LeapFrog 2006 Annual Report Download

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Table of contents

  • Page 1

  • Page 2
    ... in our product development, product management or marketing processes. With the installation of our new international leadership, we are making the changes necessary to improve performance. • Build our product line around fewer, scalable platforms. By using standards-based software methodologies...

  • Page 3
    ...the products we currently have in the market. In 2007, we are launching a number of new products, including the FLY Fusion Pentop Computer, our next generation FLY product, ClickStart My First Computer system, the largest ever software library expansion for our category leading Leapster family, Word...

  • Page 4
    ... better company for our shareholders, customers, partners, and employees. LeapFrog's Mission LeapFrog's mission is to create value for our shareholders, customers and employees in the largest markets in the world. Here's how we do it: LeapFrog makes learning fun with connected, innovative technology...

  • Page 5
    ...Hollis Street Emeryville, 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...

  • Page 6
    ... of new information, future events or otherwise after the date of this report. TRADEMARKS AND SERVICE MARKS LeapFrog, LeapFrog SchoolHouse, Alphabet Pal, Brightlings, ClickStart, FLY, FLY Through, FLY Fusion, Fridge Phonics, Language First!, Leap, LeapPad, LeapStart, LeapTrack, Leapster, Leapster...

  • Page 7
    ... About Market Risk ...Financial Statements 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, Executive Officers and Corporate...

  • Page 8
    ... designs, develops and markets technology-based educational platforms with curriculum interactive software content and stand-alone products and these products are for sale through retailers, distributors and directly to schools. We operate three business segments, namely U.S. Consumer, International...

  • Page 9
    ...identifies what children learn and when and how they learn it. The members of our Education Advisory Board meet with our creative design teams periodically throughout the year to participate in the design and development of our products. We believe that both our in-house experts and outside advisors...

  • Page 10
    .... Leapster L-Max learning system uses many of the software cartridges developed for the original Leapster handheld and offers new Leapster L-MAX software cartridges with features designed to offer an enhanced screen-based learning experience. Little Leaps Grow-with-Me Learning System (ages 9 months...

  • Page 11
    ...and sold under the "LeapTrack" system which provides assessment information to gauge the performance of individual students in a classroom environment. Current Products • LittleTouch LeapPad learning system (ages 6 months to 3 years). A learning system designed for infants and toddlers that offers...

  • Page 12
    ... and draw. Current Products • FLY Pentop Computer (ages 8 to 13). A consumer electronic device, introduced for the first time in Fall 2005, gives users real-time audio feedback as they write with special FLY paper. The FLY platform is designed for the "tween" and teen markets. FLY Software Library...

  • Page 13
    ... adapted for markets outside of the United States. SchoolHouse Products Our SchoolHouse segment offers supplemental pre-kindergarten through 5th grade school curriculum programs that incorporate our proprietary technology-empowered personal learning tools and research-based instructional principles...

  • Page 14
    ... leading education publications directed to school administrators and teachers. In addition, we periodically attend education trade shows and events. In 2006, as part of our marketing strategy to increase customer awareness of our products, we developed and expanded our online store to promote high...

  • Page 15
    ... electronic, office supply and specialty toy stores. In 2006, as part of our marketing strategy to increase customer awareness of our products, we developed and expanded our online store to promote high-traffic and repeat customer visits. Our sales team works with store buyers from our key retailers...

  • Page 16
    ... aging-up our products offerings. In 2006, we completed consolidation of our office locations, moving our research and development offices from Los Gatos, California to our corporate headquarters in Emeryville, California, to better align our product development activities. As part of our strategy...

  • Page 17
    ... Oracle enterprise resource planning, or ERP, applications. This environment supports our core financial, order management, distribution, and supply chain operations. We are also in the process of implementing new data warehouse system and metrics capabilities for improved demand planning, sales 10

  • Page 18
    ... launches and retail shelf space and market share of products sold directly through online internet based channels. We believe our products compete in these market segments based on brand, product design features, learning content and experience, quality and price. We believe the LeapFrog brand is...

  • Page 19
    ... believe that our relationship with our employees is good. In the third quarter of 2006, we reorganized our company to create four product groups: Reading Solutions, Interactive Educational Games, FLY and Grade School and Infant / Toddler / Preschool. There was little impact on headcount as a result...

  • Page 20
    ..., Chief Information Officer Senior Vice President, Human Resources General Counsel and Corporate Secretary Vice President, Controller and Principal Accounting Officer Jeffrey G. Katz has served as our Chief Executive Officer and President since July 2006 and as a member of our board of directors...

  • Page 21
    ... and system integrator of information technology products, and served as its Chief Operating Officer from September 2003 through April 2005. From May 2002 to September 2003, Mr. Dodd served as Executive Vice President, Chief Marketing Officer and Chief Operating Officer at Targus Group International...

  • Page 22
    ... financial performance. Our operating plan may not correct recent trends in our business. In July 2006, our board of directors appointed Jeffrey G. Katz as our President and Chief Executive Officer. Under Mr. Katz's leadership, we commenced and completed a full strategic review of our business. The...

  • Page 23
    ... our business. Our future success depends partly on the continued contribution of our key executives and technical, sales, marketing, manufacturing and administrative personnel. In July 2006, our board of directors appointed Jeffrey G. Katz as our President and Chief Executive Officer. Subsequent...

