LeapFrog 2008 Annual Report Download - page 11

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PART I
ITEM 1. BUSINESS
LeapFrog Enterprises, Inc. (“LeapFrog” or “we”), founded and incorporated in the State of Delaware in
1995, designs, develops and markets a family of innovative technology-based learning platforms and related
proprietary content for children of all ages at home and in schools around the world. LeapFrog has developed a
number of learning platforms, including the LeapPad Learning System, Leapster, Tag reading system, Clickstart,
and Didj, that support a broad library of software titles. We have created more than 150 interactive software
titles, covering subjects such as phonics, reading, writing, and math. In addition, we market a broad line of stand-
alone educational toys that do not require the separate purchase of software. These learning toys are generally
targeted at young children—from infants to five year olds. Our products are available in six languages and are
sold globally through retailers, distributors, directly to consumers via the leapfrog.com webstore, and directly to
schools. Our goal is to create educational products that kids love, parents trust and teachers value.
Since April 2004 we have been a majority-owned subsidiary of Mollusk Holdings, LLC (“Mollusk”), an
entity controlled by Lawrence J. Ellison, Chief Executive Officer of Oracle Corporation.
Impact of Economic Environment and Strategic Implications
The world has been suffering the effects of a nearly unprecedented meltdown in the global economy, the
pace of which accelerated during the fourth quarter of 2008. Many reports indicate that most, if not all, consumer
product companies have been severely affected due to the impact of weaker consumer spending, particularly with
respect to discretionary items. The prevailing adverse and macroeconomic conditions continued to deteriorate
into December of 2008; this crisis resulted in what many analysts have characterized as the worst shopping
holiday season in decades. In 2008, the toy industry experienced its first year-over-year sales decline in 30 years.
In line with the broader trends, the timing and severity of the economic collapse also had a negative impact on us.
Our sales increased 23% during the first nine months of 2008 as compared to the same 2007 period as in
2008, we launched our first four web-connected products, an expansive new library of content, and the learning
feedback technology we market as LeapFrog Learning Path. However, we were not immune to the increasingly
chaotic macroeconomic conditions in the fourth quarter of 2008. Our fourth quarter sales results were weaker
than expected, declining 24% year-over-year, which slowed 2008 full year-over-year sales growth to 4%. In
addition to the lower than expected sales, we recorded approximately $23.5 million in charges that reduced our
operating income during the fourth quarter of 2008. Anticipating strong consumer response to our new products
and a reasonable, though late-arriving holiday season for toy products, we shipped to retailers just as the
economic deterioration accelerated. The $23.5 million in charges related primarily to the higher than expected
levels of inventory remaining on hand at our retailers at year end, which drove increases in promotional
allowances to assist our retailers in selling through to consumers and increases to the sales return reserves, and an
increase to our bad debt reserves due to the deteriorating financial conditions of certain retailers.
We expect these adverse macroeconomic conditions to continue throughout most of 2009; therefore,
achieving profitability during this challenging environment will require enhanced discipline and focus. We will
continue to identify and develop opportunities to drive efficiencies and reduce our cost structure in
2009. However, we also plan to invest where prudent; our 2009 strategies will be focused on driving sales of our
learn-to-read and educational gaming market platforms, introducing additional connected products, expanding
our content library, establishing parents’ familiarity with the LeapFrog Learning Path, expanding our online play
components, introducing learning toy products with lower price points and finally, continuing to hire, retain and
reward our key talent. Also in 2009, we plan to substantially reduce spending to fully reflect our estimates of
softer net sales given high retail inventories at the end of 2008 and a weak 2009 economy.
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