, compared to a loss of $2.8 million for the second quarter last year, reflecting the impact of the lower sales, and operating income for the school segment was $1 million in the quarter, as compared to $3.8 million in the second quarter of 2007. The decline in earnings was a result of the $4.2 million decline in revenues in the quarter and the lower gross margins resulting from product mix.

With regard to other income and expense, net interest income fell year over year due to lower cash balances and lower interest rates. Also, including in other income and expense was $1.6 million for the impairment value of our auction rate securities. Approximately $600,000 of this amount was previously recorded as other comprehensive income on our balance sheet but we recognize this loss this quarter as related auctions have continued to fail. As of the end of the quarter, we have approximately $9.8 million of auction rate securities, which had an original purchase price of $14 million.

And with respect to income taxes, the income tax benefit for the second quarter of 2008 was $2.8 million compared with a tax expense of approximately $400,000 in the second quarter last year. The second quarter this year includes a $1.9 million benefit from the settlement by the IRS of our claim for a refund for tax credits. Specifically, this refund was associated with claims for the research and development credits for 2001, 2002, and 2003. In addition, the change in the mix of foreign earnings also caused an income tax benefit in the quarter as compared to income tax expense in the second quarter of 2007.

For the full year 2008, we expect total tax expense to be between $1 million and $3 million.

On to the balance sheet -- our balance sheet remains strong, with cash balance of $68.3 million. Given the growth we are experiencing in the business, we increased our revolving credit facility in May from $75 million to $100 million. Between our cash balances and our un-drawn revolver, we feel comfortable with our liquidity.

Over the back half of the year, we will continue to use cash to fund our seasonal working capital needs and we expect cash and investments to be around $100 million at year-end.

Accounts receivable was $51 million at the end of the second quarter, as compared to approximately $35 million at the same time last year and $127 million at year-end. Our day sales outstanding as of the end of the quarter were 67 days, unchanged from this time last year and slightly improved from the 71 days at year-end.

Inventory was $86 million at the end of the second quarter, down $18 million from the same time last year. Inventories were up $34 million from year-end due to the normal seasonal requirements, and inventory days have improved significantly at 104 days at June 30, 2008, down from 141 days at the same time last year.

Outlook -- our guidance for the year is unchanged. Specifically, we are expecting sales growth in the mid- to high-teens, an improvement in our gross margin from the 39.2% rate we achieved in 2007, a 10% to 15% reduction in the combined selling, general, and administrative and research and development expenses, and a nominal loss for the year.

I will now turn the call back over to Jeff.

Jeffrey G. Katz

Thank you, Bill. Later in the fall, we are going to share with you the details of how we expect our strategy to evolve in the coming years but for now, you should know that we have quite an extensive product plan laid out through 2009 and into 2010 and 2011. The first elements of this will be on display at Toy Fair in October.

Content and connectivity are two major themes of our 2009 plan and leveraging Learning Path will be a key priority for us as we work to monetize the value of connected consumers. We are planning an investor meeting in New York in November after Toy Fair and third quarter results where we will share with investors and analyst more details about our go-forward strategy.

So with that, I would now like to open up the call to your questions and ask the Operator to let us know who would like to begin.

Question-and-Answer Session


(Operator Instructions) At this time, you have a question from the line of Sean McGowan of Needham & Company.

Sean McGowan - Needham & Company

Thanks for taking the call. A couple of questions, if I can, and they are going to bounce around from [inaudible]. Bill, are there any longer term implications of -- not longer term, even for this year or next year, for showing a tax benefit -- I mean, part of the reason you show an expense, even though you had losses is the uncertainty of profitability. Is there anything to be read into being able to show a benefit at this point?

William B. Chiasson

We don’t see that happening and we feel comfortable with the guidance of expense of $1 million to $3 million for the year.

Sean McGowan - Needham & Company

Okay. A question about cash flows -- the implication of ending the year basically almost unchanged from last year -- last year I think you had $108 million at the end. You’re going to end with about 100. Any year where you are launching for major new platforms and entering next year hopefully with a lot of momentum and expected growth, one would assume the working capital investment would be up a lot, so what can we read into the comments that the cash flow is basically going to be neutral? Where are you getting the offset to what should be an increase in working capital?

William B. Chiasson

Well, one of the things you are seeing on the balance sheet is a very strong improvement in our -- the continued improvement on inventory levels and you’ve seen that throughout last year and this year as well, so we see that as being a big benefit to us. But I think you are right, Sean; if the growth is significantly different or greater than what we are projecting, that would put a stress on working capital levels further and our cash level further. But as we are looking at it with the sales projections that we have, we feel that that is a good expectation of where our cash position should be and again, a big piece of that improvement is coming from inventory management.

Sean McGowan - Needham & Company

Thank you. Again, Bill, can you give us a sense of the extent to which close-outs for sales of discontinued products in the international market may have brought down the gross margin in that segment?

William B. Chiasson

They’ve been having a dampening effect throughout the year. I don’t have that quantified specifically in terms of how much of an impact it was but we expect that as we exit the second quarter, a lot of that is getting behind us and we should see the benefit of not having those discounted products and more importantly, the benefit from the new products starting to affect us in the third and fourth quarters.

