LeapFrog 2007 Annual Report Download - page 133

exchange for the Inducement Grants will not be granted under our 2002 Equity Incentive Plan, but will be
nonstatutory stock options with terms similar to nonstatutory options granted under our 2002 Equity Incentive
Plan. The shares of Class A common stock for which the New Options may be exercised are currently registered
on a registration statement filed with the SEC.
Return of Eligible Options Surrendered. Consistent with the terms of the Plans, the pool of shares
available for the grant of future awards under our Plans will be increased by that number of shares equal to the
difference between (a) the number of shares underlying surrendered Eligible Options issued under the Plans and
(b) the number of shares underlying New Options issued under the Plans. Shares subject to the Inducement Grant
were not issued under the Plans and will not be returned to the pool of shares available for grant under the Plans.
Accounting Treatment. We have adopted the provisions of Financial Accounting Standards Board
Statement of Financial Accounting Standards No. 123 (Revised), or FAS 123(R), regarding accounting for share-
based payments. Under FAS 123(R), we will recognize the incremental compensation cost of the stock options
granted in the Option Exchange Program. The incremental compensation cost will be measured as the excess, if
any, of the fair value of each New Option granted to employees in exchange for surrendered Eligible Options,
measured as of the date the New Options are granted, over the fair value of the Eligible Options surrendered in
exchange for the New Options, measured immediately prior to the cancellation. This incremental compensation
cost will be recognized ratably over the vesting period of the New Options. However, because the exchange
ratios will be calculated to result in the fair value of Eligible Options surrendered being equal to the fair value of
the New Options replacing them, we do not expect to recognize any significant incremental compensation
expense for financial reporting purposes as a result of the Option Exchange Program. As would be the case with
Eligible Options, in the event that any of the New Options are forfeited prior to their vesting due to termination
of service, the compensation cost for the forfeited New Options will not be recognized.
U.S. Federal Income Tax Consequences. The following is a summary of the anticipated material U.S.
federal income tax consequences of participating in the Option Exchange Program. A more detailed summary of
the applicable tax considerations to participants will be provided in the Offer to Exchange. The tax consequences
of the Option Exchange Program are not entirely certain, however, and the Internal Revenue Service is not
precluded from adopting a contrary position, and the law and regulations themselves are subject to change. We
believe the exchange of Eligible Options for New Options pursuant to the Option Exchange Program should be
treated as a non-taxable exchange, and no income should be recognized for U.S. federal income tax purposes by
us or our employees upon the grant of the New Options. As all New Options issued under the Option Exchange
Program will be nonstatutory stock options, including the New Options issued to our CEO in exchange for the
Inducement Grants, upon exercise of the New Options, the Eligible Participant will recognize ordinary income
equal to the excess, if any, of the fair market value of the purchased shares on the exercise date over the exercise
price paid for those shares. Upon disposition of the stock, the Eligible Participant will recognize a capital gain or
loss (which will be long-or short-term depending upon whether the stock was held for more than one year) equal
to the difference between the selling price and the sum of the amount paid for the stock plus any amount
recognized as ordinary income upon acquisition (or vesting) of the stock. The tax consequences for employees
located outside of the United States may differ from the U.S. federal income tax consequences. All holders of
Eligible Options are urged to consult their own tax advisors regarding the tax treatment of participating in the
Option Exchange Program under all applicable laws prior to participating in the Option Exchange Program.
Potential Modifications to Terms to Comply with Governmental Requirements. The terms of the Option
Exchange Program will be described in an Offer to Exchange that we will file with the SEC. Although we do not
anticipate that the SEC will require us to modify the terms significantly, it is possible we will need to alter the
terms of the Option Exchange Program to comply with comments from the SEC. Changes in the terms of the
Option Exchange Program may also be required for tax purposes for participants in the United States as the tax
treatment of the Option Exchange Program is not entirely certain. In addition, we intend to make the Option
Exchange Program available to certain of our employees located outside of the United States, where permitted by
local law and where we determine it is feasible and practicable to do so. It is possible that we may need to make
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