Leapfrog Enterprises, Inc. Business Information, Profile, and History

Company Perspectives:

At LeapFrog our vision is to inspire in children and families a lifelong love of learning. That's why we're committed to the highest quality educational toys. Unique electronic toys that are not only fun to play with but also are great tools. We believe these products will fundamentally change the way children play and learn for a lifetime.

History of Leap Frog Enterprises, Inc.

LeapFrog Enterprises, Inc. is the fourth largest toy company in the United States, behind Mattel, Hasbro, and Lego. Whereas these three companies are all of long standing, LeapFrog was founded in the mid-1990s and surged to the fore with a line of electronic toys designed to help children learn to read and master other academic skills. LeapFrog products teach children phonics as well as music, math, reading, geography, social studies, and science. Its products include the LeapPad talking books, the LeapStart Learning Table, Turbo Twist, iQuest, and other interactive toys geared for children from preschool age through middle school. Some of its products are sold directly to schools through its SchoolHouse division. LeapFrog sells its products in more than 25 countries worldwide, and its electronic books have been translated into French, Spanish, Italian, and Japanese. The publicly traded company is majority owned by Knowledge Universe, Inc., a private company with worldwide interests in education-related businesses. Knowledge Universe was founded by financier Michael Milken, his brother Lowell, and Larry Ellison, founder of the software firm Oracle Corporation.

A Father's Idea in the Late 1980s

LeapFrog Enterprises was founded in 1995 by Michael Wood, a San Francisco lawyer who worked for the law firm Cooley Godward. Cooley Godward specialized in representing growing high-tech firms, and Wood often represented entrepreneurs securing financing for new companies. Wood got the idea for LeapFrog in the late 1980s, but he remained at his job while laying the groundwork for his new corporation. When Wood's son Matthew was three years old, he had already mastered the alphabet. He recognized all the letters, and he seemed on track to becoming an early reader. Yet Wood's son had trouble connecting the name of the letters with the sound the letter made. Wood hoped to find a toy that would help Matthew master phonics. But after scouring area stores, Wood could not find anything suitable. A phonics educational toy did not seem to exist in the toy industry at that time. Wood realized he might be able to make his own phonics toy while looking over the work of one of his Cooley Godward clients. This client was investing in the chip technology developed by Texas Instruments that was used in talking and singing greeting cards. Wood wondered if similar technology could be used to put chips in some kind of manipulable letters. Then when kids squeezed or pressed the letter, the letter could produce the sound associated with it.

This was the basic idea behind LeapFrog, but Wood spent years refining the concept and testing it in various ways. He spent four years doing focus groups on mothers, to see if there was interest and to get their feedback. He had a prototype made, in order to make sure the manufacturing was plausible. He also did studies to work out the cost of manufacturing and a viable retail price. He met with a buyer from Toys 'R' Us to determine interest there. In 1994 Wood took his first prototype phonics toy to Robert Calfee, a professor of education at Stanford. Dr. Calfee had spent 25 years researching how children learn to read, and he took the time to consider Wood's toy. Calfee gave Wood some suggestions, but did not expect to hear back from the inventor. But Wood took Calfee's advice to heart, and within a few months brought the professor a new and improved prototype. This became the Phonics Desk, LeapFrog's first product.

Wood had garnered $800,000 from relatives, friends, and Cooley Godward clients to launch his new company. Although he had no background in running a corporation, Wood had prepared the ground carefully, and he was sure he had a product that would go over well. He was right, and the Phonics Desk was a hit with parents and children. The release of the Phonics Desk did not go altogether smoothly, however. The young company had difficulty getting its products delivered, and in its first year LeapFrog spent $300,000 on air freight. But demand was strong, and the company set out to make a second phonics toy. Sales in 1995 were $3 million.

LeapFrog came on the market at a time when other educational toymakers were suffering. Sales of educational toys on the order of Lincoln Logs and Playskool pounding benches had languished for years when a new, high-technology wave of toys came out in the early 1980s. The first reading software, Learning Co.'s "Reader Rabbit," came out in 1984 and went on to sell millions of copies. "Math Blaster," a math game for kids, also came out that year, under the auspices of Davidson & Associates Inc. in Palos Verdes, California. Broderbund Software developed interactive "Living Books," and companies as powerful as Disney began pushing educational software by the early 1990s. Then Sony Corporation's PlayStation debuted in 1995, a video game that far surpassed educational computer programs in popularity. Within a few years, the educational software market had all but dried up. Yet LeapFrog seemed to belong to a second wave in the educational toy industry, and it eventually fared far better than the makers of "Reader Rabbit" and other competitors.

