LeapFrog 2010 Annual Report Download - page 64

LEAPFROG ENTERPRISES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
Net Income (Loss) per Share
Basic earnings per share is computed by dividing net income by the weighted average number of shares of
Class A and Class B common stock (“common shares”) outstanding during the reporting period. Diluted earnings
per share is computed by dividing net income by the combination of dilutive common share equivalents, which
comprises common shares issuable under the Company’s share-based compensation plans, and the weighted
average number of common shares outstanding during the reporting period. Dilutive common share equivalents
include in-the-money common share equivalents; whether common share equivalents are “in-the-money” is
calculated based on the average share price for each period using the treasury stock method. Under the treasury
stock method, the exercise price of an option, the amount of compensation cost, if any, for future service that the
Company has not yet recognized, and the estimated tax benefits that would be recorded in paid-in capital, if any,
when the option is exercised are assumed to be used to repurchase shares in the current period.
3. Fair Value of Financial Instruments and Investments
Fair value is defined by authoritative guidance as the exit price, or the amount that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement
date. The guidance establishes a hierarchy for inputs used in measuring fair value that maximizes the use of
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 the Company.
Unobservable inputs are inputs that reflect the Company’s assumptions about the factors market participants
would use in valuing the asset or liability. The guidance establishes three levels of inputs that may be used to
measure fair value:
• Level 1 includes financial instruments for which quoted market prices for identical instruments are
available in active markets. As of December 31, 2010, the Company’s did not hold any Level 1 assets.
• Level 2 includes financial instruments for which there are inputs other than quoted prices included
within Level 1 that are observable for the instrument. Such inputs could be quoted prices for similar
instruments in active markets, quoted prices for identical or similar instruments in markets with
insufficient volume or infrequent transactions (less active markets), or model-driven valuations in which
significant inputs are observable or can be derived principally from, or corroborated by, observable
market data, including market interest rate curves, referenced credit spreads and pre-payment rates.
The Company’s Level 2 assets and liabilities consist of outstanding foreign exchange forward contracts
used to hedge its exposure to certain foreign currencies, including the British Pound, Canadian Dollar,
Euro, and Mexican Peso. The Company’s outstanding foreign exchange forward contracts, all with
maturities of approximately one month, had notional values of $28,293 and $13,277 at December 31,
2010 and 2009, respectively. The fair market values of these instruments as of the same periods were
$(132) and $160, respectively. The fair value of these contracts was recorded in prepaid expenses and
other current assets for all periods presented.
• Level 3 includes financial instruments for which fair value is derived from valuation techniques,
including pricing models and discounted cash flow models, in which one or more significant inputs,
including the Company’s own assumptions, are unobservable.
The Company’s Level 3 assets consist of investments in ARS. Currently, there is no active market for
these securities; therefore, they do not have readily determinable market values. The Company has
engaged a third-party valuation firm to estimate the fair value of the ARS investments using a
discounted cash flow approach. Based on this valuation, the ARS investments were valued at $2,681 at
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