In Re: LeapFrog Enterprises, Inc. Securities Litigation 03...

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Joseph J. Tabacco, Jr . (75484)Christopher T. Heffelfinger (118058)Nicole Lavallee (165755 )Julie J . Bai (227047)BERMAN DEVALERIO PEASE TABACCOBURT & PUCILLO425 California Street, Suite 2100San Francisco, CA 94104-2205Telephone: (415) 433-3200Facsimile: (415) 433-638 2Email : nlavallee(o)..bermanesq .comLiaison Counsel for the Class

Steven J . Toll (admitted pro hac vice)Elizabeth Berney (admitted pro hac vice)Matthew K. Handley (admitted pro hac vice)COHEN, MILSTEIN, HAUSFELD& TOLL, P.L.L.C1100 New York Avenue, N.W .West Tower, Suite 500Washington, D .C. 20005Telephone: (202) 408-4600Facsimile : (202) 408-4699Email : stoll@cinht .comLead Counsel for the Class

UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNI A

In re LEAPFROG ENTERPRISES, INC . ) CIVIL ACTION NO . C-03-05421-RMWSECURITIES LITIGATION )

DECLARATION OF NICOLEThis Document Relates To: ) LAVALLEE IN SUPPORT OF LEAD

PLAINTIFFS' OPPOSITION TOAll Actions ) DEFENDANTS' MOTIONS TO DISMISS

THE AMENDED CONSOLIDATEDCLASS ACTION COMPLAINT

DATE: July 21, 2006TIME: 9;00 a.m.JUDGE : The Hon . Ronald M. WhyteCTRM : 6, 4th Floor

[C-03-05421-RMW) LAVALLEE DECL ISO LEAD PLAINTIFFS' OPPOSITION TODEFS' MOTIONS TO DISMISS THE AMENDED CONSOLIDATED CLASSACTION COMPLAINT

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NICOLE LAVALLEE declares and says :

1 . I am an attorney admitted to practice in this District and a member of the San

Francisco office of Berman DeValerio Pease Tabacco Burt & Pucillo, Liaison Counsel for Lead

Plaintiffs . I am submi tting this declaration in support of Lead Plaintiffs' Opposition to Defendants'

Motions to Dismiss the Amended Consolidated Class Action Complaint .

2 . Attached hereto as Exhibit A is a true and correct copy of LeapFrog Enterp rises,

Inc.'s Form 10-Q for the quarterly period ended September 30, 2003 .

3. Attached hereto as Exhibit B is a true and correct copy of LeapFrog Enterp rises,

Inc.'s Form 10-K for the fiscal year ended December 31, 2003 .

I declare under penalty of perjury pursuant to federal law and the laws of the State of

California that the foregoing is true and correct .

Executed this 26th day of May, 2006 at San Francisco , Califos ~.

LE LAVALLEE

[C-03-05421-RMW] LAVALLEE DECL ISO LEAD PLAINTIFFS' OPPOSITION TODEFS' MOTIONS TO DISMISS THE AMENDED CONSOLIDATED CLASSACTION COMPLAINT - 1

EXHIBIT A

Table of Contents

UNITED STATESSECURITIES AND EXCHANGE COMMISSION

Washington , D. C. 2054 9

FORM 10-Q

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

For the quarterly period ended September 30, 2003

OR

❑ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 193 4

For the transition period from to

Commission File Number 001-3139 6

LeapFrog Enterprises, Inc.( Exact Name of Registrant, As Spec tied In Its Charter)

Delaware 95-4652013(State of Incorporation) (I.R.S. Employer Identification No. )

6401 Hollis Street, Suite 150, Emeryville, California 94608-1071(Address of Principal Executive Offices, Including Zip Code)

Registrant's Phone Number, Including Area Code : (510) 420-500 0

Indicate by check mark whether the registrant ( 1) has fi led all reports required to be filed by Section 13 or 15 ( d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such sho rt er period that the registrant was required to file such reports ) and (2) has been subject to such filingrequirements for the past 90 days . Yes IE No ❑

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes 0 No O

The number of shares of Class A common stock, par value $0 .0001, and Class B common stock, par value $0.0001, outstanding as of November 4, 2003,was 29,919,720 and 28,882,817, respectively .

TABLE OF CONTENTS

Part IFinancial Informatio n

Item 1 . Financial Statement s

Notes to Consolidated Financial StatementsItem 2 . Management's Dis -ussion and Analysis of Financial Condition and Results of OperationsItem 3 . Ouantitativc and Qualitative Disclosures About Market Ris kItem 4 . Controls and Procedures

Part IlOther Information

Item 1 . Legal ProceedingsItem 6 . Exhibits and Rcports on Form 8- K

SignaturesExhibit Index

Page

12349

272 8

Page

3030

31

Table of ContentsPART 1 .

FINANCIAL INFORMATIO N

Item I . Financial Statements .

LEAPFROG ENTERPRISES, INC.CONSOLIDATED BALANCE SHEETS

(In thousands , except share and per share data)

Septem ber 30,

December 31 ,2003 2002 200 2

(Unau dited) ( Note t )ASSETSCurren( assets :

Cash and cash equivalents $ 84,728 $ 57, 848 $ 73,327Short term investments 13,115 ---- -Accounts receivable, net of allowances of $10,004, $11,343 and $16, 388 at September 30 ,

2003 and 2002 and December 31, 2002, respectively 155,447 130,137 169,670Inventories , net 119 ,508 92,337 84,460Prepaid expenses and other current assets 9,847 8,976 4,065Notes receivable from related parties - 595 595Deferred income taxes 26,121 10,201 16,78 3

Total current assets 408,766 300,094 348,90 0Property and equipment , net 22,028 20,449 20,23 9Other assets 185 431 28 4Investments in affiliates and related parties - 200 20 0Deferred income taxes 9,332 5,889 4,86 7Intangible assets , net 25,359 23,353 23,192

Total assets $465,670 $350,416 $ 397,682

LIABILITIES AND STOCKHOLDERS' EQUITYCurrent liabilities :

Accounts payable $ 64,230 $ 68,031 $ 58,844Accrued liabilities 32,700 26,106 40,53 3Deferred revenue 1,027 3,853 3,00 6Income taxes payable 2,440 13,730 21,832

Total current liabilities 100,397 111,720 124,21 5Deferred rent and other long term liabilities 575 478 550Deferred income taxes 3,595 4,390 4,11 9

Commitments and contingencies

Redeemable convertible series A preferred stock, $0 .0001 par value ; 2,000,000 share sauthorized;-0-outstanding at September 30, 2003 and December 31, 2002 ; 2,000,000 issued an doutstanding at September 30, 2002, net of $861 of issuance costs . (Liquidation preference o f$25,000 at September 30, 2002) -- 24,139 -

Stockholders' equity:Class A common stock, par value $0 .0001 ; 139,500,000 shares authorized ; shares issued and

outstanding : 28,165,532, 13,640,347 and 15,700,467 at September 30, 2003 and 2002 an dDecember 31, 2002, respectively 3 1 2

Class B common stock, par value $0 .0001 ; 40,500,000 shares authorized; 30,345,698, 30,487,80 5and 38,678,831 shares issued and outstanding at September 30, 2003 and 2002 and Decembe r31, 2002, respectively 3 3 4

Additional paid-in capital 286,284 199,520 227,02 0Deferred compensation (3,113) (5,871) (4,922 )

Notes receivable from stockholders - (3,860) (2,624 )Accumulated other comprehensive income 264 104 165Retained earnings 77,662 19,792 49,15 3

Total stockholders' equity 361,103 209,689 268,79 8

Total liabilities and stockholders' equity $465,670 $350,416 S 397,682

See accompanying notes .

1

Table of ContentsLEAPFROG ENTERPRISES, INC .

CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except share and per share data)

(Unaudited)

Three Months Ende d

September 30,

2003 200 2

Net sales $ 203,888 $ 182,127Cost of sales 99,066 87,07 1

Gross profit 104,822 95,05 6

Operating expenses :Selling, general and administrative 22,750 22,86 5Research and development 14,003 14,13 7Advertising 13,545 11,92 5Depreciation and amortization 1,943 1,75 1

Total operating expenses 52,241 50,678

Income from operations 52,581 44,378

Interest expense (3) (127 )Interest income 250 25 9Other income (expense), net 412 (38 )

Income before provision for income taxes 53,240 44,47 2Provision for income taxes 19,836 17,78 9

Net income $ 33,404 $ 26,68 3

Net income per common share :Basic $ 0.58 $ 0 .65Diluted $ 0.55 $ 0 .50

Shares used in calculating net income per common share :Basic 58,045,325 41,274,608Diluted 61,086,489 53,384,45 5


2

Nine Months EndedSeptember 30 ,

2003 200 2

$ 348,651 $ 283,32 5167,367 140,05 0

181,284 143,27 5

66,175 53,95 841,679 39,81 026,230 20,95 36,103 4,804

140,187 119,52 5

41,097 23,75 0

(8) (822 )958 45 9

3,034 8 5

45,081 23,47216,572 9,389

$ 0.50 $ 0.3 9$ 0.47 $ 0.3 0

56,691,770 36,275,66 760,168,609 47,221,080

LEAPFROG ENTERPRISES, INCCONSOLIDATED STATEMENTS OF CASH FLOW S

(In thousands)(Unaudited)

Nine Months Ended

September 30 ,

2003 2002

Net income $ 28,509 $ 14,083Adjustments to reconcile net income to net each provided by operating activities :

Depreciation 11,375 7,776Amortization 833 469Loss on disposal of property and equipment 20 -Loss on sale of investment with related party 19 -Provision for allowances for accounts receivable 10,667 9,98 1Deferred income taxes (14,327) (5,432 )Deferred rent 25 23 3Deferred revenue (1,979) 1,60 3Amortization of deferred compensation 1,627 1,06 9Conversion of stock appreciation rights to non-statutory stock options - 1,34 1Stock option compensation related to nonemployees 705 11 1Tax benefit from exercise of stock options and other 35,542 1,83 8Amortization of bond premium 112 ----

Other changes in operating assets and liabilities :Accounts receivable 3,556 (24,619 )Inventories (35,048) (46,234 )

Prepaid expenses and other current assets (5,782) (6,918 )Notes receivable due from related parties 595 94Other assets 99 (283 )Accounts payable 5,386 33,620Accrued liabilities (7,833) 12,31 7Income taxes payable (19,392) 4,096

Net cash provided by operating activities 14,709 5,145

Investing activities:Purchases of property and equipment (13,183) (11,368 )Purchase of intangible assets (3,000) (250 )Purchases of short term investments (19,738)Sale of short term investments 6,51 0Sale of investment in related party 18 1

Net cash used in investing activities (29,230 ) (11,618 )

Financing activities :Borrowings under credit agreement - 182,000Repayments under credit agreement - (243,163 )Proceeds from the payment of notes receivable from stockholders 2,624 505Proceeds from the exercise of stock options and employee stock purchase plan 23,199 1,50 1Proceeds from the issuance of common stock - 115,11 6

Net cash provided by fi nancing activities 25,823 55,95 9Effect of exchange rate changes on cash 99 9 3

Increase in cash and cash equivalents 11,401 49,579Cash and cash equivalents at beginning of period 73,327 8,269

Cash and cash equivalents at end of period $ 84,728 $ 57,84 8

Supplemental Disclosure of Cash Flow InformationCash paid du ri ng the period for.

Income taxes $ 14,839 $ 8,80 0Interest $ - $ 1,154

Noncash investing and financing activities :Common stock issued in exchange for notes receivable $ - $ 292Issuance of warrant for services rendered and previously accrued $ - $ 142Issuance of stock options related to conversion of stock appreciation rights $ - $ 1,04 1


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LEAPFROG ENTERPRISES, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except share and per share data)(Unaudited)

1 . Basis of Presentatio nThe accompanying unaudited consolidated financial statements and related disclosures have been prepared in accordance with accounting principles

generally accepted in the United States applicable to interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X . Inthe opinion of management, all adjustments (which include normal recurring adjustments) considered necessary for a fair presentation of the financial positionand interim results of LeapFrog Enterprises, Inc . (the "Company") as of and for the periods presented have been included, The consolidated financial statementsinclude the accounts of the Company and its wholly-owned subsidiaries . All significant intercompany accounts and transactions have been eliminated . Becausethe Company's business is seasonal, results for interim periods are not necessarily indicative of those that may be expected for a full year .

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

The balance sheet at December 31, 2002 has been derived from the audited financial statements at that date, but does not include all of the information andfootnotes required by accounting principles generally accepted in the United States for complete financial statements . The financial information included hereinshould be read in conjunction with the Company's consolidated financial statements and related notes in its 2002 Annual Report on Form 10-K filed with theSecurities and Exchange Commission on March 28, 2003 (SEC File No . 001-31396) .

2 . Stock Based CompensationThe Company generally grants stock options to its employees for a fixed number of shares with an exercise price equal to the fair value of the shares on

the date of grant . As allowed under the Statement of Financial Accounting Standards No . 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), theCompany has elected to follow Accounting Principles Board Opinion No . 25, "Accounting for Stock Issued to Employees" ("APB 25") and relatedinterpretations in accounting for stock awards to employees . Accordingly , no compensation expense is recognized in the Company ' s financial statements inconnection with stock options granted to employees where exercise prices are equal to or greater than fair value . Deferred compensation for options granted toemployees is determined as the difference between the fair market value of the Company's common stock on the date options were granted in excess of theexercise price .

Stock-based compensation arrangements with nonemployees are accounted for in accordance with SFAS 123 and EITF No . 96-18, "Accounting forEquity Instruments that Are Issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods or Services," using a fair value approach . Thecompensation costs of these arrangements are subject to remeasurement over the vesting terms as earned .

For purposes of disclosures pursuant to SFAS 123, as amended by SFAS 148, "Accounting for Stock Based Compensation Transition and Disclosure,"the estimated fair value of options is amortized over the options' vesting period . The following table illustrates the effect on net income and net income pe rcommon share if we had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation :

Three Months Ended Nine Months Ended

September 30, September 30,

2003 2002 2003 2002

Net income as reported $33,404 $26,683 $28,509 $14,083Add : Stock based employee compensation expense included in reported net income, net o frelated tax effects $ 368 $ 316 S 1,029 $ 64 1

Deduct : Total stock based employee compensation expense determined under fair value metho dfor all awards, net of related tax effects. (1,756) (1,387) (4,102) (3,071)

Pro forma net income $32,016 $25,612 $25,436 $11,653

Net income per common share as reported:Basic $ 0.58 $ 0.65 $ 0.50 S 0 .3 9Diluted $ 0.55 S 0.50 $ 0.47 $ 0.3 0

Pro forma net income per common share:Basic S 0.55 $ 0.62 $ 0 .45 $ 0.3 2Diluted $ 0.52 $ 0 .48 $ 0 .42 $ 0.25

Table of Conjrtjt§LEAPFR OG ENTERPRISES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(In thousands , except share and per share data)

(Unaudited )

3 . Cash and Cash EquivalentsCash and cash equivalents generally consist of cash and money market accounts . The Company considers highly liquid investments with original

maturities of three months or less to be cash equivalents . For the periods presented, cash equivalents consist of cash, money market funds, short-term fixedincome municipal securities and short-term corporate auction preferred securities . Concentration of credit risk is limited by diversifying investments among avariety of high credit-quality issuers .

4 . Short Term Investments

Short term investments generally consist of investment grade municipal securities with maturities of one year or less . The Company classifies all shortterm investments as available-for-sale . Available-for-sale securities are carried at estimated fair value, based on available market information, with unrealizedgains and losses, if any, reported as a component of stockholders' equity . The cost of securities sold is based on the specific identification method . At September30, 2003, the $13, 113,1 1 5 balance is comprised of municipal securities and the carrying value approximated the fair value .

5. Invento rie sInventories consist of the following :

September 30,

December 31,2003 2002 2002

Raw materials S 30,444 $ 18,849 $ 17,007

Finished goods 89,064 73,488 67,453

Inventories ,net $ 119,508 $ 92,337 $ 84,460

6. Investment In Affiliates And Related Partie s

In 2000, the Company entered into a partnership agreement with an employee of the Company for the purchase of real estate to be used as the executive'sprimary residence . Under the terms of the agreement, the Company invested $200, and in exchange was entitled to participate in any potential gains and lossesattributable to the property . In September 2003, the Company transferred 100% of its interest in the partnership to the employee in exchange for a payment of$181 . Accordingly, the Company recorded a loss of $19 in the third quarter of 2003 . The Company has no remaining rights or obligations under the partnershipagreement .

7 . Intangible AssetsIn February 2003, the Company acquired certain trademark rights in connection with the settlement agreement entered into with Publications International,

Ltd. The trademark was recorded at its estimated fair value of $3,000 and is being amortized over an estimated useful life of five years .Amortization expense

related to the trademark was $150 and $350 for the three and nine months ended September 30, 2003, respectively .

8 . Income Taxe sOur effective income tax rates were approximately 37 .3% and 36 .8% for the three and nine months ended September 30, 2003, respectively, and were 40%

for the three and nine months ended September 30, 2002 .


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(In thousands, except share and per share data)

(Unaudited)

9 . Notes Receivable From Related Parties and StockholdersNotes receivable from related parties and notes receivable from stockholders consisted of the principal, interest and payroll tax owed by employees for the

exercise of vested stock options . The receivable for the loan principal is recorded as notes receivable from stockholders under stockholders' equity . Thereceivable for the interest and payroll tax owed by employees is recorded as notes receivable from related parties under current assets .

By January 31, 2003, the entire balance of notes receivable from related parties and notes receivable from stockholders was paid to the Company by therespective related parties and stockholders. The Company has no remaining notes receivable due from related parties and stockholders .

19 . Comprehensive Incom eComprehensive income is comprised of net income and currency translation adjustment.

Three Months Nine MonthsEnded Ended

September 30, September 30,

2003 2002 2003 2002

Net income $ 33,404 $ 26,683 $ 28,509 $ 14,083

Currency translation adjustment. 126 159 99 93

Comprehensive income $ 33 ,530 $ 26,842 S 28,608 $ 14,176

11 . Net Income Per Common Share

The Company follows the provisions of SFAS No, t28, Earnings Per Share ("SFAS 128"), which requires the presentation of basic net income percommon share and diluted net income per common share . Basic net income per common share excludes any dilutive effects of options, warrants and convertiblesecurities.

The following sets forth the computation of basic and diluted net income per share :

Three Months Ended

September 30,Nine Months Ended

September 30,

2003 2002 2003 2002

Numerator :Net income $ 33,404 $ 26,683 $ 28,509 $ 14,08 3

Denominator:Class A and B common stock-weighted average share s 58,045,325 41,274,608 56,691,770 36,275,667

Denominator for net income per Class A and B commonshare-basic 58,045,325 41,274,608 56,691,770 36,275,667

Effect of dilutive securities :Employee stock options 3,041,164 3,308,681 3,476,839 2,817,94 0Warr ants - 6 ,801,166 - 6,127,47 3Convertible preferred stock - 2,000,000 - 2,000,00 0

Denominator for diluted net income per Class A and B commonshare-adjusted weighted average shares and assume dconversions 61,086,489 53,384,455 60,168,609 47,221,080

Net income per Class A and B common share :Basic $ 0 .58 $ 0.65 $ 0.50 $ 0.39Diluted $ 0.55 $ 0.50 $ 0.47 $ 0.30

6

LEAPFROG ENTERPRISES, INC .NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except share and per share data)(Unaudited)

12 . Segment Reportin g

The Company's reportable segments include U .S. Consumer, Education and Training, and International .

The U .S . Consumer segment includes the design, production and marketing of electronic educational toys and books, sold primarily through U .S . retailchannels . The Education and Training segment includes the SchoolHouse division, which designs, produces and markets educational instructional materials soldprimarily to K-12 school systems. For the International segment, the Company designs, markets and sells products in non-U .S . markets .

Income I (Loss)

Net Sales from operation s

Three Months Ended September 30, 2003U .S. ConsumerEducation and TrainingInternational

Total

Three Months Ended September 30, 2002U .S . ConsumerEducation and TrainingInternationa l

Tota l

Nine Months Ended September 30, 2003U .S . Consume rEducation and TrainingInte rnational

Tota l

Nine Months Ended September 30, 2002U.S. Consume rEducation and TrainingInternational

Total

$ 167,126 S 44,35 67,255 (1,170 )

29,507 9,39 5

$ 203,888 $ 52,58 1

$ 160,969 $ 43,77 15,332 (2,852 )

15,826 3,45 9

S 182,127 $ 44,37 8

$ 272,552 $ 30,83 726,333 (1,290 )49,766 11,550

S 348,651 S 41,097

$ 239,510 $ 26,20514,127 (6,112 )29,688 3,65 7

$ 283,325 $ 23,75 0

Total Asset s

U .S. ConsumerEducation and TrainingInternational

Total

September 30, September 30, December 31 ,

2003 2002 2002

$ 414,383 $ 324,651 $ 354,8747,783 5,760 6,602

43,504 20,005 36,206

$ 465,670 $ 350,416 $ 397,682

7

LEAPFROG ENTERPRISES, INC .NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share data)(Unaudited)

13 . Conversion of Class B Common Stoc kDuring the nine months ended September 30, 2003, a total of 8,333,133 shares of Class B common stock were converted to Class A common stock on a

one-for-one basis .

14 . Legal Proceedings

In May 2003, the Company entered into a confidential settlement agreement and release of all claims with General Creation Lt-C, and filed a joint motionin federal district court in Virginia seeking dismissal with prejudice of all of the claims and counterclaims in the patent lawsuit . The case was dismissed by thefederal district court in Virginia in May 2003 .

In September 2003, the Company, its co-defendants and Technology Innovations, LLC entered into a settlement agreement . The case was dismissed bythe federal district court for the Western District of New York in September 2003 .

In October 2003, the Company filed a complaint in the federal district court for the district of Delaware against Fisher-Price, Inc ., alleging patentinfringement involving Fisher-Price's PowerTouch teaming system . The Company is seeking damages and injunctive relief.

Table of ContentsItem 2 . Management ' s Discussion and Analysis of Financial Condition and Results of Operation s

FORWARD-LOOKING STATEMENT S

The following discussion and analysis should be read with our financial statements and notes included elsewhere in this quarterly report on Form l0-Q .This report contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 . These statements may beidentified by the use of forward-looking words or phrases such as "anticipate," "believe," "could," "expect," `intend," "may," "planned," "potential," "should,""will," and "would" or any variations of words with similar meanings . These forward-looking statements relate to future events or our future financialperformance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance orachievements to differ materially from any future results, levels of activity, performance or achievements expressed or implied by these forward-lookingstatements . Specific factors that might cause such a difference include, but are not limited to, risks and uncertainty discussed in this report, including thosediscussed under the heading "Risk Factors That May Affect Our Results and Stock Price" and those that are or may be discussed from time to time in our publicannouncements and filings with the SEC, such as in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 28, 2003(SEC File No. 001-31396) under the headings "Risk Factors That May Affect Our Results and Stock Price" and "Management's Discussion and Analysis ofFinancial Condition and Results of Operations" and our future Forms 8-K, 10-Q and 10-K . We undertake no obligation to revise the forward-lookingstatements contained in this quarterly report on Form 10-Q to reflect events or circumstances occurring after the date of the filing of this report .

OVERVIEW

We design, develop and market technology-based educational products for sale to retailers, distributors and schools . We classify our products into threeproduct categories : "platforms," or hardware devices that offer age-appropriate user interfaces and work interactively with a variety of books, cartridges or othercontent units; "software," or content such as interactive books and cartridges specifically designed for use with our platforms ; and standalone educationalproducts . Since the founding of our business in 1995, we have grown from a start-up company selling stand-alone educational toys into a company sellingmultiple platform products and related interactive software, as well as stand-alone products, with total net sales in 2002 of $531 .8 million .

We operate three business segments, which we refer to as U .S . Consumer, Education and Training, and International . In the U .S . Consumer segment, wemarket and sell our products directly to national and regional ruass-market and specialty retailers as well as to other retail stores through sales representatives .Our Education and Training segment targets the school market in the United States, including sales directly to educational institutions, to teacher supply storesand through catalogs aimed at educators . In our International segment, we sell our products outside the United States directly to overseas retailers and throughvarious distribution and strategic arrangements . To date, we have sold our products predominantly through the toy sections of major retailers . For furtherinformation regarding our three business segments, see Note 12 to our consolidated financial statements contained elsewhere in this quarterly report .

CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATE S

Our significant accounting policies are more fully described in Note 2 to our consolidated financial statements included in our Form 10-K for the fiscalyear ended December 31, 2002, filed with the SEC on March 28, 2003 (SEC File No . 001-31396) . However, some of our accounting policies are particularlyimportant to the portrayal of our financial position and results of operations and require the application of significant judgment by our management . We believethe following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financialstatements.

Revenue Recognition

We recognize revenue upon shipment of our products provided that there are no significant post-delivery obligations to the customer and collection isreasonably assured, which generally occurs upon shipment, either from our U .S . distribution facility or directly from our third-party manufacturers . Net salesrepresent gross sales less negotiated price allowances based primarily on volume purchasing levels, estimated returns and allowances for defective products . Asmall portion of our revenue is deferred and recognized as revenue over an eighteen-month period, which is the estimated period of use of the product . Wedeferred 1% or less of net sales for each of the nine months ended September 30, 2003, and 2002.

Allowances For Accounts Receivable

We reduce accounts receivable by an allowance for amounts that may become uncolleetible in the future . This allowance is an estimate based primarily onour management's evaluation of the customer's financial condition, past collection history and aging of the receivable . If the financial condition of any of ourcustomers deteriorates, resulting in impairment of their ability to make payments, additional allowances may be required .

Table of ContentsWe provide estimated allowances for product returns, chargebacks, and defectives on product sales in the same period that we record the related revenue.

We estimate our allowances by utilizing historical information for existing products . For new products, we estimate our allowances for product returns onspecific terms for product returns and our experience with similar products . In estimating returns, we analyze (i) historical returns and sales patterns, (ii) analysisof credit memo data, (iii) current inventory on hand at customers, (iv) changes in demand and (v) introduction of new products . We continually assess thehistorical rates experience and adjust our allowances as appropriate, and consider other known factors. Additional allowances may be required if actual productreturns, chargebacks and defective products are greater than our estimates .

Inventories and Related Allowance For Slow-Moving, Excess and Obsolete Inventor y

Inventories are stated at the lower of cost, on a first-in, first out basis, or market value and are reduced by an allowance for slow-moving, excess andobsolete inventories . Our estimate for slow-moving, excess and obsolete inventories is based on our review of on hand inventories compared to estimated futureusage and demand for our products . If actual future usage and demand for our products are less favorable than those that we project, additional inventorywrite-downs may be required .

Intangible Assets

Intangible assets, including excess of purchase price over the cost of net assets acquired, arose from our September 23, 1997 acquisition of substantially allthe assets and business of our predecessor, LeapFrog RBT, our acquisition of substantially all the assets of Explore Technologies on July 22, 1998, and ouracquisition of certain trademark rights in February 2003 . At September 30, 2003, our intangible assets had a net balance of $25.4 million . This balance included$19 .5 million of goodwill and other indefinite lived assets, which are not subject to amortization . At December 31, 2002, we tested our goodwill and otherintangible assets for impairment based on a combination of the fair value of the cash flows That the business can be expected to generate in the future, known asthe income approach, and the fair value of the business as compared to other similar publicly traded companies, known as the market approach . Based on thisassessment we determined that no adjustments were necessary to the stated values . We review intangible assets, as well as other long-lived assets, annually andwhenever events or circumstances indicate the carrying amount may not be fully recoverable .

Website Development, Content Development and Tooling Capitalizatio n

We capitalized website development costs in accordance with Emerging Issues Task Force 00-02, "Accounting for Website Development Costs"guidelines . The development work for our current website was largely completed in 2002 . Therefore, we did not incur any website development costs in the ninemonths ended September 30, 2003 . We depreciate capitalized website development costs on a straight-line basis over two years . We capitalized $0.3 million and$3 .1 million of website development costs for the years ended December 31, 2002 and 2001, respectively .

We capitalize the prepublication costs of books as content development costs . Only costs incurred with outside parties are capitalized . In the third quarterof 2003, we capitalized $0 .3 million of content development costs, $32,000 of which pertained to our Education and Training segment . In the third quarter of2002, we capitalized $1 .0 million in content development costs, $0 .9 million of which pertained to our Education and Training segment . In the nine monthsended September 30, 2003, we capitalized $2 .5 million of content development costs, $1 .2 million of which pertained to our Education and Training segment . Inthe nine months ended September 30, 2002, we capitalized $2 .7 million in content development costs, $2 .2 million of which pertained to our Education andTraining segment . We amortize these assets from the time of publication over their estimated useful lives, estimated to be three years, using the sum of year'sdigits method . If the related content is deemed to have a shorter useful life, its estimated useful life and the amount of periodic amortization is adjustedaccordingly . To the extent that books are taken out of circulation, any remaining unamortized content development costs are written off at the time the book istaken out of production .

As of the second quarter of 2003, we changed the reporting classification for the amortization of content development costs . Previously, such costs wereclassified as "depreciation and amortization" in the operating expenses section of our consolidated statement of operations . Beginning with the second quarter of2003, amortization of content development costs are being classified as "cost of sales" in our consolidated statement of operations . All prior periods reported inthis Form 10-Q conform to this presentation .

We capitalize costs related to manufacturing tools developed for our products . We capitalized $1 .2 million related to manufacturing tools in the thirdquarter of 2003 compared to $1 .0 million for the same period in 2002 . We capitalized $3 .9 million and $4 .2 million in the nine months ended September 30,2003 and 2002, respectively. We depreciate these

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Table of Contentsassets on a straight-line basis, to cost of sales, over an estimated useful life of two years . If the related product line or our manufacturing production results in ashorter life than originally expected, its estimated useful life and the amount of periodic depreciation is adjusted accordingly . To the extent that product lines arediscontinued, the net book value of any remaining manufacturing tools are written off at the time the tools are taken out of production .

Stock-Based Compensatio n

We account for employee stock options using the intrinsic value method in accordance with Accounting Principles Board Opinion No . 25, "Accounting forStock Issued to Employees," whereby compensation is not recorded for options granted at fair value to employees and directors .

Stock-based compensation arrangements with nonemployees are accounted for in accordance with SFAS 123, "Accounting for Stock-BasedCompensation," and EITF No . 96-18, "Accounting for Equity Instruments that Are Issued to others than Employees for Acquiring, or in Conjunction withSelling Goods or Services," using a fair value approach . The compensation costs of these arrangements are subject to remeasurement over the vesting terms asearned .

In 2002, Mr. Wood, our founder, Chief Executive Officer and President, Mr . Thomas J . Kalinske, our Chairman, and Mr . Paul A . Rioux, our ViceChairman and acting Chief Operating Officer, entered into new employment agreements providing for, among other things, acceleration of vesting of their stockoptions upon a change in control of LeapFrog during the term of the applicable agreement and continued vesting of their stock options during applicableseverance periods triggered upon the termination of their employment by LeapFrog without cause or by the employee for good reason (as defined in theagreements). Under applicable accounting principles, upon any termination of employment or change in control resulting in such acceleration or extension, wewould be required to recognize compensation expense. The amount of any such compensation expense would depend on the number of option shares affected bythe acceleration or extension and could be material to our financial results .

Prior to our initial public offering, we granted stock appreciation rights under our Amended and Restated Employee Equity Participation Plan that weremeasured at each period end against the fair value of the Class A common stock at that time . The resulting difference between periods is recognized as expense ateach period-end measurement date based on the vesting of the rights .

In February 2002, we converted 337,500 stock appreciation rights into options to purchase an aggregate of 337, 500 shares of Class A common stock .Deferred compensation of $0 .9 million related to the unvested portion will be amortized to expense through the third quarter of 2005 as the options vest ,

In July 2002, we converted 1,585,580 stock appreciation rights into options to purchase an aggregate of 1,585,580 shares of Class A common stock . Theexpense related to the conversion of the vested stock appreciation rights was $1 .6 million through July 2002 based on vested rights with respect to 192,361 sharesof Class A common stock outstanding as of July 25, 2002 at our initial public offering price of $13 .00 per share. Our deferredcompensation expense inconnection with the conversion of 1,310,594 unvested stock appreciation rights, held by employees, converted to options to purchase 1,310,594 shares of Class Acommon stock, was $4 .0 million . In accordance with generally accepted accounting principles, beginning in the third quarter of 2002 and for the following 16quarters, we have recognized and will continue to recognize this expense over the remaining vesting period of the options into which the unvested rights areconverted . Deferred compensation related to the unvested portion will be amortized to expense as the options vest . To the extent any of the unvested options areforfeited, our actual expense recognized could be lower than currently anticipated . Concurrently with our initial public offering, we stopped granting stockappreciation rights under the Amended and Restated Employee Equity Participation Plan .

Table of ContentsRESULTS OF OPERATIONS

The following table sets forth selected information concerning our results of operations as a percentage of net sales for the periods indicated :

Net salesCost of sales

Gross profitOperating expenses :

Selling, general and administrativeResearch and developmentAdvertisingDepreciation and amortization

Total operating expenses

Income from operation sInterest and other income (expense) net

Income before provision for income taxesProvision for income taxe s

Net income

Three Months Nine MonthsEnded Ended

S'ntan.hrr 14 Senu usher ia.

2003 2002 2003 2002

100 .0% 100.0% 100. 0% 100 .0%48 .6 47.8 48.0 49 .4

51 .4 52 .2 52.0 50 .6

11,2 12 .6 19.0 19. 06 .9 7 .8 12 .0 14 . 16 .6 6 .5 7 .5 7 . 4l .0 1 .0 1 .8 1 . 7

25.6 27 .8 40 .2 42 . 2

25 .8 24 .4 11 .8 8 .40.3 0 .1 1 .1 (0.1 )

26 .1 24 .4 12 .9 8.39 .7 9 .8 4 .8 3 .3

16 .4% 14 .7% 8 .2% 5 .0 %

Three Months Ended September 30, 2003 Compared to Three Months Ended September 30, 2002Net Sales

Net sales increased by $21 .8 million, or 12%, from $182 . 1 million in the three months ended September 30, 2002 to $203 .9 million in the three monthsended September 30, 2003 . Foreign currency exchange rates favorably impacted net sales by 1% due to stronger international currencies. The net sales increasewas primarily d ri ven by strong volume increases in stand-alone product sales and, to a lesser extent , software and platform sales growth . For the 2003 thirdquarter , net sales of our standalone products increased 31%, and net sales of our software products and platform products increased 14% and 2%, respectively,compared to the third quarter of 2002 .

Net sales for each segment, in dollars and as a percentage of total company net sales, were as follow s

Three Months Ended September 30,

2003 2002

% of Total % of TotalCompany Compan y

Segment S (l) Sales $ (1) Sales

U .S . Consumer $167.1 82% $161.0 88%Education and Training 7.3 4% 5.3 3%International 29.5 14% 15.8 9%

Total Company $203 .9 100% $182 .1 100%

(1) In millions.

U.S. Consumer. Our U.S . Consumer segment's net sales increased by $6 .1 million, or 4%, from $161 .0 million in the third quarter of 2002 to $167 .1million in the third quarter of 2003 . This segment comprised 82% of total company net sales for the third quarter of 2003 and accounted for 28% of the increasein total company net sales . Net sales of stand-alone products increased by $7 .5 million, or 20%, from $36 .8 million in the third quarter of 2002 to $44 .3 millionin the third quarter of 2003 in our U .S . Consumer segment . Sates of stand-alone products accounted for 27% of our U .S . Consumer segment net sales in the thirdquarter of 2003, compared to 23% in the third quarter of 2002 . The 20% increase in stand-alone sales year overyear is primarily due to the success of our newand previously existing line of stand-alone products . Software net sales in our U .S Consumer segment increased by $3 .0 million, or 7%, from $44 .1 million inthe third

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Table of Contentsquarter of 2002 to $47 .1 million in the third quarter of 2003 . Sales of software products accounted for 28% of our U .S . Consumer segment net sales in the thirdquarter of 2003, compared to 27% of our U .S . Consumer segment net sales in the third quarter of 2002 . Platform net sales in our U .S. Consumer segmentdecreased by $4.4 million , or 5%, from $ 80.1 million in the third quarter of 2002 to $75 .7 million in the third quarter of 2003 . Sales of platforms were 45% ofU .S . Consumer net sales for the third quarter of 2003 compared to 50% of total U .S . Consumer net sales in the third quarter of 2002. The decline in platformsales in the third quarter was primarily due to decreased sales of our existing line of LeapPad platforms, partially offset by strong sales of the new generation ofLeapPad -family platforms. Year-to-date U.S . Consumer segment platform sales increased 2% as compared to the some period in 2002 . We expect platformsales in the fourt h quarter of 2003 to strengthen due to the introduction of three new platforms in the second half of 2003 and continued sales of our existingplatforms .

The net sales growth experienced in the U .S. Consumer segment in the third quarter of 2003 compared to the 2002 third quarter was lower than the netsales growth in each of the first and second quarters of 2003 as compared to the same quarters in 2002, primarily due to the liming of shipments to keycustomers . We anticipate a higher level of net sales growth for this segment in the fourth quarter of 2003 as compared to the fourth quarter of 2002 than weexperienced in the third quarter of 2003, On a full-year basis, we expect sales dollar increases in platforms, software and stand-alone product lines .

Education and Training . Our Education and Training segment' s net sales increased by $2.0 million, or 36%, from $5 .3 million in the third quarter of 2002to $7.3 million in the third quarter of 2003 . This segment comprised 4% of total company net sales for the third quarter of 2003 and accounted for 9% of theincrease in total company net sales . The increase in this segment ' s net sates is primarily due to the growing success of our major products in the SchoolHousedivision , especially the LcapTrack instruction and assessment system and our instructional book series, the increase in new classroom product offerings and Theinc re ased brand awareness from the adoption of LeapFrog products by school districts around the United States.

International. Our International segment's net sales increased by $13 .7 million, or 86%, from $15 .8 million in the third quarter of 2002 to $29 .5 million inthe third quarter of 2003 . Foreign currency exchange rates favorably impacted net sates by 9% due to stronger international currencies . This segment comprised14% of total company net sales for the third quarter of 2003 and accounted for 63% of the increase in total company net sales . The strong performance in ourInternational segment is primarily due to increased market penetration in the United Kingdom and Canada, which resulted from more localized product offeringsand the recognition of the LeapFrog brand .

Gross ProfitGross pro fi t increased by $9.7 million , or 10%, from $95 .1 million in the third quarter of 2002 to $104 .8 million in the third quarter of 2003 . Gross profit

as a percentage of net sales , or gross profit margin , decreased from 52.2% in the third quarter of 2002 to 51 .4% in the third quarter of 2003 . The decrease in grossprofit margin was primarily due to decreased margin in our U .S . Consumer segment, offset by increased margin in our Inlemational and Education and Trainingsegment.

Gross profit for each segment and the related percentage of segment net sales were as follows :

Th re e Months Ended September 30,

2003 2002

%of%of

SegmentSegment

Segment $ ( 1) Net Sates $ ( 1) Net Sates

U.S. Consumer $ 84 .8 50 .8% $85.1 52.8 %Education and Training 3 .7 51 .4% 2.4 45.9 %International 16.3 55A% 7 .5 47.7 %

Total Company $104.8 51.4% $95.1 52,2 %

(1) In millions .

U.S. Consumer. Our U .S . Consumer segment's gross profit remained relatively flat at $84 .8 million in the third quarter of 2003 compared to $85 .1 millionin the third quarter of 2002 . Gross profit margin decreased from 52 .8% in the third quarter of 2002 to 50 .8% in the third quarter of 2003 . The decrease in grossprofit margin was primarily due to higher royalty expenses resulting from increased sales of royalty-bearing products, higher warehousing expenses, andincreased freight costs, partially offset by savings in lower integrated circuit costs. In the fourth quarter, we anticipate gross profit dollars will increase ascompared to the prior year .

Table of Content sEducation and Training. Our Education and Training segment's gross profit increased by $1 .3 million, or 52%, from $2 .4 million in the third quarter of

2002 to $3 .7 million in the third quarter of 2003 . Gross profit margin increased from 45 .9% in the third quarter of 2002 to 51 .4% in the second quarter of 2003 .The increase in gross profit margin in this segment was primarily due to lower product costs, partially offset by higher freight and warehousing expenses .

International. Our International segment's gross profit increased by $8.8 million, or 116%, from $7 .5 million in the third quarter of 2002 to $16 .3 millionin the third quarter of 2003 . Gross profit margin increased from 47 .7% in the third quarter of 2002 to 55 .1% in the third quarter of 2003. The increase in grossprofit margin in this segment was primarily due to lower product cost and the fact that higher-margin software sales comprised a larger percentage of the productmix.

Selling, General and Adtninistrative Expense s

Selling, general and administrative expenses decreased by $0 .1 million, or 1%, from $22 .9 million in the third quarter of 2002 to $22 .8 million in the thirdquarter of 2003, As a percentage of net sales, selling, general and administrative expenses decreased from 12 .6% in the third quarter of 2002 to 11 .2% in thesecond quarter of 2003 . The dollar decrease year-over-year was primarily due to lower incentive compensation, litigation, and bad debt expenses, offset byincreased fixed compensation expenses . Decreased incentive compensation expense was due to reduced employee incentive and commission expenses related tolower sales performance as compared to internal goals . Litigation expenses were lower in the third quarter of 2003 compared to the same period in 2002,primarily due to the settlement, in the second quarter of 2003, of most of our outstanding litigation matters . Bad debt expense was lower than last year due to theloss incurred on the sale of the remaining Kmart pre-petition bankruptcy receivables in the prior year . The higher fixed compensation expense resulted from ouremphasis on building internal sales and marketing teams and infrastructure to support our projected worldwide growth . On a full-year basis, we anticipateselling, general and administrative expenses to increase in dollars but to decrease as a percentage of net sales as compared to 2002 .

Research and Development Expenses

Research and development expenses, which include content and product development expenses, decreased by $0 .1 million, or 1%, from $14 .1 million inthe third quarter of 2002 to $14 .0 million in the third quarter of 2003 . As a percentage of net sales, research and development expenses decreased from 7 .8% inthe third quarter of 2002 to 6 .9% in the third quarter of 2003 .

Content development expense increased by $0 .4 million, or 6%, from $6 .9 million in the third quarter of 2002 to $7 .3 million in the third quarter of 2003 .As a percentage of net sales, content development expenses decreased from 3 .8% in 2002 to 3 .6% in 2003 . Spending on development of software productsincreased by 8% over the third quarter of 2002, but was fully offset by lower spending on Internet content . We anticipate content development expenses toincrease in dollars year-over-year, but to decrease as a percentage of net sales .

Product development and engineering expenses decreased by $0 .6 million, or 8%, from $7 .3 million in the third quarter of 2002, to $6 .7 million in thethird quarter of 2003 . As a percentage of net sales, product development and engineering expenses decreased from 4.0% in 2002 to 3 .3% in 2003. Spending onthe development and engineering of new platforms and stand-alone products increased by 11% over the third quarter of 2002, but was fully offset by decreasedwebsite engineering expenses . We largely completed the development and engineering of our website in 2002, and the expenses related to the maintenance of thewebsite are classified as selling, general and administrative expenses. We anticipate product development and engineering expenses to increase in dollars yearover year, but to decrease as a percentage of net sales .

Advertising Expense

Advertising expense increased by $1 .6 million, or 14%, from $11 .9 million in the third quarter of 2002 to $13 .5 million in the third quarter of 2003 . As apercentage of net sales, advertising expense increased from 6 .5% in 2002 to 6 .6% in 2003 . The increase in advertising expense was primarily due to increasedtelevision advertising to promote brand awareness for the upcoming holiday season . We anticipate this dollar increase to continue in the fourth quarter of 2003compared to the same period last year .

Depreciation and Amortization Expense sDepreciation and amortization expenses, which exclude depreciation of tooling and amortization of content development costs included in cost of sales,

increased by $0.1 million, or 11 %, from $1 .8 million in the third quarter of 2002, to $1 .9 million in the third quarter of 2003. As a percentage of net sales,depreciation and amortization expense was

14

Table of ContentsI% for the third quarter of 2003 and 2002 . The dollar increase was primarily due to higher depreciation expense of computers and software purchased to support

employee headcount growth, offset by decreased amortization of website development expenses. We largely completed the development of our website last year .

Income (Loss) From Operations

Our income from operations increased by $8 .2 million, or 19%, from $ 44 .4 million in the third quarter of 2002 to $52 .6 million in the third qua rter of2003 . As a percentage of net sales , our income from operations increased from 24 . 4% in the third qua rter of 2002 to 25 .8% in the third quarter of 2003 . The

improvement was prima ri ly due to increased operating expense leverage.

Income or loss from operations for each segment and the related percentage of segment net sales were as follows:

Three Months Ended September 30,

2003 2002

% of % o rSegment Segment

Segment $ ( 1) Net Sales S (1) Net Sale s

U .S . Consumer $44 .4 26.5% $43.8 27.2 %Education and Training (1 .2) (16.1)% (2.9) (53 .5)%

International 9 .4 31.8% 3.5 21 .9 %

Total Company $52.6 25.8% $44.4 24 .4 %

(1) In millions.

U.S. Consumer. Our U .S . Consumer segment's income from operations increased by $0 .6 million, or 1%, from $43 .8 million in the third quarter of 2002 to

$44 .4 million in the third quarter of 2003 . As a percentage of net sales, income from operations decreased from 27 .2% in the third quarter of 2002 to 26 .5% in thethird quarter of2003 . Operating income, as a percentage of net sales, decreased from last year due primarily to lower gross profit margin .

Education and Training. Our Education and Training segment's loss from operations improved by $1 .7 million, or 59%, from a loss of $2 .9 million in the

third quarter of 2002 to a loss of $1 .2 million in the third quarter of 2003 . As a percentage of net sales, loss from operations improved from (53 .5)% in the third

quarter of 2002 to (16 .1)% in the third quarter of 2003 . The improved operating loss compared to last year was primarily due to the increase in net sales, highergross profit margin and operating expense leverage .

International. Our International segment's income from operations increased by $5 .9 million, or 172%, from $3 .5 million in the third quarter of 2002 to

$9.4 million in the third quarter of 2003 . As a percentage of net sales, income from operations increased from 21 .9% in the third quarter of 2002 to 31 .8% in the

third quarter of 2003 . The dollar increase in operating income year over year is primarily due to net sales growth in the United Kingdom and Canada .

Other

Net interest income increased by $0 .1 million from $0.1 million in the third quarter of 2002 to $0.2 million in the third quarter of 2003 . This increase wa s

primarily due to higher invested average cash balances and the elimination of our debt in July 2002 .

Other income increased by $0.5 million due primari ly to foreign exchange gains relating to the United Kingdom and France .

Our effective income tax rates were 37 .3% and 40 .0% for the third quart er of 2003 and 2002, respectively . The decline in the effective tax rate wasprimarily due to research and development tax credits. We expect our annual tax rate to be approximately 37.5% for 2003 .

Net Incom e

Net income increased $6 .7 million, or 25%, from $26 .7 million in the third quarter of 2002 to $33 .4 million in the third quarter of 2003 . As a percentage of

net sales, net income increased from 8.2% in the third quarter of 2002 to 16 .4% in the third quarter 2003 .

15

Table of ContentsNine Months Ended September 30, 2003 Compared to Nine Months Ended September 30, 2002

Net Sales

Net sales increased by $65 .3 million, or 23%, from $283 .3 million in the nine months ended September 30, 2002 to $348 .7 million in the nine monthsended September 30, 2003 . Foreign currency exchange rates favorably impacted net sales by 1% due to stronger international currencies. The net sales increase isprimarily due to strong volume increases in stand-alone and software products, and to a lesser extent increases in platform products .

Net sales for each segment, in dollars and as a percentage of total company net sales, were as follows :

Nine Months Ended September 30 ,

2003 2002

% of Total % of TotalCompany Compan y

Segment S {1) Sales S(l) Sale s

U.S . Consumer $272 .6 78% $239.5 85 %Education and Training 26.3 8a/ 14.1 5 %I nternational 49.8 14% 29.7 10 %

Total Company $348.7 100% $283.3 100 %

(1) In millions .

U.S. Consumer. Our U .S. Consumer segment's net sales increased by $33 .0 million, or 14%, from $239.5 million in 2002 to $272 .6 million in 2003 . Thissegment comprised 78% of total company net sales in 2003 and accounted for 50% of the increase in total company net sales. Net sales of stand-alone products

increased by $15 .7 million , or 28%, from $55 .8 million in 2002 to $71,5 million in 2003 in our U .S . Consumer segment. Sales of stand-alone products accountedfor 26% of our U .S . Consumer segment net sales in 2003, compared to 23% in 2002 . Software net sales in our U .S Consumer segment increased by $14 .9million, or 21%, from $69 .9 million in 2002 to $84 .8 million in 2003 . Sales of software products accounted for 31% of our U .S . Consumer segment net sales in

2003, compared to 29% of our U.S . Consumer segment net sales in 2002 . Platform net sales in our U .S . Consumer segment increased by $2 .5 million, or 2%,from $113 .8 million in 2002 to $1 16 .3 million in 2003 . Sales of platforms were 43% of U .S. Consumer net sales in 2003 compared to 48% of total U .S.Consumer net sales in 2002 .

Education and Training. Our Education and Training segment's net sales increased by $12 .2 million, or 86%, from $14 .1 million in 2002 to $26 .3 millionin 2003 . This segment comprised 8% of total company net sales in 2003 and accounted for 19% of the increase in total company net sales . The increase in thissegment's net sales was primarily due to the growing success of our major products in the SchoolHouse division, especially the LeapTrack instruction andassessment system and our instructional book series, the increase in new classroom product offerings and the increased brand awareness from the adoption ofLeapFrog products by school districts around the United States .

