XNYS:LF Leapfrog Enterprises, Inc. Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2012

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                     to                    

 

Commission File Number: 001-31396

 

 
         
   

LeapFrog Enterprises, Inc.

(Exact name of registrant as specified in its charter)

 

 
         
 
 
DELAWARE   95-4652013

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

6401 Hollis Street, Suite 100, Emeryville, California   94608-1463
(Address of principal executive offices)   (Zip Code)

 

510-420-5000

(Registrant’s telephone number, including area code)

  

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   x     No   ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

             
Large accelerated filer   ¨   Accelerated filer   x
       
Non-accelerated filer   ¨ (Do not check if a smaller reporting company)   Smaller reporting company   ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   x

 

As of July 31, 2012, 58,224,064 shares of Class A common stock, par value $0.0001 per share, and 8,953,238 shares of Class B common stock, par value $0.0001 per share, of the registrant were outstanding.

 

 

 

LEAPFROG ENTERPRISES, INC.

TABLE OF CONTENTS

 

Part I.
Financial Information
     
Item 1.   Financial Statements (Unaudited):  
       
    Consolidated Balance Sheets at June 30, 2012 and 2011 and December 31, 2011 3
     
    Consolidated Statements of Operations for the Three and Six Months ended June 30, 2012 and 2011 4
     
    Consolidated Statements of Comprehensive Loss for the Three and Six Months ended June 30, 2012 and 2011 5
     
    Consolidated Statements of Cash Flows for the Six Months ended June 30, 2012 and 2011 6
     
    Notes to the Consolidated Financial Statements 7
     
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations 14
     
Item 3.   Quantitative and Qualitative Disclosures About Market Risk 22
     
Item 4.   Controls and Procedures 23
 
Part II.
Other Information
     
Item 1.   Legal Proceedings 24
     
Item 1A.   Risk Factors 24
     
Item 6.   Exhibits 25
     
Signatures 26  

 

2

 

PART I.

 

ITEM 1. FINANCIAL STATEMENTS

 

LEAPFROG ENTERPRISES, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

 

   June 30,   December 31, 
   2012   2011   2011 
   (Unaudited)   (See Note 1) 
ASSETS               
Current assets:               
Cash and cash equivalents  $126,926   $57,733   $71,863 
Accounts receivable, net of allowances for doubtful accounts of  $3,891, $840 and $659, respectively   51,360    48,964    157,418 
Inventories   52,650    63,398    34,288 
Prepaid expenses and other current assets   9,325    9,266    8,078 
Deferred income taxes   978    1,771    983 
Total current assets   241,239    181,132    272,630 
Long-term investments   -    2,681    2,681 
Deferred income taxes   1,281    980    1,311 
Property and equipment, net   19,437    18,184    17,881 
Capitalized product costs, net   11,319    13,253    12,511 
Goodwill   19,549    19,549    19,549 
Other intangible assets, net   2,150    4,589    3,350 
Other assets   1,591    2,023    1,119 
Total assets  $296,566   $242,391   $331,032 
                
LIABILITIES AND STOCKHOLDERS' EQUITY               
Current liabilities:               
Accounts payable  $32,200   $28,127   $34,629 
Accrued liabilities   31,476    23,527    50,380 
Income taxes payable   379    229    377 
Total current liabilities   64,055    51,883    85,386 
Long-term deferred income taxes   3,713    3,394    3,542 
Other long-term liabilities   8,988    12,013    9,360 
Stockholders' equity:               
Class A Common Stock, par value $0.0001;               
Authorized - 139,500 shares; Issued and outstanding: 58,230, 49,758 and  54,923 , respectively   6    5    6 
Class B Common Stock, par value $0.0001;               
Authorized - 40,500 shares; Issued and outstanding: 8,953, 15,817 and  11,113, respectively   1    2    1 
Treasury stock   (185)   (185)   (185)
Additional paid-in capital   400,193    391,592    395,627 
Accumulated other comprehensive income (loss)   (158)   2,025    (225)
Accumulated deficit   (180,047)   (218,338)   (162,480)
Total stockholders’ equity   219,810    175,101    232,744 
Total liabilities and stockholders’ equity  $296,566   $242,391   $331,032 

 

See accompanying notes

 

3

 

LEAPFROG ENTERPRISES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2012   2011   2012   2011 
                 
Net sales  $71,480   $54,420   $143,490   $94,098 
Cost of sales   42,925    35,438    85,203    63,360 
Gross profit   28,555    18,982    58,287    30,738 
                     
Operating expenses:                    
Selling, general and administrative   20,204    17,650    43,901    38,137 
Research and development   8,849    8,141    17,738    16,372 
Advertising   4,339    3,492    6,753    5,827 
Depreciation and amortization   2,633    2,791    5,913    5,344 
Total operating expenses   36,025    32,074    74,305    65,680 
Loss from operations   (7,470)   (13,092)   (16,018)   (34,942)
                     
Other income (expense):                    
Interest income   96    36    189    69 
Interest expense   -    (44)   -    (80)
Other, net   (449)   (283)   (1,116)   (843)
Total other income (expense), net   (353)   (291)   (927)   (854)
Loss before income taxes   (7,823)   (13,383)   (16,945)   (35,796)
Provision for income taxes   287    387    622    160 
Net loss  $(8,110)  $(13,770)  $(17,567)  $(35,956)
                     
Net loss per share:                    
 Class A and B - basic and diluted  $(0.12)  $(0.21)  $(0.26)  $(0.55)
                     
Weighted average shares used to calculate net loss per share:                    
 Class A and B - basic and diluted   66,928    65,293    66,662    65,027 

 

See accompanying notes

 

4

 

LEAPFROG ENTERPRISES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(In thousands)

(Unaudited)

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2012   2011   2012   2011 
Net loss  $(8,110)  $(13,770)  $(17,567)  $(35,956)
                     
Other comprehensive income (loss), before tax                    
Currency translation adjustments   (1,179)   591    157    1,733 
Transfer of temporary gain on long-term investment   -    -    (241)   - 
Total other comprehensive income (loss), before tax   (1,179)   591    (84)   1,733 
Transfer of tax expense allocated to temporary gain on long- term investments   -    -    151    - 
Other comprehensive income (loss), net of tax   (1,179)   591    67    1,733 
                     
Comprehensive loss  $(9,289)  $(13,179)  $(17,500)  $(34,223)

 

See accompanying notes

 

5

 

