In accordance with SFAS 128, unvested restricted stock units and certain stock options to purchase shares of LeapFrog Class A common stock (“Class A shares”) are excluded from the calculations of net loss per share for the three and six month periods ended June 30, 2007 and 2008, as their effect on net loss per share would be antidilutive. Outstanding weighted average common stock equivalents of Class A shares excluded from the calculations were 263 and 356, and 213 and 376 for the three and six months ended June 30, 2008 and 2007, respectively.

 

 

9.  Segment Reporting

 

LeapFrog’s reportable operating segments (“segments”) comprise its U.S. Consumer, International and School segments. The Company fully allocates most of its indirect selling, general and administrative and research and development expenses to the U.S. Consumer segment, rather than allocating these expenses proportionately across all three segments.

 

The Company’s Chief Operating Decision Maker (as defined in SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS No. 131”), is its Chief Executive Officer (CEO). LeapFrog’s CEO allocates resources to and assesses the performance of each operating segment, using information about each segment’s net sales and operating income (loss) before interest and taxes.

 

 

LeapFrog’s reportable operating segments are as follows:

 

·

The U.S. Consumer segment, which includes the development, design and marketing of electronic educational hardware products and related software, sold primarily through retail channels and online in the United States.

 

·

The International segment, which includes the localization and marketing of electronic educational hardware products and related software, sold primarily in retail channels outside of the United States.

 

·

The School segment, which includes the development, design and marketing of electronic educational hardware products and related software, sold primarily to school systems in the United States.

 

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LEAPFROG ENTERPRISES, INC.

Notes to Consolidated Financial Statements

(In thousands, except per share data)

(Unaudited)

The following tables set forth net sales and income (loss) from operations for each segment of the Company.

		Three Months Ended June 30,								Six Months Ended June 30,
		2008				2007				2008				2007
Net sales:
U.S. Consumer		$	49,991			$	31,934			$	90,566			$	75,297
International			12,310				13,842				24,975				26,312
School			6,040				10,219				11,074				15,310
Totals		$	68,341			$	55,995			$	126,615			$	116,919
Income (loss) from
operations:
U.S. Consumer		$	(19,705	)		$	(31,426	)		$	(45,923	)		$	(60,920	)
International			(3,492	)			(2,776	)			(5,967	)			(2,901	)
School			1,036				3,812				1,106				3,238
Totals		$	(22,161	)		$	(30,390	)		$	(50,784	)		$	(60,583	)

Due to the seasonal nature of Company’s business, the sales trend and product mix during the first three and six month periods ended June 30, 2008 and 2007 are not necessarily indicative of its expected full year results.

For the three months ended June 30, 2008 and 2007, aggregate sales invoiced to the Company’s major customers, Wal-Mart, Toys “R” Us and Target, accounted for approximately 74% and 68% of gross sales for the U.S. Consumer segment,  respectively.  For the six month periods ended June 30, 2008 and 2007, aggregate sales invoiced to Wal-Mart, Toys “R” Us and Target accounted for approximately 74% and 73% of gross sales for the U.S. Consumer segment, respectively.

 

In January 2008, the Company announced a reduction-in-force affecting approximately 85 employees of the U.S. Consumer segment, with total severance costs of $1,300. In June 2008, the Company announced a reduction-in-force affecting approximately 10 employees of the School segment, with total severance costs of $150.

 

10. Borrowings Under Credit Agreements

 

In November 2005, the Company entered into a $75,000 asset-based revolving credit facility with Bank of America.  In May 2008 the Company, certain banks, financial institutions and other institutional lenders and Bank of America entered into Amendment No. 1 (the “Amendment”) to the original credit facility agreement, increasing the borrowing availability on the credit line from $75,000 to $100,000. Availability under this agreement was $57,622 as of June 30, 2008. The borrowing availability varies according to the levels of the Company’s eligible accounts receivable and cash and investment securities deposited in secured accounts with the administrative agent or other lenders. The termination date of the agreement is November 8, 2010.

 

The revolving credit facility contains customary events of default, including payment failures; failure to comply with covenants; failure to satisfy other obligations under the credit agreements or related documents; defaults in respect of other indebtedness; bankruptcy, insolvency and inability to pay debts when due; material judgments; change in control provisions and the invalidity of the guaranty or security agreements. The revolving credit facility prohibits the payment of cash dividends on the Company’s common stock.  The cross-default provision applies if a default occurs on other indebtedness in excess of $5,000 and the applicable grace period in respect of the indebtedness has expired, such that the lender of, or trustee for, the defaulted indebtedness has the right to accelerate. If an event of default occurs, the lenders may terminate their commitments, declare immediately all borrowings under the credit facility as due and foreclose on the collateral. As of June 30, 2008, the Company was in compliance with all its debt covenants.

 

 

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LEAPFROG ENTERPRISES, INC.

Notes to Consolidated Financial Statements

(In thousands, except per share data)

(Unaudited)

There were no borrowings outstanding under this agreement at June 30, 2008.

 

During the second quarter of 2008, the Company paid a loan fee of $594 upon execution of the Amendment. The fee is being amortized into “other income (expense)” on a straight-line basis through the termination date of the agreement.

 

11. Commitments and Contingencies

 

From time to time, LeapFrog is party to various pending claims and lawsuits.  The Company is currently party to the lawsuit described below.

