My understanding pushes me to say they can take an approach similar to Apple (a premium product at a premium price). An inherent association most people come to acquire (sometimes good, sometimes bad for us) is that a higher price means higher quality. It's been brought up that LF can't compete with cheaper tablets (some even given out for free), and I think that's where they faltered. In my opinion, too much focus was placed on the sturdiness of the platform or other qualities that could be matched by competitors who competed on price, as opposed to the actual value delivered by the platform. Anyone can make a sturdy break resistant tablet, but the value I think LF followers see in the company is their differentiation in educational value.
I think parents are willing to spend an extra bit if they feel like their kids can succeed among their peers through the development provided by the LF product. The company can create a great product, and in consumer goods it's all about spreading the word once you've made it. It's also about spreading the "right" word, the message that actually communicates the most value you present to your customers. Value from LF perspective is their educational system, the results that provides for the child, and the success that comes after that for the child (and the pride a parent feels in seeing their investment generate the fruits of their child's full potential). If I could put an ad campaign for LF, it'd be a simple picture of a kid, a plus sign, LF product, an equals sign, and then a college acceptance letter, or something to that extent.
Bottom line, it's about connecting the dots for the customer, and they have faltered as of late by focusing on the wrong dots.
Although I never addressed it in the article, I was also aware of what you mention pertaining to the company's cash generation potential. It may be a rough time getting back to that stage, but in the meantime there are plenty of resources available to the company, and the share price luckily gives investors a head start while waiting for that situation.
I think the stock is likely to stay in the $4 to $5 per share range until they can show a path back to profitability. If they can return to profitability, then I think a $5-8 range is likely, and if they can achieve sustainable profitability over a long period of time, then I think you can see the $10+ levels again.
If it goes to $5, those in below $3 would be very happy.
I would probably sell at that level since that's about what the company is worth without a hot toy. There's not going to be some great longterm expansion in the educational toy market, so it's basically just buying and selling the value.
I was kind of hoping it would dip below $2 to add that last tranche, but maybe we've seen the bottom now? Still watching for one last dip.
Finally, although these assets alone show a unique protection for the downside, the company stated it has created a valuation allowance for its deferred tax assets in the amount of around $110M. Even if LF was able to realize half of this asset in a turnaround, this nearly adds 1/3- 1/2 (depending on discount) to the margin of safety for the stock.
Although the future of LF is murky at best, the assets of the company provide investors a reasonable safety cushion while the company realigns itself. With the downside reasonably taken care of, the upside option of a company which has shown before it can sell a product at a desirable rate is available to the patient investor willing to wait out the storm.
Only thing I would add is that the majority of the inventory build relates to the LeapTV, a new product. I believe this somewhat lowers the inventory risk, as they have not over-ordered older products (which is usually the risk in inventory build).
In this case, they simply misjudged 2014 holiday sales of the LeapTV and will just buy less this year for sales in 2015 - the LeapTV is still a "new product" this year. Also, they can update the LeapTV via firmware updates over the internet, so I think a good amount of the inventory should sell through in 2015 at lower risk than if the inventory primarily consisted of LeapPads, for example.
Also, the company has the potential to generate substantial cash when they get a product "right", as evidenced by the fact LeapFrog generated over $200 million of free cash flow in just 3 years' time (2011-2013). It is not often to find the best brand in a category (electronic learning products) selling at a discount to book value and net working capital, after just having generated more cash than the entire market value of the company today!
As you can see, the company's cash position has been basically cut in half, while inventories have grown by 50% (with most of that consisting of finished products, representing a bulge in unsold inventory). These signs are typical red flags that investors should be wary of, and normally I would be weary of them too. However, even the troubled companies in the market are worth something, and I think after walking through the balance sheet you will see that LF is more likely worth more than what it is selling for today.
Before making the necessary adjustments to the balance sheet, notes from the most recent 10-Q describe some items which would affect this analysis. The company's cash position has $25.2M held with foreign subsidiaries and management has stated they have no intent to repatriate these funds. These funds are also worth less today than what they were recorded at on the balance sheet due to the strengthening of the dollar. For simplicity's sake, I am going to write off this foreign cash holding completely from the balance sheet as it won't be easily accessible to investors.