Sean McGowan - Needham & Company

Well, there’s always old product but what I’m trying to get at is last year I believe in the second quarter, it was significant enough to call it out, that the gross margins were really affected. I would assume in the U.S. it’s not as much a factor anymore --

William B. Chiasson

That is correct.

Sean McGowan - Needham & Company

And is it fair to conclude that it continues to be a material impact in the second quarter and should be less of an impact going forward, internationally?

William B. Chiasson

In the international segment, yes.

Sean McGowan - Needham & Company

Okay. Thank you. A couple for Jeff -- you know, at some -- do you get at some point with the [inaudible] division where you just say, we’re pushing on a rope here? I mean, I don’t want to castigate the division that basically gave rise to the Learning Path but it’s been a long time since there’s been any positive surprises there.

Jeffrey G. Katz

That’s a fair point and what I would say at this point, Sean, is I would like to talk a little bit more about that when we hopefully will see you as well but get together in the fall. For right now, the focus is on let’s just make sure that we are making a contribution, so we’ve made a rather dramatic reduction, which doesn’t yet show in the results at the end of the quarter and we’ll do what’s needed. There are still some rather big accounts that buy our products, like New York City, at very attractive margins and we don’t see the point of turning away as long as, I think to your point is it’s not a distraction to either R&D funds or management.

Sean McGowan - Needham & Company

Okay, and then Bill, back to Bill, last question -- educate me again on how auction rate securities work. Eventually, are we going to get that money back or are these losses permanent?

William B. Chiasson

Well, we are writing them down to the current valuations that they have. Whether or not we get them back is going to be dependent upon when the auctions start succeeding and at what levels they succeed. So it’s very possible we could get those back but with the current valuations, we have them written down to these levels.

We have them classified as long-term, as you can tell, so we don’t expect these recovering in the near-term, so we expect that it’s going to be at least a year, probably longer, before these do recover and only at that time are we going to really know at what level do they recover at.

Sean McGowan - Needham & Company

And there’s no real pressure to realize a loss because you don’t have to.

William B. Chiasson

No real pressure to at this stage. As we’ve talked to you before about the liquidity, we feel good about where that liquidity is and nothing is twisting our arms to liquidate them at highly discounted values.

And you know, it’s also -- when you asked about the cash flow, there was one other item that affects our year-end cash flow expectations, which is LeapFrog.com. Remember LeapFrog.com is a significantly growing piece of our business and rather than having the typical terms with the retail trade, it’s basically charging consumers credit cards and collecting on the credit card and getting much more rapid payment cycle on what is becoming a more significant piece of our business at the end of the year.

Sean McGowan - Needham & Company

Thank you.


(Operator Instructions) Your next question comes from the line of John Taylor of Arcadia.

John Taylor - Arcadia

I have a couple of questions as well here. So on the tax expense line, you are talking about $1 million to $3 million. Let me be real clear about this -- so what you actually pay and what you accrue are pretty much the same? In other words, there’s no -- you’re not going to have some kind of accrual rate that’s higher than --

William B. Chiasson

That’s correct.

John Taylor - Arcadia

Okay, good. And then Jeff, I wonder if you could talk a little bit about, I know it’s early days for -- actually, you haven’t even turned this on yet but I wonder if you could give us an update on the learning path in terms of -- oh, I don’t know, any metrics or kind of behavior type things you are looking forward to seeing? Anything you can talk about on that front?

Jeffrey G. Katz

It is early. I can tell you in effect where we are going. Of course, the most straightforward thing we expect to see is that with Learning Path feedback going to the parents and actually reward incentives going to the children, we would expect to see tie ratios going forward to be a little bit stronger than we’ve seen in the past.

For example, in the LeapPad days, the steady state tie ratio of software units sold to hardware units sold was around three, three to three-and-a-half. So we do expect that Learning Path alone and perhaps other factors will take our average for Tag to be higher than that, because not only will they know what benefit or what play is actually happing with Tag -- in other words, what book, how long they are reading and so forth, more details -- but they will be exposed to recommendations of other Tag books that the parent might consider to keep the child’s reading skill advancing. So we’ll be looking at tie ratios, probably the single biggest metric we’ll be looking at as it rolls out. But I think it will be a slow process because it does take some getting used to what this information means.

We’re actually just starting right now to roll out certain phases of it and hopefully soon we’ll have more information to convey but so far, we are pretty encouraged simply by the number of people, number of consumers already connecting.

John Taylor - Arcadia

The 80% number -- so do you have any way of telling what the breakdown is between moms and dads that are actually online doing the downloading?

Jeffrey G. Katz

I don’t -- you mean mom versus dad?

John Taylor - Arcadia


Jeffrey G. Katz

I don’t but my hunch is it’s mostly moms. Here’s a fun fact though -- something like 12% of connections are from Macs, which -- mostly I think that’s reflective of the demographic but Mac compatibility, as everybody knows, is a bigger factor in the consumer marketplace.

John Taylor - Arcadia

Okay, and then the international releases of Tag, Didj, and Leapster 2 are going to take place essentially in all markets this calendar year, right? You’ve got that all going this year?

