LeapFrog 2006 Annual Report Download - page 52

SchoolHouse. The year-over-year operating income decrease in our SchoolHouse segment was due to lower
sales and higher operating expenses, primarily due to increased headcount in 2005 compared to 2004.
Other
Net Interest Income and Other Income (Expense), Net. Net interest income increased by $1.7 million from
$1.7 million in 2004 to $3.4 million in 2005. This increase was due to higher interest rates in 2005 on invested
balances.
Tax Rate. Our effective tax rate for the year ended December 31, 2005 is 26.5% as compared to 47.6% in
2004. The change in effective tax rate was due to the mix of United States and international pre-tax income in
2005 as compared to 2004, higher research and development tax credits in 2005 and higher exempt interest
income in 2005, partially offset by reduced benefits from our international sourcing operations in 2005. In 2005,
we reported a pre-tax loss from our United States operations of $1,297 and a pre-tax income from our
international operations of $25,094. In 2004, we reported a pre-tax loss from United States operations of $13,514
and a pre-tax income from our international operations of $1,057.
Net Income (Loss)
Net income (loss) improved by $24.0 million from a loss of $6.5 million in 2004 to income of $17.5 million
in 2005 due to increased net sales, lower operating expenses and higher interest income. As a percentage of net
sales, net income increased from a loss of 1.0% in 2004 to a gain of 2.5% in 2005.
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 2006 and 2005.
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 2005, due to higher sales allowances, higher operating expenses and higher
expense for excess and obsolete inventory. We were also unprofitable in the third and fourth quarter of 2006, due
to higher inventory reserves in both quarters and a non-cash valuation allowance against our deferred tax assets
in the third quarter. Relatively low sales in the third and fourth quarter of 2006 also prevented us from being able
to absorb our relatively fixed operating expenses in these quarters. 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.
45