csp2013c team 4

Capstone Strategic Project

MSMIT CVILLE Team 4Dave Epperly, Prashanth Lakshmikantha, Stephen Vanaria, Chandan Verma, Rob Wald

June 22, 2013

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Honor Pledge“On our honor, we pledge that all material in this document is original content written by

ourselves, with the exception of specific sentences, images, and ideas that were discovered or provided to us in the course of our research and that are explicitly footnoted or cited to indicate their source. We understand that a breach of this pledge by failing to indicate the source of each specific idea, image, or sentence that we did not write will result in a failing

grade.”CVILLE Team 4June 21, 2013

ContentsCapstone Strategic Project...................................................................................................1Honor Pledge........................................................................................................................ 21.0 Company Information....................................................................................................5

1.1 Founding and History.................................................................................................51.2 Ownership..................................................................................................................51.3 Company Structure....................................................................................................51.4 Customers and Key Products.....................................................................................61.5 Company Stated Strategy..........................................................................................61.6 Brief Financial Snapshot.............................................................................................6

2.0 Industry Analysis...........................................................................................................72.1 Industry Classification................................................................................................72.2 Business Models and Strategies in Kids’ Tabs and Apps............................................82.3 Rivals......................................................................................................................... 82.4 Substitutes................................................................................................................. 92.5 Competitive Analysis: The Five Forces.....................................................................102.6 Industry Forecast.....................................................................................................11

3.0 Strategic Analysis........................................................................................................123.1 Assessment of Strategy: Market Position.................................................................123.2 Strategy: Concisely Stated.......................................................................................143.3 Major Customer Segments, Differentiation, and Effectiveness................................143.4 Assessment of Strategy: Most Attractive Segment..................................................163.5 Assessment of Strategy: Strength and Differentiation.............................................163.6 Assessment of Strategy: Sustainability....................................................................17

4.0 Resources and Capabilities.........................................................................................184.1 IT Investments.........................................................................................................18

5.0 Financial Analysis........................................................................................................205.1 Key Ratios and Trends.............................................................................................205.2 Financial Performance Relative to Competition.......................................................255.3 Areas of Investment.................................................................................................275.4 LeapFrog Stock Price................................................................................................29

6.0 Strategic Motivation....................................................................................................29 of 67

6.1 Context....................................................................................................................296.2 Competitors.............................................................................................................306.3 Capabilities..............................................................................................................316.4 Customers................................................................................................................316.5 Sweet Spot...............................................................................................................32

7.0 Proposed Initiative......................................................................................................347.1 LeapFrog Landing.....................................................................................................34

7.1.1 Child Use Case....................................................................................................357.1.2 Parent Use Case.................................................................................................36

7.2 Customer Value Proposition.....................................................................................377.3 Changes Required for LeapFrog Landing.................................................................39

7.3.1 People Changes..................................................................................................397.3.2 Process Changes................................................................................................407.3.3 Technology Changes..........................................................................................40

7.4 Technology Details...................................................................................................417.5 Investments.............................................................................................................42

8.0 Strategic Rationale......................................................................................................438.1 Enhanced Customer Value.......................................................................................438.2 Strategic Fit..............................................................................................................438.3 Differentiation..........................................................................................................448.4 IT Capabilities Fit......................................................................................................44

9.0 Initiative Financial Impact Summary...........................................................................459.1 LeapPad Revenue 2013-2017..................................................................................459.2 LeapFrog Landing Revenue 2013-2017....................................................................469.3 LeapFrog Total Revenue 2013-2017........................................................................479.4 LeapFrog Operating Margins 2013-2017..................................................................489.5 LeapFrog Pro-Forma Income Statements 2013-2017...............................................489.6 Financial Impact Assumptions..................................................................................48

10.0 Conclusion.................................................................................................................49Appendix A: LFL Mobile App Navigation for Parent Mode...................................................50Appendix B: Pro-forma Income Statements........................................................................50Appendix C: Financial Impact Assumptions........................................................................54Appendix D: Awards............................................................................................................57

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Appendix E: Content Partnerships......................................................................................58

1.0 Company Information1.1 Founding and History

Mike Wood, a corporate attorney for a technology firm, started LeapFrog in 1995 after a prolonged search for the right tool to help his son learn to read yielded no results. Making use of his background in computer language processing, Wood developed a prototype toy based on input from educators at Stanford, parental focus groups, and his own needs. From this initial effort the “Phonics Desk” was born as LeapFrog’s first product offering.

The Phonics Desk, which helped children associate sounds with letters, filled a clear void in the children’s education market and sales reached $3 million within a year. In 1997, Knowledge Universe (owned by financier Michael Milkin and Oracle founder Larry Ellison) purchased a 50% stake in LeapFrog for $50 million. In 1998, LeapFrog purchased Explore Technologies along with their “Near Touch” technology used to develop interactive books that read stories aloud at the touch of a specialized pen. Near Touch based products also proved successful, pushing sales to $70 million by 1999.

By 2000, LeapFrog sales had hit $200 million. The company held an initial public offering (IPO) of stock in 2002 and by 2003 the company sold their products in over 25 countries.

LeapFrog experienced strong and consistent growth through 2008. However, in 2009 LeapFrog’s revenue fell for the first time. The company struggled financially and in 2011 the board replaced nearly the entire management team. LeapFrog’s new leaders quickly re-focused efforts onto “educational entertainment” driven by technology, a strategy that has proven successful by returning the company to profitability in short order.

In early 2011, LeapFrog introduced the LeapPad, a purpose-built kid’s tablet that enables children to use LeapFrog educational entertainment apps much in the same way adults use apps with general-purpose tablets such as the iPad.

1.2 Ownership

Leapfrog’s stock trades publicly on the NYSE under the symbol LF. The largest institutional shareholders include Wellington, Wells Fargo, Franklin Resources and The Vanguard Group. Knowledge Universe board members Owen Rissman and Thomas Kalinske, along with CEO John Barbour also own significant stakes.

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1.3 Company Structure

LeapFrog primarily organizes itself along functional lines. Exceptions include SVP and Managing Director of EMEA Christopher Spalding, along with SVP and GM Brad Rodrigues, who has accountability for digital offerings and community development.

Both Mr. Spalding and Mr. Rodrigues report directly to the CEO, which is consistent with the company’s strategic investments in these areas (see section 1.5 - Company Stated Strategy).

Figure 1: LeapFrog Organizational Chart

1.4 Customers and Key Products

LeapFrog offers educational entertainment products for children up to 9 years old. Core products include; the LeapReader learn-to-read system, the Leapster game system, and the LeapPad kid’s tablet. To complement these products, the company also offers “Learning Path” and “The App Center.” The Learning Path is an online tool where parents can review personalized feedback and recommendations regarding their children’s use of and progress with LeapFrog products. Although LeapFrog bundles several free apps with their products, the App Center offers additional downloadable digital content such as games, music, and videos, for purchase (up to 500 offerings). LeapFrog also distributes apps on iTunes for both the iPad and iPhone.

LeapFrog distributes its products through major retailers including Wal-Mart and Toys-R-Us, through distributors in international markets, and directly to consumers through the company’s website.

1.5 Company Stated Strategy

LeapFrog management summarizes their current strategy as a transformation “from an educational toy company to a leading educational entertainment company.” While LeapFrog continues to market learning toys for infants and toddlers, multi-media learning platforms (i.e. kids’ tablets) and content (i.e. apps) represent the core focus. Additionally, the following growth opportunities represent stated areas of focus:

international expansion release of additional digital content developed in-house and via partners development and launch of new multi-media learning platforms

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delivery of content via 3rd party platforms development of richer “relationships with parents, grandparents, teachers and

caregivers”

1.6 Brief Financial Snapshot

During fiscal year ending December 31, 2012, LeapFrog had revenue of $581.3 million and net income of $86.5 million, increases of 28% and 335% respectively from 2011. The company has $120 million in cash, with no debt. For additional information, see section 5 (Financial Analysis).

2.0 Industry Analysis2.1 Industry Classification

LeapFrog operates in the Dolls, Toys, and Game Manufacturing Industry (339930) according to the North American Industry Classification (NAIC) system.1 “Toys and Games” is an $852 billion international industry projected to grow 30% by 2017.3 The U.S. portion of the Toys and Games accounted for $21 billion in revenue in 2012.4 Though it includes over 700 organizations, 3 companies5 claim 30% of this revenue. “Toys and Games” is a mature, concentrated, and highly competitive industry.

As the Toys and Games industry increasingly focused on technology, LeapFrog emerged as a leader in the sub-category known as Education Gaming (or “Edu Gaming”)’.6 Edu Gaming companies deliver educational software through interactive games. Edu Gaming generated an estimated $5 billion in revenue globally in 2013.7

Figure 2: Industry Classification and Sub-categories

1 Source: NAICS Association (http://goo.gl/Vs0nX)2 Statistics and Facts on the Toy Industry (http://goo.gl/ULF35)3 GSVAdvisors and Candlestick Research, 2012 (from LeapFrog Investor Event, February 2013)4 Source: Toy Industry Association, Inc. (http://goo.gl/mpHKB) 5 Mattel (US), Hasbro (US), & Lego (Denmark) respectively.6 LeapFrog refers to Edu Gaming as “Electronic Learning Aids”7 American Revolution 2.0: http://goo.gl/1ZdOq (p. 8, p. 167)

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http://goo.gl/1ZdOq

http://goo.gl/mpHKB

Within Edu Gaming, the purpose-built kid’s tablet computer sub-category, “Kids’ Tabs & Apps”, has recently become an attractive space (Figure 2 above). LeapFrog’s flagship device (LeapPad 2) is representative of devices within Kids’ Tabs & Apps. Though LeapFrog’s learning ecosystem consists of many components, the success of LeapPad has drawn others seeking profit. Several newly minted children’s education companies have entered, taking advantage of to readily available open-source software, cheap hardware, and high demand. Figure 3 below depicts selected entrants to the Kids’ Tabs and Apps sub-category over the last three years.

