LeapFrog 2002 Annual Report Download - page 58

Our business could be affected adversely by the bankruptcy of Kmart.
On January 22, 2002, Kmart filed for bankruptcy protection. Kmart made payments to us totaling $13.0
million during the 90 days prior to filing bankruptcy, which payments may be subject to challenge by Kmart, its
creditors or others acting on behalf of Kmart’s bankruptcy estate as a preferential payment under federal
bankruptcy law. We continue to do business with Kmart while Kmart is in bankruptcy, including extending credit
for its purchases of our products, and we may have difficulty enforcing any contractual obligations and collecting
any amounts owed to us by Kmart. In 2001, a provision for $6.4 million was recorded for the write-off of our
accounts receivable from Kmart due to their bankruptcy. In 2002, an additional $0.8 million provision was
recorded. Any write-off of current or future receivables from Kmart could adversely affect our operating results.
We expect to do business with Kmart on terms similar to those in place prior to January 22, 2002, if and when
Kmart emerges from bankruptcy.
Any errors or defects contained in our products, or our failure to comply with applicable safety standards,
could result in delayed shipments or rejection of our products, damage to our reputation and expose us to
regulatory or other legal action.
We have experienced, and in the future may experience, delays in releasing some models and versions of
our products due to defects or errors in our products. Our products may contain errors or defects after
commercial shipments have begun, which could result in the rejection of our products by our retailers, damage to
our reputation, lost sales, diverted development resources and increased customer service and support costs and
warranty claims, any of which could harm our business. Children could sustain injuries from our products, and
we may be subject to claims or lawsuits resulting from such injuries. There is a risk that these claims or liabilities
may exceed, or fall outside the scope of, our insurance coverage. Moreover, we may be unable to retain adequate
liability insurance in the future. We are subject to regulation by the Consumer Product Safety Commission, or
CPSC, and similar state regulatory authorities, and our products could be subject to involuntary recalls and other
actions by such authorities. Concerns about potential liability may lead us to recall voluntarily selected products.
In December 2000, the CPSC announced our voluntary repair program for the approximately 900,000 units of
our Alphabet Pal product sold prior to that date. We had instituted the repair proceedings with the CPSC because
we were concerned that the product could cause injury. Our costs in connection with the repair were
approximately $1.1 million. Any recalls or post-manufacture repairs of our products could harm our reputation,
increase our costs or reduce our net sales.
Our rapid growth has presented significant challenges to our management systems and resources, and we
may experience difficulties managing our growth.
Since the introduction of our first platform, we have grown rapidly, both domestically and internationally.
Our net sales have grown from $71.9 million in 1999 to $531.8 million in 2002. During this period, the number
of different products we offered at retail also increased significantly. At December 31, 1999, we had 85
employees and at December 31, 2002, we had 690 employees. In addition, we plan to hire a significant number
of new employees over the next 12 months. This expansion has presented, and continues to present, significant
challenges for our management systems and resources. If we fail to develop and maintain management systems
and resources sufficient to keep pace with our planned growth, our operating results could suffer.
We depend on key personnel, and we may not be able to retain, hire and integrate sufficient qualified
personnel to maintain and expand our business.
Our future success depends partly on the continued contribution of our key executive, technical, sales,
marketing, manufacturing and administrative personnel. The loss of services of any of our key personnel could
harm our business. The loss of the services of any of our officers or senior managers could disrupt operations in
their respective departments and could cause our financial results to suffer. Recruiting and retaining skilled
personnel, including software and hardware engineers and content developers, is highly competitive. If we fail to
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