LeapFrog 2009 Annual Report Download - page 48

observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be
used when available. Observable inputs are inputs that market participants would use in valuing the asset or
liability and are developed based on market data obtained from sources independent of us. Unobservable inputs
are inputs that reflect our assumptions about the factors market participants would use in valuing the asset or
liability. The authoritative guidance establishes three levels of inputs that may be used to measure fair value:
Level 1: Unadjusted quoted market prices for identical assets or liabilities in active markets that we have the
ability to access.
Level 2: Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar
assets in inactive markets; or valuations based on models where the significant inputs are observable
(e.g., interest rates, yield curves, default rates, etc.) or can be corroborated by observable market data.
Level 3: Valuations based on models where significant inputs are not observable. The unobservable inputs
reflect our assumptions about the assumptions that market participants would use.
Our Level 1 assets consist of money market funds and certificates of deposit with original maturities of three
months or less. These assets are considered highly liquid and are stated at cost which approximates market value.
Our Level 2 assets and liabilities consist of outstanding foreign exchange forward contracts with maturities of
approximately one month used to hedge its exposure to certain foreign currencies including the British Pound,
Canadian Dollar, Euro, and Peso. Our Level 3 assets consist of investments in auction rate securities (ARS).
Currently, there is no active market for these securities; therefore, they do not have readily determinable market
values. We have engaged a third-party valuation firm to estimate the fair value of the ARS investments using a
discounted cash flow approach, which is corroborated by a separate and comparable discounted cash flow
analysis prepared internally. The assumptions used in preparing the discounted cash flow model are based on
data available as of the last day of the reporting period and include estimates of interest rates, timing and amount
of cash flows, credit and liquidity premiums, and expected holding periods of the ARS. Given the current market
environment, these assumptions are volatile and subject to change, and therefore could result in significant
changes to the estimated fair value of our ARS. In 2009 and 2008 we recognized losses on our ARS of $0.4
million and $6.0 million, respectively.
Inventory Valuation
Inventories are stated on a first-in, first-out basis at the lower of cost or market value. Inventory valuation
primarily involves our management’s estimation of slow-moving, obsolete or excess products. 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, 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. Inventories included write-downs for slow-moving, excess and obsolete inventories of $4.0
million and $10.6 million at December 31, 2009 and 2008, respectively.
Capitalization of Content Development Costs
We capitalize certain external costs related to the development of content for our learning products once
technological feasibility has been established for the related projects. Our capitalized external costs generally
relate to design, artwork, animation, layout, editing, voice, audio and software included in the learning products.
We evaluate the future recoverability of capitalized content on a quarterly basis. Capitalized costs for products
that are cancelled, abandoned or otherwise deemed impaired are charged to expense in the period of cancellation.
Our evaluation in 2009 resulted in very few impairments while the 2008 evaluation identified capitalized costs
related to several platforms that had recently been retired or discontinued. Accordingly, we accelerated the
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