LeapFrog 2012 Annual Report Download - page 40

Application of the two-step goodwill impairment test, if determined necessary, requires significant judgment,
including identification of reporting units, assignment of assets and liabilities to reporting units, assignment of
goodwill to reporting units, determination of the fair value of each reporting unit, and projections of future net
cash flows, which are inherently uncertain. The fair value of each reporting unit is estimated using a
combination of a market approach and a discounted cash flow methodology. The market approach requires
considerable judgment in selecting comparable companies and estimating the multiples of revenue implied by
their market values. The discounted cash flow methodology requires management to exercise judgment in
selecting an appropriate discount rate and to make numerous assumptions in order to develop future business
and financial forecasts and the related estimates of future net cash flows. Future net cash flows depend
primarily on future sales of our products, which are inherently difficult to predict. This is especially true when
a significant portion of our future net sales is expected to be generated by both mature products as well as
products introduced in 2012 or planned to be introduced in 2013.
After analyzing our goodwill at December 31, 2012 and 2011, we concluded no impairment charge was
required in either period. At December 31, 2012 and 2011, we had $20.5 million and $22.9 million,
respectively, of goodwill and other intangible assets.
Income Taxes
We account for income taxes using the asset and liability method. We calculate our deferred tax assets and
liabilities based on the difference between the financial statement and tax basis of assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected to reverse. We are subject to
income taxes in the U.S. and foreign jurisdictions. The determination of our income tax assets, liabilities and
expense requires us to make certain estimates and judgments in the calculation of tax benefits, tax credits and
deductions. Significant changes in these estimates or variations in the actual outcome of expected future tax
consequences may result in material increases or decreases in the tax provision or benefit in subsequent
periods. We provide valuation allowances when it is more likely than not that all or a portion of a deferred tax
asset will not be realized. Determination of whether or not a valuation allowance is warranted requires
consideration of all available positive and negative evidence, including prior earnings history, expected future
earnings, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood
of realization of a deferred tax asset.
In 2006, we recorded a $60.4 million non-cash charge to establish a valuation allowance against all of our
gross domestic deferred tax assets as we could not assert, at the required more-likely-than-not level of
certainty, that the level of future profitability needed to realize the benefit of our domestic deferred tax assets
could be achieved. As of December 31, 2011, the balance of our domestic deferred tax assets increased to
$115.9 million, primarily due to additional net operating loss and tax credit carryforwards, partially offset by
utilization of tax benefits. During 2012, our deferred tax asset balance was reduced by $45.5 million, primarily
due to utilization of tax benefits and release of a portion of our remaining valuation allowance. At
December 31, 2012, we maintained a $70.4 million valuation allowance against our deferred tax assets. We
will continue to evaluate the need for a valuation allowance in future periods.
Our financial statements also include accruals for the estimated amounts of probable future assessments that
may result from the examination of federal, state or international tax returns. Our tax accruals, tax provision,
deferred tax assets or income tax liabilities may be adjusted if there are changes in circumstances, such as
changes in tax law, tax audits or other factors, which may cause management to revise its estimates. The
amounts ultimately paid on any future assessments may differ from the amounts accrued and may result in an
increase or reduction to the effective tax rate in the year of resolution. Such adjustments could have a material
impact on our financial position, results of operations or cash flows. In 2012 and 2011, we recorded
$6.4 million and $2.9 million in benefits, respectively, associated with the recognition of previously
unrecognized tax benefits due to the expiration of statutes of limitation in some of our foreign jurisdictions.
Stock-based Compensation
Stock-based compensation expense is measured at the grant date based on the fair value of the award and is
recognized as expense over the applicable vesting period of the stock award (generally four years) using the
straight-line method. Determining the fair value of stock-based compensation awards at grant date requires
significant judgment and estimates regarding valuation variables such as volatility, expected forfeiture rates
32