Not Leap's Year

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The past year has been a test of Leap Group's reason for being, one the Chicago-based agency holding company hasn't passed yet. Client turnover, a misfire in the opening of a West Coast beachhead and resulting litigation have taken a toll. By Jan. 23, Leap's stock was trading at $1.22 per share, down from an opening price of $10 when the stock began trading in September 1996. That's quite a comedown for an agency group that said, in the filing for its initial public offering, that it would mix and match new media with traditional advertising and marketing services to become "a new generation advertising agency" building "long-term marketing partnerships with marquee clients." In 1997, it was fired by what had been its two largest clients, Nike and 3Com Corp. Nike accounted for 25% of Leap's revenues for the fiscal year ended Jan. 31, 1997, and 3Com's U.S. Robotics account represented nearly as much.


Based on its recent track record, Leap hasn't proven yet whether it can make consistent profits or build long relationships. But management is still betting it will. "It's been a long last year," admitted Thomas Sharbaugh, president of Leap Partnership, the flagship ad agency. But the company plans to deliver on the bottom line in 1998, he said. Like many other young agencies configured around new media, Leap has been earning its keep in areas outside interactive advertising. Given recent revenue generation, Leap looks more like an ethnic marketing agency than the cutting-edge shop it touted itself as to woo investors. Last year, the company bought YAR Communications, a New York multicultural marketing agency, for $23.3 million cash, and followed that by buying New York-based Asian-American shop Kang & Lee. For Kang & Lee, it paid $1.3 million cash, plus agreed to pay out 40% of the shop's pre-tax profits over the next three years to the shop's principals.


Actually, it's Leap's acquisition record that is helping cause skepticism of its prospects among investment bankers and industry analysts. Most believe Leap went public too soon, before there was the revenue flow to back up the stock price. "Leap is a microcosm of where the stock market became overenthusiastic over a company that went public when there wasn't much they could sell," said Abe Jones, managing director of AdMedia Partners, New York. Some take the fact that YAR was acquired for cash instead of stock as a sign there isn't much equity built into Leap Group. "Leap Partnership has not been a financial success," said a financial consultant who has handled several agency acquisitions. "What they were saying was, `We have this agency, give us money and we will make acquisitions.' "


Acquisitions did help Leap through its tough third quarter, helping the company boost revenues that otherwise would have declined sharply as a result of client defections. The holding company posted $7.2 million in revenues for the fiscal third quarter ended Oct. 31, up 44% from the comparable 1996 period. But subtract YAR's revenues of $4.7 million, and revenues from Leap's ongoing business actually plummeted 50% in the period, to $2.5 million. Similarly, for the nine months ended Oct. 31, Leap reported revenues of $19.2 million, up 56% from 1996. But minus YAR's $11.5 million, revenues would have fallen 37% to $7.7 million. Partially reflecting a $1.2 million restructuring charge for its struggling Santa Monica, Calif., office, Leap posted a $3 million loss for the third quarter and $5.7 million loss for the nine months. Those losses wiped out the $2 million in profits Leap managed in the previous two fiscal years--$1.3 million in the fiscal year ended Jan. 31, 1997, and $700,460 for fiscal '96.


Mr. Sharbaugh said that acquisitions are part of the holding company's plan--investments in infrastructure that will pay off even- tually. At this time, YAR is the largest company Leap owns, and because of that Mr. Jones notes that "in a way, [Leap] changed their strategy" and Leap is not really "in new media." But Leap has not altered its original vision, said Mr. Sharbaugh, who noted that all along the idea was to build an agency company that put interactive on an equal footing with all other ad disciplines. From the beginning, interactive was to be an immediate focus--Quantum Leap was formed in January 1997--while multicultural marketing was to be filled in through acquisition. "We've been talking the same talk from the beginning," said Mr. Sharbaugh. "Wall Street, for whatever reason, seems to operate on simplicity and stereotypes and tagged us as a technology company." Although Leap Partnership encountered losses, it has added new business. It earned a major endorsement last year from Anheuser-Busch, which hired the agency to handle Michelob; a new $30 million campaign breaks next month during the Winter Olympics (AA, Jan. 19).


That was a significant comeback after the December 1995 parting with A-B rival Miller Brewing Co. Miller accounted for 66% of Leap's revenues in fiscal 1996. And just weeks after 3Com consolidated its account last November, at Foote, Cone & Belding, San Francisco, Leap landed the account of modem technology rival Rockwell Semiconductor Systems. Sharon Hamilton, who left U.S. Robotics last fall to become director of marketing communications for Rockwell Semiconductor, said she jumped at the chance to work again with the agency. Leap will service the account in Santa Monica, relocating two key Chicago staffers who had worked on U.S. Robotics to California. Ms. Hamilton said she is unconcerned by Leap's financial losses or the early turmoil in the office. Leap's Santa Monica office opened with great fanfare in January 1997. By September, however, the office was restructured and forced to cut its 11-member staff. Among the cuts was Managing Director Steve Rabosky, who has sued the agency as a result (AA, Jan. 12). The opportunity to build Leap's California office had held considerable allure. And the lucky team snaring the job consisted of Mr. Rabosky, then managing partner of TBWA Chiat/Day's Venice, Calif., office, and Carisa Bianchi, an account director at the TBWA shop. In a surprise move to TBWA Chiat/ Day, the two left to join Leap--with four other TBWA executives. At first, the team thought it had carte blanche to build an agency over three years without worrying about profits. Not atypical of a startup, they unsuccessfully pitched a number of accounts before winning the $7 million Los Angeles Department of Power & Water business. But the ink was hardly dry on the news release when client management changed and the account was lost.


Soon pressure began mounting on the Santa Monica managers to bring the office into the black, according to the lawsuit subsequently filed by Mr. Rabosky in Orange County Superior Court. The suit was filed after Leap issued a September news release stating that the "unacceptable revenue performance" of the office forced it to put Mr. Sharbaugh in charge. In Mr. Rabosky's lawsuit, which seeks $500,000 plus damages, he claims the announcement hurt his reputation by implying he was not "aggressive, entrepreneurial and passionate" in doing his job. Barring a settlement, the lawsuit is expected to begin court procedures in April. Leap denied the claims and has said it "will vigorously defend" its position. In September, as losses and troubles in Santa Monica mounted, Chairman-CEO R. Steven Lutterbach stepped down as CEO, turning that responsibility over to Vice Chairman Fred Smith. If his cost-cutting plans succeed in turning around the company's revenue performance, acting CEO Mr. Smith is expected to get the job on a permanent basis. STRONGER IN `98 Mr. Smith forecasts the company will be much stronger and profitable in six months, as cost containment and new-client genera- tion bears fruit. Thanks to Michelob and Rockwell, he said, Leap Partnership will show much stronger revenue during the quarter ending Jan. 31 than it has in previous quarters, adding that Leap should show a profit for the quarter overall. "We will be profitable, and the Street will beat me up if we're not," said Mr. Smith. "We took our beating [before] and we got our act together. Now, let's go forward."

Contributing: Alice Z. Cuneo, Bradley Johnson.

Copyright January 1998, Crain Communications Inc.

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