LeapFrog 2003 Annual Report Download

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Table of contents

  • Page 1

  • Page 2
    ...To gauge LeapFrog's success, we constantly measure our performance against our vision: To become the leading brand for quality, technology-based educational products for school and home use for all ages around the world. I am pleased to say that 2003 was a very good year for LeapFrog. Net sales grew...

  • Page 3
    ...Leapster library of "game" titles are based upon grade appropriate scope and sequence that teaches essential reading and math skills, as well as art and music. In 2003, we sold nearly nine million interactive educational platforms and over 20 million software units. I am pleased to be able to report...

  • Page 4
    ..., CA 94608 (Address of principal executive offices) (510) 420-5000 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Class A common stock, par value $0.0001 per share New...

  • Page 5
    ... of new information, future events or otherwise after the date of this report. TRADEMARKS AND SERVICE MARKS "LeapFrog," the Leapfrog Logo, "LeapPad," "Above & Beyond," "Alphabet Pal," "Hug & Learn," "Imagination Desk," "iQuest," "Leap," the Leaping Frog Design, "LeapTrack," "Learning Something New...

  • Page 6
    ... Risk ... Item 9A Controls and Procedures ...PART III Item 10 Item 11 Item 12 Item 13 Item 14 Directors and Executive Officers of the Registrant ...Executive Compensation ...Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ...Certain Relationships and...

  • Page 7
    ... plush toys, our LeapStart learning table and our Fridge Phonics magnetic set products for infants and toddlers and our Explorer interactive globes for older children. Since the inception of our business in 1995, we have focused primarily on the U.S. consumer market. This market represented the...

  • Page 8
    ... versions of our products to schools, teacher supply stores and educational products catalogs in the United States. LeapFrog SchoolHouse product areas currently include assessment, early literacy, early childhood, reading, language arts, math, English Language Development, and special education. Our...

  • Page 9
    ... members of our Education Advisory Board actively participate in the design and development of our products by meeting with our creative design team several times each year. Our Education Advisory Board also is an external source of feedback for our creative design team with respect to new products...

  • Page 10
    ...English and Spanish children's books and English and Spanish reading programs. Additionally, she has shared her expertise on issues of transformative education, multicultural and multilingual education, home school interaction and early childhood education in Central and South America, the Caribbean...

  • Page 11
    ... books, magazines and activity cards designed for use with specific platforms. Our stand-alone products combine our proprietary technology with a fixed set of content. 5 PART I State University, and was Dean of the College of Education and the Co-Director of the Center for the Study of Reading...

  • Page 12
    ... our educational experts that is designed to help develop skills in reading, math, vocabulary, science, social studies, safety, community awareness and more. The My First LeapPad book series uses our family of Leap characters as well as licensed characters such as Winnie-the-Pooh, Dora the Explorer...

  • Page 13
    ... activity cards and over 200 books for use in schools, which represent over 6,000 pages of interactive content. For more details regarding the LeapPad platform products offered by our SchoolHouse division, see "Item 1. Business.-SchoolHouse." • • • • LeapPad Plus Writing learning system...

  • Page 14
    ...pad and a touch-screen enabled by a built-in stylus. In addition, the Leapster content also allows "players" to read electronic books, create works of art and watch interactive videos. Currently we have eight interactive Leapster titles available at retail, including educational games featuring Dora...

  • Page 15
    ... Center is a curriculum for reading instruction with pre-kindergarten, kindergarten and grade 1+ editions that offer an interactive multi-sensory approach to developing early literacy skills. The program includes wholeclass instruction as well as small-group and individual work using our LeapPad...

  • Page 16
    ... LeapFrog products at these retail outlets. In key retail stores, we feature our products via our Learning Center shelf displays, which are designed to highlight our LeapFrog brand as the "one stop" solution for technology-based educational products. We have received additional brand exposure...

  • Page 17
    ... our penetration of the school market. International In 2000, we established our U.K. office, located outside London, England, which sells our products directly to Woolworth's, Early Learning Centres, Toys "R" Us, Argos and other leading U.K. retailers. Our emerging success in penetrating the...

  • Page 18
    ... backgrounds in a wide variety of fields including education, child development, hardware engineering, software development, video games and toys. We have developed internally each of our current platforms and stand-alone products, although we use licensed technology if it is advantageous to do so...

  • Page 19
    ..., and works with our production team to turn our internally developed content into interactive books. Finally, this team is responsible for managing the business relationships with our growing community of third party developers that are trained to create content for our platforms. Our research and...

  • Page 20
    ... information technology environment is built around an Oracle system that supports our core order management, distribution, manufacturing and financial operations worldwide. We are also in the process of implementing new applications that are intended to further improve our supply chain management...

  • Page 21
    ... began selling an interactive educational platform product in Japan under the name "Ex-Pad." We also compete with educational software publishers, such as Knowledge Adventure (a studio of Vivendi Universal Games), whose products have distribution at mass retailers and electronics and toy stores, and...

  • Page 22
    connection with our software development and sales activities. We are not subject to any collective bargaining agreements and we believe that our relationship with our employees is good. Executive Officers of the Registrant The following table sets forth information with respect to our executive ...

  • Page 23
    ... after developing the patented Phonics Letters and Phonics Desk products. Before founding LeapFrog, Mr. Wood served as partner at Cooley Godward LLP, a national law firm, where he specialized in venture capital and emerging technology law. Mr. Wood also serves on the board of directors of Sangamo...