Figure 3: New Entrants to the “Kids' Tabs & Apps” Sub-category

2.2 Business Models and Strategies in Kids’ Tabs and Apps

Although the Kids’ Tabs & Apps sub-category is still relatively new, distinctions with respect to competitor’s strategies are beginning to appear. Participants employ one of three general business models and strategies:

hardware only hardware and software integrated hardware, software, and content (apps) distribution

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2.3 Rivals

Table 1 below denotes a few of the direct competitors to the LeapPad and the business models employed by each competitor.

Product (Company Name) Business Model and Strategy

ChildPad (Arnova) Hardware Only

PTab750 (Polaroid) Hardware Only

Tabeo (Toys-R-Us) Hardware Only

Kurio (KD Interactive) Hardware and Software

Nabi Jr. (Fuhu) Hardware and Software

VINCI Tab (VINCI – Rullingnet) Integrated Hardware, Software, and Content (apps) Distribution

InnoTab (VTech) Integrated Hardware, Software, and Content (apps) Distribution

Table 1: Competitors and Business Models in "Kids' Tablets & Apps"

Though the sub-category includes many competitors, the majority of the offerings are Android-based platforms providing “kid-friendly” tablets that rely on the Google Play Store8 to supply 3rd party educational apps. Few competitors offer compelling, kid-focused hardware & software solutions. Examples include the Vinci Tab, and the Meep!, both of which package kid-centric software for easy consumption (some developed by the company, some by 3rd party developers) along with hardware. One competitor separates itself from the rest: VTech represented in Figure 4 below by their InnoTab 2. VTech attempts to replicate LeapFrog’s platform, content, and community. As such, VTech represents the only true rival of LeapFrog within this niche sub-category.

8 www.gogle.com/play - Most platforms offer curated versions of the Play Store that direct parents toward educationally focused content.

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http://www.gogle.com/play

Figure 4: Business Model and Strategy Distribution within "Kids' Tabs & Apps"

2.4 Substitutes

While Kids’ Tabs & Apps continues to grow, compelling substitutes exist that challenge all participants. Any product or service competing for the attention of parents of pre-school children who are eager to provide their children the best opportunity to learn is considered a substitute for a kid’s purpose-built tablet. Figure 5 below captures some of these substitutes, loosely divided between products and services.

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Figure 5: Selected Substitutes for Kids' Purpose-built Tablets and Apps

2.5 Competitive Analysis: The Five Forces

A five forces analysis of the “Kids’ Tabs Apps” sub-category indicates that substitutes represent the greatest threat.

At present, neither buyers nor suppliers possess a clear position of power. Though there are many new entrants to the market, 9 only one – VTech – represents a direct rival of LeapFrog. Meanwhile, industry leaders are taking steps to deter additional would-be entrants by increasing switching costs through proprietary ecosystems. Figure 6 below plots the top threats to sub-industry profitability.

9 The low barrier to entry within edutainment is facilitated by the spread of open operating systems like Android, distribution systems such as iTunes, and the benefits of the scale of application markets.

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Figure 6: Top Threats to Kids Tabs & Apps Profitability

Substitutes maintain several advantages over purpose-built kids’ tablets. Many parents of children who might buy a purpose-built kids’ tablet already own substitutes. Additionally, as prices of substitutes continue to fall, demand for kids’ purpose-built tablets will decrease.

Within established app markets (iTunes, Google Play), the norms for pricing of educational content are well below those of LeapFrog and VTech. Research exists indicating consumers are willing to pay higher prices for quality,10 however, without overwhelming value propositions, developers of children’s educational content will likely find it increasingly difficult to maintain price premiums.

2.6 Industry Forecast

As “Kids’ Tabs and Apps” evolves over the next three years, the threat of new entrants will likely subside as today’s high margins will be difficult to maintain. Beyond 2016, substitutes will be the greatest threat, eventually morphing into rivals (Figure 7 below). Purpose-built kids’ tablets will find it difficult to survive.

10 iLearn II: An Analysis of the Education Category on Apple’s App Store (http://goo.gl/xMxsi) of 67

As the value leader, LeapFrog will be able stand on its brand and defend its established market position for the next 3 years.11 Thereafter they will likely begin to rapidly lose revenue from their line of kid-specific tablets. If they chose to enter, any large competitor leveraging economies of scale would likely win market share (for example, Amazon’s Free Time service for kids provides unlimited access to books, games, apps, and video for a low monthly fee).

Figure 7: Five Forces Analysis of the Children's "Edutainment"12 Industry Over Time

3.0 Strategic Analysis

3.1 Assessment of Strategy: Market Position

LeapFrog delivers educational entertainment via a proprietary and integrated system of hardware (LeapPad tablet), software (tablet operating system and apps), and online services (Learning Path). Introduced in early-2011, the LeapPad quickly achieved market success and remains the top-selling kids’ tablet. Attracted by high growth rates in the tablet and apps category (relative to learning toys), entrants have introduced competing products (see section 2.0 - Industry Analysis).

LeapFrog competes against these rivals by employing a strategy based on a market position of value (versus cost).13 VTech, LeapFrog’s closest rival, offers the InnoTab, and with this product has essentially imitated LeapFrog’s entire business model. However, VTech emphasizes its cheaper overall cost.14 Figure 8 below compares the total cost of 11 Seeking Alpha - Leapfrog: Growth At A Reasonable Price (http://goo.gl/hYTQA)12 During the 1990’s the children’s ‘edutainment’ market closely resembled the ‘Kid Tabs & Apps’ market of today. We used historic analysis from the report What in the World Happened to Carmen Sandiego? The Edutainment Era: Debunking Myths and Sharing Lessons Learned (http://goo.gl/joHYL), to derive insights about the past, present, and future of this industry.13 Based on the Value-Cost Framework; Ghemawat 1991; Postrel, 2000; Tirole, 1988; all cited by Walker, 2004-2009.14 VTech’s website (http://tinyurl.com/o9gfcos) explicitly highlights cost differences of the InnoTab versus the LeapPad.

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http://tinyurl.com/o9gfcos

ownership, including the cost of both the tablet and apps, of the InnoTab versus the LeapPad.

Tablet Cost Avg Price Per App

$80.00

$3.26

$99.00

$8.71

Total Cost of Ownership: InnoTab vs LeapPad

InnotabLeapPad

Figure 8: Total Cost of Ownership: InnoTab versus LeapPad

To deliver value, LeapFrog focuses on innovation, quality, and brand. The company’s core activities support and reinforce these value drivers. For example, to support innovation, the company maintains all software and hardware design in-house. To support quality, LeapFrog’s product development processes leverage internal experts in fields such as child development, child psychology, and educational research. The company has also created a comprehensive curriculum based on a proprietary database of over 2600 skills critical to a child's development. To support its brand, LeapFrog carefully curates the content in its App Center, and one of four in-house experts must approve all new content. Furthermore, the company only develops content that provides educational benefits. Figure 9 depicts the company’s activity system.15

15 Porter, 1985 of 67

Figure 9: LeapFrog Activity System

3.2 Strategy: Concisely Stated16

The following statement represents a concise summary of LeapFrog’s strategy:

Grow learning platform revenues by 10-15% annually through 2016 by providing children with personalized, life changing educational entertainment at the most critical period of their development, designed by educational experts according to a proprietary, award-winning and research-proven pedagogy.

3.3 Major Customer Segments, Differentiation, and Effectiveness

Parents today face an overabundance of choices to entertain their children. The educational value of these choices varies greatly, and it is often difficult for parents to find the right choice for their children. At the same time, parents are increasingly dissatisfied with the state of the educational system within the U.S.17 and the ability of the public school system to prepare children for a future in a competitive global economy. 16 Collis and Rukstad, 200817 Source: Gallup; “53% of Americans Are Dissatisfied with the Quality of Education Students Receive in the U.S.” – as cited in LeapFrog Investor Presentation February 2013.

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LeapFrog’s products address these problems by building solid educational foundations during pre-school years.

Table 2 provides a summary of the major customer segments – using age-based segmentation – targeted by LeapFrog, the value proposition offered each segment, the extent to which LeapFrog differentiates itself (low, medium, high) in the segment, and an assessment of LeapFrog’s effectiveness18 in serving each segment.

Segment Value Proposition Differentiation

Effectiveness

0-12 months

Infants develop an understanding of the world around them.19 Medium20 Medium20

12-36 months

Toddlers develop early language skills.19 Medium20 Medium20

3-9 years

Purpose-built tablet for children ensures ease of use and durability.

High quality, expert-driven content curriculum that drives development in over 2600 skills21

Largest and deepest catalog of over 325 apps.

Exclusive stories and characters developed in-house, and licensed from Disney, Nickelodeon, PBS, and other partners.

Online service (Learning Path) that allows parents to track progress of children and to gain personalized expert insights on progress and recommendations for additional products and services.

High22 High23

18 Effectiveness in terms of how well LeapFrog performs the “job to do” as measured by available metrics, including industry awards, market share, and revenue growth.19 Source: Leapfrog.com.20 The learning toy (also referred to as Education Gaming) category is very mature and highly competitive, with participants including Hasbro (Playskool), Mattel (Fisher Price), VTech, and others (see Industry Analysis). While LeapFrog’s products in these two segments are both high quality and highly awarded, growth in these segments is much slower than the tablet and apps category targeted to 3-9 year olds. As LeapFrog shifts to educational entertainment, learning toys represent a shrinking contribution to overall revenue (from 29% to 19% of overall revenue in 2011 and 2012 respectively). These segments, however, remain strategically important as a beachhead for new parents with the hope that as infants and toddlers reach 3 years old, they show interest in the LeapPad based on previous exposure to LeapFrog. 21 Source: Leapfrog.com, Leapfrog Investor Presentation, February 2013.22 Figure 10 provides additional details regarding LeapPad differentiation versus competition. 23 For this segment, all metrics, including awards, market share, and revenue growth, indicate effectiveness.

