LeapFrog 2015 Annual Report Download - page 46

During the quarter ended March 31, 2015, we determined that testing for recoverability of our long-lived
assets was again required based on our continued financial underperformance, and the continued decline of the
trading values of our Class A common stock and the corresponding market capitalization. As a result, we
performed step one of the impairment test and concluded that our long-lived assets in our U.S. reporting unit
were impaired as of March 31, 2015 as their carrying value exceeded the cumulative undiscounted future cash
flows that included an estimated residual market valuation. This result was primarily due to the significant
decline of the trading value of our Class A common stock and the corresponding market capitalization during
the fourth quarter of fiscal 2015. Our long-lived assets were not considered impaired in our International
reporting unit as of March 31, 2015 as their carrying value did not exceed the cumulative undiscounted future
cash flows.
Accordingly, we performed step two of the impairment test and determined the fair value of our
U.S. reporting unit using a combination of an income approach and a market approach. Under the income
approach, we used the DCF methodology which recognizes that current value is premised on the expected
receipt of future economic benefits. Indications of value are developed by discounting projected future net
cash flows to their present value at a rate that reflects both the current return requirements of the market
and the risks inherent in the specific investment. Under the market based approach, we utilized our own
information to determine earnings multiples and sales multiples that are used to value our U.S. reporting unit.
This analysis yielded a fair value below the carry value of the reporting unit.
In general, the difference between the carrying value and the fair value would be allocated on a pro-rata basis
to the assets using the relative carrying amounts of those assets. However, the individual assets should not be
written down below their respective fair values. As such, we determined the fair values of the individual
long-lived assets within the asset group and compared those values with the carrying values of those assets to
measure the overall impairment amount.
We determined the value of the capitalized content costs and the other intangible assets using a cost approach
analysis, which factors in technological and functional deterioration with a depreciated cost study used as a
proxy for the fair value. Based on the result of these analyses, we concluded that the estimated fair values of
our capitalized content costs and other intangible assets were greater than their carrying value. Therefore, no
impairment was recorded against these assets.
We determined the value of the property and equipment assets using a depreciated replacement cost study
which incorporated historical costs, published trends, market supported depreciation curves, and certain
adjustments such as indirect costs, level of asset customization and general marketability. Based on significant
economic obsolescence associated with these assets, we incorporated the valuation premise established at a
‘‘highest and best use’’ assessment, using a value-in-exchange concept. Fair value-in-exchange is defined as
the estimated value that may reasonably be expected in an exchange for an asset between a willing buyer and
seller in an orderly transaction between market participants as of the valuation date. Based on the results of
this study, we concluded that the carrying value of our property and equipment assets, including primarily our
recent investments in our internal business systems and the non-content related website systems costs,
exceeded its fair value by $36.5 million, and recorded this permanent impairment charge to these assets
appropriately.
The above mentioned valuation methodologies require significant judgment by management in selecting an
appropriate discount rate, terminal growth rate, weighted average cost of capital, projection of future net cash
flows, market exit multiple, and determining fair value-in-exchange of individual assets, which are inherently
uncertain. Future net cash flows depend primarily on future sales of our products, which are inherently
difficult to predict. This is especially true when a significant portion of our future net sales is expected to be
generated by both mature products as well as products introduced in fiscal year 2015 or planned to be
introduced in fiscal year 2016. The inputs and assumptions used in this test are classified as Level 3 inputs
within the fair value hierarchy. Due to these significant judgments, the fair value of the U.S. reporting unit
and its individual assets determined in connection with the long-lived assets impairment test may not
necessarily be indicative of the actual value that would be recognized in a future transaction.
The full impairment charge of $36.5 million recorded against the long-lived assets under our U.S. reporting
unit as of March 31, 2015 was non-cash in nature and does not directly affect our current or future liquidity.
39