  • Page 24
    ... part, on sales relating to the brief holiday season. Sales of consumer electronics and toy products in the retail channel are highly seasonal, causing the substantial majority of our sales to retailers to occur during the third and fourth quarters. In 2006, approximately 73% of our total net sales...

  • Page 25
    ... 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 our reputation, lost sales, diverted development resources and increased customer service and support costs...

  • Page 26
    ...sales for our products outside the United States may not be successful and may not achieve higher sales or gross margins or contribution to profitability. Our business is, and will increasingly be, subject to risks associated with conducting business internationally, including developing successful...

  • Page 27
    ... intellectual property rights successfully, our rights could be diminished and our competitive position could suffer, which could harm our operating results. For additional discussion of litigation related to the protection of our intellectual property, see "Part I, Financial Information, Note 11 to...

  • Page 28
    ... standards, taxation requirements (including changes in applicable income tax rates, new tax laws and revised tax law interpretations), trade restrictions, regulations regarding financial matters, environmental regulations, advertising directed toward children, safety and other administrative and...

  • Page 29
    ..., investors may lose confidence in our reported financial information, which could result in the decrease of the market price of our Class A common stock. One stockholder controls a majority of our voting power as well as the composition of our board of directors. Holders of our Class A common stock...

  • Page 30
    ... could affect our stock price. The timing of announcements in the public markets regarding new products, product enhancements by us or our competitors or any other material announcements could affect our stock price. Speculation in the media and analyst community, changes in recommendations or...

  • Page 31
    ... our office locations, moving our research and development offices from Los Gatos, California to our corporate headquarters in Emeryville, California; and opened an office in Shenzhen, China to expand our research and development activities. Item 3. Legal Proceedings. From time to time, LeapFrog is...

  • Page 32
    ...sales prices per share of our Class A common stock on the NYSE in each quarter during the last two years. The values stated below are actual high and low sales prices, inclusive of intra-day trading. The 2005 values differ slightly from our prior year filing due to a change in the source of the data...

  • Page 33
    ...period beginning on July 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, 2006. The stockholder return shown on the graph below is not necessarily indicative...

  • Page 34
    ... International segments, our largest business segments, currently are generated in the toy aisles of retailers. We have sold the products of our SchoolHouse (formerly referred to as "Education and Training") segment predominantly to educational institutions. We design, develop and market technology...

  • Page 35
    ... 2006, currently targets the pre-kindergarten through 5th grade school market in the United States, including sales directly to educational institutions and teacher supply stores, and through catalogs aimed at educators. Business Update In July 2006, our board of directors appointed Jeffrey G. Katz...

  • Page 36
    ... FLY product will launch in 2007, and will expand LeapFrog's age segment profile with an improved software library, web connectivity, and sleeker form factor, and enhanced and ease of use; International expansion, including China, where test marketing has begun. • In the third quarter of 2006...

  • Page 37
    ... promoted a number of our most successful employees to senior roles. In July 2006, we completed the installation of the second phase of our Oracle 11i ERP system. This system will improve the linkage between sales forecasting and inventory planning, and improve customer service levels for our retail...

  • Page 38
    ... drive sales, marketing and brand awareness In the third quarter of 2007, we will launch a number of new products, including our new FLY Fusion Pentop Computer, our first web-connected platform, our new ClickStart My First Computer system and a number of products in our infant / Toddler / preschool...

  • Page 39
    gross sales less negotiated price allowances based primarily on volume purchasing levels, estimated returns, allowances for defective products, markdowns and other sales allowances for customer promotions. A small portion of our revenue related to training and subscriptions is deferred and ...

  • Page 40
    ... stock options to certain of our employees for a fixed number of shares with an exercise price generally equal to the fair value of the shares on the date of grant. These options generally vest over a four-year period. Prior to January 1, 2006, we accounted for the stock-based compensation plans...

  • Page 41
    ...table sets forth selected information concerning our results of operations as a percentage of net sales for the periods indicated: Year Ended December 31, 2006 2005 2004 Net sales ...Cost of sales ...Gross profit ...Operating expenses: Selling, general and administrative ...Research and development...

  • Page 42
    ... volume of our LeapPad family of products, which is technologically past its prime. Discounts and allowances mainly due to our promotional efforts to reduce retailers' slow-moving inventories, increased by $5.0 million in 2006. Specifically, we reported 68% lower sales for our FLY Pentop Computer...

  • Page 43
    ... development strategies formalized in the third quarter of 2006. This increase unfavorably impacted gross margin by approximately 3.0 percentage points. Closeout and promotional arrangements caused by weaker demand for our LeapPad family of products and our planned replacement of FLY Pentop Computer...

  • Page 44
    ... of stock options granted to employees as well as higher compensation expense for performance shares, restricted stock units and restricted stock awards. Higher salary expense, which increased by $3.7 million, related to severance costs primarily associated with the resignation of former corporate...

  • Page 45
    ... related to the conceptual, design and testing stages of our software and books. These expenses were as follows: Year Ended December 31, 2006 % of Total Company Net sales 2005 % of Total Company Net sales Change Segment $(1) $(1) $(1) % Product development ...Content development ...Research...

  • Page 46
    research and development, product and marketing activities. In addition, to the costs associated with this relocation, research and development expense also reflected compensation costs, which increased by approximately $1.4 million primarily related to stock-based compensation expense under SFAS ...