International. Our International segment's net sales increased by $20 .1 million, or 68%, from $29.7 million in 2002 to $49 .8 million in 2003 . Foreign

currency exchange rates favorably impacted net sales by 8% due to stronger international currencies . This segment comprised 14% of total company net sales in2003 and accounted for 31% of the increase in total company net sales . The strong performance in our International segment was primarily due to increased salesin the United Kingdom and Canada, offset by a decrease in Japan . The sales increase in the United Kingdom and Canada was primarily due to larger marketpenetration resulting from more localized products and additional retail shelf space . The sales decrease in Japan was primarily due to the cancellation of ourtwo-year Quantum Pad sales program with Benesse Corporation in the first quarter of 2003 . We have an ongoing relationship with Benesse Corporation withfocus on our LeapPad platform and its related content .

Gross Profit

Gross profit increased by $38 .0 million, or 27%, from $143.3 million in 2002 to $18 1 . 3 million in 2003 . Gross profit margin increased from 50 .6°/n in 2002to 52 .0% in 2003 . Gross profit margin increased in our Education and Training and International segments, and declined in our U .S . Consumer segment .

16

Table of Content sGross profit for each segment and the related percentage of segment net sales were as follows :

Nine Months Ended Septemher 30 ,

2003 2002

%of %ofSegment Segment

Segment $(I) Net Sales $ ( t) Net Sales

U .S . Consumer $139 .4 51 .2% $123.4 51 .5 %Education and Training 15 .6 59.2% 7.6 53 .7 %

International 26 .3 52.8% 12.3 41 .5 %

Total Company $181 .3 52.0% $143 .3 50 .6 %

U.S. Consumer. Our U .S . Consumer segment's gross profit increased by $16 .0 million, or 13%, from $123 .4 million in 2002 to $139 .4 million in 2003 .Gross profit margin decreased from 51 .5% in 2002 to 51 .2% in 2003 . This segment represented 42% of the total company gross profit increase . The decrease in

gross profit margin in this segment was primarily due to higher royalty and warehousing expenses, partially offset by lower product costs .

Education and Training. Our Education and Training segment's gross profit increased by $8 .0 million, or 106%, from $7 .6 million in 2002 to $15 .6million in 2003 . Gross profit margin increased from 53 .7% in 2002 to 59 .2% in 2003 . This segment represented 21% of the total company gross profit increase .The increase in gross profit margin in this segment was primarily due to lower product cost, partially offset by higher warehousing expenses .

Internalional. Our International segment's gross profit increased by $14 .0 million, or 113%, from $12 .3 million 2002 to $26 .3 million in 2003 . Grossprofit margin increased from 41 .5% in 2002 to 52 .8% in 2003 . This segment represented 37% of the total company gross profit margin increase. The increase in

gross profit margin in this segment was primarily due to lower product cost .

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased by $12 .2 million, or 23%, from $54 .0 million in 2002 to $66 .2 million in 2003 . As a percentage ofnet sales, selling, general and administrative expenses remained flat at 19 .0% . The dollar increase year over year is primarily due to higher fixed compensationexpenses resulting from our worldwide expansion, offset by lower incentive compensation expenses .


Research and development expenses, which include content and product development expenses, increased by $1 .9 million, or 5%, from $39 .8 million in

2002 to $41 .7 million in 2003 . As a percentage of net sales, research and development expenses decreased from 14 .1% in 2002 to 12 .0% in 2003 .

Content development expenses increased by $1 .9 million, or 9%, from $21 .3 million in 2002 to $23 .2 million in 2003 . However, as a percentage of netsales, content development expenses decreased from 7 .5% in 2002 to 6 .6% in 2003 . The dollar increase in our content development expenses was primarily dueto our expanded assortment of content for use with our existing and new platforms .

Product development and engineering expenses remained flat at $18 .5 million. As a percentage of net sales, product development and engineeringexpenses decreased from 6 .5% in 2002 to 5 .3% in 2003 . Our core product development expenses increased by $3 .8 million, or 28% . The increase in core productdevelopment expenses year over year is primarily due to the development costs of our new platforms scheduled to be released in the fall of 2003, offset bydecreased website engineering expenses .

Advertising ExpenseAdvertising expense increased by $5 .3 million, or 25%, from $21 .0 million in 2002 to $26 .2 million in 2003 . As a percentage of net sales, advertising

expense increased from 7 . 4% in 2002 to 7 .5% in 2003 due to higher television advertising and higher advertising agency fees .

The increase in dollars year over year is prima ri ly due to incre ased print and television media advertising to promote brand awareness as a result of ourworldwide expansion.

17

Table of Content sDepreciation and Amortization Expenses

Depreciation and amortization expenses , which exclude depreciation of tooling and amortization of content development costs included in cost of sales,increased by $1 .3 million, or 27%, from $4. 8 million in 2002 , to $6 .1 million in 2003 . Asa percentage of net sales , depreciation and amortization expensesincreased from 1 .7% in 2002 to 1 .8% in 2003 . The dollar increase was primarily due to the depreciation of computers and software purchased to support ourworldwide expansion .

Income (Loss) From Operations

Our income from operations increased by $17 .3 million, or 73%, from $23 .8 million in 2002 to $41 .1 million in 2003 . As a percentage of net sales, ourincome from operations increased from 8 .4% in 2002 to 11 .8% in 2003 . The improvement in income or loss from operations in all three segments was primarilydue to increased sales and operating expense leverage .

Income or loss from operations for each segment and the related percentage of segment net sales were as follows :

Nine Months Ended September 30 ,

2003 2002

% of °/ ofSegment Segmen t

Segment S (1) Net Sales S()) Net Sale s

U .S . Consumer $30 .8 11 .3% $26.2 10 .9 %Education and Training (1 .3) (4.9)% (6.1) (43,3) %International 11 .6 23.2% 3.7 12 .3 %

Total Company $41 .1 11 .8% $23.8 8 .4 %

(1) In millions .

U.S. Consumer. Our U .S . Consumer segment's income from operations increased by $4 .6 million, or 18%, from $26.2 million in 2002 to $30 .8 million in2003 . As a percentage of net sales, income from operations increased from 10.9% in 2002 to 11 .3% in 2003 . The increase in operating income as a percentage ofnet sales compared to last year was primarily due to strong sales growth and operating expense leverage achieved .

Education and Training. Our Education and Training segment's loss from operations decreased by $4 .8 million, or 79%, from a loss of $6 .1 million in2002 to a loss of $1 .3 million in 2003 . As a percentage of net sales, loss from operations decreased from (43 .3)% in 2002 to (4.9)% in 2003 . The improvedoperating loss as a percentage of net sales compared to last year was primarily due to strong sales growth, improved gross margin profit and operating expenseleverage.

International. Our International segment's income from operations increased by $7 .9 million, or 216%, from $3 .7 million in 2002 to $11 .6 million in 2003 .As a percentage of net sales, income from operations increased from 12 .3% in 2002 to 23 .2% in 2003 . The increase in operating income year over year wasprimarily due to increased sales in the United Kingdom and Canada combined with improved gross profit margin, offset by decreased sales to BenesseCorporation in Japan and higher operating expenses due to our worldwide expansion .

Other

Net interest income (expense) increased by $1 .3 million from expense of $0.4 million in 2002 to income of $1 .0 million in 2003 . This increase wasprimarily due to higher invested average cash balances and the elimination of our debt.

Other income increased by $2.9 million due primarily to the one-time payment received from Benesse Corporation and net foreign exchange gains relatedto our European operations . The payment received from Benesse Corporation was in connection with the early cancellation of our Quantum Pad sales contractrelated to a discontinued direct-to-home program for Benesse's middle school subscribers .

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Table of Content sOur effective income tax rates were 36.8% and 40 .0% for the nine months of 2003 and 2002, respectively. The decline in the effective tax rate was

primarily due to research and development tax credits . We expect our annual tax rate to be approximately 37 .5% for 2003 .

Ner Incom e

Net income increased $14 .4 million, or 102%, from $14.1 million for the nine months ended September 30. 2002 to $28 .5 million for the nine monthsended September 30 . 2003. As a percentage of net sales, net income increased from 5 .0% in the nine months ended September 30. 2002 to 8 .2% in the nine

months ended September 30 . 2003 .

SEASONALITY

Our business is subject to significant seasonal fluctuations . The substantial majority of our net sales and all of our net income are realized during the thir d

and fourth calendar quarters . In addition, our quarterly results of operations have fluctuated significantly in the past, and can be expected to continue to fluctuatesignificantly in the future, as a result of many factors, including : seasonal influences on our sales, such as the holiday shopping season and back-to-schoolpurchasing ; unpredictable consumer preferences and spending trends ; the need to increase inventories in advance of our primary selling season ; timing of orders

by our customers and timing of introductions of our new products . For a discussion of these and other factors affecting seasonality, see "Our business is seasonal,and therefore our annual operating results will depend, in large part, on sales relating to the brief holiday season" and "Our quarterly operating results aresusceptible to fluctuations that could cause our stock price to decline" under the heading "Risk Factors Thai May Affect Our Results and Stock Price ."

LIQUIDITY AND CAPITAL RESOURCE SNet cash provided by operating activities was $14 .7 million for the nine months ended September 30, 2003, compared to $5 .1 million for the comparable

period in 2002 . The $9 .6 million increase in net cash provided by operating activities as compared to the same period in the prior year was due primarily toincreased net income. Cash, cash equivalents and short-tenn investments were $97 .8 million at September 30, 2003, an increase of $24 .5 million from $73 .3

million at December 31, 2002 and an increase of $40 .0 million from $57 .8 million at September 30, 2002 . The $24 .5 million increase from December 31, 2002was primarily due to proceeds from the exercise of stock options and net income from operations, partially offset by seasonal increases in inventory purchases .

The $40.0 million increase from September 30, 2002 was primarily due to net income from operations and proceeds from the exercise of stock options, offset byincreased purchases of inventory to support our sales growth and purchases of property and equipment . Accounts receivable decreased to $155 .4 million atSeptember 30, 2003, from $169.7 million at December 31, 2002, due primarily to the seasonality of sales, and increased from $130 .1 million at September 30,

2002, due to increased sales . Allowances for accounts receivable were $10 .0 million at September 30, 2003, compared to $16 .4 million at December 31, 2002,and $11 .3 million at September 30, 2002,

Net inventories were $1 19 .5 million, $84 .5 and $92 .3 million at September 30, 2003, December 31, 2002, and September 30, 2002, respectively . Netinventory at September 30, 2003 has increased 29% from September 30, 2002 as compared to third quarter year over year sales growth of 23% . We believe ourinventory position and scheduled production level is appropriate to support our projected sales for the 2003 holiday season . We typically commit to inventory

production, content development and advertising expenditures prior to the peak third and fourth quarter retail selling season . These timing differences betweenexpenditures and the related cash collection negatively impact our cash flow during the year, particularly in the second half .

Net cash used in investing activities was $29 .2 million in the nine months ended September 30, 2003, compared to $11 .6 million in the same period in

2002 . The primary components of net cash used in investing activities in 2003 were purchases of $19 .7 million of short-term investments, $13 .2 million of

property and equipment and $3 .0 million of intangible assets, offset by sales of $6 .5 million of short-term investments . In 2002, the $11 .6 million used ininvesting activities related primarily to purchases of $ l 1 .4 million of property and equipment and $0 .2 million of intangible assets .

Net cash provided by financing activities was $25 .8 million in the nine months ended September 30, 2003, compared to $56 .0 million in the same period in

2002. Net cash provided by financing activities in 2003 related to proceeds received from stock option exercises andpurcltases through our employee stock

purchase plan of $23 .2 million and the $2 .6 million payment of notes receivable from stockholders . In 2002, net cash provided by financing activities wasprimarily related to $115 .1 million in proceeds received from our July 2002 initial public offering of our Class A common stock, offset by the repayment of $61 .2

million in borrowings, which includes the $34 .1 million repayment of our entire outstanding long term debt balance on July 30, 2002 .

Table of ContentsOn December 31, 2002, we entered into a $30 .0 million three-year unsecured senior credit facility, with an option to increase the facility to $50 .0 million,

for working capital purposes . The agreement requires that we comply with certain financial covenants, including the maintenance of a minimum quick ratio on aquarterly basis and a minimum level of "earnings before interest, tax, depreciation and amortization" or EBITDA, as such term is defined in the credit facilityagreement, on a rolling quarterly basis . We were in compliance with these covenants at September 30, 2003 . The level of a certain financial ratio maintained by

us determines the interest rates on borrowings. The interest rate will be between prime and prime plus 0.25% or LIBOR plus 1 .25% and LIBOR plus 2 .00%. AtSeptember 30, 2003 and 2002, we had outstanding letters of credit of $0.3 million and $1 .7 million, respectively. At September 30, 2003, $29 .7 million of unusedborrowings were available to us .

We conduct our corporate operations from leased facilities and lease some equipment under operating leases, Generally, our leased facilities and operatingleases have initial lease periods of three to ten years and contain provisions for renewal options of five years at market rates .

We estimate that our capital expenditures for 2003 will be between $15 .0 million and $17.0 million, as compared to $14 .8 million in 2002 . Capitalexpenditures, in both years, consist primarily of manufacturing tools, computers and software, and capitalization of external costs of developing content for ourplatforms . We review our capital expenditure program periodically and modify it as required to meet current business needs .

We believe our existing cash and short lean investments and anticipated cash flow from operations will be sufficient to meet our working capital andcapital requirements through at least 2004 .

RISK FACTORS THAT MAY AFFECT OUR RESULTS AND STOCK PRIC E

Our business and our stock price are subject to many risks and uncertainties that may affect our future financial performance. Some of the risks anduncertainties that may cause our operating results to vary or that may materially and adversely affect our operating results are as follows :

If we fail to predict consumer preferences and trends accurately, develop and introduce new products rapidly or enhance and extend our existing coreproducts, our sales will suffer.

Sales of our platforms, related software and stand-alone products typically have grown in the periods following initial introduction, but we expect sales ofspecific products to decrease as they mature . The introduction of new products and the enhancement and extension of existing products, through the introductionof additional software or by other means, are critical to our future sales growth . The successful development of new products and the enhancement and extensionof our current products will require us to anticipate the needs and preferences of consumers and educators and to forecast market and technological trendsaccurately . Consumer preferences, and particularly children's preferences, are continuously changing and are difficult to predict . In addition, educationalcurricula change as states adopt new standards. The development of new interactive learning products requires high levels of innovation and this process can belengthy and costly . To remain competitive, we must continue to develop enhancements of our NearTouch and other technologies successfully. By the end of2003, we intend to introduce a significant number of new platforms, stand-alone products and interactive books and other software for each of our three businesssegments . We cannot assure you that these or other fitture products will be introduced or, if introduced, will be successful . The failure to enhance and extend ourexisting products or to develop and introduce new products that achieve and sustain market acceptance and produce acceptable margins would harm our businessand operating results .

Our business is seasonal, and therefore our annual operating results will depend, in large part, on sales relating to the brief holiday season .

Sales of consumer electronics and toy products in the retail channel are highly seasonal, causing the substantial majority of our sales to U .S . retailers tooccur during the third and fourth quarters. In 2002, approximately 81% of our total net sales occurred during this period . This percentage of total sales mayincrease as retailers become more efficient in their control of inventory levels through just-in-time inventory management systems . Generally, retailers timetheir orders so that suppliers like us will fill the orders closer to the time of purchase by consumers, thereby reducing their need to maintain larger on-handinventories throughout the year to meet demand . While these techniques reduce retailers' investments in their inventory, they increase pressure on suppliers to fillorders promptly and shift a significant portion of inventory risk and carrying costs to suppliers like us . The logistics of supplying more product within shortertime periods will increase the risk that we fail to meet tight shipping schedules, which could damage our relationships with retailers, increase our shipping costsor cause sales opportunities to be delayed or lost . The seasonal pattern of sales in the retail channel requires significant use of our working capital to manufactureand carry inventory in anticipation of the holiday season, as well as early and accurate forecasting of holiday sales . Failure to predict accurately and respondappropriately to consumer demand on a timely basis to meet seasonal fluctuations, or any disruption of consumer buying habits during this key period, wouldharm our business and operating results.

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Table of Content sWe rely on a limited number of manufacturers , virtually all of which are located in China, to produce our finished products, and our reputation andoperating results could be harmed if they fall to produce quality products in a timely manner and in sufficient quantities.

We outsource substantially all of our finished goods manufacturing to eight manufacturers, all of whom manufacture our products at facilities in theGuangdong province in the southeastern region of China . For example, Jetta Company Limited was the sole manufacturer of all our LeapPad platforms in 2002 .We depend on these manufacturers to produce sufficient volumes of our products in a timely fashion and at satisfactory quality levels . We generally allow

retailers and distributors to return or receive credit for defective or damaged products . If our manufacturers fail to produce quality products on time and insufficient quantities due to capital shortages, late payments from us, political instability, labor shortages, intellectual property disputes, natural disasters, energyshortages, terrorism or other disruptions to their businesses, our reputation and operating results would suffer . In addition, if our manufacturers decide to increase

production for their other customers, they may be unable to manufacture sufficient quantities of our products and our business could be harmed .

Outbreaks of Severe Acute Respiratory Syndrome, or SARS, may adversely impact our business or the operations of our contract manufacturers or oursuppliers .

In the past, outbreaks of SARS have been significantly focused on Asia, particularly in I long Kong, where we have an office, and in the Guangdongprovince of China, where almost all of our finished goods manufacturers are located . The design, development and manufacture of our products could suffer if asignificant number of our employees or the employees of our manufacturers or their suppliers contract SARS or otherwise are unable to fulfill theirresponsibilities. In the event of any significant outbreak, quarantine or other disruption, we may be unable to quickly identify or secure alternate suppliers ormanufacturing facilities and our results of operations would be adversely affected .

Our products are shipped from China and any disruption of shipping could harm our business .

We rely on four contract ocean carriers to ship virtually all of the products that we import to our primary distribution centers in California . Retailers thatlake delivery of our products in China rely on a variety of carriers to import those products. Any disncption or slowdown of service on importation of productscaused by SARS-related issues, labor disputes, terrorism , international incidents, quarantines, lack of available shipping containers or otherwise could

significantly harm our business and reputation . For example, in 2002, a key collective bargaining agreement between the Pacific Maritime Association and theInternational Longshore and Warehouse Union affecting shipping of products to the Western United Slates, including our products, expired and, after atemporary extension, resulted in an eleven-day cessation of work at West Coast docks . This cessation of work cost us approximately $3 .0 million in additional

freight expenses. Although the Pacific Maritime Association and International Longshore and Warehouse Union have entered into a new collective bargainingagreement, any further disruption or slowdown of service on importation of products caused by labor disputes, terrorism, international incidents, lack of availableshipping containers or otherwise could significantly harm our business and reputation .

It we are unable to compete effectively with existing or new competitors , our sales and market share could decline .We currently compete primarily in the infant and toddler and preschool categories and electronic learning aids category of the U .S . toy industry and, to

some degree, in the overall U .S . and international toy industry . Our Schooll-louse division competes in the supplemental educational materials market . Each ofthese markets is very competitive and we expect competition to increase in the future . For example, in July 2003, Mattel, Inc . introduced under its Fisher-Pricebrand a product called "PowerTouch" having functionality similar to that of our LeapPad platform . We believe that we are beginning to compete , and willincreasingly compete in the future, with makers of popular game platforms and smart mobile devices such as personal digital assistants . These companies arewell situated to compete effectively in our primary markets . Additionally, we are beginning to cross over into their markets with products such as our Leapsterplatform and iQuest handheld device . Many of our direct, indirect and potential competitors have significantly longer operating histories, greater brandrecognition and substantially greater financial, technical and marketing resources than we do . These competitors may be able to respond more rapidly than wecan to changes in consumer requirements or preferences or to new or emerging technologies . They may also devote greater resources to the development,promotion and sale of their products than we do . We cannot assure you that we will be able to compete effectively in our markets .

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Table of ContentsOur quarterly operating results are susceptible to fluctuations that could cause our stock price to decline .

Historically, our quarterly operating results have fluctuated significantly . For example, our net income (loss) for the first through fourth quarters of 2002was $(5 .1) million, $(7 .5) million, $26 .7 million and $29 .4 million, respectively. Our net income (loss) for the first through third quarters of 2003 was $(1 .0)million, $(3 .9) million and 533 .4 million, respectively . We expect these fluctuations to continue for a number of reasons, including :

• seasonal influences on our sales, such as the holiday shopping season and back-to-school purchasing ;

• unpredictable consumer preferences and spending trends ;

• the need to increase inventories in advance of our primary selling season ;

• timing of new product introductions ;

• general economic conditions ;

changes in our pricing policies, the pricing policies of our competitors and general pricing tr ends in consumer electronics and toy markets ;

• international sales volume and the mix of such sales among countries with similar or different holidays and school years than the United States ;

• the impact of strategic relationships ;

• the sales cycle to schools, which may be uneven depending on budget constraints, the timing of purchases and other seasonal influences ; an d

• the timing of orders by our customers and our ability to fulfill those orders in a timely manner , or at all .

We expect that we will continue to incur losses during the first and second quarters of each year for the foreseeable future . We do not have sufficientoperating experience to predict the overall effect of various seasonal factors and their effect on our future quarterly operating results . If we fail to meet ourprojected net sales or other projected operating results, or if we fail to meet analysts' or investors' expectations, the market price of our Class A common stockcould decrease ,

We currently rely, and expect to continue to rely, on our LeapPad platform and related Interactive books for a significant portion of our sales .Our LeapPad platform and related interactive books accounted for approximately 48% of our net sales in 2002 . No other product line, together with its

related software, accounted for more than approximately 10% of our net sales in 2002 . A significant portion of our future sales will depend on the continuedcommercial success of our LeapPad platform and related interactive books . If the sales for our LeapPad platform are below expected sales or if sales of ourLeapPad interactive books do not grow as we anticipate, sales of our other products may not be able to compensate for these shortfalls and our overall saleswould suffer .

Our business depends on three retailers that together accounted for approximately 69% of our net sales in 2002, and our dependence upon a smallgroup of retailers may increase .

Wal-Mart (including Sam's Club), Toys "R" Us and Target accounted in the aggregate for approximately 69% of our net sales in 2002 . We expect that asmall number of large retailers will continue to account for a significant majority of our sales and that our sales to these retailers may increase as a percentage of

our total sales . At December 31, 2002, Wal-Mart (including Sam's Club) accounted for approximately 33% of our accounts receivable and Toys "R" Usaccounted for approximately 30% of our accounts receivable . If any of these retailers experience significant financial difficulty in the future or otherwise fail tosatisfy their accounts payable, our allowance for doubtful accounts receivable could be insufficient . If any of these retailers reduce their purchases from us,change the terms on which we conduct business with them or experience a future downturn in their business, our business and operating results could be harmed .

We do not have long- term agreements with our retailers and changes in our relationships with retailers could significantly harm our business andoperating results.

We do not have long-term agreements with any of our retailers . As a result, agreements with respect to pricing, shelf space, cooperative advertising orspecial promotions, among other things, are subject to periodic negotiation with each retailer. Retailers make no binding long-term commitments to us regardingpurchase volumes and make all purchases by delivering one-time purchase orders . If the number of our products increases as we have planned or the roll out ofversions of our Learning Center shelf displays in selected retail stores proceeds as we anticipate, we will require more retail shelf space to display our variousproducts. Any retailer could reduce its overall purchases of our products, reduce the number and variety of our products that it carries and the shelf space allottedfor our products, decide not to incorporate versions of our Learning Center shelf displays in its stores or otherwise materially change the terms of our currentrelationship at any time . Any such change could significantly harm our business and operating results.

Our future growth will depend in part on our SchoolHouse division , which may not be successful .We launched our Schoolhouse division in June 1999, and to date the division, which accounts for substantially all of the results of our Education and

Training segment, has incurred cumulative losses . Although the division reported an

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Table of Content soperating profit for the second quarter of 2003, it incurred an operating loss in the third quarter of 2003 and we anticipate that it will incur additional operatinglosses in the near term . Sales from our SchoolHouse division's curriculum -based products will depend principally on broadening market acceptance of thoseproducts, which in turn depends on a number of factors, including :

• our ability to demonstrate to teachers and other key educational institution decision-makers the usefulness of our products to supplement traditionalteaching practices ;

• the willingness of teachers, administrators , parents and students to use products in a classroom setting from a company that may be perceived as a toymanufacturer;

• the effectiveness of our sales force, particularly since we rely on independent sales representatives ;

• the availability of state and federal government funding, which may be severely limited due to budget shortfalls currently faced by many states andthe federal government, to defray, subsidize or pay for the costs of our products ; and

• our ability to demonstrate that our products improve academic performance.

If we cannot increase market acceptance of our Schoolhouse division's supplemental educational products, including our LeapTrack assessment systemintroduced in Fall 2002, the division may not be able to achieve operating profits on a full-year basis and our future sales could suffer . As of December 31, 2001,we had capitalized $3 .5 million of our content development costs relating to our SchoolHouse division . In 2002 we capitalized an additional $3 .1 million . For thenine months ended September 30, 2003, we capitalized approximately $1 .2 million, If the SchoolHouse division does not continue to achieve operating profits,we may have to write off some or all ofthese capitalized costs, which could significantly harm our operating results .

Our planned expansion into additional international markets may not succeed and our future operating results could be harmed by economic , political,regulatory and other risks associated with international sales and operations .

We have limited experience with sales operations outside the United States . In January 2000, we expanded beyond the use of international distributors tosell our products and started selling our products directly to retailers in the United Kingdom . We began selling directly to retailers in Canada in June 2002, toretailers in France in July 2002, and to retailers in Mexico in September 2003, and we plan to enter the German-speaking markets in Europe through ourdistributor, Stadlbauer Marketing + Vertrieb G .m.b .H ., in the second half of 2004. We derived approximately 10% of our net sales from outside the United Statesin 2002 and 5% in 2001 . We intend to increase our international sales through additional overseas offices to develop further our direct sales efforts, distributorrelationships and strategic relationships with companies with operations outside of the United States, such as Benesse Corporation and Sega Toys in Japan .However, these and other efforts may not help increase sales of our products outside the United States. Our business is, and will increasingly be, subject to risksassociated with conducting business internationally, including :

• political and economic instability, military conflicts and civil unrest ;

• existing and future governmental policies ;

. greater difficulty in staffing and managing foreign operations ;

• complications in modifying our products for local markets or in complying with foreign laws, including consumer protection laws and local languagelaws ;

• transport ation delays and interruptions;

• greater difficulty enforcing intellectual property rights and weaker laws protecting such rights;

• trade protec tion measures and import or export licensing re qui re ments ;

• currency conversion risks and currency fluctuations;

• longer payment cycles, different accounting practices and problems in collecting accounts receivable ; and

• limitations , including taxes, on the repatriation of earnings .

Any difficulty with our intern ational operations could harm our future sales and operating results .

Third parties have claimed , and may claim in the future, that we are infringing their intellectual property rights, which may cause us to incursignificant litigation or licensing expenses or to stop setting some or all of our products or using some of our trademarks .

In the course of our business, we periodically receive claims of infringement or otherwise become aware of potentially relevant patents, copyrights,trademarks or other intellectual property rights held by other parties . Upon receipt of this type of com munication, we evaluate the validity and applicability ofallegations of infringement of intellectual property rights to determine whether we must negotiate licenses or cross-licenses to incorporate or use the proprietarytechnologies or trademarks or other proprietary matters in or on our products . Any dispute or litigation regarding patents, copyrights, trademarks or otherintellectual property rights, regardless of its outcome, may be costly and time-consuming ,

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Table of Contentsand may divert our management and key personnel from our business operations . If we, our distributors or our manufacturers are adjudged to be infringing theintellectual property rights of any third party, we or they may be required to obtain a license to use those rights, which may not be obtainable on reasonableterms, if at all . We also may be subject to significant damages or injunctions against the development and sale of some or all of our products or against the use ofa trademark in the sale of some or all of our products . Our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all

the liability that could be imposed . We may presently be unaware of intellectual properly rights of others that may cover some or all of our technology orproducts . We will continue to be subject to infringement claims as we increase the number and type of products we offer, as the number of products, services andcompetitors in our markets grow, as we enter new markets and as our products receive more attention and publicity . If we fail to be successful against these

claims, it could require us to stop selling our LeapPad and other platforms and to pay damages .

Our intellectual property rights may not prevent our competitors from using our technologies or similar technologies to develop competing products,which could weaken our competitive position and harm our operating results .

Our success depends in large part on our proprietary technologies that are used in our My First LeapPad, LeapPad, LeapPad Plus Writing and QuantumPad platforms, as well as our Explorer and Odyssey interactive globe series. We rely, and plan to continue to rely, on a combination of patents, copyrights,trademarks , trade secrets, confidentiality provisions and licensing arrangements to establish and protect our proprietary rights . We have entered intoconfidentiality and invention assignment agreements with our employees and contractors, and nondisclosure agreements with selected parties with whom weconduct business to limit access to and disclosure of our proprietary information . These contractual arrangements and the other steps we have taken to protect ourintellectual property may not prevent misappropriation of our intellectual property or deter independent third-party development of similar technologies . Forexample, we are aware that products very similar to some of ours have been produced in China, and we are vigorously seeking to enforce our rights. However,

we may not be able to enforce our intellectual property rights, if any, in China or other countries where such product may be manufactured or sold . Monitoringthe unauthorized use of our intellectual property is costly, and any dispute or other litigation, regardless of outcome, may be costly and time-consuming and maydivert our management and key personnel from our business operations . The steps we have taken may not prevent unauthorized use of our intellectual property,particularly in foreign countries where we do not hold patents or trademarks or where the laws may not protect our intellectual property as fully as in the UnitedStates . Some of our products and product features have limited intellectual property protection, and, as a consequence, we may not have the legal right to preventothers from reverse engineering or otherwise copying and using these features in competitive products . if we fail to protect or to enforce our intellectual propertyrights successfully, our rights could be diminished and our competitive position could suffer, which could harm our operating results .

We do not have long-term agreements with our manufacturers and suppliers, and they may stop manufacturing our products or components at anytime .

We presently order our products on a purchase order basis from our manufacturers and component suppliers, and we do not have long-term manufacturing

agreements with any of them . The absence of long-term agreements means that, with little or no notice, our manufacturers and suppliers could refuse tomanufacture some or all of our products or components, reduce the number of units of a product or component that they will manufacture or change the termsunder which they manufacture our products or components . If our manufacturers and suppliers stop manufacturing our products or components, we maybeunable to find alternative manufacturers or suppliers on a timely or cost-effective basis, if at all, which would harm our operating results . In addition, if any of

our manufacturers or suppliers changes the terms under which they manufacture for us, our costs could increase and our profitability would suffer .

We depend on our suppliers for our components, and our production would be seriously harmed if these suppliers are not able to meet our demand andalternative sources are not available .

Some of the components used to make our products, including our application-specific integrated circuits, or ASICs, currently come from a singlesupplier . Additionally, the demand for some components such as liquid crystal displays, integrated circuits or other electronic components is volatile, which maylead to shortages . If our suppliers are unable to meet our demand for our components and if we are unable to obtain an alternative source or if the price availablefrom our current suppliers or an alternative source is prohibitive, our ability to maintain timely and cost-effective production of our products would be seriouslyharmed and our operating results would suffer .

If we do not correctly anticipate demand for parti cular products, we could incur additional costs or experience manufacturing delays, which wouldreduce our gross margins or cause us to lose sales .

Historically, we have seen steady increases in demand for our products and have generally been able to incre as e

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Table of Content sproduction to meet that demand . However, the demand for our products depends on many factors such as consumer preferences, including children's preferences,and the introduction or adoption of new hardware platforms for interactive educational products, and can be difficult to forecast . We expect that it will becomemore difficult to forecast demand for specific products as we introduce and support additional products, enter additional markets and as competition in ourmarkets intensifies . If we misjudge the demand for our products, we could face the following problems in our operations, each of which could harm our operatingresults:

If our forecasts of demand are too high, we may accumulate excess inventories of components and Finished products, which could lead to markdownallowances or write-offs affecting some or all of such excess inventories . We may also have to adjust the prices of our existing products to reducesuch excess inventories .

• If demand for specific products increases beyond what we forecast, our suppliers and third-party manufacturers may not be able to increaseproduction rapidly enough to meet the demand . Our failure to meet market demand would lead to missed opportunities to increase our base of users,damage our relationships with retailers and harm our business .

• Rapid increases in production levels to meet unanticipated demand could result in increased manufacturing errors , as well as higher component,manufacturing and shipping costs, all of which could reduce our profit margins and harm our relationships with retailers and consumers .

Any errors or defects contained in our products , or our failure to comply with applicable safety standards, could result in delayed shipments orrejection of our products , damage to our reputation and expose us to regulatory or other legal action .

We have experienced, and in the future may experience, delays in releasing some models and versions of our products due to defects or errors in ourproducts. Our products may contain errors or defects after commercial shipments have begun, which could result in the rejection of our products by our retailers,damage to our reputation, lost sales, diverted development resources and increased customer service and support costs and warranty claims, any of which couldharm our business . Children could sustain injuries from our products, and we may be subject to claims or lawsuits resulting from such injuries . There is a riskthat these claims or liabilities may exceed, or fall outside the scope of, our insurance coverage . Moreover, we may be unable to retain adequate liability insurancein the future . We are subject to regulation by the Consumer Product Safety Commission, or CPSC, and similar state regulatory authorities, and our productscould be subject to involuntary recalls and other actions by such authorities. Concerns about potential liability may lead us to recall voluntarily selected products.In December 2000, the CPSC announced our voluntary repair program for the approximately 900,000 units of our Alphabet Pal product sold prior to that dale .

We had instituted the repair proceedings with the CPSC because we were concerned that the product could cause, injury . Our costs in connection with the repairwere approximately $1 .1 million . Any recalls or post-manufacture repairs of our products could harm our reputation, increase our costs or reduce our net sales .

Our rapid growth has presented significant challenges to our management systems and resources, and we may experience difficulties managing ourgrowth .

Since the introduction of our first platform, we have grown rapidly, both domestically and internationally . Our net sales have grown from $7 1 .9 million in

1999 to $531 .8 million in 2002. During this period, the number of different products we offered at retail also increased significantly. At December 31, 1999, wehad 85 employees and at December 31, 2002, we had 690 employees . In addition, we plan to hire a significant number of new employees in 2004. Thi sexpansion has presented, and continues to present, significant challenges for our management systems and resources . If we fail to develop and maintainmanagement systems and resources sufficient to keep pace with our planned growth, our operating results could suffer .

Changes in economic conditions , which can result in reduced demand for our products or higher prices for necessary commodities , could harm ourbusiness and operating results .

Recent weak economic conditions in the United States and elsewhere have adversely affected consumer confidence and consumer sales generally. Inaddition, the September 11, 2001 terrorist attacks significantly and negatively affected general economic conditions . Any future attacks and the responses to suchattacks, including military action in the Middle East, or other significant events could further impact the economy . Further weakening of the economy coulddamage our sales in our U .S. Consumer and other segments . Other changes in general economic conditions, such as greater demand or higher prices for plastic,electronic components, liquid crystal displays and fuel, may delay manufacture of our products, increase our costs or otherwise harm our margins and operatingresults .

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Table of Content sEarthquakes or other events outside of our control may damage our facilities or the facilities of third parties on which we depend .

Our two primary U .S . distribution centers, our Silicon Valley engineering office and our corporate headquarters are located in California near majorearthquake faults that have experienced earthquakes in the past . An earthquake or other natural disasters could disrupt our operations . Additionally, the loss ofelectric power, such as the temporary loss of power caused by power shortages in the grid servicing our facilities in California, could disrupt operations or impaircritical systems . Any of these disruptions or other events outside of our control could impair our distribution of products, damage inventory, interrupt criticalfunctions or otherwise affect our business negatively, harming our operating results . Our existing earthquake insurance relating to our distribution center may beinsufficient and does not cover any of our other operations. If the facilities of our third party finished goods or component manufacturers are affected byearthquakes, power shortages, floods, monsoons, terrorism or other events outside of our control, our business could suffer.

We are subject to international, federal , state and local laws and regulations that could impose additional costs on the conduct of our business .

In addition to being subject to regulation by the CPSC and similar state regulatory authorities, we must also comply with other laws and regulations . TheChildren's Online Privacy Protection Act, as implemented, requires us to obtain verifiable, informed parental consent before we collect, use or disclose personalinformation from children under the age of 13 . Additionally, the Robinson-Patman Act requires us to offer non-discriminatory pricing to similarly situatedcustomers and to offer any promotional allowances and services to competing retailers and distributors within their respective classes of trade on proportionallyequal terms . Our SchoolHouse division is affected by a number of laws and regulations regarding education and government funding . We are subject to othervarious laws, including international and U .S . immigration laws, wage and hour laws and laws regarding the classification of workers . Compliance with theseand other laws and regulations impose additional costs on the conduct of our business, and failure to comply with these and other laws and regulations or changesin these and other laws and regulations may impose additional costs on the conduct of our business .

Knowledge Universe, L .L .C ., Lawrence J. Ellison, Michael R . Milken and Lowell J . Milken , together control all stockholder voting power as well as thecomposition of our board of directors .

Holders of our Class A common stock will not be able to affect the outcome of any stockholder vote . Our Class A common stock entitles its holders to onevote per share, and our Class B common stock entitles its holders to ten votes per share on all matters submitted to a vote of our stockholders . As of November 4,2003, Lawrence J . Ellison and entities controlled by him, Michael R . Milken, Lowell J . Milken, and Knowledge Universe (which is controlled by Messrs .Milken, Milken and Ellison) and its affiliates, or, collectively, the "KU Control Group," in the aggregate beneficially owned approximately 28 .9 million shares ofour Class B common stock, which represents approximately 90 .6% of the combined voting power of our Class A common stock and Class B common stock . A sa result , the KU Control Group controls all stockholder voting power, including with respect to :

• the composition of our board of directors and, through it, any determination with respect to our business direction and policies , including theappointment and removal of officers ;

any determinations with respect to mergers, other business combinations , or changes in control ;

• our acquisition or disposition of assets ;

• our financing activities; and

• the payment of dividends on our capital stock, subject to the limitations imposed by our credit facility .

This control by the KU Control Group could depress the market price of our Class A common stock or delay or prevent a change in control of LeapFrog .The KU Control Group is not prohibited from selling a controlling interest in us to a third party and can do so without requiring a buyer to acquire any of our

Class A common stock.

Lawrence J . Ellison, Michael R . Milken and Lowell J . Milken may each be deemed to control Knowledge Universe . As a result, Lawrence J . Ellison,

Michael R . Milken and Lowell J. Milken may each be deemed to have or share the power to direct the voting and disposition, and therefore to have beneficialownership, of shares of our capital stock owned directly or indirectly by Knowledge Universe.

Conflicts of interest may arise between our controlling stockholders and us .Four of our nine directors are officers or directors of Knowledge Universe or its affiliates other than us . Our directors who are also officers or directors of

Knowledge Universe or its other affiliates will have obligations to and interests in these companies as well as in us, and conflicts or potential conflicts of interestmay result for these board members . Lawrence J. Ellison, Michael R. Milken and Lowell J . Milken formed Knowledge Universe to build, through a combinationof internal development and acquisitions, leading companies in areas relating to education, technology and career management and the improvement o f

individual and corporate performance. Knowledge Universe has formed, invested in or acquired, and in the future may form, invest in or acquire, otherbusinesses that are involved in these and

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Table of Contentsrelated areas, which businesses may be operated under the control of Knowledge Universe independently of us . Conflicts of interest between KnowledgeUniverse and its controlling owners and other affiliates and us may arise, and such conflicts of interest may not be resolved in a manner favorable to us, includingpotential competitive business activities, corporate opportunities, indemnity arrangements, registration rights, sales or distributions by Knowledge Universe or itsaffiliates of our common stock and the exercise by Knowledge Universe and its controlling owners of their ability to control our management and affairs . Ourcertificate of incorporation does not contain any provisions designed to facilitate resolution of actual or potential conflicts of interest, or to ensure that potentialbusiness opportunities that may become available to both Knowledge Universe or its other affiliates and us will be reserved for or made available to us . Pertinentprovisions of law will govern any such matters if they arise .

The limited voting rights of our Class A common stock could negatively affect its attractiveness to investors and its liquidity and, as a result , its marketvalue .

The holders of our Class A and Class B common stock generally have identical rights, except that holders of our Class A common stock are entitled to onevote per share and holders of our Class B common stock are entitled to ten votes per share on all matters to be voted on by stockholders . The holders of our ClassB common stock have various additional voting rights, including the right to approve the issuance of any additional shares of Class B common stock and anyamendment of our certificate of incorporation that adversely affects the rights of our Class B common stock. The difference in the voting rights of our Class Acommon stock and Class B common stock could diminish the value of our Class A common stock to the extent that investors or any potential future purchasersof our Class A common stock attribute value to the superior voting or other rights of our Class B common stock .

Provisions in our charter documents and Delaware law may delay or prevent an acquisition of our company, which could decrease the value of ourClass A common stock.

Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it harder for a third party to acquire us without theconsent of our board of directors . These provisions include limitations on actions by our stockholders by written consent and the voting power associated withour Class B common stock . In addition, our board of directors has the right to issue preferred stock without stockholder approval, which could be used by ourboard of directors to effect a rights plan or "poison pill" that could dilute the stock ownership of s potential hostile acquirer and may have the effect of delaying,discouraging or preventing an acquisition of our company . Delaware law also imposes some restrictions on mergers and other business combinations between usand any holder of 15% or more of our outstanding voting stock. Although we believe these provisions provide for an opportunity to receive a higher bid byrequiring potential acquirers to negotiate with our board of directors, these provisions apply even if the offer may be considered beneficial by some stockholders .

Our stockholders may experience significant additional dilution upon the exercise of options .

As of November 4, 2003, there were outstanding under our equity incentive plans options to purchase a total of approximately 6 .7 million shares of ClassA common stock . Contemporaneous with our initial public offering, we registered approximately 17 .4 million shares of Class A common stock issuable underour equity incentive plans, which includes the shares issuable upon exercise of all of our options outstanding as of the date of our initial public offering as well asoptions to be granted in the future . To the extent we issue shares upon the exercise of any of these options, investors in our Class A common stock willexperience additional dilution .

Sales of our shares could negatively affect the market price of our stock .

Sales of substantial amounts of shares in the public market could harm the market price of our Class A common stock . We had approximately 58 .8 millionshares of Class A common stock outstanding as of November 4, 2003, assuming the conversion of all outstanding Class B common stock into Class A commonstock, and assuming no exercise of our then-outstanding options . A substantial number of these 58 .8 million shares are restricted securities as defined by Rule144 adopted under the Securities Act . These shares may be sold in the public market after the date of our initial public offering only if registered or if they

qualify for an exemption from registration under Rule 144 or Rule 701 adopted under the Securities Act . We cannot predict the effect that future sales madeunder Rule 144, Rule 701 or otherwise will have on the market price of our Class A common stock .

Item 3 . Quantitative and Qualitative Disclosures About Market Risk .

We develop products in the United States and market our products primarily in North America and, to a lesser extent, in Europe and the rest of the world .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 . Becausealmost all of our revenues are currently denominated in U .S . dollars, a strengthening of the dollar could make our products less competitive in foreign markets .We

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Table of Contentsare billed by and pay our third-party manufacturers in U .S . dollars . In the three and nine months ended September 30, 2003, we experienced net foreign currencyexchange gains of $0 .4 million and $1 .2 million, respectively . In the comparable periods in 2002, exchange rate fluctuations had little impact on our operatingresults .

Cash equivalents and short-tenn investments are presented at fair value on our balance sheets. We invest our excess cash in accordance with ourinvestment policy . Any adverse changes in interest rates or securities prices may Kann the valuation of our short term investments and operating results . AtSeptember 30, 2003 our cash was invested primarily in municipal money market funds and investment grade short term fixed income municipal securities, thecarrying value of which approximate market value .

We are exposed to market risk from changes in interest rates on our outstanding bank debt . The level of a certain financial ratio maintained by LeapFrogdetermines interest rates we pay on borrowings. The interest rate will be between prime and prime plus 0 .25% or LIBOR plus 1 .25% and LIBOR plus 2 .00% .Prime rate is the rate publicly announced by Bank of America as its prime rate . The interest cost of our bank debt is affected by changes in either prime rates orLIBOR, Any adverse changes could harm our operating results . We had no outstanding debt at September 30, 2003 .

Item 4 . Controls and Procedures .

Evaluation of LeapFrog' s Disclosure Controls and Internal Controls

As of the end of the period covered by this quarterly report on Form 10-Q, LeapFrog evaluated the effectiveness of the design and operation of its"disclosure controls and procedures," or "Disclosure Controls ." This evaluation, or "Controls Evaluation," was performed under the supervision and with theparticipation of management, including our Chief Executive Officer and Chief Financial Officer.

CEO and CFO Certification s

Attached as exhibits to this quarterly report, there are " Certi fications " of the CEO and the CFO required by Rule 13a-14(a) of the Securities Exchange Actof 1934, or the Rule 13a-14(a) Certifications . This Controls and Procedures section of the quarterly report includes the information concerning the ControlsEvaluation referred to in the Rule 13a 14(a) Certifications and it should be read in conjunction with the Rule 13a-14(a) Certifications for a more completeunderstanding of the topics presented .

Disclosure Controls and Internal Control Over Financial Reportin g

Disclosure Controls are procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, such as thisquarterly report, is recorded, processed, summarized and reported within the time periods specified in the U.S . Securities and Exchange Commission's rules andforms . Disclosure Controls are also designed to ensure that such information is accumulated and communicated to our management, including the CEO and CFO,as appropriate to allow timely decisions regarding required disclosure . Internal control over financial reporting is a process designed by, or under the supervisionof, the issuer's principal executive and principal financial officers, and effected by the issuer's board of directors, management and other personnel, to providereasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generallyaccepted accounting principles and includes those policies and procedures that :

• Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the issuer ;

• Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generallyaccepted accounting principles, and that receipts and expenditures of the issuer are being made only in accordance with authorizations of managementand directors of the issuer; and

• Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the issuer's assets that couldhave a material effect on the financial statements .

Limitations on the Effectiveness of Controls

Our management, including the CEO and CFO, does not expect that our Disclosure Controls or our internal control over financial reporting will prevent allerror and all fraud . A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system'sobjectives will be met . Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must beconsidered relative to their costs . Because of the inherent limitations in all control systems, no evaluation of controls can

28

Table of Contentsprovide absolute assurance that all control issues and instances of fraud, if any, within LeapFrog have been detected . These inherent limitations include therealities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake . Controls can also be circumvented

by the individual acts of some persons, by collusion of two or more people, or by management override of the controls . The design of any system of controls isbased in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its statedgoals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree ofcompliance with its policies or procedures . Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur

and not be detected .

Conclusions

Based upon the Controls Evaluation, our CEO and CFO have concluded that, subject to the limitations noted above, our Disclosure Controls are effectiv eto ensure that material information relating to LeapFrog is made known to management, including the CEO and CFO, particularly during the period when ourperiodic reports are being prepared .

There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2003 that have materially affected, orare reasonably likely to materially affect, our internal control over financial reporting .

29

Table of ContentsPART H .

OTHER INFORMATIO N

Item 1 . Legal Proceedings.

In September 2003, we, our co-defendants and Technology Innovations, LLC entered into a settlement agreement relating to Technology Innovations' patentinfringement claim . The case was dismissed by the federal district court for the Western District of New York in September 2003 .

In October 2003, we filed a complaint in the federal district court of Delaware against Fisher-Price, Inc . alleging that Fisher Price's PowerTouch learning systemviolates United States Patent No . 5,813,861 . We are seeking damages and injunctive relief .

Item 6 . Exhibits and Reports on Form 8-K .

(a) Exhibit Inde x

3 .03 * Amended and Restated Certificate of Incorporation .

3 .04* Amended and Restated Bylaws .

4 .01 * Form of Specimen Class A Common Stock Certificate .

4 .02** Fourth Amended and Restated Stockholders Agreement , dated May 30, 2003, among I capFrog and the investors named therein .

10 .01 Employment Agreement with G . Fred Forsyth, dated August 4, 2003

31 .01 Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes -Oxley Act of 2002 .

31 .02 Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 .

32.01 Certification of the Chief Executive Officer and the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Incorporated by reference to the same numbered exhibit previously filed with the company' s registration statement on Fonn S- l (SEC File No.

333-86898)Incorporated by reference to the same numbered exhibit previously filed with the company's quarterly repo rt on Form 10-Q filed with the SEC on August12, 2003 (SEC File No . 333-86898 )

(b) Reports on Form 8- K

On July 23, 2003, we filed a report on Form 8 -K relating to a press release issued by LeapFrog to announce our fi nancial results for our fiscal quarter

ended June 30, 2003.

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Table of ContentsSIGNATURE S

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 undersignedthereunto duly authorized.

LeapFrog Enterprises, Inc.(Registrant)

/s/ Michael C . Woo d

Michael C . Woo dChief Executive Officer and President(Authorized Officer)

Dated : November 10, 2003

Is! Jaines P . Curle y

James P. CurleyChief Financial Office r(Principal Financial and Accounting Officer)

Dated : November 10. 2003

EXHIBIT INDE X

3 .03* Amended and Restated Certificate of Incorporation .

3 .04* Amended and Restated Bylaws .

4 .01 * Form of Specimen Class A Common Stock Certificate .

4.02" Fourth Amended and Restated Stockholders Agreement, dated May 30, 2003, among LeapFrog and the investors named therein .

10.01 Employment Agreement with 0 . Fred Forsyth, dated August 4, 200 3

31 .01 Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 .