 

Stockholder Class Actions

 

In December 2003, April 2005 and June 2005, six purported class action lawsuits were filed in federal district court for the Northern District of California against LeapFrog and certain of the Company’s former officers alleging violations of the Securities Exchange Act of 1934. These actions have since been consolidated into a single proceeding captioned In Re LeapFrog Enterprises, Inc. Securities Litigation. In January 2006, the lead plaintiffs in this action filed an amended and consolidated complaint. In July 2006, the Court granted the Company’s motion to dismiss the amended and consolidated complaint with leave to amend. In September 2006, plaintiffs filed a second amended consolidated class action complaint. This second amended complaint sought unspecified damages on behalf of persons who acquired LeapFrog’s Class A common stock during the period July 24, 2003 through October 18, 2004. Like the predecessor complaint, this complaint alleged that the defendants caused the Company to make false and misleading statements about its business and forecasts about its financial performance, and that certain of the Company’s current and former individual officers and directors sold portions of their stock holdings while in the possession of adverse, non-public information.

 

In September 2007, the federal district court granted the Company’s motion to dismiss the second amended complaint, with leave for the plaintiffs to amend and re-file a third amended complaint. In November 2007, the plaintiffs filed a third amended complaint. In February 2008, the parties reached an agreement-in-principle to settle these class actions. The Company expects the proposed settlement, which is subject to court approval, to be funded entirely by insurance. The parties are in the process of seeking court approval of the settlement. The Company has not accrued any amount related to this matter because it expects the settlement to be funded by insurance.

 

 

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Forward Looking Statements

 

This report on Form 10-Q, including the sections entitled “Part II, Item 1A-Risk Factors,” and “Item 2.  Management’s Discussion and Analysis of Financial Condition and Result of Operations” contains forward-looking statements, including statements regarding the scope and success of future launches, our expectations for sales, trends, margins, profitability,expenses, inventory or cash balances, capital expenditures, cash flows, or other measures of financial performance in future periods, future cash requirements and settlement of litigation. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to differ materially from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. These risks and other factors include those listed under “Risk Factors” in Item 1A of this Form 10-Q and those found elsewhere in this Form 10-Q. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “forecast”,  “potential,” “continue” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this report.

Overview

The following management's discussion and analysis is intended to help the reader understand the results of our operations and financial condition. This discussion and analysis is provided as a supplement to, and should be read in conjunction with, our unaudited consolidated financial statements and the accompanying notes to the unaudited consolidated financial statements.

 

We design, develop and market a family of innovative technology-based learning platforms, and related proprietary content for children of all ages at home and in schools around the world.  The platforms come to life with more than 100 interactive software titles, covering important subjects such as phonics, reading, writing, math and others.  In addition, we have a broad line of stand-alone educational products that do not require the separate purchase of software and are generally targeted at young children – from infants to five year olds.  Our products are available in six languages and are sold globally through retailers, distributors and directly to schools.   Our goal is to create educational products that kids love, parents trust and teachers value.

 

LeapFrog organizes, operates, and assesses its business in three primary operating segments: U.S. Consumer, International and School.

During the first half of 2008, LeapFrog entered the “grow” phase of its “fix, reload, grow” strategy, or corporate strategy, as described in more detail in our 2007 Annual Report on Form 10-K filed on March 13, 2008, or 2007 Form 10-K.  During the second quarter, we introduced the Tag reading system and 22 related Tag books in the U.S., Canada and Australia markets, and began shipping two web-connected educational gaming systems, Leapster2 and Didj, in the U.S. and Canada markets along with new software titles (eight for Didj and five for Leapster2), the LeapFrog Connect web application, and new learning toys. We expect continued sales growth in the third and fourth quarters of 2008 with the international launches of many of these new platforms in addition to launching the LeapFrog Learning Path and the Crammer study and sound system in the United States.

Our corporate strategy also included reducing our cost structure.  The number of fulltime employees declined 21% from the end of 2006 to the end of the second quarter of 2008 due to a combination of reductions in force and the migration of certain aspects of our product development cycle to external parties to increase efficiencies and shorten the time from concept to market.  These actions have contributed to lower selling, general and administrative and research and development expenses for the three and six months ended June 30, 2008 as compared to the corresponding periods in 2007.

 

17

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Net sales in the second quarter of 2008 improved over the same period in 2007, due primarily to strong sell-in of our new products in the U.S. Consumer segment to retailers, partially offset by declining sales of many of our older product lines.   The transition from selling primarily mature product lines during 2007 to selling newer, web-connected products in 2008 is an important factor to consider in analyzing the changes in our net sales and gross margin.  As new products are introduced in our international markets and become a larger proportion of our overall sales, we expect our gross margin to continue to improve over historical levels.

We are encouraged by the initial sales results of our new products, particularly Tag, and believe sales will continue to grow in the third and fourth quarters of 2008 as compared to the same periods in 2007.  However, it is still early in our selling season, and questions remain about how retailers will manage their purchasing, given the prevailing and anticipated macroeconomic conditions and the potential impact of weaker consumer spending, particularly with respect to discretionary items.

Consolidated Results of Operations

 

Our consolidated results of operations for the three and six months ended June 30, 2008 and 2007 are presented below.

 

		Three Months Ended												Six Months Ended
		June 30,								Change				June 30,								Change
		2008				2007				%				2008				2007				%
(Dollars in millions)
Consolidated Results of Operations
Net sales		$	68.3			$	56.0				22	%		$	126.6			$	116.9				8	%
Cost of sales			41.4				35.7				16	%			78.6				71.9				9	%
Gross profit			26.9				20.3				33	%			48.0				45.0				7	%
Operating expenses:
Selling, general and administrative			26.0				29.9				-13	%			56.8				62.3				-9	%
Research and development			12.9				14.0				-8	%			25.0				28.5				-12	%
Advertising			7.8				4.2				86	%			12.3				9.8				26	%
Depreciation and amortization			2.3				2.6				-12	%			4.7				5.0				-6	%
Total operating expenses			49.0				50.7				-3	%			98.8				105.6				-6	%
Loss from operations			(22.1	)			(30.4	)			-27	%			(50.8	)			(60.6	)			-16	%
Other income (expense):
Interest income			0.7				2.2				-68	%			1.9				4.4				-57	%
Interest expense			-				-				n/m				-				-				n/m
Other, net			(2.0	)			0.6				-433	%			(2.6	)			0.4				-750	%
Total other income (expense)			(1.3	)			2.8				-146	%			(0.7	)			4.8				-115	%
Loss before income taxes			(23.4	)			(27.6	)			-15	%			(51.5	)			(55.8	)			-8	%
Provision for (benefit from) income taxes			(2.8	)			0.4				n/m				(3.5	)			2.7				n/m
Net loss		$	(20.6	)		$	(28.0	)			-26	%		$	(48.0	)		$	(58.5	)			-18	%

