LeapFrog 2008 Annual Report Download - page 23

Our products may contain errors or defects that are discovered 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. Individuals 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.
Our business depends on three retailers that together accounted for approximately 60% of our
consolidated gross sales and 69% of the United States segment’s gross sales in 2008, and our dependence
upon a small group of retailers may increase.
Gross sales (“sales”) comprise the total customer billings for the year. Our top three retailers in 2008 were
Wal-Mart, Toys “R” Us and Target, which continue to account for the vast majority of our total sales. For the
foreseeable future, we expect to continue to rely on a small number of large retailers for the bulk of our sales and
expect that our sales to these retailers may increase as a percentage of our total sales.
We do not have long-term agreements with any of our retailers. As a result, agreements with respect to
pricing, shelf space, cooperative advertising or special promotions, among other things, are subject to periodic
negotiation with each retailer. Retailers make no binding long-term commitments to us regarding purchase
volumes and make all purchases by delivering one-time purchase orders. If any of these retailers reduce their
purchases from us, change the terms on which we conduct business with them or experience a future downturn in
their business or constraint on their credit and ability to pay their invoices as they become due, our business and
operating results could be harmed.
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 our retailers’ 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. If we fail to meet tight shipping schedules, we could damage our relationships
with retailers, increase our shipping costs or cause sales opportunities to be delayed or lost. In order to be able to
deliver our merchandise on a timely basis, we need to maintain adequate inventory levels of the desired products.
If our inventory forecasting and production planning processes result in our maintaining manufacturing inventory
in excess of the levels demanded by our customers, we could be required to record inventory write-downs for
excess and obsolete inventory, which would adversely affect our operating results. If the inventory of our
products held by our retailers is too high, they may not place or may reduce orders for additional products, which
would unfavorably impact our future sales and adversely affect our operating results.
Since we import our finished goods from overseas to our domestic warehouses in California, any disruption
at the ports from which our products are shipped from or to may result in us failing to meet our desired shipping
schedules, which in turn could adversely affect our operating results.
Our business is 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 the
substantial majority of our sales to retailers to occur during the third and fourth quarters. In 2008, approximately
72% of our total net sales occurred during the second half of the year and 73% occurred during the same 2007
period. This percentage of total sales may increase as retailers become more efficient in their control of inventory
levels through just-in-time inventory management systems. Generally, retailers time their orders so that suppliers
like us 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
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