32 .01 Certification of the Chief Executive Officer and the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 .

* Incorporated by reference to the same numbered exhibit previously filed with The company's registration statement on Form S-1 (SEC File No .333-86898)Incorporated by reference to the same numbered exhibit previously filed with the company's quarterly report on Fonn I0-Q filed with the SEC on August12, 2003 (SEC File No. 333-86898)

EMPLOYMENT AGREEMENT

Exhibit 10 .0 1

THIS EMPLOYMENT AGREEMENT, effective as of August 4, 2003 (" Agreement "), is made between LeapFrog Enterprises, Inc ., a Delawarecorporation ( the "Company "), and G . Fred Forsyth (" Employee") .

AGREEMENT:

followsNOW, THEREFORE, in considera ti on of the mutual promises and subject to the terms and conditions set forth herein , the part ies hereto agree as

SECTION 1 . EMPLOYMENT .

1,1 Position. Duties . Responsibilities . Authority, The Company hereby employs Employee as the Chief Operating Officer, on the terms andconditions hereinafter set forth . In such capacity, Employee shall have such duties and authority as are customa ry for, and commensurate with such position .Employee shall , to the best of Employee' s ability, carry out such responsibilities and duties in an efficient trustworthy , effective and businesslike manner.Employee's performance of services under this Agreement shall be rendered in the San Francisco Bay Area, or at any location or locations other than theaforesaid as Employee shall agree to and as the Board may designate from time to time . Employee shall perform Employee 's responsibilities hereunder for theCompany and/or such affiliates of the Company as the CEO & President of the Company may designate from time to time .

1 .2 Exclusive Employment . While Employee is employed with the Company , Employee shall devote Employee 's full business time to Employee'sduties and responsibilities set forth in this Section 1 . Without l imiting the generality of the foregoing , Employee shall not, without the prior w ri tten approval ofthe Company' s Board of Directors (the "Board"), render services of a business , professional or commercial nature to any other person , firm or corporation,whether for compensation or otherwise , except that Employee may engage in civic , philanthropic and community service activities so long as such activities donot interfere with Employee' s ability to comply with this Agreement and are not otherwise in conflict with the policies or interests of the Company .

SECTION 2 . COMPENSATION AND OTHER BENEFIT S

In consideration of Employee ' s employment , and except as otherwise provided herein , Employee shall receive from the Company the compensationand benefits described in this Section 2, in full and complete satisfaction of all of the Company ' s obligations to Employee arising from Employee's employment .The compensation and employee bene fi ts payable to Employee pursuant to this Agreement may be changed only by the written agreement of the parties .Employee authorizes the Company to deduct and withhold from all compensation to be paid to Employee any and all sums required to be deducted or withheldby the Company pursuant to the provisions of any federal , state, or local law, regulation , ruling, or ordinance, including, but not limited to, income taxwithholding and payroll taxes.

2 .1 Base Compensation . While Employee is employed with the Company, The Company shall pay to Employee, and Employee shall be entitled toreceive from the Company, as a fi xed salary for the full time employment referred to in Section I hereof, compensation ("Compensation") from the effective dateof this Agreement through July 1, 2004 at the rate of Twenty Five Thousand Dollars

($25,000) per calendar month [a rate equivalent to $300,000 per annum] . Said Compensation shall be payable in intervals not less than twice a month inaccordance with Company payment policy for executives in effect from time to time . Employee's Compensation will be subject to adjustment from time to timeas determined by the Board, and effective July 1, 2004, Employee shall be eligible to participate in the executive annual merit increase program .

2 .2 Stock Options . Subject to approval of the Board, the Company shall grant Employee an option to purchase 250,000 shares of the Company'scommon stock (the "Option"), pursuant to the Company's 2002 Equity Incentive Plan (the "Plan") . The Option will be subject to a four-year vesting period,commencing on the Employee's date of hire (the "Employment Date") as follows : twenty-five percent (25%) of the Option shares shall vest on the firstanniversary of the Employment Date, with the remaining Option shares to vest in equal portions on a monthly basis over the three-year period following the firstanniversary of the Employment Date, provided that Employee remains employed by the Company . The Option shall be subject to the terms and conditions of thePlan and the corresponding stock option grant notice and stock option agreement .

2.3 Performance Bonus . Employee is eligible to receive an annual discretionary bonus of up to 50% of Employee's then current annualCompensation (the "Bonus") based on the Company's performance and Employee's achievement of performance objectives as established in writing by the CEO& President in consultation with Employee, which achievement will be determined by the Board in its sole good faith discretion . Except as provided in Section3 .2 below, if Employee is not employed as of December 31 of the Bonus year, he will not have earned the Bonus, or any pro-rata portion of the Bonus for thatyear . Payment of any Bonus shall be subject to standard payroll deductions and withholdings . If the Company adopts a bonus plan under which Employeebecomes eligible, and the new bonus plan opportunity is at least equal to the opportunity outlined in Section 2 .3 above, Employee shall participate in the newplan and shall no longer be eligible to receive any bonus under this Section 2 .3 .

2 .4 Other Benefits . Employee shall be entitled to applicable employee benefits, such as group medical and dental for Employee, Employee's spouseand dependent children, life and disability insurance coverage, sick leave and vacation all as granted to the Company's employees in accordance with theCompany's policies and guidelines, including but not limited to contribution requirements for dependent coverage, as approved by the Board from time to time .

SECTION 3 . EMPLOYMENT TERM AND TERMINATION .

3 .1 Tern and Termination. Employee's employment with Company is for unspecified duration and constitutes at-will employment within the

meaning of California Labor Code Section 2922 . Accordingly, the employment relationship may be terminated at any time with or without Cause, by Companyor by Employee, immediately upon delivery of written notice. Except as otherwise specifically provided in Section 3 .2 below, upon termination of employmentEmployee shall not be entitled to receive any compensation or benefits other than Compensation and accrued and unused vacation earned through the date oftermination of employment (the "Separation Date") .

3 .2 Compensation and Benefits Upon Termination . In the event Employee's employment terminates for any reason, the Company shall pay toEmployee all of his accrued and unused vacation and unpaid Compensation earned through the Separation Date . If the Company terminates Employee'semployment for any reason other than his death or disability, Cause, or Employee's voluntary resignation, and Employee provides the Company with the Releasedescribed below, Employee shall be entitled to receive the following severance benefits (collectively, the "Severance Benefits") : (i) payments in an amountequivalent to the Employee's Compensation in effect as of the Separation Date,

but not less than the rate of $25,000 per calendar month, subject to required payroll deductions and withholdings (the "Severance Payments"), on the Company'sregular payroll dates during the period from the effective date of the Release and continuing through the end of the Severance Period (as defined below), (ii) apro rata portion of any bonus that Employee would otherwise have been entitled to receive in the year of the employment termination, subject to required payrolldeductions and withholdings, as and when otherwise payable under this Agreement or any bonus plan, and (iii) if Employee timely elects to continue hisCompany-provided group health insurance coverage pursuant to federal COBRA law, reimbursement from the Company for the cost of Employee's COBRApremiums to continue his health insurance coverage at the same level of coverage for him and his dependents (if applicable) in effect as of the Separation Datethrough the end of the Severance Period .

As a condition of receipt of the Severance Benefits, Employee shall : (a) prior to his receipt of any of the Severance Benefits, provide the Company with aneffective general release of known and unknown claims, in the form required by the Company (the "Release"), and (b) at any time during the Severance Period,respond fully to any Company inquiry regarding his post-termination employment, consulting and contracting activities .

In no event will Employee vest in any stock options or other similar rights during the Severance Period . As used in this Section 3 .2, the Severance Period shall

mean the period beginning on the Separation Date and ending on the earliest of :

(a) the later of (i) six (6) months, or (ii) the date that Employee becomes employed by another employer, or (iii) the date that Employee becomesengaged in any independent contractor or consulting relationship with any entity or individual other than the Company ; o r

(b) the date that is twelve (12) months alter the Separation Date, if employee does not become employed as outlined in (a) ; o r

(c) the date that Employee breaches his continuing obligations under Section 5 of this Agreement.

For purposes of this Section 3 .2, the following definitions shall apply :

The term "disability" shall mean a physical or mental disability that renders Employee unable to perform one or more of the essential functions of his job, asdetermined by the Board, for a period of 120 consecutive days or more than 180 days in any consecutive 12-month period .

The term "Cause" shall mean (i) Employee's commission of any of fraud, embezzlement or misappropriation involving the Company, (ii) Employee's convictionby a court of competent jurisdiction of, or entering a plea o€ guilty or no contest to, any felony involving moral turpitude or dishonesty, (iii) Employee's action,or failure to commit an act, involving the Company which amounts to, or with the passage of time would amount to, willful misconduct, wanton misconduct,gross negligence or a breach of this Agreement and which results or will result in material harm to the Company, or (iv) Employee's willful failure to perform theresponsibilities and duties specified herein .

SECTION 4 . BUSINESS EXPENSE S

4 .1 The Company shall pay for or reimburse Employee for all reasonable business expenses incurred by Employee in the performance ofEmployee's duties hereunder, upon submission to the Company in accordance with Company policy of a written accounting of such expenses , which accountingshall include an itemized list of all expenses incurred, the business purposes for which such expenses were incurred , and such receipts as Employee reasonablyhas been able to obtain.

SECTION 5 . COVENANTS OF EMPLOYEE .

5 .1 Acknowledgments . Employee acknowledges the following :

5 .1 .1 Access to Confidential Information . Employee's services to be rendered hereunder shall place him in a position of confidence and trustwhich shall allow him access to "Confidential Information" (as hereinafter defined) .

5 .1 .2 Fair and Reasonable. Cove o< . The type and period of restrictions imposed by the covenants in this Section 5 are fair and reasonableand such restrictions will not prevent Employee from earning a livelihood .

5 .2 Covenant as to Nondisclosure or Use of Confidential Information. Employee agrees as follows :

5.2 .1 Employee shall not at any time during or after Employee's employment, disclose to anyone outside of the Company or use for anypurpose that is not expressly authorized by the Company any Confidential Information . Employee shall not deliver, reproduce or in any way allow anyConfidential Information to be delivered to or used by any third parties without specific written consent ofa the President of the Company .

5 .2 .2 The Company' s agreements with other persons or with the U .S. government , or its agencies, may include agreements that imposeobligations or restrictions regarding inventions that occur in connection with work relating to such an agreement , or regarding the con fidential nature of workpursuant to such an agreement , Employee agrees to be bound by all such lawful obligations and restrictions, and to do whatever is necessary to satisfy theobligations of the Company .

5 .2 .3 Employee acknowledges that the Company has received and in the future will receive from third part ies confidential or proprieta ry

information ("Third Party Information ") subject to a duty on the Company's part to maintain the con fi dentiality of such information and to use it only for certainlimited purposes . Employee agrees that during the term of Employee's employment with the Company and thereafter, Employee will hold Third PartyInformation in the strictest confidence and will not disclose to anyone (other than Company personnel who need to know such information in connection withtheir work for the Company) or use, except in connection with Employee ' s work for the Company, Third Party Information unless expressly authorized by anofficer of the Company in writing .

5 .2 .4 During Employee's employment by the Company , Employee shall not improperly use or disclose any confidential information or tradesecrets, if any, of any former employer or any other person to whom Employee has an obligation of confidentiality , and Employee shall not bring on to thepremises of the Company any unpublished documents or any prope rty belonging to any former employer or any other pe rs on to whom Employee has anobligation of con fi dentiality unless consented to in writing by that former employer or person . Employee will use in the performance of Employee's duties onlyinformation generally known and used by persons with training and experience comparable to Employee ' s own, which is common knowledge in the industry orotherwise legally in the public domain, or which is otherwise provided or developed by the Company .

5 .2 .5 If this Agreement is terminated for any reason, Employee shall promptly surrender and deliver to the Company all ConfidentialInformation . Employee will not retain any description or other document that contains or relates to any Confidential Information that Employee may produce,obtain or otherwise learn about during employment with the Company .

5 .3 Assi nment of Inventions . Employee assigns and transfers to the Company Employee's entire right, title and interest in and to all inventionsincluding, but not limited to, ideas, improvements, designs and discoveries ("Inventions"), whether or not patentable and whether or not reduced to practice,made or conceived by Employee (whether made solely by Employee or jointly with others) during Employee's employment with the Company which relate inany manner to the actual or demonstrably anticipated business, work or research and development of the Company or its subsidiaries, or result from or aresuggested by any task assigned to Employee or any work performed by Employee for or on behalf of the Company or its subsidiaries . All Inventions are the soleproperty of the Company ; provided, however, that this Agreement does not require assignment of an Invention which qualifies fully for protection under Section2870 of the California Labor Code ("Section 2870"), which provides as follows :

5 .3 .1 Any provision in an employment agreement which provides that an employee shall assign or offer to assign any of Employee's or herrights in an invention to Employee's or her employer shall not apply to an invention that the employee developed entirely on Employee's or her own time andwithout using the employer's equipment, suppliers, facilities or trade secrets information except for those inventions that either :

(a) relate at the time of conception or reduction to practice of the invention to the employer's business, or actual ordemonstrably anticipated research or development of the employer ; o r

(b) result from any work performed by the employee for the employer .

5 .3 .2 To the extent a provision in an employment agreement purports to require an employee to assign an invention otherwise excluded frombeing required to be assigned under Section 5 .3 .1, the provision is against the public policy of this state and is unenforceable .

5 .4 Disclosure Of Inventions : Patents Co ri hts and Mask Work Rights . Employee agrees that in connection with any Invention :

5 .4 .1 To keep and maintain adequate and current written records of all Inventions made by Employee (in the form of notes, sketches,drawings and other forms specified by the Company) while employed by the Company . These records shall be available to the Company and shall be and remainthe sole property of the Company at all times . Employee will disclose such Inventions promptly in writing to Employee's immediate supervisor at the Company,with a copy to the Company President, whether or not Employee believes the Invention is protected by Section 2870 . Such disclosure shall be received inconfidence by the Company . Within thirty (30) days after receipt of such disclosure, the Company shall respond to Employee specifying that the Company either(i) claims that the Invention is an assignable invention (as defined below in Section 5.42), (ii) relinquishes any claim to the Invention or (iii) requires further ormore detailed disclosure to assess its rights to the Invention under this Agreement . In the case of clause (iii) above, the Company shall permit Employee timeduring normal business hours reasonably necessary to prepare a more detailed disclosure ; and the Company shall provide an additional response as described inthis Section 5 .4 .1 within thirty (30) days after receipt by the Company of such further or more detailed disclosure .

5 .4 .2 Upon request, to promptly execute a written assignment of title to the Company for any Invention required to be assigned by Section5 .3 ("assignable invention") and Employee will preserve any such assignable invention as Confidential Information .

5 .4 .3 Upon request, to assist the Company or its nominee (at its expense) during and at any time subsequent to Employee's employment inevery reasonable way to obtain for the Company's or its nominee's benefit, patents, copyrights, mask work rights and other statutory rights ("Statutory Rights")for such assignable inventions in any and all countries, which inventions shall be and remain the sole and exclusive property of the Company or its nomineewhether or not patented, copyrighted or the subject of a mask work right. Employee shall execute such papers and perform such lawful acts as the Companydeems necessary to exercise all rights, title and interest in such Statutory Rights .

5 .4 .4 To execute and deliver to the Company or its nominee upon request and at its expense all documents, including applications for andassignments of Statutory Rights to be issued therefore, as the Company determines are necessary or desirable to apply for and obtain Statutory Rights on suchassignable inventions in any and all countries and/or to protect the interest of the Company or its nominee in Statutory Rights and to vest title thereto in theCompany or its nominee .

5 .5 Return of Business Records and Equipment . Upon termination of Employee's employment hereunder, Employee shall promptly return to theCompany (i) all documents, records, procedures, books, notebooks, notes and any other documentation or materials in any form whatsoever, which was obtainedor developed in the course of Employee's employment with the Company including but not limited to written, audio, video or electronic, embodiment of anyinformation pertaining to the Company including but not limited to Confidential Information, including any and all copies of all or any portion of suchdocumentation or material then in Employee's possession or control regardless of whether such documentation was prepared or compiled by Employee,Company, other employees of the Company, representatives, agents, or independent contractors and (ii) all equipment or tangible personal property entrusted toEmployee by the Company . Employee acknowledges that all such documentation, copies of such documentation, equipment, and tangible personal property areand shall at all times remain the sole and exclusive property of the Company .

5 .6 Additional Covenants Protecting the Interests of the Company . Employee agrees that at all times during Employee's employment hereunder,Employee shall comply with the Company's employee policies and procedures reasonably established by the Company from time to time concerning matterssuch as management, supervision, recruiting, equal employment opportunity, and sexual harassment .

5 .7 Post Employment Cooperation .

5 .7.1 Employee agrees that during the period of Employee's employment by the Company, Employee will not, without the Company'sexpress written consent, engage in any employment or business activity which is competitive with, or would otherwise conflict with Employee's employment bythe Company . Employee agrees further that for the period of Employee's employment by the Company, and for eighteen (18) months after the date oftermination of Employee's employment by the Company, Employee will not either directly or indirectly solicit or attempt to solicit any employee, consultant orindependent contractor of the Company to terminate his or her relationship with the Company to become an employee, consultant or independent contractor to orfor any other person or entity .

5 .7.2 Employee agrees that, fora period of two years following Employee's termination of employment under this Agreement, Employeeshall, upon Company's reasonable request and in good faith and with Employee's best efforts, subject to Employee's reasonable availability, cooperate and assistCompany in any dispute, controversy, or litigation in which Company may be involved and with respect to which Employee obtained knowledge while employedby the Company or any of its affiliates, successors, or assigns, including, but not limited to, Employee's participation in any court or arbitration proceedings,giving of testimony, signing of affidavits, or such other personal cooperation as counsel for the Company shall request, Any such activities shall be scheduled, tothe extent reasonably possible, to accommodate Employee's business and personal obligations at the time . The Company shall pay Employee's reasonable traveland incidental out-of-pocket expenses incurred in connection with any such cooperation .

5 .8 Certain Definitions . For purposes of this Section 5, "Confidential Information" shall mean information and compilations of information relatingto the business and the owners of the Company and/or their affiliates provided to Employee in connection with Employee's employment with the Companyand/or any affiliate of the Company or to which Employee had access or which Employee corhpiled while an Employee of the Company and/or an affiliate of theCompany, including, but not limited to, information regarding any trade secrets, proprietary knowledge, operating procedures, finances, financial condition,organization, employees, customers, clients, agents, other personnel, business activities, budgets, strategic or financial plans, objectives, marketing plans, pricesand price lists, operating and training materials, data bases and analyses, designs, formulae, test data and all other documents relating thereto or strategies of theCompany ; provided, however, the term "Confidential Information" as used herein shall not include information (i) which has become public, published or isotherwise in the public domain through no fault of Employee prior to any disclosure thereof by Employee, (ii) which was known to Employee prior toEmployee's employment or affi liation with the Company, (iii) which is required to be disclosed by statute, regulation or court order, or (iv) which is knowngenerally to the public .

5 .9 Remedies . Employee agrees that LeapFrog would be irreparably banned in the event that any of the provisions of this Agreement are violatedand, therefore, in the event of any actual or threatened violation of this Agreement, LeapFrog will be entitled in addition to any other remedies to which it may beentitled, at law or in equity, to a temporary restraining order and preliminary and permanent injunctive relief and to specifically enforce the terns and provisionshereof without the necessity of posting bond or proving damages .

SECTION 6 . REPRESENTATIONS BY EMPLOYEE .

Employee represents and warrants that Employee is free to enter into and perform each of the terms and conditions of this Agreement ; and thatEmployee's execution and/or performance of all Employee ' s obligations under this Agreement does not and will not violate or breach any other agreementbetween Employee and any other person or entity . Employee acknowledges that but for this representation and warranty , the Company would not agree to enterinto this Agreement .

SECTION 7 . ASSIGNABILITY .

This Agreement is binding upon and inures to the benefit of the parties and their respective heirs, executors, administrators, personal representatives,successors and assigns. The Company may assign its rights or delegate its duties under this Agreement at any time and from time to time . However, the partiesacknowledge that the availability of Employee to perform services and the covenants provided by Employee hereunder are personal to Employee and have been amaterial consideration for the Company to enter into this Agreement . Accordingly, Employee may not assign any of Employee's rights or delegate any ofEmployee's duties under this Agreement, either voluntarily or by operation of law, without the prior written consent of the Company, which may be given orwithheld by the Company in its sole and absolute discretion .

SECTION 8 . NOTICES.

Notices under this Agreement shall be sufficient only if mailed by certified or registered United States mail, return receipt requested, or personallydelivered, to the parties at their addresses set forth on the signature page hereof or as amended by notice pursuant to this subsection . Notice by mail shall bedeemed received two (2) days after deposit .

SECTION 9 . MISCELLANEOUS .

9.1 Entire Agreement . This Agreement contains the full , complete, and exclusive embodiment of the entire agreement of the pa rt ies with regard tothe subject matter hereof and supersedes all proposals, oral or written, all negotiations , conversations or discussions between or among the parties relating to thisAgreement and all past course of dealing or indust ry custom . Employee has not entered into this Agreement or employment relationship in reliance on anyrepresentations, w ritten or oral, other than those contained herein . This Agreement may be modi fied only by a writing signed by Employee and the President ofCompany .

9 .2 Amendment . This Agreement may not be amended except by an instrument in writing duly executed by the parties hereto .

9 .3 Apalicable Law; Choice of Forum . This Agreement has been made and executed under, and will be construed and interpreted in accordancewith, the laws of the State of California .

9 .4 Attorneys' Fees . In any action or proceeding to enforce or interpret this Agreement, or arising out of this Agreement, the prevailing party orparties are entitled to recover a reasonable allowance for fees and disbursements of counsel and costs of arbitration or suit, to be determined by the arbitrator orthe court in which the action or proceeding is brought .

9 .5 Provisions Severable. Every provision of this Agreement is intended to be severable from every other provision of this Agreement . If anyprovision of this Agreement is held to be void or unenforceable, in whole or in part, the remaining provisions will remain in full force and effect, unless theremaining provisions are so eviscerated by such holding that they do not reflect the intent of the parties in entering into this Agreement . If any provision of this

Agreement is held to be unreasonable or excessive in scope or duration, that provision will be enforced to the maximum extent permitted by law or modified soas to render it enforceable consistent with the intent of the parties insofar as possible .

9 .6 Non-Waiver of Rights and Breaches . Any waiver by a party of any breach of any provision of this Agreement will not be deemed to be a waiverof any subsequent breach of that provision, or of any breach of any other provision of this Agreement . No failure or delay in exercising any right, power, orprivilege granted to a party under any provision of this Agreement will be deemed a waiver of that or any other right, power or privilege . No single or partialexercise of any right, power or privilege granted to a party under any provision of this Agreement will preclude any other or further exercise of that or any otherright, power or privilege .

9 .7 Gender and Number . Concerning the words used in this Agreement, the singular form shall include the plural form, the masculine gender shallinclude the feminine or neuter gender, and vice versa, as the context requires, and the word "person" shall include any natural person, partnership, corporation,association, trust, estate or other legal entity .

9.8 eadin s. The headings of the Sections and Paragraphs of this Agreement are inserted for ease of reference only, and will have no effect in theconstruction or interpretation of this Agreement .

9.9 Counterparts . This Agreement and any amendment or supplement to this Agreement may be executed in two or more counterparts, each ofwhich will constitute an original but all of which will together constitute a single instrument . Transmission by facsimile of an executed counterpart signaturepage hereof by a party hereto shall constitute due execution and delivery of this Agreement by such party .

9 .10 Arbitration . To ensure the timely and economical resolution of disputes that arise in connection with Employee's employment with theCompany, Employee and the Company agree that any and all disputes, claims, or causes of action arising from or relating to the enforcement, breach,performance or interpretation of this Agreement, Employee's employment, or the termination of Employee's employment, shall be resolved to the fullest extentpermitted by law by final, binding and confidential arbitration, by a single arbitrator, in San Francisco, California, conducted by Judicial Arbitration andMediation Services, Inc . ("JAMS") under the applicable JAMS employment rules . By agreeing to this arbitration procedure, both Employee and the Companywaive the right to resolve any such dispute through a trial by jury or judge or administrative proceeding . The arbitrator shall : (a) have the authority to compeladequate discovery for the resolution of the dispute and to award such relief as would otherwise be permitted by law ; and (b) issue a written arbitration decision,to include the arbitrator's essential findings and conclusions and a statement of the award . The arbitrator shall be authorized to award any or all remedies thatEmployee or the Company would be entitled to seek in a court of law . The Company shall pay all JAMS' arbitration fees in excess of the amount of court feesthat would be required if the dispute were decided in a court of law . Nothing in this Agreement is intended to prevent either Employee or the Company fromobtaining injunctive relief in court to prevent irreparable harm pending the conclusion of any such arbitration . Notwithstanding the foregoing, Employee and the

Company each have the right to resolve any issue or dispute arising under Section 5 of this Agreement by court action instead of arbitration .

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and delivered as of the date first above written .

EMPLOYEE :

Is! G . Fred Forsyth

LeapFrog Enterprises, Inc . :

By: /s! James P . Curle y

Name : Is! James P . CurleyTitle: ChiefFinancial Officer

Address :

6401 Hollis Street, Suite 150Emeryville, CA 94608

CERTIFICATION S

I, Michael C. Wood, certify that :

L I have reviewed this quarterly report on Form 1 O-Q of LeapFrog Enterprises, Inc . ;

Exhibit 31 .0 1

2 . Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report ;

3 . Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report ;

4 . The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in ExchangeAct Rules 13a--15(e) and 15d-15(e)) for the registrant and have :

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensurethat material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;

b) [intentionally omitted ]

c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectivenessof the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation ; an d

d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscalquarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect,the registrant's internal control over financial reporting; and

The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistran('s auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions) :

a) All significant deficiencies and material weaknesses in the design or operation of inte rnal control over financial reporting which are reasonablylikely to adversely affect the registrant 's ability to record , process, summarize and report fi nancial information ; an d

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control overfinancial reporting .

Date : .November 10, 2003 Is! Michael C . Wood

Michael C. WoodChief Executive Officer

CERTIFICATION S

I, James P. Curley, certify that:

1 . I have reviewed this quarterly report on Form 1 O-Q of LeapFrog Enterprises, Inc . ;

Exhibit 31 .02


3 . Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the Financialcondition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report ;

4 . The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in ExchangeAct Rules 13a-15(c) and I5d--15(e)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensurethat material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;

b) [intentionally omitted]

c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectivenessof the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation ; and

d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscalquarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect,the registrant's internal control over financial reporting; an d

The registrant' s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the

registrant ' s auditors and the audit committee of registrant 's board of directors (or persons performing the equivalent functions) :

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the registrant's ability to record, process, summarize and report financial information ; an d

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control overfinancial reporting .

Date : November 10, 2003 Is! James P . Curley

James P . Curle yChief Financial Officer

CERTIFICATION PURSUANT TO SECTION 906 OF THE PUBLIC COMPANYACCOUNTING REFORM AND INVESTOR PROTECTION ACT OF 200 2

(1 8 U .S.C . § 1350, AS ADOPTED)

Exhibit 32 .0 1

Pursuant to Section 906 of the Public Company Accounting Reform and Investor Protection Act of 2002 (18 U .S .C . § 1350, as adopted, the "Sarbanes-OxleyAct"), Michael C . Wood, the President and Chief Executive Officer ofLeapFrog Enterprises, Inc. (the "Company"), and James P . Curley, the Chief Financial

Officer of the Company, each hereby certifies that, to the best of his knowledge :

The Company's Quarterly Report on Form I O-Q for the period ended September 30, 2003, to which this Certification is attached as Exhibit 32 .01 (the

"Periodic Report"), fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended ; an d

The information contained in the Periodic Report fairly presents, in all material respects, the financial condition of the Company at the end of the periodcovered by the Periodic Report and results of operations of the Company for the period covered by the Periodic Report .

Dated : November 10, 2003

Isl Michael C . Wood /s! James P . Curley

Michael C. Wood James P. CurleyChief Executive Officer and President Chief Financial Officer

Note : This certification accompanies the Periodic Report pursuant to § 906 of the Sarbanes-Oxley Act and shall not be deemed "filed" by the Company for

purposes of Section 18 of the Securities Exchange Act of 1934, as amended.

Created by IOKWizard www .l OKWizard .com

EXHIBIT B

Table of Contents

UNITED STATESSECURITIES AND EXCHANGE COMMISSION

Washington , D.C. 20549

FORM 10-K

0 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 ( d) OF THE SECURITIES EXCHANGE ACT OF 193 4

For the fiscal year ended December 31, 2003

o r

0 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 193 4

For the Transition Period from to

Commission fi le number 001-3139 6

LEAPFROG ENTERPRISES, INC .(Exact name of registrant as specified In its charter )

Delaware(Slate or other jurisdiction of

Incorporation or organization)

6401 Hollis Street, Suite 150Emeryville, CA 9460 8

(Address of principal executive offices)

(510)420-5000(Registrant 's telephone number, Including area code)

Securities registered pursuant to Section 12(b) of the Act :

95-4652013(I.R .S. Employer

Identifi cation No .)

Title of each class Name of each exchange on which registere d

Class A common stock, par value $0.0001 per share New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act : Non e

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 duringthe preceding 12 months (or for such shorter period that the registrant was required to fi le such reports), and (2) has been subject to such filing requirements for

the past 90 days . x❑ Yes ❑ No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best ofregistrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form

10-K. ❑

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) . El Yes ❑ N o

The aggregate market value of the common equity held by non-affiliates of the registrant calculated using the market price as of the close of business on June 30,

2003 was approximately $719,166,000. The registrant does not have non-voting common stock outstanding.

The number of shares of Class A common stock and Class B common stock, outstanding as of March 1, 2004, was 31,517,258 and 27,882,817, respectively .

DOCUMENTS INCORPORATED BY REFERENCE

The registrant has incorporated by reference in Part 111 of this report on Form 10-K portions of its definitive Proxy Statement for the Annual Meeting ofStockholders, to be filed by April 29, 2004.

Table of ContentsSPECIAL NOTE ON FORWARD-LOOKING STATEMENTS

This report on Form 10-K, including the sections entitled "Item 1 . Business," and "Item 7 . Management's Discussion and Analysis of Financial Condition and

Result of Operations," contains forward-looking statements . These statements relate to future events or our future financial performance and involve known andunknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to differ materially from anyfuture results, levels of activity, performance or achievements expressed or implied by these forward-looking statements, These risks and other factors includethose listed under "Risk Factors That May Affect Our Results and Stock Price" in Item 7 of this Form 10-K and those found elsewhere in this Form l0-K . In

some cases, you can identify forward-looking statements by terminology such as

"may will ,""should expect ; "`intend,""plan,""anticipate,""believe,"'estimate""predictpotentialcontinue" or the negative of these terms or other

comparable terminology . Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future

results, levels of activity, performance or achievements . We undertake no obligation to update or revise publicly any forward-looking statements, whether as a

result of new information, future events or otherwise after the date of this report .

TRADEMARKS AND SERVICE MARKS

"LeapFrog," the Leapfrog Logo, "LeapPad," "Above & Beyond," "Alphabet Pal," "Hug & Learn," "Imagination Desk," "iQuest," "Leap," the Leaping FrogDesign, "LeapTtack," "Learning Something New Everyday," "Learning Friend," "Mind Station,"' NearTouch," "Odyssey," "Phonics Desk," "Quantum Pad"

and "Turbo Twist" are our registered trademarks or our service marks . "Baby Tad," "Fridge Phonics," "Great Reader," "Language First!," the LeapFrogSchoolHouse design, "Leap's Pond," "LeapStart," "Fun-Damental," "Ready, Set, Leap!," the green GO circle, and the Bouncing Frog Logo are some of our

trademarks or our service marks . This report on Form 10-K also includes other trademarks and service marks, as well as trade dress and trade names of ours .

Other trademarks in this report on Form 10-K are property of their respective owners .

Table of ContentsINDEX

Page

PART I

Item I Business I

Item 2 Properties 15

Item 3 Leval Proceedings I5

Item 4 Submission of Matters to a Vote of Securities Holdcrs 1 6

PART I I

Item 5 Market for Registrant's Common Equity and Related Stockholder Matters and Issuer Purchases of E uity Securities 17

Item 6 SelectedFinancial Data 18

Item 7 Mann cement's Discussion and Anal •i' of Financial Condition and Roultsof O eration 19

Item 7A quantitative and qualitative Disclosures About Market Risk 44

Item 8 Financial Statements and Sunnlcanentarv Data 44

Item 9 Changes in and Disagreements With Accountants on Accountin and Financial Disclosure 44

Item 9A Controls and Procedures 44

PART II I

Item 10 Directors and Executive Officers of the Registrant 46

Item 1 l Executive Compensation 46

Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 46

Item 13 Certain Relationships and Related Transactions 46

Item 14 Principal Accountants Fees and Set-vices 4 0

PART I V

Item 15 Exhibits . Financial Statement Schedules and Reports on Form 9-K 47

5inatures 48

Power of Attorney 48

Appendix A Schedule 11 - Valuation and Oualifying Accounts and Allowances 50

Index to Consolidated Financial Statements F-I

Report of Independent Auditors F-2

Consolidated Balance Sheets F-3

Consolidated Statements of Income F-4

Consolidated Statements of Stockholders' Equity F-5

Consolidated Statements of Cash Flow, F-6

Notes to Consolidated Financial Statements F- 7

ii

Table of ContentsPART I

Item 1 . Business

Overview

LeapFrog is a leading designer, developer and marketer of innovative, technology-based educational products and related proprietary content, dedicated tomaking learning effective and engaging . We currently design our products to help infants and toddlers through high school students learn age- andskill-appropriate subject matter, including phonics, reading, writing, math, spelling, science, geography, history and music . We base our products on sound

educational pedagogy under the guidance of our in-house educational experts and our Education Advisory Board . We then use our proprietary technologies and

content to make these products interactive and engaging. Our product line includes : (1) teaming platforms, which are portable, affordable hardware devices, (2)educational software-based content, such as interactive books and cartridges, specifically designed for use with our learning platforms and (3) stand-aloneeducational products. Our products are sold throughout the United States primarily by national and regional mass-market and specialty retailers, and to a lesser

extent into international markets and to U .S . schools .

As of December 31, 2003, we have sold more than 23 million platform products since 1999 . These platforms provide us with a large and growing installed

base on which to build continued software content sates . In 2003 we introduced three new platforms, the LittleTouch LeapPad learning system designed for ages6 months to 3 years, the LeapPad Plus Writing learning system designed for ages 4 to 8 years and the Leapster multimedia learning system designed for ages 4 to

8 years .

Our product line also includes a significant library of proprietary content, most of which has been developed internally, for use with our platforms . For our

LittleTouch LeapPad, My First LeapPad, LcapPad, LeapPad Plus Writing and Quantum Pad platforms, which together constitutes our LeapPad family ofplatforms, each set of content related to those platforms consists of an audio cartridge as well as a corresponding interactive books and activity cards . For our

Turbo Twist, iQuest and Leapster handhelds, our content comes in memory cartridges that slot easily into the platforms . We currently offer over 100 interactive

books for our LeapPad family of platforms at U .S . retail stores . We also currently offer eight Leapster cartridges with math, phonics and writing, nine TurboTwist cartridges with math, spelling and social studies questions, as well as seven cartridges for our iQuest platform covering material from over 250 majortextbooks used in 5th through 8th grade classrooms in U .S . schools and for PSAT, SAT and ACT preparation materials for high school students .

By using a specially designed stylus that incorporates our proprietary NearTouch technology, children touch words and images on our interactive booksplaced in our LeapPad family of platforms . Depending on the book, they can hear information regarding various academic subjects, read engaging stories or play

interactive, educational games . Our LeapPad family of platforms evolves with a child as his or her interests and abilities change, since switching the content is as

easy as changing the book and related audio cartridge . Many of our LeapPad family-related interactive books feature our internally developed, brandedLeapFrog characters, such as Leap, Lily, Tad and Professor Quigley, while others feature popular licensed characters such as Thomas the Tank Engine, Dora the

Explorer, Bob the Builder, Winnie-the-Pooh, Disney Princesses, Scooby-Doo, Dr . Seuss' The Cat in the Hat and characters from the movies like Monsters,

The ., The Lion King, Toy Story 2 and Finding Nenro ,

Our product line also includes over 35 stand-alone educational products . These stand-alone products combine our proprietary technologies with a fixedset of content and include our interactive plush toys, our LeapStart learning table and our Fridge Phonics magnetic set products for infants and toddlers and our

Explorer interactive globes for older children .

Since the inception of our business in 1995, we have focused primarily on the U .S. consumer market . This market represented the substantial majority of

our sales and operating profit in 2003 and will continue to be our primary focus in the near future . However, we are increasing our focus on international marketsand have customized or are planning to customize many of our products for use in foreign countries . To pursue our international strategy, we have established

sales offices in the United Kingdom, Canada, Mexico and France . We also have relationships with distributors in Spain, Germany, Korea, Australia and several

other countries. Further, we intend to leverage relationships with strategic partners in various countries, such as our existing relationships with Beness e

Corporation and Sega Toys in Japan . For additional discussion of our three business segments, including our international segment, see "Item 7 . Management's

Discussion and Analysis of Financial Condition and Results of Operations" and "Consolidated Financial Statements - Note 23 . Segment Reporting ."

In addition to our international expansion, we established our Education and Training group in 1999 . Within this group, our SchoolHouse division focuses

on developing supplemental curriculum and assessment programs for pre-kindergarten to 8th grade classrooms and on the sale of new products incorporating ourcore technologies and specially modified versions of our products to schools, teacher supply stores and educational products catalogs in the United States .

LeapFrog SchoolHouse product areas currently include assessment, early literacy, early childhood, reading, language arts, math, English Language Development,

and special education . Our Schoolilouse products are research-based products that are tied to state standards, and have been adopted or listed in 13 cities, states

and regions, including California, Illinois, New York City and Texas . Through

Table of Content sour SchoolHouse division, we currently offer exclusively for the school market, more than 200 LeapPad and Quantum Pad books, as well as over 450 interactiveskill cards, which represent over 6,000 pages of interactive content. Our LeapTrack assessment and instruction system is designed to meet the increasingdemands for accountability in schools . The LeapTrack system provides teachers with the ability to instantly assess their students, personalize student instruction

and continuously monitor student progress relative to state standards . Our Literacy Center program has been adopted and listed as a supplemental early readingcurriculum by seven states and one major metropolitan city . Our comprehensive, research-based pre-kindergarten curriculum, the Ready, Set, Leap! program,meets Head Start standards and was adopted by the Texas State Board of Education . We have also developed and introduced our nine-theme, 36-interactivebook English language development program, Language First!, which is designed to build oral language skills for students for whom English is a secondlanguage . In addition to these core programs, our SchoolHouse division offers a library of interactive books to be used with our LeapPad and Quantum Padlearning platforms, and which are designed to address challenging issues in classroom instructio n

We have grown significantly and consistently by introducing innovative new platforms and other products, expanding our content offerings and increasing

our distribution . From 2001 to 2003, our total net sales increased from $314.2 million to $680 .0 million and our total net income increased from $9 .7 million to

$72 .7 million .

The Educational Foundation of Our Products

We believe that sound educational principles are at the cote of the value of our brands and products . All LeapFrog content and curriculum is based on a

proprietary method of learning, created by our in -house educational experts with the assistance of our Education Advisory Board, that identifies what childrenlearn and when and how they learn it. Our grade-based content is aligned with state and national education standards, often mirroring what is learned in theclassroom .

The following four educational principles are at the core of our products :

Children Learn Best When Actively Engaged

Our products encourage active participation by asking children questions and requiring them to direct their own play before continuing with an activity .For example, children using our LeapPad interactive books can control the information they receive by deciding what to touch with the NearTouch stylus . Even

our Learning Drum, designed for infants, engages them by only continuing with the activity or game after receiving a response from the child .

Positive Reinforcement and I mnediate Feedback Encourage Continued Effor t

Our educational products are designed to help develop self-confidence through immediate and supportive feedback . Many of our products offer clues thatare designed to help lead a child to the correct answer, while at the same time providing information on incorrect responses . For example, if a child is asked to

locate Spain on our Explorer interactive globe and touches France, the globe will respond, "You found France!" and then provide a clue as to how the child canlocate Spain . We believe this combination of presenting new information and offering positive reinforcement encourages the child to continue teaming .

Ability-Appropriate Tasks Motivate Learners

We believe that learning is most effective when a task matches the learner's ability . For instance, a task that is too easy may quickly become boring whilea task that is too difficult may be discouraging and demoralizing . To address this issue, we offer a variety of age-appropriate platforms and a library of content

for each of these platforms to address the specific needs of children as their skills develop and interests mature . Through our Learning Center shelf displays andour LeapFrog newsletter, we provide guidance to parents on how to select the appropriate product and content for each child's age and ability . We have alsodeveloped products that adapt to the user's abilities . For example, we have designed our Turbo Twist handhelds to deliver easier or more difficult questionsbased on a child's performance. We believe this technology enables the child to spend more time within his or her optimal learning zone .

Supplemental Materials Should Complement and Enhance What Children Learn at Schoo l

We design our products and content to be consistent with the curricula used in schools across the U .S . For example, we offer a library of content cartridgescompatible with our iQuest handheld of test questions corresponding to over 250 major textbooks currently used in U .S . middle schools . With the guidance of the

educational experts in our SchoolHouse division, we also design our products in accordance with state and federal standards regarding the scope and sequence oflearning.

We believe these educational principles are fundamental building blocks on which our company is built . We implement these principles by leveraging ourteam of in-house educational experts and our outside Education Advisory Board, which consists of distinguished educators . The members of our EducationAdvisory Board actively participate in the design and development of our products by meeting with our creative design team several times each year . Our

Education Advisory Board also is an external source of feedback for our creative design team with respect to new products that are in the development stage . We

believe that both our in-house experts and outside advisors are critical in the creation of our learning products .

Table of Content sOur Education Advisory Board

The members of our Education Advisory Board are involved deeply in the research of both education and reading development . As of March 1, 2004, the

members of our Education Advisory Board were :

Robert Calfee, Ph.D. Dr . Calfee has chaired our Education Advisory Board since our business started in 1995 . He has been a prolific researcher and author

in the area of reading and reading development for the past 30 years . Dr. Calfee is presently Distinguished Professor and Dean Emeritus at the School of

Education at the University of California, Riverside . He is professor emeritus at Stanford University's School of Education, as well as a member of the board ofthe Society for Scientific Study of Reading . Dr . Calfee is editor emeritus for Education Assessment and the Journal of Educational Psychology . Dr. Cal fee has

published eight books and over 150 articles in journals such as Educational Psychologist, the Journal ofReading, Issues in Education and Assessment in

Education .

Anne Cunningham, Ph.D . Dr. Cunningham is an associate professor of cognition and development at the University ofCalifomia , Berkeley and theDirector of the Joint Doctoral Program in Special Education . She is a past member of the board of the Society for Scientific Study of Reading and the board ofdirectors for American Educational Research Association , Division C. Dr. Cunningham has published over 35 articles in journals such as Development

Psychology, Journal of Educational Psychology, Reading and Writing, and The American Educator. Dr . Cunningham is a former classroom teacher and readingresource specialist , having taught pre-school and kindergarten through third grade for 10 years . She serves on numerous state and national committeessurrounding literacy development and instruction such as the U . S. Department of Education Reading First expert panel .

Alma Flor Ada, Ph.D . Dr. Ada is the director of the Center for Multicultural Literature for Children and Young Adults at the University of San Francisco,

where she has been a professor since 1976 . She is an expert on bilingual education and was the founder and first editor-in-chief of the Journal of the National

Association f 'r Bilingual Education, where she has served on the advisory board for over 25 years . Dr. Ada is the author of numerous award-winning English

and Spanish children's books and English and Spanish reading programs . Additionally, she has shared her expertise on issues of transformative education,multicultural and multilingual education, home school interaction and early childhood education in Central and South America, the Caribbean, Europe, NewZealand, Micronesia and in the United States and Canada .

Karen Fuson, Ph.D . Dr. Fuson is a Professor Emeritus at the School of Education and Social Policy at Northwestern University . She is a mathematicseducator and cognitive scientist whose work focuses on children's mathematical understanding and the classroom conditions that can facilitate suchunderstanding . Her past work has contributed to the understanding of children's counting and understanding of whole number, fraction, and decimalcomputation . Dr. Fuson is currently a contributing editor of the Journal of Mathematical Behavior and has served as an editorial board member of Mathematical

Cognition, Mathematical Thinking and Learning, and the Journal for Research in Mathematics Education . She has reviewed proposals for the National Science

Foundation since 1978. Dr . Fuson served on the recent Mathematics Learning Committee of the National Research Council . She has published over 100 articles

in books, handbooks, encyclopedias, and journals such as Cognition and Instruction, Journal of Educational Psychology, Journal for Research in MathematicsEducation, Elenrentcny School Journal, Cognitive Psycholog, and Child Development.

Ruth Nathan, Ph.D. Since June 2003, LeapFrog has employed Dr. Nathan as its Executive Educational Advisor. In addition, Dr. Nathan is a lead instructorat the University of California, Berkeley Extension Reading Certificate Program. Dr . Nathan has co-authored many books on literacy, including: Beginnings of

Writing; Classroom Strategies Thai Work; Writers in the Classroom ; The Great Source Reading Daybooks and Reading Source Books for third through fifth

grades ; and three writing handbooks, Writers Express, Write On Track, and Write Away. Additionally, she has published more than ten articles in journals such asReading Research Quarterly, Child Development and Language Arts . Dr . Nathan has taught in the public school system over a thirty year period, alternating herfull-time, classroom experience with university professorships and district consulting .

Scott G . Paris, Ph.D. Dr . Paris is a professor in the School of Education and professor and Chair of the Graduate Program in the Department ofPsychology at the University of Michigan. He was a founding member of the Center for the Improvement of Early Reading Achievement and served on the board

of directors of the National Reading Conference . He is on the editorial boards of the Educational Psychologist. Cognition and Instruction and Reading Research

Quarterly, and he has previously served on the editorial boards of 11 other journals . Dr. Paris is a frequent contributor to scholarly publications in the field of

education and developmental psychology . He has published 11 books, 50 chapters, and more than 75 articles in journals such as the Journal of Educational

Psychology. Developmental Psychology, Child Development, Reading Research Quarterly and Educational Psychologist .

P. David Pearson, Ph .D . Dr. Pearson is the Dean of the Graduate School of Education at the University of California,

Table of ContentsBerkeley and was previously the John A . Hannah Distinguished Professor of Education in the College of Education and the Co-Director of the Center for theImprovement of Early Reading Achievement at Michigan State University, and was Dean of the College of Education and the Co-Director of the Center for theStudy of Reading at the University of Illinois, Urbana-Champaign . He has been the President of the National Reading Conference and the National Conferenceon Research in English and has served on the board of directors of the American Association of Colleges for Teacher Education . Dr. Pearson currently serves on

the editorial advisory boards of Cognition and Instruction, Educational Assessment, Reading Research Quarterly, Research in the Teaching of English and

Reading On-Line . He is a frequent speaker and publisher in the field of reading and education. Dr . Pearson has had published 12 books and over 100 articles in

journals such as Reading Research Quarterly, The Journal of Literacy Research, Language Arts and The Reading Teacher.

Jeni Leta Riley, Ph .D. Dr . Riley is the head of the School of Early Childhood and Primary Education for the Institute of Education, University of London .

Dr. Riley received her conferment of title of Reader in Literacy in Primary Education in 2000 and has been active in early childhood literacy development as a

teacher, lecturer, examiner and researcher for nearly 30 years . Among her research projects was a study of literacy development in the first year of school and is

currently involved with a funded project called Storytalk, investigating how to support spoken language development most effectively in multicultural early years

classrooms. Dr . Riley has served on many educational committees, including four years as the Deputy Chair of the National Association of Primary TeacherEducation Conference (NaPTEC), and as a member of the Committee of the Heads of School, University of London, Institute of Education . Most recent

publications include an edited book Learning in the Early Years : A guide for teachers of children 3-7 and research journal articles entitled The National Literacy

Strategy: Success with literacy for all? and Developing young children's thinking through learning to write argument .

Liliane Sprenger-Charolles, Ph .D. Dr . Sprenger-Charolles is a Senior Research Scientist and leads the Literacy Department of a laboratory that belongsboth to the French National Center for Scientific Research (CNRS, Department of Humanities and Social Sciences) and to the University Rend Descartes, Paris .

She is an expert in the field of literacy with extensive research on the role of phonological skills in reading acquisition and developmental dyslexia . Dr.Sprenger-Charolles has been widely published in dozens of international journals and textbooks including recent research findings featured in the Handbook of

Children's Literacy and in the Journal of Experimental Child Psychology . Additionally, she has shared her expertise in literacy research as a speaker inprestigious academic conferences and workshops across Europe and in the United States and Canada .

Keith E. Stanovich. Ph.D. Dr . Stanovich is a professor at the University of Toronto, Department of Human Development and Applied Psychology where

he holds the Canada Research Chair in Applied Cognitive Science . Dr. Stanovich has been recognized for his research in reading including being awarded the

Distinguished Scientific Contributions Award from the Society for the Scientific Study of Reading, July 2000, and the International Reading Association's Albert

J . Harris Award in 1988 and 1992, the only two-time winner . He was elected to the Reading Hall of Fame in 1995 by the members of that society . He has

published over 125 articles in journals such as Journal of Educational Psychology, American Educator and Scientific Studies of Reading. Dr. Stanovich served

four years on the board of directors for the Society of Scientific Study of Reading and is an editorial board member for several academic journals .