 

 

18

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Net sales growth for both the three and six months ended June 30, 2008 as compared with the corresponding periods in 2007 was driven primarily by strong sales in the U.S. Consumer segment that benefited from the launch of Tag, Leapster2, and Didj hardware and software, offset in part by declining sales in both the International and School segments.

 

Our gross margin for the second quarter of 2008 improved by 3.1 percentage points from the same 2007 time period, largely driven by increases in our U.S. Consumer segment gross margin resulting from shipping several new, higher-margin products during the second quarter of 2008.

 

Loss from operations for both the three and six months ended June 30, 2008 improved, driven by an improvement in our gross margin and decreases in overall headcount impacting both selling, general and administrative and research and development costs. These improvements were offset in part by increased advertising spending supporting the new product launches.

 

Our business is seasonal, and the majority of our sales historically occur in the last two quarters of the year as retailers expand inventories for the holiday selling season.

 

Additional information regarding certain components of our results of operations by reportable segments (“segments”) is provided below.

 

Net Sales by Segment

 

A comparison of net sales by segment  and the relationship of net sales for each segment to total company net sales for the three and six months ended June 30, 2008 to the same periods in 2007, are shown in the tables below.

 

		Three Months Ended												Six Months Ended
(Dollars in millions)		June 30,								Change				June 30,								Change
		2008				2007				%				2008				2007				%
Net sales:
U.S. Consumer		$	50.0			$	31.9				57	%		$	90.6			$	75.3				20	%
International			12.3				13.9				-12	%			25.0				26.3				-5	%
School			6.0				10.2				-41	%			11.0				15.3				-28	%
Total		$	68.3			$	56.0				22	%		$	126.6			$	116.9				8	%
As a % of total Company											(1)												(1)
net sales:
U.S. Consumer			73	%			57	%			28	%			72	%			64	%			13	%
International			18	%			25	%			-28	%			20	%			22	%			-9	%
School			9	%			18	%			-50	%			8	%			14	%			-43	%
Total			100	%			100	%							100	%			100	%
(1) Percentage change in proportion of total Company net sales.

 

·

U.S. Consumer:  Net sales increased by 57% and 20% during the three and six months ended June 30, 2008 over the corresponding periods of the prior year. The increase was primarily due to strong retail shipments of hardware and software related to the Tag, Leapster2 and Didj systems. Net sales of the products introduced in the second quarter of 2008 were $20 million.

 

 

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The table below shows sales by product category for the U.S. Consumer segment:

 

		Three Months Ended												Six Months Ended
		June 30,								Change				June 30,								Change
(Dollars in millions)		2008				2007				%				2008				2007				%
U.S. Consumer net sales:
Platform		$	23.8			$	12.0				98	%		$	39.2			$	23.5				67	%
Software			12.7				7.9				61	%			25.8				25.5				1	%
Stand-alone			13.5				12.0				13	%			25.6				26.3				-3	%
Total		$	50.0			$	31.9				57	%		$	90.6			$	75.3				20	%

 

·

International: Net sales declined 12% and 5% during the three and six months ended June 30, 2008, respectively, from the same periods in 2007. Excluding the impact of foreign currency, our International segment’s sales would have declined by 14% and 10%, respectively, for the three and six months ended June 30, 2008.  The decrease in net sales for both 2008 periods was driven primarily by significant sales declines of our retiring products.  We expect International net sales for the second half of 2008 to increase as compared to the same 2007 period as the launch of our new products continues.

 

·

School:  Net sales declined by 41% and 28% in the three and six months ended June 30, 2008 as compared to the 2007 periods, driven primarily by increased competition and budgetary issues impacting school funding.

 

Gross Profit and Gross Margin

 

Gross profit and gross margin (gross profit as a percentage of net sales) for each segment were as follows:

 

						Three Months Ended												Six Months Ended
						June 30,								Change				June 30,								Change
(Dollars in millions)						2008				2007				%				2008				2007				%
Gross profit:
U.S Consumer						$	19.8			$	9.7				104	%		$	34.0			$	25.6				33	%
International							3.7				3.9				-5	%			7.9				9.8				-19	%
School							3.4				6.7				-49	%			6.1				9.6				-36	%
Totals						$	26.9			$	20.3				33	%		$	48.0			$	45.0				7	%
Gross margin:			(1)												(2)												(2)
U.S Consumer							39.6	%			30.4	%			9.2				37.5	%			34.0	%			3.5
International							30.1	%			28.1	%			2.0				31.6	%			37.3	%			(5.7	)
School							56.7	%			65.7	%			(9.4	)			55.5	%			62.7	%			(7.6	)
Total gross margin							39.3	%			36.2	%			3.1				37.9	%			38.5	%			(0.6	)
(1) Gross margin by segment is calculated as a % of each segment's net sales; total gross margin
is calculated as a % of total net sales for the Company.
(2) Percentage point change

 

 

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·

U.S. Consumer:  Gross margin for the three and six months ended June 30, 2008 increased by 9.2 and 3.5 percentage points, respectively, compared to the same periods in 2007. The increase in gross margin for both periods was primarily driven by improved product mix as we launched several new products with accretive gross margins and sold fewer discounted low-margin end-of-life products.

