LeapFrog 2003 Annual Report Download - page 29

date, we have established our brand and products largely focused on children in the preschool through third grade
levels primarily in the U.S. retail market. We believe that LeapFrog is, first and foremost, an educational
products company, and we use the toy form factor to make learning fun and engaging. As a result, our sales in
our U.S. Consumer segment, our largest business segment, currently are generated in the toy aisles of retailers
across the United States. The market for toy retailers has seen, and continues to see consolidation. In addition to
the traditional channel of specialty toy retailers, of which Toys “R” Us has become the major player, the mass-
market retail channel has grown in importance. For example, Wal-Mart, Target and a number of regional mass-
market retailers have seen growth in their market shares within the U.S. toy retail market. The mass-market
retailers have certain competitive advantages in the highly seasonal toy market because they have the ability to
dedicate a significant amount of shelf space to toys during the Fall holiday season, and then reduce the allocated
shelf space for toys during the rest of the year. The net sales in our U.S. Consumer segment have increased in
both amount and percentage with these mass-market retailers, and as a result of the seasonal changes of retail
space allocation to toys, including our products, by these retailers, the seasonal effects of the toy retail market are
exacerbated. We anticipate that the toy industry’s dependence on mass-market retailers will continue to grow.
In the U.S. Consumer segment, we market and sell our products directly to national and regional mass-
market and specialty retailers as well as to other retail stores through sales representatives. Our U.S. Consumer
segment is our most developed business, and is subject to significant seasonal influences, with the substantial
majority of our sales occurring in the third and fourth quarters. In 2003, this segment represented approximately
80% of our total net sales. Although we are expanding our retail presence by selling our products to bookstores
and electronics and office supply stores, the significant majority of our U.S. Consumer sales are to a few large
retailers. Sales to Wal-Mart (including Sam’s Club), Toys “R” Us and Target accounted for approximately 68%
of our total net sales in 2003 compared to 69% in 2002 and 68% in 2001. At December 31, 2003, Wal-Mart,
Toys “R” Us and Target accounted for 35%, 26% and 12%, respectively, of our accounts receivable. Consistent
with industry practice, we rely on short-term purchase orders for the sale of our products to U.S. retailers. In
2003, we successfully launched three new platforms: LeapPad Plus Writing, LittleTouch LeapPad and Leapster.
Combined, these new platforms accounted for approximately 20% of our U.S. Consumer segment’s net sales in
2003. Although we believe net sales for this business segment will grow in the future, we anticipate that this
segment’s percentage of total company net sales will decrease, as we expect our other two segments to grow at a
faster rate than our U.S. Consumer segment.
Our Education and Training segment targets the school market in the United States, including sales directly
to educational institutions, to teacher supply stores and through catalogs aimed at educators. The Education and
Training segment represented approximately 6% of our total net sales in 2003. Net sales in our Education and
Training segment increased by 86% from 2002 to 2003, and the segment reduced its operating loss from $9.0
million in 2002 to an operating loss of $0.2 million in 2003.
In our International segment, we sell our products outside the United States directly to overseas retailers and
through various distribution and strategic arrangements. We have four direct sales offices in the United
Kingdom, Canada, France and Mexico, and maintain various distribution and strategic arrangements in countries
such as Australia, Japan and Korea among others. The International segment represented approximately 14% of
our total net sales in 2003. Net sales in our International segment increased 80% from 2002 to 2003 and
operating income grew from $7.7 million in 2002 to $26.4 million in 2003. We believe this segment is in the
early stage of its development and will continue its expansion to represent a larger percentage of our total net
sales in coming years.
Gross profit margins in 2003 decreased by 80 basis points, from 50.8% in 2002 to 50.0% in 2003. This
decrease was primarily due to lower profit margins in our U.S. Consumer segment, offset by higher profit
margins in our Education and Training and our International segments. The decrease in gross profit margins in
our U.S. Consumer segment was the result of lower margin Leapster platform sales, as well as higher freight and
warehousing expenses. We expect that our gross profit margins in the U.S. Consumer segment will remain
relatively flat for 2004.
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PART II