LeapFrog 2004 Annual Report Download

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FRONT฀COVER

Table of contents

  • Page 1

  • Page 2
    ... on children from birth through grade school: • We continue to be the innovation leader in the educational products market. For example, in 2005, we will introduce our groundbreaking Fly pentop computer and will expand our presence in the screen-based learning field with our new Leapster L-Max...

  • Page 3
    ...and success, our 2004 net sales declined 6%, and we reported a loss of $0.11 per share. The decline in our financial performance can be traced entirely to our U. S. consumer business. We had lower sales of our more established platforms and related software, primarily the LeapPad family of products...

  • Page 4
    ... of our new Fly pentop computer, which targets the important "tween" (i.e., middle school) age group. This is a segment of the consumer market that we have not focused on in the past. • Also in Fall 2005, we are extending the product line for our Leapster system, our latest technology platform, by...

  • Page 5
    ... market price as of the close of business on June 30, 2004 was approximately $541,900,000. Shares of common stock held by each current executive officer and director and by each person who is known by the registrant to own 5% or more of the outstanding voting power of the registrant's common stock...

  • Page 6
    ..., performance or achievements. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this report. TRADEMARKS AND SERVICE MARKS "LeapFrog," "LeapPad," "Alphabet Pal," "Hug & Learn...

  • Page 7
    ... and Supplementary Data ...Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ...Controls and Procedures ...Other Information ...PART III Item 10 Item 11 Item 12 Item 13 Item 14 Directors and Executive Officers of the Registrant ...Executive Compensation ...Security...

  • Page 8
    ..., (2) educational software-based content, such as interactive books and cartridges, specifically designed for use with our learning platforms and (3) stand-alone educational products. We serve two markets, the consumer market and the education and training market. When we started our business in...

  • Page 9
    ... pre-kindergarten curriculum, the Ready, Set, Leap! program, meets Head Start standards and was adopted by the Texas State Board of Education. We have also developed and introduced our nine-theme, 36-interactive book English language development program, Language First!, which is designed to build...

  • Page 10
    ...Board. The 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...

  • Page 11
    ... sold in U.S. schools. In 2004, we introduced the LeapPad Plus Microphone version of the LeapPad learning system, which allows children to record their voice and personalize their learning experience. The retail LeapPad library was developed with guidance from our educational experts and is designed...

  • Page 12
    ... a multi-directional control 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. Our Leapster software titles include educational games featuring licensed characters...

  • Page 13
    ...they write and draw. Our new Fly platform is designed for the "tween" and teen markets. The Fly pentop computer is scheduled to be available in Fall 2005 at select retailers in North America. Stand-Alone Products Our variety of stand-alone educational products are designed primarily for children who...

  • Page 14
    ... Texas State Board of Education. • • • Advertising and Marketing Our advertising and marketing strategy is designed to establish LeapFrog as the leading provider of engaging, effective and affordable learning solutions for the infant through high school audience and as a brand that parents...

  • Page 15
    ... build brand awareness in the education market, including placing advertisements in leading education publications targeting school administrators and teachers, and participating in key education trade shows and events. Sales and Distribution A limited number of customers historically have accounted...

  • Page 16
    ...the school market. We also publish a catalog that is aimed at and distributed to educators. In 2004, we began selling our products in Puerto Rico through a local distributor. Financial Information About Geographic Areas Our International segment represented 24% of our total consolidated net sales in...

  • Page 17
    ... 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 18
    ... May Affect Our Results and Stock Price-We rely on a limited number of manufacturers, virtually all of which are located in China, to produce our finished products, and our reputation and operating results could be harmed if they fail to produce quality products in a timely manner and in sufficient...

  • Page 19
    ...for better forecasting and inventory plans. Our customer service and retail sales service teams are based in our Emeryville, California facility. Competition We compete primarily in the infant and toddler category, preschool category and the electronic learning aids category of the U.S. toy industry...

  • Page 20
    ... with our Leapster and Leapster L-MAX systems. We believe that producers of smart mobile devices, such as personal digital assistants, non-mobile game platforms and computer-based software may be able to compete effectively in our primary markets by developing engaging educational products that run...

  • Page 21
    ... the President of Knowledge Universe LLC, which builds, through a combination of internal development and acquisitions, companies in areas relating to education, technology and career management. From 1990 to 1996, he served as President and Chief Executive Officer of Sega of America. Prior to that...

  • Page 22
    ... of Universal Studios New Media Group, the technology, Internet and video games business unit of Universal Studios, from May 1996 to May 1999. Prior to that, he worked at Sega of America from 1989 to 1996, most recently as an Executive Vice President. Mr. Rioux also served as Chief Operating Officer...