 

·

International:  Gross margin for the three months ended June 30, 2008 increased 2.0 percentage points over the same 2007 period. The increase was a result of favorable product mix and reduced costs.  Gross margin for the six months ended June 30, 2008 declined by 5.7 percentage points from the first half of 2007.  The decrease was primarily due to product mix, particularly lower sales of software. The majority of our shipments of new products to our international markets started after the end of the second quarter.

 

·

School:  Gross margin for the three and six months ended June 30, 2008 decreased by 9.4 and 7.6 percentage points, respectively, compared to the same periods in 2007.  The decrease in both 2008 periods was primarily due to product mix, coupled with the impact of relatively fixed costs, such as warehouse charges, that do not fluctuate with sales levels.

 

Operating Expenses

 

The tables below present the relationship of selling, general and administrative, or SG&A, and research and development, or R&D, and advertising expense to net sales.

 

We record substantially all of our indirect operating expenses, such as salaries of corporate and administrative personnel and other administrative costs, in our U.S. Consumer segment and do not allocate these costs to our International and School segments.

 

·

Selling, General and Administrative

 

		Three Months Ended												Six Months Ended
(Dollars in millions)		June 30,								Change				June 30,								Change
		2008				2007				%				2008				2007				%
SG&A:
U.S. Consumer		$	19.3			$	22.3				-13	%		$	42.7			$	47.0				-9	%
International			4.8				5.0				-4	%			10.0				9.9				1	%
School			1.9				2.6				-27	%			4.1				5.4				-24	%
Total		$	26.0			$	29.9				-13	%		$	56.8			$	62.3				-9	%
SG&A as a % of segment
net sales:
U.S. Consumer			39	%			70	%							47	%			62	%
International			39	%			36	%							40	%			38	%
School			31	%			25	%							37	%			35	%
Total SG&A as a % of total
Company net sales			38	%			53	%							45	%			53	%

 

Selling, general and administrative expense consists primarily of salaries and related employee benefits, legal fees, marketing expenses, systems costs, rent, office equipment, supplies and professional fees. We record most of our indirect expenses in our U.S. Consumer segment and do not allocate these expenses to our International and School segments.

 

Consistent with our corporate strategy, selling, general and administrative expenses decreased for the three and six months ended June 30, 2008, as compared to the comparable periods in 2007, driven primarily by lower salary expense resulting from the previously announced workforce reductions impacting both the U.S. Consumer and School segments which were implemented during 2008 and the latter half of 2007. In addition, in 2008 we incurred lower consulting and professional services fees, including lower audit and legal fees.

 

 

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·

Research and Development

 

		Three Months Ended												Six Months Ended
(Dollars in millions)		June 30,								Change				June 30,								Change
		2008				2007				%				2008				2007				%
R&D:
U.S. Consumer		$	11.1			$	13.1				-15	%		$	22.2			$	26.7				-17	%
International			1.5				0.7				114	%			2.1				1.2				75	%
School			0.3				0.2				50	%			0.7				0.6				17	%
Total		$	12.9			$	14.0				-8	%		$	25.0			$	28.5				-12	%
R&D as a % of segment
net sales:
U.S. Consumer			22	%			41	%							25	%			35	%
International			12	%			5	%							8	%			5	%
School			5	%			2	%							6	%			4	%
Total R&D as a % of total
Company net sales			19	%			25	%							20	%			24	%

 

Research and development expenses include payroll, employee benefits, and other related expenses associated with content development, product development and engineering.  Research and development expenses also include third-party development and programming costs and localization costs incurred to translate content for international markets.  We record most of our indirect expenses in our U.S. Consumer segment and do not allocate these expenses to our International and School segments.

 

Research and development expenses for the U.S. Consumer segment decreased for the three and six months ended June 30, 2008 over the same periods in 2007.  The decrease was driven primarily by headcount reductions, resulting in lower salary and benefits charges and the shift of certain aspects of the product development cycle to our third-party vendors during late 2007 for greater efficiency and shorter time to market. The increase in R&D expenses in the International segment during 2008 as compared to 2007 resulted from increased expenses related to localizing our new products for the international markets.

 

 

We expect to continue externalizing research and development expenses to drive these costs down further as a percent of net sales.

 

 

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·

Advertising

 

 

		Three Months Ended												Six Months Ended
(Dollars in millions)		June 30,								Change				June 30,								Change
		2008				2007				%				2008				2007				%
Advertising:
U.S. Consumer		$	6.9			$	3.3				109	%		$	10.5			$	8.2				28	%
International			0.8				0.8				0	%			1.6				1.4				14	%
School			0.1				0.1				0	%			0.2				0.2				0	%
Total		$	7.8			$	4.2				86	%		$	12.3			$	9.8				26	%
Advertising as a % of segment
net sales:
U.S. Consumer			14	%			10	%							12	%			11	%
International			7	%			6	%							6	%			5	%
School			2	%			1	%							2	%			1	%
Total advertising as a % of
total Company net sales			11	%			8	%							10	%			8	%

 

Advertising expense includes costs associated with marketing, advertising and promoting our products.  Advertising expenses increased for the three and six months ended June 30, 2008 driven primarily by increased activity supporting the Tag reading system launch.  We expect an increase in advertising expense consistent with our sales increases in 2008, as we continue to launch and promote new products.