Our ProductsWe have developed a variety of learning platforms, a significant library of related content and more than 35 stand-alone products . Our platforms are

hardware devices that work with multiple content sets . Our content comes in the form of memory cartridges and, where applicable, related interactive books,magazines and activity cards designed for use with specific platforms . Our stand-alone products combine our proprietary technology with a fixed set of content .

Hardware Platforms and Related Content

LeapPad Family of Platforms

LittleTouch LeapPad learning system (ages 6 months to 3 years) . Our LitticTouch LeapPad learning system, which was launched in Fall 2003, isdesigned for infants and toddlers and offers an opportunity for parents to introduce the reading experience and early learning concepts using fingertouch-based interactivity. The LittleTouch platform is padded on the back so that adults can rest it on their laps for a parent/child reading

experience, or young children can rest it on the ground for an independent learning experience .

The LittleTouch library of content includes interactive books and activity cards made of tear resistant material that feature activities that introduceABCs, letter sounds, numbers, colors, shapes and reading readiness . The LittleTouch content is designed to match the rapid growth and

development that occurs during the infant and toddler years . Each interactive book contains three learning experiences that are designed to stimulate

learning at various developmental levels . One setting features music, rhythms and sounds to help infants recognize key, pitch and tempo. Another

setting focuses on word play in order to introduce word-object association and early language concepts . A third setting features early learning

concepts to help build preschool readiness by introducing abstract concepts like colors, shapes and numbers, as well as word production and earlygrammar skills.

Table of Content sCurrently we have six LittleTouch LeapPad interactive books available at retail.

My First LeapPad learning system (ages 3 to 5) . Our My First LeapPad learning system encourages preschoolers to take their first steps towardpre-reading and pre-math skills development . It incorporates the same proprietary NearTouch technology of our LeapPad learning system in a

platform designed for younger children. Children place a specially designed flipbook and corresponding cartridge in the platform . On the story side,children can hear the story, play a game or perform an activity related to the story . In addition, using the NearTouch stylus, children can touch words

and pictures to hear their pronunciation as well as develop small motor skills with the "magic" pen in preparation for pre-kindergarten teaming . Onthe activity side, children can touch words, numbers and pictures to learn about them, or select from three games that help reinforce letter andnumber recognition, object identification and music . The audio feedback feature gives children the option of using the platform with or withoutadult supervision . We have developed an interactive series with guidance from our educational experts that is designed to help develop skills in

reading, tnath, vocabulary, science, social studies, safety, community awareness and more . The My First LeapPad book series uses our family ofLeap characters as well as licensed characters such as Winnie-the-Pooh, Dora the Explorer and Thomas the Tank Engine .

Sales of our My First LeapPad platfonns and related interactive books accounted for approximately 4% of our total net sates in 2001, approximately9% of our total net sales in 2002 and approximately 12% of our total net sates in 2003 .

Currently we have twelve My First LcapPad interactive books available at retail .

LeapPad learning system (ages 4 to 8). Our LeapPad learning system, the first platform of our LeapPad family of platforms, is based on our

proprietary NearTouch technology . Since 1999, the LeapPad platform has transformed our LeapPad books into audio-interactive learning devicesWhen children touch words and pictures with the stylus pen, they receive instant audio feedback that helps them sound out and pronounce words,learn to read and build vocabulary. These experiences also reinforce other fundamental learning concepts . The LeapPad learning system allowschildren to read and learn at their own pace, using educational games, activities, music and positive feedback .

The LeapPad platform is available in English, French, Korean, Japanese and Spanish, and is sold in U .S . schools .

The retail LeapPad library was developed with guidance from our educational experts and is designed to help children build skills they need to excel

in reading, math, vocabulary, science, music, logic and more. The library is divided into grade-based categories so children can learn appropriateskills at appropriate intervals, and include :

• Pre-Kindergarten and Kindergarten : First category of books designed to teach and reinforce reading and math readiness skills, such asletter and number recognition and sounds .

• Phonics Program(pre-kindergarten through 1st grade) : Ten storybooks and four activity books make up this integrated , step-by-step

approach to teaching children phonics , the key to learning how to read .

• First Grade : Helps teach basic reading fundamentals and vocabulary and expands on phonics awareness .

• Second Grade: Introduces children to chapter reading, helps strengthen vocabulary and reading comprehension and expands children'sknowledge through math, science, music and more.

• Leap's Pond magazine, which features content from Time for Kids, a children's magazine from the publishers of Time. Leap's Pondmagazine reinforces reading fundamentals with puzzles , games and articles of interest to children .

Our retail library includes titles featuring our Leap family of characters as well as popular characters like Scooby-Doo, Winnie-the-Pooh

and SpongeBob SquarePants, as well as characters from movies like Toy Story 2, The Lion King, Monsters, Inc. and Finding Nemo.

Our SchoolHouse version of the LeapPad learning system is reinforced for classroom use and comes with an AC adapter and headphones .

The SchoolHouse division offers over 450 activity cards and over 200 books for use in schools, which represent over 6,000 pages ofinteractive content. For more details regarding the LeapPad platform products offered by our SchoolHouse division, see "Item 1 . Business .

-SchoolHouse ."

Table of Content s

LeapPad Plus Writing learning system (ages 4 to 8) . Our LeapPad Plus Writing learning system adds a new dimension to the original platform byconverting the NearTouch-based stylus into a "magic" pencil that can also write on specially designed interactive books . The dual function

stylus/pencil can easily be switched between writing mode and non-writing mode . The entire LeapPad library can be used with LeapPad PlusWriting platforms . The LeapPad Plus Writing learn ing system was launched in Fall 2003 with an exclusive library of writing activity-enabledbooks.

Quantum Pad learning system (3rd to 51h grades) . Our Quantum Pad learning system incorporates design features intended to appeal to 3rd through5th grade students. The entire LeapPad library can be used with the Quantum Pad platform . The Quantum Pad learning system uses our proprietary

NearTouch technology as well as a "write-on" feature that allows students to write directly on erasable transparent plastic pages . We believe thisadded feature makes the Quantum Pad system effective for use with more complex math and science concepts. The Quantum Pad series of books isdeveloped in conjunction with our educational experts to focus on subjects children are learning in school, such as science, social science, complexreading comprehension, upper level math and the arts, including the following interactive book series :

Fun-Darnerrtals : Curriculum-based books that focus on development in academic subjects such as geography, math and science and agrade-based series of three books that provides children with information on skills essential to the 3rd, 4th and 5th grades, such as grammar,history, math and science .

Great Reader: Encourages reading and builds on more complex reading skills such as comprehension , plot, theme, characters and opinion .

Above and Beyond: Introduces new subjects to children including the arts, logic, geography, planets and space exploration, movie making,culture and music .

Aggregate sales of our LeapPad, LeapPad Plus Writing and Quantum Pad platforms, each of which are based on our NearTouch technology and can worktogether with a significant majority of the same interactive books, together with aggregate sales of the interactive books compatible with these threeplatforms, accounted for approximately 53% of our total net sales in 2001, approximately 56% of our total net sales in 2002 and approximately 47% of ourtotal net sales in 2003 .

Currently we have over 100 interactive books available at retail, the significant majority of which are compatible with each of the LeapPad, LeapPad PlusWriting and Quantum Pad platforms .

Leapster Multimedia Learning System (ages 4 to 8 )The Leapster multimedia learning system, launched in November 2003, is designed to teach kids in the manner in which they like to play . Similar to

handheld video game devices, the Leapster handheld allows children to play action-packed learning games with backlit color animation using amulti-directional control pad and a touch-screen enabled by a built-in stylus . In addition, the Leapster content also allows "players" to read electronic books,create works of art and watch interactive videos . Currently we have eight interactive Leapster titles available at retail, including educational games featuring

Dora the Explorer and SpongeBob SquarePants, a digital art title, an educational book on phonics and our interactive The Letter Factory video .

Turbo Twist Handhelds: Spelling, Math, and Vocabulater Versions and Brain Quest Edition (I"through 6rr' grades)

Our Turbo Twist handhelds let children twist, pound and press the handheld device while they learn spelling, math, social studies and vocabulary . Usingour proprietary technology, each Turbo Twist platform self-adjusts as the child answers questions to deliver content appropriate for his or her individual skilllevel . Each handheld was developed to reinforce the skills and information children learn in school. Each comes preloaded with spelling, math, social studies or

vocabulary questions . Content cartridges for math, spelling and social studies for l st through 6th grades are available at retail . The Turbo Twist Brain Questedition covers our social studies curricula, and features BrainQuest licensed content. In 2004, we expect to introduce a new version of the Turbo Twist handheldthat is compatible with grade-specific cartridges containing multiple learning categories .

Table of ContentsiQuest Interactive Handheld ( 5th grade through high school)Our iQuest interactive handheld was initially created specially to assist children in studying fur tests at the middle school level . We have created outlines,

review games and tips for over 250 major textbooks used in 5th through 8th grade social studies, science and math classes . Each iQuest handheld comespre-loaded with a 75,000 word pocket version of the Merriam-Webster dictionary and a cartridge with over 1,000 basic fact questions created in conjunctionwith The Princeton Review, as well as a program that lets children input addresses and phone numbers . Additional content cartridges are available with testquestions from over 250 textbooks used in schools across the United States . Our test preparatory materials licensed from Kaplan, Inc ., allow students to use theiriQuest handheld to study for the PSAT, SAT and ACT standardized tests and include a workbook and corresponding content cartridge .

Stand-Alone ProductsOur more than 35 stand-alone educational products are designed for children who are too young to use our platforms effectively . These stand-atone

products help develop fine motor skills and color, sound and letter recognition. These products are generally affordable and simpler to localize for foreignmarkets than our platform and content suites . Some of our more popular stand-alone products include :

LeapStart Learning Table --- a learning table designed for infants and toddlers to refine motor skills, introduce letters and numbers andencourage development ;

Fridge Phonics Magnet Set a magnetic letter set designed for preschoolers and kindergarteners that teaches letter names, letter soundsand learning songs ; an d

Explorer Globe - an interactive , touch-sensitive globe utilizing our NearTouch technology designed for older children and teens thatintroduces interesting facts about continents, countries , capitals, currency and more .

SchoolHouse

Our SchoolHouse division, part of our Education and Training group, offers supplemental pre-kindergarten through 8th grade school curriculum program sthat incorporate our proprietary technology platforms and research-based instructional principles . Our SchoolHouse division curriculum provides over 200interactive book titles and over 450 interactive assessment cards, for a total of over 6,000 pages of interactive content . The interactive content includes instructionand assessment for subject areas such as early literacy, early childhood , reading, language arts, math , science, English language development and specialeducation , Our multi-sensory classroom programs include :

Leap Track assessment and instruction system (kindergarten through 5th grade) . In 2002, we launched our LeapTrack assessment and instructionsystem, which has become our flagship SchoolHouse product . The LeapTrack system is an instructional management system using the LeapPadplatform, re-writable flash memory cartridges, a LeapPorl cartridge station and a CD-ROM-based computer program to instruct and assessstudents in kindergarten through 5th grade . Test results are uploaded from the LeapPad platform via the re-writable flash memory cartridge to themanagement system for immediate scoring and evaluation . These tests correspond to state standards, giving teachers an early opportunity to monitorthe performance of their students in subject areas such as reading, math and language arts . Based on each student's individual results, the systemthen prescribes individualized instructional content for each student, which is available for immediate download via the re-writable flash memorycartridge for use on the LeapPad platform . The LeapTrack system includes 12 LeapPad or Quantum Pad platforms for use in the classroom and hasa list price of approximately $3,795 for each individual classroom kit .

The Literacy Center (pre--kindergarten through 2nd grade) . The SchoolHouse Literacy Center is a curriculum for reading instruction withpre-kindergarten, kindergarten and grade 1+ editions that offer an interactive multi-sensory approach to developing early literacy skills . Theprogram includes whole-class instruction as well as small-group and individual work using our LeapPad platform outfitted with headphones, ourLeapDesk and LeapMat interactive products and an array of posters, books, activity cards and sing-along music for the classroom . We offermanuals to help teachers incorporate books, activity cards and other materials into an effective daily lesson plan . Some packages include backpacksto encourage students to take their LeapPad platforms home for additional practice and parental involvement .

Language First! program (kindergarten through 2nd grade+) . Our Language First ! Program is an English language development program forkindergarten through 2nd grade. Launched in 2002, our Language First! curriculum is designed to help teach English to children with limitedEnglish proficiency or for whom English

is not their primary language through the use of 36 interactive LeapPad books. Over the past few years, many states and school districts have movedaway from bilingual education for non-English speakers in favor of English immersion programs . The Language First! program is designed to help

children gain these required language skills.

Ready, Set, Leap! program (pre-kindergarten) . Also in 2002, we introduced the Ready, Set, Leap! curriculum program for the pre-kindergartenmarket. The scope and sequence of the Ready, Set, Leap! curriculum cover subject matter in language and early literacy, mathematics, socialstudies, science, fine arts, health and safety, and personal and social development, as well as physical development . This research-based programuses LeapFrog Schoolhouse's award-winning interactive platforms, including the LeapPad platform, the LeapDesk workstation, the LeapMatlearning surface, and the Imagination Desk learning system, to create a multisensory, hands-on learning experience . This program has been adopted

by the Texas State Board of Education .

International

Our international strategy includes the creation of LeapFrog products in foreign languages as well as marketing English-language products as tools fo r

learning English as a foreign language . As of December 31, 2003, our products had been marketed and sold in five languages and more than 20 countries,including the United Kingdom, Canada, France, Spain, Mexico, Japan, Australia and Korea . We currently sell our My First LeapPad and LeapPad platforms in

countries where we have created content for our platforms in the local language . We have created British English content for the U .K . market and havedeveloped a variety of our content in other languages, including French, Japanese, Korean and Spanish . We sell our LeapPad platform to the consumer market inJapan under the CoCoPad brand name through our relationship with Sega Toys . In addition, Benesse Corporation, a supplemental educational materialscompany, is currently distributing a co-branded CoCoPad version of our LeapPad platform to preschool to third grade level subscribers of its educationalprogram. We market and sell local language versions of some of our stand-alone products, including French and Spanish versions of the Discovery Ball,Learning Drum and Learning Table . These stand-alone products, with their limited set of content, are typically easier to localize than our platform and content

suites . Finally, we sell our English language content internationally through consumer retail and educational channels and believe that significant opportunitiesexist to market our products as. tools to learn English as a foreign language.

Advertising and MarketingOur advertising and marketing strategy is designed to establish LeapFrog as the leading provider of engaging, effective and affordable learning solutions

for the infant through high school audience and as a brand that parents and educators will seek to supplement a child's educational needs . We use a variety of

advertising and marketing tools to implement our strategy, including network and national cable television advertisements and national print advertisements thatfeature our LeapFrog brand and our "Learn Something New Every Day" campaign that highlights the educational nature and extended life of our products . Weare able to feature our products through cooperative print advertisements in local newspapers with key retail chains . These advertisements, run by our retail

partners such as Toys "R" Us, Wal-Mart, Kfnart and Target, highlight the availability of particular LeapFrog products at these retail outlets .

In key retail stores, we feature our products via our Learning Center shelf displays, which are designed to highlight our LeapFrog brand as the "one stop"

solution for technology-based educational products . We have received additional brand exposure through television appearances by senior management andother television spots showcasing our products, often during the key holiday season .

Sales and DistributionU.S. Consume r

We market and sell our products primarily through national and regional mass-market retail stores as well as specialty toy stores . In 2003, sales of our

products to Toys "R" Us, Wal-Mart (including Sam's Club) and Target accounted for over 79% of net sales in our U .S . Consumer segment . Our remaining U .SConsumer retail sates came from sales of our products to specialty toy stores and, to a lesser extent, to book, electronics and office supply stores and other

retailers .

Our sales team works in conjunction with store buyers from our key retailers to forecast demand for our products, develop the store floor footprint, secureretail shelf space for our products and agree upon pricing components, including cooperative advertising allowances . The large retail chains generally provide uswith a preliminary forecast of their expected purchases of our products early in the year . While these and subsequent forecasts are not contractually binding, they

provide important feedback that we use in our planning process throughout the year . We work closely with our key retailers during the year to establish andrevise our expected demand forecasts and plan our production and delivery needs accordingly . Most retailers issue purchase orders to us, as they need product .

Based on these purchase orders, we prepare shipments for delivery through various methods. We sell to smaller retail stores through a combination of sales

representatives and direct salespeople .

Table of ContentsEducation and Training

Our Education and Training group's primary customers represent U .S . pre-kindergarten through 8th grade classrooms as well as teacher supply stores and

catalogs through our SchoolHouse division. As of December 31, 2003, using our in-house sales team as well as independent sales representatives, we estimatethat we have sold our Literacy Centers, LeapTrack systems and Ready, Set, Leap! programs, as well as other products into an estimated 25,000 classrooms . We

plan to grow our sales team significantly over the next few years to provide a more focused sales effort and increase our penetration of the school market .

International

In 2000, we established our U .K . office, located outside London, England, which sells our products directly to Woolworth's, Early Learning Centres, Toy s"R" Us, Argos and other leading U .K . retailers . Our emerging success in penetrating the U.K . market is exemplified by the British Association of Toy Retailerschoosing our LeapPad platform as the top preschool toy for each of 2001, 2002 and 2003 . Our U .K . office also coordinates distribution of our U .K.-localized

British English products into Australia and New Zealand . We also have satellite offices in Hong Kong and Macau that help us oversee global manufacturing of

our products . In 2002, we began selling directly to retailers in Canada and in France and in 2003 we began selling directly to retailers in Mexico .

Prior to the establishment of overseas offices or subsidiaries, we utilize simple distribution arrangements to sell our products in other non-Englishspeaking countries, using separate distributors for the consumer and school markets as appropriate . In markets where we do not establish direct sales, we plan oncontinuing to use these distribution arrangements . Paralleling our segmentation of the U .S . market between consumer and school markets, we believe thatoverseas markets represent similar dual opportunities. Although we plan to develop most key consumer markets directly, we expect to seek a strategic educationpartner in key overseas markets given the costs and challenges associated with developing country-by-country curricula .

We currently have distribution arrangements with distributors in countries such as Spain, Korea, Australia and New Zealand . In March 2002, Sega Toysbegan distributing the CoCoPad system, a co-branded, modified version of our LeapPad platform, and Sega Toys has developed original Japanese-languagecontent for interactive books used with the CoCoPad system, including books by Berlitz International that help teach English . Benesse Corporation is assisting itsin developing the Japanese supplemental educational materials market by distributing the CoCoPad system to its preschool through third grade level subscribers .Additionally, Benesse Corporation has developed original educational content in Japanese and English for interactive books to be used with the CoCoPad system .

Financial Information about Geographic Areas

Our International segment represented 14% of our total conso lidated net sales in 2003 . For the year ended December 31, 2003, 2002 and 2001 , net sales indollars and as a percentage of our International segment net sales were as follows :

Year Ended % of TnlalDecember 31, Internationa l

2003 2002 2001 2003 2002 200 1

Europe $48,946 $25,258 5 9,696 51% 47% 59 %North America (excluding U.S.) 31,197 13,441 4,219 32% 25% 26 %Asia & Australia 16,424 14,887 2,407 17% 28% 15 %

Total International $96,567 $53,586 $16,322 100 % 100 % 100 %

(1) In thousands

No individual country within our International segment exceeded 10% of consolidated net sales during 2003 .

Our long-lived assets are primarily comprised of net fixed assets and net intangibles . In 2003, approximately 3% of our long-lived assets were locatedoutside of the United States . For the year ended December 31, 2003, 2002 and 2001, long-lived assets in dollars and as a percentage of total long-lived assets

were as follows:

Year Ended % of Tota lDecember 31, Long-Lived Asset s

2003 2002 20111 2003 2002 200 1

United States $45,420 $48,364 $42,057 97% 99% 99 %Asia 1,568 258 167 3% 1% 1 %Europe 274 159 83 0% 0% 0%

Total Long-Lived Assets $46,988 $ 48 , 622 $42,224 100% 100 % 100 %

(1) In thousands

9

Table of ContentsResearch and Developmen t

Hardware and Software Developmen t

To develop our products and content, we have assembled a team of technologists with backgrounds in a wide variety of fields including education, childdevelopment, hardware engineering, software development, video games and toys . We have developed internally each of our current platforms and stand-alone

products, although we use licensed technology if it is advantageous to do so . For example, we use a version of Macromedia's Flash player in our Leapster

platform .

We have successfully developed proprietary technologies that we use across a number of products in the markets we serve . We have made innovations in

the areas of touch detection technology, speech compression, music synthesis and content generation . By combining technology developments in mixed signalapplication-specific integrated circuits, or ASICs, we have been able to add features at comparatively low cost .

We have built internal expertise in hardware design, hardware synthesis, mixed signal custom ASIC design, real-time embedded systems, software design,tools for packaging and compiling product content and mechanical engineering. The research and development team participates in all phases of the product

development process from concept through manufacturing launch.

Content Developmen tOur dedicated content production department has written scripts and designed a large majority of the art, audio and other content for our interactive books,

activity cards and stand-alone products, applying our own pedagogical approach that is based on established educational standards . Most of the members of ourcontent production team have prior experience in the education, entertainment and educational software or video game industries .

We have developed a portion of our content using licensed characters .such as Disney Princesses, Thomas the Tank Engine, Scooby-Doo and the

characters from the movie Finding ANemo, and we plan to continue the use of licensed characters in our interactive books for our LeapPad family of platforms aswell as content for our other platforms, such as Dora the Explorer and SpongeBob SquarePants in interactive content for our Leapster platform . In addition, we

offer licensed Brain Quest content for our Turbo Twist handheld and test preparation materials from Kaplan, Inc. for use with our iQuest handheld .

We launched our Developer's Studio in July 2001, a team dedicated to creating software tools that help turn the content designed by our contentdevelopers into interactive content that work with our various platforms . The tools developed by this team have shortened the time-to-market for our new

interactive books . In an effort to increase the amount and variety of content available for our platform products, we make these tools available to outside

developers . Our Developer's Studio team trains and provides technical support to internal and external content development teams, and works with ourproduction team to turn our internally developed content into interactive books. Finally, this team is responsible for managing the business relationships with ourgrowing community of third party developers that are trained to create content for our platforms .

Our research and development expenses were $38 .4 million in 2001, $54.4 million in 2002 and $57 .6 million in 2003 .

Intellectual PropertyWe believe that the protection of our patents, trademarks, trade dress, copyrights and trade secrets is critical to our future success, and we aggressively

protect our proprietary rights through a combination of patents, trademarks, copyrights, trade secrets, confidentiality procedures, nondisclosure agreements and

other contractual agreements . As of December 31, 2003, we had over 25 utility and design patents issued by the U .S . Patent and Trademark Office, as well as

over 30 issued internationally. These include 20 domestic and foreign patents related to our LeapPad platform technology, which do not expire before 2013 .

Additionally, we have filed over 140 patent applications pending in the United States and other countries . We cannot assure you that any of our pending patent

applications will result in the issuance of any patents, or that, if issued, any of these patents, or our patents that have already issued, will offer protection againstcompetitors with similar technology. As of December 31, 2003, we also had over 62 U .S . trademark registrations, including for marks incorporating "LeapFrog"and the "LeapPad" and "NearTouch" marks, as well as over 138 foreign trademark registrations . We also rely upon trade secrets, technical know-how and

continuing invention to develop and maintain our competitive position . For a discussion of how our intellectual property rights may not prevent our competitors

from using similar or identical technology, see "Item 7 . Management's Discussion and Analysis of Financial Condition and Results of Operations - RiskFactors That May Affect Our Results and Stock Price -- Our

10

Table of Contentsintellectual property rights may not prevent our competitors from using our technologies or similar technologies to develop competing products, which couldweaken our competitive position and harm our operating results." For a discussion of how our intellectual property rights may not insulate us from claims ofinfringement by third parties, see "Item 3 . Legal Proceedings" and "Item 7 . Management's Discussion and Analysis of Financial Condition and Results ofOperations - Risk Factors That May Affect Our Results and Stock Price - Third parties have claimed, and may claim in the future, that we are infringing theirintellectual property rights, which may cause us to incur significant litigation or licensing expenses or to stop selling some or all of our products or using some ofour trademarks . "

Manufacturing, Logistics and Other Operation sOur manufacturing and operations strategy is designed to maximize the use of outsourced services particularly with respect to the actual production and

physical distribution of our products and to concentrate our internal resources on areas such as engineering, production planning and quality control . We believeour outsourcing strategy also enhances the scalability of our manufacturing efforts . In order to work closely with our manufacturing service providers, we haveestablished offices in Hong Kong and Macau . We use several turnkey contract manufacturers to source components and build finished products to ou r

specifications. We order our products on a purchase order basis from component suppliers and some of the components used to make our products, including ourASICs, currently come from a single supplier . For information as to how this concentration of suppliers could affect our business, see "Item 7 . Management'sDiscussion and Analysis of Financial Condition and Results of Operations - Risk Factors That May Affect Our Results and Stock Price We do not havelong-term agreements with our major suppliers, and they may stop manufacturing our components at any time ;" and "- We depend on our suppliers for ourcomponents, and our production would be seriously harmed if these suppliers are not able to meet our demand and alternative sources are not available . " Wecurrently use eight contract manufacturers located in mainland China to build our finished products, which are selected based on their technical and production

capabilities and are matched to particular products to achieve cost and quality efficiencies . We have our own quality assurance employees on site at each of ourcontract manufacturers . During the years from 2001 to 2003, Jetta Company Limited, one of our manufacturers in China, supplied 35%, 45% and 32% of ourproducts, respectively, and our top three manufacturers combined supplied a total of 53%, 58% and 48% of our products, respectively . For information as to howthis concentration of manufacturing could affect our business, see "Item 7 . Management's Discussion and Analysis of Financial Condition and Results ofOperations ---- Risk Factors That May Affect Our Results and Stock Price - We rely on a limited number of manufacturers, virtually all of which are located inChina, to produce our finished products, and our reputation and operating results could be harmed if they fail to produce quality products in a timely manner andin sufficient quantities ." The majority of our products are shipped directly to our contract warehouse in Ontario, California and are later shipped to meet thedemands of our major U .S . retailers and other smaller retailers and distributors throughout the United States.

Information Technolog y

Our information technology environment is built around an Oracle system that supports our core order management, distribution, manufacturing andfinancial operations worldwide . We are also in the process of implementing new applications that are intended to further improve our supply chain management

capabilities . These applications include supply chain planning software and warehouse management systems for our new distribution facility that is anticipated tobe operational in mid-2004 . In addition, we also have software systems that we use for both sales analytics and financial planning .

Customer Servic e

We believe that our ability to establish and maintain long-term relationships with consumers and retailers depends, in part, on the strength of our customersupport and service operations. We encourage and utilize frequent communication with and feedback from our customers and retailers to continually improve ourproducts and service. Our consumer service center operates 24 hours a day, 7 days a week during peak periods, specifically from November through January, and14 hours on weekdays, and 9 hours on Saturdays during off-peak periods . We offer toll-free telephone support for consumers and retailers who prefer to talk

directly with a customer service representative . We also respond to email inquiries received through our website, and we have a team of in-house customerservice representatives who oversee and coordinate our customer service activities with our third-party customer service provider . In addition, on our website,we have a knowledge resource link that directs consumers to a frequently asked questions section, which we update as we receive consumer feedback . We also

have a dedicated retail sales service team . This team works with our top retailers and provides point-of-sale related analysis for better forecasting and inventoryplans . Our service operations are based in our Emeryville, California facility .

Competition

We compete primarily in the infant and toddler category, preschool category and the electronic learning aids category of the U .S. toy industry and, to some

degree, in the overall U .S. and international toy industries . We believe the principal competitive factors impacting the market for our products in retail stores are

brand, design, features, educational soundness, quality and price . We believe that we compare favorably with many of our current competitors with respect tosome or all of

Table of Contentsthese factors . Our current principal competitors in the toy industry compete in the preschool category and include Hasbro, Inc ., Mattel, Inc. and VTech

Corporation . In 2003, Mattel introduced a product under the name "PowerTouch" under Mattel's Fisher Price brand, and Publications International, Ltd .introduced a product under the name "ActivePAD," each having functionality similar to that of some of the platforms in our LeapPad family of platforms . InJune 2002, Toshiba Corporation began selling an interactive educational platform product in Japan under the name "Ex-Pad ." We also compete with educationalsoftware publishers, such as Knowledge Adventure (a studio of Vivendi Universal Gaines), whose products have distribution at mass retailers and electronics andtoy stores, and with producers of popular handheld game platforms, such as Nintendo Co ., Ltd . and Sony Corporation, whose products may compete with our

Leapsler platform . We believe that producers of smart mobile devices, such as personal digital assistants , non-mobile game platforms and computer basedsoftware may be able to compete effectively in our primary markets by developing engaging educational products that run on their platforms . These companieshave significantly larger installed bases than we do . We are also beginning to cross over into (heir markets with products such as our iQuest handheld device . Inaddition, a number of major hardware and software makers have developed pen-based portable computers like the Tablet PC that could compete with some ofour products, such as our LeapPad family of platforms . Consequently, competitors may include companies like Acer Inc ., Apple Computer, Inc ., Fujitsu Limited,Hewlett-Packard Company, Microsoft Corporation, NEC Corporation, palmOne, Inc., PalmSource, Inc ., Sega Corporation, and Toshiba . Many of our direct,indirect and potential competitors have significantly longer operating histories, greater brand recognition and substantially greater financial, technical andmarketing resources than we do .

Our SchoolHouse division competes in the U .S . supplemental educational materials market. We believe the principal competitive factors affecting themarket for our products in the school market are educational soundness , proven effectiveness, brand, features and price . Our SchoolHouse division facescompetition in the supplemental curriculum market from major textbook publishers such as Harcourt ( a division of Reed Elsevier), Houghton Mifflin Company,McGraw-Hill, Pearson plc and Scholastic Corporation , as well as electronic educational material and service providers such as Knowledge Adventure, PLATO

Learning, I nc ., Renaissance Learning and Riverdeep Group plc . Many of the companies with whom we compete have signifi cantly more experience in thesupplemental educational materials market and greater resources than we do .

In the future , large entertainment companies such as Viacom International , Inc . and Walt Disney Co . may begin to target the school markets. For adiscussion of the possible effects that competition could have on our business , see " Management ' s Discussion and Analysis of Financial Condition and Resultsof Operations - Risk Factors That May Affect Our Results and Stock Price If we are unable to compete effectively with existing or new competitors, our netsales and market share could decline ."

Seasonality

Our business is subject to significant seasonal fluctuations . For more information, sec "Seasonality and Quarterly Results of Operations" and "Risk FactorsThat May Affect Our Results and Stock Price Our business is seasonal, and therefore our annual operating results will depend, in large part, on sales relating

to the brief holiday season" in Item 7 of this Form 10--K.

Employees

As of December 31, 2003, we had 869 full-time employees . We intend to hire additional employees as needed at each of our facilities. We also retai nindependent contractors to provide various services, primarily in connection with our software development and sales activities . We are not subject to anycollective bargaining agreements and we believe that our relationship with our employees is good .

Executive Officers of the Registran tThe following table sets forth information with respect to our executive officers as March 1, 2004 :

Name Age Position Hel d

Thomas J. Kalinske 59 Chief Executive Officer and Directo rJerome J. Perez 46 President and Directo r

Paul A. Rioux 58 Vice Chainnan and Directo rMichael C . Wood 51 Chief Vision & Creative Officer, Vice Chairman and Directo rJames P. Curley 48 Chief Financial Officer, Treasurer and Secretary

G . Frederick Forsyth 59 Chief Operating OfficerTimothy M . Bender 43 President, Worldwide Consumer Grou pRobert W. Lally 42 President, SchoolHouse Division and Executive Vice President ,

Education and Training Group

Mark B . Flowers 44 Executive Vice President, Chief Technology Office rL. James Marggraff 45 Executive Vice President, Conten tMadeline T . Schroeder 44 Executive Vice President, Publishing Services

12

Table of ContentsThomas J. Kalinske has served as our Chief Executive Officer since February 2004 and previously served in that capacity from September 1997 to March 2002 .

He has served on our board of directors since September 1997 and was the Chairman of our board of directors from September 1997 to February 2004 . From

1996 to February 2004, Mr . Kalinske served as the President of Knowledge Universe . From 1990 to 1996, he served as President and Chief Executive Officer of

Sega of America. Prior to that, he was President and Chief Executive Officer of the Universal Matchbox Group from 1987 to 1990 . Prior to that, he served as

President and Co-Chief Executive Officer of Mattel, Inc . Mr. Kalinske has served as Chairman of the Toy Manufacturers Association of America, and in 1997,

he was inducted into the Toy Industry Hall of Fame . He also is a member of the board of the Milken Family Foundation, the National Foundation for the

Improvement of Education and the RAND Education Board . He earned a B.S . from the University of Wisconsin and an M .B.A . from the University of Arizona .

Jerome J. Perez has served as our President and has served on our board of directors since February 2004 . From July 2003 to February 2004, he was President of

Geronimo Consulting LLC, a marketing and consumer product development consulting firm that provided us consulting services . From November 1995 to July

2003, Mr. Perez served in various capacities at Fisher-Price, Inc ., most recently as Executive Vice President of Marketing and Design . Prior to that, he served as

Vice President of Marketing at Kenner Products, a division of Hasbro, Inc ., from 1985 to 1991 . From 1981 to 1985, Mr. Perez served in various marketing

positions at the Quaker Oats Company. He has a B.A . from University of Notre Dame and an M .B .A from University of Michigan .

Paid A . Rioux was elected to our board of directors in January 2001, has served as our Vice Chairman since January 2001 and served as our acting ChiefOperating Officer from October 2002 to August 2003 after implementing our planning, manufacturing and operating strategy since January 2001 . Mr. Rioux

worked as an independent consultant from June 1999 to December 2000, and worked almost exclusively for us in that capacity from August 2000 to December2000 . Prior to joining us, Mr . Rioux also served as President of Universal Studios New Media Group, the technology, Internet and video games business unit of

Universal Studios, from May 1996 to May 1999 . Prior to that, he worked at Sega of America from 1989 to 1996, most recently as an Executive Vice President .

Mr. Rioux also served as Chief Operating Officer of Wonderline Toys, Inc . from 1986 to 1988 and worked at Mattel, Inc .'s Toys and Electronics divisions from

1973 to 1985, most recently as its Senior Vice President. Mr . Rioux has a B .S. and an M .S. from the California State University at Northridge .

Michael C. Wood has served as our Chief Vision & Creative Officer since February 2004 and as our Vice Chairman of our board of directors since September1997. Previously, lie served as our Chief Executive Officer from March 2002 to February 2004 and as our President from September 1997 to February 2004 . He

served as the Chief Executive Officer of LeapFrog RBT, LLC, our predecessor limited liability company, from its inception in January 1995 until September1997. Mr. Wood founded LeapFrog in 1995 after developing the patented Phonies Letters and Phonics Desk products . Before founding LeapFrog, Mr. Wood

served as partner at Cooley Godward LLP, a national law firm, where he specialized in venture capital and emerging technology law . Mr . Wood also serves on

the board of directors of Sangamo BioScicnces, Inc ., a biotechnology company . He earned his B .A . at Stanford University and also has a J .D . from the University

of California, Hastings College of the Law, and an M.B .A . from the University of California, Berkeley.

James P. Curley has served as .our Chief Financial Officer since December 2001 . Prior to joining us, he served as Chief Financial Officer of Open Table, Inc ., an

online customer relationship management company focusing on the food service industry, from October 2000 to August 2001 . From January 1998 to December

2001, Mr. Curley founded and served as President and Chief Executive Officer of Four Green Fields, a specialty retailer. From July 1992 to January 1998, he

served as Senior Vice President and Chief Financial Officer, and additionally from February 1996 as Chief Administrative Officer and a member of the board ofdirectors, of The Gymboree Corporation . From 1989 to 1992, Mr. Curley was Senior Vice President and Chief Financial Officer of Gantos, Inc ., a retailer of

women's apparel, and from 1985 to 1989, he was Vice President and Chief Financial Officer of Huffman-Koos, Inc ., an upscale furniture retailer. Mr . Curley

served on the board of directors and was chairman of the audit committee of West Marine Corporation, a publicly traded boating goods retailer, from 1993 toMay 2001 . Mr. Curley is a certified public accountant and received his B .B .A . from Texas A&M University .

G. Frederick Forsyth has served as our Chief Operating Officer since August 2003 . Prior to joining us, he served as Chief Executive Officer and President of

NewRoads, Inc ., a company providing outsourced fulfillment for the direct channel, from May 2000 to May 2003 . From February 1999 to May 2000, Mr .

Forsyth served as President of the Americas of Solectron Corporation, a provider of electronics manufacturing services to original equipment manufacturers .

From August 1997 to February 1999, he served as Corporate Senior Vice President and President of Professional Storage Products Division of IomegaCorporation, a manufacturer of removable storage systems for digital information . From July 1989 to February 1997, Mr . Forsyth served in various positions

with Apple Computer, Inc ., including Senior Vice President and General Manager of the Power Macintosh Group from May 1996 to February 1997 and SeniorVice President of Worldwide Operations of Apple Computer from June 1993 to May 1996 . Mr. Forsyth has a B .S . from University of New Hampshire and an

M .B .A. from Babson College .

Timothy M. Bender has served as our President, Worldwide Consumer Group since January 2002, and served as out Senior Vice President of Sales and

Marketing from July 1999 to December 2001 and as our Senior Vice President of Sales from

Table of ContentsNovember 1997 to June 1999. Prior to joining us , he served as the Director of National Accounts at Yes! Entertainment Corporation , a toy and entertainmentproducts company, from October 1994 to Janua ry 1997, and as Senior Vice President of Sales from Februa ry 1997 to October 1997 . P rior to that, Mr. Bender

was at Lego Systems, Inc. since 1984 , and serv ed in va ri ous positions including Senior National Account Manager . Mr . Bender has a B .S . from BradleyUniversity .

Robert W. Lally is a co-founder of LeapFrog RBT and has been with us since our business began in 1995 . He has served as President of our SchoolHousedivision since March 1999 and has served as Executive Vice President of our Education and Training Group since Janua ry 2002 . From March 1995 to Februa ry

1999, Mr. Lally was responsible for finance , accounting , distribution , production, planning , purchasing , recruitment and operations as our Chief FinancialOfficer. P rior to joining LeapFrog , he was Chief Financial Officer and Vice President of Operations at the Republic of Tea from July 1992 to March 1995, wherehe managed all financial , accounting, administrative and operational aspects, and he was a manager at Price Waterhouse from 1983 to 1991, where he consultedwith emerging growth companies . Mr . Lally has a B .S . from the University of Oregon and an M .B .A . from the Wharton School of Business .

Mark B. Flowers has served as our Executive Vice President, Chief Technology Officer since January 2002 . Previously, he served as our Vice President ofTechnology from January 2001 to December 2001, and as our Vice President of Engineering from July 1998 to December 2000. Prior to joining us , Mr. Flowerswas Vice President of Hardware Engineering and a director of Explore Technologies , Inc . from September 1995 until we acquired substantially all of ExploreTechnologies ' assets and business in July 1998 . From 1990 to 1995, Mr . Flowers ran his own Silicon Valley consulting business , whose clients included HewlettPackard and 3Com . Prior to that , Mr. Flowers was Director of Hardware Engineering at Telebit Corporation , a data communications equipment company . Heholds several patents in electronics design and has a B.S . and an M .S. from the Massachusetts Institute of Technology .

L. James Marggraff has se rved as our Executive Vice President , Content since January 2002. From March to December 2001, he was an independent consultantof ours, focusing on developing new products and software for our LeapPad and Leap's Pond product lines . From September 2000 to February 2001, Mr .Marggraff served as President of Ubiquity LLC, a subsidiary of our wholly owned subsidia ry NT(2) LLC, which was established to investigate new applicationsfor our NearTouch technology and LeapPad devices . Prior to that, from August 1999 to August 2000, Mr . Marggraff served as the President of our Internetdivision, and from July 1998 to July 1999, he served as our Vice President of Content , Mr. Marggraff is the co- inventor of the LeapPad learning system and theOdyssey and Explorer interactive globe lines, and was co-founder, President , and Vice President of Marketing and Sales of Explore Technologies fromSeptember 1995 to July 1998 . Previously , from 1984 to 1992 , he was an engineering co-founder and Manager of Marketing and Sales of StrataCom, Inc ., awide-area networking communications company that was acquired by Cisco Systems , Inc . in 1996 . Mr. Marggraff holds numerous patents and has a B .S. and an

M .S . from the Massachusetts Institute of Technology .

Madeline T. Schroeder has served as our Executive Vice President, Publishing Services since February 2004 and served as our Senior Vice President, WorldwidePublishing Services from June 2002 to February 2004 and as Vice President, Publishing Services from April 2001 to June 2002 . From April 1998 to April 2001,

Ms . Schroeder served as an interim operating executive across of variety of industries, including elder care, online syndication and electronic gaming . From

February 1996 to April 1998, she served as the Chief Executive Officer and President of Mambo .com, an integrated invitations and payment service . She wasco-founder of Crystal Dynamics, a developer and publisher of video games that was acquired by Eidos Inc, and served as Executive Vice President of Marketingand Product Development for Eidos, Inc . from February 1992 to February 1996. Ms . Schroeder holds a B .A . from University of California, Berkeley .

Available Informatio nWe are subject to the information requirements of the Securities Exchange Act of 1934, or the Exchange Act . Therefore, we file periodic reports, proxy

statements and other information with the Securities and Exchange Commission, or SEC . Such reports, proxy statements, and other information may be obtainedby visiting the Public Reference Room of the SEC at 450 Fifth Street, NW, Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330 . In addition, the

SEC maintains a website (www.sec . o~v) that contains reports, proxy and information statements, and other information regarding issuers that file electronically .

We make our annual report on Form 10-K, quarterly reports on Form I O-Q, current reports on Form 8-K and all amendments to such reports filed orfurnished pursuant to Section 13(a) or 15(d) of the Exchange Act, available (free of charge) on or through our web site located at www .leapfrog .com, as soon asreasonably practicable after they are filed with or furnished to the SEC . Information contained in our website is not deemed to be part of this report on Form

10-K.

Table of ContentsItem 2 . Properties .

Our headquarters are located in Emeryville, California, where we occupy approximately 102,810 square feet of office space under a lease that expires inJanuary 2006 . Our headquarters are used for the operation of our three business segments . We currently lease approximately 14,500 square feet in Los Gatos,California, for our engineering, research and development operations related to our three business segments under a lease that expires in January 2007 . We have

offices in Austin, Texas, which we use for our Education and Training segment, and we have offices near London, England and near Paris, France, each of which

is used for our International segment . In addition, we have offices in Hong Kong and in Macau, as well as a trade showroom in New York City, each of which is

used for all three of our business segments . We believe that our facilities are adequate for our current needs, and suitable additional or substitute space will beavailable in the future to replace our existing facilities, if necessary, or accommodate expansion of our operations .

Item 3 . Legal Proceedings .

Pending LitigationIn the ordinary course of our business, we are from time to time subject to litigation, including the following :

LeapFrog Enterprises, Inc . v. Fisher-Price, Inc .

In October 2003, we filed a complaint in the federal district court of Delaware against Fisher-Price, Inc . alleging that Fisher Price's PowerTouch learning

system violates United States Patent No . 5,813,861 . In January 2004, we served Fisher.-Price with the complaint . We are seeking damages and injunctive relief.

Learning Resources, Inc. v, LeapFrog Enterprises, inc .

In November 2003, Learning Resources filed a complaint against us in federal district cou rt in Illinois alleging that our tr ademark PRETEND & LEARN

infringes on its trademark PRETEND & PLAY . Learning Resources seeks unspecifi ed monetary damages and injunctive relief.

We believe that we have meritorious defenses to Learning Resources claims and intend to vigorously defend ourselves .

Stockholder Class Action and Derivative Lawsuits

On December 2, 2003, a class action complain( entitled Miller v. LeapFrog Enterprises, Inc ., e1 at., No . 03-5421 RMW, was filed in federal district courtfor the Northern District of California against Leapfrog and certain of its current and former officers and directors alleging violations of the Securities Exchange

Act of 1934, or 1934 Act . Subsequently, three similar actions were filed in the same cou rt : Well v. LeapFrog Enterprises, Inc., cm al., No . 03-5481 MJJ ; Abrams

v. LeapFrog Enterprises Inc., el al ., No. 03-5486 MJJ; and Ornelas v. Leap Frog Enterprises, Inc., et a!., No . 03-5593 SBA . Each of those complaints purportsto be a class action lawsuit brought on behalf of persons who acquired our Class A common stock during the period of July 24, 2003 through October 21, 2003 .

On February 18, 2004, the plaintiff in the Weil action amended her complaint and now seeks to maintain a class action on behalf of persons who acquired our

Class A common stock during the period of July 24, 2003 through February 10, 2004 . All of the complaints allege that the defendants caused us to make falseand misleading statements about our business and forecasts about our financial performance, and that certain of our individual officers and directors sold portionsof their stock holdings while in the possession of adverse, non-public information . The Weil complaint also alleges that our financial statements were false and

misleading . The complaints do not specify the amount of damages sought . We anticipate that all of these actions will ultimately be consolidated into one action

and that a consolidated amended complaint will be filed after the appointment of a lead plaintiff . The U.S . District Court has scheduled a hearing on th e

appointment of a lead plaintiff and consolidation on March 12, 2004. We have not yet responded to any of the complaints, discovery has not commenced, and no

trial date has been established . While we intend to defend against these actions vigorously and do not believe that these lawsuits will have a material effect on ourfinancial position, results of operations or cash flows, there can be no assurance as to the ultimate disposition of these lawsuits .

On December 9, 2003, a stockholder derivative complaint entitled Santos v. Michael Wood, et a!., No . RG03130947, was filed in the Superior Court of the

State of California, County of Alameda, against certain of our officers and directors . The complaint alleges causes of action for breach of fiduciary duty, abuse ofcontrol, gross mismanagement, waste of corporate assets, unjust enrichment and violations of the California Corporations Code, based upon allegations thatce rt ain of our officers and directors participated in the conduct alleged in the securities class action complaints and participated in alleged improper stock sales .The complaint seeks unspecified damages against the individual defendants on behalf of LeapFrog, equitable relief and attorneys' fees . On February 11, 2004 ,

we filed a motion to dismiss this derivative complaint . The basis of our motion is that we believe the plaintiff does not have standing to bring this lawsuit sincethe plaintiff has never served a demand on our board of directors that

IS

Table of Contentsthe board take certain actions on behalf of Leapfrog . The individual officer and director defendants have also filed a similar motion to dismiss this stockholderderivative complaint . The hearing on these motions is expected to take place in April 2004 . Discovery has not commenced and no trial date has been established .

Item 4 . Submission of Matters to a Vote of Security Holders .

No matters were submitted to our stockholders during the fourth quarter of our 2003 fiscal year .

16

Table of-ContentsPART II

Item 5 . Market for Registrant ' s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities .

Market Information and Holders

Our Class A common stock is listed on the New York Stock Exchange , or the NYSE, under the symbol "LF ." There is no established public tradingmarket for our Class B common stock . On March 1 , 2004, there were approximately 650 holders of record of our Class A common stock and six holders ofrecord of our Class B common stock .

The following table sets forth for the calendar quarter indicated the high and low sales prices per share of our Class A common stock on the NYSE . TheClass A common stock began trading on the NYSE on July 25, 2002 .

2003 High Low

First quarter $ 28.14 $ 19.0 1Second quarter $ 34.06 $ 22 .9 3Third quarter $ 40.36 $ 27 .6 5Fourth quarter $ 46.54 $ 24 .0 5

2002 High Lo w

Third quarter (commencing July 25, 2002) $ 19 .30 $ 13 .00Fourth quarter $ 35 .70 $ 14 .95

Dividend Policy

We have never declared or paid any cash dividends on our capital stock . Our current credit facility prohibits our payment of cash dividends. We expect toretain any future earnings to fund the development and expansion of our business . Therefore, we do not anticipate paying cash dividends on our common stock inthe foreseeable future .

Equity Compensation Plan Informatio n

The following table shows certain information concerning our Class A common stock to be issued in connection with our equity compensation plans as ofDecember 31 .2003 :

Plan Catceorv

Equity compensation plans approved by securityholders

Equity compensation plans not approved bysecurity holders

TOTAL

Number of securitiesto be issued upon

exercise ofoutstanding options,warrants and right s

(a)

Weighted-averageexercise price of

outstanding options,warrants and rights

(b)

Number of securitiesremaining available fo r

future issuance under equitycompensation plans

(excluding securities reflectedin column (a))

(c )

6,469,03 1

0

$ 11 .84

$ 0.00

6,469,031 $ 11 .84

5,920,765(1 )

0

5,920,765

(1) Includes 1,844,068 shares reserved for issuance under our 2002 Employee Stock Purchase Plan .

For a discussion of our equity compensation plans, see "Note 16. Stockholders' Equity" in the Notes to Consolidated Financial Statements included in this annualreport on Form 10-K.

17

Table of ContentsItem 6 . Selected Financial Data

Selected Consolidated Financial Dat a

The following selected consolidated financial data for the five years ended December 31, 2003, have been derived from our consolidated financialstatements . The following information is qualified by reference to, and should be read in conjunction with, "Item 7 . Management's Discussion and Analysis ofFinancial Condition and Results of Operations" and the consolidated financial statements and related notes thereto .