  • Page 24
    ... LeapPad learning system and the Odyssey and Explorer interactive globe lines, and was co-founder, President, and Vice President of Marketing and Sales of Explore Technologies from September 1995 to July 1998. Previously, from 1984 to 1992, he was an engineering co-founder and Manager of Marketing...

  • Page 25
    ...from time to time subject to litigation, including the following: LeapFrog Enterprises, Inc. v. Fisher-Price, Inc. In October 2003, we filed a complaint in the federal district court of Delaware against Fisher-Price, Inc. alleging that Fisher Price's PowerTouch learning system violates United States...

  • Page 26
    ..., waste of corporate assets, unjust enrichment and violations of the California Corporations Code, based upon allegations that certain of our officers and directors participated in the conduct alleged in the securities class action complaints and participated in alleged improper stock sales. The...

  • Page 27
    ... not anticipate paying cash dividends on our common stock in the foreseeable future. Equity Compensation Plan Information The following table shows certain information concerning our Class A common stock to be issued in connection with our equity compensation plans as of December 31, 2003: Number of...

  • Page 28
    ..., develop and market technology-based educational platforms, related interactive content and stand-alone products for sale to retailers, distributors and schools. Since the founding of our business in 1995, we have grown from a start-up business selling stand-alone educational toys into a company...

  • Page 29
    ... 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...

  • Page 30
    ... and related employee benefits, legal, marketing expenses, systems costs, rent and office equipment and supplies. Our research and development expenses consist primarily of costs associated with content development, product development and product engineering. Our advertising expenses consist...

  • Page 31
    ... future usage and demand for our products. If actual future usage and demand for our products are less favorable than those projected by our management, additional inventory write-downs may be required. Intangible Assets Intangible assets, including excess purchase price over the cost of net assets...

  • Page 32
    ... depend on the number of option shares affected by the acceleration or extension and could be material to our financial results. Prior to our July 2002 initial public offering, we granted stock appreciation rights under our Amended and Restated Employee Equity Participation Plan that are measured...

  • Page 33
    ...table sets forth selected information concerning our results of operations as a percentage of net sales for the periods indicated: Year Ended December 31, 2003 2002 2001 Net Sales ...Cost of Sales ...Gross Profit ...Operating expenses: Selling, general and administrative ...Research and development...

  • Page 34
    ... platform sales year-over-year was primarily due to the successful launch of our newest platform, the Leapster multimedia learning system, and the continued success of our LeapPad family of platforms. Our LeapPad family of platforms, includes two new platforms launched in 2003, LeapPad Plus Writing...

  • Page 35
    ... to 2003. The sales increase in the United Kingdom and Canada was primarily due to larger market penetration resulting from more localized products. Sales in Japan decreased 42% from 2002 to 2003, primarily due to the cancellation of our two-year Quantum Pad sales program with Benesse Corporation in...

  • Page 36
    ... ocean freight rates and due to air freight costs incurred to expedite delivery of our new platforms, particularly the Leapster platform, from Asia in time for the holiday shopping season. Higher royalty expenses were incurred due to increased sales from our expanded library of licensed products for...

  • Page 37
    ... by 78%. The increase in new product development was primarily due to the development expenses for our LeapPad Plus Writing, LittleTouch LeapPad and Leapster platforms, each of which were launched in 2003. We largely completed the development and engineering of our website in 2002, and the expenses...

  • Page 38
    ... our brand awareness and promote our expanded product line, including the introductions of our Leapster, LeapPad Plus Writing and LittleTouch LeapPad platforms. The increase in our International segment was related primarily to our television and print advertising spending in the United Kingdom and...

  • Page 39
    ... Pound, and the one-time payment received from Benesse Corporation. The payment received from Benesse Corporation was in connection with the early cancellation of a Quantum Pad sales contract related to a discontinued direct-to-home program from Benesse's middle school subscribers. In 2004, the...

  • Page 40
    ... months ended December 31, 2002 and accounted for 5% of the increase in total company net sales. We believe the year-over-year 129% increase in net sales for our Education and Training segment was the result of our larger direct sales force and increased brand offerings and awareness. International...

  • Page 41
    ... in software sales, which have a significantly higher gross margin percentage. Our Education and Training segment experienced a decrease in gross profit margin in 2002 compared to 2001 primarily due to discounting certain sales to wholesale customers and incentive pricing of new product offerings to...

  • Page 42
    ... increased leverage of our technology group based in Los Gatos, California, achieved against strong growth in net sales in all segments. This group performs all hardware and software engineering and all ASIC design for our products. The bulk of the increase in research and development expense was in...

  • Page 43
    ... year of amortization for our capitalized website and content development costs. Income From Operations Segment Year Ended December 31, 2002 2001 % of % of Segment's Segment's $(1) Net Sales $(1) Net Sales Change $(1) % U.S. Consumer ...Education and Training ...International ...Total Company...

  • Page 44
    ... Stock Price-Our business is seasonal, and therefore our annual operating results will depend, in large part, on sales relating to the brief holiday season;" and "-Our quarterly operating results are susceptible to fluctuations that could cause our stock price to decline." The following table sets...

  • Page 45
    ...of liquidity in 2003 and 2002 have been: • • Financing activities: primarily proceeds from our initial public offering of Class A common stock in July 2002, and from exercise of stock options and employee stock purchase plan; and Cash flows generated from operating activities primarily resulting...

