LeapFrog 2007 Annual Report Download - page 164

In February 2007, the compensation committee engaged Towers Perrin to conduct an analysis of equity
grant guidelines for the various seniority levels of employees within LeapFrog for both new-hire and annual
grants, and to project the resulting share usage for 2007 through 2009 based upon certain assumptions of the
number of employees at each seniority level throughout that time period. Based upon compensation committee
guidance, in 2007 Towers Perrin developed equity grant guidelines that reduced our grant levels to 20% below
median competitive grant levels in order to manage overall share usage for 2007 through 2009. The proposed
equity guidelines split the annual focal equity grant such that 50% of the projected value is delivered through
options and 50% through full value shares in the form of RSUs. Consistent with option valuation and past
practice, we grant stock options and RSUs to our employees at a ratio of approximately two option shares for
every one RSU. This ratio reflects the relative expense to the company of a stock option compared to a full value
share award like an RSU. Similarly, in accordance with the terms of our equity plan, we deduct from the pool of
shares available for issuance under the plan two shares for each RSU granted and one share for each option share
granted. Equity grants for new hires are to be made entirely in the form of stock options, except in special cases.
The compensation committee approved the equity grant guidelines proposed by Towers Perrin and the guidelines
were implemented in March 2007.
Over the course of the past few months, the compensation committee reviewed our use of equity incentives
and noted that a large number of issued stock options were no longer serving as effective incentive or retention
tools, yet were being recorded as compensation expense by us and were being included in our total dilution
calculation. In February 2008, the compensation committee recommended to the full board, and the board
subsequently approved, a stock option exchange program, under which our employees would be offered the
opportunity to exchange eligible out-of-the-money stock options for new options having an exercise price per
share equal to the higher of (a) $7.50 per share or (b) $0.25 above the closing price of our Class A common stock
as reported on the NYSE for the business day prior to the date the new options are granted (the “Exchange
Price”). Under the program, outstanding stock options with an exercise price greater than the Exchange Price are
eligible to participate. The compensation committee concluded that our named executive officers should be
eligible to participate in the option exchange program to provide them with improved incentives to increase
stockholder value, increase the retention value of outstanding options and reduce the total number of potential
shares directed towards employee incentive programs—all at no expected additional compensation expense to
the company for accounting purposes. Many of our senior executives, including all of our named executive
officers, were granted “tiered” options to purchase shares of our stock at then-fair market value as well as at
strike prices that were approximately 133% and 166% of then fair market value. If the option exchange program
is approved by our stockholders, any named executive officer who elects to surrender tiered options in the
program will receive in exchange option grants with a similar tiering structure with the result that a portion of the
new options would be issued at out-of-the-money strike prices with the same 33% and 66% premiums used with
the surrendered options. For more details regarding this program, see “Proposal Two—Approval of the Option
Exchange Program” in this proxy statement.
Stock Award Granting Policy. Our policy is that we will not seek to time or select the grant dates of stock
options or other stock awards in coordination with the release by us of material non-public information, nor will
we have any program, plan or practice to do so. In February 2007, the compensation committee recommended to
the board, and the board subsequently adopted, a specific policy regarding the grant dates of stock options and
other stock awards, including stock awards made to our executive officers. That policy stated that the grant date of
all awards to executive officers would be the 15th day of the month subsequent to the month in which the award is
approved by the board (or the next succeeding business day that the NYSE is open). If the approval is made after
the completion of the most recent fiscal quarter but prior to the announcement of the results of that quarter, then
the grant date would be delayed until the next trading day after completion of the first full trading day following
announcement of those quarterly results. The exercise price of all awards would equal the closing price of our
common stock on the date immediately preceding the grant date, in accordance with the terms of our equity plan.
In February 2008, after considering the first 12 months of operation of our stock award granting practices
under the policy, the compensation committee amended the policy to eliminate the modification of grant dates on
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