LeapFrog 2011 Annual Report Download - page 22

with our major suppliers and cannot guarantee their stability, they may stop manufacturing our components at
any time, with little or no notice. For example, 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. 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. For example, the 2011 tsunami in Japan
required us to replace a chip in the LeapPad. Although the introduction of the new chip did not ultimately
increase our cost for the product or materially affect its performance, it introduced additional complexity into
our supply chain and manufacturing processes, strained our internal resources and introduced risk to our
launch date. If there are any significant interruptions in the supply of components or if prices rise significantly,
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.
Our business is highly seasonal, and our annual operating results depend, in large part, on sales relating
to the brief holiday season.
Sales of consumer electronics and toy products in the retail channel are highly seasonal, causing a substantial
majority of our sales to retailers to occur during the third and fourth quarters. Even though we achieved net
income for the fiscal year ended December 31, 2011, we incurred losses in the first and second quarters of
2011. Approximately 79%, 76% and 79% of our total net sales occurred during the second half of fiscal years
2011, 2010 and 2009, respectively. The percentage of total net sales in the second half of the year may
increase as retailers become more efficient in their control of inventory levels through just-in-time inventory
management systems, particularly as they remain cautious about over-ordering products prior to the holiday
season in view of uncertain economic conditions. Generally, retailers time their orders so that suppliers will
fill the orders closer to the time of purchase by consumers, thereby reducing their need to maintain larger on-
hand inventories throughout the year to meet demand. If a decline in the economy, or other factors, lead to a
decline of net sales in the third or fourth quarter in particular, it can have a disproportionate negative impact
on our results for the year. In addition, soft consumer sales during the holiday season can lead to ongoing
weakness in sales to retailers well into the following year. For example, after a strong start to the 2010
holiday season, many retailers, including our online store, leapfrog.com, experienced a decrease in demand
late in the quarter relative to expectations. This decrease in demand lead to higher inventory levels in the first
half of 2011 and led to lower net sales during that period. Failure to predict accurately and respond
appropriately to retailer and consumer demand on a timely basis to meet seasonal fluctuations, or any
disruption of consumer buying habits during this key period (as demonstrated during and after the recent
economic crisis) would harm our business and operating results.
Our growing strategic focus on online products and services may not succeed, and may limit the
adoption of our products in some international markets.
We continue to build a marketing and sales model that relies on linking directly to consumers through the
Internet and we cannot be sure it will be successful. Many of our current and planned key products, such as
the LeapPad, the Leapster Explorer, the Tag reading system and some of our recent learning toys, are
designed to be connected to a computer that has Internet access in order to access content and features. In
addition, our recently launched App Center is designed to allow us to sell more content to consumers directly.
As we focus on Internet-based products and direct to consumer relationships, any resistance by parents to
buying children’s products requiring installation of software on a computer and connecting the product to a
computer could have a more pronounced effect on our business. If we are unable to design our App Center
experience in a way that is satisfying to consumers or if parents are reluctant to download content through our
App Center onto their children’s products, it would negatively affect our results and impair our future growth.
Also, adoption of Internet-based products may be limited in regions where broadband Internet access is not
widespread, such as in some international markets. If parents fail to sign up for the Learning Path or use it at
lower rates than we expect, or choose not to permit us to send them marketing email, or if our web efforts
prove ineffective at generating repeat customers, our investment in building, maintaining and improving our
Internet-based services may not yield the return on our investment that we anticipate. See also ‘‘System
failures in our online services or web store could harm our business’’ below.
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