LeapFrog 2006 Annual Report Download - page 37

Our loss from operations of $124.7 million, compared to income of $21.0 million in 2005, was primarily
driven by the decline in our sales, lower gross margin and higher operating expenses in our U.S. Consumer and
International segments.
Our provision for income taxes for 2006 was approximately $26.6 million, compared to $6.3 million for
2005. The increase in income tax expense was driven by the recognition of a non-cash charge to establish a
valuation allowance against our gross domestic deferred tax assets in accordance with the criteria of Statement of
Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS 109”).
Our net loss was $145.1 million for 2006, respectively, compared to net income of $17.5 million for 2005.
The change was primarily due to the decline in our sales, lower gross margin and higher income tax expense.
Our cash and cash equivalents combined with short-term investments increased to $148.1 million in 2006
from $72.2 million in 2005. The increase was primarily due to the reduction in our inventories and accounts
receivable, partially offset by reduced earnings.
Inventories, net of allowances, were $73.0 million at December 31, 2006 and $169.1 million at
December 31, 2005. Inventories decreased by $96.1 million, or 57%, from December 31, 2005 to December 31,
2006. In an effort to reduce inventory levels, we significantly curtailed 2006 inventory purchases, which resulted
in lower inventory levels at December 31, 2006. Inventory levels also reflect an increase of $10.0 million in the
allowance for excess and obsolete inventory. This increase was primarily due to our expectations related to future
sales of existing products as well as products to be discontinued or replaced as a result of our updated strategic
direction. We have implemented strategies intended to improve our capability to forecast and control our
inventory.
We have made and continue to make substantive changes that we believe will correct recent trends in our
business. Specifically, during 2006, we have taken the following actions:
• We have consolidated some of our business groups and support functions based on the newly created
core brands of our products. These changes are consistent with our ongoing strategic plan and goals and
we expect clearer accountability and authority over resources to lead to improved performance.
• We completed the consolidation of our engineering facilities with our corporate headquarters in
Emeryville, California during the fourth quarter of 2006. We expect the improved integration of
engineering with product and marketing to lead to product and cost improvements.
• During 2006 and early 2007, we hired new employees that have relevant experience and expertise for
our senior management team and skills consistent with our new plan. These include a new VP of
Software Engineering, VP of Web Products, EVP of International, VP of Hardware Engineering, EVP
of Product, Innovation and Marketing, and SVP of Human Resources. We have also promoted a number
of our most successful employees to senior roles.
• In July 2006, we completed the installation of the second phase of our Oracle 11i ERP system. This
system will improve the linkage between sales forecasting and inventory planning, and improve
customer service levels for our retail customers, as well as the quality and timeliness of information to
facilitate decision-making. The benefits of the ERP installation will not be fully realized until after the
2006 season. This system is also facilitating inventory reduction by our retailers.
• We completed our SKU “redesign” and rationalization, with total SKU reduction of 18% expected for
2007.
• We selected strategic suppliers and manufacturers to help us deliver our product strategy and improve
costs.
• We established a China engineering office to allow us to improve product costs and cycle times.
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