After adjusting the cash position, the Accounts Receivable should also be adjusted. However, I am going to change it in a different way than usual. First, as a majority of the company's sales just took place, and the period leading up through March usually sees about 70% of the A/R balance turn to cash, I am going to forecast that about 60% of the current balance changes to cash (or around $60M), and that 30% of the current balance is left to be collected (thereby imposing a 10% shave on the original balance). LF's cash position has thus far been decreased from $94M to $69M from the first adjustment, and then increased from $69M to $129M, while A/R has decreased from $100M to $30M.
Cash and cash equivalents $ 129,000
Accounts receivable, net of allowances for doubtful accounts of $818, $139 and $306, respectively 30,000
Prepaid expenses and other current assets 10,449
Deferred income taxes 0
Total current assets 227,449
Deferred income taxes 0
Property and equipment, net 19,096
Capitalized content and website development costs, net 11,596
Other intangible assets, net 1,918
Other assets 669
Total assets $ 260,727
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 23,440
Accrued liabilities 32,137
Deferred revenue 12,526
Deferred income taxes 1,290
Income taxes payable 431
Total current liabilities 69,824
Other long-term liabilities 198
Total liabilities 70,022
Total stockholders' equity 190,705
Total Shares Outstanding
Apr. 14, 2015 2:03 PM ET | 2 comments | About: LeapFrog Enterprises Inc. (LF)
•LeapFrog's poor management of its product portfolio and overall strategy have led the company to realize large asset writedowns and resulted in the stock dropping by over 70%.
•Though the direction of the company is still up in the air, underlying assets point to a strong margin of safety.
•Even substantially discounted assets produce upside over liabilities while waiting for a turnaround.
LeapFrog (NYSE:LF) has entered a dry period pertaining to its sales and profitability, and for a consumer product driven company, this usually never bodes well. This has certainly been the case at LeapFrog as the company has realized a 9-month net loss nearly equal to its market cap ($142M net loss vs market cap of around $155M). These losses are not easy for investors to swallow, and the performance of the stock has surely matched the performance of the company after falling more than 70% from its 52-week highs. Although there are those still of the opinion that the worst is still not over for the company, I feel that investors today have the opportunity to buy a company with solid downside protection and all the optionality available for the upside from a turnaround.
My thesis centers around the company's balance sheet which has admittedly deteriorated as of late, but is still in much better shape than it could be.
LeapFrog is currently selling for less than cash and net working capital. The market has sent the company shares tanking to the point that LeapFrog is now a classic Benjamin Graham play. The company is selling for -4x its earnings and 0.6x its book value. LeapFrog has a net current asset value of $3.5 per share and has a tangible book value of $3.96 per share. The company is selling for 0.65x its net current asset and has a current ratio of 4.0x. LeapFrog is facing stiff competitions from its competitors and has little to no diversification with its products. The company is selling for at least a 30% discount to NCAV giving any rational investor a margin of safety of at least 30%. With a 30% margin of safety with little to no risk of losing your capital since the company is selling below liquidation value. If the company liquidated shareholders would receive atleast $3.00 a share at its current price is a at least a 25% return on your investment. Market has created great opportunity to buy a NCAV with a 30% margin of safety since the LeapFrog should sell for at least NCAV per share.
•Sega toys and Benesse produces localized versions of the toys for the Japanese market.
•Macromedia to co-develop the Leapster handheld gaming console.
•Liongate Home Entertainment has produced LeapFrog learning DVDs.