  • Page 23
    ...Chief Information Officer and Deputy Director of Operations for the Office of Naval Research in Washington, D.C., for which he received the Navy's Distinguished Service Medal. Mr. Moon received his B.S. from the United States Navel Academy and pursued graduate studies at George Washington University...

  • Page 24
    ... of the California Corporations Code, based upon allegations that certain of our officers and directors issued or caused to be issued alleged false statements and allegedly sold portions of their stock holdings while in the possession of adverse, non-public information. In April 2004, the Superior...

  • Page 25
    Stockholder Class Action On December 2, 2003, a class action complaint entitled Miller v. LeapFrog Enterprises, Inc., et al., No. 03-5421 RMW, was filed in federal district court for the Northern District of California against LeapFrog and certain of its current and former officers and directors ...

  • Page 26
    ...Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities. Market Information and Holders Our Class A common stock is listed on the New York Stock Exchange, or the NYSE, under the symbol "LF." There is no established public trading market for the Class B common stock. On March...

  • Page 27
    ... brand and products largely focused on infants, toddlers, and children in preschool through grade school and 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 and price points to make learning fun and cost...

  • Page 28
    ...at a faster rate than our U.S. Consumer segment. 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...

  • Page 29
    ... the related information technology systems. We recently hired a new Chief Information Officer and are searching for an executive to be in charge of our supply chain. We are also implementing a new company-wide three-year planning process that will allow us to plan our business and investments over...

  • Page 30
    ... 2005, we expect to launch our new Fly pentop computer platform, which targets the middle school age group, a consumer market that we have not focused on in the past. Also in Fall 2005, we are extending the product line for our Leapster system, our screen-based technology platform, by launching our...

  • Page 31
    ... on specific terms for product returns and our experience with similar products. In estimating returns, we analyze (i) historical returns and sales patterns, (ii) analysis of credit memo data, (iii) current inventory on hand at customers, (iv) changes in demand, and (v) introduction of new products...

  • Page 32
    ... million in asset cost and $0.9 million in associated accumulated amortization. There were no write-offs in prior periods. We capitalize costs related to the production of home video in accordance with AICPA Statement of Accounting Position No 00-2, "Accounting by Producers or Distributors of Film...

  • Page 33
    ...July 25, 2002 at our initial public offering price of $13.00 per share. Our deferred compensation expense in connection with the conversion of 1,310,594 unvested stock appreciation rights held by employees converted to options to purchase 1,310,594 shares of Class A common stock was $4.0 million. In...

  • Page 34
    ... of net sales for the periods indicated: Year Ended December 31, 2004 2003 2002 Net sales ...Cost of sales ...Gross profit ...Operating expenses: Selling, general and administrative ...Research and development ...Advertising ...Depreciation and amortization ...Total operating expenses ...(Loss...

  • Page 35
    ... 2004. We estimate that retailers have reduced their inventory levels of our products by approximately $30 million, based on wholesale prices, by the end of 2004. Price reductions on some of our LeapPad family of platforms and higher sales allowances. Weaker holiday toy sales in the United States...

  • Page 36
    personal learning tools. In addition, our SchoolHouse division experienced strong sales of our interactive content library resulting from successful direct marketing promotions, an overall expansion of a dedicated sales force, and increased product offerings and brand awareness. Gross Profit The ...

  • Page 37
    ...'s gross profit percentage year-over-year was primarily due to better net sales leverage achieved as the segment's fixed expenses represent a lower percentage of those sales, partially offset by lower margin ancillary services sold in conjunction with the LeapTrack learning system. Selling, General...

  • Page 38
    ...costs of Leapster software and internal costs associated with the production of new video titles. The increase in product development was primarily due to the development of our new Fly pentop computer platform. Advertising Expense The advertising expenses in dollars for each segment and the related...

  • Page 39
    ... from Higher depreciation expense for computers and software; Increased amortization of intangible assets primarily related to a technology license purchased in 2004; and Lower amortization of website development expenses. Our original website design and development was fully amortized in August...

  • Page 40
    ... rates favorably impacted our total company net sales by 1% due to stronger international currencies. Net sales of our stand-alone, software and platform products increased by 42%, 31% and 18%, respectively, year-over-year. Net sales for each segment and its percentage of total company net sales...

  • Page 41
    ... 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 42
    ... ocean freight rates and due to airfreight 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 43
    ... by lower litigation and incentive compensation expenses as follows: • Salaries and related employee benefits were higher than in 2002 by $11.8 million, primarily due to the emphasis on building internal sales and marketing teams and infrastructure to support our worldwide expansion; Litigation...

