LeapFrog 2007 Annual Report Download - page 42

The sales of our products are affected by our ability to accurately predict the level of demand for them. Also, our
revenue and earnings are dependent on our ability to meet our product launch schedules. If we have sales
shortfalls, we may not realize the future net cash flows essential to recover the carrying value of our intangible
assets. Accordingly, future impairment tests may result in a charge to earnings. Therefore, the potential for a
write-down of intangible assets in connection with the annual impairment test exists.
Stock-Based Compensation
Prior to January 1, 2006, we accounted for stock-based compensation under the measurement and
recognition provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related
Interpretations, permitted under Statement of Financial Accounting Standard No. 123, “Accounting for Stock-
Based Compensation” (“SFAS 123”).
Effective January 1, 2006, we adopted the recognition provisions of Statement of Financial Accounting
Standard No. 123 (R), “Share-Based Compensation” (“SFAS 123(R)”), using the modified-prospective transition
method. Under this transition method, compensation cost in 2006 included the portion vesting in the period for
(1) all share-based payments granted prior to, but not vested, as of January 1, 2006, based on the grant date fair
value estimated in accordance with the original provisions of SFAS 123, and (2) all share-based payments
granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the
provisions of SFAS 123(R).
The fair value of each stock option granted is estimated on the date of the grant using the Black-Scholes
option-pricing model. The total grant date fair value is recognized over the vesting period of the options on a
straight-line basis. The weighted-average assumptions for the expected life and the expected stock price volatility
used in the model require the exercise of judgment. The expected life of the options represent the period of time
the options are expected to be outstanding and is currently based on the guidance provided in the SEC Staff
Accounting Bulletin No. 107 on Share-Based Payment as we do not have sufficient historical data on exercise
behavior, post-vesting termination patterns, options outstanding and future expected exercise behavior. Expected
stock price volatility is based on a consideration of our stock’s historical and implied volatilities as well as
consideration volatilities of other public entities within our industry. The risk–free interest rate used in the model
is based on the U.S. Treasury yield curve in effect at the time of grant and has a term equal to the expected life.
Restricted stock awards and restricted stock units are payable in shares of our Class A common stock. The
fair value of each restricted stock or unit is equal to the closing market price of our stock on the trading day
immediately prior to the date of grant. The grant date fair value is recognized in income over the vesting period
of these stock-based awards, which is generally four years. Stock-based compensation arrangements to
non-employees are accounted for using a fair value approach. The compensation costs of these arrangements are
subject to re-measurement over the vesting terms.
We calculate employee stock-based compensation expense based on awards ultimately expected to vest and
accordingly, the expense has been reduced for estimated forfeitures. We review forfeitures periodically and we
adjust compensation expense, if considered necessary. Stock-based compensation expense may be significantly
affected by changes in our stock price, our assumptions used in the Black-Scholes option valuation calculation
and our forfeiture rates as well as the extent of future grants of equity awards.
Income Taxes
We account for income taxes using the liability method. Under this method, deferred tax assets and
liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities
and are measured using enacted tax rates and laws that will be in effect when the differences are expected to
reverse. In determining our income tax assets, liabilities and expense, we make certain estimates and judgments
in the calculation of tax benefits, tax credits and deductions. Significant changes in these estimates may result in
increases or decreases in the tax provision or benefit in subsequent periods. Effective January 1, 2007, we
adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes.”
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