LEAPFROG ENTERPRISES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

   Six Months Ended June 30, 
   2012   2011 
Operating activities:          
Net loss  $(17,567)  $(35,956)
Adjustments to reconcile net loss to net cash provided by operating activities:          
Depreciation and amortization   11,122    9,447 
Deferred income taxes   212    111 
Stock-based compensation expense   3,039    2,424 
Loss on sale of long-term investments, net of tax   91    - 
Loss on disposal of long-term assets   2    53 
Allowance for doubtful accounts   3,252    279 
Other changes in operating assets and liabilities:          
Accounts receivable, net   102,842    108,835 
Inventories   (18,293)   (15,191)
Prepaid expenses and other current assets   (1,234)   (821)
Other assets   (472)   (236)
Accounts payable   (2,435)   (3,312)
Accrued liabilities   (18,922)   (18,100)
Other long-term liabilities   (372)   388 
Income taxes payable   2    62 
Net cash provided by operating activities   61,267    47,983 
Investing activities:          
Purchases of property and equipment   (6,392)   (7,284)
Capitalization of product costs   (3,892)   (4,340)
Sales of investments   2,500    - 
Other   -    2 
Net cash used in investing activities   (7,784)   (11,622)
Financing activities:          
Proceeds from stock option exercises and employee stock purchase plans   2,739    1,944 
Net cash paid for payroll taxes on restricted stock unit releases   (1,212)   (610)
Net cash provided by financing activities   1,527    1,334 
Effect of exchange rate changes on cash   53    559 
Net change in cash and cash equivalents   55,063    38,254 
Cash and cash equivalents, beginning of period   71,863    19,479 
Cash and cash equivalents, end of period  $126,926   $57,733 

 

See accompanying notes

 

6

 

LEAPFROG ENTERPRISES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share data)

(Unaudited)

 

1.Basis of Presentation

 

In the opinion of management, all normal, recurring adjustments considered necessary for a fair statement of the financial position and interim results of LeapFrog Enterprises, Inc. and its consolidated subsidiaries (collectively, the “Company” or “LeapFrog” unless the context indicates otherwise) as of and for the periods presented have been included. The accompanying unaudited consolidated financial statements and related disclosures have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) applicable to interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. The consolidated financial statements include the accounts of LeapFrog and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

 

The consolidated balance sheet at December 31, 2011 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The financial information included herein should be read in conjunction with the consolidated financial statements and related notes in the Company’s 2011 Annual Report on Form 10-K filed with the United States (“U.S.”) Securities and Exchange Commission (the “SEC”) on February 29, 2012 (the “2011 Form 10-K”).

 

The accounting policies used by the Company in its presentation of interim financial results are consistent with those presented in Note 2 to the consolidated financial statements included in the Company’s 2011 Form 10-K.

 

Due to the seasonality of the Company’s business, the results of operations for interim periods are not necessarily indicative of the operating results for a full year.

 

Certain amounts in the financial statements for prior periods have been reclassified to conform to the current year presentation.

 

2.Fair Values 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 June 30, 2012, the Company’s 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.

 

·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.

 

7

 

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 $37,626, $21,299 and $0 at June 30, 2012, December 31, 2011 and June 30, 2011, respectively. The fair market values of these instruments as of the same periods were $(299), $40 and $0, respectively. The fair value of these contracts was recorded in accrued liabilities for June 30, 2012; and in prepaid expenses and other current assets for December 31, 2011.

 

·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 did not hold any Level 3 assets as of June 30, 2012. As of December 31, 2011 and June 30, 2011, the Company’s Level 3 assets consisted of investments in auction rate securities (“ARS”), for which the Company engaged a third-party valuation firm to estimate the fair value using a discounted cash flow approach as of the periods then ended.

 

The following table presents the Company’s fair value hierarchy for assets and liabilities measured at fair value on a recurring basis as of June 30, 2012, December 31, 2011 and June 30, 2011:

 

   Estimated Fair Value Measurements 
   Carrying Value   Quoted Prices in
Active Markets
(Level 1)
   Significant
Other
Observable
Inputs 
(Level 2)
   Significant
Unobservable
Inputs 
(Level 3)
 
June 30, 2012:                    
Financial Assets:                    
Money market funds and certificates of deposit  $85,479   $85,479   $-   $- 
Financial Liabilities:                    
Forward currency contracts  $(299)  $-   $(299)  $- 
December 31, 2011:                    
Financial Assets:                    
Money market funds  $45,000   $45,000   $-   $- 
Forward currency contracts   40    -    40    - 
Long-term investments   2,681    -    -    2,681 
Total financial assets  $47,721   $45,000   $40   $2,681 
June 30, 2011:                    
Financial Assets:                    
Money market funds and certificates of deposit  $21,000   $21,000   $-   $- 
Long-term investments   2,681    -    -    2,681 
Total financial assets  $23,681   $21,000   $-   $2,681 

 

During the three months ended March 31, 2012, the Company divested its remaining ARS investments for $2,500, resulting in a loss of $181 recorded in other income (expense) in the consolidated statement of operations during the period then ended. The Company also transferred the temporary gain of ARS of $241, previously recorded as other comprehensive income in stockholders’ equity, to other income (expense) in the consolidated statement of operations during the three months ended March 31, 2012. In addition, the Company transferred the associated income tax of $151, previously recorded as other comprehensive loss in stockholders’ equity, to the provision for income taxes in the consolidated statement of operations during the same quarter. The proceeds of $2,500 were recorded to other current assets as of March 31, 2012, and received by the Company in early April 2012.

 

3.Inventories

 

Inventories consisted of the following as of June 30, 2012 and 2011, and December 31, 2011:

 

   June 30,   December 31, 
   2012   2011   2011 
Raw materials  $5,329   $7,818   $3,444 
Finished goods   47,321    55,580    30,844 
Total  $52,650   $63,398   $34,288 

 

8

 

4.Other Intangible Assets, net

 

The Company’s other intangible assets, net, were as follows as of June 30, 2012 and 2011, and December 31, 2011:

 

   June 30,   December 31, 
   2012   2011   2011 
Intellectual property, license agreements and other intangibles  $16,755   $16,755   $16,755 
Less: accumulated amortization   (14,605)   (12,166)   (13,405)
Total  $2,150   $4,589   $3,350 

 

5.Income Taxes

  

The Company’s income tax provisions for the three and six months ended June 30, 2012 were $287 and $622, respectively, compared with income tax provisions of $387 and $160, respectively, for the same periods of the prior year. The tax provision for the 2012 periods was primarily attributable to certain discrete tax items including amortization of goodwill for tax purposes and an accrual for potential interest and penalties on certain tax positions, offset by tax benefits from the Company’s foreign operations. The tax provisions for the 2011 periods were primarily attributable to certain discrete tax items including amortization of goodwill for tax purposes and an accrual for potential interest and penalties on certain tax positions, and tax provisions (benefits) from our foreign operations.

 

The Company’s effective income tax rate was (3.7)% for both the three and six months ended June 30, 2012, compared with (2.9)% and (0.4)%, respectively, for the same periods of the prior year. Calculation of the effective tax rate for all periods included a non-cash valuation allowance recorded against the Company’s domestic deferred tax assets. Accordingly, no federal or state tax benefit has been recorded on the Company’s domestic operating loss for the three and six months ended June 30, 2012 and 2011, respectively. Long-term deferred tax liabilities of $3,713 and other long-term tax liabilities of $7,595 are reported as long-term liabilities on the consolidated balance sheet as of June 30, 2012.