 

Income (Loss) from Operations by Segment

 

		Three Months Ended												Six Months Ended
(Dollars in millions)		June 30,								Change				June 30,								Change
		2008				2007				%				2008				2007				%
Income (loss) from
operations:
U.S Consumer		$	(19.6	)		$	(31.4	)			-38	%		$	(45.9	)		$	(60.9	)			-25	%
International			(3.5	)			(2.8	)			25	%			(6.0	)			(2.9	)			107	%
School			1.0				3.8				-74	%			1.1				3.2				-66	%
Totals		$	(22.1	)		$	(30.4	)			-27	%		$	(50.8	)		$	(60.6	)			-16	%
Income (loss) from operations
as a % of net sales:
U.S Consumer			-39.2	%			-98.4	%							-50.7	%			-80.9	%
International			-28.5	%			-20.3	%							-24.0	%			-11.0	%
School			16.7	%			37.3	%							9.9	%			20.9	%
Totals			-32.4	%			-54.3	%							-40.1	%			-51.8	%

 

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Other Income (Expense)

 

The components of total other income (expense) for the three and six months ended June 30, 2008 as compared to the same periods in 2007 are set forth in the table below.

 

		Three Months Ended												Six Months Ended
		June 30,								Change				June 30,								Change
		2008				2007				$					2008			2007					$
(Dollars in millions)
Other income (expense):
Interest income		$	0.7			$	2.2			$	(1.5	)		$	1.9			$	4.4			$	(2.5	)
Interest expense **			-				-				-				-				-				-
Other, net			(2.0	)			0.6				(2.6	)			(2.6	)			0.4				(3.0	)
Total		$	(1.3	)		$	2.8			$	(4.1	)		$	(0.7	)		$	4.8			$	(5.5	)
** There are nominal amounts of interest expense in each period that are significantly less than $1 million.

 

·

Interest income:  During the three and six months ended June 30, 2008, interest income decreased, reflecting a reduction in the average balance of interest-bearing investments,  as well as lower interest rates in 2008 as compared to 2007.

 

·

Other, net:  During the three and six months ended June 30, 2008, “other, net” declined  primarily due to “other than temporary” impairments related to our investment in auction rate securities, or ARS.  We incurred $1.6 million and $1.7 million in ARS related impairments for the three and six months ended June 30, 2008, respectively.  Both periods include $0.6 million of impairment charges which were previously categorized as temporary and included in “accumulated other comprehensive income”. Recharacterization of these impairments as “other than temporary” reflected the further deterioration of market conditions and our conclusion, at June 30, 2008, that it was unlikely that we would ultimately recover the par value of the securities. The remainder of the decline in “other, net” from 2007 to 2008 is largely attributable to changes in the net effects of foreign currency on the financial statements from year to year.

 

Income Taxes

 

During the three months ended June 30, 2008, the Internal Revenue Service, or IRS, completed and settled its audit of our research and development ("R&D") carryback claims for the period of 2001-2003. As a result of the settlement, we recorded a tax benefit of $1.9 million in the second quarter of 2008, which included both previously unrecognized tax benefits and interest paid by the IRS.

 

The effective income tax rates were 6.7% and (4.8) % for the six months ended June 30, 2008 and 2007, respectively. The calculation of the effective tax rates for both periods included a non-cash valuation allowance recorded against our domestic deferred tax assets. In addition to the tax benefit from the IRS settlement, changes in the mix of foreign earnings also caused an income tax benefit in the first two quarters of 2008 compared to income tax expense in the first two quarters of 2007.

 

The income tax benefit  for the three and six months ended June 30, 2008 was $2.8 million and $3.5 million, respectively, compared with a tax  provision of  $0.4 million and $2.7 million, respectively, for the same periods last year.  The second quarter of 2008 includes a $1.9 million benefit from the settlement of an audit by the IRS of our claim for a refund for tax credits.  In addition, the changes in the mix of foreign earnings also caused an income tax benefit in the first two quarters of 2008 compared to income tax expense in the first two quarters of 2007.

 

 

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The full year income tax expense for 2008 is estimated to be in the range of $1.0 million to $3.0 million, compared to $3.7 million for 2007.  The majority of the tax expense in both years is attributable to the Company’s foreign operations, with the 2008 tax expense partially offset by the impact of the IRS settlement. The 2007 consolidated loss before income taxes resulted in an effective tax rate of (3.8) % in 2007.  The Company expects a higher effective tax rate in 2008 given the estimated 2008 income tax expense coupled with expected year-over-year improved results.

 

Liquidity and Capital Resources

 

LeapFrog’s primary source of liquidity during the three and six months ended June 30, 2008 was cash received from the collection of accounts receivable balances generated from sales in the fourth quarter of 2007 and the first quarter of 2008, partially offset by operating losses and decreases in accrued liabilities.

 

Cash and Cash Equivalents and Short-Term Investments

 

Our most liquid assets comprise cash and cash equivalents and short-term investments.  Their balances as of June 30, 2008 and 2007, the changes in the balances from year to year and the ratio of our most liquid assets to total assets were as follows:

		June 30,								Change
(Dollars in millions)		2008				2007					$
Cash and cash equivalents and
short-term investments:
Cash and cash equivalents		$	68.3			$	64.3			$	4.0
Short-term investments			-				75.5				(75.5	)
Totals		$	68.3			$	139.8			$	(71.5	)
Total assets		$	309.9			$	383.8			$	(73.9	)
As a % of total assets			22	%			36	%

 

Financial Condition

 

We anticipate that our primary liquidity requirements will be for working capital and capital expenditures.  We believe that cash generated from operations and available borrowing under our credit facility will be sufficient for us to meet our cash requirements for 2008.

