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 September 30, 2013

 

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 October 31, 2013, 64,527,938 shares of Class A common stock, par value $0.0001 per share, and 4,395,461 shares of Class B common stock, par value $0.0001 per share, of the registrant were outstanding.

 

 

Table of Contents

LEAPFROG ENTERPRISES, INC.

TABLE OF CONTENTS

 

Part I.
Financial Information
Item 1.	Financial Statements	3
	Consolidated Balance Sheets at September 30, 2013 and 2012 and December 31, 2012	3
	Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2013 and 2012	4
	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2013 and 2012	5
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2013 and 2012	6
	Notes to the Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	21
Item 4.	Controls and Procedures	21
Part II.
Other Information
Item 1.	Legal Proceedings	23
Item 1A	Risk Factors	23
Item 6.	Exhibits	23
Signatures		24

 

 

Table of Contents

 

PART I.

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

  

LEAPFROG ENTERPRISES, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

               

		September 30,								December 31,
		2013				2012				2012
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	78,373			$	49,427			$	120,000
Accounts receivable, net of allowances for doubtful accounts of  $106, $3,893 and $292, respectively			184,798				170,106				180,043
Inventories			121,738				115,083				40,311
Prepaid expenses and other current assets			8,727				9,522				8,353
Deferred income taxes			4,248				1,035				9,315
Total current assets			397,884				345,173				358,022
Deferred income taxes			6,181				1,309				13,269
Property and equipment, net			32,233				20,411				23,723
Capitalized product costs, net			15,825				10,935				12,109
Goodwill			19,549				19,549				19,549
Other intangible assets, net			200				1,550				950
Other assets			1,161				1,534				1,283
Total assets		$	473,033			$	400,461			$	428,905
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable		$	59,086			$	82,128			$	31,617
Accrued liabilities			35,348				37,546				51,353
Deferred revenue			12,696				8,176				8,516
Income taxes payable			712				414				493
Total current liabilities			107,842				128,264				91,979
Long-term deferred income taxes			3,759				3,798				3,759
Other long-term liabilities			1,824				2,723				3,224
Total liabilities			113,425				134,785				98,962
Commitments and contingencies (Note 11)
Stockholders' equity:
Class A Common Stock, par value $0.0001;
Authorized - 139,500 shares; Outstanding: 64,524, 61,905 and 61,970, respectively			6				6				6
Class B Common Stock, par value $0.0001;
Authorized - 40,500 shares; Outstanding: 4,395, 5,715 and 5,715, respectively			1				1				1
Treasury stock			(185	)			(185	)			(185	)
Additional paid-in capital			415,618				403,187				405,078
Accumulated other comprehensive income			124				976				1,071
Accumulated deficit			(55,956	)			(138,309	)			(76,028	)
Total stockholders’ equity			359,608				265,676				329,943
Total liabilities and stockholders’ equity		$	473,033			$	400,461			$	428,905

 

See accompanying notes

 

  

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 LEAPFROG ENTERPRISES, INC.

 CONSOLIDATED STATEMENTS OF OPERATIONS

 (In thousands, except per share data)

 (Unaudited)

                       

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Net sales		$	200,985			$	193,072			$	366,908				336,562
Cost of sales			121,607				115,771				223,316				200,974
Gross profit			79,378				77,301				143,592				135,588
Operating expenses:
Selling, general and administrative			18,893				21,257				62,612				65,158
Research and development			7,543				9,164				25,250				26,902
Advertising			7,411				7,179				14,253				13,932
Depreciation and amortization			2,631				2,838				8,041				8,751
Total operating expenses			36,478				40,438				110,156				114,743
Income from operations			42,900				36,863				33,436				20,845
Other income (expense):
Interest income			12				37				54				226
Interest expense			(9	)			(49	)			(9	)			(49	)
Other, net			37				(898	)			12				(2,014	)
Total other income (expense), net			40				(910	)			57				(1,837	)
Income before income taxes			42,940				35,953				33,493				19,008
Provision for (benefit from)  income taxes			16,567				(5,785	)			13,421				(5,163	)
Net income		$	26,373			$	41,738			$	20,072			$	24,171
Net income per share:
Class A and B - basic		$	0.38			$	0.62			$	0.29			$	0.36
Class A and B - diluted		$	0.37			$	0.60			$	0.28			$	0.35
Weighted-average shares used to calculate net income
per share:
Class A and B - basic			68,552				67,400				68,200				66,912
Class A and B - diluted			71,051				69,512				70,744				69,071

 

See accompanying notes

 

 

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LEAPFROG ENTERPRISES, INC.  

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME  

(In thousands)  

(Unaudited)

  

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Net income		$	26,373			$	41,738			$	20,072			$	24,171
Other comprehensive income, before tax:
Currency translation adjustments			558				1,134				(947	)			1,291
Transfer of temporary gain on long-term investments			-				-				-				(241	)
Total other comprehensive income, before tax			558				1,134				(947	)			1,050
Transfer of tax expense allocated to temporary gain on long-term investments			-				-				-				151
Other comprehensive income, net of tax			558				1,134				(947	)			1,201
Comprehensive income		$	26,931			$	42,872			$	19,125			$	25,372

 

See accompanying notes

 

 

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LEAPFROG ENTERPRISES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