Over the last 13 years has generated $6 billion of revenues and over $2.6 billion in profits as well. Since going public LeapFrog has spent over $1.3 billion on Sells, General & Overhead. Leapfrog is profitable and generates double-digit margins similar to its peers. Leapfrog is very capable of generating a large amount of revenues and gross profits, but its very cyclical since the company has little product diversification. The company operates with lower gross margins then its competitors. Leapfrog spent $1.3 billion over 13 years on advertising and R&D to build its products and brand. Clearly the company is suffering from the lack of diversification and manufacturing scale. This lack of diversification and scale have lower margins then its competitors. For the nine months ending in December 2014, the firm reported revenues of $305 million and a net loss of $142 million. Leapfrog has during the first of half of fiscal year 2015 reported back-to-back quarterly losses. The company has seen a 43% decline over the prior year in net sales.
Leapfrog a few months ago entered the fitness tracker market with its LeapBand that sells for $40. The LeapBand encourage kids to move with 50 different movement challenges. LeapFrog through its wearable LeapBand is targeting kids between the ages of 4 and 7 with parents that use Fitbit, Jawbone, UP, and other wearable movement-tracking bands. The company's other big products is the LeapTV, which is the firm's biggest play into the gaming console market. Its new LeapTV console that encourages fitness with its motion-based controller. At a $150 price tag its console is cheaper than traditional next-generation console. LeapTV games cost about half what its competitors' games do. The company is clearly not putting all of its eggs in its new product line and is continuing to update LeapPad and other legacy learning toys.
LeapFrog's product portfolio
•LeapTV – A TV video game console that uses motion control.
•LeapBand – A wearable tracking risk band for four through seven year olds.
•LeapReader – A specially designed stylus that reads audio books aloud and teaches basic writing skills.
•LeapPad – A personalized learning tablet designed for childern ages 4 to 9.
LeapFrog has developed educational smartphone applications that includes;
•Scout's ABC Garden App – iPhone, iPod Touch and iPad application that was released in 2011.
•Creativity Camera – An iPhone and iPod app that was released in 2011.
•Mr. Pencil: Learn To Write – An iPhone, iPod and iPad app that was released in 2013.
LeapFrog's licensing and partnerships
The company licenses its LeapFrog Learning Friends to third parties and partners with various companies.
•Kiddieland Limited produces ride-on toys.
•Masterpieces Puzzles produces jgsaw puzzles.
•Learning Horizons produces books and various stationeries.
As I went through Gurufocus' 52-week lows list, LeapFrog popped up on the list. The company is selling below book value and net current asset. LeapFrog is currently a classic Benjamin Graham net net play. The market is currently value LeapFrog for less then cash and net working capital. Mr. Market has given us value investors an rare net net opportunity with an margin of safety of 30%.
LeapFrog Enterprises (LF) is an educational entertainment company that designs, develops, and markets technology-based learning products for children. The company has a strong well recognized brand power,as well as strong commercial and sales distribution relationships. LeapFrog has created several well-regarded products that parents trust to educate their children with. Despite LeapFrog's strong brand name the firm stock fell 41% during 2014 and had light demand for its educational products. The company goes through cycles where its is quite profitable and other years like 2014 where its makes no money. LeapFrog lost the bulk of its market value last year, and the market is currently valuing the company at less then its cash and net working capital. Since the company earnings, revenues,and sells go through a cycle so does the markets value of the firm. This creates an opportunity for rational investors to buy stake in LeapFrog for less then net current asset value.
LeapFrog has been a pioneer in making reading and learning fun with its devices that have been very popular with the market. Until recently with the introduction of cheaper kid-friendly versions of the Kindle and Samsung tablets has taken a toll on the company's sales. In 2011 the company introduced the LeapPad which sold out during the 2011 holiday season and in 2012 introduced an updated version of the LeapPad sold just as well. But now with cheaper kid-friendly devices on the market LeapFrop has seen its sales fall and earning fall as a result of stiffer competition.
Yes I am including all balance sheet items.
The company ended the December 31, 2014 quarter with:
$94M of cash
$100M of receivables
$78M of inventories
Total Working Capital Assets = $272M
$23M of Payables
$32M of Accrued Liabilities
$13M of Deferred revenue
Total Working Capital Liabilities = $68M
As you can see, the company has plenty of liquidity. Around 2/3 of those receivables convert to cash during the Jan-Mar quarter.
Last year during that quarter, the company burned about $19M of cash.