 

Cash Flows for the Six Months ended June 30, 2008 and 2007

 

Cash and cash equivalents decreased to $68.3 million at June 30, 2008 from $93.5 million at December 31, 2007. The components of the year over year change in cash and cash equivalents were as follows:

 

 

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		June 30,								Change
(Dollars in millions)		2008				2007					$
Cash flow (used in) provided by:
Operating activities		$	(12.6	)		$	12.0			$	(24.6	)
Investing activities			(12.6	)			(19.0	)			6.4
Financing activities			0.4				1.6				(1.2	)
Effect of exchange rate fluctuations on cash			(0.4	)			2.3				(2.7	)
Decrease in cash and cash equivalents		$	(25.2	)		$	(3.1	)		$	(22.1	)

 

 

·

Operating Activities

Cash flow from operating activities decreased $24.6 from the first six months of 2007 due to lower cash collections on accounts receivable of $32 million, as sales had been on a downward trend throughout 2007, partially offset by a $10 million improvement in the net loss year-over-year.

 

·

Investing Activities

Net cash used in investing activities during the six months ended June 30, 2008 decreased $6.4 million from the same time period in 2007, due primarily to a change in our investing strategy.  During 2007 we invested in a variety of short-term instruments such as commercial paper, municipal and corporate bonds and auction rate securities.  However, following the credit market upheaval in the third quarter of 2007, we decided to invest our available funds in cash equivalents only.

 

·

Financing Activities

Net cash provided by financing activities during the six months ended June 30, 2008 decreased $1.2 million from the same time period in 2007 due to a decline in employee stock option exercise volume in addition to declining purchase of stock pursuant to our employee stock purchase plan.

 

Our cash flow is seasonal, and the vast majority of our sales historically occur in the last two quarters of the year as retailers expand inventories for the holiday selling season. Our accounts receivable balances are generally the highest in the last two months of the fourth quarter, and payments are not due until the first quarter of the following year. Cash used in operations is typically the highest in the third quarter as we increase inventory to meet the holiday season demand. The following table shows certain quarterly cash flows from operating activities that illustrate the seasonality of our business:

 

(Dollars in millions)		2008				2007				2006
Cash flows from operations:
1st quarter		$	18.1			$	49.6			$	133.1
2nd quarter			(30.7	)			(37.6	)			(21.2	)
Subtotal for first half of fiscal year			(12.6	)			12.0				111.9
3rd quarter							(52.4	)			(40.1	)
4th quarter							25.0				18.6
Subtotal for second half of fiscal year			n/a				(27.4	)			(21.5	)
Total cash flows from operations for year to date periods			n/a			$	(15.4	)		$	90.4

 

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Line of Credit and Borrowing Availability

In November 2005, we entered into a $75.0 million asset-based revolving credit facility with Bank of America.  In May 2008 we, certain banks, financial institutions and other institutional lenders and Bank of America entered into Amendment No. 1 to the original credit facility agreement, increasing the borrowing availability on the credit line from $75.0 million to $100.0 million. Availability under this agreement was $57.6 million as of June 30, 2008. The borrowing availability varies according to the levels of our eligible accounts receivable and cash and investment securities deposited in secured accounts with the administrative agent or other lenders. The termination date of the agreement is November 8, 2010.

 

The revolving credit facility contains customary events of default, including payment failures; failure to comply with covenants; failure to satisfy other obligations under the credit agreements or related documents; defaults in respect of other indebtedness; bankruptcy, insolvency and inability to pay debts when due; material judgments; change in control provisions and the invalidity of the guaranty or security agreements. The revolving credit facility prohibits the payment of cash dividends on our common stock.  The cross-default provision applies if a default occurs on other indebtedness in excess of $5.0 million and the applicable grace period in respect of the indebtedness has expired, such that the lender of, or trustee for, the defaulted indebtedness has the right to accelerate. If an event of default occurs, the lenders may terminate their commitments, declare immediately all borrowings under the credit facility as due and foreclose on the collateral. As of June 30, 2008 we were in compliance with all our debt covenants.

 

We had no borrowings outstanding under this agreement at June 30, 2008.

 

Critical Accounting Policies, Judgments and Estimates

 

Our management’s discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.  Our significant accounting policies are described in Note 2 to our consolidated financial statements in our 2007 Form 10-K. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and reported disclosures. We believe that certain accounting policies, which we refer to as critical accounting policies, are particularly important to the portrayal of our financial position and results of operations and require the use of significant estimates and the application of significant judgment by our management. On an on-going basis, we evaluate our estimates, particularly those related to our critical accounting policies, which include:  Sales returns and allowances, the valuation and nature of impairments of financial instruments, inventory valuation, the valuation of deferred tax assets and tax liabilities, valuation of intangible assets and stock-based compensation assumptions. We base our estimates on historical experience and on complex and subjective judgments often resulting from our evaluation of the impact of events and conditions that are inherently uncertain. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

Our critical accounting policies are described below.

 

Revenue Recognition and Related Allowances

 

We recognize revenue when products are shipped and title passes to the customer provided that:

 

·	There is evidence of a commercial arrangement.  This condition is satisfied by evidence of an agreement with the customer that reflects the terms and conditions to deliver products that must be present in order to recognize revenue.

 

·

Delivery has occurred.   Delivery is considered to occur when a product is shipped, the risk of loss and rewards of ownership have been transferred to the customer and no significant post delivery obligations exist. For online downloads, delivery is considered to occur when the download occurs. For professional training services, delivery is considered to occur when the training has been performed.

 

·	The fee is fixed and determinable. If a portion of the arrangement fee is not fixed or determinable, we recognize revenue as the amount becomes fixed or determinable. For gift certificates, we recognize revenues when the certificates are redeemed.

 

·	Collection is reasonably assured.  Collection is reasonably assured if we expect the customer to be able to pay amounts under the arrangement as those amounts become due. If we determine that collection is not reasonably assured, we recognize revenue upon cash collection.

 

Net sales represent gross sales less negotiated price allowances based primarily on volume purchasing levels, estimated returns, allowances for defective products, markdowns and other sales allowances for customer promotions. A small portion of our revenue related to subscriptions is recognized as revenue over the period of the subscription.

