The Toy That's Leaping Off the Shelves

Five-year-old Alexia Hernandez has already mastered letters and numbers, and mother Michele thinks she knows why: Alexia has a LeapPad, one of the hottest-selling high-tech educational toys. "She thinks it's so cool and has learned so much from it," says Hernandez, a college admissions consultant in Lake Oswego, Ore. She says the toy, which emits sounds and music when kids point to pictures, numbers, and letters with a stylus, also has helped Alexia improve her hand-eye coordination and attention span.

Reviews like that have got business hopping at LeapPad's maker, LeapFrog Enterprises Inc. (LF ) in Emeryville, Calif. The ticket to a hot Christmas, says CEO Michael C. Wood: toys that make kids "squeal with delight but also help them learn a lot." LeapFrog is projecting a holiday-quarter sales jump of as much as 30% over last year, to $200 million, and a profit increase of as much as 86%, to $21.6 million. Its products account for 7 of the 15 top-selling toys at Inc.

LeapFrog has come a long way in seven years. Wood, searching for a way to teach his son phonics, started the outfit in 1995. Two years later, he sold it to Knowledge Universe Inc., a holding company founded by financier Michael Milken and Oracle Corp. (ORCL ) chief Lawrence J. Ellison. Sales have flown ever since, based largely on the LeapPad product. They should hit about $480 million this year, up from $31 million in 1998. The company went public in July, and its shares have since bounded 79%.

Now, LeapFrog is being touted as one of the rare bright spots in the $25 billion toy industry. Driving the company's success is its core LeapPad line, designed for children three and older. The basic $40 LeapPad looks like a notebook PC from the outside. Folded inside, though, is a kid's book and a stylus. Touch the stylus to the page, and the gadget reads stories out loud, identifies the sounds of musical instruments, and guides tots along on basic addition.

To keep parents buying, the company is working on new software and book inserts to upgrade the pads as kids grow older. LeapFrog now sells five such titles at about $15 each for every LeapPad, up from two a year ago. In each successive version, math, reading, and music lessons become increasingly challenging.

Those upgrades are key to LeapFrog's future success. Sales growth is slowing now that most retail outlets already offer LeapPads. The 30% projected sales gain for the fourth quarter is down from a 76% increase during the first three quarters.

And not everyone is singing LeapFrog's praises. Critics say the company is just preying on parents' fears that kids will be failures without the latest "educational" gizmo. Toys such as the LeapPad "might help keep your kid away from the junk on TV, but if you think it'll have anything but a minor effect academically, you're deluded," says Jonas Langer, a psychology professor at University of California at Berkeley.

Perhaps. But as long as parents keep buying LeapFrog toys, Wood and his well-known backers will enjoy the kind of math lesson investors like best.

By Louise Lee in San Mateo

    Before it's here, it's on the Bloomberg Terminal.