LeapFrog 2010 Annual Report Download - page 24

learning platforms was winding down its operations, which required us to negotiate a license for the technology
used in the ASIC and arrange to purchase it directly from the semiconductor fabrication plant. Also, in 2010, a sole-
source supplier of an ASIC for one of our reading systems informed us that it was having financial difficulties,
which required us to negotiate the purchase of certain intangible assets from the supplier in order to continue
production of the ASIC. We may not always be successful in negotiating rights to technologies or products that
threaten to become unavailable or the rights may be available only at a cost that is prohibitive. In addition, if we are
required to use alternative sources, we may be required to redesign some aspects of the affected products, which
may involve delays and additional expense. If there are any significant interruptions in the supply of components,
we may be unable to manufacture sufficient quantities of our finished products or we may be unable to manufacture
them at targeted cost levels, and our business and operating results could be harmed.
We rely on a limited number of manufacturers, virtually all of which are located in China, to produce our
finished products, and our reputation and operating results could be harmed if they fail to produce quality
products in a timely and cost-effective manner and in sufficient quantities or if our manufacturing process
is otherwise disrupted.
We outsource substantially all of our manufacturing to several Asian manufacturers, most of which manufacture
our products at facilities in the Guangdong province in the southeastern region of China. These manufacturers are
selected based on their technical and production capabilities and are matched to particular products to achieve
cost and quality efficiencies. We depend on these manufacturers to produce sufficient volumes of our finished
products in a timely fashion, at satisfactory cost and quality levels and in accordance with our and our customers’
terms of engagement. We believe the recent economic downtown has caused manufacturers to scale back their
output capacity to match demand. Accordingly, if we determine that we need to order larger quantities of our
products to meet customer demand, we may encounter delays and shortfalls in shipments based on manufacturer
capacity issues. Such delays could have a particularly significant impact on our business to the extent that
retailers attempt to manage their inventory levels by delaying orders, which may lead to shorter lead times to
match changes in consumer demand. In addition, the costs of using contract manufacturers are subject to
increase, which has had, and could continue to have, a negative impact on our cost of sales. Since the fourth
quarter of 2009, commodity and labor costs in China have increased due to a variety of factors, including
tightening Chinese labor markets, delays in ramping up production of raw materials to meet growing demand for
finished goods, and the recent revaluation of Chinese currency to permit it to rise in value versus the U.S. dollar,
among other things, leading to increased prices for us with some of our contract manufacturers. Furthermore, in
the recent past, there have been product quality and safety issues for other producers of toys and other companies
that manufacture goods in China. In addition, the risk of political instability and civil unrest exists in China,
which could temporarily or permanently damage our manufacturing operations located there. If our
manufacturers fail or are unable to produce quality finished products on time, at expected cost targets and in
sufficient quantities, or if any of our products are found to be tainted or otherwise raise health or safety concerns,
our reputation and operating results would suffer.
See also “Political developments, including trade relations, natural disasters, the threat or occurrence of armed
hostilities, terrorism, labor strikes or public health issues could have a material adverse effect on our business.”
below.
If we do not maintain sufficient inventory levels or if we are unable to deliver our products to our
customers in sufficient quantities, or on a timely basis, or if retail inventory levels are too high, our
operating results will be adversely affected.
The high degree of seasonality of our business places stringent demands on our inventory forecasting and
production planning processes. This inventory management approach may be particularly challenging when
combined with “just-in-time” inventory management systems increasingly used by retailers as they remain
cautious about future inventory levels. See also “Our business is highly seasonal, and our annual operating
results depend, in large part, on sales relating to the brief holiday season” above. If we fail to meet tight
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