  • Page 44
    ... 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 Canada. Depreciation...

  • Page 45
    ...need to increase inventories in advance of our primary selling season; and the timing of introductions of new products. For a discussion of these and other factors affecting seasonality, see "Risk Factors That May Affect Our Results and Stock Price-Our business is seasonal, and therefore our annual...

  • Page 46
    ... of employee stock options and employee stock purchase plan of $13.0 million and $28.0 million in 2004 and 2003, respectively. Cash and related balances are: 2004(1) December 31, 2003(1) Change(1) Cash and cash equivalents ...Short-term investments ...Total ...% of total assets ...Restricted...

  • Page 47
    ... from the exercise of stock options and employee stock plan purchases. Our cash flow is very seasonal, as more than 75% of our sales typically occur in the last two quarters of the year as retailers expand inventories for the holiday selling season. Our accounts receivable balances are the 40

  • Page 48
    ... to meet the holiday season demand. However, in 2004 we began increasing our inventory build earlier than in past years in order to be in a better position to fulfill third and fourth quarter demand, and to facilitate the implementation of our supply chain initiatives. We also ended the year with...

  • Page 49
    ... and related software and certain stand-alone products; $14.5 million increase in finished goods in the International segment; $11.7 million increase in raw materials due to longer lead times in our manufacturing process and new product components primarily related to Leapster platform products; and...

  • Page 50
    ...10.6 We have provided irrevocable standby letters of credit to several of our inventory manufacturers and one technology partner. The standby letters of credit guarantee performance of the obligations of certain of our foreign subsidiaries to pay for trade payables and contractual obligations of up...

  • Page 51
    ...2002 we purchased software products and support services from Oracle Corporation totaling $406,000, $569,000, and $280,000 respectively. As of December 31, 2004, Lawrence J. Ellison, the Chairman and Chief Executive Office of Oracle Corporation, may be deemed to have or share the power to direct the...

  • Page 52
    ...total purchase price of $300,000. We purchased the assets in order to obtain the contents of a children's website developed by Knowledge Kids Network and to benefit from a contract giving us online advertising impressions. In July 2002, we entered into a tax sharing agreement with Knowledge Universe...

  • Page 53
    ... successfully integrate third-party technology with our own. In Fall 2005, we plan to introduce a number of new platforms, stand-alone products and interactive books and other software for each of our three business segments, including our Fly pentop computer, which is targeted at an older age group...

  • Page 54
    ...; changes in our pricing policies, the pricing policies of our competitors and general pricing trends in consumer electronics and toy markets; international sales volume and the mix of such sales among countries with similar or different holidays and school years than the United States; the...

  • Page 55
    ... to date. Insufficient internal controls could also cause investors to lose confidence in our reported financial information, which could result in the decrease of the market price of our Class A common stock. Our rapid growth has presented significant challenges to our management systems and...

  • Page 56
    ... makers of popular game platforms and smart mobile devices such as personal digital assistants. For example, we are beginning to cross over into their markets with products such as our Leapster handhelds, iQuest handheld and planned products, such as our Fly pentop computer. These companies are well...

  • Page 57
    ... 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 the number of our products increases...

  • Page 58
    ..., which may not be successful. We launched our Education and Training Group in June 1999 to deliver classroom instructional programs to the pre-K through 8th grade school market and explore adult learning opportunities. To date the SchoolHouse division, which accounts for substantially all of the...

  • Page 59
    ... 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 our LittleTouch LeapPad, My First LeapPad, Classic LeapPad, LeapPad Plus Writing, Quantum LeapPad and Leapster...

  • Page 60
    ... our gross margins or cause us to lose sales. Demand for our products depends on many factors such as consumer preferences, including children's preferences, and the introduction or adoption of new hardware platforms for interactive educational products and related content, and can be difficult to...

  • Page 61
    ...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, any of which could harm our business. Children could sustain injuries from our products, and we may be subject...

  • Page 62
    ...imposed by our credit facility. This control by Mr. Ellison could depress the market price of our Class A common stock or delay or prevent a change in control of LeapFrog. The limited voting rights of our Class A common stock could negatively affect its attractiveness to investors and its liquidity...

  • Page 63
    ... Disclosures About Market Risk. We develop products in the United States and market our products primarily in North America and, to a lesser extent, in Europe and the rest of the world. We are billed by and pay our third-party manufacturers in U.S. dollars. Sales to our international customers are...

  • Page 64
    ... Executive Officer and Chief Financial Officer. Disclosure controls are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Exchange Act, such as this report, is recorded, processed, summarized and reported within the time...