  • Page 47
    ..., software and stand-alone products in dollars and as a percentage of the segment's total net sales were as follows: Net Sales Year Ended December 31, 2005(1) 2004(1) % of Total Year Ended December 31, 2005 2004 Change $(1) % Platform ...Software ...Stand-alone ...Total U.S. Consumer Net Sales...

  • Page 48
    ... of our FLY Pentop Computer and related software and accessories, which began shipping to retail customers in the third quarter of 2005 for our October 2005 product launch. Introduction of our Leapster L-MAX system in the third quarter which added to the increased demand for our screen-based...

  • Page 49
    ... of the following: • • Shipments to retail customers in the third and fourth quarters of our FLY Pentop Computer and related software and accessories, which have relatively strong margins. Reduced sales allowances in 2005 compared to 2004 when customers received allowances to offset operational...

  • Page 50
    ... the costs related to the conceptual, design and testing stages of our software and books. These expenses were as follows: Year Ended December 31, 2005 2004 % of % of Net Sales $(1) Net Sales Change $(1) % $(1) Content development ...Product development ...Research and development ...(1) In...

  • Page 51
    ... as follows: Year Ended December 31, 2005 2004 % of % of Total Total Segment's Segment's Net Sales $ (1) Net Sales Change Segment $ (1) $ (1) % U.S. Consumer ...International ...SchoolHouse ...Total Company ...(1) In millions. $52.5 17.0 0.5 $70.0 11.0% 13.0% 1.1% 10.8% $63.2 19.6 0.4 $83...

  • Page 52
    ... at peak demand times, or adversely impacting our own inventory levels by the need to pre-build products to meet the demand. For more information, see "Item 1A-Risk Factors-Our business is seasonal, and therefore our annual operating results depend, in large part, on sales relating to the brief...

  • Page 53
    ...Quarter Quarter Quarter December 31, (In thousands, except per share data) 2006 Net sales ...$ 66,548 Cost of sales ...41,759 Gross profit ...Operating expenses: Selling, general and administrative ...Research and development ...Advertising ...Depreciation and amortization ...Total... 279,636 126,187...

  • Page 54
    ... activities in 2006. Proceeds from the exercise of employee stock options and the employee stock purchase plan in 2006 and 2005. Cash and related balances are: 2006(1) December 31, 2005(1) Change(1) Cash and cash equivalents ...Short-term investments ...Total ...% of total assets ...Restricted...

  • Page 55
    ... the following year. The following table shows quarterly cash flows from operating activities data that illustrate the seasonality of our business. Cash Flow From Operating Activities 2006(1) 2005(1) 2004(1) 1st Quarter ...2nd Quarter ...3rd Quarter ...4th Quarter ...Total ...(1) In millions. $133...

  • Page 56
    ..., respectively. The capital expenditures will be primarily for new products and purchases related to the upgrading of our information technology capabilities. Operating activities Net cash provided by operating activities was $90.4 million in 2006. In 2005, net cash used in operating activities...

  • Page 57
    ...our employee stock purchase plan. Contractual Obligations We conduct our corporate operations from leased facilities and rent some equipment under operating leases. Generally, these have initial lease periods of three to twelve years and contain provisions for renewal options of five years at market...

  • Page 58
    ... requires a company to disclose its accounting policy (i.e. gross vs. net basis) relating to the presentation of taxes within the scope of EITF 06-3. Furthermore, for taxes reported on a gross basis, an enterprise should disclose the amounts of those taxes in interim and annual financial statements...

  • Page 59
    ... 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 60
    ...was performed under the supervision and with the participation of management, including our Chief Executive Officer, or CEO and Chief Financial Officer or CFO. Disclosure controls are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed...

  • Page 61
    ... on Effectiveness of Controls LeapFrog's management, including our CEO and CFO, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide...

  • Page 62
    ...to achieve these results, future events affecting the Company's business may cause management to modify its disclosure controls and procedures. Changes in Internal Control over Financial Reporting We took the following actions during the quarter ended December 31, 2006 Identified and hired seasoned...

  • Page 63
    ... Independent Registered Public Accounting Firm The Board of Directors and Stockholders of LeapFrog Enterprises, Inc. We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting, that LeapFrog Enterprises, Inc., (the "Company...

  • Page 64
    ...will disclose any reportable waivers, if and when granted, of our Code of Business Conduct and Ethics in the corporate governance section of our website located at www.LeapFroginvestor.com. On July 17, 2006, we filed with the NYSE the Annual CEO Certification regarding LeapFrog's compliance with the...

  • Page 65
    ...the Board of Directors" "Board of Directors and Corporate Governance-Committees of the Board" (first paragraph and table following only) Item 14. Principal Accountant Fees and Services. The information appearing in our 2007 Proxy Statement under the heading "Independent Registered Public Accounting...

  • Page 66
    ...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. 59

  • Page 67
    ... Exchange Act of 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/ JEFFREY G. KATZ Jeffrey G. Katz Chief Executive Officer (Principal Executive Officer), President and Director...

  • Page 68
    Signatures Title Date /S/ DAVID C. NAGEL David C. Nagel Director March 8, 2007 /S/ CADEN WANG Caden Wang Director March 8, 2007 /S/ RALPH R. SMITH Ralph R. Smith Director March 8, 2007 61

  • Page 69
    ...process, summarize and 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/ Jeffrey G. Katz Jeffrey G. Katz Chief Executive Officer 62 b) Date...