  • Page 46
    ... and software expenses, resulting from our continued growth, and increased manufacturing tool purchases for use in the production of our existing and new products. We believe our current cash and short-term investments and anticipated cash flow from operations will be sufficient to meet our working...

  • Page 47
    ... the existing or future liabilities of the company. In March 2001, we entered into an agreement with Knowledge Kids Network, in which Knowledge Kids Network, an affiliate of Knowledge Universe, agreed to develop content and provide technical services in connection with LeapPad interactive books. We...

  • Page 48
    ... non-voting units of a limited liability company that holds an equity interest in Knowledge Universe. These non-voting units amount to a less than 1% economic interest in Knowledge Universe. In 2003, 2002 and 2001 we purchased software products and support services from Oracle Corporation totaling...

  • Page 49
    ...of innovation and this process can be lengthy and costly. To remain competitive, we must continue to develop enhancements of our NearTouch and other technologies successfully. In 2004, we intend to introduce a number of new platforms, stand-alone products and interactive books and other software for...

  • Page 50
    ... our products and our business could be harmed. If we are unable to compete effectively with existing or new competitors, our sales and market share could decline. We currently compete primarily in the infant and toddler and preschool categories and electronic learning aids category of the U.S. toy...

  • Page 51
    ...product line, together with any related software, accounted for more than approximately 10% of our net sales in 2003. A significant portion of our future sales will depend on the continued commercial success of our LeapPad, LeapPad Plus Writing, Quantum Pad platforms and compatible interactive books...

  • Page 52
    ... educational products, including our LeapTrack assessment system introduced in Fall 2002, the division may not be able to achieve operating profits on a full-year basis and our future sales could suffer. As of December 31, 2001, we had capitalized $3.5 million of our content development costs...

  • Page 53
    ... intend to increase our international sales through additional overseas offices to develop further our direct sales efforts, distributor relationships and strategic relationships with companies with operations outside of the United States, such as Benesse Corporation and Sega Toys in Japan. However...

  • Page 54
    ...develop competing products, which could weaken our competitive position and harm our operating results. Our success depends in large part on our proprietary technologies that are used in our learning platforms and related software, such as My First LeapPad, LeapPad, LeapPad Plus Writing, Quantum Pad...

  • Page 55
    ...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 49 PART...

  • Page 56
    ...31, 2003, we had 869 full-time employees. In addition, we plan to hire a significant number of new employees in 2004. We are upgrading existing and implementing new operational software systems, including supply chain management systems. Further, we are planning on consolidating multiple third party...

  • Page 57
    ... information from children under the age of 13. Additionally, the Robinson-Patman Act requires us to offer non-discriminatory pricing to similarly situated customers and to offer any promotional allowances and services to competing retailers and distributors within their respective classes of trade...

  • Page 58
    ...Universe to build, through a combination of internal development and acquisitions, leading companies in areas relating to education, technology and career management and the improvement of individual and corporate performance. Knowledge Universe has formed, invested in or acquired, and in the future...

  • Page 59
    ... predict the effect that future sales made under Rule 144, Rule 701 or otherwise will have on the market price of our Class A common stock. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. We develop products in the United States and market our products primarily in North America...

  • Page 60
    ... this annual report, is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission's rules and forms. Disclosure Controls are also designed to ensure that such information is accumulated and communicated to our management, including...

  • Page 61
    ...our internal control over financial reporting. PART III Certain information required by Part III is omitted from this Report on Form 10-K since we intend to file our definitive proxy statement relating to our 2004 annual meeting of stockholders, pursuant to Regulation 14A of the Securities Exchange...

  • Page 62
    (THIS PAGE INTENTIONALLY LEFT BLANK) 56

  • Page 63
    ... a press release regarding our financial results for the quarter ended September 30, 2003. On December 5, 2003, we filed a Form 8-K reporting under Item 5 that on December 2, 2003 a class action complaint had been filed in the United States District Court for the Northern District of California...

  • Page 64
    ... 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. LEAPFROG ENTERPRISES, INC. By: /s/ JAMES P. CURLEY James P. Curley, Chief Financial Officer Date: March 10, 2004 POWER OF ATTORNEY Each...

  • Page 65
    ... Maron Director March 10, 2004 /s/ E. STANTON MCKEE E. Stanton McKee Director March 10, 2004 /s/ BARRY MUNITZ Barry Munitz Director March 10, 2004 /s/ STEWART A. RESNICK Stewart A. Resnick Director March 10, 2004 /s/ SARINA D. SIMON Sarina D. Simon Director March 10, 2004 59 PART...

  • Page 66
    ... in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and Any fraud, whether or not material, that involves management or other employees who...

  • Page 67
    ...report financial information; and Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ James P. Curley James P. Curley Chief Financial Officer b) Date: March 10, 2004 61 PART...

  • Page 68
    ... estimated future usage and demand for products. (f) Increase in deductions in 2001 were primarily related to the write down of inventory in connection with obsolete product lines. (g) Decrease in obsolescence, slow-moving and excess inventory provision charged to operations in 2003 was primarily...

  • Page 69
    LEAPFROG ENTERPRISES, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Report of Independent Auditors ...Consolidated Balance Sheets ...Consolidated Statements of Income ...Consolidated Statements of Stockholders' Equity ...Consolidated Statements of Cash Flows ...Notes to Consolidated ...

  • Page 70
    ... financial position of LeapFrog Enterprises, Inc. at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States. Also...