		Nine Months Ended September 30,
		2013				2012
Operating activities:
Net income		$	20,072			$	24,171
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization			15,241				16,871
Deferred income taxes			12,140				238
Stock-based compensation expense			7,166				5,066
Loss on sale of long-term investments, net of tax			-				91
Loss on disposal of long-term assets			-				2
Allowance for doubtful accounts			(101	)			3,371
Other changes in operating assets and liabilities:
Accounts receivable, net			(5,117	)			(15,493	)
Inventories			(81,848	)			(80,149	)
Prepaid expenses and other current assets			(424	)			(1,367	)
Other assets			122				(414	)
Accounts payable			27,509				47,454
Accrued liabilities and deferred revenue			(11,712	)			(4,805	)
Other long-term liabilities			(1,400	)			(6,638	)
Income taxes payable			224				37
Net cash used in operating activities			(18,128	)			(11,565	)
Investing activities:
Purchases of property and equipment			(17,127	)			(10,396	)
Capitalization of product costs			(9,605	)			(5,623	)
Sales of investments			-				2,500
Net cash used in investing activities			(26,732	)			(13,519	)
Financing activities:
Proceeds from stock option exercises and employee stock purchase plan			4,499				4,007
Net cash paid for payroll taxes on restricted stock unit releases			(1,126	)			(1,513	)
Net cash provided by financing activities			3,373				2,494
Effect of exchange rate changes on cash			(140	)			154
Net change in cash and cash equivalents			(41,627	)			(22,436	)
Cash and cash equivalents, beginning of period			120,000				71,863
Cash and cash equivalents, end of period		$	78,373			$	49,427

  

See accompanying notes

 

 

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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, 2012 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 2012 Annual Report on Form 10-K filed with the United States (“U.S.”) Securities and Exchange Commission (the “SEC”) on March 11, 2013 (the “2012 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 2012 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.

 

Accumulated other comprehensive income consists solely of currency translation adjustments.

 

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 September 30, 2013, the Company’s Level 1 assets consist of money market funds with original maturities of three months or less and recorded in cash and cash equivalents. 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 prepayment rates.

 

The Company’s Level 2 assets and liabilities consist of outstanding foreign exchange forward contracts used to hedge its exposure to certain foreign currencies, including the British Pound, Canadian Dollar and Euro. The Company’s outstanding foreign exchange forward contracts, all with maturities of approximately one month, had notional values of $70,665, $53,577 and $72,632 at September 30, 2013, December 31, 2012 and September 30, 2012, respectively. The fair market values of these instruments were $(195), $(255) and $(87) and recorded in accrued liabilities as of September 30, 2013, December 31, 2012 and September 30, 2012, respectively.

 

 

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LEAPFROG ENTERPRISES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except per share data)

(Unaudited)

 

·

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 September 30, 2013, December 31, 2012 and September 30, 2012.

 

The following table presents the Company’s fair value hierarchy for assets and liabilities measured at fair value on a recurring basis as of September 30, 2013, December 31, 2012 and September 30, 2012:

 

		Estimated Fair Value Measurements
						Quoted Prices in Active Markets				Significant Other Observable Inputs				Significant Unobservable Inputs
		Carrying Value				(Level 1)				(Level 2)				(Level 3)
September 30, 2013:
Financial Assets:
Money market funds		$	58,761			$	58,761			$	-			$	-
Financial Liabilities:
Forward currency contracts		$	(195	)		$	-			$	(195	)		$	-
December 31, 2012:
Financial Assets:
Money market funds		$	85,003			$	85,003			$	-			$	-
Financial Liabilities:
Forward currency contracts		$	(255	)		$	-			$	(255	)		$	-
September 30, 2012
Financial Assets:
Money market funds		$	30,000			$	30,000			$	-			$	-
Financial Liabilities:
Forward currency contracts		$	(87	)		$	-			$	(87	)		$	-

 

During the three months ended March 31, 2012, the Company divested its remaining auction rate security (“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 related to ARS valuation 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 received by the Company during the second quarter of 2012.

 

3.

Inventories

 

Inventories consisted of the following as of September 30, 2013 and 2012, and December 31, 2012:

 

		September 30,								December 31,
		2013				2012				2012
Raw materials		$	5,364			$	6,385			$	1,243
Finished goods			116,374				108,698				39,068
Total		$	121,738			$	115,083			$	40,311

 

 

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LEAPFROG ENTERPRISES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except per share data)

(Unaudited)

 

4.

Other Intangible Assets

 

The Company’s other intangible assets were as follows as of September 30, 2013 and 2012, and December 31, 2012:

 

		September 30,								December 31,
		2013				2012				2012
Intellectual property, license agreements and other intangibles		$	16,755			$	16,755			$	16,755
Less: accumulated amortization			(16,555	)			(15,205	)			(15,805	)
Total		$	200			$	1,550			$	950

 

5.

Income Taxes

 

The Company’s provision for (benefit from) income taxes and effective tax rates were as follows:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Provision for (benefit from) provision for income taxes		$	16,567			$	(5,785	)		$	13,421			$	(5,163	)
Income before income taxes			42,940				35,953				33,493				19,008
Effective tax rate			38.6	%			(16.1	%)			40.1	%			(27.2	%)

 

The Company excludes jurisdictions with tax assets for which no benefit can be recognized from the computation of effective tax rate and tax provision. Accordingly, due to the full valuation allowance recorded against the Company’s domestic deferred tax as of September 30, 2012, the Company’s domestic operations were excluded from the computation of tax benefits for the three and nine months ended September 30, 2012. The tax benefits for the 2012 periods were primarily attributable to the recognition of previously unrecognized tax benefits due to the expiration of statutes of limitations in the Company’s foreign jurisdictions, offset by foreign tax expense and certain discrete tax items including amortization of goodwill for tax purposes.

