LeapFrog 2002 Annual Report Download - page 33

content sales will represent a growing portion of our net sales. In the future, our total gross profit margins may be
increasingly affected by sales in our Education and Training segment, which sales typically have higher gross
profit margins, and by net sales in our International segment, which sales typically have lower gross profit
margins.
Selling, general and administrative expenses consist primarily of salaries and related employee benefits,
legal, marketing expenses, systems costs, rent and office equipment and supplies. Our research and development
expenses consist primarily of costs associated with content development, product development and product
engineering. Our advertising expenses consist primarily of television advertising, cooperative advertising and in-
store displays. Depreciation and amortization expenses consist primarily of depreciation of capitalized website
development and content development expenses as well as depreciation of fixed assets, excluding manufacturing
tools which are classified in cost of sales.
Critical Accounting Policies, Judgments and Estimates
Our significant accounting policies are more fully described in Note 2 to our consolidated financial
statements. However, some of our accounting policies are particularly important to the portrayal of our financial
position and results of operations and require the application of significant judgment by our management. We
believe the following critical accounting policies, among others, affect our more significant judgments and
estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
We recognize revenue upon shipment of our products provided that there are no significant post-delivery
obligations to the customer and collection is reasonably assured, which generally occurs upon shipment, either
from our U.S. distribution facility or directly from our third-party manufacturers. Net sales represent gross sales
less negotiated price allowances based primarily on volume purchasing levels, estimated returns and allowances
for defective products. A small portion of our revenue is deferred and recognized as revenue over an eighteen
months period, which is the estimated period of use of the product. We deferred approximately 0.9% and 2.5% of
net sales in 2002 and 2001, respectively.
Allowances For Accounts Receivable
We reduce accounts receivable by an allowance for amounts that may become uncollectible in the future.
This allowance is an estimate based primarily on our management’s evaluation of the customer’s financial
condition, past collection history and aging of the receivable. If the financial condition of any of our customers
deteriorates, resulting in impairment of its ability to make payments, additional allowances may be required.
We provide estimated allowances for product returns, chargebacks, and defectives on product sales in the
same period that we record the related revenue. We estimate our allowances by utilizing historical information
for existing products. For new products, we estimate our allowances for product returns on specific terms for
product returns and our experience with similar products. In estimating returns, we analyze (i) historical returns
and sales patterns, (ii) analysis of credit memo data, (iii) current inventory on hand at customers, (iv) changes in
demand, and (v) introduction of new products. We continually assess the historical rates experience and adjust
our allowances as appropriate, and consider other known factors. If actual product returns, chargebacks, and
defective products are greater than our estimates, additional allowances may be required.
Inventories and Related Allowance For Slow-Moving, Excess and Obsolete Inventory
Inventories are stated at the lower of cost, on a first-in, first-out basis, or market value and are reduced by an
allowance for slow-moving, excess and obsolete inventories. Our estimate for slow-moving, excess and obsolete
inventories is based on our management’s review of on hand inventories compared to their estimated future
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