  • Page 71
    ...: 31,273 and 15,700 at December 31, 2003 and 2002, respectively ...Class B common stock, par value $0.0001; 40,500 shares authorized; 27,883 and 38,679 shares issued and outstanding at December 31, 2003 and 2002, respectively...Additional paid-in capital ...Deferred compensation ...Notes receivable...

  • Page 72
    LEAPFROG ENTERPRISES, INC. CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data) Year Ended December 31, 2003 2002 2001 Net sales ...Cost of sales ...Gross profit ...Operating expenses: Selling, general and administrative ...Research and development ...Advertising ...Depreciation ...

  • Page 73
    ...to employee termination ...Class A common stock issued upon exercise of stock options and warrants (470 shares) ...Class A common stock issued in exchange for notes receivable (66 shares) ...Public offering of Class A common stock, net of offering costs (9,960 shares) ...Issuance of stock options to...

  • Page 74
    ... the issuance of common stock ...Proceeds from the exercise of stock options and employee stock purchase plan ...Proceeds from issuance of redeemable convertible Series A preferred stock, net of issuance costs ...Net cash provided by financing activities ...Effect of exchange rate changes on cash...

  • Page 75
    ... Knowledge Kids Enterprises, Inc., is a designer, developer and marketer of technology-based educational products and related proprietary content, dedicated to making learning effective and engaging. The Company currently designs its products to help infants and toddlers through high school students...

  • Page 76
    ...facilities to customers are recorded in cost of goods sold. Content and Video Capitalization and Amortization The Company capitalizes certain external costs related to the content development of its books. Amortization of these costs begins when the respective book is initially released for sale and...

  • Page 77
    ... per share and percent data) unrealized gains and losses, if any, reported as a component of stockholders' equity. The cost of securities sold is based on the specific identification method. Concentration of credit risk is limited by diversifying investments among a variety of high credit-quality...

  • Page 78
    ... in connection with stock options granted to employees with exercise prices not less than fair value. Deferred compensation for options granted to employees is determined as the difference between the deemed fair market value of the Company's common stock on the date options were granted and...

  • Page 79
    ...-pricing model for options granted after January 1, 2002 and the minimum value option pricing model was used for options granted prior to January 1, 2002. The following weighted average assumptions were used: Year Ended December 31, 2003 2002 2001 Expected life (years) ...Risk-free interest rate...

  • Page 80
    LEAPFROG ENTERPRISES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share and percent data) arrangements entered into after June 30, 2003. The application of EITF 00-21 did not have a material impact to our financial position, operating results or cash flows for the year ...

  • Page 81
    ... Company invested $200, and in exchange was entitled to participate in any potential gains and losses attributable to the property. In September 2003, the Company transferred 100% of its interest in the partnership to the employee in exchange for a payment of $181. Accordingly, the Company recorded...

  • Page 82
    ... units of a limited liability company that holds an equity interest in Knowledge Universe. These non-voting units amount to a less than 1% economic interest in Knowledge Universe. In 2003, 2002 and 2001 the Company purchased software products and support services from Oracle Corporation totaling...

  • Page 83
    ... of the Company's capital stock owned directly or indirectly by Knowledge Universe. Jeffrey Berg, a director of the Company, is a member of Oracle Corporation's board of directors. Affinity Squared, Inc., an affiliate of Knowledge Universe, provides health and welfare plan administration services to...

  • Page 84
    ... material losses on cash equivalents or shortterm investments. The Company manufactures and sells its products primarily to national and regional mass-market retailers in the United States. Credit is extended based on an evaluation of the customers' financial condition, and generally collateral is...

  • Page 85
    ...limited number of customers historically have accounted for a substantial portion of the Company's net sales. The significant customers and the relative percentage of net sales for these customers are approximately as follows: Year ended December 31, 2003 2002 2001 Wal-Mart ...Toys "R" Us ...Target...

  • Page 86
    ... examination of prior year's tax returns. The amounts ultimately paid on any possible future assessments may differ from the amounts accrued. Tax benefits of $37,100 related to employee stock options were credited directly to Stockholders' equity. The components of the Company's deferred taxes are...

  • Page 87
    ... its status as part of a related taxpayer controlled group with Knowledge Universe, Inc., the Company joined in the filing of several unitary/combined state tax returns with the Knowledge Universe, Inc. group for part of 2003 and in prior years. Beginning on April 30, 2003, the Company is no longer...

  • Page 88
    ...its initial public offering, the Company granted stock appreciation rights under its Amended and Restated Employee Equity Participation Plan, In February 2002, the Company converted 338 stock appreciation rights into options to purchase an aggregate of 338 shares of Class A common stock. The Company...

  • Page 89
    ...common stock upon their initial appointment or election to the Board (2) an option to purchase 10 shares of Class A common stock shall be granted annually on July 1, commencing in 2003, to all existing Non-Employee Directors. Shares will be prorated based on annual service time. Each stock option is...

  • Page 90
    ... years ended December 31, 2003, 2002 and 2001, the Company granted options to consultants to purchase 14, 125 and 165 shares of Class A common stock at average exercise prices of $21.77, $9.89 and $5.00 per share, respectively. These options were granted in exchange for consulting services performed...

  • Page 91
    ...per share and percent data) Shares Reserved For Future Issuance The following table summarizes the number of shares of Class A common stock that are reserved for future issuance at December 31, 2003. Class A Options available and outstanding ...Shares issuable under the Employee Stock Purchase Plan...