For the Year Ended December 31 ,

Consolidated Statements of Operations Data :Net sale sGross profi t

Income from operations

Net income (loss)

Net income (loss) per common share :BasicDiluted

Shares used in calculating net income (loss) per share ;BasicDilute d

Consolidated Balance Sheet Data .Cash, cash equivalents, and short term investments

2003 2002 2001 2000 199 9

(In thousands, except per sha re data)

$ 680,012 $ 531,772 $ 314,243 $ 160,128 $71,86 7340,144 270,041 144,645 68,281 28,989

109,458 71,351 16,435 132 1,449

$ 72,675 $ 43,444 $ 9,669 $ (2,259) $ 1,53 9

$ 1 .27 $ 1 .09 $ 0 .29 $ (0.07) $ 0 .0 5$ 1 .20 $ 0.86 $ 0 .25 $ (0.07) $ 0 .0 5

57,246 39,695 33,449 32,462 31,87 860,548 50,744 38,470 32,462 33,26 8

December 31 ,

2003 2002 2001 2000 1999

tin rnausanns 7

$ 112,603 $ 73,327 $ 8,269 $ 5,327 $ 12,00 9

Working capitalTotal assetsLong term deb tRedeemable convertible Series A preferred stockTotal stockholders' equity

368,456 224,685 117,960 30,323 35,569552,659 397,682 221,973 139,797 84,588- - 61,163 - -- - 24,139 - -

415,146 268,798 72,848 61,811 63,75 1

18

Table of ContentsItem 7. Management 's Discussion and Analysis of Financial Condition and Results of Operation.

Overvie w

We design, develop and market technology-based educational platforms, related interactive content and stand-alone products for sale to retailers,distributors and schools . Since the founding of our business in 1995, we have grown from a start-up business selling stand-alone educational toys into acompany selling multiple platform products and related interactive content, as well as stand-alone products, with total net sales in 2003 of $680 .0 million . We

operate three business segments, which we refer to as U .S . Consumer, Education and Training, and International . To date, we have sold our productspredominantly through the toy sections of major retailers . For further information regarding our three business segments, see "Note 23 . Segment Reporting" in

the Notes to Consolidated Financial Statements included in this annual report on Form 10-K .

Our vision for Leapfrog is to become the leading brand for technology-based educational products for home and school use for all ages around the world .We believe that LeapFrog is in the early stage of this vision . To date, we have established our brand and products largely focused on children in the preschoolthrough third grade levels primarily in the U .S . retail market . We believe that LeapFrog is, first and foremost, an educational products company, and we use the

toy form factor to make learning fun and engaging. As a result, our sales in our U .S . Consumer segment, our largest business segment, currently are generated inthe toy aisles of retailers across the United States . The market for toy retailers has seen, and continues to see consolidation . In addition to the traditional channelof specialty toy retailers, of which Toys "R" Us has become the major player, the mass-market retail channel has grown in importance . For example, Wal-Mart,Target and a number of regional mass-market retailers have seen growth in their market shares within the U .S . toy retail market . The mass-market retailers havecertain competitive advantages in the highly seasonal toy market because they have the ability to dedicate a significant amount of shelf space to toys during theFall holiday season, and then reduce the allocated shelf space for toys during the rest of the year . The net sales in our U .S. Consumer segment have increased inboth amount and percentage with these mass-market retailers, and as a result of the seasonal changes of retail space allocation to toys, including our products, bythese retailers, the seasonal effects of the toy retail market are exacerbated . We anticipate that the toy industry's dependence on mass-market retailers will

continue to grow.

In the U .S . Consumer segment, we market and sell our products directly to national and regional mass-market and specialty retailers as well as to otherretail stores through sales representatives . Our U.S . Consumer segment is our most developed business, and is subject to significant seasonal influences, with thesubstantial majority of our sales occurring in the third and fourth quarters . In 2003, this segment represented approximately 80% of our total net sales . Althoughwe are expanding our retail presence by selling our products to bookstores and electronics and office supply stores, the significant majority of our U .S . Consumer

sales are to a few large retailers . Sales to Wal-Mart (including Sam's Club), Toys "R" Us and Target accounted for approximately 68% of our total net sales in2003 compared to 69% in 2002 and 68% in 2001 . At December 31, 2003, Wal-Mart, Toys "R" Us and Target accounted for 35%, 26% and 12%, respectively, ofour accounts receivable . Consistent with industry practice, we rely on short-term purchase orders for the sale of our products to U .S . retailers . In 2003, we

successfully launched three new platforms : LeapPad Plus Writing, LittleTouch LeapPad and Leapster . Combined, these new platforms accounted forapproximately 20% of our U .S . Consumer segment's net sales in 2003 . Although we believe net sales for this business segment will grow in the future, weanticipate that this segment's percentage of total company net sales will decrease, as we expect our other two segments to grow at a faster rate than our U .S .Consumer segment .

Our Education and Training segment targets the school market in the United States, including sales directly to educational institutions, to teacher supplystores and through catalogs aimed at educators . The Education and Training segment represented approximately 6% of our total net sales in 2003 . Net sales inour Education and Training segment increased by 86% from 2002 to 2003, and the segment reduced its operating loss from $9 .0 million in 2002 to an operatingloss of $0 .2 million in 2003 .

In our International segment, we sell our products outside the United States directly to overseas retailers and through various distribution and strategicarrangements . We have four direct sales offices in the United Kingdom, Canada, France and Mexico, and maintain various distribution and strategicarrangements in countries such as Australia, Japan and Korea among others . The International segment represented approximately 14% of our total net sales in

2003 . Net sales in our International segment increased 80% from 2002 to 2003 and operating income grew from $7 .7 million in 2002 to $26.4 million in 2003.We believe this segment is in the early stage of its development and will continue its expansion to represent a larger percentage of our total net sales in comingyears .

Gross profit margins in 2003 decreased by 80 basis points, from 50.8% in 2002 to 50.0% in 2003 . This decrease was primarily due to lower profit marginsin our U .S . Consumer segment, offset by higher profit margins in our Education and Training and our International segments . The decrease in gross profitmargins in our U .S . Consumer segment was the result of lower margin Leapster platform sales, as well as higher freight and warehousing expenses . We expect

that our gross profit margins in the U .S . Consumer segment will remain relatively flat for 2004.

Table of Content sSelling, general and administrative expenses consist primarily of salaries and related employee benefits, legal, marketing expenses, systems costs, rent and

office equipment and supplies . Our research and development expenses consist primarily of costs associated with content development, product development andproduct engineering . Our advertising expenses consist primarily of television advertising, cooperative advertising and in-store displays . Depreciation andamortization expenses consist primarily of depreciation of fixed assets and capitalized website development and amortization of intangibles, however it excludesdepreciation of manufacturing tools and capitalized content development, which are classified in cost of sales .

Critical Accounting Policies, Judgments and Estimate s

Our management's discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, whichhave been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us tomake estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and reported disclosures . On an on-going basis, weevaluate our estimates, including those related to revenue recognition, allowances for accounts receivable, inventories and related allowances, intangible assetsand stock-based compensation . We base our estimates on historical experience and on various other assumptions we believe are reasonable under thecircumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other

sources . Actual results may differ from these estimates under different assumptions or conditions .

Our significant accounting policies are more fully described in Note 2 to our consolidated financial statements . However, some of our accounting policiesare particularly important to the portrayal of our financial position and results of operations and require the application of significant judgment by ourmanagement . We believe the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation ofour consolidated financial statements .

Revenue Recognitio n

We recognize revenue upon shipment of our products provided that there are no significant post-delivery obligations to the customer and collection isreasonably assured, which generally occurs upon shipment, either from our U .S . distribution facility or directly from our third-party manufacturers . Net salesrepresent gross sales less negotiated price allowances based primarily on volume purchasing levels, estimated returns and allowances for defective products . Asmall portion of our revenue is deferred and recognized as revenue over a period of twelve to eighteen months, which is the estimated period of use of theproducts . We deferred approximately 0.3%, 0 .9% and 2 .5% of net sales in 2003, 2002 and 2001, respectively .

Allowances For Accounts Receivable

We reduce accounts receivable by an allowance for amounts that may become uncollectible in the future . This allowance is an estimate based primarily onour management's evaluation of the customer's financial condition, past collection history and aging of the receivable . If the financial condition of any of our

customers deteriorates, resulting in impairment of its ability to make payments, additional allowances may be required .

We provide estimated allowances for product returns, charge backs and defectives on product sales in the same period that we record the related revenue.We estimate our allowances by utilizing historical information for existing products . For new products, we estimate our allowances for product returns onspecific terms for product returns and our experience with similar products . In estimating returns, we analyze (i) historical returns and sales patterns, (ii) analysisof credit memo data, (iii) current inventory on hand at customers, (iv) changes in demand and (v) introduction of new products . We continually assess thehistorical rates experience and adjust our allowances as appropriate, and consider other known factors . If actual product returns, charge backs and defectiveproducts are greater than our estimates, additional allowances may be required . Historically, our estimated reserves for accounts receivables, returns, charge

backs and defectives have been adequate to cover actual charges .

Inventories and Related Allowance For Slow-Moving, Excess and Obsolete Inventory

Inventories are stated at the lower of cost, on a first-in, first-out basis, or market value and are reduced by an allowance for slow-moving, excess and

obsolete inventories . Our estimate for slow-moving, excess and obsolete inventories is based on our management's review of on hand inventories compared totheir estimated future usage and demand for our products . If actual future usage and demand for our products are less favorable than those projected by ourmanagement, additional inventory write-downs may be required .

Intangible AssetsIntangible assets, including excess purchase price over the cost of net assets acquired, arose from our September 23, 1997 acquisition of substantially all

the assets and business of our predecessor, LeapFrog RBT, and our acquisition of substantially all the assets of Explore Technologies on July 22, 1998 . At

December 31, 2003, our intangible assets had a net

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Tabte of Content sbalance of $25 .0 million . The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, "Goodwill and OtherIntangible Assets" (SFAS 142). SFAS 142 requires the use of a nonamortization approach to account for goodwill and some other intangible assets . We adoptedthe pronouncement effective January 1, 2002, and accordingly we no longer amortize goodwill and other indefinite-lived intangible assets . As of December 31,2003, we had $19.5 million, net, of goodwill and other indefinite-lived intangible assets, which are no longer subject to amortization . At December 31, 2003, wetested our goodwill and other intangible assets for impairment based on the fair value of the cash flows that the business can be expected to generate in the future,known as the income approach . Based on this assessment we determined that no adjustments were necessary to the stated values .

The determination of related useful lives and whether the intangible assets are impaired involves significant judgment . Changes in strategy or marketconditions could significantly impact these judgments and require that adjustments be recorded to asset balances . We review intangible assets, as well as otherlong-lived assets, for impairment whenever events or circumstances indicate that the carrying value may not be fully recoverable .

Content Development, Home Video Production and Tooling Capitalization

Our management is required to use professional judgment in determining whether development costs meet the criteria for immediate expense orcapitalization.

We capitalize the prepublication costs of books as content development costs . Only costs incurred with outside parties are capitalized . In 2003, wecapitalized $1 .7 million of content development costs, $ 1 . 3 million of which pertained to our Education and Training segment . In 2002, we capitalized $3 .6

million in content development costs, $3 .1 million of which pertained to our Education and Training segment . We depreciate these assets from the time ofpublication over their estimated useful lives, estimated to be three years, using the sum ofyears digits method . If the related content is deemed to have a shorteruseful life, the remaining balance is written off when the content is no longer used in production .

In 2003, we changed the reporting classification for the amortization of content development costs. Previously, such costs were classified as "depreciationand amortization" in the operating expenses section . Amortization of content development costs are now being classified as "cost of sales ." All prior periodsreported have been reclassified in this Form 10-K to conform to this presentation .

We capitalize costs related to the production of home video in accordance with AICPA Statement of Accounting Position No . 00-2, "Accounting byProducers or Distributors of Film ." Video production costs are amortized based on the ratio of the current period's gross revenues to estimated remaining totalgross revenues from all sources on an individual production basis . In the year ended December 31, 2003, we capitalized $1 .0 million and amortized $0 .6 millionof video production costs . We had no video production cost in prior years . If the related video production costs are deemed to have lower gross revenues thanoriginally expected, the remaining balance is written off when the revised revenues are earned .

We capitalize costs related to manufacturing tools developed for our products . We capitalized $4 .8 million in 2003 compared with $5 .4 million in 2002related to manufacturing tools . We depreciate these assets on a straight-line basis, in cost of sales, over an estimated useful life of two years . If the relatedproduct line or our manufacturing production results in a shorter life than originally expected, we write off the remaining balance when we remove the tool fromproduction .

Stock-Based Compensation

We account for employee stock options using the intrinsic value method in accordance with Accounting Principles Board Opinion No . 25, "Accounting forStock Issued to Employees," whereby compensation is generally not recorded for options granted at fair value to employees and directors .

In connection with stock options granted to employees in August 2001, we recorded an aggregate of $3 .3 million of deferred compensation instockholders' equity for the year ended December 31, 2001 . These options were considered compensatory because the deemed fair value of the underlying sharesof Class A common stock in August 2001, as subsequently determined, was greater than the exercise price of the options . In accordance with AccountingPrinciples Board Opinion No . 25, this deferred compensation will be amortized to expense through the third quarter of 2005 as the options vest.

Stock based compensation arrangements to nonemployees are accounted for in accordance with SFAS 123, "Accounting for Stock-BasedCompensation," and EITF No. 96-18, "Accounting for Equity Instruments That Are Issued to Others than Employees for Acquiring, or in Conjunction withSelling Goods or Services," using a fair value approach. The compensation costs of these arrangements are subject to remeasurement over the vesting terms asearned .

In 2002, Mr. Kalinske, our Chief Executive Officer ; Mr . Rioux, our Vice Chairman and Mr . Wood our Chief Vision and

Table of Content sCreative Officer, and in 2003, Mr . Bender, our President, Worldwide Consumer Group, entered into new employment agreements providing for, among otherthings, acceleration of vesting and extension of the exercise period of their stock options upon the termination of their employment by LeapFrog without cause orby the employee for good reason (as defined in the agreements) or a change in control of LeapFrog during the term of the applicable agreement . Under applicableaccounting principles, upon any termination of employment or change in control resulting in such acceleration or extension, we would be required to recognizecompensation expense . The amount of any such compensation expense would depend on the number of option shares affected by the acceleration or extensionand could be material to our financial results .

Prior to our July 2002 initial public offering, we granted stock appreciation rights under our Amended and Restated Employee Equity Participation Planthat are measured at each period end against the fair value of the Class A common stock at that time . The resulting difference between periods is recognized asexpense at each period-end measurement date based on the vesting of the rights .

In February 2002, we converted 337,500 stock appreciation rights into options to purchase an aggregate of 337,500 shares of Class A common stock .Deferred compensation of approximately $0.9 million related to the unvested portion will be amortized to expense through the third quarter of 2005 as theoptions vest .

In July 2002, we converted 1,585,580 stock appreciation rights into options to purchase an aggregate of 1,585,580 shares of Class A common stock . Theexpense related to the conversion of the vested stock appreciation rights was $ 1 . 5 million through July 2002 based on vested rights with respect to 192,361 sharesof Class A common stock outstanding as of July 25, 2002 at our initial public offering price of $13 .00 per share . Our deferred compensation expense inconnection with the conversion of 1,310,594 unvested stock appreciation rights held by employees converted to options to purchase 1,310,594 shares of Class Acommon stock, was $4 .0 million . In accordance with generally accepted accounting principles, beginning in the third quarter of2002 and for the following 16quarters, we will recognize this expense over the remaining vesting period of the options into which the unvested rights are converted . Deferred compensationrelated to the unvested portion will be amortized to expense as the options vest . To the extent any of the unvested options are forfeited, our actual expenserecognized could be lower than currently anticipated . Concurrently with our initial public offering, we stopped granting stock appreciation rights under theEmployee Equity Participation Plan .

Results of Operation sThe following table sets forth selected information concerning our results of operations as a percentage of net sales for the periods indicated :

Year Ended December 31 ,

2003 2002 200 1

Net Sales 100 .0% 100.0% 100.0 %Cost of Sales 50 .0 49.2 54. 0

Gross Profit 50 .0 50.8 46 . 0Operating expenses :

Selling, general and administrative 13 .5 15 .2 17 . 7Research and development 8 .5 10.2 12 .2Advertising 10.8 10 .7 9 .6Depreciation and amo rt ization 1 .1 1 .3 1 .3

Total operating expenses 33 .9 37 .4 40 .8

Income from operations 16.1 13 .4 5. 2Interest and other income (expense), net 0 .9 0 .2 (0.6)

Income before provision for income taxes 17 .0 13 .6 4 : 6Provision for income taxes 6 .3 5 .4 1 . 5

Net income 10 .7% 8 .2% 3 .1 %

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Table of ContentsTwelve Months Ended December 31, 2003 Compared To Twelve Months Ended December 31, 2002

Net Sales

Net sales increased by $148 .2 million, or 28%, from $531 .8 million in 2002 to $680.0 million in 2003 . Each of our three segments had increased sales overlast year . Our Education and Training segment increased by 86% to $37 .5 million, our international segment increased by 80% to $96 .6 million and our U .S .

Consumer segment increased by 19% to $546 .0 million compared to 2002 . Net sales of our standalone, software and platform products increased by 42%, 31%

and 18% , respectively, year-over-year. Foreign currency exchange rates favorably impacted our total company net sales by 1% due to stronger internationalcurrencies .

Net sales for each segment and its percentage of total company net sales were as follow s


2003 2002 Change

%ur %urTotal Tota l

Company Company

segment 5(t) Sales S (1) Sales 5(1) %

U .S. Consumer $546 .0 80% $458.0 86% $ 87 .9 19 %Education and Training 37.5 6% 20.1 4% 17 .3 86 %International 96.6 14% 53.6 10% 43 .0 80 %

Total Company $680 .0 100% $ 531 .8 100% $ 148.2 28 %

(1) In millions .

U.S. Consurner. Our U .S . Consumer segment' s net sales increased by $87 . 9, or 19% , from $458 .0 million in 2002 to $546 . 0 million in 2003 . This segmentcomprised 80% of total company net sales in 2003 and accounted for 59% of the increase in total company net sales from 2002 to 2003 .

Net sales of platform, software and standalone products in dollars and as a percentage of total net sales were as follows :

Sales % of Tota l

Year Ended December 31, Change Year Ended December 31,

2003(1) 2002 ( 1) S(I) % 2003 2002

Platform $232.9 $207.1 $25.8 13% 42.7% 45.2 %Software 175.9 139.6 36.3 26% 32.2% 30.5 %Standalone 137.2 111.3 25.9 23% 25.1% 24.3 %

Net Sales $546 ,0 $458 .0 $88.0 19 % 100.0 % 100 .0 %

(1) In millions.

• The 13% increase in platform sales year-over-year was primarily due to the successful launch of our newest platform, the Leapster multimedialearning system, and the continued success of our LeapPad family of platforms . Our LeapPad family of platforms, includes two new platforms

launched in 2003, LeapPad Plus Writing and LittleTouch LeapPad, and also includes our classic LeapPad, My First LeapPad and Quantum Padplatforms .

• The 26% growth in software sales year over year was primarily due to increased software sales related to our LeapPad family of platforms, andsoftware sales for our Leapster platform.

• The 23% increase in standalone sales was primarily due to the continued growth of our Leapstart Learning Table, Alphabet Pal and Hug and Lea rnBaby Tad product sales .

Education and Training. Our Education and Training segment ' s net sales increased by $17 .3 million, or 86%, from $ 20 .1 million in 2002 to $37 .5 millionin 2003 . This segment compri sed 6% of total company net sales in 2003 and accounted for 12% of the increase in total company net sales from 2002 to 2003 .

The segment's 86% net sales increase year-over-year is attributed to the success and sales growth of our top four selling products in this segment , the LeapTrackLearning Center, the Literacy Center, the Ready, Set, Leap! program and the Language First! program . 2003 was the first full year of sales for each of the

LeapTrack system, the Ready, Set, Leap! program and the Language First! program .

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Table of ContentsInternational. Our International segment's net sales increased by $43 .0 million, or 80%, from $53 .6 million in 2002 to $96 .6 million in 2003. This segment

comprised 14% of total company's net sales in 2003 and accounted for 29% of the increase in total company net sales from 2002 to 2003 . The increase in ourInternational segment was primarily due to increased sales in the United Kingdom and Canada, and to a lesser extent sales increases in France and Australia,offset by a decrease in Japan . Sales into the United Kingdom and Canada accounted for 44% and 38%, respectively, of the segment's sales increase from 2002 to2003. The sales increase in the United Kingdom and Canada was primarily due to larger market penetration resulting from more localized products . Sales inJapan decreased 42% from 2002 to 2003, primarily due to the cancellation of our two-year Quantum Pad sales program with Benesse Corporation in the firstquarter of 2003, however, we have an ongoing relationship with Benesse Corporation with focus on our LeapPad platform and its related content .

Foreign currency exchange rates favorably impacted our International segment 's net sales by 8.0% in 2003 . The favorable currency impact was due to thestrength of the Canadian Dollar and the British Pound , and to a lesser extent , the Euro .

Gross ProfitGross profit increased by $70 .1 million, or 26%, from $270.0 million in 2002 to $340 .1 mil lion in 2002 . Gross profit as a percentage of net sates decreased

from 50. 8% in 2002 to 50 .0% in 2003. The gross profit in dollars for each segment and the related percentage of segment net sales were as follows :


2003 2002 Change

%of % o rSegment's Segment' s

Segment $( 1) Net Sales $ ( 1) Net Sales $(1) %

U.S .Consumer $266 .1 48 .7% $236 .4 51 .6% $29.7 13 %Education and Training 22 .7 60 .5% 10 .3 51 .1% 12.4 121 %International 51 .4 53 .2% 23 .4 43 .6% 28.0 120 %

Total Company $ 340 .1 50 .0% $270.0 50 .8% $70.1 26 %

(1) In millions.

U.S Consumer. Our U .S . Consumer segment ' s gross profit increased by $29 .7 million, or 13%, from $236 .4 million in 2002 to $266.1 million in 2003 .Gross profit as a percentage of net sales decreased from 51 .6% in 2002 to 48 .7% in 2003 . The 290 basis points decrease in gross profit percent year-over-yearwas prima ri ly due to product mix and increased warehousing, freight and royalty expenses as follows :

• Unfavorable product mix was primarily due to sales of the new Leapster platform, which has a lower gross margin percent than our other platforms .We are seeking to build a large base of installed Leapster platform users that will lead to sales of higher margin Leapster software . In addition, ourother two new platforms, LeapPad Plus Writing and LittleTouch LeapPad, have lower margins than our existing mature platforms . Historically, as ourplatforms mature, gross margins have benefited from engineering improvements and higher sales volumes .

• Higher warehousing fees were incurred due to increased sales volume and average inventory levels compared to last year .

• Higher freight expenses were due to increased ocean freight rates and due to air freight costs incurred to expedite delivery of our new platforms,particularly the Leapster platform, from Asia in time for the holiday shopping season .

. Higher royalty expenses were incurred due to increased sales from our expanded library of licensed products for our existing and new platforms .

Education and Training. Our Education and Training segment's gross profit increased by $12 .4 million, or 121 %, from $10.3 million in 2002 to $22 .7million in 2003 . Gross profit as a percentage of net sales increased from 51 .1% in 2002 to 60 .5% in 2003 . The 940 basis points increase in gross profit percentyear-over-year was primarily due to lower product cost and favorable product mix, offset by higher warehousing due to higher inventory levels, and contentamortization expenses.

International. Our International segment's gross profit increased by $28 .0 million, or 120%, from $23 .4 million in 2002 to $51 .4 million in 2003 . Grossprofit as a percentage of net sales increased from 43 .6% in 2002 to 53 .2% in 2003 . The 960 basi s

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Table of Contentspoints increase in gross profit percent year-over-year was primarily due to lower product cost, offset by higher royalty, warehousing and freight expenses .Foreign exchange gains favorably impacted our International segment's gross profit by 8 .3% in 2003 .

Selling, General and Administra five Expenses

Selling, general and administrative expenses increased by $10.7 million, or 13%, from $80.9 million in 2002 to $91 .6 million in 2003 . As a percentage ofnet sales, selling, general and administrative expenses decreased from 15 .2% in 2002 to 13 .5% in 2003 . All three of our business segments had reductions inselling, general and administrative expenses as a percentage of net sales . This was due primarily to leverage achieved against the strong growth in sales in allsegments.

Selling, general and administrative expenses for our U .S. Consumer segment increased $4 .3 million or 7% from 2002 to 2003 . As a percentage of netsales, this expense decreased from 13 .1% in 2002 to 11 .8% in 2003 . The dollar increase was primarily due to higher salaries and benefit expenses , offset bylower litigation and incentive compensation expenses as follows :

• Salaries and related employee benefits were higher than last year by $1 1 .8 million, primarily due to the emphasis on building internal sales andmarketing teams and infrastructure to support our worldwide expansion .

Litigation expenses decreased by $9 .4 million compared to last year primarily due to the settlement in the First half of 2003 of a number ofoutstanding legal proceedings that had been active throughout most or all of 2002 .

• Incentive compensation expense decreased by $2 .7 million compared to last year as a result of reduced bonuses .

Selling , general and administrative expenses for our Education and Training segment increased by $3 .2 million or 24% from 2002 to 2003 . As apercentage of net sales , this expense decreased from 65 . 3% in 2002 to 43 .6% in 2002 . The dollar increase in these expenses was primarily due to higher salariesand sales commissions expenses resulting from our substantial investment in our own direct sales force, offset by lower direct marketing and consultingexpenses .

Selling, general and administrative expenses for our International segment increased $3 .2 million or 42% from 2002 to 2003 . As a percentage of net sales,this expense decreased from 14 .4% in 2002 to 1 1 . 3% in 2003 . The dollar increase in these expenses was largely related to higher fixed compensation expensesresulting from our operations in Europe, Canada and Asia.

We anticipate that selling, general and administrative expenses will increase in dollars and as a percentage of sales in 2004, primarily due to anticipatedhigher litigation expenses, and to support our continued expansion and growth in sales .


Research and development expenses increased by $3 .2 million, or 6%, from $54 .4 million in 2002 to $57 .6 million in 2003 . As a percentage of net sales,research and development expenses decreased from 10 .2% in 2002 to 8 .5% in 2003 . The reduction in the percentage of net sales was primarily achieved throughstrong net sales growth in all segments and increased leverage of our internal software and platform development groups . The increased expensesyear-over-year were due to higher spending in our U .S ..Consumer and International segments, offset by lower spending in our Education and Training segment .

• The increase in the U .S . Consumer and International segments was primarily due to the increased development of content for existing platforms andthe development of three new platforms and their related content .

• The expense increase in our International segment was due to the localization of existing content to foreign cultures .

• The development of the current generation of platforms in our Education and Training segment was largely completed in 2002 . Thus the spending in2003 was only related to the refresh of existing content and development of new content .

Content development expenses increased by $1 .9 million, or 6%, from $29.1 million in 2002 to $31 .0 million in 2003 . As a percentage of net sales, contentdevelopment expenses decreased from 5 .5% in 2002 to 4 .6% in 2003 . Spending on development of software content increased by 6% year-over-year primarilydue to the development of content for our new line of platforms and an expanded assortment of content for our existing line of platforms.

Product development and engineering expenses increased by $1 .3 million, or 5%, from $25 .3 million in 2002 to $26 .6 million in 2003 . As a percentage ofnet sales, product development expenses decreased from 4 .8% in 2002 to 3 .9% in 2003 . Spending on the development and engineering of new platforms andstandalone products increased by 25% year-over--year while website engineering expenses decreased by 78% . The increase in new product development wasprimarily due to the

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Table of Contentsdevelopment expenses for our LeapPad Plus Writing, LittleTouch LeapPad and Leapster platforms, each of which were launched in 2003 . We largely completedthe development and engineering of our website in 2002, and the expenses related to the maintenance of the website are classified as selling, general andadministrative expenses beginning in the second quarter of 2003 .

We anticipate that in 2004, our overall research and development expenses will continue to increase in dollars primarily due to continued increases incontent offerings and research and development of new platforms and stand alone products, but to remain relatively flat as a percentage of sales .

Advertising Expense

Advertising expense increased by $17 .0 million, or 30%, from $56.7 million in 2002 to $73 .8 million in 2003 . As a percentage of net sales, advertising

expense increased from 10 .7% in 2002 to 10 .8% in 2003 . Our U .S . Consumer and International segments accounted for the entire increase in the advertisingexpense .

The increase in advertising expense was primarily related to increases in television advertising . The increase in television advertising expense was due to asubstantial increase in media time used in an effort to strengthen our brand awareness and promote our expanded product line, including the introductions of ourLeapster, LeapPad Plus Writing and LittleTouch LeapPad platforms . The increase in our International segment was related primarily to our television and printadvertising spending in the United Kingdom and Canada .

We anticipate advertising expenses to increase in dollars but remain relatively flat, as a percentage of net sales, in 2004 .

Depreciation and A,nortization Expenses (excluding depreciation of tooling and amortization ofcontent development costs, which are included in cost of

sales)

Depreciation and amortization expenses increased by $l .0 million, or 16%, from $6 .6 million in 2002, to $7 .7 million in 2003 . As a percentage of netsales, depreciation and amortization expense decreased from 1 .3%u in 2002 to 1,1% in 2003 .

The increase in the depreciation and amortization expense is primarily due to higher depreciation expense of computers and software purchased to supportour worldwide expansion, offset by lower amortization of website development expenses . We are no longer capitalizing website development costs as ourwebsite design and development was largely completed in 2002 .

Income {Loss) From OperationsOur income from operations increased by $38 . 1 million , or 53%, from $71 .4 million in 2002 to $109.5 million in 2003 . As a percentage of net sales, our

income from operations increased from 13 .4% in 2002 to 16 .1% in 2003 . The improvement was primarily due to increased sales and operating expense leverage .

Income (loss) from operations in dollars and the related percentage of segment net sales were as follows :


2003 2002 Change

% of % ofSegment 's Segment's

Segment $ (t) Net Sales $(1) Net Sales S(1) %

U .S . Consumer $ 83.2 15 .2% $72.7 15 .9% $10 .5 15 %Education and Training (0.2) (0 .5)%u (9.0) (44 .9)% 8 .8 98 %

International 26.4 27 .4% 7 .7 14 .4% 18 .7 243 %

Total Company $109 .5 16 .1% $71 .4 13 .4% $ 38 .1 53 %

(I) In millions .

U.S. Consurner. Our U .S . Consumer segment's income from operations increased by $10 .5 million, or 15%, from $72 .7 million in 2002 to $83.2 million in

2003 due largely to strong sales growth . As a percentage of net sales, income from operations decreased from 15 .9% in 2002 to 15 .2% in 2003 . The decline wasprimarily due to lower gross margin, offset by improved expense leverage .

Education and Training. Our Education and Training segment's loss from operations improved from a loss of $9 .0 million in 2002 to a loss of $0 .2 million

in 2003 . This improvement in operating results was largely due to strong sales growth, increased gross profit margins and operating expense leverage . Weanticipate the sales growth to continue, and we expect this segment to generate positive income from operations in 2004 ; however, we cannot provide any

assurances in this regard.

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Table of Content sInternational. Our International segment's income from operations increased by $18 .7 million, or 243%, from $7 .7 million in 2002 to $26 .4 million in

2003 . As a percentage of net sales, income from operations increased from 14 .4% in 2002 to 27.4% in 2003 . The operating income increase was largely due tostrong sales growth, primarily in the United Kingdom and Canada, increased gross profit margins, and operating expense leverage . Foreign currency exchangerates favorably impacted our International segment's operating income by 9 .6% in 2003 . The favorable currency impact was due to the strengthening of theCanadian Dollar and the British Pound, and to a lesser extent, the Euro .

Other

Net interest income (expense) increased by $1 .3 million, from an expense of $0 .1 million in 2002 to income of $1 .2 million in 2003 . This increase resultedfrom our higher balance of invested average cash and short-term investment balances and the elimination of our debt in July 2002 .

Other income increased by $3 .6 million , or 343%, from $1 .1 million in 2002 to $4 .7 million in 2003 . This increase was primarily due to foreign exchangegains resulting from the strengthening of the Canadian Dollar and the British Pound, and the one-time payment received from Benesse Corporation . Thepayment received from Benesse Corporation was in connection with the early cancellation of a Quantum Pad sales contract related to a discontinueddirect-to-home program from Benesse's middle school subscribers . In 2004, the impact of foreign currencies on our income statement is expected to be minimalas we have put in place a foreign currency hedging policy to minimize the impact of adverse currency movements on reported foreign currency gains or losses .

Our effective tax rate was 37.0% in 2003 and was 39 .9% in 2002 . The 2003 effective lax rate was impacted by the research and development tax creditsaccumulated from current and prior years . We anticipate that our effective tax rate for 2004 will be approximately 34 .0%.

Net income

Net income increased by $29 .3 million, or 67%, from $43 .4 million in 2002 to $72 .7 million in 2003 due to the above-described factors . As a percentageof net sales , net income increased from 8 .2% in 2002 to 10 .7% in 2003 .

Twelve Months Ended December 31, 2002 Compared To Twelve Months Ended December 31, 2001

Net Sales

Net sales increased by $217 .6 million, or 69%, from $314 .2 million in 2001 to $531 .8 million in 2002 . Our U .S . Consumer segment's net sales increased$168 .9 million, or 58%, from $289 .1 million in 2001 to $458 .0 million in 2002 . Our Education and Training segment's net sales increased by $11 .3 million, or129%, from $8.8 million in 2001 to $20 .1 million in 2002. Our International segment's net sales increased by $37 .3 million, or 228%, from $16 .3 million in 2001to $53 .6 million in 2002 .

Net sales for each segment and its percentage of total company net sales were as follows :


2002 2001 Change

%of %o fTotal Tota l

Company Company

Segment $(t) Sales $ (1) Sales S(1) %

U .S . Consumer $458 .0 86% $289.1 92% $168 .9 58 %Education and Training 20 .1 4% 8.8 3% 11 .3 129 %International 53 .6 10% 16.3 5% 37 .3 228 %

Total Company $ 531 .8 100% $314 .2 100% $217.6 69 %

(1) In millions .

27

Table of ContentsU.S. Consumer. Our U .S. Consumer segment comprised 86% of total company net sales for the twelve months ended December 31, 2002 and accounted

for 78% of the increase in total company net sales from 2001 to 2002 . Platform net sales in our U.S. Consumer segment increased 38%, from $149.9 million in2001 to $207 .1 million in 2002 . Platform sales, as a percentage of total U .S. Consumer sales, were 45% and 52% in 2002 and 2001, respectively . The increase innet sales from platform products is primarily due to the successful introduction of the Quantum Pad platform, the growth in our My First LeapPad and iQuestplatforms, and to the continued success in our LeapPad platform . Software net sales in our U .S . Consumer segment increased 126%, from $61 .8 million in 2001to $139.6 million in 2002 . Software sales, as a percentage of total U .S. Consumer sales, were 31 % and 21% in 2002 and 2001, respectively . The increase in netsales from software products is primarily due to our LeapPad books, the introduction of Quantum Pad books and the growth in My First LeapPad books andiQuest cartridges . Net sales of standalone products increased 44%, from $77 .4 million in 2001 to $11 1 .3 million in 2002 . Standalone sales, as a percentage oftotal U .S . Consumer sales, were 24% and 27% in 2002 and 2001, respectively . The increase in net sales from standalone products is primarily due to theintroduction of the LeapStart learning table and the LeapFrog shopping cart .

Net sales of platform, software and standalone products in dollars and as a percentage of total net sales we re as follows :

Sales / of Total

Year Ended December 31, Change Year Ended December 31 ,

2002(l) 2001 ( 1) S(1) % 2002 2001

Platform $207.1 $149.9 $ 57 .2 38% 45 .2% 51 .8 %Software 139.6 61 .8 77 .8 126% 30 .5% 21 .4 %Standalone 111 .3 77.4 33 .9 44% 24.3% 26.8 %

Net Sales $ 458.0 $289. 1 5 168.9 58% 100 .0% 100.0 %

(1) In millions .

Education and Training . Our Education and Training segment comprised 4% of total company net sales for the twelve months ended December 31, 2002and accounted for 5% of the increase in total company net sales . We believe the year-over-year 129% increase in net sales for our Education and Trainingsegment was the result of our larger direct sales force and increased brand offerings and awareness .

International. Our International segment comprised 10% of total company's net sales in 2002 and accounted for 17% of the increase in total company netsales from 2001 to 2002 . The year-over-year increase of 228% was primarily due to sales into the United Kingdom, Japan and Canada . Sales into the UnitedKingdom accounted for 33% of the segment's increase from 2001 to 2002 . This increase is primarily due to strong advertising and marketing campaigns andlarger shelf space in the major toy retailers . Our sales into Japan accounted for 31% of the segment's increase in net sales . This increase was primarily the resultof our strategic relationships with Benesse Corporation and Sega Toys that commenced in January 2002 . Our sales into Canada represented 23% of the segment'sincrease in net sales. The increase in net sales into Canada was primarily due to our transition from an outside distributor to an internally controlled supply anddistribution operation .

Gross Profit

Gross profit increased by $125 .4 million, or 87%, from $144 .6 million for the twelve months ended December 31, 2001 to $270 .0 million for the sameperiod in 2002 . Gross profit as a percentage of net sales increased from 46.0% for the twelve months ended December 31, 2001 to 50 .8% for the twelve monthsended December 31, 2002 . The gross profit in dollars for each segment and the related percentage of segment net sales were as follows :

Segment

U.S . Consumer

Education and Training

International

Total Company

(1) In millions.


2002 2001 Change

%of %o1

Segment 's Segment's

$(1) Net Sales S(1) Net Sales 5(I) %

$236.4 51 .6% $133 .2 46 .1% $103 .2 77 %10.3 51 .1% 5.6 63 .8% 4 .7 84 %23 .4 43.6% 5 .8 35 .4% 17.6 303 %

$270 .0 50.8% $144 .6 46 .0% $125.4 87 %

28

Table of Content sOur U .S . Consumer and International segments experienced significant dollar and percentage increases for 2002 compared to 2001 . This improvement was

primarily due to lower manufacturing and chip costs and the relatively larger increase in software sales, which have a significantly higher gross marginpercentage .

Our Education and Training segment experienced a decrease in gross profit margin in 2002 compared to 2001 primarily due to discounting certain sales towholesale customers and incentive pricing of new product offerings to establish an installed base .

Selling, General and Adarinistrative Expense s

Selling, general and administrative expenses increased by $25 .4 million, or 46%, from $55 .5 million in 2001 to $80 .9 million in 2002 . As a percentage ofnet sales, selling, general and administrative expenses decreased from 17.7% in 2001 to 15 .2% in 2002 .

All of our three business segments had reductions in selling, general and administrative expenses as a percentage of net sales . This was due primarily toleverage achieved against the strong growth in sales in all segments .

Selling, general and administrative expenses for our U.S . Consumer segment increased $15 .5 million or 35% from 2001 to 2002. Asa percentage of netsales, this expense decreased from 15 .4% in 2001 to 13 .1 % in 2002 . The dollar increase in these expenses was primarily due to an increase in salaries and benefitexpenses associated with a larger employee base and higher legal expense, In 2001, a provision for $6 .4 million was recorded for the write-off of our accountsreceivable from Kmart due to their bankruptcy. In 2002, an additional $0 .8 million provision was recorded . Without the effect of the Kmart write-off, selling,general and administrative expenses for our U .S . Consumer segment, as a percentage of net sales, would have been 12 .9% and 13 .2% for 2002 and 2001,respectively .

Selling, general and administrative expenses for our Education and Training segment increased $4 .9 million or 60% from 2001 to 2002 . As a percentage ofnet sales, this expense decreased from 93 .3% in 2001 to 65 .3% in 2002 . The dollar increase in these expenses was primarily due to our substantial investment inour own direct sales force and marketing programs .

Selling, general and administrative expenses for our International segment increased $5 .0 million or 180% from 2001 to 2002 . As a percentage of net sales,this expense decreased from 16.9% in 2001 to 14 .4% in 2002. The dollar increase in these expenses was largely related to increased personnel and legal setupcosts associated with our operations in Canada and Europe .


Research and development expenses increased by $16 .0 million, or 42%, from $38 .4 million in 2001 to $54.4 million in 2002. As a percentage of net sales,research and development expenses decreased from 12 .2% in 2001 to 10.2% in 2002 .

Content development expenses increased by $14 .1 million, or 95%, from $15 .0 million in 2001 to $29 .1 million in 2002 . As a percentage of net sales,content development expenses increased from 4 .8% in 2001 to 5 .5% in 2002 . The increase was largely related to the development of an expanded assortment ofinteractive books, activity sheets, chapter outlines and test questions for use with our existing and new platforms .

We capitalized $3 .6 million of content development expense in 2002 as compared to $5.0 million in 2001 . This decrease in content development expensecapitalization is due to the reduction of the use of outside developers whose costs are capitalized . We had $0.3 million in website development expensescapitalized in 2002 compared to $3 .1 million in 2001 . The development work for our current website has been largely completed and we do not anticipatecapitalizing further website development expenses .

Product development and engineering expenses increased by $1 .9 million, or 8%, from $23 .4 million in 2001 to $25 .3 million in 2002 . As a percentage ofnet sales, product development expenses decreased from 7 .5% in 2001 to 4.8% in 2002 . The reduction in the percentage of net sales resulted primarily fromincreased leverage of our technology group based in Los Gatos, California, achieved against strong growth in net sales in all segments . This group performs allhardware and software engineering and all ASIC design for our products .

The bulk of the increase in research and development expense was in our U .S. Consumer segment, which accounted for 80% of the total increase from2001 to 2002, and related to increased content development for our platforms and product development design and engineering related to new products to belaunched in 2003 .

29

Table of Content sThe research and development expenses in our Education and Training segment, which accounted for 12% of the total increase from 2001 to 2002, was

due to increased development of content and the LeapTrack as sessment system .

The research and development expenses in our International segment, which accounted for 8% of the total increase from 2001 to 2002, was due toexpenses associated with the localization of content to foreign cultures .

Advertising Expens e

Advertising expense increased by $26.6 million, or 88%, from $30 . 1 million in 2001 to $56 .7 million in 2002. As a percentage of net sales, advertising

expense increased from 9.6% in 2001 to 10 .7% in 2002 .

Our U .S . Consumer accounted for 81 % of the increase in the advertising expense, primarily related to increases in television advertising and cooperativeadvertising with our major retailers . The increase in television advertising expense was due to a substantial increase in media time used in an effort to promoteour expanded product line and strengthen our brand awareness . Co-operative advertising agreements with our major retailers were expanded in 2002 to increaseour advertising exposure to their large customer bases . The increase in our International segment is related primarily to our television and print advertisingspending in the United Kingdom, which increased 295% from 2001 to 2002 .

Depreciation and Amortization Expenses (excluding depreciation of fooling and other manufacturing equipment, which is included in cost of sales)

Depreciation and amortization expenses increased by $2 .4 million, or 57%, from $4 .2 million in 2001, to $6.6 million in 2002. As a percentage of net

sales, depreciation and amortization expense remained flat at 1 .3% .

Our U .S . Consumer segment's depreciation and amortization expense increased by $2 .4 million or 57%, and accounted for 99% of the total companydepreciation and amortization expense . The increase in the depreciation and amortization expense is primarily due to increased depreciation of computers and

software, amortization of intangibles and having a full year of amortization for our capitalized website and content development costs .

Income From Operations

Our income from operations increased by $54 .9 million, or 334%, from $16.4 million in 2001 to $71 .4 million in 2002 . As a percentage of net sales, ourincome from operations increased from 5 .2% in 2001 to 13 .4% in 2002 . Income from operations in dollars and the related percentage of segment net sales wereas follows :


2002 2001 Change

%of % ofSegment ' s Segment' s

Segment S( 1) Net Sales S{1) Net Sales 5(1) %

U .S . Consumer $72 .7 15 .9% $21.8 7 .5% $50.9 234 %Education and Training (9 .0) (44.9)% (6.7) (75.9)% (2 .3) (34)%Inte rnational 7 .7 14.4% 1 .3 8 .2% 6 .4 476%

Total Company $71 .4 13 .4% $16 .4 5 .2% $54 .9 335%

(1) In millions .

Income from operations in the U .S . consumer segment increased by $50 .9 million, or 234%, from 2001 to 2002 . The increase is largely due to strong salesgrowth and our increased gross profit margins .

Our Education and Training segment experienced an operating loss of $9 .0 million compared to an operating loss of $6.7 million in 2001 . This increase inoperating loss was due primarily to higher operating expenses and lower capitalization of content costs as compared to the prior year . This segment is in the earlystage of growth, and our decision to invest in operations, personnel and product development is based on what we believe to be a large opportunity in the U .S .

school market. Income from operations in our international segment increased by $6 .4 million or 476% from 2001 to 2002, primarily due to increased sales andgross profit margins .

30

Table of ContentsOther

Net interest and other (expense) income increased by $2 .9 million from an expense of $2.0 million in 2001 to an income of $0 .9 million in 2002 . Thisincrease resulted from a decline in interest expense due to lower average borrowings and lower average interest rates in 2002, and the favorable impact of anunrealized gain related to the translation of foreign subsidiaries intercompany loan balances .

Our effective tax rate was 39 .9% and 33 .1 % in 2002 and 2001, respectively . The 2001 effective tax rate was impacted by the complete reversal of a

deferred tax valuation allowance . We anticipate that our effective tax rate for 2003 will be approximately 37% .

Net Income

Net income increased by $33 .7 million, or 350%, from $9.7 million in 2001 to $43 . 4 million in 2002 . As a percentage of net sales, net income increased from

3 .1 % in 2002 to 8 .2% in 2003 .

Seasonality and Quarterly Results of Operations

Our business is subject to significant seasonal fluctuations. The substantial majority of our net sales and all of our net income are realized during the thirdand fourth calendar quarters . In addition, our quarterly results of operations have fluctuated significantly in the past, and can be expected to continue to fluctuatesignificantly in the future, as a result of many factors, including :

seasonal influences on our sales , such as the holiday shopping season and back- lo-school purchasing ;

• unpredictable consumer preferences and spending trends;

• the need to increase inventories in advance of our primary selling season ; an d

the timing of introductions of new products .

For a discussion of these and other factors affecting seasonality, see "Risk Factors That May Affect Our Results and Stock Price - Our business is seasonal, andtherefore our annual operating results will depend, in large part, on sales relating to the brief holiday season;" and "- Our quarterly operating results are

susceptible to fluctuations that could cause our stock price to decline ."

The following table sets forth selected unaudited quarterly statement of operations information for 2002 and 2003 . The unaudited quarterly informationincludes all normal recurring adjustments that management considers necessary for a fair presentation of the information shown . Historically, we have been

profitable in our third and fourth quarters and unprofitable in our first and second quarters . We expect that we will continue to incur losses during the first andsecond quarters of each year for the foreseeable future . Because of the seasonality of our business and other factors, results for any interim period are notnecessarily indicative of the results that may be achieved for the full fiscal year.

First Second Third Fourth Year Ended

Quarter Quarter Quarter Quarter December 31,

2003Net salesGross profi tIncome (loss) from operationsNet income (loss)Net income (loss) per common share :

Basi cDilute d

Net salesGross profitIncome (loss) from operationsNet income (loss)Net income (loss) per common share :

BasicDiluted

(In thousands)

$ 76,733 $ 68,030 $ 203,888 $ 331,361 $ 680,01 240,641 35,821 104,822 158,860 340,144(3,542) (7,942) 52,581 68,361 109,45 8

(969) (3,926) 33,404 44,166 72,675

$ (0.02) $ (0 .07) $ 0 .58 $ 0 .75 $ 1 .27$ (0.02) $ (0 .07) $ 0 .55 5 0 .72 $ 1 .20

$ 57,980 $ 43,218 $ 182,127 $ 248,447 $ 531,77227,278 20,941 95,056 126,766 270,041 .(8,073) (12,555) 44,378 47,601 71,35 1(5,059) (7,541) 26,683 29,361 43,444

$ (0.15) $ (0.22) $ 0 .65 $ 0.59 $ 1 .09$ (0.15) $ (0.22) $ 0.50 S 0.50 $ 0.86

31

Table of ContentsThe amortization of capitalized content development has been reclassified from depreciation and amortization to cost of sales to conform with the presentation ofthe annual consolidated financial statements.

Liquidity and Capital ResourcesLeapFrog's primary sources of liquidity in 2003 and 2002 have been :

• Financing activities : primarily proceeds from our initial public offering of Class A common stock in July 2002, and from exercise of stock optionsand employee stock purchase plan ; an d

• Cash flows generated from operating activities primarily resulting from increased net income .

Prior to our IPO, we relied on our long term secured credit facility with Foothill Capital Corporation to fund our operations . On July 30, 2002, uponcompletion of our initial public offering we repaid the entire outstanding balance of $34 .1 million under this credit facility . On October 28, 2002, we formallyterminated this facility .

On December 31, 2002, we entered into a $30.0 million three year unsecured senior credit facility, with an option to increase the facility to $50.0 million,for working capital purposes . The agreement requires that we comply with certain financial covenants, including the maintenance of a minimum quick ratio on aquarterly basis and a minimum: level of EBITDA on a rolling quarterly basis . We were in compliance with these covenants at December 31, 2003 . The level of acertain financial ratio maintained by us determines interest rates on borrowings. The interest rate will be between prime and prime plus 0 .25% or LIBOR plus

1 .25% and LIBOR plus 2 .00% . We had outstanding letters of credit of $0.3 million at December 31, 2003 and $1 .4 million at December 31, 2002 . At December31, 2003, $29.7 million of unused borrowings were available to us .

We typically commit to inventory production, content development and advertising expenditures prior to the peak third and fourth quarter retail sellingseason . In addition, our accounts receivable balance typically peaks in the third and fourth quarters, and most of these accounts receivable are not due forpayment until the fourth quarter or the subsequent year . As a result, cash flow from operating activities is strongest in the first and fourth quarters of the year .

