LeapFrog 2005 Annual Report Download - page 52

Other
Net Interest Income and Other (Expense) Income, net. Net interest income and Other income (expense), net
decreased by $4.8 million from income of $4.7 million in 2003 to expense of 0.2 million in 2004, primarily due
to the following factors:
• A cash settlement we received in the first quarter of 2003 from Benesse Corporation, one of our primary
distributors in Japan, for the early termination of a two-year sales agreement; and
• Gains in 2003 from fluctuation of foreign currency exchange rates. As discussed in the notes to our
financial statements, in January 2004 we implemented a foreign exchange hedging program that is
designed to minimize the impact of currency exchange rate movements on remeasurable balance sheet
items.
This was partially offset by higher net interest income resulting from our larger average cash balances and
higher interest rates on invested balances.
Tax Rate. Our effective tax rate was 47.6% in 2004 and was 37.0% in 2003. The change in effective tax rate
in 2004 resulted from several factors including tax benefits resulting from international sourcing operations,
research and development credits and state tax benefits. Due to our pre-tax loss, the tax benefits caused the
effective tax rate to increase.
Net Income (Loss)
Net income (loss) decreased by $79.2 million from income of $72.7 million in 2003 to a loss of $6.5 million
in 2004 due to the above-described factors. As a percentage of net sales, net income (loss) decreased from 10.7%
in 2002 to (1.0)% in 2004.
Seasonality and Quarterly Results of Operations
LeapFrog’s business is highly seasonal, with our retail customers making a large percentage of all purchases
in preparation for the traditional holiday season. Our business, being subject to these significant seasonal
fluctuations, generally realizes the majority of our net sales and all of our net income during the third and fourth
calendar quarters. These seasonal purchasing patterns and production lead times cause risk to our business
associated with the under-production of popular items and over-production of items that do not match consumer
demand. In addition we have seen our customers managing their inventories more stringently, requiring us to
ship products closer to the time they expect to sell to consumers, increasing our risk to meet the demand for
specific products at peak demand times, or adversely impacting our own inventory levels by the need to pre-build
products to meet the demand.
For more information, see “Item 1A.—Risk Factors—Our business is seasonal, and therefore our annual
operating results depend, in large part, on sales relating to the brief holiday season” and “—If we do not maintain
sufficient inventory levels or if we are unable to deliver our product to our customers in sufficient quantities, or if
our or our retailers’ inventory levels are too high, our operating results will be adversely affected.”
The following table sets forth unaudited quarterly statements of operations information for 2005 and 2004.
The unaudited quarterly information includes all normal recurring adjustments that management considers
necessary for a fair presentation of the information shown. Given the low sales volumes in the first half of the
calendar year, and the relatively fixed nature of our operating expenses, historically, we have been profitable in
our third and fourth quarters and unprofitable in our first and second quarters. We expect that we will continue to
incur losses during the first and second quarters of each year for the foreseeable future. In addition, we were
unprofitable in the fourth quarter of 2004, due to higher sales allowances, higher operating expenses and higher
expense for excess and obsolete inventory. Because of the seasonality of our business and other factors, results
for any interim period are not necessarily indicative of the results that may be achieved for the full fiscal year.
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