  • Page 92
    ... were converted into non-qualified stock options, and the plan was terminated in July 2002. At December 31, 2003 and 2002, there were no rights outstanding. The Company recognized $0, $1,341 and $1,265 of compensation expense in connection with the Equity Plan for the years ended 2003, 2002 and 2001...

  • Page 93
    ... for renewal options of five years at market rates. Rent expense for the years ended December 31, 2003, 2002 and 2001 was $3,656, $2,772 and $2,083, respectively. The Company is also obligated to pay certain minimum royalties in connection with license agreements to which the Company is a party.

  • Page 94
    ... al. v. LeapFrog Enterprises, Inc. et al. In January 2002, General Creation LLC filed a lawsuit against the Company and against Knowledge Universe in federal district court in Virginia alleging that by making, using, importing and selling reading toys, the Company was infringing United States Patent...

  • Page 95
    ..., selling and offering for sale a number of our products. LeapFrog Enterprises, Inc. v. Fisher-Price, Inc. In October 2003, we filed a complaint in the federal district court of Delaware against Fisher-Price, Inc. alleging that Fisher Price's PowerTouch learning system violates United States Patent...

  • Page 96
    ...of electronic educational toys and books, sold primarily through the retail channels. The Education and Training segment includes the design, production and marketing of educational books and toys sold primarily to school systems. For the International segment, the Company designs, markets and sells...

  • Page 97
    ... presentation in the current year annual financial statements. 25. Subsequent Events (unaudited) In January 2004, the Company and one of its subsidiaries entered into a technology license agreement with a foreign company to jointly develop and customize our respective technologies to be combined in...

  • Page 98
    ... amended, filed with the SEC. Net Lease, dated November 14, 2000, between Hollis Street Investors, LLC and LeapFrog, as amended. Standard Lease Agreement, dated January 15, 2002, between Knowles Los Gatos, LLC and LeapFrog. Amended and Restated Stock Option Plan. Amended and Restated Employee Equity...

  • Page 99
    ...on Form 10-K filed on March 28, 2003 (SEC File No. 001-31396) (b) Incorporated by reference to the exhibit number 10.01 filed with the company's report on Form 10-Q filed on November 10, 2003 (SEC File No. 001-31396) †Compensation plans or arrangements in which directors or executive officers are...

  • Page 100
    ... number of shares of our Class A common stock authorized for issuance under the plan by 2,500,000 shares and to implement a performance-based stock award program. To approve amendments to our 2002 Non-Employee Directors' Stock Option Plan to increase the initial grant and annual grant received...

  • Page 101
    ... the aggregate number of shares of our Class A common stock authorized for issuance under the plan by 2,500,000 shares and to implement a performance-based stock award program; Amendments to our 2002 Non-Employee Directors' Stock Option Plan to increase the initial grant and annual grant received by...

  • Page 102
    ...-Employee Directors' Stock Option Plan and "For" the ratification of Ernst & Young as independent auditors of LeapFrog for our fiscal year ending 2004. If any other matter is properly presented at the meeting, your proxy (one of the individuals named on your proxy card) will vote your shares using...

  • Page 103
    ... your shares in street name. When are stockholder proposals due for next year's annual meeting? To be considered for inclusion in next year's proxy materials, your proposal must be submitted in writing by December 29, 2004, to LeapFrog's Secretary at 6401 Hollis Street, Suite 150, Emeryville, CA...

  • Page 104
    • Proposal 3-Amendments to Our 2002 Non-Employee Directors' Stock Option Plan. This proposal must receive a "For" vote from the majority of shares present and entitled to vote either in person or by proxy on the proposals. If you "Abstain" from voting, it will have the same effect as an "Against"...

  • Page 105
    ... of the shares of our common stock, as the case may be, and Schedules 13D and 13G filed with the Securities and Exchange Commission, or SEC. Except as otherwise noted below, the address for each person listed on the table is c/o LeapFrog Enterprises, Inc., 6401 Hollis Street, Suite 150, Emeryville...

  • Page 106
    ... 2004, Knowledge Universe, LLC, a private company focused on building leading companies in areas relating to education, technology and career management and the improvement of individual and corporate performance, or Knowledge Universe, distributed 8,065,801 shares of our Class B common stock to its...

  • Page 107
    ...capital stock owned directly or indirectly by Knowledge Universe. 392,945 shares held by Knowledge Kids and Knowledge Universe may be acquired by persons other than Messrs. Ellison, M. Milken and L. Milken within 60 days of April 8, 2004 under options granted by Knowledge Kids and Knowledge Universe...

  • Page 108
    ... stock presently held by Knowledge Kids which may be acquired within 60 days after April 8, 2004 by Mr. Kalinske upon the exercise of a call option that Knowledge Kids has granted to Mr. Kalinske. Mr. Kalinske shares voting and investment power with respect to these shares with Knowledge Universe...

  • Page 109
    ... of Class B common stock presently held by Knowledge Kids which may be acquired within 60 days of April 8, 2004 by Mr. Fink upon the exercise of a call option that Knowledge Kids has granted to Mr. Fink. Mr. Fink shares voting and investment power with respect to these shares with Knowledge Universe...

  • Page 110
    ... created by increases in the number of directors that make up our board of directors. In Fall 2003, Mr. McKee was recommended by our then Chairman of the board, Thomas Kalinske. It is the Company's policy to encourage nominees for directors to attend the annual meeting. Four of the nine nominees...