  • Page 70
    ... and 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/ William B. Chiasson William B. Chiasson Chief Financial Officer 63 b) Date: March...

  • Page 71
    ...Annual Report. 2. Dated: March 8, 2006 /s/ Jeffrey G. Katz Jeffrey G. Katz Chief Executive Officer /s/ William B. Chiasson William B. Chiasson Chief Financial Officer Note: This certification accompanies the Annual Report pursuant to § 906 of the Sarbanes-Oxley Act and shall not be deemed "filed...

  • Page 72
    ... was associated with improved resolution of customer claims and lower sales volume. (d) Excess and obsolete inventory allowance was increased due to obsolete and defective inventory of raw materials and discontinued finished goods. The increase in allowance was due, at least in part, to lower sales...

  • Page 73
    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 74
    ...January 1, 2006 the Company adopted FASB Statement No. 123(R), Share-Based Payments. 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...

  • Page 75
    ... AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ...Accrued liabilities and deferred revenue ...Income taxes payable ...Total current liabilities ...Long-term liabilities ...Stockholders' equity: Class A common stock, par value $0.0001; 139,500 shares authorized; shares issued and...

  • Page 76
    ... (In thousands, except per share data) Year Ended December 31, 2006 2005 2004 Net sales ...Cost of sales ...Gross profit ...Operating expenses: Selling, general and administrative ...Research and development ...Advertising ...Depreciation and amortization ...Total operating expenses ...Income (loss...

  • Page 77
    ... ...Total comprehensive income ...Balances at December 31, 2005 ...Stock-based compensation ...Class A common stock issued upon exercise of stock option and employee purchase plan (602 shares) ...Issuance of stock options to nonemployees ...Tax related to stock-based compensation ...Treasury stock...

  • Page 78
    ... 9 (117) Financing activities: Cash used to collateralize letter of credit ...- (150) - Proceeds from release of restricted cash ...150 - - Purchase of treasury stock ...(37) (148) - Proceeds from the exercise of stock options and employee stock purchase plan ...4,059 10,597 13,016 Net cash provided...

  • Page 79
    ...To date, the Company has established its brands and products primarily for children up to age 12 in the U.S. retail markets and in a number of international retail markets. Sales in the U.S. Consumer and International segments, the largest business segments, currently are generated in the toy aisles...

  • Page 80
    ...to titles not planned to be sold. The Company capitalizes 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." Video production costs are amortized based on the ratio of the current period...

  • Page 81
    ... market value net of allowance for slow-moving, excess and obsolete inventories. The allowance for slow-moving, excess and obsolete inventories is based on management's review of on-hand inventories compared to their estimated future usage, demand for its products, anticipated product selling prices...

  • Page 82
    ...") No. 00-02, "Accounting for Website Development Costs." The costs capitalized include those to develop or acquire and customize code for web applications, costs to develop HTML web pages or develop templates and costs to create initial graphics for the website that included the design or layout of...

  • Page 83
    ... periods for restricted stock and restricted stock units are generally three and four years, respectively. The Company also grants stock options to certain of its employees for a fixed number of shares with an exercise price generally equal to the fair value of the shares on the date of grant. These...

  • Page 84
    ... expected life. Restricted stock awards and restricted stock units are payable in shares of the Company's Class A common stock. The fair value of each restricted stock or unit is equal to the closing market price of the Company's stock on the trading day immediately prior to the date of grant. The...

  • Page 85
    ... requires a company to disclose its accounting policy (i.e. gross vs. net basis) relating to the presentation of taxes within the scope of EITF 06-3. Furthermore, for taxes reported on a gross basis, an enterprise should disclose the amounts of those taxes in interim and annual financial statements...

  • Page 86
    ..., receivables, accounts payable and accrued liabilities, approximated their fair values. 4. Investments Available-for-sale securities consisted of the following classified by original maturity date: Maturing within 5 to 10 5 YR YR Over 10 YR At December 31, 2006 1 YR 2 YR Total Auction rate...

  • Page 87
    ... 31, 2006 2005 Raw materials ...Work in process ...Finished goods ...Allowances ...Inventories, net ... $ 6,755 8,093 92,301 (34,129) $ 73,020 $ 31,954 11,220 150,629 (24,731) $169,072 At December 31, 2006 and 2005, the Company accrued liabilities for cancelled purchase orders totalling $2,451...

  • Page 88
    ... by Lawrence J. Ellison. In 2006, the Company purchased software products and support services from Oracle Corporation totaling $391. As of December 31, 2006, Lawrence J. Ellison, the Chief Executive Officer of Oracle Corporation, may be deemed to have or share the power to direct the voting and...

  • Page 89
    ...31, 2006 2005 Advertising and promotion ...Employee-related costs ...Royalties payable ...Accrued inventory, manufacturing, and warehousing ...Deferred revenue ...Legal fees and settlement costs ...Capital lease obligation ...Consulting, contractor costs and commissions payable ...Sales and VAT tax...

  • Page 90
    ...certificates and foreign exchange transactions with highly rated financial institutions. 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...

  • Page 91
    ... 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, 2006 2005 2004 Wal-Mart ...Toys "R" Us ...Target ...Total ... 26% 22...

