LeapFrog 2007 Annual Report Download - page 93

LEAPFROG ENTERPRISES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share and percent data)
specified geographic territories. The total amount of royalty expense related to these license agreements was
$21,768, $14,839, and $15,193, for 2007, 2006 and 2005, respectively. LeapFrog recorded $8,114 and $6,723 in
accrued royalties at December 31, 2007 and 2006, respectively. The Company licenses its trademark or service
marks to third parties for manufacturing, marketing, distribution and sale of various products. The total amount
of royalty income related to these agreements was $1,540 and $479 in 2007 and 2006, respectively, which is
included in net sales. In addition, the Company wrote off $5,164 of advanced royalty payments made in prior
years, related to its FLY Fusion Pentop products in the U.S. Consumer Segment, and which had been recorded on
the balance sheet as prepaid expenses and other current assets.
12. 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. Current
constraints in the capital and credit market have recently adversely affected the market value of the Company’s
holdings of auction rate securities, and the Company recorded an other than temporary impairment expense of
$2,476 in the fourth quarter of 2007 against earnings and a temporary impairment of $598 in accumulated other
comprehensive income. Foreign exchange transactions consist primarily of short-term foreign currency
transactions with highly rated financial institutions.
LeapFrog 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 LeapFrog’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 LeapFrog to produce excess inventory, which could adversely affect 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 LeapFrog’s relations with its customers.
Vendor Concentration
LeapFrog’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.
LeapFrog uses contract manufacturers located in Asia, primarily in the People’s Republic of China to build its
finished products. Given the highly seasonal nature of our business, any unusual delays or quality control
problems could have a material adverse effect on LeapFrog’s operating results and financial condition.
LeapFrog’s top three vendors supplied a total of 52%, 72% and 44% of LeapFrog’s products in 2007, 2006 and
2005, respectively. Jetta Company Limited or Jetta, located in China, supplied 24%, 51% and 22%, respectively.
During 2007, 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.
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