  • Page 65
    ... timely reconciliation and review processes related to sales discounts and allowances, shipment and invoicing, and cash receipts. Inadequate staffing to determine that internal controls over reconciliations, review of account balances and closing procedures are performed consistently and on a timely...

  • Page 66
    ...purchase price and production variances included in inventories and cost of sales. Inadequate staffing to ensure that internal controls over reconciliations, review of account balances and closing procedures are performed consistently and on a timely basis. In the area of information technology...

  • Page 67
    ...history of changes to key elements of the data. • In relation to the material weakness in the area of cost of goods sold and inventory, we plan to take the following actions in 2005 Supply chain leadership will be upgraded through the addition of a senior executive with overall responsibilities...

  • Page 68
    ... following actions in 2005: • Our new Chief Information Officer will develop a comprehensive information technology system strategy that is in line with and supports our business strategy and our need for appropriate processes and policies related to internal controls. Corporate ERP systems will...

  • Page 69
    ... in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our...

  • Page 70
    ... over changes to bills of materials and work orders. Inadequate review of purchase price and production variances included in inventories and cost of sales. Inadequate staffing to ensure that internal controls over reconciliations, review of account balances and closing procedures are performed...

  • Page 71
    In our opinion, management's assessment that LeapFrog Enterprises, Inc. did not maintain effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO control criteria. Also, in our opinion, because of the effect of the ...

  • Page 72
    ... filing as exhibits to this annual report, the applicable certifications of our Chief Executive Officer and our Chief Financial Officer required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, regarding the quality of the Company's public disclosures. Item 11. Executive Compensation The...

  • Page 73
    ... shares reserved for issuance under our 2002 Employee Stock Purchase Plan. For a discussion of our equity compensation plans, see "Note 17. Stockholders' Equity" in the Notes to Consolidated Financial Statements included in this annual report on Form 10-K. Item 13. Certain Relationships and Related...

  • Page 74
    ...Financial Statement Schedules: The following financial statement schedule is included as Appendix A of this report: Valuation and Qualifying Accounts and Allowances (3) The exhibits listed in the accompanying index to exhibits are filed or incorporated by reference as part of this Annual Report. 67

  • Page 75
    ...1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signatures Title Date /s/ THOMAS J. KALINSKE Thomas J. Kalinske Chief Executive Officer (Principal Executive Officer) and Director Chief Financial Officer...

  • Page 76
    Signatures Title Date /s/ E. STANTON MCKEE E. Stanton McKee Director March 28, 2005 /s/ BARRY MUNITZ Barry Munitz Director March 28, 2005 /s/ STEWART A. RESNICK Stewart A. Resnick Director March 28, 2005 69

  • Page 77
    ... 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. b) Date: March 28, 2005 /s/ THOMAS J. KALINSKE Thomas J. Kalinske Chief Executive Officer...

  • Page 78
    ...'s auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the...

  • Page 79
    ... 2004, we changed our disclosure of receivable allowances to include only allowances for doubtful accounts to better conform to the prevailing practice in our industry. Our other receivable allowances: allowances for product returns, charge backs, defective products and promotional markdowns totaled...

  • Page 80
    LEAPFROG ENTERPRISES, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Report of Independent Registered Public Accounting Firm ...Consolidated Balance Sheets ...Consolidated Statements of Operations ...Consolidated Statements of Stockholders' Equity ...Consolidated Statements of Cash Flows ......

  • Page 81
    ...all material respects the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of LeapFrog Enterprises, Inc.'s internal control over financial reporting as of December 31, 2004, based...

  • Page 82
    ... BALANCE SHEETS (In thousands, except per share data) December 31, 2004 2003 ASSETS Current assets: Cash and cash equivalents ...Short-term investments ...Restricted Cash ...Accounts receivable, net of allowances of $2,519 and $1,620 at December 31, 2004 and 2003, respectively ...Inventories...

  • Page 83
    ...(In thousands, except per share data) Year Ended December 31, 2004 2003 2002 Net sales ...Cost of sales ...Gross profit ...Operating expenses: Selling, general and administrative ...Research and development ...Advertising ...Depreciation and amortization ...Total operating expenses ...(Loss) Income...

  • Page 84
    ... ...Total comprehensive income ...Balances at December 31, 2003 ...Amortization of deferred compensation ...Deferred compensation ...Reversal of deferred compensation due to employee termination ...Class A common stock issued upon exercise of stock option and employee purchase plan (1,759 shares...

  • Page 85
    ... compensation related to nonemployees and non recourse notes receivable ...Tax benefit from exercise of stock options and other ...Amortization of investment premium ...Other changes in operating assets and liabilities: Accounts receivable ...Inventories ...Prepaid expenses and other current assets...