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Table 2: Major Customer Segments' Value Proposition and Differentiation

3.4 Assessment of Strategy: Most Attractive Segment

The most attractive segment for LeapFrog is children 3-7 years old as research24 indicates that children 8-9 years old show much less interest in LeapPads. Additionally:

• The learning toys (targeted to infants and toddlers aged 0-36 months old) category is a much more mature, highly competitive, and slower growing category. Participants include Hasbro (Playskool), Mattel (Fisher Price), VTech, and others (see section 2.0 - Industry Analysis). Although LeapFrog’s products in this category are both high quality and highly awarded, they do not possess a high degree of uniqueness and differentiation. Consequently, LeapFrog’s learning toys have lower margins.

• LeapPad enjoys both a high degree of differentiation and effectiveness in the segment for pre-school/primary schoolchildren. This segment is also more profitable as evidenced by significantly improving financial performance (see section 5.0 – Financial Analysis) since the introduction of the LeapPad. Additionally, LeapPads enable a long-tail business model25 helping LeapFrog to smooth out the cyclical/seasonal nature of the toy industry. Typically, these companies make most of their revenue and profits during the 2nd half of the year, particularly in December.

3.5 Assessment of Strategy: Strength and Differentiation

With its sole focus on educational toys over the past 18 years, LeapFrog has created substantial resources, capabilities (see section 4.0 – Resources and Capabilities), and a unique activity system. Evidence of this strength and differentiation is found in the following areas:

• Industry awards: the LeapPad has received at least eight different industry awards - the highest number among all of its rivals – since its introduction in 2011, including the Toy Industry Association People’s Choice Award for 2013, and the Toy Industry Association Educational Toy of the Year for 2013.26

• Sales: the LeapPad is the #1 selling Kids’’ tablet.27

• Financial strength: indicates significantly improving return on equity driven largely by increasing profit margins (see section 5.0 – Financial Analysis).

While LeapFrog clearly differentiates itself as a value leader based on high quality “educationally nutritious” offerings, exclusivity, and higher overall pricing; a group of Android-based devices position themselves at the opposite end of the market, offering thousands of applications at low prices. VTech (represented within the strategy canvas by their InnoTab 2 in Figure 10 below) offers a mix of the two, cheaper applications along 24 Negative reviews of the LeapPad for 8-9 year olds include: http://tinyurl.com/occkasm, http://tinyurl.com/pfsedje, http://tinyurl.com/oskxygt 25 Source: http://en.wikipedia.org/wiki/Long_Tail#Business_Models26 Source: LeapFrog.com27 Source: NPD Group, Retail Tracking Services

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http://tinyurl.com/oskxygt

http://tinyurl.com/pfsedje

http://tinyurl.com/occkasm

with the attempt to copy LeapFrog’s high quality. The strategy canvas clearly illustrates the position of LeapFrog versus the competition with emphasis on 3 general areas: higher prices, an educationally exclusive focus, and a closed system.

Figure 10: LeapFrog Strategy Map

3.6 Assessment of Strategy: Sustainability

Despite LeapFrog’s current success, substitutes in the form of general-purpose tablet computers remain a growing strategic threat. A substantial number of households already own a tablet,28 and research forecasts strong sales of tablets globally through 2017.29 Additionally, tablets are increasingly present in classrooms. From 2011 to 2012 access to tablets within classrooms rose 15%. During that same period,30 the percentage of public school technology officials that identified tablet usage as a top priority increased from 25% to 40%.31

As children are increasingly exposed to general-purpose adult tablets either in the household or in the classroom, it will be much more difficult for LeapFrog to maintain children’s interest in a kids’ purpose-built tablet. Furthermore, new entrants exist today that possess similar resources and capabilities, albeit perhaps on a lesser scale. For example, Kidaptive (www.kidaptive.com) is a Silicon Valley, venture-capital backed start-up that offers educational apps for the iPad, and the company offers a similar capability to LeapFrog’s Learning Path which provides personalized feedback and insight to parents 28 Source: Pew Research, 2013; 28% of U.S. households earning $50,000 to $74,999, and 56% of U.S. households earning $75,000 or more owned a tablet as of June 2013.29 Source: IDC, 2013; by 2017, global tablet sales expected to by 352 million in 2017, which is 174.5% growth over 2012.30 Source: PBS Teacher Technology Usage Survey, 201331 Source: Education Week/MDR, 2013.

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regarding their children’s learning progress. The emergence of Kidaptive is part of a broader trend in the industry as substitutes morph over time to become more like direct rivals.

Given their current strategy, significant deterioration of LeapFrog’s uniqueness and differentiation is likely to occur over the next five years. Left unchecked, the results will be evident in LeapFrog’s bottom line.

4.0 Resources and Capabilities

LeapFrog’s investments in resources and capabilities reflect management’s awareness of where the company enjoys uniqueness and differentiation. For example, LeapFrog maintains a substantial in-house hardware and software engineering team focused on the delivery of a proprietary purpose-built kid’s tablet (including OS). This allows the company to have complete control over the user experience, consistent with LeapFrog’s market position focused on value. Similarly, LeapFrog outsources manufacturing of the LeapPad, consistent with the company’s desire to avoid competing on cost (versus direct rivals such as VTech).

4.1 IT Investments

LeapFrog IT investments have resulted in the creation of significant resources and capabilities for the company.32

(1) Substantial, focused, and talented in-house hardware and software engineering teams.

(2) The most award-winning and best selling purpose-built kid’s tablet available in the market. The LeapPad includes proprietary hardware and software (Linux-based operating system).

(3) A content (apps) development process that leverages both in-house and external educational research and expertise that is focused on a proprietary database of over 2600 different skills essential to children’s development.

(4) A rigorous quality control and testing process utilizing specialized usability labs where approximately 1,200 families participate in over 1,100 testing sessions per year. Additionally, approximately 250 families per year participate in in-home testing. Both the Learning Path and the quality control/testing process produce significant data that is maintained by LeapFrog for sophisticated analyses.

(5) The largest education-focused content catalog in the industry.

32 Source: Company 2012 10K, investor presentations, and leapfrog.com; see also activity system depicted in Figure 9 of 67

http://leapfrog.com/

(6) An online resource – the Learning Path – that provides personalized feedback to Kids’ and provides parents an ability to track the progress of their children’s use of LeapPads, along with recommendations about additional apps available to purchase.

(7) An extensive website (LeapFrog.com) that provides the company with a direct channel through which the company can interact with its customers globally. Web site capabilities include e-commerce, customer support, and extensive content for parents relating to not only use of LeapFrog products and services, but also significant resources (articles, etc.) relating to children’s education, learning, and growth. LeapFrog.com uses technology from Amazon (AWS/EC2-infrastructure), and Oracle (RightNow-service and support).

(8) Sophisticated social media relationship management. LeapFrog maintains an active social media presence on Facebook, YouTube, Twitter, and Pinterest using technology from Oracle (Vitrue).

Table 3 below represents an assessment of how each IT investment contributes to LeapFrog’s value drivers (see also section 3.1 - Assessment of Strategy: Market Position), and the extent to which the investment contributes to the company’s strategy, including evidence of this contribution.

IT Investme

nt

Associated Value Driver

Cost to Imitate

Competitive

AdvantageEvidence of Uniqueness

(1) Quality, innovation,

brand

High High LeapFrog 2012 10-K, Figure 9: LeapFrog Activity System

(2) Quality, brand

Low Low #1 Selling Kids’’ Learning Tablet**Source: NPD Group/Retail Tracking Services & LeapFrogWinner of 18 Toy of the Year Awards Over the Past 13 Years!Winner of Two TOTY’s 2013: People’s Choice Award and Educational Toy of the Year90%+ of all product reviews* received four stars or greater [*Based on reviews at Amazon.com, Walmart.com, ToysRUs.com, and LeapFrog.com.]

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IT Investme

nt

Associated Value Driver

Cost to Imitate

Competitive

AdvantageEvidence of Uniqueness

(3) Quality, Brand,

High High #1 Selling Kids’’ Learning TabletIndustry awards Largest and deepest education-focused content catalog

(4) Quality, Brand

High High Unsurpassed quality control – no documented evidence exists that rivals possess this level of sophistication with testing and quality control.

(5) Quality, Brand

High High Over 325 education-focused apps

(6) Quality, Innovation,

Brand

Medium Medium 13 million connected parents* *Source: LeapFrog Rivals, including VTech, offer the same capability, although with less sophistication.

(7) Quality, Brand

Medium Medium Net Promoter Score of 50 “Excellent”No other rival possesses this high of a score.

(8) Quality, Brand

Medium Medium 13 million connected parents**Source: LeapFrog Given social media is a very fluid and dynamic, it is very difficult to assess that LeapFrog has a significant competitive advantage here.

Table 3: IT Investments and Contribution to Strategy

Clearly, LeapFrog’s IT investments contribute to both top and bottom-line financial results, allowing the company to describe itself as a technology company in the toy industry.

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It is worth noting that due to changing market conditions several IT investments, including the company’s tablet hardware, software, and the online tool ‘Learning Path’, do not currently contribute significantly to competitive advantage, particularly in the face of the emerging threat of substitutes.

5.0 Financial Analysis

5.1 Key Ratios and Trends

Over the period 2010-2012, LeapFrog’s transition to an educational entertainment company led to a remarkable turnaround in the firm’s financial performance, increasing ROE over 28% (Figure 11 below). LeapFrog’s transition period has been marked by an improvement in all three ROE levers (Figure 12 below). Profit margin has proven to be the most important lever as it has increased over 9% since 2010. This improvement is largely attributable to a 34% increase in sales ($148 million) during the same period.

2008 2009 2010 2011 2012

-40

-30

-20

-10

0

10

20

30

40Return on Equity

Figure 11: LeapFrog ROE

2008 2009 2010 2011 2012

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

Profit Margin

2008 2009 2010 2011 20120

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

Financial Leverage

2008 2009 2010 2011 20120

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

Asset Turnover

Figure 12: ROE Levers

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LeapFrog engineered this turnaround through two parallel efforts. First, the firm shifted away from educational toys to focus more on kid’s tablets and apps (as previously noted). Second, the firm improved its operating efficiency making better use of its assets.