LeapFrog's Phonics Desk differed from other products in the educational market in that it was not computer software but a sturdy plastic toy. It was designed for very young children, and Wood had already determined that no other toy on the market filled its particular function. Although school-age children had a host of electronic toys to choose from by the mid-1990s, not much else was aimed at the preschool set. After initial sales went well, LeapFrog hired executives with toy industry experience. In early 1997 the company hired a vice-president for sales and marketing, Brad Crawford, who had previously worked for the toy company Little Tikes. At Little Tikes, Crawford already had experience managing accounts with major toy retailers such as Wal-Mart, Kmart, and Target. These companies soon became major clients of LeapFrog. That year the company also hired another former toy company executive to oversee engineering and manufacturing. LeapFrog sales took off, and by 1997 the company had distribution in almost ten countries overseas as well as a growing domestic market. The company announced sales growth of 300 percent between early 1996 and early 1997. But the company really took off after winning the backing of a huge multinational education and training conglomerate, Knowledge Universe.

Sale to Knowledge Universe in 1997

By 1997 LeapFrog was off to a great start, with growing sales of its Phonics Desk and one other toy. But the company had potential to do more. It was in a unique position in the market and seemed to have tapped a demand other toy companies had overlooked. LeapFrog began looking for an investment partner who could provide cash for further growth. In 1997 Wood and his investors sold 50 percent of the company to Knowledge Kids, a division of Knowledge Universe, for $50 million. Knowledge Universe had been founded only a year earlier by Michael Milken, his brother Lowell, and Larry Ellison, CEO of Oracle Corporation. Milken was perhaps the most notorious financier of the 1980s, a high-flying dealmaker for Drexel Burnham Lambert who was ultimately convicted of six counts of securities fraud. Milken paid a fine of $447 million and served 22 months of a ten-year prison term. He was barred for life from working in the securities industry, and after his release from prison, still one of the richest men in the country, he worked in several philanthropic enterprises and began the holding company Knowledge Universe. Knowledge Universe was dedicated to education in a broad spectrum, from training of adult workers to daycare facilities. Milken and Ellison seemed particularly intrigued with the influence of new technology on education, and so LeapFrog seemed like a natural choice for the conglomerate to acquire. The company's Knowledge Kids division was headed by Michael Kalinske, a former president of one of the top U.S. toy companies, Mattel. Kalinske had the kind of expertise and contacts in the toy industry that Michael Wood could not duplicate. Although Wood remained president of his company, Kalinske's clout quickly pushed LeapFrog into new markets and greatly expanded sales.

At the time of the acquisition by Knowledge Universe, LeapFrog's sales stood at around $10 million. Two years later, sales had jumped to around $70 million. Soon after its acquisition, LeapFrog itself acquired Explore Technologies Inc., which owned a technological process called NearTouch. NearTouch formed the basis of LeapFrog's new product line of LeapPad point-and-press talking books. The company brought out ten new products in the two years after the sale to Knowledge Universe, zeroing in on products for children ages three to ten. In 1999 the company opened a new division, called LeapFrog SchoolHouse, which marketed LeapFrog products directly to schools. The SchoolHouse division developed a set of educational toys with some functions different from the main company's more parent-oriented line. It called its new school-oriented line Leap into Literacy, and this was designed specifically to meet the needs of classroom teachers. The core product of the new line was the LeapPad, a toy that could hold a variety of electronic "interactive" books. Children used an electronic pen to point to words or letters, and the LeapPad produced the appropriate sounds. The LeapPad began with just a few titles, but by 2000 there were more than 30 books in the SchoolHouse line, including titles for kids up to fifth grade and in subjects such as geography, music, and history. The Leap into Literacy line also included the LeapDesk, a larger version of the LeapPad with removable three-dimensional plastic letters. Children could use the LeapDesk to do word or letter recognition exercises. The LeapDesk also had an assessment mode, which administered eight different tests to determine students' skill levels. The LeapMat was an even larger format letter-recognition toy. Children touched circles on the mat to hear an associated letter and its sound. The Leap into Literacy toys came with a comprehensive phonics curriculum, which was developed to correlate with existing state standards for teaching reading.

