Case 5:03-cv-05421-RMW Document 191 Filed 01/27/2006 Page 1 of 151 1 Joseph J. Tabacco, Jr. (75484) Christopher T. Heffelfinger (118058) 2 Nicole Lavallee (165755) Julie J. Bai (227047) 3 BERMAN DEVALERIO PEASE TABACCO BURT & PUCILLO 4 425 California Street, Suite 2100 San Francisco, CA 94104-2205 5 Telephone: (415) 433-3200 Facsimile: (415) 433-6382 6 Email: [email protected] Liaison Counsel for the Class 7 Steven J. Toll (admitted pro hac vice) Elizabeth Berney (admitted pro hac vice) Matthew K. Handley (admitted pro hac vice) 8 COHEN, MILSTEIN, HAUSFELD & TOLL, P.L.L.C 9 1100 New York Avenue, N.W. West Tower, Suite 500 10 Washington, D.C. 20005 Telephone: (202) 408-4600 11 Facsimile: (202) 408-4699 Email: [email protected] 12 Lead Counsel for the Class 13 UNITED STATES DISTRICT COURT 14 NORTHERN DISTRICT OF CALIFORNIA 15 ) In re LEAPFROG ENTERPRISES, INC. ) CIVIL ACTION NO. C-03-05421-RMW 16 SECURITIES LITIGATION ) ) 17 ) AMENDED CONSOLIDATED CLASS This Document Relates To: ) ACTION COMPLAINT FOR 18 ) VIOLATIONS OF FEDERAL All Actions ) SECURITIES LAWS 19 ) ) DEMAND FOR JURY TRIAL 20 21 22 23 24 25 26 27 28 [C-03-05421-RMW] AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIONS OF FEDERAL SECURITIES LAWS Case 5:03-cv-05421-RMW Document 191 Filed 01/27/2006 Page 2 of 151 1 TABLE OF CONTENTS 2 INTRODUCTION ...........................................................................................................................1 3 JURISDICTION AND VENUE ....................................................................................................13 4 THE PARTIES...............................................................................................................................14 5 CONFIDENTIAL WITNESSES ...................................................................................................20 6 DEFENDANTS KNEW AND CONCEALED MATERIAL ADVERSE INFORMATION............................................................................................................................28 7 A. Background............................................................................................................28 8 B. Defendants Knew That Mattel’s Competing PowerTouch Product Had 9 Caused Leapfrog To Lose Sales And Lower Prices When Defendants Falsely Told Investors That PowerTouch Was Only A Potential Risk To 10 Leapfrog’s Sales.....................................................................................................31 11 C. Defendants Knew There Were Numerous Problems With Leapfrog’s Distribution And Supply-Chain Operations...........................................................43 12 1. Defendants Knew That Its Third Party Logistics Suppliers, DSS 13 And CLI, Repeatedly Failed To Fulfill Customer Orders Which Caused The Sales Shortfall In 3Q03 And Other Problems........................46 14 2. Defendants Knew Leapfrog Cancelled The Implementation Of 15 Supply-Chain Software Before 3Q03 That Was Needed To Accurately Forecast Customer Demand And To Meet Production 16 Requirements .............................................................................................48 17 3. Defendants Schemed To Fabricate Sales To Avoid The 3Q03 Shortfall......................................................................................................50 18 4. Defendants Knew That Their Delays In Consolidating Warehouse 19 Operations, Changing Warehouse Providers And Implementing Supply-Chain And Warehouse Management Software Caused 20 Continuing Distribution And Supply-Chain Problems Throughout The Class Period ........................................................................................51 21 5. Defendants Knew The Distribution And Supply-Chain Problems 22 Caused Leapfrog To Report Materially False And Misleading Financial Results That Were Not Prepared In Accordance With 23 GAAP Or The Company’s Publicly Reported Accounting Policies .........63 24 a. Improper Revenue Recognition .....................................................64 25 b. Failure To Accurately Report Inventories .....................................66 26 c. Understatement Of Expenses And Liabilities................................69 27 6. After The Class Period, Defendants Admitted There Were Numerous Material Weaknesses In Leapfrog’s Distribution And 28 Supply-Chain Operations That Prevented The Company From [C-03-05421-RMW] AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIONS OF FEDERAL SECURITIES LAWS - i - Case 5:03-cv-05421-RMW Document 191 Filed 01/27/2006 Page 3 of 151 1 Accurately Forecasting Results And From Reporting The Company’s Financial Results In Accordance With GAAP .......................70 2 D. Defendants Knew That Leapfrog’s Results Depended On A Few 3 Customers That Were Deferring