LeapFrog’s strategy shift is apparent from the growing importance of multimedia learning platforms as a source of revenue. In 2012, multimedia learning platforms accounted for a full 80% of its sales, an increase of over 10% from the previous year and part of a four-year trend (Figure 13). LeapFrog’s 28% revenue increase ($126 million) in 2012 (Figure 14 below) is largely attributable to the LeapPad and follow-on sales (e.g. apps and accessories)33.

2009 2010 2011 2012

64% 69% 69%80%

34% 30% 29%19%

2% 1% 2% 1%

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OtherLearningToysMultimediaLearningPlatforms

Figure 13: Net Sales by Product Segments

33 Source: LeapFrog 10K, 2012 of 67

2009 2010 2011 2012

$380$433 $455

$581

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Figure 14: Net Revenue by Year

LeapFrog’s financial statements also illustrate the company’s progress to grow internationally. In 2012 international sales accounted for 27% of total revenues, a 7% increase from 2010 (Figure 15 below). This trend is likely to continue with LeapFrog’s release of the LeapPad in France34 and its plans to localize more content for international markets35. International growth is a sensible objective given LeapFrog’s international sales comprise a much smaller percentage of overall revenue compared to competitors (Figure 16 below).

2010 2011 2012

80% 75% 73%

20% 25% 27%

International & Domestic Revenue as a Percentage of Total Sales

Interna-tionalUS

Figure 15: International Mix of Global Sales

34 Source: http://www.journaldugeek.com/2012/06/12/leapfrog-leappad/35 Source: http://tinyurl.com/lxl2m7n

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LeapFrog Mattel Hasbro

27%

44% 46%

International Sales as a Percentage of Total Revenue in 2012

Figure 16: International Sales as a Percent of Total Revenue versus Competition

As previously mentioned, LeapFrog’s turnaround relies on a two-prong approach, and its financial performance is not entirely attributable to a shift in strategy. A series of efficiency improvements also bolstered the firm’s financial performance. Since 2010, LeapFrog improved its days sales outstanding (from 129 to 106), accounts receivable turnover (from 2.84 to 3.44), and its total asset turnover (from 1.44 to 1.53) (Figure 17 below).

2010 2011 2012

128.69 126.33

105.95

DSO

2010 2011 2012

2.84 2.89

3.44

AR Turnover

2010 2011 2012

1.44

1.46

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Figure 17: LeapFrog Efficiency Ratios

LeapFrog’s new strategy and its operating gains have significantly improved its financial health. LeapFrog has virtually no debt, and sits on $120 million (28% of 2012 revenue) in cash (Figure 18 below). Over the period 2010-2012, the company turned healthy liquidity ratios, into industry leading ratios (Figure 19 below). Overall, the firm is well positioned to make strategic investments to maintain momentum.

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2010 2011 2012

$19,479

$71,863

$120,000

LeapFrog Cash & Cash Equivalents

Figure 18: LeapFrog's Growing Cash Balance

2010 2011 20120

0.5

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2010 2011 20120

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LFHasbroMattel

Figure 19: Financial Health Ratio Comparison

5.2 Financial Performance Relative to Competition

LeapFrog's strategic shift and focus on digital educational entertainment also enabled the company to outperform much larger competitors36. As Figure 20 below demonstrates, Leapfrog’s ROE surpassed both Mattel and Hasbro in 2012. In addition, LeapFrog turned over its inventory 1.5 more times than competitors (Figure 21 below); another indicator of the LeapPad’s37 growing importance to the company’s financial performance.

36 LeapFrog is compared to Hasbro and Mattel because financials for direct competitors in the tablet space are not available. Although VTech’s financials are available, it is not a good comparison. VTech is a global firm traded on The Stock Exchange of Hong Kong Limited and its product offerings range from telecommunications products to contract manufacturing services.37 LeapPad1 was released in early 2011. LeapPad2 was released in mid-2012. 2012 marks the first full-year of LeapPad sales.

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2008 2009 2010 2011 2012

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LFHasbroMattel

Figure 20: ROE Comparison versus Competition

2008 2009 2010 2011 20120123456789

10Inventory Turns

LFHasbroMattel

Figure 21: Inventory Turns Comparison

Comparing LeapFrog’s financial documents to competitors provides additional insight into how the firm differentiates itself. Relative to traditional mass production toy companies Hasbro and Mattel, LeapFrog has higher COGS (Figure 22 below) and lower gross margins (Figure 23 below). These comparisons align with the company’s strategy to invest more in value drivers such as innovation, quality, and brand to over-deliver educational quality.

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2008 2009 2010 2011 20120.00%

10.00%

20.00%

30.00%

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LFHasbroMattel

Figure 22: COGs Comparison

2008 2009 2010 2011 20120.00

10.00

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LFHasbroMattel

Figure 23: Gross Margin Comparison

5.3 Areas of Investment

Aside from above the line indicators, LeapFrog’s financials indicate significant ongoing investment in differentiation. In 2012, the firm increased year-over-year spend in advertising, R&D, and SG&A38 (Figure 24 below). LeapFrog’s significant increase in sales somewhat masks these increases as all costs, including COGS, are down as a percentage of revenue (Figure 25 below). Regardless of the trend in its common-sized financials, it is

38 According to LeapFrog’s 2012 10K, SG&A increases are largely attributable to incentive-based rewards to their staff based on the firm’s stellar performance.

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apparent that LeapFrog continues to invest in improving its performance, and its turnaround is not a short-term gain from simple cost cutting measures.

2010 2011 2012$0

$10,000$20,000$30,000$40,000$50,000$60,000$70,000$80,000$90,000

$100,000LeapFrog Operating Expenses

SG&AR&DAdvertising

Figure 24: LeapFrog Operating Expenses

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2010 2011 2012

58.62% 59.10% 57.86%

17.47% 17.13% 15.41%

8.12% 7.42% 6.30%

11.40% 8.68%7.40%

LeapFrog Expenses as a Percentage of Revenues

AdvertisingR&DSG&ACost of sales

Figure 25: Trend of LeapFrog Operating Expenses as a Percentage of Revenue

5.4 LeapFrog Stock Price

Despite LeapFrog’s remarkable turnaround and an improving overall economy, the company’s stock trades below 2012 highs, and it trails (Figure 26 below) both the performance of general market indexes (DJIA, S&P 500), and the stock performance of competitors Hasbro (HAS), and Mattel (MAT).

Analyst opinion on LeapFrog stock is mixed. Currently,39 three of nine analysts rate LeapFrog a hold, while five rate LeapFrog a buy, and one rates LeapFrog a strong buy. LeapFrog skeptics40 cite strong competition from rivals and substitutes as their rationale.41

39 Source: Thomson/First Call, June 6, 201340 One example: http://tinyurl.com/l8oapkk41 When Toys "R" Us, LeapFrog's second largest customer, announced its Tabeo Kids’ tablet in late 2012, LeapFrog's stock dropped 11%

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Figure 26: LeapFrog Stock Compared to Competition and Overall Market

6.0 Strategic Motivation

6.1 Context

The Kids Tabs & Apps industry is somewhat of an enigma. On one hand, it seems poised to continue rapid customer and competitor growth as it expands within international markets. However, a broader contextual look at the industry indicates that the good fortune of kid-specific tablets will soon be at an end.

The growth in demand for general-purpose tablets and smartphones42 is illustrated within figure 27 below. Predictions for the growth of these devices dwarf the analogous best-case scenarios for kid-specific tablets. It is therefore reasonable to assume that by 2017 nearly every would-be, kid-specific tablet consumer will already have at least one robust, powerful, mobile, affordable device within their possession. By extension, it is reasonable to assess that few parents will purchase an additional kid-specific device on top of the substitute in hand.43,44

42 iPad, Branded Android Tablets, Kindle, etc., along with smartphones that are an additional substitute for kid-specific tablets43 Especially considering recent studies indicating the pervasiveness of the “passback effect” (passback effect is defined as adults passing devices on to children vs. children ‘owning’ their own device). 44 Source: http://www.joanganzcooneycenter.org/2010/06/02/kids-apps-the-pass-back-effect-marches-forward/

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Figure 27: Growth in Sales of Mobile “Smart” Devices: 2013 05 BEA “Mobile is eating the world45”

Given this grim outlook for the future likelihood of sales of their flagship device(s), LeapFrog and other industry participants must prepare now:

Contextual Challenge: Address predicted decline in revenues from future loss of tablet sales

6.2 Competitors

Demand for Kids Tabs and Apps is predicted to continue growing through 2017, mostly within international markets. This growth has drawn the attention of two types newcomers; those who compete with LeapFrog by copying their value-driven offerings, and those who choose to provide a low cost option.

Companies that copy the LeapFrog model have met with success (again, VTech being the best example). However, LeapFrog remains the clear market leader. Their reputation (brand) amongst consumers is hard-won and strong. Additionally, LeapFrog dominates industry awards and accolades from educationally focused content reviewers. In order to remain on top of the heap LeapFrog must distance itself from rivals:

Competition Challenge: Create a sustainable business model through continued differentiation from competitors

Cost-leaders have two advantages over LeapFrog at present:

45 Source and quote from: CSS Insight (http://goo.gl/O1tpT) of 67

http://goo.gl/O1tpT

1. their hardware costs will continue to fall2. they outsource their content and can focus on making quality hardware

Consumers of kid-specific tablets have many options and the list grows weekly. Android-based devices continue to proliferate and continue to fall in price, especially within the very countries that LeapFrog has targeted for international growth.46

Cost-leader competitors rely on the Google Play market to provide their applications. As such, their cost to produce content is zero. Meanwhile, the market provides thousands of options that are priced well below what LeapFrog can afford to charge. In the short to mid-term it will be harder for LeapFrog to justify their expensive, proprietary, platform in light of cheaper and more capable platforms:

Competition Challenge: Provide a low-cost option without sacrificing value

6.3 Capabilities

LeapFrog has honed its capabilities that specifically address the educational entertainment needs of pre-school children. They develop sophisticated, educationally sound offerings on sturdy platforms that have earned trust and loyalty amongst 13 million parents. With a curriculum built by educational professionals and tested by a network of families they ensure high quality they ensure parents that children receive “educationally nutritious” content. Further augmented by partnerships with the leading entertainment providers47 that bring familiar characters and story lines to the learning environment, LeapFrog has become a perennial winner of the most prestigious industry awards.48 Over time, these capabilities have built the strongest brand within the industry, allowing LeapFrog to justify a high price for their products.