Quarterly cash flow from operating activities were as follows:

Cash Flow From Operating

Activitie s

1st Qtr2nd Qtr3rd Qtr4th Qt r

Total

(1) In millions .

2003(l) 2002(1) 2001(l )

$ 50.1 $ 40.7 $ 3.4(1 .4) (1 .5) (16.2)

(34.0) (34.0) (22.2)12.1 17.3 (0,4)

$ 26.8 $ 22.5 $(35.3 )

Operating activitiesNet cash provided by operating activities was $26.8 million in 2003 compared to $22 .5 million in 2002 . Net cash used in operating activities was $35 .3

million in 2001 . The $4 . 3 million increase in net cash provided by operating activities from 2002 to 2003 was primarily due the following factors :

Our inventory balances increased at a lower rate from 2002 to 2003, an increase of $6 .4 million, compared to $38 .4 million from 2001 to 2002 . Ourinventory balances were adequate in supporting our sales growth in 2003, as reflected by the year-over-year sales growth in all our segments . Webelieve that our inventory is at an adequate level to support our continued growth in the first half of 2004 .

32

Table

• The $29 .2 million, or 67%, growth in net income also contributed to the improvement of net cash provided by operating activities . Net incomeincreased primarily due to increased sales and operating expense leverage achieved in 2003 compared to 2002 .

• Increase in tax benefit from exercise of stock options of $34 .2 million due to the increase in option exercises in 2003 .

• The higher receivable balances negatively impacted our cash flows from operations by $58 .0 million from 2002 to 2003 . Our days sales outstanding,or DSO, increased from 6 1 . 5 days at December 31, 2002 to 76 .5 days at December 31, 2003 . The DSO increase was primarily due to the timing ofshipments, as a higher percentage of sales in 2003 were shipped later in the fourth quarter, pushing collection into early 2004 . As of February 29,2004, our account receivables balance, net of allowances, was approximately $87 .0 million . We anticipate the collection of these receivables willpositively impact our cash flow from operations in the first quarter of 2004 . Our year-end allowances related to accounts receivable were $27 .0million at December 31, 2003, $16.4 million at December 31, 2002 and $9 .9 million at December 31, 2001, primarily due to lower average sellingprices resulting from discounts on our more matured platforms .

The net cash used in operating activities in 2001 of$35 . 3 million consisted primarily of the net income in 2001 of $ 9 .7 million, and increases in theprovision for allowances for accounts receivable of $16 .0 million and income taxes payable of $ 9.6 million , offset by the increase in accounts receivable of $77 .3million .

Investing activities

Net cash used in investing activities was $59 .0 million in 2003 compared to $17 .6 million in 2002 and $14 .6 million in 2001 . The primary component ofnet cash used in investing activities for 2003 was net purchases of short-tern investments of $40 .4 million and $15 .8 million in purchases of properly andequipment . The primary components of the net cash used in investing activities for 2002 and 2001 were purchases of property and equipment of $14,8 million in2002 and $13.6 million in 2001, used in the ordinary course of our business .

Financing activities

Net cash provided by financing activities was $30 .6 million in 2003 compared to $57 .5 million in 2002 and $52 .8 million in 2001 . The primary componentof cash from financing activities in 2003 was proceeds received from the exercise of stock options and purchases of our common stock pursuant to our employeestock purchase plan. In 2001 and for part of 2002, we relied on our long-term secured credit facility with Foothill Capital Corporation and proceeds receivedfrom the issuance of Series A preferred stock to fund our operations . We repaid the entire amount of our outstanding long-term loan with Foothill from theproceeds from our initial public offering in 2002 . The Series A preferred stock was converted to Class A common stock in November 2002 .

We estimate that our capital expenditures for 2004 will be between $ 19 .0 million and $ 24 .0 million , as compared to $15 .8 million in 2003, $14 .8 million in2002 and $13. 6 million in 2001 . The increase in our 2004 estimate over 2003 is primarily related to increased computers and software expenses, resulting fromour continued growth , and increased manufacturing tool purchases for use in the production of our existing and new products.

We believe our current cash and short- semi investments and anticipated cash flow from operations will be sufficient to meet our working capital andcapital requirements through 2005 .

Contractual Obligations

We conduct our corporate operations from leased facilities and lease some equipment under operating leases. Generally, these have initial lease periods ofthree to ten years and contain provisions for renewal options of five years at market rates . The following table summarizes our outstanding long-term contractualobligations at December 31, 2003 .

Payments Due by Period

Less Than More Tha n

Total I Year 1-3 Years 4-5 Years 5 Year s

(In thousands)Operating Leases $ 9,947 $ 4,284 $ 5,367 $ 296 $ -Royalty Guarantees 12,477 4,503 7,912 62 -

Total $22,424 $ 8,787 $ 13,279 $ 358 $

33

Table ofCsgtentsIn January 2004, we and one of our subsidiaries entered into a ten-year technology license agreement with a foreign company to jointly develop and

customize our respective technologies to be combined in a platform and related licensed products . The agreement calls for contractual payments by oursubsidiary of $6 .0 million in license fees payable in 2004 and $11 .0 million in advance royalties payable in 2005 . Additionally, there are $1 .0 million ofengineering fees payable subject to attainment of specific milestones .

Related Party Transaction s

In 2000, we extended loans to four of our current executive officers for the purpose of purchasing stock from us and paying associated expenses . The loanswere evidenced by full recourse promissory notes bearing interest at an annual rate of 6 .62% and were due on the earlier of (l) December 31, 2006 or (2) tendays following the later of an initial public offering or the expiration of the applicable lock-up period . Each of these promissory notes was paid in full in January2003 .

As of March 1, 2004, Knowledge Universe and its affiliates beneficially owned 31,636,962 shares of our Class B conunon stock, which representsapproximately 87% of the combined voting power of our Class A common stock and Class B common stock . For more information, see "Risk Factors That MayAffect Our Results and Stock Price - Knowledge Universe, L .L .C ., Lawrence J. Ellison, Michael R . Milken and Lowell J . Milken, together control allstockholder voting power as well as our board of directors . "

In August 1999, we purchased a 19 .9% ownership interest in Knowledge Kids Media Group, Inc ., an affiliate of Knowledge Universe, for $2 .0 million .Knowledge Universe indirectly owns 80 .1 % of Knowledge Kids Media Group . Knowledge Kids Media Group owns substantially all of the voting power ofKnowledge Kids Network, Inc . Salina D . Simon, a member of our board of directors, is Chief Executive Officer of Knowledge Kids Media Group andKnowledge Kids Network . In 1999 and 2000, we wrote off our entire investment in Knowledge Kids Media Group . We have no obligation to provide additionalfunding to Knowledge Kids Media Group, and we are not responsible for the repayment of any of the existing or future liabilities of the company .

In March 2001, we entered into an agreement with Knowledge Kids Network, in which Knowledge Kids Network, an affiliate of Knowledge Universe,agreed to develop content and provide technical services in connection with LeapPad interactive books . We incurred $122,000, $658,000 and $1,371,000 in2003, 2002 and 2001, respectively, in expenses for services from Knowledge Kids Network.

Since 1998, we and certain other Knowledge Universe affiliates have filed combined state income tax returns in California and other states in which wehave been deemed to constitute a "unitary" group of taxpayers under applicable state laws . Accordingly, we have not filed separate income tax returns or paidincome taxes in those states, and those functions have been performed by another Knowledge Universe affiliate on behalf of all members of the group . In July2002, we entered into a tax sharing agreement with Knowledge Universe, Inc ., a Knowledge Universe affiliate, formalizing this arrangement . Under theagreement, Knowledge Universe, Inc . agreed to prepare and file combined income tax returns in the relevant states and to pay any income taxes the group mayowe to such states, and we agreed to pay Knowledge Universe, Inc . a cash amount equal to what our income tax liability to the relevant states, reduced to reflectthe lost tax benefit, if any, for state taxes paid on our federal tax return, would have been if we had been a stand-alone taxpayer . The liabilities computed underthe tax sharing agreement were $0 in 2003, $2 .7 million in 2002 and $79,000 in 2001 . In March 2004, Knowledge Universe notified us that as of April 2003, wewere no longer a "unitary" group of taxpayers due to Knowledge Universe no longer having voting control over us as of April 2003 . We will be included in thecombined state income tax returns filed by Knowledge Universe through April 2003 . For all subsequent periods we will be filing our own state income taxreturns.

The law firm of Maron & Sandler served as our primary outside general counsel from August 1997 through July 2002 and they continue to provide legalservices to us . Maron & Sandler is the transfer agent for our Class B common stock . Stanley E . Maron, a member of our board of directors, is a partner of Maron& Sandler. In 2003, 2002 and 2001, we paid Maron & Sandler $5,000, $320,000 and $222,000, respectively, for legal services rendered to us . In addition, Mr.Maron and other attorneys of Maron & Sandler hold interests in an entity that holds non-voting units of a limited liability company that holds an equity interestin Knowledge Universe . These non-voting units amount to a less than 1 % economic interest in Knowledge Universe .

34

Table of ContentsIn 2003, 2002 and 2001 we purchased software products and support services from Oracle Corporation totaling $569,000, $280,000 and $137,000,

respectively. Lawrence J . Ellison, the Chairman and Chief Executive Officer of Oracle Corporation, may be deemed to have or share the power to direct thevoting and disposition, and therefore to have beneficial ownership, of any shares of our capital stock owned directly or indirectly by Knowledge Universe .Jeffrey Berg, a member of our board of directors, serves on the board of directors of Oracle Corporation.

In March 2001, we sold 2,000,000 shares of our Series A preferred stock for aggregate consideration of $25 million to CSC LF Holdings, LLC, Publishingand Broadcasting International Ltd . and Windsor Digital Studio LLC . In connection with this sale, we entered into an Amended and Restated Stockholders

Agreement with these purchasers, Knowledge Kids, L .L .C ., an affiliate of Knowledge Universe, FrogPond, Michael C . Wood and Explore Technologies, aholder of our Class A common stock . In May 2003, the agreement was amended and restated to delete provisions that terminated as a result of our initial publicoffering and subsequent trading results of our Class A common stock, to clarify the transfer provisions set forth in the agreement and to accept and acknowledgethe distribution of shares by certain stockholders that are a party to the agreement . Explore Holdings LLC and FrogPond LLC are not parties to this FourthAmended and Restated Stockholders Agreement as neither entity held any of our common stock as of the date of the amended and restated agreement .

Recent Accounting Pronouncement s

In January 2003, the Financial Accounting Standards Board, or FASB, issued FASB Interpretation No, 46, "Consolidation of Variable Interest Entities," orFIN 46 . FIN 46 clarifies the application of Accounting Research Bulletin No . 51, "Consolidated Financial Statements," to certain entities in which equityinvestors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities withoutadditional subordinated financial support from other parties . In December 2003, the FASB issued a revision to FIN 46, or FIN 46R. FIN 46R provides a broaddeferral of the latest date by which all public entities must apply FIN 46 to certain variable interest entities to the first reporting period ending after March 15,2004 . We do not expect the adoption of FIN 46 to have a material impact on our financial position, cash flows or results of operations .

In November 2002, the Emerging Issues Task Force, or EITF, issued EITF 00-21, "Revenue Arrangements with Multiple Deliverables," which addressescertain aspects of the accounting for arrangements that involve the delivery or performance of multiple products, services or rights to use assets . Under EITF00--21, revenue arrangements with multiple deliverables should be divided into separate units of accounting if the deliverables meet certain criteria, includingwhether the delivered items have stand alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items.In addition, the consideration should be allocated among the separate units of accounting based on their fair values, and the applicable revenue recognitioncriteria should be considered separately for each of the separate units of accounting . EITF 00-21 was effective for revenue arrangements entered into after June30, 2003 . The application of EITF 00-21 did not have a material impact on our financial position, operating results or cash flows for the year ended December

31, 2003 .

Risk Factors That May Affect Our Results and Stock Pric eOur business and our stock price are subject to many risks and uncertainties that may affect our future financial performance . Some of the risks and

uncertainties that may cause our operating results to vary or that may materially and adversely affect our operating results are as follows :

tf we fail to predict consumer preferences and trends accurately , develop and introduce new p roducts rapidly or enhance and extend our existing coreproducts , our sales will suffer .

Sales of our platforms, related software and stand -alone products typically have grown in the periods following initial introduction, but we expect sales ofspecific products to decrease as they mature . The introduction of new products and the enhancement and extension of existing products, through the introductionof additional software or by other means, are critical to our future sales growth . The successful development of new products and the enhancement and extensionof our current products will require us to anticipate the needs and preferences of consumers and educators and to forecast market and technological trendsaccurately . Consumer preferences, and particularly children's preferences, are continuously changing and are difficult to predict. In addition, educationalcurricula change as states adopt new standards . The development of new interactive learn ing products requires high levels of innovation and this process can be

lengthy and costly. To remain competitive, we must continue to develop enhancements of our NearTouch and other technologies successfully . In 2004, we intend

to introduce a number of new platforms, stand-alone products and interactive books and other software for each of our three business segments . We cannotassure you that these or other future products will be introduced or, if introduced, will be successful . The failure to enhance and extend our existing products or todevelop and introduce new products that achieve and sustain market acceptance and produce acceptable margins would harm our business and operating results.

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Table of ContentsOur business is seasonal, and therefore our annual operating results depend , in large part, on sales relating to the brief holiday season.

Sales of consumer electronics and toy products in the retail channel are highly seasonal, causing the substantial majority of our sales to U .S. retailers tooccur during the third and fourth quarters . In 2003, approximately 79% of our total net sales occurred during this period . This percentage of total sales mayincrease as retailers become more efficient in their control of inventory levels through just in-time inventory management systems . Generally, retailers timetheir orders so that suppliers like us will fill the orders closer to the time of purchase by consumers, thereby reducing their need to maintain larger on-handinventories throughout the year to meet demand . While these techniques reduce retailers' investments in their inventory, they increase pressure on suppliers to fillorders promptly and shift a significant portion of inventory risk and carrying costs to suppliers like us. The logistics of supplying more product within shortertime periods will increase the risk that we fail to meet tight shipping schedules, which could damage our relationships with retailers, increase our shipping costs

or cause sales opportunities to be delayed or lost. For example, in the second half of 2003, one of our largest retail customers changed its order pattern to occurlater in the holiday season, which we believe delayed a significant portion of our net sales to this customer from the third quarter of 2003 to the fourth quarter of

2003 . The seasonal pattern of sales in the retail channel requires significant use of our working capital to manufacture and carry inventory in anticipation of theholiday season, as well as early and accurate forecasting of holiday sales . Failure to predict accurately and respond appropriately to consumer demand on atimely basis to meet seasonal fluctuations, or any disruption of consumer buying habits during this key period, would harm our business and operating results .

We rely on a limited number of manufacturers , virtually all of which are located in China, to produce our finished products , and our reputation andoperating results could be harmed if they fail to produce quali ty products in a timely manner and in sufficient quantities .

We outsource substantially all of our finished goods manufacturing to eight manufacturers, all of whom manufacture our products at facilities in theGuangdong province in the southeastern region of China . One of these manufacturers, Jetta Company Limited, was the sole manufacturer of all our LeapPadplatforms in 2002 . We depend on these manufacturers to produce sufficient volumes of our products in a timely fashion and at satisfactory quality levels . Wegenerally allow retailers and distributors to return or receive credit for defective or damaged products . If our manufacturers fail to produce quality products on

time and in sufficient quantities due to capital shortages, late payments from us, political instability, labor shortages, intellectual property disputes, naturaldisasters, energy shortages, terrorism or other disruptions to their businesses, our reputation and operating results would suffer . In addition, if our manufacturersdecide to increase production for their other customers, they may be unable to manufacture sufficient quantities of our products and our business could beharmed .

If we are unable to compete effectively with existing or new competitors, our sales and market share could decline .

We currently compete primarily in the infant and toddler and preschool categories and electronic learning aids category of the U .S . toy industry and, tosome degree, in the overall U .S . and international toy industry . Our SchoolHouse division competes in the supplemental educational materials market . Each of

these markets is very competitive and we expect competition to increase in the future . For example, in July 2003, Mattel, Inc . introduced under its Fisher-Pricebrand a product called "PowerTouch" having functionality similar to that of our LeapPad platform . We believe that we are beginning to compete, and willincreasingly compete in the future, with makers of popular game platforms and smart mobile devices such as personal digital assistants . These companies are

well situated to compete effectively in our primary markets . Additionally, we are beginning to cross over into their markets with products such as our Leapsterplatform and iQuest handheld device. Many of our direct, indirect and potential competitors have significantly longer operating histories, greater brandrecognition and substantially greater financial, technical and marketing resources than we do . These competitors may be able to respond more rapidly than wecan to changes in consumer requirements or preferences or to new or emerging technologies . They may also devote greater resources to the development,promotion and sale of their products than we do . We cannot assure you that we will be able to compete effectively in our markets.

Our quarterly operating results are susceptible to fluctuations that could cause our stock price to decline .

Historically, our quarterly operating results have fluctuated significantly . For example, our net income (loss) for the first through fourth quarters of 2003

was $(l .0) million, $(3 .9) million, $33 .4 million and $44 .2 million, respectively. Our net income (loss) for the first through fourth quarters of 2002 was $(5 .J)

million, $(7 .5) million, $26 .7 million and $29 .4 million, respectively . We expect these fluctuations to continue for a number of reasons, including :

• seasonal influences on our sales, such as the holiday shopping season and back to-school purchasing ;

• unpredictable consumer preferences and spending trends ;

• the need to increase inventori es in advance of our primary selling season ;

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• timing of new product introductions ;

• general economic conditions ;

• the results of legal proceedings;

• changes in our pricing policies, the pricing policies of our competitors and general pricing trends in consumer electronics and toy markets ;

• international sales volume and the mix of such sales among countries with similar or different holidays and school years than the United States ;

• the impact of strategic relationships ;

• the sales cycle to schools, which may be uneven depending on budget constraints, the timing of purchases and other seasonal influences ; an d

• the timing of orders by our customers and our ability to fulfill those orders in a timely manner, or at all .

For example, FAO, Inc . filed for bankruptcy protection in December 2003 and KB Toys, Inc . filed for bankruptcy in January 2004 . These and otherretailers may elect to close a significant number of stores in 2004, and such actions would affect the timing and amounts of orders o€our products from theseretailers . In turn, the effects of any changes in orders from these retailers could have a material effect on our quarterly operating results, particularly in the firsttwo quarters of the year, when our sales are generally much lower than in the second half of the year .

We expect that we will continue to incur losses during the first and second quarters of each year for the foreseeable future . We do not have sufficient

operating experience to predict the overall effect of various seasonal factors and their effect on our future quarterly operating results . If we fail to meet ourprojected net sales or other projected operating results, or if we fail to meet analysts' or investors' expectations, the market price of our Class A common stockcould decrease .

We currently rely, and expect to continue to rely, on our LeapPad family of platforms and related interactive books for a significant portion of oursales.

Our LeapPad, LeapPad Plus Writing and Quantum Pad platforms, each of which is based on our NearTouch technology, together with interactive booksrelated to those platforms that are generally compatible with any of those platforms, accounted for an aggregate of approximately 47% of our net sales in 2003 .Our My First LeapPad platform and My First LeapPad interactive books accounted for an aggregate of approximately 12% of our net sales in 2003 . No otherproduct line, together with any related software, accounted for more than approximately 10% of our net sales in 2003 . A significant portion of our future saleswill depend on the continued commercial success of our LeapPad, LeapPad Plus Writing, Quantum Pad platforms and compatible interactive books, and our MyFirst LeapPad platforms and related interactive books . If the sales for our LeapPad, LeapPad Plus Writing, Quantum Pad and My First LeapPad platforms arebelow expected sales or if sales of their related interactive books do not grow as we anticipate, sales of our other products may not be able to compensate forthese shortfalls and our overall sales would suffer .

Our business depends on three retailers that together accounted for approximately 68% of our net sales in 2003, and our dependence upon a smallgroup of retailers may increase .

Wal-Mart (including Sam's Club), Toys "R" Us and Target accounted in the aggregate for approximately 68% of our net sales in 2003 . We expect that asmall number of large retailers will continue to account for a significant majority of our sales and that our sales to these retailers may increase as a percentage ofour total sales . At December 31, 2002, Wal-Mart (including Sam's Club) accounted for approximately 33% of our accounts receivable and Toys "R" Usaccounted for approximately 30% of our accounts receivable . If any of these retailers experience significant financial difficulty in the future or otherwise fail tosatisfy their accounts payable, our allowance for doubtful accounts receivable could be insufficient . If any of these retailers reduce their purchases from us,change the terms on which we conduct business with them or experience a future downturn in their business, our business and operating results could be harmed .

We do not have long-term agreements with our retailers and changes in our relationships with retailers could significantly harm our business andoperating results.

We do not have long-term agreements with any of our retailers . As a result, agreements with respect to pricing, shelf space, cooperative advertising orspecial promotions, among other things, are subject to periodic negotiation with each retailer. Retailers make no binding long-term commitments to us regardingpurchase volumes and make all purchases by delivering one-time purchase orders . If the number of our products increases as we have planned or the toll out ofversions of our Learning Center shelf displays in selected retail stores proceeds as we anticipate, we will require more retail shelf space to display our variousproducts. Any retailer could reduce its overall purchases of our products, reduce the number and variety of our product s

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Table o f Content sthat it carries and the shelf space allotted for our products, decide not to incorporate versions of our Learning Center shelf displays in its stores or otherwisematerially change the terms of our current relationship at any time . Any such change could significantly harm our business and operating results.

Our future growth will depend in part on our SchoolHouse division, which may not be successful .

We launched our SchoolHouse division in June 1999, and to date the division, which accounts for substantially all of the results of our Education andTraining segment, has incurred cumulative losses . Although the division reported an operating profit for the second quarter of 2003, it incurred operating lossesin the third and fourth quarters of 2003 and we anticipate that it may incur additional operating losses in the near teen . Sales from our SchoolHouse division'scurriculum-based products will depend principally on broadening market acceptance of those products, which in turn depends on a number of factors, including :

• Our ability to demonstrate to teachers and other key educational institution decision-makers the usefulness of our products to supplement traditionalteaching practices;

• the willingness of teachers, administrators, parents and students to use products in a classroom setting from a company that may be perceived as a toymanufacturer;

• the effectiveness of our sales force, particularly since we rely on independent sales representatives ;

• the availability of state and federal government funding , which may be severely limited due to budget shortfalls currently faced by many states andthe federal government , to defray, subsidize or pay for the costs of our products; and

Our ability to demonstrate that our products improve academic performance .

If we cannot increase market acceptance of our SchoolHouse division's supplemental educational products, including our LeapTrack assessment systemintroduced in Fall 2002, the division may not be able to achieve operating profits on a full-year basis and our future sales could suffer . As of December 31, 2001,we had capitalized $3 .5 million of our content development costs relating to our SchoolHouse division . In 2002 we capitalized an additional $3 .1 million . In2003, we capitalized approximately $1 .3 million. If the SchoolHouse division does not achieve operating profits, we may have to write off some or all of thesecapitalized costs, which could significantly harm our operating results .

Our planned expansion into additional international markets may not succeed and our future operating results could be harmed by economic, political,regulatory and other risks associated with international sales and operations .

We have limited experience with sales operations outside the United States . In 2000, we expanded beyond the use of international distributors to sell ourproducts and started selling our products directly to retailers in the United Kingdom. We began selling directly to retailers in Canada in June 2002, to retailers inFrance in July 2002, and to retailers in Mexico in September 2003, and we plan to enter the German-speaking markets in Europe through our distributor,Stadlbauer Marketing + Vertrieb G .m .b .H., in the second half of 2004 . We derived approximately 14% of our net sales from outside the United States in 2003and 10% in 2002 . We intend to increase our international sales through additional overseas offices to develop further our direct sales efforts, distributorrelationships and strategic relationships with companies with operations outside of the United States, such as Benesse Corporation and Sega Toys in Japan .However, these and other efforts may not help increase sales of our products outside the United Stales . Our business is, and will increasingly be, subject to risksassociated with conducting business internationally, including :

• political and economic instability, military conflicts and civil unrest ;

• existing and future governmental policies ;

• greater difficulty in staffing and managing foreign operations ;

• complications in modifying our products for local markets or in complying with foreign laws, including consumer protection laws and local languagelaws ;

• transportation delays and interruptions ;

• greater difficulty enforcing intellectual property rights and weaker laws protecting such rights ;

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• trade protection measures and import or export licensing requirements ;

currency conversion risks and currency fluctuations;

• longer payment cycles, different accounting practices and problems in collecting accounts receivable ; and

• limitations, including taxes, on the repatriation of earnings .

Any difficulty with our intern ational operations could harm our future sales and operating results .

Third parties have claimed, and may claim in the future, that we are infringing their intellectual property rights, which may cause us to incursignificant litigation or licensing expenses or to stop selling some or all of our products or using some of our trademarks .

In the course of our business, we periodically receive claims of infringement or otherwise become aware of potentially relevant patents, copyrights,trademarks or other intellectual property rights held by other parties . Upon receipt of this type of communication, we evaluate the validity and applicability ofallegations of infringement of intellectual property rights to determine whether we must negotiate licenses or cross-licenses to incorporate or use the proprietarytechnologies or trademarks or other proprietary matters in or on our products . Any dispute or litigation regarding patents, copyrights, trademarks or otherintellectual property rights, regardless of its outcome, may be costly and time-consuming, and may divert our management and key personnel from our businessoperations . if we, our distributors or our manufacturers are adjudged to be infringing the intellectual properly rights of any third party, we or they may berequired to obtain a license to use those rights, which may not be obtainable on reasonable terms, if at all . We also may be subject to significant damages orinjunctions against the development and sale of some or all of our products or against the use of a trademark in the sale of some or all of our products . Ourinsurance may not cover potential claims of this type or may not be adequate to indemnify us for all the liability that could be imposed . We may presently beunaware of intellectual property rights of others that may cover some or all of our technology or products . We will continue to be subject to infringement claimsas we increase the number and type of products we offer, as the number of products, services and competitors in our markets grow, as we enter new markets andas our products receive more attention and publicity. For additional discussion of litigation related to the protection of our intellectual property, see "Item 3 .Legal Proceedings . -Learning Resources, Inc. v. Leap Frog Enterprises, Inc ." If we fail to be successful against these claims, it could require us to stop sellingour LeapPad and other platforms and to pay damages .

Our intellectual property rights may not prevent our competitors from using our technologies or similar technologies to develop competing products,which could weaken our competitive position and harm our operating results .

Our success depends in large part on our proprietary technologies that are used in our learning platforms and related software, such as My First LeapPad,LeapPad, LeapPad Plus Writing, Quantum Pad and Leapster platforms, as well as our Explorer and Odyssey interactive globe series . We rely, and plan tocontinue to rely, on a combination of patents, copyrights, trademarks, trade secrets, confidentiality provisions and licensing arrangements to establish and protectour proprietary rights . The contractual arrangements and the other steps we have taken to protect our intellectual property may not prevent misappropriation ofour intellectual property or deter independent third-party development of similar technologies . For example, we are aware that products very similar to some ofours have been produced by others in China, and we are vigorously seeking to enforce our rights . However, we may not be able to enforce our intellectualproperty rights, if any, in China or other countries where such product may be manufactured or sold . Monitoring the unauthorized use of our intellectual propertyis costly, and any dispute or other litigation, regardless of outcome, may be costly and time-consuming and may divert our management and key personnel fromour business operations . The steps we have taken may not prevent unauthorized use of our intellectual property, particularly in foreign countries where we do nothold patents or trademarks or where the laws may not protect our intellectual property as fully as in the United States . Some of our products and product featureshave limited intellectual property protection, and, as a consequence, we may not have the legal right to prevent others from reverse engineering or otherwisecopying and using these features in competitive products. For additional discussion of litigation related to the protection of our intellectual property, see "Item 3 .Legal Proceedings . - LeapFrog Enterprises. Inc. v. Fisher-Price, Inc." If we fail to protect or to enforce our intellectual property rights successfully, our rightscould be diminished and our competitive position could suffer, which could harm our operating results .

Outbreaks of health epidemics , such as Severe Acute Respiratory Syndrome, or SAILS, and the so-called "Asian bird flu" may adversely impact ourbusiness or the operations of our contract manufacturers or our suppliers.

In the past, outbreaks of SARS have been significantly focused on Asia, particularly in Hong Kong, where we have an office, and in the Guangdongprovince of China, where almost all of our finished goods manufacturers are located . In addition, recent outbreaks of avian influenza, or "Asian bird flu" haveoccurred throughout Asia, including cases in Guangdong province .

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Table of Content sThe design, development and manufacture of our products could suffer if a significant number of our employees or the employees of our manufacturers or theirsuppliers contract SARS or Asian bird flu or otherwise are unable to fulfill their responsibilities or quarantine or other disease-mitigation measures disruptoperations. In the event of any significant outbreak, quarantine or other disruption, we may be unable to quickly identify or secure alternate suppliers ormanufacturing facilities and our results of operations would be adversely affected .

Our products are shipped from China and any disruption of shipping could harm our business .We rely on four contract ocean carriers to ship virtually all of the products that we import to our primary distribution centers in California . Retailers that

lake delivery of our products in China rely on a variety of carriers to import those products . Any disruption or slowdown of service on importation of products

caused by SARS--related issues, labor disputes, terrorism, inte rn ational incidents, quarantines, lack of available shipping containers or otherwise couldsignificantly harm our business and reputation . For example, in 2002, a key collective bargaining agreement between the Pacific Maritime Association and theInternational Longshore and Warehouse Union affecting shipping of products to the Western United States, including our products, expired and, after a

temporary extension, resulted in an eleven-day cessation of work at West Coast docks . This cessation of work cost us approximately $3 .0 million in additionalfreight expenses . Although the Pacific Maritime Association and International Longshore and Warehouse Union have entered into a new collective bargainingagreement, any further disruption or slowdown of service on importation of products caused by labor disputes, terrorism, international incidents, lack of availableshipping containers or otherwise could significantly harm our business and reputation .

We do not have long-term agreements with our major suppliers, and they may stop manufacturing our components at any time.

We presently order our products on a purchase order basis from our component suppliers, and we do not have long-term manufacturing agreements withany of them. The absence of long°-tenn agreements means that, with little or no notice, our suppliers could refuse to manufacture some or all of our components,reduce the number of units of a component that they will manufacture or change the terms under which they manufacture our components . if our suppliers stopmanufacturing our components, we may be unable to find alternative suppliers on a timely or cost-effective basis, if at all, which would hams our operatingresults. In addition, if any of our suppliers changes the terms under which they manufacture for us, our costs could increase and our profitability would suffer .

We depend on our suppliers for our components , and our production would be seriously harmed if these suppliers are not able to meet our demand andalternative sources are not available .

Some of the components used to make our products, including our ASICs, currently come from a single supplier . Additionally, the demand for somecomponents such as liquid crystal displays, integrated circuits or other electronic components is volatile, which may lead to shortages . If our suppliers are unableto meet our demand for our components and if we are unable to obtain an alternative source or if the price available from our current suppliers or an alternativesource is prohibitive, our ability to maintain timely and cost-effective production of our products would be seriously harmed and our operating results would

suffer .

if we do not correctly an ti cipate demand for particular products, we could incur additional costs or experience manufacturing delays, which wouldreduce our gross margins or cause us to lose sales .

Historically, we have seen steady increases in demand for our products and have generally been able to increase production to meet that demand . However,the demand for our products depends on many factors such as consumer preferences, including children's preferences, and the introduction or adoption of newhardware platforms for interactive educational products, and can be difficult to forecast . We expect that it will become more difficult to forecast demand forspecific products as we introduce and support additional products, enter additional markets and as competition in our markets intensifies . if we misjudge the

demand for our products, we could face the following problems in our operations, each of which could harm our operating results :

If our forecasts of demand are too high, we may accumulate excess inventories of components and finished products, which could lead to markdownallowances or write-offs affecting some or all of such excess inventories . We may also have to adjust the prices of our existing products to reduce

such excess inventories .

• If demand for specific products increases beyond what we forecast, our suppliers and third-party manufacturers may not be able to increaseproduction rapidly enough to meet the demand . Our failure to meet market demand would lead to missed opportunities to increase our base of users,damage our relationships with retailers and harm our business .

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Rapid increases in production levels to meet unanticipated demand could result in increased manufacturing errors, as well as higher component,manufacturing and shipping costs, all of which could reduce our profit margins and harm our relationships with retailers and consumers .

Any errors or defects contained in our products , or our failure to comply with applicable safety standards, could result in delayed shipments orrejection of our products, damage to our reputation and expose us to regulatory or other legal action .

We have experienced, and in the future may experience, delays in releasing some models and versions of our products due to defects or errors in ourproducts . Our products may contain errors or defects after commercial shipments have begun, which could result in the rejection of our products by our retailers,damage to our reputation, lost sales, diverted development resources and increased customer service and support costs and warranty claims, any of which couldharm our business . Children could sustain injuries from our products, and we may be subject to claims or lawsuits resulting from such injuries . There is a riskthat these claims or liabilities may exceed, or fall outside the scope of, our insurance coverage . Moreover, we may be unable to retain adequate liability insurance

in the future . We are subject to the Federal Hazardous Substances Act, the Flammable Fabrics Act, regulation by the Consumer Product Safely Commission, orCPSC, and other similar federal and slate roles and regulatory authorities . Our products could be subject to involuntary recalls and other actions by suchauthorities . Concerns about potential liability may lead us to recall voluntarily selected products . In December 2000, the CPSC announced our .voluntaty repair

program for the approximately 900,000 units of our Alphabet Pal product sold prior to that date . We had instituted the repair proceedings with the CPSC becausewe were concerned that the product could cause injury . Our costs in connection with the repair were approximately $ 1 .1 million . Any recalls orpost-manufacture repairs of our products could harm our reputation, increase our costs or reduce our net sales .

Our rapid growth has presented significant challenges to our management systems and resources, and we may experience difficulties managing ourgrowth .

Since 2001, we have grown rapidly, both domestically and internationally . Our net sales have grown from $314 .2 million in 2001 to $680.0 million in2003 . During this period, the number of different products we offered at retail also increased significantly, and we have opened offices in Canada, France, Macac

and Mexico. At December 31, 2001, we had 438 full-time employees and at December 31, 2003, we had 869 full-time employees . In addition, we plan to hire asignificant number of new employees in 2004 . We are upgrading existing and implementing new operational software systems, including supply chainmanagement systems . Further, we are planning on consolidating multiple third party distribution warehouses into a single distribution warehouse to handle ourneeds . This expansion has presented, and continues to present, significant challenges for our management systems and resources. If we fail to develop andmaintain management systems and resources sufficient to keep pace with our planned growth, our operating results could suffer.

Changes in economic conditions, which can result in reduced demand for our products or higher prices for necessary commodities , could harm ourbusiness and operating results .

Recent weak economic conditions in the United States and elsewhere have adversely affected consumer confidence and consumer sales generally. In

addition, the September 11, 2001 terrorist attacks significantly and negatively affected general economic conditions . Any future attacks and the responses to suchattacks, including military action in the Middle East, or other significant events could further impact the economy . Further weakening of the economy coulddamage our sales in our U.S . Consumer and other segments . Other changes in general economic conditions, such as greater demand or higher prices for plastic,electronic components, liquid crystal displays and fuel, may delay manufacture of our products, increase our costs or otherwise harm our margins and operating

results .

Earthquakes or other events outside of our control may damage our facilities or the facilities of third parties on which we depend .

Our two primary U .S. distribution centers, our Silicon Valley engineering office and our corporate headquarters are located in California near majorearthquake faults that have experienced earthquakes in the past . An earthquake or other natural disasters could disrupt our operations . Additionally, the loss of

electric power, such as the temporary loss of power caused by power shortages in the grid servicing our facilities in California, could disrupt operations or impaircritical systems . Any of these disruptions or other events outside of our control could impair our distribution of products, damage inventory, interrupt criticalfunctions or otherwise affect our business negatively, harming our operating results. Our existing earthquake insurance relating to our distribution center may be

insufficient and does not cover any of our other operations. If the facilities of our third party finished goods or component manufacturers are affected byearthquakes, power shortages, floods, monsoons, terrorism or other events outside of our control, our business could suffer.

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Table of ContentsWe are subject to international , federal, state and local laws and regulations that could impose additional costs on the conduct of our business .

In addition to being subject to regulation by the CPSC and similar state regulatory authorities, we must also comply with other laws and regulations . TheChildren's Online Privacy Protection Act, as implemented, requires us to obtain verifiable, informed parental consent before we collect, use or disclose personalinformation from children under the age of 13 . Additionally, the Robinson-Patman Act requires us to offer non-discriminatory pricing to similarly situatedcustomers and to offer any promotional allowances and services to competing retailers and distributors within their respective classes of trade on proportionallyequal terms . Our SchoolHouse division is affected by a number of laws and regulations regarding education and government funding . We are subject to othervarious laws, including international and U .S . immigration laws, wage and hour laws and laws regarding the classification of workers . Compliance with theseand other laws and regulations impose additional costs on the conduct of our business, and failure to comply with these and other laws and regulations or changesin these and other laws and regulations may impose additional costs on the conduct of our business .

Knowledge Universe, L.L.C ., Lawrence J . Ellison, Michael R. Milken and Lowell J . Milken , together control all stockholder voting power as well as thecomposition of our board of directors .

Holders of our Class A common stock will not be able to affect the outcome of any stockholder vote . Our Class A common stock entitles its holders to onevote per share, and our Class B common stock entitles its holders to ten votes per share on all matters submitted to a vote of our stockholders . As of December31, 2003, Lawrence J . Ellison and entities controlled by him, Michael R . Milken, Lowell J. Milken, and Knowledge Universe (which is controlled by Messrs .Milken, Milken and Ellison) and its affiliates, or, collectively, the "KU Control Group," in the aggregate beneficially owned approximately 27 .9 million shares ofour Class B common stock, which represents approximately 90 .0% of the combined voting power of our Class A common stock and Class B common stock . A sa result, the KU Control Group controls all stockholder voting power, including with respect to :

• the composition of our board of directors and, through it, any determination with respect to our business direction and policies, including theappointment and removal of officers ;

• any determinations with respect to mergers, other business combinations, or changes in control ;

our acquisition or disposition of assets ;

• our financing activities; an d

• the payment of dividends on our capital stock, subject to the limitations imposed by our credit facility.

This control by the KU Control Group could depress the market price of our Class A common stock or delay or prevent a change in control of LeapFrog .The KU Control Group is not prohibited from selling a controlling interest in us to a third party and can do so without requiring a buyer to acquire any of ourClass A common stock .

Lawrence J . Ellison, Michael R . Milken and Lowell J . Milken may each be deemed to control Knowledge Universe . As a result, Lawrence J . Ellison,Michael R. Milken and Lowell J. Milken may each be deemed to have or share the power to direct the voting and disposition, and therefore to have beneficialownership, of shares of our capital stock owned directly or indirectly by Knowledge Universe .

Conflicts of interest may arise between our controlling stockholders and us .

Four of our eleven directors are officers or directors of Knowledge Universe or its affiliates other than us . Our directors who are also officers or directorsof Knowledge Universe or its other affiliates will have obligations to and interests in these companies as well as in us, and conflicts or potential conflicts ofinterest may result for these board members . Lawrence J . Ellison, Michael R . Milken and Lowell J . Milken formed Knowledge Universe to build, through acombination of internal development and acquisitions, leading companies in areas relating to education, technology and career management and the improvementof individual and corporate performance. Knowledge Universe has formed, invested in or acquired, and in the future may form, invest in or acquire, otherbusinesses that are involved in these and related areas, which businesses may be operated under the control of Knowledge Universe independently of us .Conflicts of interest between Knowledge Universe and its controlling owners and other affiliates and us may arise, and such conflicts of interest may not beresolved in a manner favorable to us, including potential competitive business activities, corporate opportunities, indemnity arrangements, registration rights,sales or distributions by Knowledge Universe or its affiliates of our common stock and the exercise by Knowledge Universe and its controlling owners of theirability to control our management and affairs . Our certificate of incorporation does not contain any provisions designed to facilitate resolution of actual orpotential conflicts of interest, or to ensure that potential business opportunities that may become available to both Knowledge Universe or its other affiliates andus will be reserved for or made available to us . Pertinent provisions of law will govern any such matters if they arise .

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Table of ContentsThe limited voting rights of our Class A common stock could negatively affect its attractiveness to investors and its liquidi ty and , as a result, its marketvalue .

The holders of our Class A and Class B common stock generally have identical rights, except that holders of our Class A common stock are entitled to onevote per share and holders of our Class B common stock are entitled to ten votes per share on all matters to be voted on by stockholders . The holders of our Class

B common stock have various additional voting rights, including the right to approve the issuance of any additional shares of Class B common stock and anyamendment of our certificate of incorporation that adversely affects the rights of our Class B common stock . The difference in the voting rights of our Class A

common stock and Class B common stock could diminish the value of our Class A common stock to the extent that investors or any potential future purchasersof our Class A common stock attribute value to the superior voting or other rights of our Class B common stock.

Provisions in our charter documents and Delaware law may delay or prevent an acquisition of our company, which could decrease the value of ourClass A common stock.

Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it harder for a third party to acquire us without theconsent of our board of directors . These provisions include limitations on actions by our stockholders by written consent and the voting power associated withour Class B common stock . In addition, our board of directors has the right to issue preferred stock without stockholder approval, which could be used by ourboard of directors to effect a rights plan or "poison pill" that could dilute the stock ownership of a potential hostile acquirer and may have the effect of delaying,discouraging or preventing an acquisition of our company, Delaware law also imposes some restrictions on mergers and other business combinations between usand any holder of 15% or more of our outstanding voting stock . Although we believe these provisions provide for an opportunity to receive a higher bid by

requiring potential acquirers to negotiate with our board of directors, these provisions apply even if the offer may be considered beneficial by some stockholders.

Our stockholders may experience significant additional dilution upon the exercise of options.

As of December 31, 2003, there were outstanding under our equity incentive plans options to purchase a total of approximately 6 .5 million shares of Class

A common stock. Contemporaneous with our July 2002 initial public offering, we registered approximately 17 .4 million shares of Class A common stockissuable under our equity incentive plans, which includes the shares issuable upon exercise of all of our options outstanding as of the date of our initial publicoffering as well as options to be granted in the future . To the extent we issue shares upon the exercise of any of these options, investors in our Class A common

stock will experience additional dilution .

Sales of our shares could negatively affect the market price of our stock .Sales of substantial amounts of shares in the public market could harm the market price of our Class A common stock . We had approximately 59 .2 million

shares of Class A common stock outstanding as of December 31, 2003, assuming the conversion of all outstanding Class B common stock into Class A commonstock, and assuming no exercise of our then-outstanding options. A number of these 59.2 million shares are restricted securities as defined by Rule 144 adoptedunder the Securities Act of 1933, as amended, or the Securities Act . These shares may be sold in the public market only if registered or if they qualify for an

exemption from registration under the Securities Act, including exemptions provided by Rules 144 and 701 . We cannot predict the effect that future sales madeunder Rule 144, Rule 701 or otherwise will have on the market price of our Class A common stock .

43

Table of Content sItem 7A . Quantitative and Qualitative Disclosures About Market Risk .

We develop products in the United States 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 localcurrency . 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 .

In 2003, we experienced a foreign currency exchange gain of approximately $2 .0 million, as compared to a foreign currency exchange gain of approximatel y

$ 1 .0 million in 2002 . Prior to 2002, exchange rate fluctuations had little impact on our operating results .

Beginning in the first quarter of 2004, we began managing our foreign currency transaction exposure by entering into short-term forward contracts . Thepurpose of this hedging program is to minimize the foreign currency exchange gain or loss reported in our financial statements .

Cash equivalents and short term investments are presented at fair value on our balance sheets . We invest our excess cash in accordance with our

investment policy. Any adverse changes in interest rates or securities prices may harm the valuation of our short term investments and operating results . AtDecember 31, 2003 and December 31, 2002, our cash was invested primarily in municipal money market funds, short term fixed income municipal securities andauction preferred securities .

We are exposed to market risk from changes in interest rates on our outstanding bank debt. The level of a certain financial ratio maintained by usdetermines interest rates we pay on borrowings . The interest rate will be between prime and prime plus 0 .25% or LIBOR plus 1 .25% and LIBOR plus 2 .00% .Prime rate is the rate publicly announced by Bank of America as its prime rate The interest cost of our bank debt is affected by changes in either prime rates orLIBOR. Any adverse changes could harm our operating results . We had no outstanding debt at December 31, 2003 .

Item 8 . Financial Statements and Supplementary Data.

See "Index to Consolidated Financial Statements" at page F-1 below .

Item 9 . Changes in and Disagreements With Accountants on Accounting and Financial Disclosure .

Non e

Item 9A. Controls and Procedures .

Evaluation of LeapFrog' s Disclosure Controls and Internal Control sAs of the end of the period covered by this annual report on Form 10-K, we evaluated the effectiveness of the design and operation of our "disclosure

controls and procedures," or "Disclosure Controls ." This evaluation, or "Controls Evaluation," was performed under the supervision and with the participation ofmanagement, including our Chief Executive Officer and Chief Financial Officer .

CEO and CFO Certification s

Attached as exhibits to this annual report, there are "Certifications" of our CEO and the CFO required by Rule 13a-l4(a) of the Securities Exchange Actof 1934, or the Rule 13a- 14(a) Certifications . This Controls and Procedures section of the annual report includes the information concerning the ControlsEvaluation referred to in the Rule 13a-14(a) Certifications and it should be read in conjunction with the Rule 13a-14(a) Certifications for a more completeunderstanding of the topics presented .

Disclosure Controls and Internal Control Over Financial ReportingDisclosure Controls are procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this

annual report, is recorded, processed, summarized and reported within the time periods specified in the U .S . Securities and Exchange Commission's rules andforms . Disclosure Controls are also designed to ensure that such information is accumulated and communicated to our management, including the CEO and CFO,

as appropriate to allow timely decisions regarding required disclosure . Internal control over financial reporting is a process designed by, or under the supervisionof, an issuer's principal executive and principal financial officers, and effected by the issuer's board of directors, management and other personnel, to providereasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generallyaccepted accounting principles and includes those policies and procedures that :

• Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the issuer ;

44

Table of Contents

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generallyaccepted accounting principles, and that receipts and expenditures of the issuer are being made only in accordance with authorizations of managementand directors of the issuer ; an d

• Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the issuer's assets that couldhave a material effect on the financial statements .

Limitations on the Effectiveness of Control s

Our management, including our CEO and CFO, does not expect that our Disclosure Controls or our internal control over financial reporting will preventall error and all fraud . A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the controlsystem's objectives will be met . Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls mustbe considered relative to their costs . Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that allcontrol issues and instances of fraud, if any, within our company have been detected . These inherent limitations include the realities that judgments indecision-making can be faulty, and that breakdowns can occur because of simple error or mistake . Controls can also be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management override of the controls . The design of any system of controls is based in part upon certainassumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potentialfuture conditions . Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with its policies orprocedures . Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected .

Conclusions

Based upon the Controls Evaluation , our CEO and CFO have concluded that, subject to the limitations noted above , our Disclosure Controls are effectiv eto ensure that material information relating to our business is made known to management , including the CEO and CFO, particularly during the period when ourperiodic reports are being prepared .

There have been no changes in our internal control over financial reporting during the quarter ended December 31, 2003 that have materially affected, orare reasonably likely to materially affect, our internal control over financial reporting .

45

PART 11 1

Certain information required by Part III is omitted from this Report on Form 10-K since we intend to file our definitive proxy statement relating to our 2004annual meeting of stockholders, pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, also referred to in this Form l0-K as our 2004Proxy Statement, no later than April 29, 2004, and certain information to be included in this our 2004 Proxy Statement is incorporated herein by reference.

Item 10 . Directors and Executive Officers of the Registrant

The information regarding Directors and Executive Officers appearing under the heading "Proposal I : Election of Directors" and "Section 16(a) Beneficial

Ownership Reporting Compliance" of our 2004 Proxy Statement is incorporated by reference . The information under the heading "Executive Officers of theRegistrant" in Item I of this Form 10-K is also incorporated by reference in this section .

On February 9, 2004, our Board of Directors adopted the LeapFrog Finance Code of Ethics which applies to our Chief Executive Officer, Chief FinancialOfficer (who also serves as our Principal Accounting Officer) and each member of our finance team . The text of this code of ethics is posted on our web sitelocated at www.leapfrog .com. To date, there have been no waivers under our Finance Code of Ethics. We will post any waivers, if and when granted, of ourFinance Code of Ethics on our web site located at www .leapfrog .comn .

Item 11 . Executive Compensation

The information appearing under the headings "Compensation of Directors," "Executive Compensation," "Employment Agreements," and "CompensationCommittee Interlocks and Insider Participation" in the 2004 Proxy Statement is incorporated by reference .

Item 12 , Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information appearing in our 2004 Proxy Statement under the heading "Security Ownership of Certain Beneficial Owners and Management" i sincorporated by reference .

See the information contained under the heading "Equity Compensation Plan Information" within Item 5 of this Form 10-K regarding shares authorizedfor issuance under equity compensation plans approved by stockholders and not approved by stockholders .

Item 13 . Certain Relationships and Related Transactions

The information appearing in our 2004 Proxy Statement under the heading "Certain Relationships and Related Transactions" is incorporated by reference .

Item 14 . Principal Accountant Fees and Services .

The information appearing in our 2004 Proxy Statement under the heading "Independent Auditor Fee Information" is incorporated by reference .

46

Temple of ContentsPART IV

Item 15 . Exhibits, Financial Statement Schedules and Reports on Form 8-K .

( a) (I) Financial Statements : See "Index to Consolidated Financial Statements " at page F-I below.