  • Page 92
    ... outcome of known tax contingencies at this time. As of December 31, 2006 and 2005, the Company recorded $15,670 and $17,138, respectively, in long-term liabilities for these contingencies. Tax benefits of $109 and $2,662 related to employee stock options were credited directly to Stockholders...

  • Page 93
    ... California research credits can be carried forward indefinitely. During 2006, the Company recorded a non-cash charge to establish a valuation allowance of $60,433 against its gross deferred tax assets of $60,433. The amount represents 100% of the domestic deferred tax assets as set out in the table...

  • Page 94
    ...the Company recorded total expense of $829, $479 and $307, respectively, related to the defined contribution plan. 16. Stockholders' Equity Common Stock The Company is authorized to issue 180,000 shares of common stock at a $0.0001 par value per share, of which 139,500 shares are designated as Class...

  • Page 95
    ... these plans to increase the number of shares of Class A common stock reserved for issuance to employees to 21,000 from 19,000 and to increase the number of shares of Class A common stock reserved for issuance to nonemployee directors to 1,250 from 750. Effective January 1, 2006, the Company adopted...

  • Page 96
    ...$ (0.11) (0.11) (0.25) (0.25) Stock Options Stock options to purchase Class A common stock were granted with an exercise price equal to the closing market price of the Company's stock on the trading day immediately prior to the date of grant. Each stock option generally has a vesting period of four...

  • Page 97
    ... represent the period of time the options are expected to be outstanding and is based on the guidance provided in SEC Staff Accounting Bulletin No. 107 on Share-Based Payment. Expected stock price volatility is based on consideration of historical and current implied volatilities of the Company...

  • Page 98
    ... of Class A common stock options to its new President and Chief Executive Officer, resulting in an increase in the number of shares issued under stock option awards outstanding. Of these awards, options to purchase 2,000 shares were granted under the Company's 2002 Equity Incentive Plan and options...

  • Page 99
    ... the number of shares of Class A common stock that are reserved for future issuance under the Company's equity plans at December 31, 2006. Number of Shares Options and stock awards available and outstanding under the Equity Incentive Plan ...Shares issuable under the Employee Stock Purchase Plan...

  • Page 100
    ...31) (2.31) If the Company had reported net income for the year ended December 31, 2006, the calculation of diluted net income (loss) per Class A and B share would have included an additional 299 common equivalent shares related to outstanding stock options and unvested stock (determined using the...

  • Page 101
    ... infringed, and induced others to infringe, United States Patent No. 6,739,874 by making, selling and/or offering for sale in the United States and/or importing the Company's LeapPad and Leapster platforms and other unspecified products. Tinkers & Chance seeks unspecified monetary damages, including...

  • Page 102
    ... the Company's business and forecasts about the Company's financial performance, and that certain of the Company's current and former individual officers and directors sold portions of their stock holdings while in the possession of adverse, non-public information. The Company has filed a motion...

  • Page 103
    ... thousands, except per share and percent data) 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 International segment, the Company designs, markets and sells products primarily in the...

  • Page 104
    ...145,092) Net loss per common share: Basic ...Diluted ...2005 Net sales ...Cost of sales ...Gross profit ...Operating expenses: Selling, general and administrative ...Research and development ...Advertising ...Depreciation and amortization ...Total operating expenses ...Income (loss) from operations...

  • Page 105
    ... Purchase Plan. Form of Offering under the 2002 Employee Stock Purchase Plan. Compensation Arrangements between LeapFrog and its Board of Directors (the description contained under the heading "Compensation of Directors" in LeapFrog's definitive proxy materials filed with the SEC on April 19, 2006...

  • Page 106
    ... by reference (n) Filed as an exhibit to the company's Annual Report on Form 10-K filed with Securities and Exchange Commission on March 7, 2006 (SEC File No. 001-31396) and incorporated herein by reference †Compensation plans or arrangements in which directors or executive officers are eligible...

  • Page 107
    ...annual meeting of stockholders of LeapFrog Enterprises, Inc., a Delaware corporation. The meeting will be held on Tuesday, May 1, 2007 at 9:00 a.m. local time at our headquarters located at 6401 Hollis Street, Emeryville, California for the following purposes: 1. 2. 3. 4. 5. To elect eight directors...

  • Page 108
    ... Trust Company, our transfer agent for our Class A common 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...

  • Page 109
    ... the proxy card, simply complete, sign and date the enclosed proxy card and return it promptly in the envelope provided. If you return your signed proxy card to us before the annual meeting, we will vote your shares as you direct. Beneficial Owner: Shares Registered in the Name of Broker or Bank If...

  • Page 110
    ... 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 November 29, 2007 to LeapFrog's Corporate Secretary at 6401 Hollis Street, Emeryville, California 94608. If you wish to submit...

  • Page 111
    ... 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, 2007. This proposal must receive a "For" vote from the majority of shares present and entitled to vote either in person or by proxy...

  • Page 112
    ...Heron International, a European real estate development company, and as a member of the board of Spring Group plc, an information technology services company in the United Kingdom, and is a director of Nextera Enterprises, a producer and marketer of personal care products, Nobel Learning Communities...

  • Page 113
    ... Mounte 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. From 1990 to 1996, he served as President and Chief Executive Officer of Sega of America. Prior to that...