  • Page 86
    ... (2) educational software-based content, such as interactive books and cartridges, specifically designed for use with the Company's learning platforms and (3) stand-alone educational products. The Company's products are sold throughout the United States primarily by national and regional mass-market...

  • Page 87
    ...on management's evaluation of the customer's financial condition, past collection history and aging of the accounts receivable balances. The Company also provides for allowances related to returns, discounts, promotions and defective products. The Company records these allowances on product sales in...

  • Page 88
    ... of credit risk is managed by diversifying investments among a variety of high credit-quality issuers. Inventories Inventories, net of an allowance for slow-moving, excess quantities and obsolescence, are stated at the lower of cost (first-in, first-out basis) or market value. The Company's estimate...

  • Page 89
    ...ensure that the related product line is still in production and that the estimated useful lives of the manufacturing tools are consistent with the Company's depreciation policy. Depreciation expense for manufacturing tools is included in costs of goods sold. In 2004, the Company recorded accelerated...

  • Page 90
    ... a fixed number of shares with an exercise price equal to the fair value of the shares on the date of grant. As allowed under the Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), the Company has elected to follow Accounting Principles Board...

  • Page 91
    ...to fair value. The Company regularly evaluates its long-lived assets for indicators of possible impairment. Recent Accounting Pronouncements In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment." SFAS No. 123R requires employee stock options and rights to purchase shares under stock...

  • Page 92
    ... per share and percent data) conversion be based on the normal capacity of the production facilities. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not expect the adoption of this standard to have any material impact...

  • Page 93
    ... 31, 2004 2003 Raw materials ...Work in process ...Finished goods ...Reserves ...Inventories, net ... $ 39,684 6,058 102,801 (17,354) $131,189 $29,307 - 64,887 (3,297) $90,897 Valuation of work in process inventory is an estimation of the Company's liability for products in production at the...

  • Page 94
    ... 2002 the Company purchased software products and support services from Oracle Corporation totaling $406, $569, and $280 respectively. As of December 31, 2004, Lawrence J. Ellison, the Chairman and Chief Executive Office of Oracle Corporation, may be deemed to have or share the power to direct the...

  • Page 95
    .... The Company purchased the assets in order to obtain the contents of a children's website developed by Knowledge Kids Network and to benefit from a contract giving the Company online advertising impressions. • In July 2002, the Company entered into a tax sharing agreement with Knowledge Universe...

  • Page 96
    ... any material losses on cash equivalents, short-term and long-term investments, and foreign exchange transactions. 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...

  • Page 97
    ...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, 2004 2003 2002 Wal-Mart ...Toys "R" Us ...Target...

  • Page 98
    ... or reduction to the effective tax rate in the year of resolution. The Company believes that the tax contingency accruals reflect the probable outcome of known tax contingencies at this time. Tax benefits of $8,420 related to employee stock options were credited directly to Stockholders' equity. The...

  • Page 99
    ..., except per share and percent data) For federal income tax purposes, the Company files a separate federal income tax return. However, due to its status as part of a unitary group with Knowledge Universe, Inc., the Company joined in the filing of several unitary/combined state tax returns with the...

  • Page 100
    ... public offering of 9,960 shares of its Class A common stock at a price to the public of $13.00 per share. Conversion of Stock Appreciation Rights Prior to its initial public offering, the Company granted stock appreciation rights under its Amended and Restated Employee Equity Participation Plan...

  • Page 101
    ...value of a share of Class A common stock on the date the stock option is granted, provided that the option price of an incentive stock option granted to any owner of 10% or more of the total combined voting power of the Company shall be 110% of such fair market value. The aggregate fair market value...

  • Page 102
    ...annual service time. Each stock option is exercisable for a period of ten years from the date of grant, no stock option shall be exercisable after the expiration of its option term, the exercise price of the option shall be 100% of the fair market value of a share of Class A common stock on the date...

  • Page 103
    ...Class A common stock at average exercise prices of $12.05, $21.77, and $9.89 per share, respectively. These options were granted in exchange for consulting services performed. The Company determined the fair value of these options using the Black-Scholes valuation model. Compensation expense related...

  • Page 104
    ... received 1,474 shares of Class B common stock on a net basis. In March 2002, in connection with recruiting services rendered, the Company issued a warrant to purchase 20 shares of Class A common stock at an exercise price of $10.00 per share. The Company accounted for the fair value of the warrants...

  • Page 105
    ... 31, 2004, the Company had outstanding foreign exchange forward contracts, all with maturities of approximately one month, to purchase and sell the equivalent of approximately $60,300 in foreign currencies, including British Pounds, Canadian Dollars, Euros and Mexican Pesos. The fair market value of...

