LeapFrog 2006 Annual Report Download - page 90

LEAPFROG ENTERPRISES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share and percent data)
In August 2005, the Company entered into a software capital lease agreement for a new enterprise resource
planning (ERP) system, Oracle 11i. The total commitment of the lease, which expires on December 31, 2007 is
$1,566. At December 31, 2006, the Company had a remaining balance of $570 related to this lease which is
included in the accrued liabilities and deferred revenue on the balance sheet.
12. Content License Agreements
The Company licenses certain of its content from third parties under exclusive and nonexclusive
agreements, which permit the Company to utilize characters, stories, illustrations and trade names throughout
specified geographic territories. The total amount of royalty expense related to these license agreements was
$14,839, $15,193, and $12,435 for the years ended December 31, 2006, 2005 and 2004, respectively. The
Company reflected $6,723 and $8,375 in accrued royalties at December 31, 2006 and 2005, respectively.
13. Concentrations of Credit Risk and Certain Other Risks
Financial instruments that subject the Company to concentrations of credit risk include cash equivalents,
short-term investments, foreign exchange transactions and trade receivables. Cash and cash equivalents consist
principally of cash and money market funds. Investments consist principally of auction rate certificates and
foreign exchange transactions with highly rated financial institutions.
The Company manufactures and sells its products primarily to national and regional mass-market retailers in
the United States. Credit is extended based on an evaluation of the customers’ financial condition, and generally
collateral is not required. Allowances for credit losses are provided for in the consolidated financial statements at
the time of sale.
Seasonality of Sales
Sales of the Company’s products have historically been highly seasonal with a significant majority of the
sales occurring during the third and fourth quarters. Failure to accurately predict and respond to consumer
demand may cause the Company to produce excess inventory, which could adversely affect the Company’s
operating results and financial condition. Conversely, if a product achieves greater success than anticipated, the
Company may not have sufficient inventory to meet retail demand, which could adversely impact the Company’s
relations with its customers.
Vendor Concentration
The Company’s manufacturing and operations strategy is designed to maximize the use of outsourced
services particularly with respect to the actual production and physical distribution of its products. The Company
believes that its outsourcing strategy enhances the scalability of the manufacturing process. Since the Company
does not have its own manufacturing facilities, it is dependent on close working relationships with its contract
manufacturers for the supply and quality of its products and the computer chips contained in these products. The
Company uses contract manufacturers located in Asia, primarily in the People’s Republic of China or PRC, to
build its finished products. Given the highly seasonal nature of the Company’s business, any unusual delays or
quality control problems could have a material adverse effect on the Company’s operating results and financial
condition. The Company’s top three vendors supplied a total of 72%, 44% and 42% of the Company’s products
in 2006, 2005 and 2004, respectively; Jetta Company Limited or Jetta, located in China, supplied 51%, 22% and
24%, respectively. During 2006, the Company used Jetta primarily for high volume production of its major
products such as Leapster, Leapster L-Max and related cartridges. The Company expects to continue to use a
limited number of contract manufacturers and fabricators, most of which are located in Asia.
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