 

We reduce accounts receivable by an allowance for amounts we believe may become uncollectible. Determining the amounts that may become uncollectible requires judgment that may have a significant effect on the amounts reported in accounts receivable. This allowance is an estimate based primarily on our management’s evaluation of the customer’s financial condition in the context of current economic conditions, past collection history and aging of the accounts receivable balances. If changes in the economic climate or the financial condition of any of our customers result in impairment of their ability to make payments, additional allowances may be required. We disclose accounts receivable net of our allowances for doubtful accounts on the face of the balance sheet.

 

We provide estimated allowances against revenues and accounts receivable for product returns, defective products, charge-backs, discounts and promotions on product sales, in the same period that we record the related revenue. We estimate our allowances by utilizing historical information for existing products. For new products, we estimate our allowances for product returns on the basis of the specific terms for product returns of that product and our experience with similar products. We also take into account current inventory levels of our retailers, sell-through of our retailers and distributors, current trends in retail for our products, changes in customer demand for our products and other related factors.

 

We continually evaluate our historical experience and adjust our allowances as appropriate. These adjustments result in changes in our net sales and accounts receivable. If actual product returns or defective products were significantly greater than our estimated allowances, additional allowances would be required; thereby reducing reported net sales and accounts receivable. If actual product returns or defective products were significantly less than our estimated allowances, an adjustment increasing reported net sales and accounts receivable would be required.

 

Fair Value Measurements of Financial Instruments

 

Effective January 1, 2008, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”). In February 2008, the FASB issued FASB Staff Position No. FSP 157-2, “Effective Date of FASB Statement No. 157, which provides for a one-year deferral of the effective date of SFAS 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value on a recurring basis (at least annually). Therefore, in 2008, we adopted the provisions of SFAS 157 with respect to our financial assets and liabilities (“financial instruments” or “instruments”) only.

 

In accordance with the provisions of SFAS 157, the fair values of our financial instruments reflect the estimates of amounts that would be either received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price).  The fair value estimates presented in this report are based on information available to us as of June 30, 2008 and December 31, 2007.

 

The carrying values of cash and cash equivalents and foreign currency forward contracts approximate fair value.  We have estimated the fair value of our investment in auction rate securities as of June 30, 2008 and December 31, 2007, using significant unobservable inputs and using the market approach as of June 30, 2007.  We estimated the fair value of our currency contracts at June 30, 2008 and 2007 and December 31, 2007 using a market approach.

 

In accordance with SFAS No. 157, we apply a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value.

 

 

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The three levels are the following:

 

·

Level 1 - Quoted prices in active markets for identical assets or liabilities.

 

·

Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities

 

·

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

We update our estimates of the fair values of our financial instruments at least quarterly, using the guidance provided in SFAS 157. In this process, we obtain and evaluate the most recently available market information for observable inputs (Level 1 and Level 2 instruments) and update our evaluation of unobservable inputs for Level 3 instruments.  The fair values of the financial instruments are written down when considered necessary.  An estimate of potential future losses or gains cannot be made at this time.

 

We recognize write-downs to the fair values of our financial instruments in accordance with the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”). Unrealized losses that are deemed to be temporary are recorded in “accumulated other comprehensive income”, a component of stockholders’ equity; losses deemed to be “other than temporary” are recorded in the statements of operations in “Other income (expense)”.  The characterization of losses as temporary, or “other than temporary”, requires us to make complex and subjective judgments, using currently available data as well as projections about the potential impact of possible future events and conditions, which judgments and projections are inherently uncertain.

 

Inventories

 

Inventories are stated at the lower of cost, on a first-in, first-out basis, or market value.  Inventory balances include write-downs of slow-moving, excess and obsolete inventories. Our estimate of the write-downs for slow-moving, excess and obsolete inventories is based on management’s review of current inventories on hand compared to their estimated future usage, demand for our products, anticipated product selling prices and products planned for discontinuation.  If actual future usage, demand for our products and/or anticipated product selling prices are less favorable than those projected by 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 sales.

 

Intangible Assets

 

Our intangible assets comprise primarily goodwill, which we recognized in accordance with the guidelines of SFAS No. 141, Business Combinations (“SFAS 141”). SFAS 141 defines goodwill as “the excess of the cost of an acquired entity over the net of the estimated fair values of the assets acquired and the liabilities assumed at date of acquisition.”  Goodwill, as well as all of our other intangible assets, is allocated to our U.S. reporting unit, or U.S. Consumer segment, pursuant to SFAS 141.

We test goodwill and all our other intangible assets with indefinite lives (collectively, “intangible assets”) for impairment at least annually in accordance with the provisions of SFAS No. 142, “Goodwill and Other Intangible Asset” (“SFAS 142”). When evaluating goodwill for impairment, SFAS 142 requires us to first compare the fair value of the reporting unit to its carrying value to determine if there is an impairment loss. If the fair value of the reporting unit exceeds its carrying value, goodwill is considered not impaired. Application of the second step of the two-step approach in SFAS 142 is not required. Application of the goodwill impairment tests require significant judgment by us, including identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, determination of the fair value of each reporting unit and projections of future net cash flows, which judgments and projections are inherently uncertain.

 

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We consider the results generated from using both of the approaches set forth in SFAS 142 to estimate the fair value of each relevant reporting unit as follows:

·

We use the market approach to develop indications of fair value.  This approach uses market values and revenue multiples of other publicly traded companies engaged in the same or similar lines of business as ours.

·

We use the discounted cash flow, or DCF, methodology to develop an additional estimate of fair value.  The DCF methodology 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.