  • Page 114
    ...their Audit Committee and a member of their Nominating and Corporate Governance Committee. Since August 2005, Mr. Wang has service on the board of directors of Fossil, Inc., a publicly held company that designs, develops, markets and distributes fashion-related consumer products, and serves on their...

  • Page 115
    ... 2.65 million options in July 2006 to Jeffrey G. Katz, our Chief Executive Officer and President. Of these 5.0 million options, approximately half were granted at exercise prices that were approximately 30% to 60% higher than the fair market value at the time of grant. Employees who received these...

  • Page 116
    ... that in order to enhance long-term stockholder value we need to maintain competitive employee compensation and incentive programs. An equity stake in the success of the company is a critical component of these programs. We believe an increase in the number of shares to our option plan will enable...

  • Page 117
    ... stock unit award. 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. Shares may be issued in connection with a merger or acquisition as permitted by the rules of the applicable national securities exchange...

  • Page 118
    ...as set forth in the option agreement. If an option is not exercised within the time specified in the option agreement, such option terminates. Class A common stock issued pursuant to stock options granted under the Equity Plan may, at the discretion of the board of directors, be paid for (i) in cash...

  • Page 119
    ... the fair market value of the Class A common stock on the date of grant or at the time the purchase is made. Shares awarded under a restricted stock award may be subject to repurchase by us in accordance with a vesting schedule to be determined by the board of directors. If a restricted stock award...

  • Page 120
    ... 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 121
    ..."), then at the time of disposition the optionee will realize taxable ordinary income equal to the lesser of (i) the excess of the stock's fair market value on the exercise date over the exercise price, or (ii) the optionee's actual gain, if any, on the purchase and sale. The optionee's additional...

  • Page 122
    ... of the performance goal). EQUITY COMPENSATION PLAN INFORMATION The following table shows certain information concerning our Class A common stock to be issued in connection with our Equity Plan, our Director Plan and our Employee Stock Purchase Plan as of December 31, 2006: Number of securities...

  • Page 123
    ... and senior leadership team, including hiring Jeffrey G. Katz as our Chief Executive Officer and President. The board of directors believes that the value of our new strategic business plan and the future prospects of the company would not be realized by "the prompt sale of LeapFrog Enterprises, Inc...

  • Page 124
    ... employees, customers and vendors. The potential adverse impact could lead to a reduction in sales and profits and, in turn, stockholder value. Therefore, the board of directors believes that growth of the business through continued implementation of our strategic business plan and not a forced sale...

  • Page 125
    ... independent registered public accounting firm at any time during the year if they determine that such a change would be in the best interests of the company and our stockholders. The affirmative vote of the majority of the votes represented by the holders of shares present in person or represented...

  • Page 126
    ...internal control testing and review of correspondence with the SEC. Audit-Related Fees The aggregate fees billed by Ernst & Young LLP for audit-related services totaled $43,000 in 2006 and $0.2 million in 2005, which consisted of fees related to FAS 123R, S-8 registration and SAB99 consultation work...

  • Page 127
    ... 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 128
    ... in the footnotes to this table, the applicable address for each of our directors and executive officers is c/o LeapFrog Enterprises, Inc., 6401 Hollis Street, Emeryville, California 94608. (2) These percentages reflect the ownership of our Class A common stock and our Class B common stock on an as...

  • Page 129
    ... solely on information provided in a Schedule 13G filed on February 14, 2007 by Vardon Capital Management, LLC or Vardon. The address for Vardon is 120 West 45th Street, 17th Floor, New York, NY 10036. (10) Includes 19,062 shares of Class A common stock issuable upon the exercise of options that are...

  • Page 130
    ...they were no longer serving as an executive officer of LeapFrog as of March 1, 2007, the date of the information in the table. Includes 923,378 shares of Class A common stock held by our executive officers who are not named executive officers, provided that LeapFrog has the right to repurchase 8,334...

  • Page 131
    ... of our voting shares. In 2006 we purchased software products and support services from Oracle Corporation totaling $390,693. As of December 31, 2006, Lawrence J. Ellison, the Chief Executive Office of Oracle Corporation, may be deemed to have or share the power to direct the voting and disposition...

  • Page 132
    ...senior management and our independent registered public accounting firm, our board of directors affirmatively has determined that all of our directors are independent directors within the meaning of the applicable NYSE listing standards, except for Mr. Katz, our President and Chief Executive Officer...

  • Page 133
    ...December 31, 2006, the total cash compensation paid to non-employee directors was $454,833. The members of our board of directors are also eligible for reimbursement of their expenses incurred in attending board meetings. The 2002 Non-Employee Directors' Stock Option Plan, or Director Plan, provided...

  • Page 134
    ... is an option to purchase 30,000 shares of our Class A common stock and the annual grant is an option to purchase 15,000 shares of our Class A common stock; provided, however, that a non-employee director who holds the position of Chairman of our board of directors at the time of the annual grant...

  • Page 135
    ... 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 136
    ... of partners of the independent registered public accounting firm on LeapFrog's engagement team as required by law; confers with management and the independent registered public accounting firm regarding the effectiveness of internal control over financial reporting; establishes procedures, as...

  • Page 137
    ... to the board of directors that LeapFrog's financial statements be included in LeapFrog's quarterly and annual reports. In fulfilling this responsibility, prior to the release of each of the company's annual financial results for 2006, the Audit Committee reviewed the financial statements...

