Learn to Read with Bobyfonics is a great first app for toddlers to get them started on their letters and reading journey.
It offers three difficulty levels and is very easy for them to play. A narrator and a fun bear direct the toddler to press the letter, or letter combo, that make the sound indicated.
Advance through the levels and basic words start appearing. This app will teach five sight words to your toddler and 17 letter sounds.
Babyfonics also offers a full phonics-learning app for children who are slightly older and ready to start learning to read for real. But I find this app to be at a very good level for kids under the age of five.
Compatible with iPhone, iPod touch, and iPad.