(2) Financial Statement Schedules : The following financial statement schedule is included as Appendix A of this report:

Valuation and Qualifying Accounts and Allowance s

(3) The exhibits listed in the accompanying index to exhibits are filed or incorporated by reference as part of this Annual Report .

(b) The following reports on Form 8-K were furnished or filed by us during the last quarter of the period covered by this report on Form 10-K :

• On October 21, 2003, we furnished a Form 8-K reporting under Item 12 that on October 21, 2003 we issued a press release regarding our financialresults for the quarter ended September 30, 2003 .

• On December 5, 2003, we filed a Form 8-K reporting under hem 5 that on December 2, 2003 a class action complaint had been filed in the UnitedStates District Court for the Northern District of California alleging that we violated the federal securities laws, specifically Sections I0 (b) and 20(a)of the Securi ties Exchange Act of 1934 and Rule I Ob-5 of the Securities and Exchange Commission, by making certain alleged false and misleadingstatements.

47

Table of ContentsSIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized .

LEAPFROG ENTERPRISES, INC .

By: !s! James P . Curley

James P . Curley ,Chief Financial Officer

Date : March 10, 2004

POWER OF ATTORNEY

Each individual whose signature appears below constitutes and appoints Thomas J . Kalinske and James P . Curley, and each of them, his or her tnie and lawfulattorneys-in-fact and agents with full power of substitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign any and allamendments to this report on Form 10-K, and to file the same, with all exhibits thereto and all documents in connection (herewith, with the Securities andExchange Commission, granting unto said attorneys--in-fact and agents, and each of them, full power and authority to do and perform each and every act andthing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifyingand confirming all that said attorneys-in-fact and agents or any of them, or his, her or their substitute or substitutes, may lawfully do or cause lobe done or byvirtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

Signatures Title Date

/s! Thomas J . Kalinske Chief Executive Officer (Principal Executive Officer) March 10, 2004

Thomas J. Kalinske

Is/ James P . Curley Chief Financial Officer (Principal Financial and March W, 2004Accounting Officer)

James P. Curley

Isl Steven B. Fink Chairman and Director March 10, 2004

Steven B . Fink

/sl Michael C. Wood Chief Creative and Vision Officer, Vice Chairman and March 10, 2004Director

Michael C . Wood

/s/ Paul A . Rioux Vice Chairman and Director March 10, 2004

Paul A . Rioux

1st Jerome J . Perez President and Director March 10, 2004

Jerome J. Perez

Isl Jeffrey Berg Director March 10, 2004

Jeffrey Berg

Isl Stanley E . Moron Director March 10, 2004

Stanley E. Moron

48

Table of Contents

Isl E . Stanton McKee Director March 10, 200 4

E. Stanton McKe e

/s/ Barry Munitz Director March 10, 2004

Barry Munitz

Is/ Stewart A. Resnick Director March 10, 2004

Stewart A . Resnick

Isl Sarina D . Simon Director March 10, 2004

Sarina D . Simon

49

Table of ContentsAppendix A

Schedule It - Valuation and Qualifying Accounts and Allowances(In thousands)

Balance at Addition sBeginning of Chargedto Balance at

Year Operations Net Deductions End ofYear

Allowances for accounts receivableYear ended December 31, 2001 $ 11,424 $ 16,008(a) $ 17,578(b) S 9,854Year ended December 31, 2002 9,854 24,043(c) 17,509 16,388Year ended December 31, 2003 16,388 40,165(d) 29,573 26,980

Allowance for inventoryYear ended December 31, 2001 $ 2,956 $ 5,359(e) $ 1,969(0 $ 6,346Year ended December 31, 2002 6,346 2,005 2,999 5,352Year ended December 31, 2003 5,352 41(g) 2,096 3,297

(a) Increase in bad debt expense charged to operations in 2001 is due to the bankruptcy filing of Kmart, which led to $6,400 in bad debt expense, as well asincreased sales and related returns .

(b) Includes the write-off of $6,400 in accounts receivable from Kmart considered to be uncollectible, as well as other write-offs taken in the ordinary courseof business .

(c) Increase in expense charged to operations in 2002 due primarily to the increase in sales, and related returns from retailers, for 2002 .(d) Increase in expense charged to operations in 2003 due primarily to the ratable increase in sales and higher promotional allowances given to major retailers

for in-store promotions .(e) Increase in obsolescence, slow-moving and excess inventory provision charged to operations in 2001 is due to discontinued and slow-moving products .

Our primary discontinued products included the previous versions of our globe and Internet connectivity products, which have been replaced by our newglobe and Mind Station products, respectively. The total reserve taken for these two items was $2,824 . The remaining provision was primarily for excessand slow-moving inventory . The estimates of the reserve necessary for excess and obsolete inventory is based on a review of inventories on handcompared to their estimated future usage and demand for products .

(f) Increase in deductions in 2001 were primarily related to the write down of inventory in connection with obsolete product lines .(g) Decrease in obsolescence, slow--moving and excess inventory provision charged to operations in 2003 was primarily due to the fact that we did not have

any discontinued products in 2003 and that reserves are adequate to cover all anticipated inventory risks .

50


Page

Index to Consolidated Financial Statements

Renort of Independent Auditors F-2

Consolidated Balance Sheets F-3

Consolidated Statements of Income F-4

Consolidated Stalcmcnts of Stockholders ' Equity F-5

Consolidated Statements of Cash Flows F-6

Notes to Cousolidatcd Financial Statements F-7

F-1

Table of ContentsReport of Ernst & Young LLP, Independent Auditors

The Board of DirectorsLeapFrog Enterprises, Inc .

We have audited the accompanying consolidated balance sheets of LeapFrog Enterprises, Inc . (the "Company"), as of December 31, 2003 and 2002, andthe related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 3 1 , 2003 . Our auditsalso included the financial statement schedule listed in the Index at Item 15(a) . These financial statements and schedule are the responsibility of the Company'smanagement . Our responsibility is to express an opinion on these financial statements and schedule based on our audits .

We conducted our audits in accordance with auditing standards generally accepted in the United States . Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements are free of material misstatement . An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financial statement presentation . We believe that our audits provide a reasonable basis for ouropinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of LeapFrogEnterprises, Inc. at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period endedDecember 31, 2003, in conformity with accounting principles generally accepted in the United States . Also, in our opinion, the related financial statementschedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein .

As discussed in the Note 2 to the consolidated financial statements, in 2002 the Company changed its method of accounting for goodwill and otherindefinite lived intangible assets .

!s/ ERNST & YOUNG LL P

San Francisco, CaliforniaFebruary 4, 2004

F-2


CONSOLIDATED BALANCE SHEET S(In thousands , except per share data)

December 31 ,

ASSETSCurrent assets :

Cash and cash equivalentsShort term investmentsAccounts receivable, net of allowances of $26,980 and $16,388 at December 31, 2003 and 2002, respectivelyInventories, netPrepaid expenses and other current assetsNotes receivable due from related partiesDeferred income taxes

Total current assets

Property and equipment, netOther assessInvestments in affiliates and related partiesDeferred income taxe sIntangible assets, net

Total asset s

LIABILITIES AND STOCKHOLDERS' EQUITYCurrent liabilities :

Accounts payableAccrued liabilitiesDeferred revenueIncome taxes payabl e

Total current liabilitie s

Deferred rent and other long teen liabilitiesDeferred income taxes

Commitments and contingencie s

Stockholders' equity :Class A common stock, par value $0 .0001 ; 139,500 shares authorized ; shares issued and outstanding : 31,273 and 15,700

at December 31, 2003 and 2002, respectivel yClass B common stock, par value $0 .0001 ; 40,500 shares authorized ; 27,883 and 38,679 shares issued and outstanding at

December 31, 2003 and 2002, respectively .Additional paid-in capitalDeferred compensatio nNotes receivable from stockholdersAccumulated other comprehensive incomeRetained earning s

Total stockholders' equity

Total liabilities and stockholders' equity

2003 2002

$ 69,844 $ 70,82742,759 2,50 0

281,792 169,67 090,897 84,46 0

8,370 4,06 5- 595

11,735 16,78 3

505,397 348,900

20,547 20,23 91,048 28 4

20 0619 4,86 7

25,048 23,19 2

$552,659 $397,682

S 86,161 $ 58,84444,634 40,5331,417 3,0064,729 21,83 2

136,941 124,21 5

572 550- 4,11 9

3 2

3 4294,976 227,02 0

(2,492) (4,922 )- (2,624 )828 165

121,828 49,15 3

415,146 268,798

$552,15 59 $397,682

See accompanying notes

F-3

LEAPFROG ENTERPRISES, INC.CONSOLIDATED STATEMENTS OF INCOM E

(In thousands, except per share data)

Net salesCost of sales

Gross profit

Operating expenses:Selling, general and administrativeResearch and developmentAdvertisingDepreciation and amortization

Total operating expenses

Income from operations

Interest expenseInterest incomeOther income, ne t

Income before provision for income taxes

Provision for income taxes

Net income

Net income per common share :Basi cDiluted

Shares used in calculating net income per common share :BasicDiluted


2003 2002 200 1

$680,012 $531,772 $314,243339,868 261,731 169,598

340,144 270,041 144,64 5

91,619 80,915 55,51 957,605 54,405 38,37 673,765 56,722 30,1247,697 6,648 4,19 1

230,686 198,690 128,21 0

109,458 71,351 16,43 5

(10) (823) (2,889 )1,191 694 61 34,656 1,051 29 4

115,295 72,273 14,453

42,620 28,829 4,784

$ 72,675 $ 43,444 $ 9,669

$ 1.27 $ 1 .09 $ 0.2 9$ 1.20 $ 0.86 $ 0.2 5

57,246 39,695 33,44 960,548 50,744 38,470


F-4

l i

Table of ContentsLEAPFROG ENTERPRISES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY(In thousands)

Accum uNotes laced Other Retained

Class A Class B Additional Receivable Comprehen- Earnings Tota lCommon Common Treasury Paid - In Deferred from sive ( Loss )I (Accumulated Stockholder' s

Stock Stock Stock Capital Compensation Stockholders Income Deficit) Equity

Balances at December 31, 2000 S S 3 $ (550) $ 69,673 $ (61) $ (3,255) $ (39) $ (3,960) $ 61,81 1Amo rt ization of deferred

compensation -- - - 681 - 68 1

Deferred compensation - - 3,250 (3,250) - - -

Revers al of deferredcompensation due toemployee termination - - (70) 70 --- - -

Class A common stock issue din exchange for notesreceivable ( 174 shares) - - - 818 - (818) - - -

Issuance of stock options t ononemployees and note sreceivable - - - 637 - - - 637

Comprehensive income :Net income - --- - - - 9,669 9,66 9Cumulative translation

adjustment - - - - 50 5 0

Total comprehensive income - - - - - - 9,71 9

Balances at December 31, 2001 3 (550) 74,308 (2,560) (4,073) 11 5,709 72,848

Amortization of deferredcompensation -- - - 1,752 - 1,752

Deferred compensation --- - 5,034 (5,034) - -- -Reversal of deferre d

compensation due t oemployee termination ---- - - (920) 920 -- - - -

Class A common stock issue dupon exercise of stockoptions and warrants (470shares) 1 - - 1,821 - - - 1,82 2

Class A common stock issuedin exchange for note sreceivable (66 shares) - - 292 - (292) - -

Public offering of Class Acommon stock, net o foffe ring costs (9,960 shares) 1 - - 115,115 - ---- - - 115,11 6

Issuance of stock options tononemployees and notesreceivable - - - 349 - - - 349

Warrants issued in exchangefor services rendered - - - 142 - - - - 142

Conversion of stockappre ciation ri ghts t onon-qualified stock options - - 2,382 - - - --- 2,38 2

Conversion of Series Apreferred stock to Class Acommon stock (2,000shares) 24,139 - - - - 24,13 9

Class B common stock issue dupon exercise of warrants(8,191 shares) 1 - - - - ---- - 1

Tax benefit of stock optionexercises - - 4,908 - - - 4,908

Repayments of notesreceivable fro mstockholders - - - - - 1,741 - - 1,74 1

Retirement of treasury stock(232 shares) - - 550 (550) - - - - -

Comprehensive income :Net income - - - - - - 43,444 43,444Cumulative translatio n

adjustment - - - - - 154 - 154

Total comprehensive income - - - - - --- - - 43,598

Balances at December 31, 2002 2 4 - 227,020 (4,922) (2,624) 165 49,153 268,79 8- - - - 2,203 - - 2,203

Amortization of deferredcompensatio n

Deferred compensation - - - 127 (127) - - -Reversal of deferre d

compensation due toemployee termination - - - (354) 354 - - -

Repayments of notesreceivable fromstockholders - - - - 2,624 - - 2,624

Class A common stock issuedupon exercise of stockoption and employe epurchase plan (4,777 shares) - - 27,960 - - 27,960

Issuance of stock options tononemployees - - 1,093 - - - - 1,093

Tax benefit of stock optio nexercises and other - - 39,130 - - 39,130

Conversion of Class B to Clas sA shares (10,796 shares) 1 (1) - - - - -

Comprehensive income:Net income - - - - 72,675 72,675Cumulative translatio nadjustment - - - - - --- 663 663

Total comprehensive income - - --- - - - 73,338

Balances at December 31, 2003 $ 3 $ 3 $ $ 294,976 $ (2,492) $ --- $ 828 $ 121,828 $ 415,14 6


F-5


CONSOLIDATED STATEMENTS OF CASH FLOW S(In thousands)


2003 2002 2001

Net income $ 72 ,675 $ 43,444 $ 9,669Adjustments to reconcile net income to net cash provided by (used in ) operating activities :

Depreciation 15,481 11,274 4,69 5Amortization 1,144 630 1,08 1Loss on disposal of property and equipment 21 176 25 6Loss on sale of investment with related party 19 1 6Provision for allowances for accounts receivable 40,165 25 , 178 16,00 8Deferred income taxes 5,177 (11,263 ) (5,068 )Deferred rent 22 305 22 3Deferred revenue (1,589) 756 2,01 3Amortization of deferred compensation 2,203 1,752 68 1Conversion of stock appreciation rights to non-statuto ry stock options - 1,341 -Stock option compensation related to nonemployees and non recourse notes receivable 1,093 349 637Tax benefit from exercise of stock options and other 39,130 4,908 -Amortization of investment premium 142 - -

Other changes in operating assets and liabilities :Accounts receivable ( 152,287 ) (79,349) (77,309 )Inventories (6,437) (38,357) (3,199 )Prepaid expenses and other current assets (4,305) (2,007) (293 )Notes receivable due from related parties 595 94 (25 )Other assets (764) (136) 7Accounts payable 27,317 24,433 1,24 7

Accrued liabilities 4,101 26,744 4,42 0Income taxes payable ( 17,103) 12 , 198 9,63 4

Net cash provided by (used in) operating activities 26,800 22,470 (35,307 )

Investing activities:Purchases of property and equipment (15,810) (14 , 832) (13,593 )Purchase of intangible assets (3,000) (250) (1,300 )Purchases of short term investments ( 76,136 ) ( 2,500) -Sale of short term investments 35,735 -Sale of investment in related party 181 -- -Investments in affiliates and related parties - 284

Net cash used in investing activities ( 59,030 ) ( 17,582 ) ( 14,609 )

Financing activities :Borrowings under credit agreement 182,000 313,03 2Repayments under credit agreement - (243,163) (279,245 )

Repayments on notes payable to affiliates - - ( 5,118 )Proceeds fr om the payment of notes receivable fro m stockholders 2,624 1,741 -Proceeds from the issuance of common stock - 115,116 -Proceeds from the exercise of stock options and employee stock purchase plan 27,960 1,822 -Proceeds from issuance of redeemable convertible Series A preferred stock, net of issuanc e

costs - - 24,13 9

Net cash provided by financing activities 30,584 57,516 52,808

Effect of exchange rate changes on cash 663 154 5 0

Increase (decrease) in cash and cash equivalents ( 983) 62,558 2,94 2Cash and cash equivalents at beginning of year 70 , 827 8,269 5,32 7

Cash and cash equivalents at end of period $ 69,844 $ 70,827 $ 8,269

Supplemental Disclosure of Cash Flow Informati on

Cash paid during the period for:Income taxes $ 15,716 $ 23,476 $ 16Interest $ - $ 1,163 $ 2,810

Noncash investing and financing activities :Common stock issued in exchange for notes receivable $ - $ 292 $ 818

Issuance of warrant for services rendered and previously accrued $ - $ 142 $ -Issuance of stock options related to conversion of stock appreciation rights $ $ 1,041 $ -Issuance of Class A common stock related to conversion of redeemable convertible Series A

preferred stock $ - $ 24,139 $ -


. F-6


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(in thousands, except per share and percent data )

1 . Description of BusinessLeapFrog Enterprises, Inc . (the "Company"), formerly known as Knowledge Kids Enterprises, Inc ., is a designer, developer and marketer of

technology-based educational products and related proprietary content, dedicated to making seaming effective and engaging. The Company currently designs its

products to help infants and toddlers through high school students learn age- and skill-appropriate subject matter, including phonics, reading, math, spelling,science, geography, history and music . The Company's product line includes : (1) platforms, which are portable hardware devices, (2) content, such as books andcartridges, specifically designed for use with the Company's platforms and (3) stand-alone educational products . The Company's products are sold throughoutthe United States primarily by national and regional mass-market and specialty retailers, and, to a lesser extent into international markets and to U .S . schools.

The Company was a subsidiary of Knowledge Universe, L .L.C . until April 2003 .

2. Summary of Signi fi cant Accounting PoliciesBasis of Presentation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, primarily those organized in the United

Kingdom, Canada, Macau (which includes Hong Kong), France and Mexico . Intercompany accounts and transactions have been eliminated in consolidation .

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

Use ofEstimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to makeestimates and assumptions affecting the amounts reported in the financial statements and accompanying notes . Actual results could differ front those estimates.

Revenue Recognition

The Company recognizes revenue upon shipment of its products , provided that there are no significant post-delivery obligations to the customer andcollection is reasonably assured . The Company provides for discounts , sales retu rn s and allowances , including allowances for defective retu rns. Sales allowancesmay vary as a percentage of gross sales due to changes in the Company's product mix, defective product allowances or other sales allowances . Sales returns andallowances were $88,450, $62,418 and $31,623 for the years ended December 31, 2003, 2002 and 2001, respectively . Actual amounts for returns and allowancesmay differ from the Company' s estimates and such differences could be material to the consolidated financial statements .

The revenue and related cost for the Company's products whose sole purpose is Internet connectivity, principally the Mind Station connector, which hasgenerally been packaged with other products, is recognized over a period of 12 to 18 months, based on an estimated period of use of the product . If the Companychanges its estimate of the period of use, revisions to the revenue recognition may be required . At December 31, 2003 and 2002, the Company had deferred

revenue of $1,416 and $3,006, respectively. In the year ended December 31, 2003 and 2002, revenue totaling $3,163 and $2,302, respectively, was recognized.No revenue was recognized in 2001 .

Allowances for Accounts Receivable

The Company has established an allowance for uncollectible accounts based primarily on management ' s evaluation of the customer ' s financial condition,past collection history and aging of the accounts receivable balances .

The Company also provides for allowances related to returns, discounts and defective products. The Company records these allowances on product sales inthe same period that the related revenues are recorded . The Company bases these estimates on histo rical sales retu rns, defective retu rns, analysis of creditmemoranda and other known factors, as required .

F-7


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(in ( housands, except per share and percent data)

Shipping and Handling Costs

Costs to ship merchandise from the Company's warehouse facilities to customers are recorded in cost of goods sold

Content and Video Capitalization and Amortizatio n

The Company capitalizes certain external costs related to the content development of its books. Amortization of these costs begins when the respectivebook is initially released for sale and is then amortized over a three-year life using the sum of the years digits method . In the years ended December 31, 2003 and2002, the Company capitalized $1,662 and $3,616, respectively, and amortized $3,604 and $1,991, respectively, of external content development costs .Capitalized content development is included in property and equipment, and the related amortization is included in cost of sales .

The Company capitalizes costs related to the production of home video in accordance with AICPA Statement of Accounting Position No . 00-2, "Accounting by

Producers or Distributors of Film ." Video production costs are amortized based on the ratio of the current period's gross revenues to estimated remaining totalgross revenues from all sources on an individual production basis . In the year ended December 31, 2003, the Company capitalized $1,015 and amortized $620 ofvideo production costs . The Company had no video production cost in prior years . Capitalized video production cost is included in property and equipment, and

the related amortization is included in cost of sales .

Advertising ExpenseProduction costs of commercials and programming are expensed when the production is first aired . The costs of advertising, in-store displays and

promotion programs are expensed as incurred . Advertising costs associated with cooperative advertising are accrued as the related revenue is recognized .

Translation of Foreign CurrenciesAssets, liabilities and operations of the Company's United Kingdom, Hong Kong, France and Mexico subsidiaries are recorded based on their functional

currency . When included in these consolidated financial statements, the assets and liabilities are translated at period-end exchange rates and revenues andexpenses are translated at the average of the monthly exchange rates that were in effect during the year. The resulting translation adjustments are included as a

separate component of equity. Foreign currency transaction gains and losses are included in income as incurred . In the year ended December 31, 2003 and 2002,respectively, transaction gains included in other income totaled $2,776 and $987, respectively . In 2001, transaction gain/loss was immaterial .

Cash and Cash Equivalents

Cash and cash equivalents consist of cash, money market funds, and highly liquid short-term fixed income municipal securities with an original maturityof 90 days or less .

Short-Term InvestmentsShort-term investments consist primarily of fixed income municipal securities and auction preferred securities with maturities of one year or less . The

Company classifies all short-teen investments as available-for-sate . Available-for-sale securities are carried at estimated fair value, based on available marketinformation, with unrealized gains and losses, if any, reported as a component of stockholders' equity . The cost of securities sold is based on the specificidentification method.

Concentration of credit risk is limited by diversifying investments among a variety of high credit-quality issuers .

Inventories

Inventories , net of an allowance for slow- moving, excess quantities and obsolescence , are stated at the lower of cost (first-in, first-out basis ) or market

value . The Company' s estimate for excess and obsolete inventory is based on a review of inventories on hand compared to their estimated future usage anddemand for products. If actual future usage and demand for the products are less favorable than those projected by the Company , additional allowances may berequired .

F-8


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(In thousands , except per share and percent data )

Property and Equipment

Property and equipment are slated at cost less accumulated depreciation . Depreciation expense is calculated using the straight-line method over the

estimated useful life of the assets, generally two to five years, except for leasehold improvements, which are depreciated over the shorter of the estimated relateduseful life of the asset or the remaining term of the lease .

Included in property and equipment are manufacturing tools used to produce the Company's products . These tools are generally depreciated over two

years on a straight-line basis . The Company periodically reviews its capitalized manufacturing tools to ensure that the related product line is still in production

and that the estimated useful lives of the manufacturing tools are consistent with the Company's depreciation policy . Depreciation expense for manufacturing

tools is included in costs of goods sold.

The Company capitalizes website development costs in accordance with Emerging Issues Task Force ("EITF") No . 00-02, "Accounting for Website

Development Costs ." The costs capitalized included those to develop or acquire and customize code for web applications, costs to develop HTML web pages ordevelop templates and costs to create initial graphics for the website that included the design or layout of each page . These costs are amortized on a straight-line

basis over two years . For the years ended December 31, 2003 and 2002, the Company amortized $2,083 and $3,037, respectively, of website development costs,At December 31, 2003, all capitalized website development costs were fully amortized .

Intangible Assets

Intangible assets consist principally of trademarks and tradenames ; product design and existing technology ; patents and goodwill and are amortized on a

straight-line basis over their estimated useful lives, ranging from 3 to 15 years . The Company periodically evaluates the recoverability of its intangible assets,including goodwill, by comparing the projected undiscounted net cash flows associated with such assets against its respective carrying value . Impairment, if any,

is based on the excess of the carrying value over the fair value .

In July 2001, the Financial Accounting Standards Board issued SFAS No . 141, "Business Combinations," and SFAS No . 142, "Goodwill and Other

Intangible Assets ." SFAS 141 specifies the criteria that intangible assets acquired in a purchase business combination must meet to be recognized and reportedapart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately . SFAS No . 142 requires, amongother things, that the assembled workforce be reclassified to goodwill and that goodwill (including the assembled workforce) and intangible assets with indefiniteuseful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with SFAS No . 142 . The Company adopted the

provisions of SFAS 141 immediately and SFAS 142 effective January 1, 2002, Accordingly, $19,500 in goodwill is no longer being amortized .

Income TaxesThe Company accounts for income taxes using the liability method of accounting for income taxes . Under this method, deferred tax assets and liabilities

are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates and laws that will

be in effect when the differences are expected to reverse .

Comprehensive Earnings

Comprehensive earnings are comprised of gains and losses on the translation of foreign curr ency financial statements .

Stock-Based Compensation

The Company generally grants stock options to its employees for a fixed number of shares with an exercise price equal to the fair value of the shares onthe date of grant . As allowed under the Statement of Financial Accounting Standards No . 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), the

Company has elected to follow Accounting Principles Board Opinion No . 25, "Accounting for Stock Issued to Employees" ("APB 25") and relatedinterpretations in accounting for stock awards to employees . Accordingly, no compensation expense is recognized in the Company's financial statements in

connection with stock options granted to employees with exercise prices not less than fair value . Deferred compensation for options granted to employees isdetermined as the difference between the deemed fair market value of the Company's common stock on the date options were granted and the exercise price .

F-9


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(In thousands, except per share and percent data)

Stock-based compensation arrangements to nonemployees are accounted for in accordance with SFAS 123 and EITF No . 96-18, "Accounting for EquityInstruments that Are Issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods or Services," using a fair value approach . Thecompensation costs of these arrangements are subject to remeasurement over the vesting terms as earned.

For purposes of disclosures pursuant to SFAS 123, as amended by SFAS 148, "Accounting for Stock-Based Compensation-Transition and Disclosure,"the estimated fair value of options is amortized over the options' vesting period . The following table illustrates the effect on net income (loss) and net income(loss) per common share if we had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation ( in thousands , except pershare amounts) :

Year Ende dDecember 31 ,

2003 2002 200 1

Net income as reported $72,675 $43,444 $ 9,669Add : Stock-based employee compensation expense included in reported net income, net o f

related tax effects $ 1,389 $ 1,053 $ 456Deduct : Total stock-based employee compensation expense determined under fair value

method for all awards, net of related tax effects (6,100) (4,027) (1,497 )

Pro forma net income $67,964 $40,470 $ 8,62 8

Pro forma net income per common share :Basic $ 1 .19 $ 1 .02 $ 0 .2 6

Diluted $ 1 .13 $ 0.80 $ 0 .2 2

The fair value of these options was estimated at the date of grant using the Black-Scholes option-pricing model for options granted after January 1, 2002and the minimum value option pricing model was used for options granted prior to January 1, 2002 . The following weighted average assumptions were used:

Year Ended

December 31 ,

2003 2002 200 1

Expected life (years ) 4.0 4.0 4 .0Risk-free interest rate 2 .5% 4.4% 4 .3 %Volatility factor 68 .7% 70.0% 70.0%Dividend yield 0% 0% 0%

The minimum value option-pricing model is similar to the Black-Scholes option valuation model which was developed for use in estimating the fair valueof traded options which have no vesting restrictions and are fully transferable, except that it excludes the factor of volatility . In addition, option valuation modelsrequire the input of highly subjective assumptions . Because the Company's employee stock options have characteristics significantly different from those oftraded options, and because changes in the subjective assumptions can materially affect the fair value estimate, in management's opinion the existing models donot necessarily provide a reliable single measure of the fair value of its employee stock options .

The weighted-average fair value of options granted , which is the value assigned to the options under this disclosure policy for December 31, 2003, 2002and 2001 was $15 .66, $7 .33 and $0 .78 per sha re, respectively .

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Impairment ofLong-LivedAssels Other Than GoodwillLong-lived assets, other than Goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that their carrying amounts

may not be recoverable. Recoverability of assets is measured by comparison of the carrying amount of the asset to the net undiscounted future cash flowsexpected to be generated from the asset . If the future undiscounted cash flows are not sufficient to recover the carrying value of the assets, the assets' carryingvalue is adjusted to fair value . The Company regularly evaluates its long-lived assets for indicators of possible impairment . To date, no impairment has been

recorded .

Recent Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No . 46, "Consolidation of Variable Interest Entities,"("FIN 46") . FIN 46 clarifies the application of Accounting Research Bulletin No . 51, "Consolidated Financial Statements," to certain entities in which equityinvestors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities withoutadditional subordinated financial support from other parties . In December 2003, the FASB issued a revision to FIN46, ("FIN 46R") . FIN 46R provides a broaddeferral of the latest date by which all public entities must apply FIN 46 to certain variable interest entities to the first reporting period ending after March 15,2004 . We do not expect the adoption of FIN 46 to have a material impact on our financial position, cash flows or results of operations.

In November 2002, the EITF issued EITF 00--21, Revenue Arrangetuenls with Multiple Deliverables, which addresses certain aspects of the accounting forarrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. Under EITF 00-21, revenue arrangements withmultiple deliverables should be divided into separate units of accounting if the deliverables meet certain criteria, including whether the delivered items have standalone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items . In addition, the consideration shouldbe allocated among the separate units of accounting based on their fair values, and the applicable revenue recognition criteria should be considered separately foreach of the separate units of accounting. EITF 00-21 was effective for revenue arrangements entered into after June 30, 2003 . The application of EITF 00-21 did .

not have a material impact to our financial position, operating results or cash flows for the year ended December 31, 2003 .

3. Fair Value of Financial Instrument sAt December 31, 2003 and 2002, the respective carrying values of the Company's financial instruments, including cash and cash equivalents, short-term

investments , receivables, accounts payable and accrued liabilities , approximated their fair values .

4, Short-Term Investments

Available-for-sale securities consisted of the following :

December 31,

2003 2002

Municipal bonds $13,509 $ -Auction preferred securities 8,550 -Corporate auction preferred securities 20,700 2,500

Total $42 ,759 $2,500

At December 31, 2003 and 2002, the carrying value of these securities approximated the fair value and had maturities of less than one year .

5. InventoriesInventories consisted of the following :

Raw MaterialsFinished Goods

Inventories, net

December 31,

2003 2002

$27,911 $ 17,00762,986 67,453

$ 90,897 $ 84,46 0

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(In thousands , except per share and percent data)

6. Property and Equipmen tProperty and equipment consisted of the following :

December 31 ,

2003 2002

Tooling, cards, dies, and plates $ 15,903 $ 11,372Computers and software 14,363 8,21 0Equipment, furniture and fixtures 3,756 2,795Leasehold improvements 1,817 1,60 4Capitalized content development 10,298 8,63 6Capitalized websile costs 6,267 6,26 7Capitalized video costs 1,015 -Displays 602 60 2

54,021 39,486Less : accumulated depreciation (33,474) (19,247 )

Properly and equipment, net $ 20,547 $ 20,239

7 . Intangible Assets

December 31 ,

2003 2002

Trademarks, patents and other intangibles $ 8,058 $ 5,058Less accumulated amortization (2,559) (1,415 )

5,499 3,643

Goodwill 19,549 19,549

Intangible assets, net $25,048 $23,192

The Company adopted SFAS 142 on January 1, 2002 . The Company ceased amortizing goodwill and other indefinite-lived intangible assets on January 1,2002. The amortization expense and adjusted net income for the three years ended December 31, 2003 is as follows :

Year EndedDecember 31 ,

Net income as reporte dAdd back amortization, net of tax

Adjusted net income

Adjusted net income per common share - basic

Adjusted net income per common share - diluted

2003 2002 20D 1

$72,675 $43,444 $ 9,669- - 502

$72,675 $43,444 $10,17 1

$ 1 .27 $ 1 .09 $ 0.3 0

$ 1.20 $ 0 .86 $ 0.2 6

F-12



Amortization expense related to other intangible assets was $1,144, $630 and $260 for the years ended December 31, 2003, 2002, and 2001, respectively .The estimated future amortization expense related to these intangible assets is as follows :


2004 $1,24 42005 1,09 12006 1,03 42007 81 7

2008 31 7Thereafter 996

$5,499

8 . Investments in Affi liate and Related Partie s

In 2000, the Company entered into a partnership agreement with an employee of the Company for the purchase of real estate to be used as the executive'sprimary residence. Under the terms of the agreement, the Company invested $200, and in exchange was entitled to participate in any potential gains and losses

attributable to the property . In September 2003, the Company transferred 100% of its interest in the partnership to the employee in exchange for a payment of$181 . Accordingly, the Company recorded a loss of $19 in 2003 . The Company has no remaining rights or obligations under the partnership agreement.

9 . Related Party Transaction sIn 2000, the Company extended loans to four of its executive officers for the purpose of purchasing stock from the Company and paying associated

expenses . See Note 18 (Notes Receivable From Stockholders) .

In August 1999, the Company purchased a 19 .9% ownership interest in Knowledge Kids Media Group, Inc ., an affiliate of Knowledge Universe, for

$2,000 . Knowledge Universe indirectly owns 80.1% of Knowledge Kids Media Group . Knowledge Kids Media Group owns substantially all of the voting power

of Knowledge Kids Network, Inc . Sarina D. Simon, a member of the Company's board of directors, is Chief Executive Officer of Knowledge Kids Media Groupand Knowledge Kids Network . In 1999 and 2000, the Company wrote off its entire investment in Knowledge Kids Media Group . The Company has no

obligation to provide funds to Knowledge Kids Media Group, Inc .

In March 2001, the Company entered into an agreement with Knowledge Kids Network, in which Knowledge Kids Network agreed to develop content andprovide technical services in connection with LeapPad interactive books. The Company incurred $122, $658 and $1,371 in 2003, 2002 and 2001, respectively, in

expenses for services from Knowledge Kids Network . The Company had $0 and $5 recorded in accounts payable to Knowledge Kids Network at December 31,2003 and 2002, respectively.

In April 2000, Ubiquity LLC ("Ubiquity") was formed as a subsidiary of NT(2) LLC, an affiliate . Ubiquity was approximately 15% owned by theCompany and 85% owned by NT(2) . NT(2) was owned by Knowledge Universe. Ubiquity obtained an exclusive license to use the Company's NearTouch

technology. In turn, Ubiquity granted a cross license to the Company to use certain of Ubiquity's inventions related to improvements and use the technology inareas outside of the educational toy business .

The Company committed to lend Ubiquity up to $5,000 pursuant to the terms of a three-year promissory note . The Company was obligated to fund the

losses of Ubiquity and was the sole source of financing in 2000 for Ubiquity . In February 2001, Ubiquity discontinued its efforts to pursue uses of the technologyoutside of educational toys . In consideration of, among other things, Knowledge Kids, L .L.C . being released from any commitment to invest in NT(2) orUbiquity, Knowledge Kids executed a quitclaim effective as of January 2001, by which it abandoned and quitclaimed to the Company all of Knowledge Kids'title and interest in and to NT(2) and Ubiquity . Since Knowledge Kids was the only other entity that held equity interests in NT(2) or Ubiquity, NT(2) became awholly owned subsidiary of the Company and Ubiquity became an indirect wholly owned subsidiary of the Company upon the execution of the quitclaim byKnowledge Kids. As the Company provided the financing for the development efforts of Ubiquity, the amount funded in 2001 was $1,913 and was classified asresearch and development in the accompanying statement of operations . No funding was made in 2003 or 2002.

The law firm of Maron & Sandler has served as the Company's primary outside general counsel from August 1997 through July 2002 and they continue toprovide legal services to the Company. Maron & Sandler is the transfer agent for the Company's Class B common stock . Stanley E . Maron, the Company'sassistant secretary and a member of the Board, is a partner of Maron & Sandler. In 2003, 2002 and 2001, the Company paid Maron & Sandler $6, $320 and $222,

respectively, for legal services

F-13



rendered to the Company . In addition, Mr. Maron and other attorneys of Maron & Sandler hold interests in an entity that holds non-voting units of a limitedliability company that holds an equity interest in Knowledge Universe . These non-voting units amount to a less than 1% economic interest in KnowledgeUniverse .

In 2003, 2002 and 2001 the Company purchased software products and support services from Oracle Corporation totaling $569, $280 and $137,respectively. Lawrence 1 . Ellison, the Chairman and Chief Executive Officer of Oracle Corporation, may be deemed to have or share the power to direct thevoting and disposition, and therefore to have beneficial ownership, of any shares of the Company's capital stock owned directly or indirectly by KnowledgeUniverse . Jeffrey Berg, a director of the Company, is a member of Oracle Corporation's board of directors .

Affinity Squared, Inc ., an affiliate of Knowledge Universe, provides health and welfare plan administration services to us . In 2003, 2002 and 2001, $201,

$267 and $414, respectively, was incurred by us for services provided by Affinity Squared, Inc . Accounts payable to Affinity Squared, Inc . was $14, $26 and $0at December 31, 2003, 2002 and 2001, respectively.

In March 2001, the Company sold 2,000 shares ofits Series A preferred stock for an aggregate consideration of $25,000 to CSC LF Holdings, LLC,Publishing and Broadcasting International Ltd, and Windsor Digital Studio LLC . In connection with this sale, the Company entered into an Amended andRestated Stockholders Agreement with these purchasers, Knowledge Kids, L.L.C., an affiliate of Knowledge Universe, FrogPond, Michael C . Wood, theCompany's President and Chief Executive Officer, and Explore Technologies . This agreement was amended and restated in July 2002 and May 2003 .

Also, see Note 14 (Income Taxes) for a discussion of a tax sharing agreement between the Company and Knowledge Universe, Inc .

10 . Accrued Liabilities

December 31 ,

2003 200 2

Cooperative advertising $ 16,243 $ 15,03 7Royalties and commission payable 8,437 5,58 7Accrued inventory related costs 6,954 3,37 2Accrued compensation and benefits 5,273 4,70 1Sales and VAT tax payable 963 1,33 9Legal fees and settlement costs 538 5,56 2Other 6,226 4,93 5

$ 44,634 $ 40,533

11 . Borrowings Under Credit Agreements and Long-Term Deb tOn July 30, 2002, upon completion of our initial public offering the Company repaid the entire outstanding balance of $34,100 owing under our long term

secured credit facility with Foothill Capital Corporation . On October 28, 2002, the Company formally terminated this facility .

On December 31, 2002 the Company entered into a $30,000 three year unsecured senior credit facility with a financial institution, with an option toincrease the facility to $50,000 . The agreement requires the Company to comply with certain financial covenants, including the maintenance of a minimum quickratio on a quarterly basis and a minimum level of EBITDA on a rolling quarterly basis . The Company was in compliance with these covenants at December 31,2003 . The level of a certain financial ratio maintained by the Company determines interest rates on borrowings . The interest rate will be between prime andprime plus 0.25% or LIBOR plus 1 .25% and LIBOR plus 2 .00%.

There was no outstanding balance at December 31, 2003 and 2002 . At December 31, 2003 and 2002, the Company had outstanding letters of credit of$300 and $1,350, respectively. At December 31, 2003, $29,700 of unused borrowings were available to the Company .

F-14

Table of Contents

12 . License Agreements

LEAPFROG ENTERPRISES, INC.NOTES TO . CONSOLIDATED FINANCIAL STATEMENTS

(In thousands , except per share and percent data )

The Company licenses certain of its content from third parties under exclusive and nonexclusive agreements, which permit the Company to utilize

characters, stories, illustrations and/or trade names throughout specified geographic territories . The total amount of royalty expense related to these license

agreements was $12,628, $6,463 and $1,223 for the years ended December 31, 2003, 2002 and 2001, respectively . The Company had $7,290 and $3,949 in

accrued royalties at December 31, 2003 and 2002, respectively . Sec Note 21 (Commitments and Contingencies) .

13 . Concentrations of Credit Risk and Certain Other Risk sFinancial instruments that subject the Company to concentrations of credit risk include cash equivalents, short-tens investments and trade receivables .

Cash and cash equivalents consist principally of cash, money market funds, short-term fixed income municipal securities . Short-term investments consist

principally of fixed income municipal securities` and auction preferred securities . These instruments are short-term in nature and bear minimal risk . To date, theCompany has not experienced any material losses on cash equivalents or short-term investments .

The Company manufactures and sells its products primarily to national and regional mass-market retailers in the United States . Credit is extended based

on an evaluation of the customers' financial condition, and generally collateral is not required . However, letters of credit are sometimes requested . Credit losses

are provided for in the consolidated financial statements as are the related reserves .

Seasonality of SalesSales of the Company's products have historically been highly seasonal with a significant majority of the sales occurring during the third and fourth

quarters . Failure to accurately predict and respond to consumer demand may cause the Company to produce excess inventory, which could adversely affect theCompany's operating results and financial condition . Conversely, if a product achieves greater success than anticipated, the Company may not have sufficientinventory to meet retail demand, which could adversely impact the Company's relations with its customers .

Off -Shore ManufacturingSince the Company does not have its own manufacturing facilities, it is dependent an close working relationships with its contract manufacturers for the

supply and quality of its products and the computer chips contained in these products . The Company expects to continue to use a limited number of contractmanufacturers and fabricators, most of which are located in China, and, accordingly, will continue to be highly dependent upon sources outside (he Company fortimely production . Given the highly seasonal nature of the Company's business, any unusual delays or quality control problems could have a material adverseeffect on the Company's operating results and financial condition . The Company's top three vendors supplied a total of 48%, 58% and 53% of the Company'sproducts in 2003, 2002 and 2001, respectively ; Jetta Company Limited, located in China, supplied 32%, 45% and 35%, respectively .

Gtstorner ConcentrationA limited number of customers historically have accounted for a substantial portion of the Company's net sales . The significant customers and the relative

percentage of net sales for these customers are approximately as follows :

Year ende dDecember 31 ,

2003 2002 200 1

Wal-Mart 31% 30% 30 %Toys "R" Us 25 28 2 8

Target 12 11 1 0

Kmart 4 6 1 0

Total 72% 75% 78%

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Wal-Mart, Toys "R" Us and Target accounted for 35%, 26% and 12%, respectively, of gross accounts receivable at December 31, 2003 . At December 31,2002, Wal-Mart, Toys "R" Us and Target accounted for 33%, 30% and 14%, respectively, of gross accounts receivable .

14. Income TaxesFor financial reporting purposes, income before taxes includes the following components:

Year ende d

December 31 ,

2003 2002 200 1

Pre-tax income :United States $ 110,586 $ 64,189 $14,98 9Foreign 4,709 8,084 (536 )

Total $ 115,295 $ 72,273 $14,45 3

The income tax provision recognized in the consolidated statements of operations consists of the following :

Year Ende dDecember 31 ,

2003 2002 200 1

Current:Federal $31,129 $ 31,505 $ 8,25 1State 3,746 5,834 1,60 1Intern ational 2,534 2,75 3

37,409 40,092 9,852

Deferred :Federal 4,824 (10,130) (3,660)State 505 (1,133) (110)International (118) -Valuation allowance - - (1,298 )

5,211 (11,263) (5,068 )

Provision for income taxes $42,620 S 28,829 $ 4,784

While the Company believes that its tax return positions are supportable, the tax provision includes sufficient accruals for possible futureassessments that may result from the examination of prior year's tax returns . The amounts ultimately paid on any possible future assessments may differ from the

amounts accrued .

Tax benefits of $37,100 related to employee stock options were credited directly to Stockholders' equity .

The components of the Company's deferred taxes are as follows :

December 3 1

2003 2002

Deferred tax assets :Inventory and other reserves $ 10,272 $12,856Equity in affiliates - 698Depreciation 227 1,11 8Amortization of intangibles 392 -Other 1,463 3,92 8

12,354 18,60 0

Deferred tax liabilities :Amortization of intangibles - (1,069)

Net deferred tax assets $ 12,354 $17,53 1

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As of December 31, 2003 and 2002, the Company had net deferred tax assets of $12,354 and $17,531, respectively . SFAS Statement 109, "Accounting for

Income Taxes," states that a valuation allowance must be recognized if, based on the weight of available evidence, it is more likely than not that some portion orall of the deferred tax asset will not be realized . Management has determined that the Company is more likely than not to realize its entire deferred tax asset .

Therefore, no valuation allowance has been established for 2003 or 2002.

The differences between the provision for income taxes and the income tax determined by applying the statutory federal income tax rate of 35% for 2003,

2002 and 2001 were as follows :

Year Ended

December 31 ,

2003 21102 200 1

Income tax at the statutory rate $40,353 $ 25,295 $ 5,05 9

State income taxes 4,798 2,632 70 3Nondeductible items 180 108 I 1

R&D credit ( 4,808) -

Valuation allowance - - (1,298 )

Other 2,097 794 20 9

Income tax provision $42,620 $ 28,829 $ 4,784

Undistributed earnings of the Company's foreign subsidiaries amounted to approximately $10,800 at December 31, 2003 . The earnings are considered to

be permanently reinvested and no deferred U .S . income taxes have been provided thereon . Upon distribution of those earnings in the form of dividends orotherwise, the Company would be subject to U .S . income lax in the approximate amount of $1,700.

For federal income tax purposes, the Company files a separate federal income tax return . However, due to its status as part of a related taxpayer controlled

group with Knowledge Universe, Inc., the Company joined in the filing of several unitary/combined state tax returns with the Knowledge Universe, Inc . group

for part of 2003 and in prior years . Beginning on Apri1 30, 2003, the Company is no longer part of a related taxpayer controlled group of Knowledge Universe,

Inc .

In July 2002, the Company entered into a tax sharing agreement with Knowledge Universe, Inc, with respect to certain state tax matters . In accordance

with the agreement, the Company pays Knowledge Universe, Inc . amounts equal to what its liability would have been if it had been a stand-alone taxpayer .

During 2003, payments totaling $3,590 were made to Knowledge Universe, Inc . pursuant to the tax sharing agreement for the 2002, 2001 and prior lax years . The

liabilities computed under the tax sharing agreement for 2003, 2002, and 2001 were, $0, $2,701 and $79, respectively .

15 . Redeemable Convertible Series A Preferred Stoc k

In March 2001, the Company issued 2,000 shares of Series A preferred stock at $12 .50 per share for total proceeds of $24,139, net of issuance costs o f

$861 .

In November 2002, all outstanding shares of our Series A preferred stock automatically converted into our Class A common stock on a one-for-one basis .

Accordingly, 2,000 shares of our Series A preferred stock were converted into 2,000 shares of our Class A common stock .

16. Stockholders' Equity

Common Stoc kThe Company is authorized to issue 180,000 shares of common stock at a $0.0001 par value per share, of which 139,500 shares are designated as Class A

common stock and 40,500 shares are designated as Class B common stock .

Conversion

Each holder of Class B common stock shall have the right to convert each share of Class B common stock into one share of Class A common stock .

F-17



DividendsClass A and B stockholders shall be entitled to dividends when and as declared by the Board out of funds legally available . When dividends are declared ,

such dividends shall be paid in equal amounts per share on all shares of Class A and Class B common stock .

Voting

The Class A stockholders are entitled to one vote per share and the Class B stockholders are entitled to ten votes per share .

Liquidation

Class A and B common stockholders are equally entitled to all assets of the Company available for distribution .

Initial Public Offering

In July 2002, the Company raised $ 115, 100, after offering expenses and underwriters' commissions, in its initial public offering of 9,960 shares of its

Class A common stock at a price to the public of $13 .00 per share . The Company used $34,100 of the net proceeds to repay the entire balance outstanding under

its revolving credit facility in July 2002 .

Conversion of Stock Appreciation Rights

Prior to its initial public offering, the Company granted stock appreciation rights under its Amended and Restated Employee Equity Participation Plan,

In February 2002, the Company converted 338 stock appreciation rights into options to purchase an aggregate of 338 shares of Class A common stock .

The Company recognized approximately $820 in expense through February, 2002 related to the vested portion of these rights. Deferred compensation of $868

related to the unvested portion will be amortized to expense through the third quarter of 2005 as the options vest . To the extent any of the unvested options are

forfeited, the actual expense recognized could be lower than currently anticipated . Concurrent with the initial public offering, the Company slopped grantingstock appreciation rights under the Employee Equity Participation Plan ,

In July 2002, the Company converted 1,586 stock appreciation rights into options to purchase an aggregate of 1,586 shares of Class A common stock . Theexpense related to the conversion of the vested stock appreciation rights was $1,562 through July 2002 based on vested rights with respect to 192 shares of ClassA common stock outstanding as of July 25, 2002 at the Company's initial public offering price of $13 per share . The Company's deferred compensation expensein connection with the conversion of 1,311 unvested stock appreciation rights held by employees, options to purchase 1,311 shares of Class A common stock,was $4,033 The Company will recognize this expense over the remaining vesting period of the options into which the unvested rights are converted . Deferred

compensation related to the unvested portion will be amortized to expense as the options vest .

Stock Option Plans

The Company, with the approval of its stockholders and directors, began the granting of options to employees, directors and consultants in 1997 . TheCompany adopted a Stock Option Plan (the "Plan") in March 1999, which covered the conditions of options previously granted . Under the Plan, employees,outside directors and consultants are able to participate in the Company's future performance through awards of incentive stock options and nonqualified stock

options. The number of shares reserved and available for grant and issuance pursuant to the Plan is 15,000 shares .

In May 2002, the Board of Directors adopted the 2002 Equity Incentive Plan, which amends and restates the Plan . An additional 1,500 shares of Class A

common stock have been reserved bringing the total issuable under the Equity Incentive Plan to 16,500. The Company's stockholders approved the 2002 Equity

Incentive Plan in July 2002 . Each stock option is exercisable pursuant to the vesting schedule set forth in the stock option agreement granting such stock option .Unless a different period is provided for by the Board or a stock option agreement, each stock option is generally exercisable for a period often years from thedate of grant, No stock option shall be exercisable after the expiration of its option term . Any incentive stock option granted to an y

F-18


(In thousands , except per share and percent data)

owners of 10% or more of the total combined voting power of the Company may be exercised only until December 31, 2002 . The exercise price of the optionshall be 100% of the fair market value of a share of Class A common stock on the date the stock option is granted, provided that the option price of an incentivestock option granted to any owner of 10% or more of the total combined voting power of the Company shall be 110% of such fair market value . The aggregatefair market value of Class A common stock with respect to which incentive stock options are exercisable by an optionee during any calendar year shall notexceed $100.