  • Page 106
    ... of the Emeryville lease signed in March 2005. The Company is also obligated to pay certain minimum royalties in connection with license agreements to which the Company is a party. Commitments to be paid in 2005 include $11,000 in royalties related to a technology agreement. Amounts related to...

  • Page 107
    ... of the California Corporations Code, based upon allegations that certain of the Company's officers and directors issued or caused to be issued alleged false statements and allegedly sold portions of their stock holdings while in the possession of adverse, non-public information. In April 2004, the...

  • Page 108
    ...respectively. 23. Segment Reporting The Company's reportable segments include U.S. Consumer, International and Education and Training. The U.S. Consumer segment includes the design, production and marketing of electronic educational toys and books, sold primarily through the retail channels. For the...

  • Page 109
    ... 72,675 $ $ 1.27 1.20 In March 2005, the Company amended its lease agreement for the Company's corporate offices in Emeryville, California. The amendment to the lease extended the term of the lease agreement from January 31, 2006 to March 31, 2016. Payments totaling $20,000 are due over the term of...

  • Page 110
    ... the 2002 Employee Stock Purchase Plan. Compensation Arrangements between LeapFrog and its Board of Directors (the description contained under the heading "Proposal One-Election of Directors-Compensation of Directors" in LeapFrog's definitive proxy materials filed with the SEC on April 26, 2004 is...

  • Page 111
    ... on May 10, 2004 (SEC File No. 001-31396) Incorporated by reference to the same numbered exhibit previously filed with the company's report on Form 10-Q filed on November 9, 2004 (SEC File No. 001-351396) Compensation plans or arrangements in which directors or executive officers are eligible to...

  • Page 112
    ... this notice. The record date for the annual meeting is April 11, 2005. Only stockholders of record at the close of business on that date may vote at the meeting or any adjournment thereof. By Order of the Board of Directors Peter M. O. Wong Corporate Secretary Emeryville, California April 28, 2005...

  • Page 113
    ...stock, or your shares of LeapFrog's Class B common stock were registered directly with LeapFrog, then you are a stockholder of record. As a stockholder of record, you may vote in person at the meeting or vote by proxy. Whether or not you plan to attend the meeting, we urge you to fill out and return...

  • Page 114
    ...? We will pay for the entire cost of soliciting proxies. In addition to these mailed proxy materials, our directors and employees may also solicit proxies in person, by telephone, or by other means of communication. Directors and employees will not be paid any additional compensation for soliciting...

  • Page 115
    ... Audit Committee of the Board of Directors of Ernst & Young LLP as the Independent Registered Public Accounting Firm of LeapFrog for Our Fiscal Year Ending December 31, 2005. This proposal must receive a "For" vote from the majority of shares present and entitled to vote either in person or by proxy...

  • Page 116
    ... date, there were 33,995,981 shares of Class A common stock outstanding and 27,614,263 shares of Class B common stock outstanding, all of which are entitled to vote and represent a total of 310,138,611 votes. Thus shares representing at least 155,069,306 votes must be represented at the meeting...

  • Page 117
    ... all members of our board of directors and all other matters submitted to a vote of our stockholders. Mr. Ellison is Chief Executive Officer of Oracle Corporation. Beneficial Ownership of Our Common Stock The following table sets forth certain information regarding the ownership of LeapFrog's common...

  • Page 118
    ..., formerly known as 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, held 309,134 shares of Class B common stock. Messrs. Ellison, M. Milken...

  • Page 119
    ...187,700 shares. The address for Royce is 1414 Avenue of the Americas, New York, New York 10019. (9) Based solely on information provided in a Schedule 13G filed on February 16, 2005 by Ziff Asset Management, L.P. Philip B. Korsant shares voting and dispositive power over the shares of common stock 7

  • Page 120
    ... in 2004, provided that LeapFrog has the right to repurchase these shares until Mr. Perez's ownership vests in three equal annual installments, beginning on the first anniversary of the date the stock bonus award was granted to Mr. Perez by the Compensation Committee of our board of directors; and...

  • Page 121
    ... applicable. Messrs. Wood and Forsyth are not included as executive officers as neither of them was serving as an executive officer of LeapFrog as of April 11, 2005, the date of the information in the table. Includes an additional 364,528 shares of Class A common stock held by our executive officers...

  • Page 122
    ... also serves as a Vice Chairman of Knowledge Universe (now renamed Krest 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, a position he has held since 1996. 10

  • Page 123
    ... Spring Group plc, an information technology services company in the United Kingdom, and is a director of Nextera Enterprises, a former provider of economic consulting services that has sold its operating businesses, Nobel Learning Communities, Inc., a non-sectarian, for-profit provider of education...

