LeapFrog 2007 Annual Report Download - page 50

We record indirect expenses in our U.S. Consumer segment and do not allocate these expenses to our
International and School segments. Additional financial information regarding our segments is included in Note
20 to the Consolidated Financial Statements—Segment Reporting in this report.
Other
Net Interest Income and Other Income (Expense), Net
Net Interest Income and Other Income (Expense), Net, includes the three lines of the Consolidated
Statements of Operations labeled: 1) Interest expense, 2) Interest income, and 3) Other income (expense), net.
Net interest income (interest expense plus interest income) declined by $2.6 million from $7.2 million in 2006 to
$4.6 million in 2007. This decline was primarily due to the recognition of $2.5 million of impairment in our
short-term investment holdings. As of December 31, 2007, we had available-for-sale investments in auction rate
securities (“ARS”) with a carrying value of $10.9 million. Due to the uncertainty and the lack of liquidity in the
credit markets, the auctions of our ARS holdings have failed and the fair value of these investments has fallen.
As a result, we recorded a $2.5 million other-than-temporary impairment charge on $6.0 million of original cost
ARS against earnings and a $0.6 million temporary impairment charge on $8.0 million of original cost ARS
against other comprehensive income to reduce the carrying value of the ARS to their estimated fair value.
The recent uncertainties in the credit markets have prevented us and other investors from liquidating the
holdings of auction rate securities in recent auctions for these securities because the amount of securities
submitted for sale has exceeded the amount of purchase orders. Accordingly, we still hold these auction rate
securities and are receiving interest at a higher rate than similar securities for which auctions have cleared. These
investments are insured against loss of principal and interest and have credit ratings of AAA to AA-. We are
uncertain as to when the liquidity issues relating to these investments will improve.
The carrying value of our investments in ARS as of December 31, 2007 represents our best estimate of the
fair value of these investments based on currently available information. We evaluated the estimated fair value at
January 31, 2008 and concluded that the estimated fair value at that date was indicative of circumstances that
existed at the balance sheet date. As a result, the estimated fair value calculated at January 31, 2008 was
determined to be the carrying value as of December 31, 2007.
The estimation process included consideration of such factors as issuer and insurer credit rating, comparable
market data, if available, credit enhancement structures, projected yields, discount rates and terminal periods.
Due to the uncertainty in the credit markets, it is reasonably possible the fair value of these investments may
change in the near term. If the credit markets recover and successful auctions resume, we may be able to recover
an amount greater than the carrying value of the ARS as of December 31, 2007, which would result in a gain.
However, if the issuers are unable to successfully close future auctions and their credit ratings deteriorate, we
may be required to further adjust the carrying value of its investment in ARS through additional impairment
charges. We cannot estimate these future losses or gains at this time.
Other Income (Expense), Net, includes losses on fixed asset sales and various intercompany charges.
Tax Rate
Our effective tax rate for 2007 was (3.8)%, compared to (22.5)% in 2006. The negative tax rate for both
years was due to a non-cash valuation allowance recorded against our domestic deferred tax assets. Tax expense
for 2006 included a valuation allowance of $24.9 million that related to pre-2006 deferred tax assets, which
resulted in higher tax expense in 2006 and 2007. The remaining tax expense related primarily to taxes in non-US
jurisdictions. See “Critical Accounting Policies, Judgments and Estimates” for further details regarding the
increase in the valuation allowance.
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