 

The Company believes it is reasonably possible that the total amount of unrecognized income tax benefit in the future could decrease by up to $4,575, excluding potential interest and penalties, related to its foreign operations over the course of the next twelve months ending June 30, 2013 due to expiring statutes of limitations, that, if recognized would affect its effective tax rate.

 

As of June 30, 2012 and 2011, and December 31, 2011, the Company had approximately $2,572, $3,120 and $2,373, respectively, of accrued interest and penalties related to uncertain tax positions.

 

6.Defined Contribution Plan

 

LeapFrog sponsors a defined contribution plan under Section 401(k) of the Internal Revenue Code. The 401(k) plan allows employees to defer up to 100% of their eligible compensation, not to exceed the Internal Revenue Service (the “IRS”) maximum contribution limit. The Company provides a matching opportunity of 100% of eligible contributions up to a maximum of $3.5 per year, which vests over three years. For the three and six months ended June 30, 2012, the Company recorded total compensation expense of $216 and $923, respectively, related to the defined contribution plan. The Company suspended its matching program from 2010 through 2011 and therefore did not incur any related compensation expense in 2011.

 

7.Stock-Based Compensation

 

The Company currently has outstanding two types of stock-based compensation awards to its employees and directors: stock options and restricted stock units (“RSUs”). Both stock options and RSUs can be used to acquire shares of the Company’s Class A common stock, are exercisable or convertible, as applicable, over a period not to exceed ten years, and are most commonly assigned four-year vesting periods. The Company also has an employee stock purchase plan (“ESPP”).

 

9

 

Stock plan activity

 

The table below summarizes award activity for the six months ended June 30, 2012:

 

   Stock       Total 
   Options   RSUs   Awards 
Outstanding at December 31, 2011   5,204    1,184    6,388 
Grants   1,385    640    2,025 
Stock option exercises/vesting RSUs   (661)   (517)   (1,178)
Retired or forfeited   (187)   (86)   (273)
Outstanding at June 30, 2012   5,741    1,221    6,962 
                
Total shares available for future grant at June 30, 2012             10,120 

 

As of June 30, 2012, the total shares available for future grant under the ESPP were 1,223.

 

Impact of stock-based compensation

 

The table below summarizes stock-based compensation expense for the three and six months ended June 30, 2012 and 2011:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2012   2011   2012   2011 
SG&A:                    
Stock options  $604   $434   $1,128   $790*
RSUs   634    582    1,352    1,330 
ESPP   97    -    164    - 
Total SG&A   1,335    1,016    2,644    2,120 
R&D:                    
Stock options   145    112    238    195 
RSUs   87    68    157    109 
Total R&D   232    180    395    304 
Total expense  $1,567   $1,196   $3,039   $2,424 

 

 

*Amount includes the reversal of $950 in stock option compensation expense related to unvested stock options cancelled in connection with the departure of certain senior level employees including the former Chief Executive Officer.

 

Valuation of stock-based compensation

 

Stock-based compensation expense related to stock options is calculated based on the fair value of each award on the grant date. In general, the fair value for stock option grants with only a service condition is estimated using the Black-Scholes option pricing model with the following weighted average assumptions for the three and six months ended June 30, 2012 and 2011:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2012   2011   2012   2011 
Expected term (years)   4.49    4.86    4.49    4.86 
Volatility   74.3%   58.5%   74.3%   58.5%
Risk-free interest rate   0.77%   1.6%   0.82%   1.8%
Expected dividend yield   -    -    -    -

 

RSUs are payable in shares of the Company’s Class A common stock. The fair value of these stock-based awards is equal to the closing market price of the Company’s common stock on the date of grant. The grant date fair value is recognized on a straight-line basis in compensation expense over the vesting period of these stock-based awards, which is generally four years.

 

Effective September 1, 2011, the Company increased the discount from the fair market value of the Company’s common stock offered to participants of the ESPP from 5% to 15%, which resulted in stock-based compensation expense, beginning with the third quarter of 2011, due to departure from the IRS safe harbor limit of 5%. Stock-based compensation expense related to the ESPP is estimated using the Black-Scholes option pricing model with the following assumptions for the three and six months ended June 30, 2012:

 

10

 

   Three Months
Ended June 30,
2012
   Six Months
Ended June 30,
2012
 
Expected term (years)   0.5    0.5 
Volatility   59.8%   44.1% - 59.8
Risk-free interest rate   0.13%   0.05% - 0.13
Expected dividend yield   -    -

 

8.Derivative Financial Instruments

 

At June 30, 2012, December 31, 2011 and June 30, 2011, the Company had outstanding foreign exchange forward contracts with notional values of $37,626, $21,299 and $0, respectively. The gains and losses on these instruments are recorded in “other income (expense)” in the consolidated statements of operations. Gains and losses from foreign exchange forward contracts, net of gains and losses on the underlying transactions denominated in foreign currency, for the three and six months ended June 30, 2012 and 2011 are shown in the table below:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2012   2011   2012   2011 
Gains (losses) on foreign exchange forward contracts  $(57)  $65   $(595)  $(84)
Losses on underlying transactions denominated in foreign currency   (182)   (74)   (92)   (178)
Net losses  $(239)  $(9)  $(687)  $(262)

 

9.Net Loss Per Share

 

For all periods presented, common stock equivalents, including unvested RSUs and certain stock options, were excluded from the calculations of net loss per share, as their effect on net loss per share would be antidilutive. Outstanding weighted average common stock equivalents of Class A common stock excluded from the calculations were 2,027 and 672 for the three months ended June 30, 2012 and 2011, respectively, and 1,844 and 825 for the six months ended June 30, 2012 and 2011, respectively.

 

10.Borrowings Under Credit Agreements

 

On August 13, 2009, the Company, certain financial institutions and Bank of America, N.A., entered into an amended and restated loan and security agreement for an up to $75,000 asset-based revolving credit facility (the “revolving credit facility”). The Company has granted a security interest in substantially all of its assets to the lenders as security for its obligations under the revolving credit facility. Provided there is no default under the revolving credit facility, the Company may elect, without the consent of any of the lenders, to increase the size of the revolving credit facility up to an aggregate of $150,000.

 

The borrowing availability varies according to the levels of the Company’s accounts receivable and cash and investment securities deposited in secured accounts with the lenders. Subject to the level of this borrowing base, the Company may make and repay borrowings from time to time until the maturity of the revolving credit facility. The interest rate is, at the Company’s election, Bank of America, N.A.’s prime rate (or base rate) or a LIBOR rate defined in the loan agreement, plus, in each case, an applicable margin. The applicable margin for a loan depends on the average daily availability for the most recent fiscal quarter and the type of loan.

