Merry Christmas and Happy New Year! I hope this Sleuth finds you and your family in great spirits.

I flew back home to Cincinnati to spend time with my family this past weekend. It was nice. I ate more food that I should have. I drank more red wine that I could handle. And I played more guitar than anyone wanted to hear. Life was good. But the highlight for me was being home as my little nephew, Ty, celebrated his very first Christmas.

At six months old, Ty could have cared less about gifts, food or anything else – including my bad guitar skills. But that didn’t stop us from sharing the Christmas spirit with him. We dressed the little tike up in red and white Santa clothes. We sang Christmas songs to him ’til our throats hurt. And we flew him around the room like a reindeer – taking pictures every 30 seconds.

But the best was watching him try to open his presents on Christmas morning.

With the help of his mom and dad, Ty unwrapped what seemed like dozens of packages. He got toys that talked, toys that sang, toys that moved and toys that lit up. During the 20 minutes it took to open all his gifts, I noticed two things.

1) My little nephew made out like a bandit.
2) And without exception, all of his toys were made by LeapFrog.

After opening about three of four LeapFrog presents in a row, I remember thinking to myself this company must be raking in some serious bucks right now. So this morning, I did some digging. Who is LeapFrog, I wanted to know?

LeapFrog: Know This company

It turns out LeapFrog is a small-cap company with a market cap of $738 million. It trades on the NYSE under the ticker LF. And whether you have little ones or not, you should know this company.

LeapFrog is a leading designer of educational toys. It makes stuffed animals, DVDs, drums, books, basketball hoops and hundreds of other fun items that help kids learn their ABC’s, count to 10, solve simple logic problems and improve their motor skills.

As LeapFrog says on its Web site… “We put learning first – a philosophy that distinguishes us from our competitors and fuels the entire company.”

Distinguish from the competition they have…

Every parent I have talked to this week has raved about LeapFrog’s toy line. Every infant, toddler and kid in the Boric family got something with LeapFrog written on the box. For instance…

The first gift Ty opened on Christmas morning was LeapFrog’s “Baby Counting Pal.” It looks like the old glow-worm we used to get as kids. But instead of just lighting up and making noises, it teaches you to count, color and appreciate classical music.

After putting the caterpillar aside, Ty opened up the LittleTouch LeapPad Learning System, Learning Hoops Basketball Set and the Touch & Tug Discovery Book – all LeapFrog products. (I will admit, I played with the Learning Hoops Basketball Set. I shot the tiny little orange ball over my poor mom’s head, through the dining room and over the TV set. I only made about 2 in 10 tries. But it was a lot of fun).

When it was all said and done, Ty must have had $200 or $300 worth of LeapFrog gifts. And he isn’t the only one…

Andrew (our in-house e-commerce director) has a three-year old son. He told me Keegan couldn’t live without his LeapFrog Math Circus DVD, his “Baby Tad” stuffed animal and his “Learning Drum.”

So I asked him…

“Andrew, honestly, do you anticipate Keegan will keep getting LeapFrog toys when he gets older? Or is this just a fad that will come to an end when he reaches 5?”

“Oh no,” Andrew bellowed across the room! “Go to the Web site. LeapFrog makes stuff for kids as old as 18. Soon Keegan will start getting into the computerized games. Right now its stuffed animals and DVDs. But we’ll shuffle those out soon and start upgrading to the new stuff.”

LeapFrog: Not Annoying

And that’s exactly what Cheryl Ivey told me too. Cheryl is a marketing director for another publishing company I work with. And her little two-year old girl, Meredith, has been playing with LeapFrog toys since she was an infant. If you looked in Meredith’s toy box right now you’d find the Fridge Phonics Magnetic Set, the Learning Friend Lily and the Fridge Farm Magnetic Set – all from LeapFrog!

I asked Cheryl a couple questions…

“Why would you choose LeapFrog over any other brand – like Hasbro or Disney?”

Cheryl quickly replied, “Their stuff isn’t annoying!”

She went on to declare, “I will never have anything with Barney in my house. I hate that stupid “I love you, you love me” song. But there isn’t a single LeapFrog toy that annoys me.”

Ok, fair enough. “But will you keep buying LeapFrog toys even when Meredith gets older?”

“Heck yeah!”

Cheryl proceeded by taking me to the LeapFrog Web site and showing me all the stuff they have for toddlers, grade school-age kids and even high schoolers.

“How can you not like these toys?’ she asked as I left her office to write today’s Sleuth.

Ok, so LeapFrog is making the hottest toys on the market. But, the million-dollar question is, should you invest in the company?

LeapFrog: A Look at the Numbers

Well, let’s look at the facts…

The company has been operating since 1995 and public since 2002.

In FY 2003 it brought in $680 million in sales and $1.19 a share in earnings. In FY 2004 the numbers fell considerably. Sales totaled $640.2 million and the company reported a loss of 12 cents per share. Not good! And as you might have guessed, the stock fell from a high of more than $47 to $9.20.

But now it is back on the rise again.

Currently LF is trading for $11.95 a pop. And through three quarters of FY 2005, the numbers are looking pretty good. Sales are at $401.8 million – on pace for a record year. And earnings are back in the black – totaling 4 cents a share right now.

We’ll see how it pans out during the last quarter – which you would expect to be a big one. (Jeez, based on Ty’s gifts alone, I can’t see how the company could do anything but have a good quarter!) It will announce year-end results at the end of January.

As far as the fundamentals go, LeapFrog is trading for 1.15 times sales and 1.68 times book value. It also has nothing in the way of long-term debt and $42 million in cash. Not bad. The average company in the toys and games industry trades for 1.16 times sales and 2.23 times book. So LF is trading at or slightly below its peers.

But if you are a stock trader (not a long-term investor) you should be careful.

Shares of LF have spiked in October in two of the three full years it has been trading on the NYSE. Obviously this is a seasonal play – where earnings spike in the third and fourth quarters of the year. So if you are a trader, you may want to really study an annual chart very closely. It seems buying in the spring is a good bet if you only want to hold for a few months.

But if you are an investor – willing to buy and hold for years on end – LeapFrog will have a lot of staying power. Just ask any parent with a little child. They swear by its toys.

At $12 a share, I wouldn’t be surprised to see it make its way back up to the $35 or $45 in the next couple of years. Only time will tell…

Happy Holidays!

James Boric
December 28, 2005

LeapFrog: LeapFrog Hysteria was originally featured in the Penny Sleuth.