  • Page 138
    ... the board of directors that the financial statements be included in LeapFrog's 2006 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 139
    ... and the total number of shares that may be granted in any given year. Our policy is that we will not time or select the grant dates for any stock options or stock-based awards in coordination with the release by us of material non-public information, nor will we have any program, plan or practice...

  • Page 140
    ... of the board, assessing the performance of management and the board, reviewing the compensation paid to non-employee directors for their service on our board and its committees, and developing a set of corporate governance principles for LeapFrog. Our Governance Committee is currently comprised of...

  • Page 141
    ... 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 rules adopted to...

  • Page 142
    ...Nominating and Corporate Governance Committee by writing to our Corporate Secretary at 6401 Hollis Street, Emeryville, California 94608. CODE OF ETHICS We have adopted the LeapFrog Code of Business Conduct and Ethics that applies to all officers, directors and employees. Our Code of Business Conduct...

  • Page 143
    ... and senior leadership team, including hiring Jeffrey G. Katz as our Chief Executive Officer and President. In developing our new strategic plan, the Compensation Committee, with input from senior management and the full board, reviewed the total compensation of the executives that we retained...

  • Page 144
    ...for 12 publicly traded technology companies that had hired new CEOs since 2004, which companies are Akamai Technologies, Inc., Business Objects, S.A., Computer Associates, Inc., Cadence Design Systems, Inc., Eclipsys Corp, i2 Technologies, Inc., Lawson Software, Macrovision Corp, Siebel Systems, Inc...

  • Page 145
    ... objectives. For executives reporting to our Chief Executive Officer (other than our former President, LeapFrog SchoolHouse), which includes certain of our named executive officers, the individual performance component of the bonus plan increased to 40% of the total target bonus potential, provided...

  • Page 146
    ... July 2006, the board awarded Mr. Katz, upon his appointment as our new Chief Executive Officer and President, options for an aggregate of 2.65 million shares, of which an option for 1.2 million shares had a strike price of $10.30, which was 100% of the closing price of our common stock on the date...

  • Page 147
    ...and 10,000 performance shares, respectively, measured at target levels of achieving the 2006-2008 program measures. In 2006, we did not meet the threshold goals for 2006 on the three annual measures of net income, net sales and operating cash flow (adjusted for current accounts receivable), and thus...

  • Page 148
    ...officer who did not hold any restricted stock or RSUs. Stock Option Grant Date Policy Our policy is that we will not time or select the grant dates of any stock options or stock-based awards in coordination with the release by us of material non-public information, nor will we have any program, plan...

  • Page 149
    ... 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. We generally intend to grant stock options and performance shares to our executives in a manner...

  • Page 150
    ...Chief Marketing Officer in September 2006. Summary Compensation Table Salary ($) Bonus ($) Stock Awards ($)(1) Option Awards ($)(2) All Other Compensation ($) Total Compensation ($) Name and Principal Position Year Jeffrey G. Katz(3) ...2006 300,000 Chief Executive Officer, President and Director...

  • Page 151
    ... 2007 for performance in 2006. (9) Mr. Dodd received relocation assistance in the amount of $88,616 and an annual automobile allowance of $7,200. (10) Mr. Kalinske resigned as our Chief Executive Officer in July 2006 but remained our Vice Chairman and an employee through December 2006, when he...

  • Page 152
    ... Other Option Awards: Number of Securities Underlying Options (#)(2) Exercise or Base Price of Option Awards ($/Sh) (3) Closing Grant Market Date Fair Price Value of on Stock and Grant Option Date Awards ($)(3) ($) Name Grant Date Jeffrey G. Katz, ...07/06/06 07/03/06 Chief Executive Officer and...

  • Page 153
    ... the closing market price of our common stock on the trading day immediately preceding the date of grant. This long-standing practice allows the Compensation Committee to grant options to participants at a known exercise price. (4) In connection with his employment with us as Chief Executive Officer...

  • Page 154
    ... information regarding outstanding equity awards at fiscal year end for the named executive officers. Outstanding Equity Awards at December 31, 2006 Option Awards(1) Stock Awards Market Equity Incentive Value of Equity Incentive Plan Awards: Number of Shares Plan Awards: Market or Shares or or Units...

  • Page 155
    ...the program and no possibility that any performance shares will be earned. For further information, see footnote 1 to the Summary Compensation Table. (4) Calculated by multiplying the closing market price of our common stock at December 29, 2006, $9.48, by the number of shares of restricted stock or...

  • Page 156
    ... the named executive officers: Option Exercises and Stock Vested in Fiscal 2006 Option Awards Number of Shares Value Acquired on Realized on Exercise Exercise (#) ($) Stock Awards Number of Shares Value Acquired Realized on on Vesting Vesting (#) ($) Name Jeffrey G. Katz ...Chief Executive Officer...

  • Page 157
    ... exercise periods in connection with a named executive officer's termination or a change-in-control of LeapFrog, the actual value of the options, if any, realized will depend on the extent to which the market value of our common stock exceeds the exercise price on the date the option is exercised...

  • Page 158
    ... our stockholders of a plan of dissolution or liquidation or the sale or transfer of substantially all of our assets. Non-Solicitation, Non-Competition, Non-Interference, Release Mr. Katz has agreed to refrain from engaging in certain activities that are competitive with our business for a period of...