 

On May 1, 2012, the Company entered into an amendment to the revolving credit facility that, among other things: (i)  reduced the lenders’ commitment under the revolving credit facility to $50,000 during the seasonal period of January through August of each year, (ii) extended the maturity date to May 1, 2017, (iii) lowered the borrowing availability levels at lower applicable interest rate margins, (iv) reduced the applicable interest rate margins to a range of 1.50% to 2.00% above the applicable LIBOR rate for LIBOR rate loans, depending on the Company’s borrowing availability, (v) reduced the ratio of Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”), to fixed charges (the “Fixed Charge Coverage Ratio”) to 1.0:1.0 from 1.1:1.0 and changed the applicable periods when such ratio is to be maintained, and (vi) permitted additional dividends, stock repurchases and acquisitions upon compliance with certain Fixed Charge Coverage Ratio and availability requirements.

 

11

 

The revolving credit facility contains customary events of default including for: payment failures; failure to comply with covenants; failure to satisfy other obligations under the revolving credit facility or related documents; defaults in respect of other indebtedness; bankruptcy, insolvency and inability to pay debts when due; change-in-control provisions; and the invalidity of guaranty or security agreements. If any event of default occurs, the lenders may terminate their respective commitments, declare immediately due all borrowings under the revolving credit facility and foreclose on the collateral. A 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. The Company is also required to maintain a Fixed Charge Coverage Ratio, during a trigger period as defined under the revolving credit facility when certain borrowing-availability thresholds are not met.

 

Borrowing availability under the revolving credit facility was $50,000 as of June 30, 2012. The Company had no borrowings outstanding under the revolving credit facility at June 30, 2012.

 

11.Segment Reporting

 

The Company’s business is organized, operated and assessed in two geographic segments: U.S. and International.

 

The Company attributes sales to non-U.S. countries on the basis of sales billed by each of its foreign subsidiaries to its customers. Additionally, the Company attributes sales to non-U.S. countries if the product is shipped from Asia or one of its leased warehouses in the U.S. to a distributor in a foreign country. The Company charges all of its indirect operating expenses and general corporate overhead to the U.S. segment and does not allocate any of these expenses to the International segment.

 

The primary business of the two operating segments is as follows:

 

·The U.S. segment is responsible for the development, design, sales and marketing of the Company’s multimedia learning platforms, related content and learning toys, which are sold primarily through retailers, distributors, and directly to consumers via the leapfrog.com online store and the LeapFrog App Center in the U.S.

 

·The International segment is responsible for the localization, sales and marketing of multimedia learning platforms, related content and learning toys, originally developed for the U.S., sold primarily in retail and distributor channels outside of the U.S.

 

The table below shows certain information by segment for the three and six months ended June 30, 2012 and 2011:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2012   2011   2012   2011 
Net sales:                    
United States  $49,141   $39,123   $101,359   $65,475 
International   22,339    15,297    42,131    28,623 
Totals  $71,480   $54,420   $143,490   $94,098 
(Loss) income from operations:                    
United States  $(11,021)  $(14,442)  $(22,722)  $(35,716)
International   3,551    1,350    6,704    774 
Totals  $(7,470)  $(13,092)  $(16,018)  $(34,942)

 

For the three and six months ended June 30, 2012, the U.S. and the United Kingdom individually accounted for more than 10% of the Company’s consolidated net sales. For the three and six months ended June 30, 2011, no countries other than the U.S. accounted for more than 10% of the Company’s consolidated net sales.

 

12

 

12.Contingencies

 

From time to time, the Company is subject to legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of patents and other intellectual property rights, claims related to breach of contract, employment matters and a variety of other claims. Unsettled matters are in various stages of litigation and their outcome is currently not determinable. However, in the opinion of management, based on current knowledge, none of the pending legal proceedings or claims is likely to have a material adverse effect on the Company’s financial position, results of operations or cash flows. Regardless of the outcome, litigation can have an adverse impact on the Company because of defense costs, diversion of management resources and other factors. In addition, although management considers the likelihood of such an outcome to be remote, if one or more of these legal matters were resolved against the Company in a particular reporting period for amounts in excess of management’s expectations, the Company’s consolidated financial statements of the same reporting period could be materially adversely affected.

 

In addition, as of June 30, 2012, the Company had outstanding off-balance sheet commitments for outsourced manufacturing and component purchases of $22,016, which generally covers the remainder of the year ending December 31, 2012.

 

13

 

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

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains forward-looking statements about management’s expectations, including, without limitation, statements concerning our expectations regarding the effect of our domestic valuation allowance on any tax liability associated with the repatriation of cash held by our foreign subsidiaries, the anticipated impact of our accumulated deficit, the funding, nature and amount of future capital expenditures, the future funding of our working capital needs, the timing, seasonality and expectations of cash flows from operations, the anticipated impact of recently issued accounting guidance on our consolidated financial statements as well as any statements regarding our existing and future products, our anticipated results of operations and other measures of financial performance, our strategic priorities, our future marketing efforts, our future research and development, and other anticipatory matters. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “future,” “potential,” or the negative of these terms or other comparable terminology. Our actual results, levels of activity, performance, achievements or the timing of events may differ materially from those expressed or implied by such forward-looking statements. The risks that could cause our results to differ include, without limitation, deterioration of global economic conditions, our ability to correctly predict highly changeable consumer preferences and product trends, our ability to continue to develop new products and services, our reliance on a small group of retailers for the majority of our gross sales, our dependence on our suppliers for our components and raw materials, the seasonality of our business, our growing focus on online products and services, system failures in our online services or web store, our reliance on a limited number of manufacturers, our ability to maintain sufficient inventory levels, our ability to compete effectively with competitors, our ability to maintain or acquire licenses, third parties who claim we are infringing on their intellectual property rights, errors or defects in our products, privacy concerns about our Internet-connected products, the sufficiency of our liquidity, the risk associated with international operations, continued compliance and associated costs with and/or changes in laws and regulations, negative political developments, natural disasters, armed hostilities, terrorism, labor strikes or public health issues, the loss of members of our executive management team, continued ownership by a few stockholders of a majority of voting power in us, and the volatility of our stock price. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, achievements or the timing of any events. We make these statements as of the date of this Quarterly Report on Form 10-Q and 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, except as required by law.

 

The following management’s discussion and analysis of financial condition and results of operations (“MD&A”) is intended to help the reader understand the results of operations and financial condition of LeapFrog Enterprises, Inc. (“LeapFrog”, “we”, “us” or “our”). This MD&A is provided as a supplement to, and should be read in conjunction with, our Consolidated Financial Statements and the accompanying Notes to the Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.