 

During the fourth quarter of 2012, after considering the relative impact of all evidence, positive and negative, the Company determined, at the required more-likely-than-not level of certainty, that a portion of its domestic deferred tax assets will be realized. Accordingly, for the three and nine months ended September 30, 2013, in addition to tax provisions attributable to its foreign operations, the Company’s effective tax rate and income tax provision included tax expense attributable to its domestic operating income for the respective periods.

 

Current and non-current deferred tax assets were $4,248 and $6,181 at September 30, 2013, respectively, as compared to $1,035 and $1,309 at September 30, 2012, respectively. The increase is due to the release of a portion of the deferred tax valuation allowance that occurred in the fourth quarter of 2012, partially offset by the realization of tax benefits in the current year.

 

During the three months ended September 30, 2013, the Company did not recognize any previously unrecognized tax benefits. During the nine months ended September 30, 2013, the Company recognized $207 of previously unrecognized tax benefits due to the expiration of the statutes of limitations in one of its foreign jurisdictions, and reduced the balance of gross unrecognized tax benefits accordingly. The tax provision for the three months ended September 30, 2013 did not include any release of interest and penalties related to uncertain tax positions. The tax provision for the nine months ended September 30, 2013 included a release of interest and penalties of $57. The recognition of previously unrecognized tax benefits and the release of associated accrued interest and penalties reduced other long-term tax liabilities. As of September 30, 2013 and 2012, and December 31, 2012, the Company had approximately $647, $2,645 and $625, respectively, of accrued interest and penalties related to uncertain tax positions.

 

The Company believes it is reasonably possible that the total amount of unrecognized income tax benefit in the future could decrease by up to $495, excluding potential interest and penalties, related to its foreign operations over the course of the next twelve months ending September 30, 2014 due to expiring statutes of limitations that, if recognized, would affect its effective tax rate.

 

As of September 30, 2013, the Company had long-term deferred tax liabilities of $3,759 and other long-term tax liabilities of $1,003. Both are reported as long-term liabilities on the consolidated balance sheet.

 

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 per employee, which vests over three years. The Company recorded total compensation expense of $147 and $1,294, related to the defined contribution plan, for the three and nine months ended September 30, 2013, respectively, and $164 and $1,087 for the three and nine months ended September 30, 2012, respectively.

 

 

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LEAPFROG ENTERPRISES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except per share data)

(Unaudited)

 

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”).

 

Stock plan activity

 

The table below summarizes award activity for the nine months ended September 30, 2013:

 

		Stock								Total
		Options				RSUs				Awards
Outstanding at December 31, 2012			6,148				1,251				7,399
Grants			2,064				821				2,885
Stock option exercises/vesting RSUs			(827	)			(346	)			(1,173	)
Retired or forfeited			(93	)			(39	)			(132	)
Outstanding at September 30, 2013			7,292				1,687				8,979
Total shares available for future grant at September 30, 2013											6,717

 

As of September 30, 2013, the total shares available for future grant under the ESPP were 964.

 

Impact of stock-based compensation

 

The table below summarizes stock-based compensation expense for the three and nine months ended September 30, 2013 and 2012:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
SG&A:
Stock options		$	1,347			$	968			$	3,723			$	2,096
RSUs			849				746				2,269				2,098
ESPP			97				80				342				244
Total SG&A			2,293				1,794				6,334				4,438
R&D:
Stock options			215				150				537				388
RSUs			115				83				295				240
Total R&D			330				233				832				628
Total expense		$	2,623			$	2,027			$	7,166			$	5,066

 

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 is estimated using the Black-Scholes option pricing model with the following weighted-average assumptions for the three and nine months ended September 30, 2013 and 2012:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Expected term (years)			5.18				4.49				4.6				4.49
Volatility			69.9	%			74.3	%			72.5	%			74.3	%
Risk-free interest rate			1.51	%			0.55	%			0.80	%			0.72	%
Expected dividend yield			-	%			-	%			-	%			-	%

 

 

Table of Contents

 

LEAPFROG ENTERPRISES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except per share data)

(Unaudited)

 

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.

 

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 nine months ended September 30, 2013 and 2012:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Expected term (years)			0.49 - 0.5				0.5				0.48 - 0.5				0.5
Volatility			36.0% - 57.5%				49.9% - 59.8%				36.0% - 57.5%				44.1% - 59.8%
Risk-free interest rate			0.05% - 0.12%				0.13% - 0.14%				0.05%-0.14%				0.05% - 0.14%
Expected dividend yield			- %				- %				- %				- %

 

8.

Derivative Financial Instruments

 

At September 30, 2013, December 31, 2012 and September 30, 2012, the Company had outstanding foreign exchange forward contracts with notional values of $70,665, $53,577 and $72,632, 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 nine months ended September 30, 2013 and 2012 are shown in the table below:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Gains (losses) on foreign exchange forward contracts		$	(1,307	)		$	(1,326	)		$	203			$	(1,921	)
Gains (losses) on underlying transactions denominated
in foreign currency			1,291				587				(786	)			495
Net losses		$	(16	)		$	(739	)		$	(583	)		$	(1,426	)

 

9.

