Monday, January 28, 2008

LeapFrog Hopes for Next Hit With Interactive Reading Toy

EMERYVILLE, Calif.-- LeapFrog Enterprises needs a knockout hit.

The company’s LeapPad became an instant sensation after it was introduced in 1999 and helped turn the small educational toy maker into one of the fastest-growing toy companies in history. But as the LeapPad aged, LeapFrog’s fortunes sagged.

This week, LeapFrog pulls the wraps off the LeapPad’s successor, the Tag, a thick, white and green plastic stylus that turns paper books into interactive playthings. LeapFrog is betting that the $50 Tag, which will be available this summer along with an 18-volume library that includes children’s classics like “The Little Engine That Could” and “Olivia,” will be the hit it badly needs. It calls the Tag its “biggest launch ever.”

The Tag, officially called the Tag Reading System, works a lot like the LeapPad. Children can tap a word with it and the stylus reads the word, or its definition, aloud. They can tap on an image to hear a character’s voice come alive. Interactive games test their reading comprehension. At its simplest, the Tag can also act as an audio book and simply read a story from beginning to end.

But while the LeapPad system required spiral-bound books to be placed on a clunky, laptop-sized plastic console with a pointing device attached to it, LeapFrog has put all of the Tag’s smarts into the inch-and-a-half-thick stylus. It works on books whose pages are imprinted with invisible dots that allow a small infrared camera at the tip of the Tag to recognize words or images on the page. That makes it far more portable and easier to use than the LeapPad, says Jeffrey G. Katz, the chief executive of LeapFrog.

“LeapPad was a phenomenon,” said Mr. Katz. “But Tag is a better product.”

The real question that LeapFrog investors are asking, however, is whether Tag will match, or even approximate, the commercial success of the LeapPad. “I’m reluctant to say,” Mr. Katz said. “I think it can be bigger, but I’m not going to forecast that.”

It’s not hard to see why Mr. Katz hesitates. The LeapPad quickly became the industry’s best-selling toy — a first for an educational product.

LeapFrog went on to sell 30 million LeapPads and related products worldwide, as well as more than 70 million companion books. In 2003, the LeapPad family of products brought in $330 million, nearly half of LeapFrog’s revenues.

But the LeapPad’s appeal began fading as it faced growing competition from the likes of Fisher-Price and VTech.

For investors, the LeapFrog story quickly turned from fairy tale to bad dream. While LeapFrog has introduced several other award-winning products, none matched the LeapPad in sales or profitability. LeapPad sales plunged and the company racked up losses that, in the past two years alone, are expected to top $200 million. LeapFrog shares closed Friday at $5.81, almost 90 percent below their October 2003 peak.

Analysts say Mr. Katz, the former chief executive of the online travel booking service Orbitz, who became LeapFrog’s chief executive in the summer of 2006, has helped rein in expenses and resolve long-standing inventory and manufacturing problems. He made modest staff cuts. On Friday, he announced another 85 layoffs amounting to about 10 percent of the company’s workforce.

But the linchpin of Mr. Katz’s turnaround strategy is a string of products that LeapFrog plans to introduce in the next few months. None is more important that the Tag.

“Tag needs to be successful,” said Sean McGowan, an analyst with Needham & Company. “LeapFrog needs this to redefine their leadership in the reading market.”

The Tag will be shown at DEMO, a high-profile technology conference in Palm Desert, Calif.

Mr. McGowan and other analysts who have seen the product are upbeat about its prospects and note that it is priced appropriately and aimed at LeapFrog’s core demographic — 4- to 8-year-old children. But predicting success in the toy business is notoriously difficult. “We’ll see if the market wants it,” Mr. McGowan said.

The Tag has already garnered some fans.

“When you put your pen on a character that doesn’t even have a line in the book and there is something funny that comes out of the character’s mouth, it’s a kick,” said Jane O’Connor, author of the best-selling Fancy Nancy series. Two of her titles are being adapted for the Tag.

Ms. O’Connor, who described herself as “not a very pro-technology person,” was a skeptic at first, but has since come around.

“Sometimes it might be easier for a child who is struggling not to have a parent breathing down their neck,” she said. “You get stuck, you tap a word. The only expectation is coming from you, the kid.”

LeapFrog developed the Tag in a relatively short 18 months because it already had much of the technology on hand. The company had licensed the micro-dot reading technology from a Swedish company called the Anoto Group and in 2005 used it in the Fly, a “pentop computer.” Some of the Fly’s capabilities — you could draw a calculator on a piece of paper, for example, and use it to perform everything from additions to square roots by tapping the Fly on it — dazzled critics, and earned top toy industry awards.

But at $99 and aimed at tweens, who tend to gravitate toward sophisticated electronic gadgets like cellphones and MP3 players, the Fly fell far short of expectations and never came close to making up for the LeapPad’s decline. Only about 700,000 units were sold, according to analysts.

(Coincidentally, Jim Marggraff, a former LeapFrog executive who was a driving force behind both the LeapPad and the Fly, is now chief executive of Livescribe and will be at DEMO this week to introduce a more advanced pen-computer based on the Anoto technology, aimed at college students.)

Like the LeapPad, which is used as a learning aid in some 100,000 classrooms across the country, LeapFrog will market the Tag to schools. The Tag will also have something that the LeapPad and most other LeapFrog products have lacked: an Internet strategy.

Tag will be sold with a single book. Parents who purchase additional titles, which will cost $14 each, have to connect to the company’s Web site to download the digital versions of those books into the Tag’s memory. At the Web site, parents will be encouraged to create a profile page for their child. Every time they connect the Tag to the computer, a record of the child’s activities will be uploaded to that profile, giving parents a detailed look at what the child read, learned and struggled with.

Future LeapFrog products will work the same way, so parents will be able to track their children’s progress as they grow out of one LeapFrog toy and into another.

The site will also recommend new LeapFrog products, depending on a child’s progress.

“Historically, a shortcoming of LeapFrog is that we sold great products, but we had no up-sell,” Mr. Katz said. “The Web is the glue that hangs it all together.”

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