 

Our Business

 

LeapFrog, founded in 1995 and incorporated in 1997 in the State of Delaware, is a leading developer and distributor of educational entertainment for children. Our product portfolio consists of multimedia learning platforms and related content and learning toys. We have developed a number of learning platforms, including the LeapPad Explorer (“LeapPad”) learning tablet, the Leapster family of multimedia learning platforms and the Tag and Tag Junior reading systems, which support a broad library of software titles. We have created hundreds of interactive content titles for our platforms, covering subjects such as phonics, reading, writing and math. In addition, we have a broad line of stand-alone learning toys. Many of our products connect to our proprietary online LeapFrog Learning Path which provides personalized feedback on a child’s learning progress and offers product recommendations to enhance each child’s learning experience. Our products are available in four languages and are sold globally through retailers, distributors and directly to consumers via the leapfrog.com online store and the LeapFrog App Center. In addition, beginning in late 2011, we began distributing third-party content through our App Center in the U.S. and certain international territories.

 

14

 

Due to the seasonality of our business, our results of operations for interim periods are not necessarily indicative of the operating results for a full year.

 

Consolidated Results of Operations

 

   Three Months Ended
June 30,
   % Change
2012 vs.
   Six Months Ended 
June 30,
   % Change
2012 vs.
 
   2012   2011   2011   2012   2011   2011 
   (Dollars in millions) 
Net sales  $71.5   $54.4    31%  $143.5   $94.1    52%
Cost of sales   42.9    35.4    21%   85.2    63.4    34%
Gross margin *   39.9%   34.9%   5.0**   40.6%   32.7%   7.9**
Operating expenses   36.0    32.1    12%   74.3    65.7    13%
Loss from operations   (7.5)   (13.1)   43%   (16.0)   (34.9)   54%
Net loss per share - basic and diluted  $(0.12)  $(0.21)   43%  $(0.26)  $(0.55)   53%

 

 

 *  Gross profit as a percentage of net sales
 **  Percentage point change in gross margin

 

Net sales for the three and six months ended June 30, 2012 increased 31% and 52%, respectively, as compared to the same periods in 2011. The increase for the three month period was largely driven by continued strong demand for LeapPad and strong content sales. The increase for the six month period was largely driven by continued strong demand for LeapPad and associated content, as well as the impact of lower volume and higher quality of beginning retail channel inventory as compared to the prior year. Net sales for the three and six months ended June 30, 2012 included a 1% negative impact from changes in foreign currency exchange rates.

 

Cost of sales for the three and six months ended June 30, 2012 increased 21% and 34%, respectively, as compared to the same periods in 2011. The increase for both periods was primarily driven by higher sales volume.

 

Consolidated gross margin for the three and six months ended June 30, 2012 was 39.9% and 40.6%, respectively, an increase of 5.0 and 7.9 percentage points over the same periods of 2011, respectively, primarily driven by higher sales volume which reduced the impact of fixed logistic costs, lower trade allowances and discounts, as well as changes in product mix with proportionally higher sales of higher margin content. The gross margin for the three month period also benefited from lower trade allowances and discounts as a percentage of net sales.

  

Operating expenses for the three and six months ended June 30, 2012 increased 12% and 13%, respectively, as compared to the same periods of 2011, primarily driven by higher employee compensation expenses and higher advertising expenses to support higher net sales. The increase for the six month period also included an increase in our allowance for doubtful accounts due to an isolated customer credit concern.

 

Loss from operations for the three and six months ended June 30, 2012 reduced 43% and 54%, respectively, as compared to the same periods in 2011, due to the increase in net sales and higher gross margin, partially offset by higher operating expenses.

 

Basic and diluted net loss per share for the three and six months ended June 30, 2012 reduced by $0.09 and $0.29, respectively, as compared to the same periods of 2011.

 

Operating Expenses

 

Selling, General and Administrative Expenses

 

Selling, general and administrative (“SG&A”) expenses consist primarily of salaries and related employee benefits, including stock-based compensation expense and other headcount-related expenses associated with executive management, finance, information technology, supply chain, facilities, human resources, other administrative headcount, legal and other professional fees, indirect selling expenses, systems costs, rent, office equipment and supplies.

 

15

 

   Three Months Ended
June 30,
   % Change
2012 vs.
   Six Months Ended 
June 30,
   % Change
2012 vs.
 
   2012   2011   2011   2012   2011   2011 
   (Dollars in millions) 
SG&A expenses  $20.2   $17.7    14%  $43.9   $38.1    15%
As a percent of net sales   28%   32%   (4)*   31%   41%   (10)*

 

 

 *  Percentage point increase (decrease)

 

SG&A expenses for the three and six months ended June 30, 2012 increased 14% and 15%, respectively, as compared to the same periods in 2011, primarily driven by increased headcount and higher employee compensation expenses. The increase for the six month period also included a significant increase in our allowance for doubtful accounts due to an isolated customer credit concern.

 

Research and Development Expenses

 

Research and development (“R&D”) expenses consist primarily of salaries, employee benefits, stock-based compensation and other headcount-related expenses associated with content development, product development, product engineering, third-party development and programming and localization costs to translate content for international markets. We capitalize external third-party costs related to content development, which are subsequently amortized into cost of sales in the statements of operations.

 

   Three Months Ended
June 30,
   % Change
2012 vs.
   Six Months Ended 
June 30,
   % Change
2012 vs.
 
   2012   2011   2011   2012   2011   2011 
   (Dollars in millions) 
R&D expenses  $8.8   $8.1    9%  $17.7   $16.4    8%
As a percent of net sales   12%   15%   (3)*   12%   17%   (5)*

 

 

 *  Percentage point increase (decrease)

 

R&D expenses for the three and six months ended June 30, 2012 increased 9% and 8%, respectively, as compared to the same periods in 2011, primarily due to increased headcount and higher employee compensation expenses.

 

Advertising Expense

 

Advertising expense consists of costs associated with marketing, advertising and promoting our products, including customer-related discounts and promotional allowances.

 

   Three Months
Ended June 30,
   % Change
2012 vs.
   Six Months Ended 
June 30,
   % Change
2012 vs.
 
   2012   2011   2011   2012   2011   2011 
   (Dollars in millions) 
Advertising expenses  $4.3   $3.5    24%  $6.8   $5.8    16%
As a percent of net sales   6%   6%   -*   5%   6%   (1)*

 

 

 *  Percentage point increase (decrease)

 

Advertising expense for the three and six months ended June 30, 2012 increased 24% and 16%, respectively, as compared to the same period in 2011, primarily due to higher spending in the international segment.

 

16

 

Income Taxes

 

Our provision for income taxes and effective tax rate were as follows:

 

   Three Months Ended
June 30,
   Six Months Ended 
June 30,
 
   2012   2011   2012   2011 
   (Dollars in millions) 
Provision for income taxes  $0.3   $0.4   $0.6   $0.2 
Loss before income taxes   (7.8)   (13.4)   (16.9)   (35.8)
Effective tax rate   (3.7)%   (2.9)%   (3.7)%   (0.4)%

 

Calculation of the effective tax rate for all periods included a non-cash valuation allowance recorded against our domestic deferred tax assets. Accordingly, no federal or state tax benefit was recorded on our domestic operating loss for all periods presented.

