LeapFrog 2008 Annual Report Download - page 38

Fiscal Year 2008 Compared to Fiscal Year 2007
Net sales increased 7% primarily due to the strong performance of platform and related content products
associated with the key 2008 product launches of Tag, Leapster2 and Didj and solid net growth in LeapFrog.com,
offset by declining sales of older products such as the classic Leapster, LeapPad, Little Leaps, LeapTrack and
other school market-related products.
Net sales related to new platform products and related content introduced in 2008 totaled approximately
$104.5 million, or 29% of total 2008 United States net sales. Additionally, the ratio of platforms sold as a
percentage of total net sales increased to 42% in 2008 as compared to 36% and 34% in 2007 and 2006,
respectively. The increase in the ratio of platforms to net sales in 2008 was driven by the Tag, Leapster2 and Didj
launches; typically, new platform-related software sales lag platform adoption for a period after the platform is
initially released for sale.
Gross margin remained level at 40% year-over-year reflecting a number of offsetting factors. The 2008
gross margin benefited from sales of new, higher margin products launched during the year, lower asset write-
offs than those experienced in 2007, specifically the FLY Fusion assets which were written down to reflect
declining sales trends in 2007, and reductions in the allowances for unclaimed reimbursements due to customers
under promotional and co-operative advertising agreements, based on lack of customer performance and aging of
the claim. These improvements were essentially offset by lower sales through the school channel, increased
discounting and higher sales returns allowances related to weakening consumer demand and higher than expected
retail inventory levels at the end of 2008 and costs associated with a voluntary recall of the Didj recharging
station.
Loss from operations improved, reflecting the net sales increase and a decline in operating expenses. The
decrease in operating expenses is largely a result of lower headcount-related expenses due to headcount
reductions and lower legal and settlement costs in 2008.
Fiscal Year 2007 Compared to Fiscal Year 2006
U.S. net sales constituted 77% of LeapFrog’s total net sales for both 2007 and 2006. Net sales in the U.S.
decreased as the decline in sales of products being phased out and the decline in school-related revenue offset the
cost savings from the migration of certain aspects of our product development cycle to external parties, relatively
robust growth on LeapFrog.com and strong sales of our classic Leapster products.
Our gross margin improved significantly in 2007 as compared to 2006 due to lower allowances for excess
and obsolete inventory and an increased ratio of higher margin products sold to total net sales in 2007. These
positive effects were partially offset by a non-cash write-off of $8.0 million in 2007 associated with FLY Fusion-
related assets, which was made to bring the carrying values of the assets to levels we believed were recoverable,
given the then expected future sales trends. The FLY Fusion assets included inventories, advance royalty
payments, tooling equipment and capitalized content. The write-off negatively impacted the 2007 gross margin
by approximately 2.6 percentage points.
Loss from operations improved, reflecting an increase in gross profit during the year. The 13% decline in
net sales was more than offset by a 25% decline in cost of sales. The improvement in cost of sales was primarily
attributable to providing lower allowances for excess and obsolete inventory.
2009 Outlook
Given higher-than-expected retail inventory levels and the current economic crisis, we expect our net sales
to lag behind any improvement in our retailers’ sales to consumers, which will depress sales during the first part
of 2009. We expect content sales will represent a higher percentage of net sales, which we expect to lead to
improvements in gross margin. We anticipate that further planned reductions in expenditures, primarily due to
the decreased headcount, should result in improving our 2009 operating results and net cash flows.
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