Jeffrey G. Katz

Tag in all markets this year. Leapster 2 will roll out in the United Kingdom and Canada but not in France, for example, so Tag is more of a targeted, and Didj is only in Canada.

John Taylor - Arcadia

Okay, so those will be next year drivers then?

Jeffrey G. Katz

Those will be next year drivers in most markets.

John Taylor - Arcadia

Right, okay. And then I wonder if you can talk about the licensed versus owned books, you know, the content, what you are seeing, any tie ratios there, anything particularly interesting? I’m thinking The Clone Wars is coming up and all that stuff.

Jeffrey G. Katz

Yeah. Clearly licensees are definitely carrying the day, as I mentioned WALL-E, we were able to sort of co-promote WALL-E as Pixar was launching it. It had a significant impact on the performance of the title. We would expect Star Wars to be important, if not maybe even the biggest title we’ve ever launched, which is sort of an expectation we will soon see.

So the licenses are really -- you know, that is carrying the title volume. There are some surprisingly strong titles though that I don’t think I would have guessed, like from Scholastic continues to be big sellers. They are licensed but not from an entertainment brand per se. And then we have one or two homegrown but rule of thumb, we see a very large tie ratio improvement driven by strong licenses.

John Taylor - Arcadia

Good. And then Bill, for you, shares outstanding and a profitable quarter, what are we going to look at as a full dilution count number?

William B. Chiasson

We’ll get back to you on that.

John Taylor - Arcadia

Okay. All right, and then Jeff, maybe one other one -- so promotional expense goes up to launch Tag in the U.S. Can you talk a little bit maybe about the launch budgets for each of these things, since we are going to get them concentrated in the month of July, the September quarter? And then kind of how that looks relative to sort of whatever umbrella or holiday programs you are going to put up there, just to raise awareness and so on? If there’s a way to segment the launch piece from the total -- you know, any way to think about that?

Jeffrey G. Katz

Not really. We did some launch specific -- mostly launch specific support, as Bill mentioned, behind Tag. The rest of the marketing program will really begin to roll out at the -- towards the end of the third quarter and then really the peak will be in the fourth quarter. And it is not so much a launch per se as it’s about sell-through, so we have quite a large increase in spend consistent with the increase in sales we are expecting and it’s driving all of our lines from the -- what we call learning toys at sort of six months through 24 months, preschool, and then grade school gaming, which is principally Didj and Crammer, and it’s really all about driving sell-through at retail.

John Taylor - Arcadia

Okay. Thank you.

William B. Chiasson

Let me follow-up on that question on the stock in a profitable quarter -- we’re only talking around 300,000 shares impact.

John Taylor - Arcadia

Okay, great. Thank you.


Your next question comes from Drew Crum of Stifel Nicolaus.

Drew Crum - Stifel Nicolaus

I wonder if I could star with what you are seeing in terms of commodity inflation and what your expectations are for the second half of the year.

Jeffrey G. Katz

In terms of commodity inflation, we are pretty much hedged through year-end on most of our significant materials. Keep in mind that due to the nature of our products, we are largely -- labor and plastics in particular are not as large a proportion of our products as they might be for some other participants in the industry, but screens, memory and so forth are a bigger percent. But we are essentially hedged. The only place where we have seen some pressure has been paper and so far that’s been -- you know, our Tag books in particular consume a lot of paper and so far, that’s been a nominal exposure. I think going into next year, as others have reported, we’ll be looking really carefully at what our exposure to -- principally to plastics, anything with an impact due to petroleum products is and certainly in the learning toys line, that’s a pretty tangible cost exposure. But for this year, we don’t see anything of significance due to the way we purchase and due to the composition of most of our products.

Drew Crum - Stifel Nicolaus

And were there any severance charges in the quarter? And the 15% reduction to the force in the school segment that you mentioned, did that in any way impact the quarter?

William B. Chiasson

It was a relatively small amount. It was around $150,000 and we did charge that in the second quarter.

Drew Crum - Stifel Nicolaus

Okay, very good. Did you guys offer any tie ratios on Tag or Leapster? Did I miss that or is that something you can offer?

Jeffrey G. Katz

We did not offer that up yet, just because it’s early in the process. I did mention that they were better than planned and we will say more when we have both more sales volume in the third quarter.

Drew Crum - Stifel Nicolaus

Okay, and last question -- Jeff, are you seeing anything new or different on the competitive front, given you’ve got a new slate of products out?

Jeffrey G. Katz

Nothing that I think is -- has not already been sort of called out in the industry, so we’ve seen no negative surprises and again, early reads on our own product are good and there’s been no -- at this stage, no runaway hit that we didn’t expect to be a hit.

Operator, do we have other questions?


There are no further questions at this time.

Jeffrey G. Katz

Well, let me then thank everybody for participating, for joining us today and for your continued support and following of our company. We are excited about our recent product launches and the rest of 2008 and really beyond 2008, so we look forward to keeping you updated on our progress and I want to wish you all a great afternoon and a good summer.


This concludes today’s conference call. You may now disconnect.

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