Unfortunately, they have also been built upon a closed, proprietary system. The result: award winning content that (without costly conversion) is incompatible with the dominant operating systems of the future. While other companies take advantage of open markets that attract millions of consumers LeapFrog remains (for the most part49) closed. In addressing this problem, LeapFrog must face the next challenge:

Capabilities Challenge: Extend the reach of products and services beyond the current closed system

6.4 Customers

As LeapFrog looks to expand in international markets they will face two of the challenges mentioned above: cost and limited reach. Additionally, consumers where market growth will be greatest have less money to spend and will have more options on which to spend

46 Aakash Tablet: http://en.wikipedia.org/wiki/Aakash_(tablet)47 Disney, LionsGate, etc.48 2012 Toy of the Year (TOTY) http://www.toyawards.org/imis15/toyaward/last_years_winners.aspx49 LeapFrog has a very limited number of applications within iTunes, unconnected to LeapPath, and missing a coherent plan of study.

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it. They will expect products to work with limited connectivity, and across multiple platforms.

Customer Challenge: Meet future customers expectations of platform-independent, affordable, mobile solutions that thrive with limited connectivity

6.5 Sweet Spot

The overall Kids Tabs & Apps market is illustrated within figure 28 below.

Figure 28: “Sweet Spot” analysis of LeapFrog’s position within Kids Tabs & Apps

In order to ‘hit the spot’ LeapFrog must not only consider the subtleties of the context of their market, their capabilities, their competition, and customers, they must also address the challenges associated within each. These crucial challenges are summarized within figure 29:

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Figure 29: Crucial Challenges that LeapFrog must address over the next few years

Of these challenges, most concerning is that of addressing the impending substitution of generic tablet computers over kid-specific devices. Given LeapFrog’s closed system, if this challenge is not addressed it will be impossible to get content to customers. Differentiation from competitors within the Kids Tabs market will not matter if the market itself is overcome by substitutes.

The good news for LeapFrog is that in addressing this most crucial challenge it may also address others within their capabilities, and with respect to both competitors and customers. If more evidence for action is required, it can be found within the comments section of an industry blog providing the first glimpse of LeapFrog’s new kid-specific tablet offering (figure 30 below).

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Figure 30: Top 5 comments from an engadget.com posting regarding the FCC teardown of the new LeapPad- set to launch in June 2013.50

7.0 Proposed Initiative

7.1 LeapFrog Landing

Given the crucial challenges LeapFrog faces, it should develop a capability that provides access to cloud-based, LeapFrog content on general-purpose tablets and phones via a subscription model. This capability, referred to hereafter as the LeapFrog Landing (LFL), consists of three components:

an app that can be installed on iOS and Android devices, designed solely to access LeapFrog’s cloud-based content;

50 Source: (http://goo.gl/ihA1o) of 67

cloud-based content such as games and ebooks delivered through HTML5 and JavaScript; and

a subscription model that provides customers with access to LeapFrog's entire library of cloud-ready content.

From a customer perspective, LFL expands LeapFrog’s ability to deliver educational content through two top-level use cases: a child use case and a parent use case.

7.1.1 Child Use Case

LFL essentially transforms a general-purpose tablet or smartphone into a LeapPad. When a child opens LFL, he/she is presented with a personalized app launcher.51 This launcher contains icons to access LeapFrog content (e.g. videos, games, ebooks, etc.). The options included in the app launcher are based on a child’s individual learning needs. The personalized launcher is powered by the firm’s recommendation engine and adaptive learning engine.52 While a child is actively using the mobile device, LFL will lock down the device to prevent the child from accessing anything other than LeapFrog content. Figure31 below summarizes the top-level child use case.

51 If LFL is configured to use facial recognition, LFL will launch automatically when an authorized child powers up the device.52 The recommendation engine and the adaptive learning engine are existing capabilities that already tie into LeapFrog’s curriculum.

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Figure 31: Storyboard for Top-Level Child Use Case

7.1.2 Parent Use Case

LFL also provides parents an opportunity to engage in their child’s development through a number of features. Parents can use the mobile app to access reports53 that summarize their child’s learning. These reports provide insight into how well a child is progressing through the curriculum and identify areas where he/she would benefit from additional focus. Parents can also use LFL to access articles and learning activities54 that allow them to assist with their child’s development and reinforce LFL lessons. The articles and activities are personalized for each child; another feature powered by LeapFrog’s recommendation engine. LFL also provides parents access to interactive games. These games are grouped into two categories: single-device and multi-device. Single-device games refer to games a parent and child play from a single device. Multi-device games refer to games designed for synchronous play between a parent and child from different devices.55 Similar to other content, interactive games are recommended based on a

53 This feature is currently provided by LeapFrog’s Learning Path web application, which will be ported to LFL54 This feature is currently provided by LeapFrog’s Learning Path web application, which will be ported to LFL; however, the recommendations do not currently include interactive learning content. 55 Interactive, multi-device games rely on WebSockets and are only available with an internet connection.

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child’s individual development. Figure 32 below walks through the top-level parent use case and Figure 41 in Appendix A illustrates the LFL’s navigation menus for parent mode.

Figure 32: Storyboard for Top-Level Parent Use Case

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7.2 Customer Value Proposition

LFL centers around LeapFrog’s core value of providing children with educationally nutritious entertainment. However, LFL strengthens this value proposition by making curriculum (rather than a device) the centerpiece of its offering and providing new features that fulfill additional customer needs.

LeapFrog's current per-app pricing model weakens its value proposition by obfuscating the benefits of its extensive curriculum. A child's successful progression through the curriculum inherently requires an accumulation of individual, high-price transactions. Individual purchasing decisions are encumbered by a range of questions that challenge LeapFrog's value proposition: is this app worth its relatively high price? If this app does not work, can I get my money back? Is the current app good enough? Is there a cheaper alternative? These questions conceal the value of LeapFrog's curriculum, impairing one if its competitive advantages and undermining the authenticity of its value proposition.

LFL addresses the complications created by LeapFrog’s current per-app pricing model. LFL's subscription model provides customers unlimited access to LeapFrog's entire catalog of learning resources. This arrangement unlocks the full potential of LeapFrog’s curriculum, as the benefits of its comprehensive library are no longer overshadowed by the high costs of individually packaged content. Indeed, there is more than a nuanced difference between an offer that states “buy this game, your child needs it to develop” versus an offer that states “this game will help your child develop, if not, you can fire us." With LFL, customers are no longer buying individual apps to help their child learn compartmentalized lessons; rather they are buying a comprehensive service that will progressively teach them new skills and expertly guide them through the most critical years of their development.

Aside from making curriculum the foundation of its offer, LFL also introduces features that address targeted customer needs. Features such as tablet-lockdown, offline content, and facial recognition are prioritized for the first LFL release because they perform jobs customers need done56. Figure 33 below summarizes LFL’s priority features from the customer’s perspective.

56 Source: Christensen, Clayton, Scott D. Anthony, Gerald Berstell, and Denise Nitterhouse. Finding the Right Job for Your Product. MIT Sloan Management Review. Spring 2007.

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Figure 33: LeapFrog Landing Features

7.3 Changes Required for LeapFrog Landing

LeapFrog will undergo significant changes as a result of LFL. These changes can be grouped into three categories: people, process, and technology.

7.3.1 People Changes

LFL relies heavily on new and rapidly evolving technologies, including HTML5, WebSockets, and JavaScript. These modern technologies move LeapFrog away from Adobe Flash and its proprietary version of Linux towards an ecosystem characterized by open web standards and popular mobile operating systems. Although LeapFrog has some experience with these technologies,57 the company needs to build deeper and broader expertise. LeapFrog will need to fill its current talent void through internal hiring and outsourcing. LeapFrog should focus the majority of their talent acquisition on internal hires given the strategic importance of these skills.

57 For example, LeapFrog has a dozen apps for iOS and already hosts some capabilities on Amazon Web Services of 67

Customers familiar with LeapFrog will also need to change their buying patterns and transition to steady and sustainable monthly fees. Although subscription models will be nothing new to target segments, LeapFrog will need to effectively utilize advertising and other marketing programs to positively influence customer’s willingness to pay monthly subscription fees.

7.3.2 Process Changes

LFL’s subscription model will require process changes with several functional groups. Finance will need to adjust forecasting and AR processes built-around seasonal revenue streams to accommodate a more steady flow of monthly invoices. Marketing will need to develop processes58 that allow them to mine knowledge from web analytics and customer service metrics. Marketing must also work with product development and customer service to develop processes that turn this quantitative knowledge into actions that will drive up customer acquisition and retention.

LFL’s transition to the cloud also requires development teams, marketing, and product management move away from processes built around big-batch, yearly delivery cycles and move towards agile processes that exploit the benefits of fast moving, cloud based services.59 This transition to cloud based content requires terms-of-partnership changes with external content providers. Royalties tied to distribution rights or individual app purchases will change to a flat percentage of subscription fees regardless of whether someone uses the app.60

7.3.3 Technology Changes

In recent years, LeapFrog has begun to migrate away from the world of low-tech, slow-moving, device embedded toys. LFL will accelerate this migration as LeapFrog becomes more dependent on the technologies that power the fast moving, high performance worlds of cloud and consumer devices. From a technology perspective, this change will be prevalent in two areas: infrastructure and development platforms and analytics.

In terms of infrastructure and development platforms, LeapFrog’s current content is heavily dependent on Adobe Flash and their proprietary Linux OS.61 LeapFrog will port this content to more modern technologies such as HTML5, WebSockets, and JavaScript. LeapFrog will also need to build a secure, scalable, high performance infrastructure using Amazon Web Services (AWS) to deliver their ported content.