  • Page 111
    ... of the board of Spring Group plc, an information technology services company in the United Kingdom, and is a director of Nextera Enterprises and Nobel Learning Communities, Inc. Mr. Fink also serves on the boards of directors of privately held companies, and he is a member of the board of trustees...

  • Page 112
    ...Oracle Corporation, an enterprise software company, and of the American Film Institute, and serves on the board of visitors of The Anderson School of Management at the University of California, Los Angeles. In the past, Mr. Berg was co-chair of the California Information Technology Council, a member...

  • Page 113
    .... Resnick is a member of the Executive Board of the University of California, Los Angeles, Medical Sciences, and of the Advisory Board of the Anderson School of Management at the University of California, Los Angeles, and he is affiliated with the SEI Center for Advanced Studies in Management of the...

  • Page 114
    ... management, Chief Executive Officer performance evaluation and succession planning, and board committees and compensation. The Corporate Governance Guidelines were adopted by the board to, among other things, reflect changes to the NYSE listing standards and Securities and Exchange Commission rules...

  • Page 115
    .... In April 2004, our board formed a third committee, a Nominating and Corporate Governance Committee. The following table provides membership and meeting information for each of the board committees existing in 2003: Member of our board of directors in the fiscal year 2003 Audit Compensation Thomas...

  • Page 116
    ... board, assessing the performance of management and the board, and developing a set of corporate governance principles for LeapFrog. Our Governance Committee charter will be posted on the investor relations section of our website at www.leapfrog.com no later than the date of our 2004 annual meeting...

  • Page 117
    ...written communications addressed to the Corporate Counsel of LeapFrog at 6401 Hollis Street, Suite 150, Emeryville, CA 94608. All communications will be compiled by our Corporate Counsel and submitted to the board or the individual directors on a periodic basis. These communications will be reviewed...

  • Page 118
    ... the Director Plan are non-discretionary. Upon election to LeapFrog's board of directors, a non-employee director is granted an initial option to purchase 25,000 shares of LeapFrog's Class A common stock. On July 1 of each year (or the next business day if that date is a legal holiday), each member...

  • Page 119
    ... As set forth in Proposal 3 of this proxy statement, we are seeing stockholder approval of an amendment to the Director Plan such that a non-employee director who serves on our board of directors will receive an initial option grant of 30,000 shares of our Class A common stock and an annual grant of...

  • Page 120
    ... directors in accordance with the rules and regulations of the New York Stock Exchange. The responsibilities of the Audit Committee include recommending to the board an accounting firm to be engaged as LeapFrog's independent auditors and pre-approving any non-audit services provided by LeapFrog...

  • Page 121
    ..., and the financial statement review, and such other matters deemed relevant and appropriate by the Audit Committee, the Audit Committee recommended to the board of directors that these financial statements be included in LeapFrog's 2003 annual report on Form 10-K filed with the SEC. Audit Committee...

  • Page 122
    ... the Code. Compensation Philosophy The Compensation Committee sets the salaries of the executive officers, establishes the annual executive and employee bonus plans, approves specific company-wide and individual executive performance objectivesand executive bonus payments, and makes stock option and...

  • Page 123
    ...-year period. Together with the stock option program, the performance share program is intended to motivate and reward executives for outstanding company and individual performance that directly benefits the company's stockholders. Going forward, the company intends to make ongoing grants of options...

  • Page 124
    ... that such grants have exercise prices of no less than 100% of fair market value on the date of grant and do not exceed a calendar year limit for the executive officer that is set forth in the 2002 Equity Incentive Plan. LeapFrog generally intends to grant stock options and performance shares to its...

  • Page 125
    ... we pay him $265,000 in annual salary. For additional discussion of this agreement, see "Employment Agreements." (5) A bonus amount earned in 2002 and paid in 2003. (6) Mr. Rioux served as our acting Chief Operating Officer from October 2002 to August 2003. (7) Mr. Curley joined LeapFrog in December...

  • Page 126
    ...to purchase 2,787,859 shares remained available for grant under the plan. All stock options were granted at an exercise price equal to their fair market value on the date of grant. The following tables show for the fiscal year ended December 31, 2003, certain information regarding options granted to...

  • Page 127
    ... 25, 2002 (based on the closing price of LeapFrog's Class A common stock on the date on which LeapFrog's Class A common stock began trading on the New York Stock Exchange) through December 31, 2003. (3) This section is not "soliciting material," is not deemed "filed" with the SEC and is not to be...

  • Page 128
    ...control of LeapFrog, we will pay Mr. Kalinske a gross-up payment equal to the excise tax and any other taxes to which Mr. Kalinske is subject. In addition, pursuant to the agreement, Mr. Kalinske was granted an option to purchase 250,000 shares of our Class A common stock at an exercise price of $12...

  • Page 129
    ... based on our performance. For 2003, Mr. Rioux did not receive a performance bonus and he waived the guaranteed portion of his bonus. In addition, Mr. Rioux was granted an option to purchase a total of 150,000 shares of our Class A common stock at an exercise price of $12.50 per share, which vest on...

  • Page 130
    ... to develop content and provide technical services in connection with LeapPad interactive books. Sarina D. Simon, a member of our board of directors, is Chief Executive Officer of Knowledge Kids Network. In 2003, we paid Knowledge Kids Network an aggregate sum of $122,000 in fees and costs under...