 

The tax provisions for the three and six months ended June 30, 2012 were primarily attributable to certain discrete tax items including the effect of amortization of goodwill for tax purposes and an accrual for potential interest and penalties on certain tax positions, offset by tax benefits from our foreign operations. The tax provisions for the three and six months ended June 30, 2011 were primarily attributable to certain discrete tax items including the effect of amortization of goodwill for tax purposes and an accrual for potential interest and penalties on certain tax positions, and tax provisions (benefits) from our foreign operations.

 

Results of Operations by Segment

 

We organize, operate and assess our business in two primary operating segments: U.S. and International. This presentation is consistent with how our chief operating decision maker reviews performance, allocates resources and manages the business.

 

U.S. Segment

 

The U.S. segment includes net sales and related expenses directly associated with selling our products to national and regional mass-market and specialty retailers, other retail stores and distributors, school-related distributors and resellers, and online channels including our online store and App Center. Certain corporate-level operating expenses associated with sales and marketing, product support, human resources, legal, finance, information technology, corporate development, procurement activities, R&D, legal settlements and other corporate costs are charged entirely to our U.S. segment.

 

   Three Months Ended
June 30,
   % Change
2012 vs.
   Six Months Ended 
June 30,
   % Change
2012 vs.
 
   2012   2011   2011   2012   2011   2011 
   (Dollars in millions) 
Net sales  $49.1   $39.1    26%  $101.4   $65.5    55%
Cost of sales   28.8    25.2    14%   59.7    43.6    37%
Gross margin *   41.4%   35.7%   5.7**   41.1%   33.5%   7.6**
Operating expenses   31.4    28.4    10%   64.3    57.6    12%
Loss from operations  $(11.0)  $(14.4)   24%  $(22.7)  $(35.7)   36%

 

 

 *  Gross profit as a percentage of net sales
 **  Percentage point change in gross margin

 

Net sales for the three and six months ended June 30, 2012 increased 26% and 55%, respectively, as compared to the same periods in 2011. The increase for the three month period was largely driven by the continued strong customer demand for LeapPad and strong content sales. The increase for the six month period was largely driven by continued strong demand for LeapPad and associated content, as well as the impact of lower volume and higher quality of beginning retail channel inventory as compared to the prior year.

 

Cost of sales for the three and six months ended June 30, 2012 increased 14% and 37%, respectively, as compared to the same periods in 2011. The increase for both periods was primarily driven by higher sales volume.

 

Gross margin for the three and six months ended June 30, 2012 increased 5.7 and 7.6 percentage points over the same periods of 2011, respectively, primarily driven by higher sales volume which reduced the impact of fixed costs, lower trade allowances and discounts, as well as changes in product mix with proportionally higher sales of higher margin content. Gross margin for the three month period also benefited from lower trade allowances and discounts as a percentage of net sales.

 

17

 

Operating expenses for the three and six months ended June 30, 2012 increased 10% and 12%, respectively, as compared to the same periods in 2011, primarily driven by higher employee compensation expenses. The increase for the six month period also included a significant increase in our allowance for doubtful accounts due to an isolated customer credit concern.

 

Loss from operations for the three and six months ended June 30, 2012 reduced by 24% and 36%, respectively, as compared to the same periods in 2011, due to increases in net sales and gross margin percentage, partially offset by higher operating expenses.

 

International Segment

 

The International segment includes the net sales and related expenses directly associated with selling our products to national and regional mass-market and specialty retailers and other outlets through our offices in the United Kingdom, France, Canada and Mexico as well as through distributors in markets such as Australia, South Africa and Spain. Certain corporate-level operating expenses associated with sales and marketing, product support, human resources, legal, finance, information technology, corporate development, procurement activities, research and development, legal settlements and other corporate costs are allocated to our U.S. segment and not allocated to our International segment.

 

   Three Months Ended
June 30,
   % Change
2012 vs.
   Six Months Ended 
June 30,
   % Change
2012 vs.
 
   2012   2011   2011   2012   2011   2011 
   (Dollars in millions) 
Net sales  $22.3   $15.3    46%  $42.1   $28.6    47%
Cost of sales   14.1    10.3    37%   25.5    19.8    29%
Gross margin *   36.8%   32.8%   4.0**   39.5%   30.8%   8.7**
Operating expenses   4.7    3.7    27%   10.0    8.1    24%
Income from operations  $3.6   $1.4    N/M   $6.7   $0.8    N/M 

 

 

 *  Gross profit as a percentage of net sales
**  Percentage point change in gross margin

 

Net sales for the three and six months ended June 30, 2012 increased 46% and 47%, respectively, as compared to the same periods in 2011 largely driven by the continued strong customer demand for LeapPad and strong content sales. Net sales for the three and six months ended June 30, 2012 included a 5% and 4% negative impact from changes in currency exchange rates, respectively.

 

Cost of sales for the three and six months ended June 30, 2012 increased 37% and 29%, respectively, as compared to the same periods in 2011. The increase for both periods was primarily driven by higher sales volume.

 

Gross margin for the three and six months ended June 30, 2012 improved 4.0 and 8.7 percentage points as compared to the same periods of 2011, respectively, primarily driven by higher sales volume which reduced the impact of fixed costs, lower trade allowances and discounts, as well as changes in product mix with proportionally higher sales of higher margin content. The gross margin for the three month period also benefited from lower trade allowances and discounts as a percentage of net sales.

 

Operating expenses for the three and six months ended June 30, 2012 increased 27% and 24%, respectively, as compared to the same periods in 2011, primarily due to higher employee compensation expenses and higher advertising expenses.

 

Income from operations for the three and six months ended June 30, 2012 improved by $2.2 million and $5.9 million, respectively, as compared to the same period in 2011, primarily due to significantly increased net sales and improved gross margin percentage offset by higher operating expenses.

 

18

 

Liquidity and Capital Resources

 

Financial Condition

 

Cash and cash equivalents totaled $126.9 million and $57.7 million at June 30, 2012 and 2011, respectively. The increase in cash balance was due to an increase in net sales as well as more timely cash collections from our customers. Cash and cash equivalents held by our foreign subsidiaries totaled $19.2 million and $14.3 million at June 30, 2012 and 2011, respectively. We do not intend to repatriate any foreign cash and cash equivalents as it will be used to fund foreign operations. However, if we were to do so, any associated tax liability would be fully offset by our domestic valuation allowance. In line with our investment policy, all cash equivalents were invested in high-grade certificates of deposit and money market funds as of June 30, 2012.

 

Inventory, stated on a first-in, first-out basis at the lower of cost or market, totaled $52.7 million and $63.4 million at June 30, 2012 and 2011, respectively. The year over year decrease in inventory levels is attributable to focused efforts to improve forecasting and inventory control.