Net Income per Share

 

The following table sets forth the computation of basic and diluted net income per share for three and nine months ended September 30, 2013 and 2012:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
(Numerator)
Net income		$	26,373			$	41,738			$	20,072			$	24,171
(Denominator)
Weighted average shares outstanding during period:
Class A and B - basic			68,552				67,400				68,200				66,912
Common stock equivalents			2,499				2,112				2,544				2,159
Class A and B - diluted			71,051				69,512				70,744				69,071
Net income per share:
Class A and B - basic		$	0.38			$	0.62			$	0.29			$	0.36
Class A and B - diluted		$	0.37			$	0.60			$	0.28			$	0.35

 

Options to purchase shares of our common stock and RSUs, totaling 3,470 and 2,871 were excluded from the calculation of diluted net income per share for the three and nine months ended September 30, 2013, respectively, as the effect would have been antidilutive. Options to purchase shares of our common stock and RSUs, totaling 2,002 and 1,207 were excluded from the calculation of diluted net income per share for the three and nine months ended September 30, 2012, respectively, as the effect would have been antidilutive. 

 

10.

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. 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 expenses, legal settlements and other corporate costs are charged entirely to the Company’s U.S. segment and are not allocated to its International segment.

 

 

Table of Contents

 

LEAPFROG ENTERPRISES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except per share data)

(Unaudited)

 

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 (“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 through retailers, distributors outside of the U.S., and directly to consumers via online stores and App Centers directed to certain international jurisdictions.

 

The table below shows certain information by segment for the three and nine months ended September 30, 2013 and 2012:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Net sales:
United States		$	146,831			$	145,691			$	263,285			$	247,050
International			54,154				47,381				103,623				89,512
Totals		$	200,985			$	193,072			$	366,908			$	336,562
Income from operations:
United States		$	29,652			$	24,781			$	10,186			$	2,059
International			13,248				12,082				23,250				18,786
Totals		$	42,900			$	36,863			$	33,436			$	20,845

 

For all periods presented, no countries other than the U.S. accounted for more than 10% of the Company’s consolidated net sales, respectively.

 

11.

Commitments and 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 September 30, 2013, the Company had outstanding off-balance sheet commitments for outsourced manufacturing and component purchases of $791.

 

 

Table of Contents

 

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, the release of a considerable portion of our domestic deferred tax valuation allowance and the associated effect on net income, the normalization of our effective tax rates in periods following the release and the associated effect on net income, the indefinite reinvestment of the undistributed earnings of our foreign subsidiaries, our intention not to repatriate any foreign earnings to the U.S., expectations regarding the effect of our net operating loss or tax credit carryforwards 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, and the timing, seasonality and expectations of cash flows from operations. 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 ability to compete effectively with competitors, the seasonality of our business, consumer acceptance of downloadable content and data collection, system failures in our online services or web store, our dependence on our suppliers for our components and raw materials, our reliance on a limited number of manufacturers, our ability to maintain sufficient inventory levels, 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, the sufficiency of our liquidity, the risk associated with international operations, costs or changes associated with compliance with 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 significant percentage of the voting power in the company, 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 family of learning tablets, the Leapster family of handheld learning game systems, the LeapReader reading and writing systems, and the Tag and Tag Junior reading systems, all of which support a broad library of content 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 LeapFrog App Center.

 

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.

 

 

Table of Contents

 

Consolidated Results of Operations

 

		Three Months Ended September 30,								Change 2013 vs.				Nine Months Ended September 30,								Change 2013 vs.
		2013				2012				2012				2013				2012				2012
		(Dollars in millions, except per share data)
Net sales		$	201.0			$	193.1				4	%		$	366.9			$	336.6				9	%
Cost of sales			121.6				115.8				5	%			223.3				201.0				11	%
Gross margin *			39.5	%			40.0	%			(0.5	)**			39.1	%			40.3	%			(1.2	)**
Operating expenses			36.5				40.4				(10	%)			110.2				114.7				(4	%)
Operating expenses as a percent of net sales			18	%			21	%			(3	)**			30	%			34	%			(4	)**
Income from operations			42.9				36.9				16	%			33.4				20.8				60	%
Net income per share - basic		$	0.38			$	0.62			$	(0.24	)***		$	0.29			$	0.36			$	(0.07	)***
Net income per share - diluted		$	0.37			$	0.60			$	(0.23	)***		$	0.28			$	0.35			$	(0.07	)***

 

*   Gross profit as a percentage of net sales

**   Percentage point change

***   Dollar change                         

  

Net sales for the three months ended September 30, 2013 increased 4% as compared to the same period in 2012, largely driven by sales of multimedia learning platforms, including LeapPad2 Power, LeapPad Ultra and LeapReader, which launched in the second quarter of 2013. Net sales for the nine months ended September 30, 2013 increased 9% as compared to the same period in 2012, largely driven by higher sales in LeapPad2, LeapPad2 Power, LeapPad Ultra, LeapReader and learning toys, partially offset by higher trade allowances and discounts as a percentage of net sales. Net sales for the three months ended September 30, 2013 included a 1% negative impact from changes in currency exchange rates. Net sales for the nine months ended September 30, 2013 were not materially affected by foreign currency exchange rates.

 

Cost of sales for the three and nine months ended September 30, 2013 increased 5% and 11%, respectively, as compared to the same periods in 2012, primarily driven by higher sales volume, higher product costs resulting from a change in sales mix with proportionally higher sales of lower-margin hardware and higher royalty costs resulting from an increase in sales of licensed content. 