In terms of analytics, LeapFrog will become more dependent on web analytics once the point of customer contact moves to the cloud. LeapFrog must develop the resources to properly capture web usage data.62 In addition, organizations such as marketing, IT, and 58 For example, A/B testing, AARRR conversion funnels, etc.59Scaled Agile Framework (http://scaledagileframework.com/) or other more modern product development methodologies would be a good fit for the LFL initiative60 Over time, usage analytics will help determine the true value of partnerships and LF will structure partnerships accordingly61 http://ianfrench.hubpages.com/hub/Leappad-Tablet-Explorer-is-it-Worth-the-Hype62 LFL will lease web analytics from Amazon Web Services

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http://ianfrench.hubpages.com/hub/Leappad-Tablet-Explorer-is-it-Worth-the-Hype

http://scaledagileframework.com/

product development must learn to harness insight from this data to influence product development, customer acquisition, and customer retention.

LFL's subscription model also increases the importance of analytics that drive LeapFrog's adaptive learning engine, its recommendation engine, and its child learning reports. These capabilities will become the foundation of LeapFrog’s customer value proposition; responsible for guiding each child uniquely through a critical learning period and demonstrating development to his/her parents. This increased importance requires LeapFrog continuously invest and evolve these technologies to ensure they drive customer value.

7.4 Technology Details

LFL has four main technical components: (1) client app for Android and iOS, (2) content developed in HTML563 and JavaScript, (3) WebSocket64 transport gateway, and (4) a content server farm. These components are described below and summarized in figure 34.

Figure 34: LeapFrog Landing Solution Architecture

63 For more info on HTML5 see http://www.html5rocks.com/en/why64 For more info on WebSockets see http://www.html5rocks.com/en/tutorials/websockets/basics

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The Client “App” is essentially a purpose-built web browser that can be installed on iOS and Android devices, designed solely to access cloud based LeapFrog content.

Content developed in HTML5 and JavaScript are advanced web applications designed to be used entirely within a browser (aka LFL client app).65 Content will take advantage of new advances in HTML5 to run offline. Offline capabilities are achieved through a combination of caching, local storage, and synching.66

The WebSocket Transport Gateway are WebSocket servers that provide the full duplex connection to client devices across the public internet. These servers proxy connections to the content servers. The WebSocket servers will provide real-time, event-driven, experience that is critical to LFL. The WebSocket transport servers will be hosted in the AWS cloud.

The Content Server Farm will serve LFL content. The servers will be hosted in the AWS cloud.

7.5 Investments

New investments required by LFL are summarized in table figure 35 below and included within the financial model in section 9, Initiative Financial Impact Summary.

Figure 35: Investments Required for LeapFrog Landing

65 This component is similar to Chrome Apps or what Google calls "packaged apps." http://developer.chrome.com/apps/about_apps.html 66 This feature is often referred to as "online-offline" apps. More information is available here: http://www.html5rocks.com/en/tutorials/offline/whats-offline/ There will be some limitations based on the type of content or device resource availability.

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http://www.html5rocks.com/en/tutorials/offline/whats-offline/

http://developer.chrome.com/apps/about_apps.html

8.0 Strategic Rationale

Leapfrog has been on a path of growth over the last few years. During this period Leapfrog has placed an increasing emphasis on multimedia content given its higher margins. Due the symbiotic relationship that exists between its multimedia and hardware platforms, LeapFrog's content success is entirely dependent on its proprietary tablets. This symbiotic relationship and its dependence on LeapPad are LeapFrog's Achilles heal. A look to the future reveals the high likelihood of substitutes destroying today’s lucrative kid-tablet market. LeapFrog Landing is a powerful, strategic maneuver that is both offensive and defensive. LFL ensures that LeapFrog will sustain leadership within the educational kids entertainment arena by addressing the highest priority “crucial challenge” faced by the industry. Further, by addressing the threat of substitutes through LFL, LeapFrog can also address additional industry challenges by:

providing consumers with an affordable, high-quality and complete curriculum - addressing Competition/Customer Challenges

opening its currently closed ecosystem to unreachable market segments on Android-based hardware and expand offerings for iOS-based hardware - addressing Capabilities Challenges

allowing LeapFrog to avoid dependence on a proprietary device as the primary content delivery platform - addressing Capabilities Challenges

expanding the possibilities for LeapFrog to enhance its current app development skills/experience through modern technologies - addressing Capabilities Challenges

meeting future customers expectations of platform-independent solutions - addressing Customer Challenges

providing LeapFrog with the opportunity to improve the user experience of Learning Path; currently a cumbersome and sluggish tool - addressing Customer Challenges

8.1 Enhanced Customer Value

LeapFrog Landing will provide users with:

Excellent overall value – immediate access to the full catalogue of web-ready LeapFrog content

The ability to access content on both their iOS and Android based devices The capability to continue to access content while offline Access to an enhanced Learning Path containing automatically updated LFL usage

information, learning reports, and recommendations

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8.2 Strategic Fit

LeapFrog Landing is aligned with the LeapFrog's emphasis on multimedia learning content. LFL reduces focus on hardware and strengthens LeapFrog’s position vis-a-vis the current and future competition from tablets, mobile devices, and apps. Additionally, it will continue to reinforce Leapfrog’s leadership role within the educationally focused content delivery field.

LFL also supports LeapFrog management’s goal of generating mid to high single digit growth rates. With LeapFrog’s current revenue share increasingly coming from the international market in future years, LeapFrog Landing offers the potential of low cost expansion into newer international markets thus, maintaining or increasing margins.

8.3 Differentiation

LeapFrog’s nearest competitor's offerings are quite similar to those of LeapFrog. LFL will create competitive differentiation by:

Providing LeapFrog with the opportunity to leverage its vast base of connected parents (13 million) who are already familiar with the value of Leapfrog’s curriculum – converting them to LFL subscribers before they choose to utilize substitutes

Taking advantage of LeapFrog’s branded proprietary curricula to develop apps compatible with multiple OS - currently offered by few competitors or substitutes

Offering unique customer value with unlimited online/offline content access. Making Leapfrog an early mover in the subscriber based online educational

entertainment segment with the potential to increase its market share

Figure 36 below outlines differentiation before and after the LeapFrog Landing initiative:

Figure 36: Differentiation Driven by LFL

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8.4 IT Capabilities Fit

LeapFrog currently possesses the technical expertise to develop apps; evident from its current offerings through LeapPad, The App Center, and their (limited) presence within iTunes. It also outsources much of its IT infrastructure.67

The proposed initiative will leverage the following IT driven product strengths to deliver the enhanced value to the customers

Recommendation engine Learning Path Adaptive learning

LeapFrog will utilize a cloud based solution offered by Amazon to deliver LeapFrog Landing service to customers; in-line with its current IT strategy of outsourcing commodity services.

LeapFrog Landing not only aligns with LeapFrog’s current strategy but bolsters their business model. LFL will create clear, sustainable differentiation from competitors and prepare LeapFrog to tackle future competition by providing a strong and unique customer value proposition.

9.0 Initiative Financial Impact Summary

The threat of substitutes to LeapFrog’s core business manifests itself over the next 5 years as forecasted LeapPad revenue begins a significant, decline. The LeapFrog Landing (Table 4 below) initiative68 addresses this negative impact to LeapPad revenue, and it provides a platform upon which the company can build both significant revenue streams and higher operating margins. Additionally, the LeapFrog Landing subscription service delivers recurring revenue streams, providing both management and shareholders enhanced visibility into future performance.69

ScenarioTotal

Project Cost

Total Project Operating

Income 2013-2017

NPV (10% Discount Rate)

Payback Period

(In Months)

Worst Case $36,199,000 $53,127,000 $40,279,000 40.92

Most Likely Case $39,022,000 $291,238,000 $220,804,000 8.04

Best Case $101,564,000 $1,203,806,000 $912,129,000 5.04

67 Based on LeapFrog job openings. 68 For additional details, see pro-forma LeapFrog income statements in Appendix B for all scenarios, periods 2013 through 2017, and the associated assumptions upon which pro-forma income statements are based in Appendix C.69 As noted before, LeapFrog’s current product and service mix leads to highly seasonal revenue and profits.

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Table 4: LeapFrog Landing project cost, operating income, NPV, and payback period

9.1 LeapPad Revenue 2013-2017

Although not solely attributable to the LeapFrog Landing initiative, it is important to note (within Figure 37 below) that forecasts indicate LeapPad revenue declines in all scenarios during years 2015-2017.

2013 2014 2015 2016 2017 $-

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Worst CaseMost Likely CaseBest Case

Figure 37: LeapPad revenue 2013-2017

9.2 LeapFrog Landing Revenue 2013-2017

LeapFrog Landing launches in 201470 and generates increasing revenue (Figure 39 below) during years 2014-2017 based on subscriptions (Figure 38 below) from existing LeapPad customers that migrate to the new service, and from net-new customers.

70 LeapFrog Landing launches in 2014 with the 50 most popular apps, and in both the most likely and best case scenarios, migration of remaining apps completes in 2014. In the worst case scenario, due to project overruns, the migration of remaining apps completes in 2015.

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2013 2014 2015 2016 20170

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4000

5000

6000LFL Subscriber Growth 2013-2017 (in thousands)


Figure 38: LeapFrog Landing subscriber growth 2013-2017

2013 2014 2015 2016 2017 $-

$50,000 $100,000 $150,000 $200,000 $250,000 $300,000 $350,000 $400,000 $450,000 $500,000

LeapFrog Landing Revenue 2013-2017 (in thousands)


Figure 39: LeapFrog Landing subscription revenue 2013-2017

9.3 LeapFrog Total Revenue 2013-2017

In all scenarios – worst, most likely, and best – LeapFrog must carefully manage a difficult product transition as LeapPad revenue declines and as LeapFrog Landing revenue ramps up. While the best case scenario shows a smooth transition, the worst and most likely case scenarios indicate a choppy transition as LeapFrog Landing revenue fails to grow as fast as LeapPad revenue declines (figure 40 below).