 

We have an asset-based revolving credit facility (the “revolving credit facility”), which is discussed in more detail below, with a potential borrowing availability of up to $75.0 million. Borrowing availability under this revolving credit facility was $50.0 million as of June 30, 2012. There were no borrowings outstanding on our revolving credit facility at June 30, 2012.

 

Our accumulated deficit of $180.0 million at June 30, 2012 is not expected to have an impact on our future ability to operate, given our anticipated cash flows from operations, strong cash position and the availability of our revolving credit facility.

 

Future capital expenditures are primarily planned for new product development and purchases related to the upgrading of our information technology capabilities. We expect that capital expenditures for the remainder of 2012, including those for capitalized content and website development costs, will be funded with cash flows generated by operations. Capital expenditures were $10.3 million for the six months ended June 30, 2012, and $11.7 million for the same period of 2011. The Company expects capital expenditures to be in the range of $20.0 million to $25.0 million for the year ending December 31, 2012.

 

We believe that cash on hand, cash flow from operations and amounts available under our revolving credit facility will provide adequate funds for our foreseeable working capital needs and planned capital expenditures over the next twelve months. Our ability to fund our working capital needs and planned capital expenditures, as well as our ability to comply with all of the financial covenants of our revolving credit facility, depend on our future operating performance and cash flows, which in turn are subject to prevailing economic conditions.

 

Cash Sources and Uses

 

The table below shows our sources and uses of cash for the six months ended June 30, 2012 as compared to the same period in 2011:

 

   Six Months Ended
June 30,
   % Change
2012 vs.
 
   2012   2011   2011 
   (Dollars in millions) 
Cash flows provided by (used in):               
Operating activities  $61.3   $48.0    28%
Investing activities   (7.8)   (11.6)   33%
Financing activities   1.5    1.3    14%
Effect of exchange rate fluctuations on cash   0.1    0.6    (91)%
Increase in cash and cash equivalents  $55.1   $38.3    44%

 

Cash flow provided by operations for the six months ended June 30, 2012 increased $13.3 million, as compared to the same period in 2011, primarily due to a significant reduction in net loss and a higher proportion of revenue from our online businesses. This was largely offset by a decrease in cash provided by accounts receivable collection during the period, which was the result of improved accounts receivable collection efforts in the fourth quarter of 2011 as compared to the fourth quarter of 2010.

 

19

 

Net cash used in investing activities for the six months ended June 30, 2012 decreased $3.8 million as compared to the same period of 2011, primarily due to the proceeds from the divestment of our ARS investment of $2.5 million and a decrease in hardware and software purchases during the 2012 period.

 

Net cash provided by financing activities for the six months ended June 30, 2012 increased $0.2 million as compared to the same period of 2011, primarily due to increases in employee stock option exercises and stock purchases under the employee stock purchase plan, partially offset by higher payroll taxes related to an increase in employee restricted stock units released in the 2012 period as compared to 2011.

 

Seasonal Patterns of Cash Provided By or Used in Operations

 

Generally, our cash flow provided by operations is highest in the first quarter of the year when we collect the majority of our accounts receivable booked in the fourth quarter of the prior year. Cash flow used in operations tends to be highest in our third quarter and early fourth quarter, as collections from prior accounts receivables taper off and we invest heavily in inventory in preparation for the fourth quarter holiday season. Cash flow generally turns positive again late in the fourth quarter as we start to collect on the accounts receivables associated with the holiday season. However, these seasonal patterns may vary depending upon general economic conditions and other factors.

 

Line of Credit and Borrowing Availability

 

On August 13, 2009, we entered into an amended and restated loan and security agreement for an up to $75.0 million asset-based revolving credit facility with Bank of America, N.A. and certain other financial institutions. We have granted a security interest in substantially all of our assets to the lenders as security for our obligations under the revolving credit facility. Provided there is no default under the revolving credit facility, we may elect, without the consent of any of the lenders, to increase the size of the revolving credit facility up to an aggregate of $150.0 million.

 

The borrowing availability varies according to the levels of our accounts receivable and cash and investment securities deposited in secured accounts with the lenders. Subject to the level of this borrowing base, we may make and repay borrowings from time to time until the maturity of the revolving credit facility. The interest rate is, at our election, Bank of America, N.A.’s prime rate (or base rate) or a LIBOR rate defined in the loan agreement, plus, in each case, an applicable margin. The applicable margin for a loan depends on the average daily availability for the most recent fiscal quarter and the type of loan.

 

On May 1, 2012, we entered into an amendment to the revolving credit facility that, among other things: (i)  reduced the lenders’ commitment under the revolving credit facility to $50.0 million during the seasonal period of January through August of each year, (ii) extended the maturity date to May 1, 2017, (iii) lowered the borrowing availability levels at lower applicable interest rate margins, (iv) reduced the applicable interest rate margins to a range of 1.50% to 2.00% above the applicable LIBOR rate for LIBOR rate loans, depending on our borrowing availability, (v) reduced the ratio of Earnings Before Interest, Taxes, Depreciation and Amortization, or EBITDA, to fixed charges (“Fixed Charge Coverage Ratio”) to 1.0:1.0 from 1.1:1.0 and changed the applicable periods when such ratio are to be maintained, and (vi) permitted additional dividends, stock repurchases and acquisitions upon compliance with certain Fixed Charge Coverage Ratio and availability requirements.

 

The revolving credit facility contains customary events of default, including for: payment failures; failure to comply with covenants; failure to satisfy other obligations under the revolving credit facility or related documents; defaults in respect of other indebtedness; bankruptcy, insolvency and inability to pay debts when due; change-in-control provisions; and the invalidity of guaranty or security agreements. If any event of default occurs, the lenders may terminate their respective commitments, declare immediately due all borrowings under the revolving credit facility and foreclose on the collateral. A 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. We are also required to maintain a Fixed Charge Coverage Ratio, during a trigger period as defined under the revolving credit facility when certain borrowing-availability thresholds are not met.

 

20

 

Borrowing availability under the revolving credit facility was $50.0 million as of June 30, 2012. There were no borrowings outstanding under the revolving credit facility at June 30, 2012.

 

Contractual Obligations and Commitments

 

We have had no material changes outside the ordinary course of our business in our contractual obligations during the three and six months ended June 30, 2012.

 

In addition, as of June 30, 2012, we had outstanding off-balance sheet commitments for outsourced manufacturing and component purchases of $22.0 million, which generally covers the remainder of the year ending December 31, 2012.

 

Critical Accounting Policies

 

In the ordinary course of business, we make a number of estimates and assumptions relating to the reporting of results of operations and financial position in the preparation of our consolidated financial statements in conformity with U.S. generally accepted accounting principles. Actual results could differ significantly from those estimates under different assumptions and conditions. We included in our 2011 10-K a discussion of our critical accounting policies that are particularly important to the portrayal of our financial position and results of operations and that require the use of our management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

 

We have made no material changes to any of our critical accounting policies through June 30, 2012.