Public Stock Offering in 2002

Annual sales at LeapFrog reached steadily upward, getting close to $200 million by 2000. The company expanded in many ways, hiring more employees (from 85 in late 1999 to almost 450 by 2001), moving into international markets, and increasing its penetration of the school market through its SchoolHouse division. The company continued to focus on sturdy portable toys even as it evolved products for older children. Perhaps for this reason it did well even as the educational software market fell apart. Educational software that had been selling for $50 plunged to $20 as competitors slashed prices and discount stores offered cheap titles. The industry suffered as investors backed out. But LeapPad seemed unaffected by this and was the stellar player in the educational toy segment. In 2000, the LeapPad garnered a variety of awards. By 2001, with toy sales overall flat, LeapFrog had revenue of more than $300 million, a 95 percent increase over the previous year, and net income of more than $10 million. Its products were now in stores everywhere. Its largest customer was Wal-Mart, which was responsible for 30 percent of the company's sales. Toys 'R' Us was a close second, accounting for 28 percent of sales, and the department store chain Target generated approximately 10 percent of sales. The only sore spot in 2001 was Kmart, which accounted for another 10 percent of LeapFrog's sales in 2001, but filed for bankruptcy and had trouble paying the toy supplier. But LeapFrog Enterprises now had a number of hit toys, including LeapPad, with 35 different titles that could be plugged into it, the LeapStart Learning Table for younger kids, and for older children the Twist and Shout math toy, Turbo Twist Vocabulator, and the iQuest, a palm pilot-like device that gave students quiz questions on a variety of topics from math to social studies. These toys retailed between roughly $40 and $60.

With LeapFrog's products so well known and thriving, the company decided to file for a public stock offering in 2002. LeapFrog hoped to raise $150 million from the offering, which was only for a portion of the company. Knowledge Universe owned 86 percent of LeapFrog by that time. The stock market had been falling since 2001, and the week LeapFrog debuted was particularly turbulent. A sharp decline early in the week led four other companies to delay their public offerings, but LeapFrog went ahead, pricing its stock at what was considered a modest $13 a share. The price rose almost immediately, despite the fact that a competitor filed suit against LeapFrog for patent infringement the following day. The offering went through in July, and as LeapFrog entered its crucial holiday sales period a few months later, it predicted a 30 percent jump over the previous year. LeapFrog's share price rose almost 80 percent between July and December. For the 2002 Christmas season LeapFrog's LeapPad was the fourth best-selling toy in the country, and a collection of electronic books to be read on the LeapPad took the number one spot. "Milken Bumps Barbie," declared Forbes magazine (February 3, 2003), marking LeapFrog's astonishing rise to become the fourth largest toy company in the United States. The Wall Street Journal (January 6, 2003) ranked LeapFrog the best performing initial public offering of 2002, noting that the company had done so well because "Investors knew, and loved, the product."

LeapFrog looked to increase its sales in Japan over the next few years. Beginning in 2002 it had partnered with Sega Toys Ltd. and the Benesse Corp. to introduce Japanese versions of its LeapPad product line. By 2003 the company's products were sold in more than 25 countries. LeapFrog hoped to maintain interest at home in its product line by offering updated titles to be read with its LeapPad base, and to develop more sophisticated toys for older children as well. The company had scarcely stumbled since its inception, and was exceedingly successful even during a recessionary economy and a generally flat toy market in the early 2000s. It remained to be seen whether LeapFrog could maintain its remarkable momentum, but its future seemed quite promising.

Principal Divisions: LeapFrog SchoolHouse.

Principal Competitors: Educational Insights, Inc.; Vtech Industries, L.L.C.

Chronology

• Key Dates:
• 1995: Company is founded by Michael Wood.
• 1997: Knowledge Universe buys a stake in LeapFrog.
• 2002: A public stock offering is made.