  • Page 131
    ... these purchasers, Knowledge Kids, L.L.C., an affiliate of Knowledge Universe, FrogPond, Michael C. Wood and Explore Technologies, a holder of our Class A common stock. In May 2003, the agreement was amended and restated to delete provisions that terminated as a result of our initial public offering...

  • Page 132
    ...Equity Plan, and 2,787,859 shares of Class A common stock (plus any shares that might in the future be returned to the Equity Plan as a result of reacquisition of unvested options, or as a result of cancellations or expirations) remained available for future grant under the Equity Plan. In the event...

  • Page 133
    ... this overall maximum number, no more than 4,500,00 shares of Class A common stock may be issued pursuant to stock awards other than options. In addition, no person may be granted awards under the Equity Plan covering more than 2,000,000 shares of Class A common stock in any calendar year. If an...

  • Page 134
    ... granted under the Equity Plan may be paid for in cash or, if provided in the stock option agreement at the discretion of the board of directors, in shares of Class A common stock previously owned by the optionee, pursuant to a deferred payment arrangement, pursuant to a "cashless" exercise program...

  • Page 135
    ... of shares, exchange of shares, change in corporate structure or otherwise), the class(es) and maximum number of shares subject to the Equity Plan, the maximum annual award limit applicable under the Equity Plan and the class(es) and number of shares and price per share of stock subject to...

  • Page 136
    ...on whether the stock was held for more than one year. Certain different rules may apply to recipients who are subject to Section 16(b) of the Exchange Act. Potential Limitation on Company Deductions. Section 162(m) of the Code denies a deduction to any publicly held corporation for compensation paid...

  • Page 137
    ... to our "covered employees" within the meaning of Section 162(m) of the Internal Revenue Code, but we will grant the options set forth in the table. Number of Shares of Class A Common Stock Underlying Options Number of Shares of Class A Common Stock Underlying Performance Grants Name and Principal...

  • Page 138
    ... certain information concerning our Class A common stock to be issued in connection with our Equity Plan and our Director Plan as of December 31, 2003: Number of securities to be issued upon exercise of outstanding options, warrants and rights (a) Number of securities remaining available for future...

  • Page 139
    ...of our board of directors. The proposed amendment to the Director Plan would also increase the number of shares underlying options granted to non-employee directors such that a non-employee director would receive an initial grant of 30,000 shares of our Class A common stock and an annual grant of 15...

  • Page 140
    ... board at the time of the Annual Grant, such non-employee director will instead receive an Annual Grant to purchase 25,000 shares of our Class A common stock. Initial and Annual Grants vest in monthly installments over a three-year period from the date of grant. An option granted to a non-employee...

  • Page 141
    ... depending on whether the stock was held for more than 1 year. Slightly different rules may apply to optionees who are subject to Section 16(b) of the Exchange Act. NEW PLAN BENEFITS The following table presents the annual grants to be received by our non-employee directors in July 2004, assuming...

  • Page 142
    ...2003 and $1.4 million in 2002. The above amounts include fees associated with the annual audit, the reviews of our quarterly reports on Form 10-Q and statutory audits required internationally. The amount in 2002 includes $0.9 million related to services in connection with our initial public offering...

  • Page 143
    ...Mr. McKee the authority to grant pre-approvals of audit and non-audit services to be provided by Ernst & Young, LeapFrog's independent auditors. All such pre-approvals are required to be reported at the Audit Committee's regularly scheduled meetings. The Board of Directors Recommends A Vote in Favor...

  • Page 144
    ... a separate proxy statement and annual report, you may: (1) notify your broker; (2) direct your written request to our Director of Investor Relations, 6401 Hollis Street, Suite 150, Emeryville, California 94608 or to [email protected] or (3) contact our Director of Investor Relations at 510-420-5150...

  • Page 145
    ... Options, (ii) Nonstatutory Stock Options, (iii) stock bonuses and (iv) rights to acquire restricted stock. (c) General Purpose. The Company, by means of the Plan, seeks to retain the services of the group of persons eligible to receive Stock Awards, to secure and retain the services of new members...

  • Page 146
    ... Class A common stock of the Company. (f) "Code" means the Internal Revenue Code of 1986, as amended. (g) "Committee" means a committee of one or more members of the Board appointed by the Board in accordance with Section 3(c). (h) "Company" means LeapFrog Enterprises, Inc., a Delaware corporation...

  • Page 147
    ... of a share of Class A Common Stock shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such exchange or market (or the exchange or market with the greatest volume of trading in the Class A Common Stock) on the last market trading day prior to...

  • Page 148
    ...a "non-employee director" for purposes of Rule 16b-3. (v) "Nonstatutory Stock Option" means an Option not intended to qualify as an Incentive Stock Option. (w) "Officer" means a person who is an officer of the Company within the meaning of Section 16 of the Exchange Act and the rules and regulations...

  • Page 149
    ... LeapFrog Enterprises, Inc. 2002 Equity Incentive Plan. (ii) "Rule 16b-3" means Rule 16b-3 promulgated under the Exchange Act or any successor to Rule 16b-3, as in effect from time to time. (jj) "Securities Act" means the Securities Act of 1933, as amended. (kk) "Stock Award" means any right granted...

  • Page 150
    ... time of recognition of income resulting from such Stock Award or (b) not persons with respect to whom the Company wishes to comply with Section 162(m) of the Code and/or (2) delegate to a committee of one or more members of the Board who are not Non-Employee Directors the authority to grant Stock...