 

Recently Adopted Accounting Guidance

 

In May 2011, the Financial Accounting Standards Board (“FASB”) issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This guidance represents the converged guidance of the FASB and the International Accounting Standards Board on fair value measurement, which resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” For public entities, this guidance was effective for interim and annual reporting periods beginning after December 15, 2011, and is to be applied prospectively. We adopted this guidance on January 1, 2012. The adoption of this guidance did not result in any material impact to our consolidated financial statements.

 

21

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Our market risk disclosures set forth in Item 7A of our 2011 Annual Report on Form 10-K (the “2011 Form 10-K”) have not changed materially for our quarter ended June 30, 2012.

 

We develop products in the U.S. and market our products primarily in North America and, to a lesser extent, in Europe and the rest of the world. We are billed by and pay our third-party manufacturers in U.S. dollars. Sales to our international customers are transacted primarily in the country’s local currency. As a result, our financial results could be affected by factors such as changes in foreign currency rates or weak economic conditions in foreign markets.

 

We manage our foreign currency transaction exposure by entering into short-term forward contracts. The purpose of this hedging program is to minimize the foreign currency exchange gain or loss reported in our financial statements, but the program, when properly executed, may not always eliminate our exposure to movements of currency exchange rates. The results of our hedging program for the three and six months ended June 30, 2012 and 2011 are summarized in the table below:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2012   2011   2012   2011 
   (Dollars in thousands) 
Gains (losses) on foreign exchange forward contracts  $(57)  $65   $(595)  $(84)
Losses on underlying transactions denominated in foreign currency   (182)   (74)   (92)   (178)
Net losses  $(239)  $(9)  $(687)  $(262)

 

Our foreign exchange forward contracts generally have original maturities of one month or less. A summary of all foreign exchange forward contracts outstanding as of June 30, 2012 is as follows:

 

   As of June 30, 2012 
   Average
Forward
Exchange Rate
   Notional
Amount in
Local
Currency
   Fair Value of
Instruments
in USD
 
       (1)   (2) 
Currencies:               
British Pound (GBP/USD)   1.555    14,123   $(90)
Euro (Euro/USD)   1.248    3,571    (65)
Canadian Dollar (USD/CAD)   1.035    10,256    (142)
Mexican Peso (USD/MXN)   13.821    17,934    (2)
Total fair value of instruments in USD            $(299)

 

 

(1)  In thousands of local currency
(2)  In thousands of USD

 

Cash equivalents and short-term and long-term investments are presented at fair value on our consolidated balance sheet. We invest our excess cash in accordance with our investment policy. As of June 30, 2012 and 2011, our excess cash was invested only in high-grade money market funds and certificates of deposit. As of December 31, 2011, our excess cash was invested only in money market funds. Any adverse changes in interest rates or securities prices may decrease the value of our investments and operating results.

 

22

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

We have evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. This evaluation was performed under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”). Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported, within the time periods specified in the U.S. SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act, is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

 

The evaluation of our disclosure controls and procedures included a review of the controls’ objectives and design, our implementation of the controls and the effect of the controls on the information generated for use in our reports. In the course of the controls evaluation, we reviewed any identified data errors and control problems and sought to confirm that appropriate corrective actions, including process improvements, were undertaken. This type of evaluation is performed on a quarterly basis so that the conclusions of management, including our CEO and CFO, concerning the effectiveness of the disclosure controls and procedures can be reported in our periodic reports filed with the U.S. SEC on Forms 10-Q, 10-K, and others as may be required from time to time.

 

Based upon the evaluation of our disclosure controls and procedures, our CEO and CFO have concluded that our disclosure controls and procedures were effective as of June 30, 2012.

 

Inherent Limitations on Effectiveness of Controls

 

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure system are met.

 

Changes in Internal Control over Financial Reporting

 

There has been no change in our internal control over financial reporting during the three months ended June 30, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

23

 

PART II.

 

OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

From time to time, we are subject to legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of patents and other intellectual property rights, claims related to breach of contract, employment matters and a variety of other claims. Unsettled matters are in various stages of litigation and their outcome is currently not determinable. However, in the opinion of management, based on current knowledge, none of the pending legal proceedings or claims is likely to have a material adverse effect on our financial position, results of operations or cash flows. Regardless of the outcome, litigation can have an adverse impact on us because of defense costs, diversion of management resources and other factors. In addition, although management considers the likelihood of such an outcome to be remote, if one or more of these legal matters were resolved against LeapFrog in a particular reporting period for amounts in excess of management’s expectations, our consolidated financial statements of the same reporting period could be materially adversely affected.

 

ITEM 1A. RISK FACTORS

 

There have been no material changes to the risk factors disclosed under Part I, Item 1A. “Risk Factors” in our 2011 Form 10-K.

 

24

 

ITEM 6. EXHIBITS

 

        Incorporated by Reference    
Exhibit Number   Exhibit Description   Form   File No.   Original Exhibit Number   Filing Date   Filed Herewith
3.01   Amended and Restated Certificate of Incorporation   S-1/A   333-86898   3.03   7/22/2002    
                         
3.02   Amended and Restated Bylaws   8-K   001-31396   3.01   6/5/2009    
                         
4.01   Form of Specimen Class A Common Stock Certificate   10-Q   001-31396   4.01   11/3/2011    
                         
4.02   Fourth Amended and Restated Stockholders Agreement, dated as of May 30, 2003, by and among LeapFrog Enterprises, Inc. and the other persons named therein   10-Q   001-31396   4.02   8/12/2003    
                         
10.01   LeapFrog Enterprises, Inc. Amended and Restated 2011 Equity and Incentive Plan   8-K   001-31396   10.1   6/7/2012    
                         
10.02*   Offer Letter, dated May 29, 2012, by and between LeapFrog Enterprises, Inc. and Gregory Brian Ahearn                   X
                         
10.03*   Offer Letter, dated July 5, 2012, by and between LeapFrog Enterprises, Inc. and Raymond L. Arthur.                   X
                         
31.01   Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                   X
                         
31.02   Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                   X
                         
32.01   Certification of the Chief Executive Officer and the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                   X
                         
101   The following materials from the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2012, formatted in Extensible Business Reporting Language (XBRL), include: (i) the Consolidated Statements of Operations, (ii) the Consolidated Balance Sheets, (iii) the Consolidated Statements of Cash Flows, and (iv) related notes (furnished herewith).                   X

 

 

* Indicates management contract or compensatory plan or arrangement.
25

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

LeapFrog Enterprises, Inc.  
(Registrant)  
   
/s/ John Barbour  
John Barbour  
Chief Executive Officer  
(Principal Executive Officer)  
   
Date: August 6, 2012  
   
/s/ Raymond L. Arthur  
Raymond L. Arthur  
Chief Financial Officer  
(Principal Financial Officer)  
   
Date: August 6, 2012  

 

26

 

XNYS:LF Leapfrog Enterprises, Inc. Quarterly Report 10-Q Filling

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