Orders To Reduce Their Levels Of Leapfrog Inventory And Reducing Their Purchases Due To Leapfrog’s 4 Distribution Problems ............................................................................................72 5 E. Defendants Obtained Millions Of Dollars From Sales Of Leapfrog Stock While Making Material Misrepresentations And Concealing Material 6 Adverse Information From Investors.....................................................................75 7 DEFENDANTS ISSUED FALSE AND MISLEADING STATEMENTS DURING THE CLASS PERIOD............................................................................................................................77 8 A. Between 7/24/03 And 10/20/03, Defendants Falsely Assured Investors 9 There Were No Impediments To Leapfrog Meeting 3Q03 Guidance, Misleadingly Listed And Concealed Actual Problems As Mere Risk 10 Factors, And Downplayed The Impact Of The Powertouch..................................77 11 B. Defendants Issued False And Misleading Statements Between 10/21/03 And 2/9/04, Including False And Misleading Financial Results For 3Q03, 12 False Assurances That The Distribution And Supply-Chain Problems That Caused The 3Q03 Revenue Shortfall Were Fixed, And False And 13 Misleading Risk Factors In Leapfrog’s 3Q03 10-Q ..............................................90 14 C. Between 2/10/04 And 3/9/04 Defendants Falsely Portrayed Management Changes, Caused Leapfrog To Report False And Misleading Financial 15 Results For 4Q03 And FY03, And Provided Investors With Guidance For 2004 That They Knew Leapfrog Could Not Meet...............................................100 16 D. Between 3/10/04 And 4/20/04, Defendants Preannounced 1Q04 Results 17 Just One Month After Providing Initial Guidance, Assured Investors That Supply-Chain Operations Are Being Strengthened, And Included 18 Materially False And Misleading Financial Results And “Risk Factors” In The FY03 10-K....................................................................................................108 19 E. Between 4/21/04 And 7/20/04 Defendants Cause Leapfrog To Report 20 False And Misleading Financial Results For 1Q04 And Include Materially False And Misleading Risk Factors In The Company’s 1Q04 10-Q...................113 21 F. Between 7/21/04 And 10/18/04, Defendants Caused Leapfrog To Report 22 False And Misleading Financial Results For 2Q04 And Include Materially False And Misleading “Risk Factors” In The Company’s 2Q04 Form 10-Q......120 23 THE END OF THE CLASS PERIOD AND POST CLASS PERIOD EVENTS 24 FURTHER DEMONSTRATED DEFENDANTS’ FRAUD.......................................................130 25 DEFENDANTS FALSELY REPORTED LEAPFROG’S FINANCIAL RESULTS IN VIOLATION OF GAAP..............................................................................................................135 26 A. Improper Revenue Recognition And Failure To Adequately Reserve For 27 Accounts Receivable With Doubtful Collectibility .............................................136 28 B. Defendants Improperly Accounted For Leapfrog’s Inventory ............................137 [C-03-05421-RMW] AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIONS OF FEDERAL SECURITIES LAWS - ii - Case 5:03-cv-05421-RMW Document 191 Filed 01/27/2006 Page 4 of 151 1 C. Defendants Failed To Report Expenses Related To Goods And Services Purchased From Leapfrog’s Vendors ..................................................................138 2 D. Defendants Falsely Represented And Certified That Leapfrog’s Financial 3 Reporting Was Reliable, Leapfrog’s Financial Statements Were Prepared In Accordance With Gaap And That Leapfrog’s Disclosure Controls And 4 Internal Controls Over Financial Reporting Were Effective ...............................139 5 E. Additional Violations Of GAAP And SEC Regulations .....................................140 6 PROXIMATE LOSS CAUSATION ...........................................................................................141 7 CLASS ACTION ALLEGATIONS ............................................................................................143 8 FIRST CLAIM FOR RELIEF For Violation Of §10(B) Of The 1934 Act And Rule 10b-5 Against All 9 Defendants .......................................................................................................................144 10 SECOND CLAIM FOR RELIEF For Violation Of §20(A) Of The 1934 Act Against The Individual Defendants.............146 11 PRAYER FOR RELIEF ..............................................................................................................146 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 [C-03-05421-RMW] AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIONS OF FEDERAL SECURITIES LAWS - iii - Case 5:03-cv-05421-RMW Document 191 Filed