I estimate they'll burn about $25M this time around. That should leave them with about $140M of cash on the balance sheet dated 3/31/15.
In Calendar Year 2014, the company burned about $65M of cash. The company has cut some of its workforce, and will be purchasing less inventory this year (unless sales pick up).
I think it is reasonable to assume the company does not burn more than $70M this year (which would still be terrible, of course).
So the company has more than a couple years' of liquidity.
The company, even in the disastrous year of 2014, burned about $65 million of cash. Their annual cash burn before the announced lay-offs, assuming they don't sell a single item and have $0 of revenue, would be around $90-100 million per year. The company has nearly $200 million of cash and receivables (receivables are from Wal-Mart, Target, Toys R Us and Amazon and are 99%+ money good). It is unlikely they lose any more than $50-60 million in 2015, which would assume another total disaster of a year. You are 3-4 years early on your Chapter 11 forecasts. That is a long time, and leaves plenty of time for something better to happen here.
Seeking alpha article + some comments from same article
The fact that LeapFrog's current market capitalization is less than the cash and working capital on the balance sheet strongly suggests the market does not believe management has put forth a credible strategic path to sustained profitability. In the hands of a larger enterprise with greater resources, LeapFrog may be worth substantially more than it is worth to shareholders as a standalone, publicly-traded company. As with nearly all common stock investments, shareholders own the business and are ultimately responsible for helping to shape its future.
The Class B voting control has declined from 88% of the vote five years ago to 40% of the vote today, as Class B shareholders have converted their shares to Class A shares and sold them. While Class B shareholders no longer have a majority, their voting power is still significant. The Class B shareholders have been around for a long time and are just as aware of the issues this company faces as a standalone company as the rest of us. I believe all investors in LeapFrog are willing to listen to any proposals that can increase shareholder value.
The company, even in the disastrous year of 2014, burned about $65 million of cash. Their annual cash burn before the announced lay-offs, assuming they don't sell a single item and have $0 of revenue, would be around $90-100 million per year.
The company has nearly $200 million of cash and receivables (receivables are from Wal-Mart, Target, Toys R Us and Amazon and are 99%+ money good).
It is unlikely they lose any more than $50-60 million in 2015, which would assume another total disaster of a year.
You are 3-4 years early on your Chapter 11 forecasts. That is a long time, and leaves plenty of time for something better to happen here.
All from seeking alpha article....I just pasted some part and comments from the piece
The Class B voting control has declined from 88% of the vote five years ago to 40% of the vote today, as Class B shareholders have converted their shares to Class A shares and sold them.
While Class B shareholders no longer have a majority, their voting power is still significant.
The Class B shareholders have been around for a long time and are just as aware of the issues this company faces as a standalone company as the rest of us.
I believe all investors in LeapFrog are willing to listen to any proposals that can increase shareholder value.
The fact that LeapFrog's current market capitalization is less than the cash and working capital on the balance sheet strongly suggests the market does not believe management has put forth a credible strategic path to sustained profitability.
In the hands of a larger enterprise with greater resources, LeapFrog may be worth substantially more than it is worth to shareholders as a standalone, publicly-traded company.
As with nearly all common stock investments, shareholders own the business and are ultimately responsible for helping to shape its future.
Some years the stock market seems to think the brand is worth more than $10 per share - or over $500 million of enterprise value. At other times, the market places virtually no value on the brand (such as today, with a current market capitalization less than the value of cash and net working capital).
After reviewing the company's quarterly financials over the past thirteen years, the following observations stand out:
1) The company is capable of generating a large amount of revenue and gross profit, but the revenue is cyclical owing to a lack of product diversification. Despite this cyclicality, average revenue over any period of time has been fairly stable:
2) LeapFrog operates with a lower sustained gross margin than Hasbro or Mattel, owing to lack of manufacturing scale combined with less product diversification.