  • Page 124
    ...to helping build better futures for disadvantaged children in the United States. Since 2004, Mr. Smith has served on the board of directors of Nobel Learning Communities, Inc., a non-sectarian, for-profit provider of education and educational services for the pre-elementary through 12th grade market...

  • Page 125
    ... meetings and involvement of senior 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 SEC...

  • Page 126
    ... board of directors oversees LeapFrog's corporate accounting and financial reporting process. For this purpose, the Audit Committee performs several functions. Among other things, the Audit Committee evaluates the performance of and assesses the qualifications of the independent registered public...

  • Page 127
    ...formal education and experience as a chief financial officer for a public reporting company. COMPENSATION COMMITTEE The Compensation Committee reviews and approves the overall compensation strategy and policies for LeapFrog. The Compensation Committee reviews and approves corporate performance goals...

  • Page 128
    ... the current needs of the board and LeapFrog, to maintain a balance of knowledge, experience and capability. In the case of incumbent directors, the Nominating and Corporate Governance Committee reviews such directors' overall service to LeapFrog during their term, including the number of meetings...

  • Page 129
    ... Code to any executive officer or director, we will promptly disclose the nature of the amendment or waiver on the investor relations section of our website at www.leapfroginvestor.com. COMPENSATION OF DIRECTORS Each non-employee director of LeapFrog receives a meeting fee of $1,500 for each board...

  • Page 130
    ...'s directors and executive officers, and persons who own more than ten percent of a registered class of LeapFrog's equity securities, to file with the SEC initial reports of ownership and reports of changes in ownership of common stock and other equity securities of LeapFrog. Officers, directors and...

  • Page 131
    ...filing requirements applicable to our officers, directors and greater than ten percent beneficial owners were complied with except that: (a) two reports, covering the transfer of 11,580 shares of our Class B common stock from one Class B stockholder to another were filed late by Hampstead Associates...

  • Page 132
    ...the Audit Committee reviews and evaluates, and discusses and consults with LeapFrog management, LeapFrog internal audit personnel and the independent registered public accounting firm regarding the following the plan for, and the independent registered public accounting firm's report on, each audit...

  • Page 133
    ... the board of directors that the financial statements be included in LeapFrog's 2004 annual report on Form 10-K filed with the SEC. Oversight of Independent Registered Public Accounting Firm The Audit Committee appoints the independent registered public accounting firm and reviews their performance...

  • Page 134
    ...registered public accounting firm's opinion on the effectiveness of internal control over financial reporting that were included in the company's annual report on Form 10-K for the fiscal year ended December 31, 2004. Management has presented to the Audit Committee its plan to remediate the material...

  • Page 135
    ...the specific peer companies. The Compensation Committee uses the services of an independent consultant to conduct its periodic review of the effectiveness and competitiveness of LeapFrog's executive pay. (2) The material in this report is not "soliciting material," is not deemed "filed" with the SEC...

  • Page 136
    ... of $550,000 from which the executives could issue 2004 Exceptional Worker Awards to a small group of LeapFrog employees who had outstanding performance in 2004. The board of directors approved the plan and the Chief Executive Officer and President approved payments totaling $495,900 to be paid to...

  • Page 137
    ... stock represents full-value shares, we can grant fewer shares to deliver a competitive compensation value to our key employees and strengthen the retention power of the equity grant program. Chief Executive Officer Compensation The Compensation Committee meets each year to evaluate the performance...

  • Page 138
    ...qualified option to purchase 190,000 shares of LeapFrog common stock at $22.25 per share, the then fair market value of our class A common stock, vesting at the rate of 1/48th of the option per month for four years, and (2) a grant of 95,600 performance shares under the 2004-2006 plan cycle. In line...

  • Page 139
    ... potential to earn attractive compensation rewards through the plans described above. A significant portion of executive compensation, including that of the Chief Executive Officer, is generated based upon company performance, and actual rewards are closely linked to LeapFrog's success in achieving...

  • Page 140
    ... by multiplying the closing market price of LeapFrog's unrestricted common stock on the date of grant, November 10, 2004 ($13.50), by the number of shares awarded (40,000). As of December 31, 2004, Mr. Perez held an aggregate of 40,000 shares of restricted stock valued at $544,000, calculated...

  • Page 141
    ... relating to his services as our Chief Executive Officer and President. For additional discussion of this agreement, see "Employment Agreements and Compensation Arrangements." (13) Mr. Wood received $841, $1,700 and $1,151 in matching grants made to his 401(k) savings plan by LeapFrog in 2004...