The determination of whether the intangible assets are impaired involves numerous assumptions, estimates and the application of significant judgment. For the market approach, considerable judgment is required to select comparable companies and estimate the multiples of revenues implied by their market values. For the DCF approach, we must exercise judgment in selecting an appropriate discount rate and must also make numerous assumptions in order to develop future business and financial forecasts and the related estimates of future net cash flows. Future net cash flows depend primarily on future product sales, which are inherently difficult to predict. This is especially true at times such as the present, when a significant portion of our future net sales is expected to be generated not by existing products but by products we plan to introduce in the current year and in future years.

We tested our goodwill and other intangible assets with indefinite lives for impairment as of December 31, 2007 and determined that no adjustments to the carrying values of the intangible assets were necessary as of that date. On a quarterly basis, we consider the need to update our most recent annual tests for possible impairment of our intangible assets with indefinite lives, based on management’s assessment of changes in our business and other economic factors since the most recent annual evaluation.  Such changes, if significant or material, could indicate a need to update the most recent annual tests for impairment of the intangible assets during the current period. The results of these tests could lead to write-downs of the carrying values of the intangible assets in the current period. No such significant or material changes in our business or economic environment have come to our attention since December 31, 2007 through the date of this report.

 

Any future impairment tests may result in a charge to earnings if we experience sales shortfalls, fail to reduce our expenses or if the market approach results in a fair value less than the carrying value of goodwill. Therefore, the potential exists for future write-downs of intangible assets in connection with impairment testing.

 

Income Taxes

 

We account for income taxes in accordance with the guidelines provided in SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”), 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 are expected to 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”, (“FIN 48”), an interpretation of SFAS No. 109. FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold an uncertain tax position is required to meet before tax benefits associated with such uncertain tax positions are recognized in the financial statements.

The interim tax provision is calculated based on the best estimate of the effective tax rate expected to be applicable for the full fiscal year increased or decreased by discrete items affecting the rate as the items occur.  The estimated full year effective tax rate may fluctuate due to changes in expected full year tax expense or changes in expected pre-tax earnings or both.

 

Valuation allowances are provided when it is more likely than not that all or a portion of a deferred tax asset will not be realized. In determining whether a valuation allowance is warranted, we take into account such factors as prior earnings history, expected future earnings, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset.

 

 

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Our financial statements also include accruals for the estimated amounts of probable future assessments that may result from the examination of federal, state or international tax returns. Our tax accruals, tax provision, deferred tax assets or income tax liabilities may be adjusted if there are changes in circumstances, such as changes in tax law, tax audits or other factors, which may cause management to revise its estimates. The amounts ultimately paid on any future assessments may differ from the amounts accrued and may result in an increase or reduction to the effective tax rate in the year of resolution.

 

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, as 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 estimated based on the guidance for applying SFAS 123(R) provided in SEC  “Staff Accounting Bulletin No. 107”.  Expected stock price volatility is based on a consideration of our stock’s historical and implied volatilities as well as the volatilities of other public entities in 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 with a term equal to the expected lives of the options.

Restricted stock awards and restricted stock units are payable in shares of our Class A common stock. The fair value of each restricted share or unit is equal to the closing market price of our Class A common stock on the trading day immediately prior to the date of grant. The grant date fair value is recognized as compensation expense 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 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.

 

    Recent Accounting Pronouncements Not Yet Adopted

 

In March 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand the effects of the derivative instruments on an entity’s financial position, financial performance and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. We are currently assessing the potential impact of SFAS No. 161 on our financial statements.

 

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In February 2008, the FASB issued FASB Staff Position No. SFAS 157-2, “Effective Date of FASB Statement No. 157” (“SFAS 157-2”), which provides for a one-year deferral of the effective date of SFAS 157  for non-financial assets and non-financial liabilities, except those that are already recognized or disclosed in the financial statements at fair value on a recurring basis (at least annually). Pursuant to this pronouncement, we adopted the provisions of SFAS 157 as of January 1, 2008 with respect to our financial assets and liabilities only.  SFAS 157-2 is effective for fiscal years beginning after November 15, 2008.  We are currently assessing the potential impact of SFAS No. 157-2 on our financial statements.

 

    Recent Accounting Pronouncement Not Adopted

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115” (“SFAS 159”). Adoption of SFAS 159 is optional; however, once adopted, the election to use fair value measurements for certain assets and liabilities included in the scope of SFAS No. 159 is irrevocable. SFAS 159 expands the use of fair value measurements for both financial assets and financial liabilities beyond current accounting practices. If the use of fair value is elected under SFAS 159, any upfront costs and fees related to the items that are stated at fair value must be recognized in earnings and cannot be deferred, e.g., debt issue costs.  At the adoption date, unrealized gains and losses on existing items for which fair value has been elected are reported as a cumulative adjustment to beginning retained earnings; retrospective treatment is not permitted.  Subsequent to the adoption of SFAS 159, changes in fair value are recognized in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007 for companies electing to adopt its provisions.

 

As permitted, we elected not to adopt the provisions of this statement; thus SFAS 159 had no effect on our financial statements.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

 

Our stockholders may experience significant additional dilution upon the exercise of options or issuance of stock awards.

 

As of December 31, 2007, there were outstanding awards under our equity incentive plans that could result in the issuance of approximately 10.2 million shares of Class A common stock. To the extent we issue shares upon the exercise of any options or vesting of any other equity incentive awards, investors in our Class A common stock will experience additional dilution.

 

Our stock price could become more volatile and your investment could lose value.

 

All the factors discussed in this section could affect our stock price. The timing of announcements in the public markets regarding new products, product enhancements or product recalls by us or our competitors or any other material announcements could affect our stock price. Speculation in the media and analyst community, changes in recommendations or earnings estimates by financial analysts, changes in investors’ or analysts’ valuation measures for our stock and market trends unrelated to our stock can cause the price of our stock to change. A significant drop in the price of our stock could also expose us to the risk of securities class action lawsuits, which could result in substantial costs and divert management’s attention and resources, which could adversely affect our business.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES  

       None.