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2013 2014 2015 2016 2017 $-

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

$1,400,000 LeapFrog Total Revenue 2013-2017 (in thousands)


Figure 40 - LeapFrog Total Revenue 2013-2017

9.4 LeapFrog Operating Margins 2013-2017

Although, overall revenue growth is choppy, operating margin growth is consistent in two of the three scenarios. LeapFrog Landing is a software-based service therefore, cost of goods sold (COGS) decreases as a percentage of revenue. Figure 41 below represents operating margin growth for years 2013-2017.

2013 2014 2015 2016 20170.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%LeapFrog Operating Margins 2013-2017


Figure 41: LeapFrog operating margins 2013-2017

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9.5 LeapFrog Pro-Forma Income Statements 2013-2017

Tables in Appendix B provide LeapFrog pro-forma income statements for the worst case, most likely case, and best case scenarios respectively:

Appendix B, Table 5 – LeapFrog worst-case scenario pro-forma income statement Appendix B, Table 6 - LeapFrog most-likely scenario pro-forma income statement Appendix B, Table 7 - LeapFrog best-case scenario pro-forma income statement

9.6 Financial Impact Assumptions

Appendix C, Table 8 details all assumptions that apply to the financial impact analysis, including:

definitions of the worst, most likely, and best case scenarios project cost model assumptions revenue model assumptions income statement assumptions

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10.0Conclusion

The core problem LeapFrog founder Mike Wood sought to solve in 1995 for his son exists today just as it did 18 years ago. In an increasingly competitive global economy where educational outcomes are in question, parents seek to provide their children with “educationally nutritious” entertainment to assist with their children’s learning and development. Since early 2011, LeapFrog has executed an effective strategy with the LeapPad. Its focus on value by leveraging its unique resources and capabilities has resonated with parents and children, delivering strong revenue and profit growth. However, the LeapPad is under assault from general-purpose adult tablets, smartphones, and the apps available for these devices. Explosive tablet growth in the household and in the classroom represents LeapFrog’s most pressing challenge, and while the company is experiencing success financially with the LeapPad, it must not be lulled into a false sense of security. Interestingly, LeapFrog experienced a similar challenge with its Leapster handheld gaming device; 71 the introduction of the LeapPad was the company’s response. Unfortunately, the company must once again act quickly to respond to substitutes. If the company does nothing, it faces significant negative financial impact as LeapPad revenue is expected to decline sharply.

LeapFrog Landing provides the company with a strong response to the strategic threat of general purpose tablets and smartphones. This new subscription-based service enables customers to access the company’s research-driven and award-winning educational entertainment via Android and iOS devices, leveraging the growth of these platforms. Migration to these platforms offers exciting new ways for parents and family members to engage with their children through interactive game play via other devices in the household. Through a simple, easy-to-use app that controls access to other apps and the Internet, children access the same high quality content – including the largest educationally-focused catalog of 325 apps – that currently exists for the LeapPad. LFL delivers this value for a low-monthly fee that recognizes the downward pressure of app prices. Given the extent of the LeapFrog content catalog and the significant resources and capabilities that deliver this catalog, this new service is something few, if any, existing or emerging competitors can match very easily.

Although delivery of LFL requires significant effort and financial resources, this initiative is something LeapFrog can and should undertake. The transition to a subscription-based service exploits existing resources, capabilities, and value drivers to enhance LeapFrog’s existing value proposition. The company has ample cash on hand, and an investment in LFL drives significant recurring revenue and higher operating margins. Finally, with a move towards Web standards such as HTML5, the company better insulates itself from shifting platform demand, and it also positions itself to take advantage of emerging platforms, 72 an existing stated focus of management.71 See http://tinyurl.com/mt5gezo72 See also Pandora’s use of HTML5: http://tinyurl.com/ll5pqdh

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http://tinyurl.com/ll5pqdh

AppendixAppendix A: LFL Mobile App Navigation for Parent Mode

Figure 41: LeapFrog Landing Navigation for Parent Mode

Appendix B: Pro-forma Income Statements

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Figures in USD Thousands (000's), Years Ending 31-DEC

2012% of

Revenue

2013% of

Revenue

2014% of

Revenue

2015% of

Revenue

2016% of

Revenue

2017% of

Revenue

Revenue

Net sales 581,28

8 100.00

% 645,6

34 100.00

% 694,207 100.00

% 637,7

57 100.00

% 620,7

98 100.00

% 629,3

09 100.00

%

Cost of sales 336,34

4 57.86% 368,0

11 57.00% 395,698 57.00% 363,5

21 57.00% 347,6

47 56.00% 352,4

13 56.00%

Gross profit 244,944 42.14% 277,623 43.00% 298,509 43.00% 274,236 43.00% 273,151 44.00% 276,896 44.00%

Operating expensesSelling, general & administrative

89,599 15.41%

96,845 15.00%

107,602 15.50%

98,852 15.50%

93,120 15.00%

94,396 15.00%

Research & development

36,627 6.30%

51,651 8.00%

55,537 8.00%

54,209 8.50%

43,456 7.00%

44,052 7.00%

Advertising 43,02

3 7.40% 45,1

94 7.00% 52,0

65 7.50% 47,8

32 7.50% 43,4

56 7.00% 44,0

52 7.00%

Depreciation & amortization

11,629 2.00%

12,913 2.00%

13,884 2.00%

12,755 2.00%

12,416 2.00%

12,586 2.00%

Total operating expenses

180,878 31.12%

206,603 32.00%

229,088 33.00%

213,649 33.50%

192,447 31.00%

195,086 31.00%

Income (loss) from operations

64,066 11.02%

71,020 11.00%

69,421 10.00%

60,587 9.50%

80,704 13.00%

81,810 13.00%

Earnings before interest and taxes/operating margin 64,066 11.02%

71,020 11.00%

69,421 10.00%

60,587 9.50%

80,704 13.00%

81,810 13.00%

Other income (expense)

Interest income 24

1 0.04%

Interest expense (

50) -0.01%

Other income (expense), net

(2,309) -0.40%

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Total other income (expense), net

(2,118) -0.36%

Income (loss) before income taxes 61,948 10.66%

Provision for (benefit) income taxes

(24,504) -4.22%

Net income (loss) 86,45

2 14.87%

Table 5 - LeapFrog worst-case scenario pro-forma income statement

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2012% of

Revenue

2013% of

Revenue

2014% of

Revenue

2015% of

Revenue

2016% of

Revenue

2017% of

Revenue

Revenue

Net sales 581,28

8 100.00

% 645,6

34 100.00

% 763,4

47 100.00

% 731,1

32 100.00

% 725,9

88 100.00

% 741,9

10 100.00

%


4 57.86% 361,5

55 56.00% 419,8

96 55.00% 394,8

12 54.00% 384,7

74 53.00% 385,7

93 52.00%

Gross profit 244,944 42.14% 284,07

9 44.00% 343,55

1 45.00% 336,32

1 46.00% 341,21

5 47.00% 356,11

7 48.00%


89,599 15.41%

96,845 15.00%

118,334 15.50%

113,326 15.50%

108,898 15.00%

111,287 15.00%

Research & development

36,627 6.30%

51,651 8.00%

61,076 8.00%

51,179 7.00%

50,819 7.00%

51,934 7.00%

Advertising 43,02

3 7.40% 45,1

94 7.00% 57,2

58 7.50% 54,8

35 7.50% 50,8

19 7.00% 51,9

34 7.00%


11,629 2.00%

12,913 2.00%

15,269 2.00%

14,623 2.00%

14,520 2.00%

14,838 2.00%

Total operating expenses

180,878 31.12%

206,603 32.00%

251,937 33.00%

233,962 32.00%

225,056 31.00%

229,992 31.00%


64,066 11.02%

77,476 12.00%

91,614 12.00%

102,359 14.00%

116,158 16.00%

126,125 17.00%

Earnings before interest and taxes/operating margin 64,066 11.02%

77,476 12.00%

91,614 12.00%

102,359 14.00%

116,158 16.00%

126,125 17.00%


Interest income 24

1 0.04%

Interest expense (

50) -0.01%


(2,309) -0.40%

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(2,118) -0.36%

Income (loss) before income taxes 61,948 10.66%


(24,504) -4.22%


2 14.87%

Table 6 - LeapFrog most-likely case scenario pro-forma income statement

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2012% of

Revenue

2013% of

Revenue

2014% of

Revenue

2015% of

Revenue

2016% of

Revenue

2017% of

Revenue

Revenue

Net sales 581,28

8 100.00

% 645,6

34 100.00

% 932,0

67 100.00

% 973,8

31 100.00

% 1,048,9

81 100.00

% 1,161,4

49 100.00

%


4 57.86% 355,0

99 55.00% 493,9

95 53.00% 496,6

54 51.00% 514,0

01 49.00% 545,8

81 47.00%

Gross profit 244,944 42.14

% 290,53

5 45.00

% 438,07

1 47.00

% 477,17

7 49.00

% 534,98

0 51.00

% 615,56

8 53.00

%


89,599 15.41%

96,845 15.00%

116,508 12.50%

121,729 12.50%

125,878 12.00%

139,374 12.00%

Research & development 36,62

7 6.30% 51,6

51 8.00% 74,5

65 8.00% 68,1

68 7.00% 73,4

29 7.00% 81,3

01 7.00%

Advertising 43,02

3 7.40% 45,1

94 7.00% 69,9

05 7.50% 73,0

37 7.50% 73,4

29 7.00% 81,3

01 7.00%


11,629 2.00%

12,913 2.00%

18,641 2.00%

19,477 2.00%

20,980 2.00%

23,229 2.00%

Total operating expenses 180,87

8 31.12% 206,6

03 32.00% 279,6

20 30.00% 282,4

11 29.00% 293,7

15 28.00% 325,2

06 28.00%


64,066 11.02%

83,932 13.00%

158,451 17.00%

194,766 20.00%

241,266 23.00%

290,362 25.00%

Earnings before interest and taxes/operating margin 64,066

11.02%

83,932

13.00%

158,451

17.00%

194,766

20.00%

241,266

23.00%

290,362

25.00%


Interest income 24

1 0.04%

Interest expense (

50) -0.01%


(2,309) -0.40%

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(2,118) -0.36%

Income (loss) before income taxes 61,948

10.66%


(24,504) -4.22%


2 14.87%

Table 7 - LeapFrog best-case scenario pro-forma income statement

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Appendix C: Financial Impact Assumptions

DEFINITIONS OF WORST, MOST LIKLEY AND BEST CASE SCENARIOS (SEE ALSO REVENUE MODEL ASSUMPTIONS)

The following four variable inputs are associated with each scenario:

(1) LeapFrog Landing monthly subscription fee(2) LeapFrog Landing annual subscriber initial capture rate and subsequent YOY growth rate for

migration and net-new customers(3) LeapPad revenue growth rates(4) Project duration

Worst case inputs set to:

(1) 2.99 and 3.99 per month for migration and net-new subscribers respectively,(2) 8% initial capture rate for existing (migration) LeapPad customers and 8% subsequent YOY

growth; 8% of migration subscribers as the initial capture rate for net-new subscribers and 8% subsequent YOY growth,

(3) 0% or flat LeapPad revenue growth during 2014 and 40% revenue decline per year during 2015-2017.