 

Consolidated gross margin for the three and nine months ended September 30, 2013 was 39.5% and 39.1%, respectively, a decrease of 0.5 and 1.2 percentage points, respectively, as compared to the same periods of 2012, primarily driven by changes in product mix with proportionally higher sales of lower-margin hardware, higher trade allowances and discounts as a percentage of net sales, and higher royalty costs resulting from an increase in sales of licensed content. The decreases were partially offset by lower inventory allowances and higher sales volume which reduced the impact of fixed logistic costs.

 

Operating expenses for the three months ended September 30, 2013 decreased 10% as compared to the same period of 2012, primarily driven by a decrease in the provision for incentive compensation expense, partially offset by higher expenses due to an increase in headcount to support our strategic initiatives and slightly higher advertising expense. Operating expenses for the nine months ended September 30, 2013 decreased 4% as compared to the same period of 2012, primarily due to bad debt expense of $3.1 million in the prior year period related to an isolated customer bankruptcy, and a decrease in the provision for incentive compensation expense, largely offset by higher expenses due to an increase in headcount to support our strategic initiatives and slightly higher advertising expense. Operating expenses as a percentage of net sales declined by 3 percentage points and 4 percentage points for the three and nine months ended September 30, 2013, respectively, as higher sales volume reduced the impact of fixed costs.

 

Income from operations for the three and nine months ended September 30, 2013 increased 16% and 60%, respectively, as compared to the same periods in 2012, due to the increase in net sales and lower operating expenses, partially offset by lower gross margin.

 

Basic and diluted net income per share for the three and nine months ended September 30, 2013 decreased by $0.24 and $0.23, respectively, as compared to the same periods of 2012. Basic and diluted net income per share for the three and nine months ended September 30, 2013 included $0.22 and $0.17 of tax expense attributable to our U.S. operations, which were excluded in prior year periods due to the full valuation allowance recorded against our domestic deferred tax as of September 30, 2012. Basic and diluted net income per share for the same periods of 2012 included $0.10 and $0.09 of tax benefit, respectively, attributable to the recognition of tax benefits previously unrecognized due to the expiration of statutes of limitations in our foreign jurisdictions.

 

Table of Contents

 

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.

 

		Three Months Ended September 30,								% Change 2013 vs.				Nine Months Ended September 30,								% Change 2013 vs.
		2013				2012				2012				2013				2012				2012
		(Dollars in millions)
SG&A expenses		$	18.9			$	21.3				(11	%)		$	62.6			$	65.2				(4	%)
As a percent of net sales			9	%			11	%			(2	)*			17	%			19	%			(2	)*

 

*   Percentage point change 

 

SG&A expenses for the three months ended September 30, 2013 decreased 11% as compared to the same period in 2012, primarily due to a decrease in the provision for incentive compensation expense, largely offset by higher infrastructure and professional services spending, and higher expenses due to an increase in headcount. SG&A expenses for the nine months ended September 30, 2013 decreased 4% as compared to the same period in 2012, primarily due to bad debt expense of $3.1 million in 2012 related to an isolated customer bankruptcy, and a decrease in the provision for incentive compensation expense, largely offset by higher infrastructure and professional services spending, and higher expenses due to an increase in headcount.

 

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 September 30,								% Change 2013 vs.				Nine Months Ended September 30,								% Change 2013 vs.
		2013				2012				2012				2013				2012				2012
		(Dollars in millions)
R&D expenses		$	7.5			$	9.2				(18	%)		$	25.3			$	26.9				(6	%)
As a percent of net sales			4	%			5	%			(1	)*			7	%			8	%			(1	)*

 

*   Percentage point change

 

R&D expenses for the three and nine months ended September 30, 2013 decreased 18% and 6%, respectively, as compared to the same periods in 2012, primarily due to a decrease in the provision for incentive compensation expense, partially offset by higher expenses due to an increase in headcount to support our strategic initiatives.

 

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 September 30,								% Change 2013 vs.				Nine Months Ended September 30,								% Change 2013 vs.
		2013				2012				2012				2013				2012				2012
		(Dollars in millions)
Advertising expenses		$	7.4			$	7.2				3	%		$	14.3			$	13.9				2	%
As a percent of net sales			4	%			4	%			-	*			4	%			4	%			-	*

 

*   Percentage point change

 

 

Table of Contents

 

Advertising expense for the three months ended September 30, 2013 increased 3% as compared to the same period in 2012, primarily due to an increase in marketing materials, social and search spending, partially offset by lower online advertising, and lower media and production spending. Advertising expense for the nine months ended September 30, 2013 increased 2% as compared to the same period in 2012, primarily due to an increase in cooperative print advertising to drive higher retail sales, an increase in marketing materials, social and search advertising spending, partially offset by a planned reduction in television commercial spending, lower online advertising, and lower media and production spending in the current period.

 

Depreciation and Amortization Expenses

 

		Three Months Ended September 30,								% Change 2013 vs.				Nine Months Ended September 30,								% Change 2013 vs.
		2013				2012				2012				2013				2012				2012
		(Dollars in millions)
Depreciation and amortization		$	2.6			$	2.8				(7	%)		$	8.0			$	8.8				(8	%)
As a percent of net sales			1	%			1	%			-	*			2	%			3	%			(1	)*

 

*   Percentage point change

 

Depreciation and amortization expenses for the three and nine months ended September 30, 2013 decreased 7% and 8%, respectively, as compared to the same period in 2012, primarily due to a reduction in amortization of other intangible assets as a result of certain assets reaching their full amortization during the first quarter of 2012, partially offset by an increase in depreciation of property and equipment as a result of an increase in capital expenditures in the current year period.

