LeapFrog 2007 Annual Report Download - page 41

2007, 2006 and 2005, respectively. The Company engaged in reduced promotional activities in the fourth quarter
of 2007 as compared to prior years.
Inventory Valuation
Inventories are stated at the lower of cost, on a first-in, first-out basis, or market value. Inventory valuation
primarily requires estimation of slow-moving, obsolete or excess products. Accordingly, inventories included
write-downs for slow-moving, excess and obsolete inventories of $16.2 million and $34.1 million at
December 31, 2007, and 2006, respectively.
Our estimate of the write-down for slow-moving, excess and obsolete inventories is based on our
management’s review of on-hand inventories compared to their estimated future usage, our product demand
forecast, anticipated product selling prices, the expected product lifecycle, and products planned for
discontinuation. If actual future usage, demand for our products and anticipated product selling prices were less
favorable than those projected by our management, additional inventory write-downs would be required resulting
in a negative impact on our gross margin.
We monitor the estimates of inventory write-downs on a quarterly basis. When considered necessary, we
make additional adjustments to reduce inventory to its net realizable value, with corresponding increases to cost
of goods sold. The lower write down for excess and obsolescence in 2007 as compared to 2006 reflects the
progress we have made in reducing inventories of older products, especially the LeapPad line of products and
other legacy products that are being replaced or phased out.
Intangible Assets
Intangible assets principally include the excess purchase price over the cost of net assets acquired, or
goodwill. Goodwill arose from our 1997 acquisition of substantially all the assets and business of our
predecessor, LeapFrog RBT, and our acquisition of substantially all the assets of Explore Technologies in 1998.
Our intangible assets had a net balance of $24.5 million and $25.9 million at December 31, 2007 and 2006,
respectively, and are allocated to our U.S. reporting unit, or U.S. Consumer segment, pursuant to Statement of
Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (SFAS 142). Goodwill and
other intangibles with indefinite lives are tested for impairment at least annually. A two-step approach is required
to test goodwill for impairment for each reporting unit. The first step tests for impairment by applying fair value-
based tests at the reporting unit level. The second step (if necessary) measures the amount of impairment by
applying fair value-based tests to individual assets and liabilities within each reporting unit. Application of the
goodwill impairment test requires judgment, including identification of reporting units, assignment of assets and
liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each
reporting unit. The fair value of each reporting unit is estimated using a discounted cash flow methodology,
which requires significant judgment to estimate the future cash flows, determine the appropriate discount rates,
growth rates and other assumptions. We tested our goodwill and other intangible assets with indefinite lives for
impairment during the fourth quarter and determined that no adjustments were necessary to the stated values. At
December 31, 2007 and 2006, we had $19.5 million of goodwill and other intangible assets with indefinite lives.
Intangible assets with other than indefinite lives include patents, trademarks and licenses, one of which is a
ten-year technology license agreement entered into in January 2005 to jointly develop and customize our optical
scanning technology. At December 31, 2007 and 2006, we had $4.9 million of intangible assets with other than
indefinite lives. We recognized an insignificant amount of impairment in the years ended December 31, 2007,
2006 and 2005 for intangible assets with other than indefinite lives.
The determination of estimated useful lives and whether the intangible assets are impaired involves
assumptions and significant judgment.
Management makes various assumptions about the future value of intangible assets by evaluating future
business forecasts and estimated cash flows. Future net cash flows primarily depend on the sale of our products.
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