  • Page 159
    ..., adoption by our stockholders of a plan of dissolution or liquidation or the sale or transfer of substantially all of our assets. A termination by Mr. Dodd is for good reason if it occurs within 60 days of any of the following events: (a) removal from his position as Senior Vice President, Supply...

  • Page 160
    ...bonus for 2006, in the amount of $67,500. Mr. Kalinske will continue as a member of our board of directors, his stock options will continue to vest, and he will have continued use of his office space through February 28, 2008. Non-Solicitation, Non-Competition, Non-Interference, Release Mr. Kalinske...

  • Page 161
    ... Kathryn Olson, our former Chief Marketing Officer, pursuant to which Ms. Olson's employment with us terminated effective September 7, 2006. In connection with her termination we agreed to provide (a) on customary payroll dates, payments equal to her then current base salary payments for a period...

  • Page 162
    ... our directors and executive officers, and persons who own more than ten percent of a registered class of our 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 163
    ... that 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...

  • Page 164
    ...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 of this group and to provide incentives for such persons to exert maximum efforts for the success of the Company and its...

  • Page 165
    ..."Class A Common Stock" means the 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...

  • Page 166
    ... chief executive officer and the four (4) other highest compensated officers of the Company for whom total compensation is required to be reported to stockholders under the Exchange Act, as determined for purposes of Section 162(m) of the Code. (m) "Director" means a member of the Board of Directors...

  • Page 167
    ...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 168
    ... or exchange of shares or other similar corporate change, or any distributions to common shareholders other than regular cash dividends. In addition, with respect to Performance Goals established for Participants who are not Covered Employees, and who will not be Covered Employees at the time the...

  • Page 169
    ... to elect a majority of the board of directors of such corporation (irrespective of whether, at the time, stock of any other class or classes of such corporation shall have or might have voting power by reason of the happening of any contingency) is at the time, directly or indirectly, Owned by the...

  • Page 170
    ... any time and revest in the Board the administration of the Plan. (ii) Section 162(m) and Rule 16b-3 Compliance. In the discretion of the Board, the Committee may consist solely of two or more Outside Directors, in accordance with Section 162(m) of the Code, and/or solely of two or more Non-Employee...

  • Page 171
    ...Class A Common Stock during any calendar year. (d) Consultants. A Consultant shall not be eligible for the grant of a Stock Award if, at the time of grant, a Form S-8 Registration Statement under the Securities Act ("Form S-8") is not available to register either the offer or the sale of the Company...

  • Page 172
    ...as the Board shall deem appropriate. All Options shall be separately designated Incentive Stock Options or Nonstatutory Stock Options at the time of grant, and, if certificates are issued, a separate certificate or certificates shall be issued for shares of Class A Common Stock purchased on exercise...

  • Page 173
    ... to the Board. Unless otherwise specifically provided in the Option, the purchase price of Class A Common Stock acquired pursuant to an Option that is paid by delivery to the Company of other Class A Common Stock acquired, directly or indirectly from the Company, shall be paid only by shares of the...

  • Page 174
    ... shares of Class A Common Stock so purchased may be subject to a repurchase option in favor of the Company or to any other restriction the Board determines to be appropriate. The Company will not exercise its repurchase option until at least six (6) months (or such longer or shorter period of time...

  • Page 175
    ... Fair Market Value on the date such award is made or at 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...

  • Page 176
    ... number of shares of Class A Common Stock equivalents in which the Participant is vested under such Stock Appreciation Right, and with respect to which the Participant is exercising the Stock Appreciation Right on such date, over (B) the strike price that will be determined by the Board at the time...

  • Page 177
    ... wholly or partly in cash must be exercised and paid in accordance with a fixed pre-determined schedule. 8. COVENANTS OF THE COMPANY. (a) Availability of Shares. During the terms of the Stock Awards, the Company shall keep available at all times the number of shares of Class A Common Stock required...

  • Page 178
    ... and business matters and that he or she is capable of evaluating, alone or together with the purchaser representative, the merits and risks of exercising the Stock Award; and (ii) to give written assurances satisfactory to the Company stating that the Participant is acquiring Class A Common Stock...

  • Page 179
    ... avoid variable award accounting); or (iii) delivering to the Company owned and unencumbered shares of Class A Common Stock. (g) Lock-Up Period. Upon exercise of any Stock Award, a Participant may not sell, dispose of, transfer, make any short sale of, grant any option for the purchase of, or enter...

  • Page 180
    ... 162(m) of the Code and the regulations thereunder regarding the exclusion of performance-based compensation from the limit on corporate deductibility of compensation paid to Covered Employees. (c) Contemplated Amendments. It is expressly contemplated that the Board may amend the Plan in any respect...

  • Page 181
    ... STOCK Continental Stock Transfer & Trust Company New York, New York (212) 509-4000 x206 ANNUAL MEETING The 2007 Annual Meeting of Stockholders will take place at 9:00 a.m. Pacific time on Tuesday, May 1, 2007, at the company's headquarters in Emeryville, California. INVESTOR RELATIONS LeapFrog...

  • Page 182
    LeapFrog Enterprises, Inc. 6401 Hollis Street • Emeryville, CA 94608 • 510.420.5000 www.leapfrog.com