LeapFrog 2006 Annual Report Download - page 54

During the second quarter, our net loss increased from $9.8 million in 2005 to $25.6 million in 2006. The
higher loss was due to a reduction of gross profit of $20.7 million. Gross margin was unfavorably impacted by
higher sales discounts and allowances and higher sales of closeout products. In addition, gross margin in the
second quarter of 2005 benefited from the reduction of allowance for defective products, while allowances for
defective products increased slightly in the second quarter of 2006. In addition, sales declined in all three of our
segments. The decline was primarily due to continuing sales volume decline in LeapPad family of products.
During the third quarter of 2006, our net loss increased by $82.5 million compared to the same period of
2005. Our gross profit had a reduction of $59.1 million in 2006 compared to 2005, due to lower sales and higher
discounts and allowances. In addition, as a result of the sales decline, combined with changing priorities related
to our updated strategic direction in 2006, we recorded $21.5 million of reserves for excess and obsolete
inventories in the third quarter. We also we recorded a $43.2 million 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”), resulting to higher income tax
expense.
During the fourth quarter, our net loss increased by $60.3 million from income of $14.3 in the fourth quarter
of 2005. Net sales declined approximately 27% on a consolidated basis reflecting lower LeapPad sales, and lower
sales of FLY in its last selling seasons, as well as the impact of retailers working off excess retailer inventories.
Gross margin decreased to 30% from 43% in 2005, mostly due to sales discounts and allowances to clear our and
retailer inventories. We also recorded a $3.1 million charge on purchase orders for inventory that we cancelled.
In addition, during the fourth quarter of 2006, we recorded charges for employee termination costs in selling,
general and administrative expense of $3.7 million.
Liquidity and Capital Resources
LeapFrog’s primary sources of liquidity in 2006 and 2005 have been:
• Net cash flows provided by operating activities in 2006.
• Proceeds from the exercise of employee stock options and the employee stock purchase plan in 2006
and 2005.
Cash and related balances are:
December 31,
2006(1) 2005(1) Change(1)
Cash and cash equivalents .............................................. $ 67.3 $48.4 $18.9
Short-term investments ................................................ 80.8 23.7 57.1
Total ........................................................... $148.1 $72.1 $76.0
% of total assets ...................................................... 33% 12%
Restricted Cash
Short-term ...................................................... $ — $ 0.2 $(0.2)
(1) In millions.
Financial Condition
We believe our current cash and short-term investments, anticipated cash flow from operations, and future
seasonal borrowings, if any, will be sufficient to meet our working capital and capital requirements through at
least the end of 2007.
Cash and cash equivalents increased $18.9 million in 2006 to $67.3 million from $48.4 million in 2005.
Together with short-term investments, the increase was $76.0 million. The increase was primarily due to the
reduction in inventory and accounts receivable, partially offset by reduced earnings. At December 31, 2006, we
47