LeapFrog 2010 Annual Report Download - page 82

LEAPFROG ENTERPRISES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
18. Concentrations of Credit Risk and Certain Other Risks
Financial instruments that subject the Company to concentrations of credit risk include cash equivalents, foreign
exchange transactions, long-term investments and trade receivables. Cash and cash equivalents consist
principally of cash and money market funds. Long-term investments consist of ARS, which are generally illiquid
and experienced significant impairment losses beginning in the fourth quarter of 2007 due to the adverse credit
and financial markets conditions that prevailed at the time. The carrying value of the Company’s investment in
ARS has declined 67% from its original book value, or par, as of December 31, 2010. Although beginning in
2009, the value of these investments stabilized significantly, further impairment losses may be incurred. 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; generally,
collateral is not required. Allowances for credit losses are provided for in the consolidated financial statements at
the time of sale. Three major retailers account for 67% and 61% of total accounts receivable at December 31,
2010 and 2009, respectively. Should any of these three retailers experience difficulties paying their debts to
LeapFrog, this could have a significant negative impact on the Company’s statement of operations and cash
flows.
Seasonality of Sales
Sales of LeapFrog’s products have historically been highly seasonal with a substantial majority of the sales
occurring during the third and fourth quarters. Failure to predict accurately and respond appropriately to retailer
and 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 customer demand, which could adversely impact LeapFrog’s relations
with its customers.
Manufacturing 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 China, to build its finished products. Given
the highly seasonal nature of its 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 57%, 64% and 49% of LeapFrog’s products in 2010, 2009 and 2008, respectively. In 2010 and 2009,
LeapFrog’s largest individual vendor, WKK Technology Limited, located in China, supplied 24% and 26%,
respectively, of its products. In 2008, Askey Computer Corporation, located in China, supplied 20% of
LeapFrog’s products. The Company expects to continue to use a limited number of contract manufacturers and
fabricators.
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