(4) 30 months starting 01-JUL-2013

Most likely case inputs set to:

(1) 4.99 and 5.99 per month for migration and net-new subscribers respectively(2) 15% initial capture rate for existing (migration) LeapPad customers and 15% subsequent YOY

growth; 15% of migration subscribers as the initial capture rate for net-new subscribers, and 15% subsequent YOY growth

(3) 10% LeapPad revenue growth during 2014 and 30% revenue decline per year during 2015-2017. (4) 18 months starting 01-JUL-2013

Best case inputs set to:

(1) 6.99 and 7.99 per month for migration and net-new subscribers respectively(2) 30% initial capture rate for existing (migration) LeapPad customers and 30% subsequent YOY

growth; 30% of migration subscribers as the initial capture rate for net-new subscribers, and 30% subsequent YOY growth (

(3) 20% LeapPad revenue growth during 2014 and 20% revenue decline per year during 2015-2017. (4) 18 months starting 01-JUL-2013

PROJECT COST MODEL ASSUMPTIONS

COGS: LeapFrog Landing hosting costs, including both infrastructure (IaaS, PaaS) and web analytics software (SaaS) provided by Amazon Web Services; $1M hosting fees per year starting in 2014 in all scenarios.

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SGA: Pro-forma LeapFrog Landing operating income includes SGA for employee recruiting and training related to the project, and for employee incentive compensation associated with the rollout of the new service, approximately 10% of initiative revenue during both 2014 and 2015.

Project R&D Costs: 325 total apps to port over 18 months (most likely and best case scenarios, 30 months worst case scenario) starting 7/1/13. Estimating 7 FTE per app per month, with each team completing 6 apps over 6 months. With 50 apps to complete in year one = 8.33 teams in year one; $75 per hour developer costs, 140 hrs per month; 20% overhead includes project and executive management costs, and R&D incentive compensation costs. In the most likely and best case scenarios, the migration of remaining apps in the catalog (275) completes in 2014, assuming project team productivity increases over 2013. In the worst case scenario, due to project overruns, the migration of remaining apps in the catalog (275) completes in 2015.

Discount rate: 10%

REVENUE MODEL ASSUMPTIONS

Subscriber initial capture and YOY growth: At end of 2013, LeapFrog is expected to have 15.6M connected parents; this is based on 13M (actual) at end of 2012 plus 20% growth during 2013. Based on the existing assumption that 40% of multi-media learning platform (MMLP) revenue is attributable to the LeapPad, then at end of 2013, 40% of forecasted 15.6M of connected customers are LeapPad customers and are target customers to migrate to the LeapFrog Landing subscription service. For all scenarios - worst case, most likely case, and best case - the initial subscription capture rates for both migration customers and net-new customers, and the YOY subscription growth rates use Sirius radio (8% initial capture/YOY growth) (Source: http://tinyurl.com/m8w7fby), Rhapsody (15%) (Source: http://tinyurl.com/mxwvltp), and Hulu (30%) (Source: http://tinyurl.com/jwlt8ro). For Hulu, the actual growth rate is approximately 50% YOY. Because the target audience for LeapFrog Landing is a smaller subset (children 3-9 years old) of the general populace versus Hulu (whose target is a broader subset of the general populace), there are limits above which growth is unreasonable because subscribers cannot be more than the actual number of children 3-9 years old. As such, the best case initial capture and YOY growth rate is capped at 30%.

Monthly subscription fees: A majority of mobile devices (tablets and smartphones) have fewer than 20 apps specifically for children (Source: http://tinyurl.com/kdswag9). Using approximately 15 apps per customer at an average LeapFrog price per app as 8.71 as a starting point to price the LeapFrog Landing service you get a value of approximately $131. Assuming apps have a "life" of one year, then parents would spend $131 per year on LeapFrog apps. The starting point to evaluate a monthly subscription fee is then nearly $11 per month. However, this does not factor in downward pressure on LeapFrog app prices based on substitutes that exist on iTunes and Google Play. This also does not factor in substitutes such as Amazon's Kindle Free Time Unlimited (children's app and video subscription service with parental controls) which is priced at $4.99 per month for a single child. Based on these factors, the monthly subscription fee for the LeapFrog Landing service is set at $3.99 (worst case), 5.99 (most likely), and 7.99 (best case) per month for an unlimited number of children. A $1 per month discount is offered to all existing LeapPad customers to migrate to the LeapFrog Landing service.

LeapPad Revenue: LeapPad specific revenue is not broken out but instead included in multi-media learning platform (MMLP) revenues (which includes all revenues associated with LeapPad, Leapster, LeapReader, and all associated revenues from apps, accessories, etc.); in 2010 and 2011, MMLP revenue was 69% of revenue, and in 2012 it was 80%; it is assumed that LeapPad and associated revenue was 40% in 2012. The remaining revenue (60% of MMLP) includes Leapster, Tag, and associated apps and accessories. The LeapFrog Landing service is expected to go live 01-JAN-2014 and will materially cannibalize LeapPad revenue starting 2015; this decline would have happened anyway due to the emerging threat of substitutes and as such this cost is not included in pro-forma project costs. LeapPad revenue growth is forecasted to be 20% in 2013. In 2014, because the LeapFrog Landing service is available only in the U.S. LeapPad revenue will grow (flat in worst case scenario) due to international

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sales. Then in 2015-2017, LeapPad revenue declines 40%, 30% and 20% YOY in the worst, most likely, and best case scenarios.

Remaining MMLP Revenue: Remaining MMLP revenue (Leapster, Tag, and associated apps and accessories) grows 10% annually 2013-2017

Learning Toys Revenue: Learning toys revenue (19% of revenue in 2012) shrinks in revenue 2% annually 2013-2017; other revenue (1% of revenue in 2012) remains as 1% of revenue 2013-2017.

Other Revenue: Consistent with 2012 actuals, other revenue remains constant as 1% of overall revenue for years 2013-2017.

INCOME STATEMENT MODEL ASSUMPTIONS

COGS: As LeapPad revenue declines and as LeapFrog Landing revenue increases and becomes a greater share of revenue, COGS decreases as a percent of revenue. Starting 2014 when the LeapFrog Landing service starts, COGS includes LeapFrog Landing hosting costs. Service hosting is provided by Amazon Web Services and it is estimated that hosting costs will be $1 million per year based on CPU, memory, storage, database, data transfer, monitoring, and disaster recovery (multiple hosting locations) capabilities.

SGA: Over the period 2010-2012, SGA has been trending down (17.47, 17.13, 15.41 respectively). During 2013, SGA decreases as a percent of revenue, then increases in 2014 and 2015 to account for increased compensation costs associated with the new initiative. SGA then decreases again as a percent of revenue in 2016-2017. In the most likely scenario, SGA decreases as a percent of revenue but increases in absolute terms due to significant growth of the LeapFrog Landing service revenue.

R&D: Over the period 2010-2012, R&D has been trending down (8.12, 7.42, 6.3 respectively). During 2013 and 2014, R&D increases as a percent of revenue to account for increased costs associated with the new initiative. R&D then decreases again as a percent of revenue in 2015-2017. In the worst scenario, R&D increases also in 2015 as a percent of revenue due to project delays/cost overruns.

Advertising: Over the period 2010-2012, advertising has been trending down (11.41, 8.68, 7.4 respectively). During 2013, SGA decreases as a percent of revenue, then increases in 2014 and 2015 to account for increased advertising associated with the new initiative. Advertising then decreases again as a percent of revenue in 2016-2017. In the most likely scenario, advertising decreases as a percent of revenue but increases in absolute terms due to significant growth of the LeapFrog Landing service revenue.

Depreciation and Amortization: It is assumed that depreciation and amortization costs remain unchanged as a percent of revenues over the period 2013-2017. Note that the entire project cost is expensed vs capitalized. Per the 2012 10K, the following content development costs are capitalized "design, artwork, animation, layout, editing, voice, audio". For the LeapFrog Landing service, these elements of content exist already and the R&D effort consists of an effort to migrate existing content to another platform.

Operating Income: Both EBIT and net income (including net income per share) are calculated and presented in 2012 (actual), but in all forecasted years (2013-2017), to simplify the forecast only EBIT is presented. This is due to the lack of stable assumptions upon which to base the calculation of a tax rate and the provision of taxes. LeapFrog in 2012 calculated its provision for taxes using "the asset and liability method" (see 2012 10K) and as of 31-DEC-2012, the company had approximately $140 million in net operating losses to carry forward. During 2012, LeapFrog had negligible interest income and expense, no debt, and all forecasted years assume no interest income and expense.

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Table 8 - Financial impact analysis assumptions

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Appendix D: Awards

73

74

73 Source: LeapFrog Investor Presentation – 05/21/201374 Source: LeapFrog Investor Presentation – 05/21/2013

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Appendix E: Content Partnerships

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75 Source: LeapFrog Investor Presentation – 05/21/2013 of 67

csp2013c team 4

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