  • Page 151
    ...to the Plan may be unissued shares or reacquired shares, bought on the market or otherwise. 5. Eligibility. (a) Eligibility for Specific Stock Awards. Incentive Stock Options may be granted only to Employees. Stock Awards other than Incentive Stock Options may be granted to Employees, Directors and...

  • Page 152
    ... discretion of the Board at the time of the grant of the Option (or subsequently in the case of a Nonstatutory Stock Option) (1) pursuant to a program developed under Regulation T as promulgated by the Federal Reserve Board, (2) by delivery to the Company of other Class A Common Stock, (3) according...

  • Page 153
    ... may elect at any time before the Optionholder's Continuous Service terminates to exercise the Option as to any part or all of the shares of Class A Common Stock subject to the Option prior to the full vesting of the Option. Any unvested shares of Class A Common Stock so purchased may be subject to...

  • Page 154
    ... the time the purchase is consummated. (ii) Consideration. The purchase price of Class A Common Stock acquired pursuant to the restricted stock purchase agreement shall be paid either: (i) in cash at the time of purchase; (ii) at the discretion of the Board, according to a deferred payment or other...

  • Page 155
    ... provisions of the corporate law of the state in which the Company or the Affiliate is incorporated, as the case may be. (d) Incentive Stock Option $100,000 Limitation. To the extent that the aggregate Fair Market Value (determined at the time of grant) of Class A Common Stock with respect to...

  • Page 156
    ... not sell, dispose of, transfer, make any short sale of, grant any option for the purchase of, or enter into any hedging or similar transaction with the same economic effect as a sale, any shares of Class A Common Stock or other securities of the Company held by the Participant, for a period of time...

  • Page 157
    ... or advisable to provide eligible Employees with the maximum benefits provided or to be provided under the provisions of the Code and the regulations promulgated thereunder relating to Incentive Stock Options and/or to bring the Plan and/or Incentive Stock Options granted under it into compliance...

  • Page 158
    ... the case of a stock bonus, shall be granted) unless and until the Plan has been approved by the stockholders of the Company, which approval shall be within twelve (12) months before or after the date the Plan is adopted by the Board. 15. Choice of Law. The law of the State of Delaware shall govern...

  • Page 159
    ... the Class A Common Stock through the granting of Nonstatutory Stock Options. (c) General Purpose. The Company, by means of the Plan, seeks to retain the services of its NonEmployee Directors, to secure and retain the services of new Non-Employee Directors and to provide incentives for such persons...

  • Page 160
    ... "Company" means LeapFrog Enterprises, Inc., a Delaware corporation. (j) "Consultant" means any person, including an advisor, (i) engaged by the Company or a Controlled Corporation to render consulting or advisory services and who is compensated for such services or (ii) who is a member of the Board...

  • Page 161
    ...determined in good faith by the Board. (u) "Initial Grant" means an Option granted to a Non-Employee Director who meets the specified criteria pursuant to subsection 6(a) of the Plan. (v) "IPO Date" means the date the Company's Class A Common Stock is first offered to the public under a registration...

  • Page 162
    (dd) "Plan" means this LeapFrog Enterprises, Inc. 2002 Non-Employee Directors' Stock Option Plan. (ee) "Rule 16b-3" means Rule 16b-3 promulgated under the Exchange Act or any successor to Rule 16b-3, as in effect from time to time. (ff) "Securities Act" means the Securities Act of 1933, as amended. ...

  • Page 163
    ... Non-Employee Director, as applicable, be granted an Initial Grant to purchase Thirty Thousand (30,000) shares of Class A Common Stock on the terms and conditions set forth herein. (b) Annual Grants. Without any further action of the Board, on each July 1, commencing on July 1, 2004, each person who...

  • Page 164
    ... Grants: 1/36th of the shares of Class A Common Stock covered by an Initial Grant shall vest monthly over thirty-six (36) months. (ii) Annual Grants: 1/36th of the shares of Class A Common Stock covered by an Annual Grant shall vest monthly over thirty-six (36) months. (f) Early Exercise. The Option...

  • Page 165
    ... the number of shares of Class A Common Stock required to satisfy such Options. (b) Securities Law Compliance. The Company shall seek to obtain from each regulatory commission or agency having jurisdiction over the Plan such authority as may be required to grant Options and to issue and sell shares...

  • Page 166
    ...not sell, dispose of, transfer, make any short sale of, grant any option for the purchase of, or enter into any hedging or similar transaction with the same economic effect as a sale, any shares of Class A Common Stock or other securities of the Company held by the Optionholder, for a period of time...

  • Page 167
    ... the Payment): reduction of cash payments; cancellation of accelerated vesting of Options; reduction of employee benefits. In the event that acceleration of vesting of Option compensation is to be reduced, such acceleration of vesting shall be cancelled in the reverse order of the date of grant of...

  • Page 168
    .... 14. Effective Date of Plan. The Plan shall become effective on the date the Plan is adopted by the Board, but no Option shall be exercised unless and until the Plan has been approved by the stockholders of the Company, which approval shall be within twelve (12) months before or after the date...

  • Page 169
    ...FOR CLASS A COMMON STOCK Continental Stock Transfer & Trust Company New York, New York ANNUAL MEETING The Annual Meeting of Stockholders will take place at 9:00 AM Pacific time on Thursday, June 10, 2004 at the company's headquarters in Emeryville, California. INVESTOR RELATIONS LeapFrog Enterprises...

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