3) LeapFrog has spent a substantial sum of money on overhead costs associated with being a standalone, publicly-traded company. Since going public, LeapFrog has spent over $1.3 billion on Selling, General & Overhead, which the company describes on page 21 of its 2013 10-K as:
"Selling, general and administrative ("SG&A") expenses consist primarily of salaries and related employee benefits, including stock-based compensation expense and other headcount-related expenses associated with executive management, finance, information technology, supply chain, facilities, human resources, other administrative headcount, legal and other professional fees, indirect selling expenses, systems costs, rent, office equipment and supplies."
4) LeapFrog has also spent over $1.3 billion on advertising and R&D to build its brand. A new market entrant would likely need to spend a significant amount of time and money to achieve a reputation with consumers and channel/distribution partners similar to LeapFrog's.
5) LeapFrog suffers from a lack of diversification and scale compared to its peers.
•LeapFrog is a powerful brand, well-recognized by families, parents and educators, and the company possesses strong commercial & sales distribution relationships.
•However, LeapFrog's cumulative profits since going public (in 2002) are less than zero.
•LeapFrog has spent over $1.3 billion on overhead costs, much of which would likely be unnecessary if LeapFrog were a subsidiary of a larger company.
•During the shareholder meeting this August, the Board should discuss the value of LeapFrog's brand to an acquirer compared to the value of its current strategic direction.
•LeapFrog's current value to an acquirer (including its balance sheet today) is likely higher than $6 per share, and possibly higher than $10 per share.
LeapFrog (TICKER: LF) is an interesting situation.
On the one hand, the company possesses a very strong brand with high consumer awareness. LeapFrog creates several well-regarded products and parents trust these products to help educate their kids. Such brand identity and trust usually take years to cultivate.
On the other hand, LeapFrog continually faces intense competition and has historically been unable to earn any return on its massive research & development investments and advertising expenditures, despite generating over $6 billion of revenue and over $2.7 billion of gross profit since 2002.
over $6 billion of revenue and over $2.7 billion of gross profit since 2002.
How should investors value a brand with a product offering that generates sizable, though lumpy, revenue streams and gross profits, but can't seem to find a business model capable of sustained profitability?
As an independent company, it is very difficult to put a value on LeapFrog's business. In some years, the company is quite profitable, and generates low double-digit margins similar to peers such as Mattel (TICKER: MAT), Hasbro (TICKER: HAS) and VTech (TICKER: OTCPK:VTKLY). Some years the company makes no money, like in 2014.
During tough years they would cut 10% of their workforce, they said during this last cc that they were reducing 16% of their staff so that's a good start. Lots of issues and problems moving forward but thru the years they have always managed to do a decent job. The landscape has changed alot so it will be interesting to see how they deal with all the competition moving forward.
LF was at it's peak during July of 2012 and July of 2013 floating in the 11's a share so this wasn't just because of wonderful xmas sales. Probably because of the tablet boom era which is probably over or at least in big decline. If you make great products like Apple and Microsoft people buy them all year round. I hope if nothing else you break even sometime next year. I didn't get that feel during the cc that management was going to go all out and really be gungho about changing things. I hope they aren't going to just do more of the same with little changes here and there.
I will say this I was here during the 1's in 2009 and again in the 2's in 2011. LF almost hit 7 in 2009 after and hit the 12's briefly in 2012. LF floated between 8 and 12 for 2 years straight during 2012 and 2013. It had a 52 week high of 7.85 in 2014 so things aren't hopeless even though this is as bad as I've seen LF in along time.
On March 25, 2015, the board of directors of LeapFrog Enterprises, Inc. (the "Company") appointed Raymond L. Arthur, the Company's Chief Financial Officer (principal financial officer), as the principal accounting officer of the Company. There needs to be all kinds of serious changes around here moving forward.
"We are taking a deep look into our calendar 2014 performance to squeeze as much learning as possible out the year. In addition, we're reviewing our product strategies, operations and cost structure in order to improve our financial performance and return the business to a growth path. It’s likely that this return to growth will be built upon the valuable assets that the company has developed over its rich 20-year history of innovation and education. The LeapFrog brand is a valuable brand built in the heritage of quality and trust that parents believe in." - we shall see.......