 

Other income (expense), net

 

Other income (expense) for the three and nine months ended September 30, 2013 improved $0.9 million and $1.8 million, respectively, as compared to the same periods in 2012, resulting primarily from our foreign currency activity. Other income (expense) for the nine months ended September 30, 2013 also included a one-time settlement of a dispute with a supplier.

 

Income Taxes

 

Our provision for (benefit from) income taxes and effective tax rates were as follows:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Provision for (benefit from) provision for income taxes		$	16,567			$	(5,785	)		$	13,421			$	(5,163	)
Income before income taxes			42,940				35,953				33,493				19,008
Effective tax rate			38.6	%			(16.1	%)			40.1	%			(27.2	%)

 

We exclude jurisdictions with tax assets for which no benefit can be recognized from the computation of effective tax rate and tax provision. Accordingly, due to the full valuation allowance recorded against our domestic deferred tax as of September 30, 2012, our domestic operations were excluded from the computation of tax benefits for the three and nine months ended September 30, 2012. The tax benefits for the 2012 periods were primarily attributable to the recognition of previously unrecognized tax benefits due to the expiration of statutes of limitations in our foreign jurisdictions, offset by foreign tax expense and certain discrete tax items including amortization of goodwill for tax purposes.

 

During the fourth quarter of 2012, after considering the relative impact of all evidence, positive and negative, we determined, at the required more-likely-than-not level of certainty, that a portion of our domestic deferred tax assets will be realized. Accordingly, for the three and nine months ended September 30, 2013, in addition to tax provisions attributable to our foreign operations, our effective tax rate and income tax provision included tax expense attributable to our domestic operating income for the respective periods.

 

We maintain a valuation allowance of $70,385 as of September 30, 2013 against our deferred tax assets related to various net operating loss carry forwards, tax credits, and loss carry forwards that are capital in nature. Continued improvement in operating results could lead to a release of a portion of our remaining domestic valuation allowance, as early as the fourth quarter of 2013. However, the exact timing and the portion of the valuation allowance released are subject to change based on the level of profitability in the remainder of 2013, and our visibility into future period results. We expect that a considerable portion of the valuation allowance release will be recorded as an income tax benefit, which may significantly increase our net income. We expect our effective tax rate in periods following the release to be normalized, which may negatively impact our net income. Any valuation allowance release will not affect the amount of cash paid for income taxes.

 

 

Table of Contents

 

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, distributors, 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 September 30,								% Change 2013 vs.				Nine Months Ended September 30,								% Change 2013 vs.
		2013				2012				2012				2013				2012				2012
		(Dollars in millions)
Net sales		$	146.8			$	145.7				1	%		$	263.3			$	247.1				7	%
Cost of sales			86.9				86.5				-	%			158.9				146.2				9	%
Gross margin *			40.8	%			40.6	%			0.2	**			39.7	%			40.8	%			(1.1	)**
Operating expenses			30.3				34.4				(12	%)			94.2				98.8				(5	%)
Operating expenses as a percent of net sales			21	%			24	%			(3	)**			36	%			40	%			(4	)**
Income from operations		$	29.7			$	24.8				20	%		$	10.2			$	2.1				395	%

 

*   Gross profit as a percentage of net sales

**   Percentage point change                           

 

Net sales for the three months ended September 30, 2013 increased 1% as compared to the same period in 2012, largely driven by sales of multimedia learning platforms, including LeapPad2 Power, LeapPad Ultra and LeapReader, which launched in the second quarter of 2013, and lower trade allowances and discounts. The increases were partially offset by lower sales in learning toys. Net sales for the nine months ended September 30, 2013 increased 7% as compared to the same period in 2012, largely driven by sales of multimedia learning platforms, partially offset by higher trade allowances and discounts.

 

Cost of sales for the three months ended September 30, 2013 remained relatively flat as compared to the same period in 2012. Cost of sales for the nine months ended September 30, 2013 increased 9% as compared to the same period in 2012, primarily driven by higher sales volume, higher product costs resulting from a change in sales mix with proportionally higher sales of lower-margin hardware, and higher royalty costs resulting from an increase in sales of licensed content. 

 

Gross margin for the three months ended September 30, 2013 increased 0.2 percentage points as compared to the same period of 2012, primarily driven by lower inventory allowances, and lower trade allowances and discounts as a percentage of net sales. The increases were largely offset by changes in product mix with proportionally higher sales of lower-margin hardware and higher royalty costs resulting from an increase in sales of licensed content. Gross margin for the nine months ended September 30, 2013 decreased 1.1 percentage points as compared to the same period of 2012, primarily driven by changes in product mix with proportionally higher sales of lower-margin hardware, higher royalty costs resulting from an increase in sales of licensed content, and slightly higher trade allowances and discounts as a percentage of net sales. The decreases were partially offset by lower inventory allowances and higher sales volume which reduced the impact of fixed logistic costs.