  • Page 142
    ... by the named executive officers: Option Grants in 2004 Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Option Term Exercise Or Base Price (per share) Name Individual Grants % of Total Number of Options Securities Granted to Underlying Employees Options in Fiscal...

  • Page 143
    ... date. The company did not meet the 2004 performance goals set by the Compensation Committee of our board of directors. Accordingly, the named executive officers will not receive a grant of shares under the performance share program for the 2004 period. Estimated Future Payouts Under Non-Stock Price...

  • Page 144
    ... 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, 2004. (3) This section is not "soliciting material," is not deemed "filed" with the SEC and is not to be...

  • Page 145
    ... of his then-current annual salary, less $67,500, based on LeapFrog's performance and Mr. Kalinske's achievement of performance objectives established in writing by the board of directors. Mr. Kalinske must be an active employee of LeapFrog as of December 31 of the bonus year in order to receive the...

  • Page 146
    ... within the first three years of his employment with LeapFrog and he sells his Bay Area residence within 12 months after the termination date to an unaffiliated third party for a sale price that is less than his purchase price, he will be reimbursed for his lost principal investment in the Bay Area...

  • Page 147
    ... into an employment agreement with LeapFrog for the position of Advisor to LeapFrog's Chief Executive Officer. Under the new employment agreement, Mr. Rioux will provide his services to LeapFrog on a part-time basis and will be compensated at a monthly rate of $3,333.33 less payroll deductions...

  • Page 148
    ... from LeapFrog, provided that payments made to him during the six additional months will be reduced by the gross amount of any monetary compensation earned by Mr. Forsyth from any consulting or other work relationship, including fees earned for service on a company's board of directors. 36

  • Page 149
    ... 2004, KU LLC changed its name to "Krest LLC." • In 2004 we purchased software products and support services from Oracle Corporation totaling $406,000. As of December 31, 2004, Lawrence J. Ellison, the Chief Executive Office of Oracle Corporation, may be deemed to have or share the power to direct...

  • Page 150
    ...Committee of the board of directors has selected Ernst & Young LLP as LeapFrog's independent registered public accounting firm for the fiscal year ending December 31, 2005, and has further directed that management submit the selection of independent registered public accounting firm for ratification...

  • Page 151
    ...of the Sarbanes-Oxley Act. The Audit Committee has determined that the rendering of the services other than audit services by Ernst & Young LLP is compatible with maintaining the registered public accounting firm's independence. The Board of Directors Recommends A Vote in Favor of Proposal Two. 39

  • Page 152
    ... proxy statement and annual report, you may: (1) notify your broker; (2) direct your written request to our Vice President of Investor Relations, 6401 Hollis Street, Suite 150, Emeryville, California 94608 or to [email protected] or (3) contact our Vice President of Investor Relations at (510) 420...

  • Page 153
    ...of Board members as meet such requisite qualifications, which lesser number shall meet the requirements regarding the composition of Audit Committees as set forth in the corporate governance standards of the New York Stock Exchange, as amended from time to time. PROCEDURES Committee procedures shall...

  • Page 154
    ... and Information Needs-The Committee should communicate to the Chief Executive Officer and President or their designees, internal auditors (or other personnel responsible for the internal audit function), and other external parties the specific nature, timing, and extent of any specific information...

  • Page 155
    ... Committee shall review the experience and qualifications of the external auditor's senior personnel that are providing audit services to the Company. The internal audit function shall be responsible to senior management, but have a direct reporting responsibility to the Board through the Committee...

  • Page 156
    ... accounting and reporting financial errors, fraud and defalcations, illegal act, and noncompliance with the corporate code of conduct and regulatory requirements. Internal Audit Responsibilities-The Committee shall review and assess the annual audit plan and the process used to develop the plan...

  • Page 157
    ... partner responsible for reviewing the audit, will be prohibited from performing external audit services for the Company for more than five (5) consecutive years; and an external accounting firm will be prohibited from performing any audit services if the chief executive officer, chief financial...

  • Page 158
    ... is a controlling stockholder of LeapFrog. The director is an employee, officer or director of a foundation, university or other non-profit organization to which LeapFrog gives directly, or indirectly through the provision of property or services, in the current fiscal year, donations that do not...

  • Page 159
    ... Officer Electronic Arts Inc. Mark B. Flowers EVP, Chief Technology Officer INVESTOR฀RELATIONS LeapFrog Enterprises welcomes inquiries from its stockholders and other interested investors. To obtain a copy of the company's recent SEC filings and other corporate information, please direct your...

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