 

Operating expenses for the three months ended September 30, 2013 decreased 12% as compared to the same period of 2012, primarily driven by a decrease in the provision for incentive compensation expense and a decrease in advertising expense attributable to lower cooperative print advertising, lower online advertising, and lower media and production spending. The decreases were partially offset by higher expenses due to an increase in headcount to support our strategic initiatives. Operating expenses for the nine months ended September 30, 2013 decreased 5% as compared to the same period of 2012, primarily due to bad debt expense of $3.1 million in the prior year period related to an isolated customer bankruptcy, a decrease in the provision for incentive compensation expense, and lower advertising expenses attributable to a planned reduction in television commercial spending. The decreases were partially offset by higher expenses due to increased headcount in 2013 to support our strategic initiatives. Operating expenses as a percentage of net sales declined by 3 percentage points and 4 percentage points for the three and nine months periods, respectively, as higher sales volume leveraged costs.

 

 

Table of Contents

 

Income from operations for the three months ended September 30, 2013 increased 20% as compared to the same periods in 2012, primarily due to the increase in net sales and decrease in operating expenses, partially offset by lower gross margin. Income from operations for the nine months ended September 30, 2013 increased 395% as compared to the same periods in 2012, due to the increase in net sales and decrease in operating expenses, partially offset by lower gross margin.

 

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 and Canada and through distributors in markets such as Australia, Mexico, South Africa and Spain, as well as through our online channels including App Centers and online stores directed to certain international jurisdictions. 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 September 30,								% Change 2013 vs.				Nine Months Ended September 30,								% Change 2013 vs.
		2013				2012				2012				2013				2012				2012
		(Dollars in millions)
Net sales		$	54.2			$	47.4				14	%		$	103.6			$	89.5				16	%
Cost of sales			34.7				29.3				18	%			64.4				54.8				18	%
Gross margin *			35.9	%			38.2	%			(2.3	)**			37.8	%			38.8	%			(1.0	)
Operating expenses			6.2				6.0				3	%			15.9				16.0				- %
Operating expenses as a percent of net sales			11	%			13	%			(1	)**			15	%			18	%			(3	)
Income from operations		$	13.2			$	12.1				10	%		$	23.3			$	18.8				24	%

 

*   Gross profit as a percentage of net sales

**   Percentage point change                          

 

Net sales for the three and nine months ended September 30, 2013 increased 14% and 16%, respectively, as compared to the same periods in 2012, largely driven by sales of multimedia learning platforms, including LeapPad2 Power, LeapPad Ultra and LeapReader, which launched in the second quarter of 2013, partially offset by higher trade allowances and discounts. Net sales for the nine months ended September 30, 2013 were also negatively impacted by higher trade allowances and discounts.Net sales for the three and nine months ended September 30, 2013 included a 3% and 1% negative impact from changes in currency exchange rates, respectively.

 

Cost of sales increased 18% for both the three and nine months ended September 30, 2013 as compared to the same periods in 2012, primarily driven by higher sales volume, higher product costs resulting from a change in sales mix with proportionally higher sales of lower-margin hardware, and higher royalty costs resulting from an increase in sales of licensed content.

 

Gross margin for the three and nine months ended September 30, 2013 decreased 2.3 and 1.0 percentage points, respectively, as compared to the same periods of 2012, primarily driven by changes in product mix with proportionally higher sales of lower-margin hardware, higher trade allowances and discounts as a percentage of net sales, and higher royalty costs resulting from proportionally higher sales of licensed content.

 

Operating expenses for the three months ended September 30, 2013 increased 3% as compared to the same period in 2012, primarily driven by higher advertising spending attributable to cooperative print advertising to drive higher retail sales and higher television commercial spending in the current period as compared to the prior year period. Operating expenses for the nine months ended September 30, 2013 remained relatively flat as compared to the same period in 2012. Operating expenses as a percentage of net sales declined by 1 and 3 percentage points, respectively, for the three and nine months ended September 30, 2013, as higher sales volume reduced the impact of fixed costs.

 

Income from operations for the three and nine months ended September 30, 2013 increased 10% and 24%, respectively, as compared to the same periods in 2012, primarily due to the increase in net sales, partially offset by decreased gross margin percentage and higher operating expenses.

 

 

Table of Contents

 

Liquidity and Capital Resources

 

Financial Condition

 

Cash and cash equivalents totaled $78.4 million and $49.4 million at September 30, 2013 and 2012, respectively. The increase in cash and cash equivalents was primarily due to an increase in cash provided by accounts receivable collection and improved operating results. Cash and cash equivalents held by our foreign subsidiaries totaled $13.3 million and $11.4 million at September 30, 2013 and 2012, respectively. In line with our investment policy, all cash equivalents were invested in high-grade short-term money market funds as of September 30, 2013.

 

We consider the undistributed earnings of our foreign subsidiaries as of September 30, 2013 to be indefinitely reinvested, and accordingly, no U.S. income taxes have been provided thereon. We do not currently intend to repatriate any foreign earnings to the U.S. to satisfy domestic liquidity needs arising in the ordinary course of business. However, if we were to repatriate these amounts, any associated tax liability would be fully offset by our net operating loss or tax credit carry forwards for the foreseeable future. 

 

We have an asset-based revolving credit facility (the “revolving credit facility”) with a potential borrowing availability of $75.0 million for the months of September through December and $50.0 million for the remaining months. The borrowing availability varies according to the levels of our accounts receivable and cash and investment securities deposited in secured accounts with the lenders. Borrowing availability under this revolving credit facility was $75.0 million as of September 30, 2013. There were no borrowings outstanding on our revolving credit facility at September 30, 2013.

 

Our accumulated deficit of $56.0 million at September 30, 2013 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 2013, including those for capitalized content and website development costs, will be funded with cash flows generated by operations. Capital expenditures were $26.7 million for the nine months ended September 30, 2013 and $16.0 million for the same period of 2012. We expect capital expenditures to be in the range of $30.0 million to $35.0 million for the year ending December 31, 2013.

 

We believe that cash on hand, cash flow from operations and amounts available under our revolving credit facility will provide adequate funds for our 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 nine months ended September 30, 2013 as compared to the same period in 2012:

 

		Nine Months Ended September 30,								% Change 2013 vs.
		2013				2012				2012
		(Dollars in millions)
Cash flows provided by (used in):
Operating activities		$	(18.1	)		$	(11.6	)			(57	%)
Investing activities			(26.7	)			(13.5	)			(98	%)
Financing activities			3.4				2.5				35	%
Effect of exchange rate fluctuations on cash			(0.1	)			0.2				N/M
Increase in cash and cash equivalents		$	(41.6	)		$	(22.4	)			86	%

 

Cash flow used in operations for the nine months ended September 30, 2013 increased $6.5 million as compared to the same period in 2012, primarily due to a lower accounts payable balance attributable to timing of purchases, higher inventory levels and higher incentive compensation payouts, partially offset by an increase in cash provided by accounts receivable collection, and improved net income related to operating activities.

 

 

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Net cash used in investing activities for the nine months ended September 30, 2013 increased $13.2 million as compared to the same period of 2012, primarily due to an increase in computer hardware and software purchases to upgrade our information technology capabilities.

 

Net cash provided by financing activities for the nine months ended September 30, 2013 increased $0.9 million as compared to the same period of 2012, primarily due to lower payroll taxes paid related to a decrease in the number of vested employee RSUs, and an increase in proceeds from stock option exercises and employee stock purchase plan purchases.

 

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.

 

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 nine months ended September 30, 2013.

 

In addition, as of September 30, 2013, we had outstanding off-balance sheet commitments for outsourced manufacturing and component purchases of $0.8 million.

 

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 2012 Form 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 the critical accounting policies discussed in our 2012 Form 10-K through September 30, 2013.

 

Recently Adopted Accounting Guidance

 

In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Updates (“ASU”) 2013-11, Income Taxes (Topic 740). The objective of this guidance is to eliminate the diversity in practice in the presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This guidance is effective for reporting periods beginning after December 15, 2013, with early adoption permitted. We adopted this guidance during the three months ended September 30, 2013. The adoption of this guidance did not result in any material impact to our consolidated financial statements.

 

In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220). The objective of this guidance is to improve the reporting of reclassifications out of accumulated other comprehensive income by requiring an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. This guidance became effective prospectively for reporting periods beginning after December 15, 2012. We adopted this guidance on January 1, 2013. The adoption of this guidance did not result in any material impact to our consolidated financial statements.

 

In July 2012, the FASB issued ASU 2012-02, Intangibles—Goodwill and Other (Topic 350). The objective of this guidance is to simplify how an entity tests indefinite-lived intangible assets other than goodwill for impairment by providing entities with an option to perform a qualitative assessment to determine whether further impairment testing is necessary. This guidance became effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. We adopted this guidance on January 1, 2013. The adoption of this guidance did not result in any material impact to our consolidated financial statements.

 

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Our market risk disclosures set forth in Item 7A of our 2012 Form 10-K have not changed materially for our quarter ended September 30, 2013.

 

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 nine months ended September 30, 2013 and 2012 are summarized in the table below:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
		(Dollars in thousands)
Gains (losses) on foreign exchange forward contracts		$	(1,307	)		$	(1,326	)		$	203			$	(1,921	)
Gains (losses) on underlying transactions denominated
in foreign currency			1,291				587				(786	)			495
Net losses		$	(16	)		$	(739	)		$	(583	)		$	(1,426	)

 

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 September 30, 2013 is as follows:

 

		As of September 30, 2013
		Average Forward Exchange Rate				Notional Amount in Local Currency				Fair Value of Instruments in USD
						(1)				(2)
Currencies:
British Pound (GBP/USD)			1.611				23,131			$	(117	)
Euro (Euro/USD)			1.347				11,724				(61	)
Canadian Dollar (USD/CAD)			1.033				18,190				(17	)
Total fair value of instruments in USD										$	(195	)

 

(1)  In thousands of local currency

(2)  In thousands of USD

 

Cash equivalents are presented at fair value on our consolidated balance sheet. We invest our excess cash in accordance with our investment policy. As of September 30, 2013 and December 31, 2012 and September 30, 2012, our excess cash was invested in high-grade money market funds. Any adverse changes in interest rates or securities prices may decrease the value of our investments and operating results.

 

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, as amended (the “Exchange Act”), 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.

 

 

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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 September 30, 2013.

 

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 September 30, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 

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PART II.

 

OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

Refer to Note 11—“Commitments and Contingencies” in our Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

 

ITEM 1A. RISK FACTORS

 

There have been no material changes to the risk factors disclosed under Part I, Item 1A. “Risk Factors” in our 2012 Form 10-K.

 

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

11/20/2012

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

Employment Agreement, dated as of August 13, 2013, between LeapFrog Enterprises, Inc. and Michael Dodd

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 September 30, 2013, formatted in eXtensible Business Reporting Language (XBRL), include: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Cash Flows, and (v) Notes to the Consolidated Financial Statements

X

 

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, 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: November 6, 2013

/s/ Raymond L. Arthur

Raymond L. Arthur

Chief Financial Officer

(Principal Financial Officer)

Date: November 6, 2013