In July 2002, the Board of Directors adopted, and the Company's stockholders approved, the 2002 Non-Employee Directors' Stock Option Plan ("NEDPlan"), under which 750 shares of Class A Common Stock have been reserved . The NED Plan provides for the following grants to be made to Non- EmployeeDirectors without further action of the Company's Board of Directors : (1) an option to purchase 25 shares of Class A common stock upon their initialappointment or election to the Board (2) an option to purchase 10 shares of Class A common stock shall be granted annually on July 1, commencing in 2003, toall existing Non-Employee Directors . Shares will be prorated based on annual service time . Each stock option is exercisable for a period often years from thedate of grant, no stock option shall be exercisable after the expiration of its option term, the exercise price of the option shall be 100% of the fair market value ofa share of Class A common stock on the date the stock option is granted, and options shall vest ratably over a thirty six month period .

A summary of the activity under the stock option plans is as follows

Optioned Class A Shares

Weighted -Reserved but Averag eUnoptioned Number Price Exercis e

Shares of Shares per Share Pric e

Balances, December 31, 2000 4,038 4,581 2 .37-7.50 4 .5 1Options granted (3,723) 3,723 5 .00-7.50 5 .0 0Options exercised - (174) 2.37-5.00 4 .72Options canceled 862 (862) 2 .37-5 .00 4 .99

Balances, December 31, 2001 1,177 7,268 2 .37-7.50 4 .72

Increase in options reserved 7,250 -Options granted (4,041) 4,041 5 .00-19 .71 10 .4 1Options exercised - (529) 2 .37-10 .00 3 .99Options canceled 583 (583) 2 .37-19 .71 5 .3 2

Balances, December 31, 2002 4 ,969 10,197 2 .37-19 .71 6 .96Options granted (1,170) 1,170 20 .60-44 .60 29 .5 6Options exercised - (4,621) 2 .37-24 .69 5 .5 9Options canceled 277 (277) 5 .00-24 .69 9 .3 0

Balances, December 31, 2003 4 ,076 6,469 $ 2 .37-44.60 $ 11 .84

The following table summarizes information concerning outstanding and exercisable options as of December 31, 2003 :

Class A Options Outstanding Class A Options Exercisable

Weighted-Average

Remaining Weighted- Weighted -Range of Contractual Average AverageExercise Number Life Exercise Number ExercisePrice Outstanding ( Years ) Price Exercisable Pric e

$ 2 .37 97 3 .00 $ 2.37 97 $ 2.3 75 .00 2,446 7 .07 5 .00 1,697 5.00

6 .25-7.50 453 6 .25 6 .95 295 6.9310.00 1,066 8.08 10 .00 359 10.0 012.50 1,141 8.22 12 .50 355 12.5 0

19 .71 - 30.30 932 9.21 24 .88 71 20.5 131 .40 -44.60 334 9.76 38 .64 12 35 .2 7

$ 2 .37 - 44 .60 6,469 7 .77 S 11 .84 2,886 $ 7.1 6

F-19


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(in thousands , except per share and percent data )

The number of Class A options exercisable at December 31, 2002 and 2001, were 5, 158 shares and 3,142, respectively .

During the years ended December 31, 2003, 2002 and 2001 , the Company granted options to consultants to purchase 14, 125 and 165 shares of Class Acommon stock at average exercise prices of $21 .77, $9 . 89 and $5 .00 per share, respectively . These options were granted in exchange for consulting servicesperformed . The Company determined the fair value of these options using the Black -Scholes valuation model . Compensation expense related to options toconsultants was $1,093, $349 and $420 far the years ended December 31, 2003, 2002 and 2001 , respectively . Included in the 125 options granted to consultantsin 2002 are 40 options issued in connection with the conversion of stock appreciation rights that were originally issued in prior years . Excluding these convertedrights, 85 options at an average price of $ 12 .20 were issued to consultants in 2002 .

During the years ended December 31, 2003, 2002 and 2001, in connection with the grant of certain stock options to employees , the Company recordeddeferred stock compensation for fi nancial statement reporting purposes of $127, $5,034 and $3,250, respectively . Deferred stock compensation is included as acomponent of stockholders ' equity and is being amortized to expense on a straight- line basis over the vesting periods of the options . The Company recorded$2,203, $1,752 and $ 681 of stock-based compensation for the years ended December 31, 2003, 2002 and 2001, respectively .

Employee Stock Purchase Plai tIn July 2002, the Company's stockholders adopted the 2002 Employee Stock Purchase Plan, under which 2,000 shares of Class A common stock have

been reserved . In the year ended December 31, 2003, 156 shares were issued under this plan . No shares were issued prior to 2003 .

Shares Reserved For Future Issuanc e

The following table summarizes the number of shares of Class A common stock that are reserved for future issuance at December 31, 2003 .

Class A

Options available and outstanding 10,545Shares issuable under the Employee Stock Purchase Plan 1,844Conversion of Class B Common Stock 27,88 3

40,272

17. Warrant sOn July 21, 1998 , the Board of Directors approved a dividend to be declared and paid to its then current stockholders of Class B common stock. The

dividend was in the form of five-year warrants , terminating on July 20, 2003 , to purchase an aggregate of 10,000 shares of Class B common stock of theCompany for $5 .00 per share . One warrant was issued to Knowledge Kids, L . L .C . for the purchase of 8,200 shares of Class B common stock . Another wa rr antwas issued to F ro gPond, LLC for the purchase of 1,800 shares of Class B common stock . At the time of the dividend, Knowledge Kids owned approximately79% of the equity interests and approximately 82% of the voting power of the Company , and FrogPond owned approximately 17% of the equity interest andapproximately 18% of the voting power of the Company . Knowledge Kids is an indirect, wholly owned subsidiary of Knowledge Universe . FrogPond owns theshares that were issued as consideration for the assets of LeapFrog RBT, LLC at the time that the Company acquired the assets of LeapFrog RBT in September1997 .

On November 8, 2002, Knowledge Kids, L.L.C . exercised such warrant through the surrender of 1,483 shares of previously-owned Class B commonstock, the aggregate value of which was the total $41,000 exercise price in accordance with the terms of the warrant . As a result, Knowledge Kids acquired 6,717additional shares of the Company's Class B common stock on a net basis .

Also on November 8, 2002, FrogPond, LLC exercised such warrant by canceling a portion of the warrant equal in value to the total $9,000 exercise price

in accordance with the terms of the warrant . As a result, FrogPond received 1,474 shares of Class B common stock on a net basis .

In March 2002 , in connection with recruiting services rendered, the Company issued a warrant to purchase 20 shares of

F20



Class A common stock at an exercise price of $] 0 .00 per share . The Company accounted for the fair value of the warrants of approximately $142 as an increaseto additional paid in capital with a corresponding reduction of accrued expenses . The fair value of the warrant, which was expensed in 2001, was estimated usingthe Black-Scholes valuation model .

On July 29, 2002 such warrant was exercised through a cashless exercise , in accordance with the terms of the warrant , and 7 shares of Class A commonstock were issued .

There were no warrants outstanding as of December 31, 2003 .

18 . Notes Receivable From Stockholder sNotes receivable from related parties and notes receivable from stockholders consisted of the principal, interest and payroll tax owed by employees for the

exercise of vested stock options . The receivable for the loan principal is recorded as notes receivable from stockholders under stockholders' equity . Thereceivable for the interest and payroll tax owed by employees is recorded as notes receivable from related parties under current assets .

By January 31, 2003, the entire balance of notes receivable from related parties and notes receivable from stockholders was paid to the Company by therespective related parties and stockholders . The Company has no remaining notes receivable due from related parties and stockholders .

19 . Equity Participation Pla n

Effective in March 2000, the Company adopted the 2000 Employee Equity Participation Plan (the "Equity Plan") whereby participants were, subject tovesting and forfeiture rules, entitled to receive in cash the appreciation in value of a vested right . Participants did not own actual shares of the Company . Vestingin the Equity Plan is generally 25% on the one-year anniversary date and monthly for the remaining three years .

In 2002, all existing, unexercised rights tinder the Equity Plan were converted into non-qualified stock options, and the plan was terminated in July 2002 .At December 31, 2003 and 2002, there were no rights outstanding.

The Company recognized $0, $1,341 and $1,265 of compensation expense in connection with the Equity Plan for the years ended 2003, 2002 and 2001,respectively .

20. Net Income Per Shar eThe Company follows the provisions of SFAS No . 128, Earnings Per Share ("SFAS 128"), which requires the presentation of basic net income (loss) per

common share and diluted net income (loss) per common share . Basic net income (loss) per common share excludes any dilutive effects of options, warrants andconvertible securities .

The following table sets forth the computation of basic and diluted net income (loss) per share .

Year EndedDecember 31,

2003 2002 200 1

Numerator:Net income $72,675 $43,444 $ 9,669

Denominator :Class A and B - weighted average shares 57,246 39,695 33,554Less: weighted average shares of unvested stock - - (105 )

Denominator for net income per Class A and B share - basic 57,246 39,695 33,449Effect of dilutive secu rities:Employee stock options 3,302 3,359 1,144Unvested stock - - 66Warrants - 5,909 2,260Convertible preferred stock - 1,781 1,55 1

Denominator for diluted net income per Class A and B share-adjuste dweighted average shares and assumed conversions 60,548 50,744 38,470

Net income per Class A and B :Basic $ 1 .27 $ 1 .09 $ 0.29Diluted $ 1 .20 $ 0.86 $ 0.2 5

F-21



21 . Commitments and ContingenciesThe Company leases office and warehouse space under noncancelable operating leases having initial terms in excess of one year and expiring in various

years between 2004 and 2008 . The Company also has several noncancelable office equipment leases with initial terms in excess of one year and which expire invarious years between 2004 and 2008, certain leases contain rent escalation clauses . Generally, these have initial lease periods of three to ten years, and containprovisions for renewal options of five years at market rates . Rent expense for the years ended December 31, 2003, 2002 and 2001 was $3,656, $2,772 and$2,083, respectively . The Company is also obligated to pay certain minimum royalties in connection with license agreements to which the Company is a party .

Future minimum annual payments under the Company's commitments for the years ended December 31 are :

Year Commitments

2004 $ 8,7872005 8,29 12006 4,98 82007 35 42008 4

Total $ 22,424

Legal Proceedings

Various claims and lawsuits involving patent and trademark infringement are pending against the Company . The Company intends to defend these suitsvigorously .

Publications International, Lid. v. LeapFrog Enterprises, Inc.

In May 2001, Publications Inte rn ational , Ltd ., or PIL, filed a lawsuit against the Company in federal court in Illinois alleging that the Company wasinfringing PIL' s alleged common law, or unregistered , trademark LEAP FROG for children ' s books . PIL's complaint sought unspecified moneta ry damages,injunctive relief and cancellation of the company ' s U .S . trademark registration for LEAPFROG for coloring books, children's books, children ' s activity booksand educational books . The Company had counter -sued PIL for infringement by PIL of three of the Company 's federally registered LEAPFROG trademarks,including one that it had acquired in 1996 from another company . In Februa ry 2003, we entered into a settlement agreement and release of claims with PIL. As aresult of the settlement, we acquired PIL's rights to the designation LEAP FROG and LEAP FROG design trademark , and the lawsuit against us in federal cou rtin Illinois alleging that we infringed PIL's alleged common law, or unregistered , trademark LEAP FROG for children's book was dismissed with prejudice .

General Creation LLC, et a!. v. LeapFrog En!etprises, Inc. el al.

In January 2002, General Creation LLC fi led a lawsuit against the Company and against Knowledge Universe in federal district court in Virginia allegingthat by making, using, importing and selling reading toys , the Company was infri nging United States Patent No . 5,795,213 . General Creation sought unspecifiedmoneta ry damages, including t ri ple damages based on its allegation of willful infringement , attorneys' fees and injunctive relief. The Company joinedKnowledge Universe in filing a motion to dismiss based on lack of personal jurisdiction over Knowledge Universe , or in the alternative, to transfer the suit to afederal district court in California . In response, General Creation filed a motion to dismiss Knowledge Universe and an opposition to the Company's motion todismiss or transfer the suit . Knowledge Universe was subsequently dismissed as a party to the lawsuit . The Company filed an answer and counterclaim seeking

declarato ry relief that the patent was invalid , unenforceable and not infri nging . In May 2003 , we entered into a confidential settlement agreement and re lease ofall claims with General Creation, and filed a joint motion in federal district court in Virginia seeking dismissal with p rejudice of all of the claims andcounterclaims in the patent lawsuit .

F-22


(in thousands , except per share and percent data)

Technology Innovations, LLC v. LeapFrog Enterprises, Inc.

In July 2002, Technology Innovations, LLC filed a complaint against the Company in the western federal district court of New York alleging that theCompany infringed, and induced others to infringe, United States Patent No . 5,517,407, which it purported to own, by manufacturing, using, offering for saleand/or selling our LeapPad, LeapPad Pro and My First LeapPad platforms and other unspecified products . Technology Innovations sought unspecified monetarydamages, including triple damages based on its allegation of willful infringement, an accounting for all profits received by us from the sale of allegedlyinfringing products, attorneys' fees and injunctive relief. In August 2002, Technology Innovations filed an amended complaint adding seven defendants to thecomplaint: Knowledge Universe, LLC ; F .A .O ., Inc. ; KBToys, Inc . ; Staples, Inc . ; Target Corporations ; Toys "R" Us, Inc . ; and Wal-Mart Stores, Inc . InSeptember 2003, we, our co-defendants and Technology Innovations entered into a confidential settlement agreement relating to Technology Innovation'scomplaint. The case was dismissed by the federal district court for the Western District of New York in September 2003 .

LeapFrog Enterprises. Inc. v. Franklin Electronic Publishers, Inc .

In April 2002, based in part on assertions by Franklin Electronic Publishers, Inc . that a number of the Company's products, infringed, contributorilyinfringed or induced infringement of United States Patent No . 5,203,705, issued to Franklin, the Company filed a lawsuit against Franklin in federal district courtin California seeking declaratory relief that the patent was invalid, unenforceable and not infringing. In July 2002, Franklin filed a complaint against theCompany and one of its finished goods manufacturers with the U .S . International Trade Commission, or ITC, requesting an investigation into whether theimportation, distribution and sale of a number of the Company's products directly infringed, induced infringement or contributorily infringed one or more claimsof Franklin's patent . In November 2002, the ITC granted Franklin Electronic Publishers, Inc .'s motion to withdraw its complaint and terminate the associatedinvestigation . In February 2003, we entered into a settlement agreement and release of all claims with Franklin, and the northern federal district court ofCalifornia granted the joint motion by Franklin and Leapfrog to dismiss with prejudice all of the claims and counterclaims in the patent lawsuit that alleged wehad willfully infringed, actively induced infringement of and contributorily infringed Franklin's United States Patent No . 5,203,705 patent by making, using,selling and offering for sale a number of our products .

LeapFrog Enterprises, hie. v. Fisher-Price, Inc.

In October 2003, we filed a complaint in the federal district court of Delaware against Fisher-Price, Inc. alleging that Fisher Price's PowerTouch learningsystem violates United States Patent No . 5,813,861 . In January 2004, we served Fisher-Price with the complaint , We are seeking damages and injunctive relief.

Learning Resources, Inc. v . LeapFrog Enterprises, Inc,In November 2003, Learning Resources filed a complaint against us in federal district court in Illinois alleging that our trademark PRETEND & LEARN

infringes on its trademark PRETEND & PLAY . Learning Resources seeks unspecified monetary damages and injunctive relief . We believe that we havemeritorious defenses to Learning Resources claims and intend to vigorously defend ourselves.

Securities Class Action Litigations and Shareholder Derivative Sui t

In December 2003, four securities class action lawsuits alleging, among other things, securities fraud were filed against us in federal district court in theNorthern District of California on behalf of purchasers of our class A common stock . The class actions are Miller v. LeapFrog Enterprises, Inc., el at, Well v.LeapFrog Enterprises, Inc., e1 at, Abrams v. LeapFrog Enterprises, Inc ., el at, and Ornelas v. LeapFrog Enterprises, Inc., el at. In January 2004, the courtissued a notice of related case as to the four class actions . We anticipate that all four securities class actions will be consolidated into one action . In December2003, a shareholder derivative suit, Santos v. Mike Wood, et at., was filed against us in the superior court of California for Alameda County alleging, among otherthings, that our directors and officers breached their fiduciary duty to the company . We believe that we have meritorious defenses to the allegations contained inthe four class action complaints and the shareholder derivative complaint and intend to vigorously defend ourselves . We do not believe that the lawsuits will havea material effect on our financial position, results of operations or cash flows, however, there can be no assurance as to the ultimate disposition of the lawsuits .

F-23

Table of rontent§LEAPFROG ENTERPRISES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(In thousands , except per share and percent data )

22 . Defined Contribution Pla nThe Company participates in a defined contribution plan sponsored by Knowledge Universe, Inc . under Section 401(k) of the Internal Revenue Code . The

401(k) plan is elective and provides for the Company to match 25% of employee contributions up to 4% of the participant's compensation . The matchingcontributions are fully vested at the time the contribution is made .

Total expense to the Company related to this plan was $238, $169 and $114 in 2003, 2002 and 2001, respectively .

23 . Segment Reportin gThe Company's reportable segments include U .S . Consumer, Education and Training and International .

The U .S . Consumer segment includes the design, production and marketing of electronic educational toys and books, sold primarily through the retailchannels . The Education and Training segment includes the design, production and marketing of educational books and toys sold primarily to school systems .For the International segment, the Company designs, markets and sells products in non-U .S. markets .

The accounting policies of the segments are the same as (hose described in Note 2 of these notes to consolidated financial statements .

Incom e(Loss) from Tota l

Net Sales Operations Assets

2003U .S. Consumer $ 545,976 $ 83,209 $ 485,15 8Education and Training 37,469 (194) 7,870International 96,567 26,443 59,63 1

Total $ 680,012 $ 109,458 $ 552,65 9

200 2U.S . Consumer $ 458,048 $ 72,692 $ 354,874

Education and Training 20,138 (9,042) 6,60 2International 53,586 7,701 36,20 6

Total $ 531,772 $ 71,351 $ 397,68 2

200 1U .S . Consumer $ 289,115 $ 21,755 $ 211,27 6Education and Training 8,806 (6,681) 3,49 2International 16,322 1,361 7,20 5

Total $ 314,243 $ 16,435 $ 221,973

24. Quarterly Financials - Unaudited

First Second Third Fourth Year EndedQuarter Quarter Quarter Quarter December3l ,

200 3Net sales $ 76,733 $ 68,030 S 203,888 $ 331,361 $ 680,012Gross profit 40,641 35,821 104,822 158,860 340,14 4Income (loss) from operations (3,542) (7,942) 52,581 68,361 109,45 8Net income (loss) (969) (3,926) 33,404 44,166 72,67 5

Net income (loss) per common share -Basic $ (0.02) $ (0.07) $ 0 .58 $ 0.75 $ 1 .2 7Diluted $ (0.02) $ (0 .07) $ 0 .55 $ 0.72 $ 1.20

200 2

Net sales $ 57,980 $ 43,218 $ 182,127 $ 248,447 $ 531,772Gross profit 27,278 20,941 95,056 126,766 270,04 1Income (loss) from operations (8,073) (12,555) 44,378 47,601 71,35 1Net income (loss) (5,059) (7,541) 26,683 29,361 43,444Net income (loss) per common share -

Basic $ (0,15) $ (0.22) $ 0 .65 $ 0.59 $ 1.09Diluted $ (0 .15) $ (0.22) $ 0 .50 $ 0.50 $ 0.86

F-24



Certain amounts have been reclassified to conform to the presentation in the current year annual financial statements .

25. Subsequent Events (unaudited)In January 2004, the Company and one of its subsidiaries entered into a technology license agreement with a foreign company to jointly develop and

customize our respective technologies to be combined in a platform and related licensed products . The agreement calls for contractual payments of $17,000 inlicense fees and advance royalties . Additionally, there are $1,000 of engineering fees payable, subject to attainment of specific milestones.

F-25

EXHIBIT INDE X

.3 .03 * Amended and Restated Certificate of Incorporation .

3 .04 * Amended and Restated Bylaws.

4 .01 * -Form of Specimen Class A Common Stock Certificate .

4 .02 ** Fourth Amended and Restated Stockholders Agreement, dated May 30, 2003, among LeapFrog and the investors named therein .

10 .01 * Fonn of Indemnification Agreement entered into by the Company with each of its directors and each of its officers named as an officer in theCompany's Registration Statement on Form S-I, as amended, filed with the SEC.

10 .02 * Net Lease, dated November 14, 2000, between Hollis Street Investors, LLC and LeapFrog, as amended .

10.03 * Standard Lease Agreement, dated January 15, 2002, between Knowles Los Gatos, LLC and LeapFrog .

10.04* Amended and Restated Stack Option Plan .

10.05 * Amended and Restated Employee Equity Participation Plan .

10.06* t 2002 Equity Incentive Plan .

10.07 * f Form of Stock Option Agreement under the 2002 Equity Incentive Plan .

I0.08* f 2002 Non-Employee Directors' Stock Option Plan .

10 .09* t Fonn ofNonstatutory Stock Option Agreement under the 2002 Non-Employee Directors' Stock Option Plan.

10 .10* t 2002 Employee Stock Purchase Plan .

10 .1 1 * t Form of Offering under the 2002 Employee Stock Purchase Plan .

10 .12* t Amended and Restated Employment Agreement, dated effective as of January I, 2002, between Michael C . Wood and LeapFrog.

10 .13 * t Employment Agreement, dated as of April 1, 2002, between Thomas J . Kalinske and LeapFrog.

10 .14* t Employment Agreement, effective as of April 1, 2002, between Paul Rioux and LeapFrog, as amended .

10.15 Employment Agreement, effective as of November 1, 2003, between Timothy Bender and LeapFrog.

10 .22 * Tax Sharing Agreement dated as of July 3, 2002, between Knowledge Universe, Inc . and LeapFrog .

10 .26 (a) Business Loan Agreement, dated December 31, 2002, between Bank of America, N .A . and LeapFrog .

10 .27(b) Employment Agreement with G. Frederick Forsyth, dated August 4, 2003 .

10 .28 Employment Agreement, effective as of February 10, 2004, between Jerome Perez and LeapFrog .

21 .01 List of Subsidiaries .

23.01 Consent of Ernst & Young LLP, Independent Auditors .

24.01 Power of Attorney (See signature page to this Form 10-K) .

31 .01 Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 .


32 .01 Certification of the Chief Executive Officer and the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 200 2

* Incorporated by reference to the same numbered exhibit previously filed with the company's registration statement on Form S-1 (SEC File No .

333-86898)** Incorporated by reference to the same numbered exhibit previously fi led with the company's report on Form 10-Q filed on August 12, 2003 (SEC File No .

001-31396)(a) Incorporated by reference to the same numbered exhibit previously filed with the company's report on Form 10-K fi led on March 28, 2003 (SEC File No .

001-31396)(b) Incorporated by reference to the exhibit number 10 .01 filed with the company's report on Form 10-Q filed on November 10, 2003 (SEC File No .

001-31396 )t Compensation plans or arrangements in which directors or executive officers are eligible to participate or participate .

Exhibit 10 .1 5

EMPLOYMENT AGREEMENT

THIS EMPLOYMENT AGREEMENT, effective as of November 1, 2003 ("Agreement"), is made between LeapFrog Enterp rises, Inc ., a Delawarecorporation ( the " m n ' ), and Timothy Bender ("Executive ') and amends , restates and supersedes the Employment Agreement dated November 17, 1997 .

RECITALS :

WHEREAS, Executive has been a key executive of the Company, and the Company deems the continuation of Executive's services during the term of thisAgreement to be material and significant to the Company's success and desires to ensure that the skills and experience of Executive will remain available to theCompany;

WHEREAS, the Compensation Committee of the Company's Board of Directors approved the general terms of this Agreement on July 22, 2003, and,subsequent to such approval, the Company and Executive have agreed to changes as set forth this Agreement ; and

WHEREAS, the parties hereto desire to enter into this Agreement, which will supersede any and all prior and contemporaneous agreements andunderstandings pursuant to Section 9.1 below, providing for the continued employment of Executive by the Company on the terms and conditions hereinafter setforth .

AGREEMENT:

NOW, THEREFORE, in consideration of the mutual promises and subject to the terms and conditions set forth herein , the pa rt ies hereto agree as follows :

SECTION 1 . EMPLOYMEN T

1 .1 Position . Duties, Responsibilities . Authurity . The Company hereby employs Executive as the President of the Global Consumer Group, reporting to thePresident and Chief Executive Officer of LeapFrog Enterprises, Inc ., for the Employment Term (as defined below) and on the terms and conditions hereinafterset forth . In such capacity, Executive shall have such duties and authority as are customary for, and commensurate with such position, and such other duties asthe Board of Directors may prescribe. Executive shall, to the best of Executive's ability, carry out such responsibilities and duties as are commensurate with thisposition . Executive's principal office for the performance of services under this Agreement shall be in the San Francisco/Oakland Bay Area or at any location orlocations other than the aforesaid as Executive shall agree to and as the Company's Board of Directors may designate from time to time .

1 .2 Exclusive Employment. During the Employment Term, Executive shall devote his full business time to his duties and responsibilities set forth in thisSection 1 . Without

limiting the generally of the foregoing, Executive shall not, without the prior written approval of the Company's Board of Directors, during the EmploymentTerm, render services of a business, professional or commercial nature to any other person, firm or corporation, whether for compensation or otherwise, exceptthat Executive may engage in civic, philanthropic and community service activities so long as such activities do not interfere with Executive's ability to complywith this Agreement and are not otherwise in conflict with the policies or interest of the Company .

SECTION 2 . COMPENSATION AND OTHER BENEFITS .In consideration of Executive's employment, and except as otherwise provided herein, Executive sha ll receive from the Company the compensation and

benefi ts described in this Section 2, in full and complete satisfaction of all of the Company's obligations to Executive arising from Executive ' s employment . Thecompensation and employee benefi ts payable to Executive pursuant to this Agreement may be changed only by the written agreement of the parties . Executiveauthorizes the Company to deduct and withhold from all compensation to be paid to him any and all sums required to be deducted or withheld by the Companypursuant to the provisions of any federal, state, or local law, regulation , ruling, or ordinance , including, but not limited to, income tax withholding and payrolltaxes.

2 .1 . Base Comnensation and Bonus . During the Employment Term, the Company shall pay to Executive, and Executive shall be entitled to receive fromthe Company, a base salary for the full time employment referred to in Section I hereof of $260,000 per year ("Sal'), or such higher amount as approved bythe Company's Board of Directors or any committee thereof. Executive shall be eligible to receive an annual bonus ("Bonus"), of $90,000, or such higheramount as approved by the Company's Board of Directors or any committee thereof, based upon performance standards as established in writing by the Presidentand Chief Executive Officer of LeapFrog and the Board of Directors, with consultation with Executive, provided Executive is employed as of December 31 ofthe year of the Bonus .

2 .2 . Vacation. Executive shall be entitled to four weeks paid vacation in any fiscal year during the Employment Tenn in accordance with Companyvacation and leave policies and to one additional week of personal leave during each fiscal year during the Employment Term . Vacation time shall be plannedand taken consistent with Executive's duties and obligations hereunder .

2 .3 Other Benefits . During the Employment Term, Executive shall be entitled to receive an automobile allowance of $650 per month and such otherspecific and applicable employee benefits, such as group medical and dental for Executive, Executive's spouse and dependent children, life and disabilityinsurance coverage, and sick leave all as granted to the Company's executive employees in accordance with the Company's policies and guidelines, including butnot limited to contribution requirements for dependent coverage, as approved by the Company's Board of Directors from time to time . In addition, conditioned

on Executive's medical condition being such that he will not be rated as a health risk resulting in higher than normal premium costs for such policy or policiesand Executive's agreement to submit to all physical and medical examinations required to obtain such policy or policies, the Company shall obtain and maintainduring the Employment Term one or more policies of term life insurance

providing an aggregate benefit in the amount of $1,000,000, over and above the basic life insurance benefit provided to all employees (this insurance will bepurchased after the completion of a medical examination on behalf of the applicable insurance company) . Executive shall have the right to designate thebeneficiary or beneficiaries of the benefit payable upon death pursuant to such policy or policies and may transfer ownership of such policy or policies to any lifeinsurance trust, family trust or other trust. After a policy is in effect, if the Company fails to maintain the full amount of such coverage, upon the Executive'sdeath while employed by the Company, the Company shall pay to his benef iciaries any difference between $1,000,000 and the benefit payable to Executive orhis beneficiaries under such policy or policies

2 .4 Stock Options. Executive's prior stock option agreements shall remain in full force and effect .


3 .1 Tenn. Executive's term of employment under this Amended and Restated Employment Agreement shall commence as of the date hereof and shallterminate on March 31, 2005, unless terminated earlier pursuant to Sections 3 .2, 3.3, 3 .4 or 3 .5 hereof ("Employment Term") .

3 .2 Termination by Death. Executive' s term of employment will terminate upon the death of Executive ; provided that the Company shall pay to the estateof the Executive any unpaid Salary or Bonus to the extent earned at the date of death, any amounts payable by the Company at the dale of death under the lifeinsurance policies as provided in Section 2 .3, and any amounts payable pursuant to the Company's employee benefit plans in accordance with such plans .

3 .3 Termination Unon Permanent Disability . Executive's term of employment shall terminate upon the "permanent disability" of Executive . As usedherein, the term "nermanent disability" shall mean a physical or mental disability that renders Executive unable to perform his normal duties for the Company fora period of 120 consecutive days as determined by a licensed physician . The Company and Executive or his legal representative shall use their best efforts toagree on the physician to detennine permanent disability. If they cannot agree within ten (10) days after the first party makes a written proposal staling the nameof a physician, then the other party shall select a physician within ten (10) days and within ten (10) days thereafter the two physicians shall select a thirdphysician . All such physicians must be board certified in The medical area giving rise to the alleged disability . The determination of the third physician shall befinal and binding . If one party fails to select a physician within said ten (10) day period, the physician named by the other party shall make the determination ofpermanent disability . Upon termination of Executive for permanent disability, the Company shall pay to Executive any unpaid Salary or Bonus to the extentearned at the date of termination for permanent disability, any amounts payable by the Company at the date of tennination for permanent disability under theCompany's disability policies, and any amounts payable by the Company pursuant to the Company's other employee benefit plans in accordance with suchplans .

3 .4 Termination for Cause . The Company shall have the ri ght to terminate the employment of Executive for "Cause" by delivering to him a written noticespecifying such

Cause . Executive shall be entitled to at least ten (10) days' prior written notice of the Company's intention to terminate his employment for any Cause specifyingthe grounds for such termination . If the Company exercises such right, its obligation under this Agreement to make any further payments to Executive, other thanany unpaid Salary, Bonus and any amounts payable pursuant to the Company's employee benefit plans in accordance with such plans due in, or allocable to, theperiod prior to said termination, shall thereupon cease and terminate . For purposes of this Agreement, a termination shall be for ° ause" if the Executive shall : (i)commit an act of fraud, embezzlement or misappropriation involving the Company ; (ii) be convicted by a court of competent jurisdiction of, or enter a plea ofguilty or no contest to, any felony involving moral turpitude or dishonesty ; (iii) commit an act, or fail to commit an act, involving the Company which amountsto, or with the passage of time would amount to, willful misconduct, wanton misconduct, gross negligence or a breach of this Agreement and which results orwill result in significant harm to the Company ; or (iv) willfully fail to perform the responsibilities and duties specified herein fora period of ten (10) daysfollowing receipt of written notice from the Company which specifically describes past instances of willful failure of performance ; provided that in the case of(iv) above, during the ten (10) day period following receipt of such notice, Executive shall be given the opportunity to take reasonable steps to cure any suchclaimed past failure of performance .

3 .5 Compensation and Benefits Upon Termination Without Cause . In the event the Company terminates the Executive's employment for any reason otherthan the death or permanent disability of Executive, or Cause, or Executive resigns for Good Reason, and Section 3 .6 hereof is not applicable to such terminationor resignation, the Company shall pay to Executive : (i) in a lump sum within thirty (30) days of the effective date of termination, any Salary due through the dateof termination ; (ii) in a lump sum within thirty (30) days of the effective date of termination, the balance of Executive's Salary, which he would have beenentitled to receive through the end of the Severance Period (defined below), (iii) in a lump sum within thirty (30) days of the effective date of termination, all ofExecutive's guaranteed Bonus and a pro rata portion of Executive's Bonus which is not guaranteed (annualizing results of operations for the period prior to thedate of termination), which he would have been entitled to receive through the end of the Severance Period, and (iv) continuation of benefits upon the same termsand conditions then in effect on the date of termination under all medical, dental and life insurance plans through the end of the Severance Period, provided thatExecutive at his own expense shall be entitled to continue appropriate benefits under any applicable COBRA program thereafter . In addition to the foregoing, allunvested stock options held by Executive shall continue to vest through the end of the Severance Period and shall be exercisable for that specific periodfollowing the end of the Severance Period as provided under the applicable stock option agreements in the case of termination of employment . As used in thisSection 3 .5, the Severance Period shall mean twelve (12) months after the effective date of termination.

3 .6 Compensation Pa le in the Event of a Chance of Control . If, in connection with a Change of Control transaction as defined below, either theemployment of Executive is terminated by the Company for any reason other than the death or permanent disability of Executive or Cause within ninety (90)days prior to or within twelve (12) months after a Change of Control transaction or Executive resigns for Good Reason within such period, the Company shallpay to Executive, within five (5) business days following the consummation of a Change of

Control transaction , an amount equal to 1 .5 times Executive ' s Sala ry and Bonus paid for the immediately preceding fiscal year of the Company . Executive alsoshall receive bene fits under applicable employee benefit plans as provided in Section 3 . 5(iv), In addition , notwithstanding anything to the contrary containedherein or in any stock option or similar agreement to which Executive is a party , upon the occurrence of a Change of Contro l, regardless of whether Executive'semployment is terminated , all unvested stock options shall immediately vest and become exercisable in full (or, if applicable, all repurchase obligations of theCompany shall immediately lapse ) and such options shall remain exercisable for the period specified in the applicable option agreement, For purposes of thisAgreement , a "Change of Control" of the Company shall mean ( i) any "person" (as such term is used in Section 13(d) of the Securi ties Exchange Act of 1934, asamended , the "Exchange Act ") other than an Affiliated Purchaser becomes the "beneficial owner " ( as defined in Rule 13d-3 under the Exchange Act) after thedate of this Agreement of securities of the Company representing at least a majority of the combined voting power of the Company 's outstanding securiti esordinarily having the right to vote at elections of directors; ( ii) the Company is merged or consolidated with any person other than an Affiliated Purchaser and asa result of such merger or consolidation the beneficial owners of secu rities of the Company before such merger or consolidation hold immediately after suchmerger or consolidation less than a majority of the combined voting power of the outstanding securities of the surviving or resulting company ordinarily havingthe right to vote at elections of directors , or (iii) the Company sells or transfers all or substantial ly all of its assets to a person other than an Affiliated Purchaser .For purposes of the foregoing , an "Affiliated Purchaser" means (i) any person that is a bene fi cial owner of securities of the Company on or before the dale of thisAgreement and/or any affiliate thereof (including , without limitation, the members of Frogpond , LLC), and/or (ii) any employee benefi t plan , sponsored ormaintained by the Company or any affiliate, or any group of persons which includes such a plan ,

3 .7 [RESERVED]

3 .8 Definition of Good Reason . For purposes of Sections 3 .5 and 3. 6, Executive's termination of employment with the Company shall be deemed for"Good Reason" if any of the following events occur without Executive's express written consent and Executive resigns within six months after such eventoccurring but only if Executive provides the Company with written notice of his belief that any one of the following specific events has occurred and during thethirty (30) day period following receipt of such notice, the Company fails to cure any such event :

(a) The assignment to Executive by the Company of duties inconsistent with, or a substantial alteration in the nature or status of, Executive'sresponsibilities as provided in Section 1 .1, other than the assignment of more senior duties, or the failure to elect or re-elect Executive as a director of theCompany or the removal of him from any such positions ;

(b) A reduction by the Company in Executive's cash compensation pursuant to Section 2 .1 including any reduction of such cash compensation as suchmay be increased by the Company ;

(c) Any failure by the Company to continue in effect without substantial adverse change any compensation, incentive, welfare or benefit plan orarrangement, in which Executive is participating at the time of a Change of Control (or any other plans providing Executive with substantially similarbenefits) (hereinafter referred to as "Benefit Plans "), or the taking of any action by the Company which would adversely affect, either as to the past orprospectively, Executive's participation in or materially reduce or deprive Executive of his benefits that were provided under any such Benefit Plan at thetime of a Change of Control ; unless an equitable substitute arrangement (embodied in an ongoing substitute or alternative Benefit Plan) has been made forthe benefit of Executive with respect to the Benefit Plan in question ;

(d) Relocation to any place more than 25 miles from the office regularly occupied by Executive, except for required travel by Executive on the Company'sbusiness to an extent substantially consistent with past practice ;

(e) Any material breach by the Company of any provision of this Agreement or the failure by the Company or by any successor or assign of the Company(whether by operation of law or otherwise, including any surviving company in a merger or similar transaction involving the Company), within len (10)business days after written request to the Company or any successor or assign of the Company by Executive following a Change of Control to deliver toExecutive an agreement expressly reaffirming its obligations under or agreeing to assume and comply with the obligations of the Company under thisAgreement .

SECTION 4. BUSINESS EXPENSE SThe Company shall pay for or reimburse Executive for all reasonable business expenses incurred by Executive in the performance of his duties hereunder,

upon submission to the Company in accordance with Company policy of a written accounting of such expenses, which accounting shall include an itemized listof all expenses incurred, the business purposes for which such expenses were incurred, and such receipts as Executive reasonably has been able to obtain .

SECTION 5 . COVENANTS OF EXECUTIVE .

5 .1 Acknowledgments . Executive acknowledges the following :

5 .1 .1 Access to Confidential Information . Executive ' s services previously rendered to the Company and to be rendered hereunder have placed himand shall continue to place him in a position of con fi dence and trust which shall allow him access to "Con fi dential Information" (as hereinafter de fined) .

5 .1 .2 Fair and Reasonable Covenants . The type and period of restrictions imposed by the covenants in this Section 5 are fair and reasonable andsuch restrictions will not prevent Executive from earning a livelihood .

5 .2 Covenant as to Nondisclosure or Use of ConfidglItial InfQrmation Executive agrees as follows:5 .2 .1 Executive shall not at any time during or after Executive's employment, disclose to anyone outside of the Company or use for any purpose that

is not expressly authorized by the Company Confidential Information . Executive shall not deliver, reproduce or in any way allow any Confidential Information tobe delivered to or used by any third parties without specific written consent of a duly authorized representative of the Company.

5 .2.2 The Company's agreements with other persons or with the U .S . government, or its agencies, may include agreements that impose obligationsor restrictions regarding inventions that occur in connection with work relating to such an agreement, or regarding the confidential nature of work pursuant to

such an agreement . Executive agrees to be bound by all such lawful obligations and restrictions, and to do whatever is necessary to satisfy the obligations of theCompany.

5.2.3 If this Agreement is terminated for any reason, Executive will promptly surrender and deliver to the Company all Confidential Information .Executive will not retain any description or other document that contains or relates to any Confidential Information that Executive may produce, obtain orotherwise learn about during employment with the Company .

5 .3 Assignment of Inventions . Executive assigns and transfers to the Company Executive's entire right, title and interest in and to all inventions ; including,

but not limited to, ideas, improvements, designs and discoveries (" Inventions"), whether or not patentable and whether or not reduced to practice, or conceivedby Executive (whether made solely by Executive or-jointly with others) during Executive's employment with the Company which relate in any manner to theactual or demonstrably anticipated business, work or research and development of the Company or its subsidiaries, or result from or are suggested by any taskassigned to Executive or any work performance by Executive for or on behalf of the Company or its subsidiaries . All Inventions are the sole property of the

Company ; provided, however . that this Agreement does not require assignment of an Invention which qualifies fully for protection under Section 2870 of the

California Labor Code (Section 2870), which provides as follows :

5 .3 .1 Any provision in an employment agreement which provides that an employee shall assign or offer to assign any of his or her rights in aninvention to his or her employer shall not apply to an invention that the employee developed entirely on his or her own time and without using the employer'sequipment, suppliers, facilities or trade secrets information except for those Inventions that either :

(a) relate at the time of conception or reduction to practice of the invention to the employer's business, or actual or demonstrably anticipatedresearch or development of the employer ; o r

'(b) result from any work performed by the employee for the employer

5 .3 .2 To the extent a provision in an employment agreement purports to require an employee to assign an invention otherwise excluded from beingrequired to be assigned under Section 5 .3 . 1, the provision is against the public policy of this state and is unenforceable .

5 .4 Disclosure Of Inventions : Patents. Copyrights and Mask Work Riehts . Executive agrees that in connection with any Invention:

5 .4 .1 To keep and maintain adequate and current written records of all Inventions made by Executive (in the form of notes, sketches, drawings andother forms specified by the Company) while employed by the Company . These records shall be available to the Company and shall be and remain the soleproperty of the Company at all times . Executive will disclose such Inventions promptly in writing to Executive's immediate supervisor at the Company, with acopy to the Company Secretary, whether or not Executive believes the Invention is protected by Section 2870 . Such disclosure shall be received in confidence by

the Company . Within thirty (30) days after receipt of such disclosure, the Company shall respond to Executive specifying that the Company either (i) claims thatthe Invention is an assignable invention (as defined below in Section 5 .4 .2), (ii) relinquishes any claim to the Invention or (iii) requires further or more detailed

disclosure to assess its rights to the Invention under this Agreement . In the case of clause (iii) above, the Company shall permit Executive time during normalbusiness hours reasonably necessary to prepare a more detailed disclosure ; and the Company shall provide an additional response as described in this Section

5 .4 .1 within thirty (30) days after receipt by the Company of such further or more detailed disclosure .

5 .4 .2 Upon request, to promptly execute a written assignment of title to the Company for any Invention required to be assigned by Section 5 .3

("assienable invention") and Executive will preserve any such assignable invention as Confidential Information .

5 .4.3 Upon request, to assist the Company or its nominee (at its expense) during and at any time subsequent to Executive's employment in everyreasonable way to obtain for the Company's or its nominee's benefits ., patents, copyrights, mask work rights and other statutory rights (" Statutory Rights") forsuch assignable inventions in any and all countries, which inventions shall be and remain the sole and exclusive property of the Company or its nominee whetheror not patented, copyrighted or the subject of a mask work right . Executive shall execute such papers and perform such lawful acts as the Company deems

necessary to exercise all rights, title and interest in such Statutory Rights ,

5 .4.4 To execute and deliver to the Company or its nominee upon request and at its, expense all documents , including applications for andassignments of Statutory Rights to be issued therefore, as the Company determines are necessa ry or desirable to apply for and obtain Statutory Rights on suchassignable inventions in any and all countries arid/or to protect the interest of the Company or its nominee in Statutory Rights and to vest title thereto in theCompany or its nominee .

5 .5 Return of Business Records andEauioment . Upon termination of Executive's employment hereunder, Executive shall promptly return to theCompany : (i) all documents, records, procedures, books, notebooks, and any other documentation in any form whatsoever, including but not limited to written,audio, video or electronic, containing any information pertaining to the Company which includes Confidential Information, including any and all copies of suchdocumentation then in Executive's possession or control regardless of whether such documentation was prepared or compiled by Executive, Company, otheremployees of the Company, representatives, agents, or independent contractors, and (ii) all equipment or tangible

personal property entrusted to Executive by the Company. Executive acknowledges that all such documentation, copies of such documentation, equipment, andtangible personal property are and shall at all times remain the sole and exclusive property of the Company .

5 .6 Additional Covenants Protecting the Interests of the Company . Executive agrees as follows :

5 .6.1 That at all times during his employment hereunder, he shall comply with the Company's employee manual and other policies and proceduresreasonably established by the Company from time to time concerning matters such as management, supervision, recruiting, diversity, and sexual harassment .

5 .6.2 That during his employment hereunder, he shall not directly or indirectly, individually or together or through any affiliate or other person ,firm, corporation or entity engage in any other business activity which would materially interfere with the performance of his duties hereunder including, but notlimited to, engaging in any Competitive Business with that conducted by Company. For purposes of this Section 5 .6 .2, " Competitive Business" shall mean thetoy/game and children's educational and entertainment products business as conducted or contemplated to be conducted by the Company during the EmploymentTerm .

5 .6.3 That for a period of one year following a termination of employment other than following a Change of Control, he shall not, directly orindirectly, hire any member of senior management of the Company (defined as an officer with a title of vice president or higher) or solicit for hire any employeeof the Company; provided, however, that general solicitations not targeted to Company employees shall not be deemed to violate this covenant .

5 .6.4 That during his employment hereunder, he will not, directly or indirectly, solicit or take away or attempt to solicit or take away, the business ofany of the material customers of or suppliers to the Company .

5,6,5 Thai Executive agrees that, for a period of one year following his termination of employment under this Agreement, he shall, upon Company'sreasonable request and in good faith and with his best efforts, subject to his reasonable availability, cooperate and assist Company in any dispute, controversy, orlitigation in which Company may be involved and with respect to which Executive obtained knowledge while employed by the Company or any of its affiliates,successors, or assigns, including, but not limited to, his participation in any court or arbitration proceedings, giving of testimony, signing of affidavits, or suchoilier personal cooperation as counsel for the Company shall request . Any such activities shall be scheduled, to the extent reasonably possible, to accommodateExecutive's business and personal obligations at the time . The Company shall pay Executive's reasonable [ravel and incidental out-of-pocket expenses incurredin connection with any such cooperation, as well as the reasonable costs of an attorney Executive engages to advise him in connection with the foregoing .

5 .7 Certain Definitijin. The following definitions are applicable to this Section 5 :

5 .7 .2 Confidential Information . "Confidential Information " shall mean information and compilation of information relevant to the business of theCompany provided to Executive during his employment with the Company and/or an affiliate of the Company or to

which Executive had access or which he compiled while an employee of the Company mid/or an affiliate of the Company, including, but not limited to,information regarding any trade secrets, proprietary knowledge, operating procedures, finances, financial condition, organization, employees, customers, clients,agents, other personnel, business activities, budgets, strategic or financial plans, objectives, marketing plans, prices and price lists, operating and trainingmaterials, data bases and analyses, designs, formulae, test data and all other documents relating thereto or strategies of the Company ; provided, however, the term

Confidential Information as used herein shall not include information : (i) which has become public, published or is otherwise in the public domain through nofault of Executive prior to any disclosure thereof by Executive ; (ii) which was known to Executive prior to his employment or affiliation with the Company; (iii)which is required to be disclosed by statute, regulation or court order, or (iv) which is known generally to the toy/game and children's educational andentertainment products industry .

5 .7 .3 The Company. As used throughout this Section 5, the term "Company" shall be deemed to include and refer to any company or personaffiliated with the Company .

5 .8 Remedies . In view of the position of confidence which Executive will enjoy with the Company and the anticipated relationship with the clients, customers,and employees of the Company and its affiliates pursuant to his employment hereunder, and recognizing both the access to confidential financial and otherinformation which Executive will have pursuant to his employment, Executive expressly acknowledges that the restrictive covenants set forth in this Section 5are reasonable and necessary in order to protect and maintain the proprietary interests and other legitimate business interests of the Company and its affiliates.Executive further acknowledges that (1) it would be difficult to calculate damages to the Company and its affiliates from any breach of his obligations under thisSection 5, (ii) that injury to the Company and its affiliates from any such breach would be irreparable and impossible to measure, and (iii) that the remedy at lawfor any breach or threatened breach of this Section 5 would therefore be an inadequate remedy and, accordingly, the Company shall, in addition to all otheravailable remedies (including without limitation seeking such damages as it can show it and its affiliates has sustained by reason of such breach and/or theexercise of all other rights it has under this Agreement), be entitled to injunctive and other similar equitable remedies .

SECTION 6 . REPRESENTATIONS BY EXECUTIVE

Executive represents and warrants that he is free to enter into and perform each of the terms and conditions of this Agreement; and that his executionand/or performance of all his obligations under this Agreement does not and will not violate or breach any other agreement between Executive and any otherperson or entity . Executive acknowledges that but for this representation and warranty, the Company would not agree to enter into this Agreement .


This Agreement is binding upon and inures to the benefit of the par ties and their respective heirs, executors , administrators, personal representatives,successors and assigns. The Company may assign its rights or delegate its duties under this Agreement at any time and from time to time , but such assignmentshall not relieve the Company of its obligations hereunder.

However, the parties acknowledge that the availability of Executive to perform services and the covenants provided by Executive hereunder have been a materialconsideration for the Company to enter into this Agreement. Accordingly, Executive may not assign any of his rights or delegate any of his duties under thisAgreement, either voluntarily or by operation of law, without the prior written consent of the Company, which may be given or withheld by the Company in itssole and absolute discretion .

SECTION 8 . NOTICES .

All notices, requests, demands or other communications hereunder shall be deemed to have been duly given when delivered, addressed as follows(or at such other address is the addressed party may have substituted by notice pursuant to this Section 8):

If to Executive : Tim Bender148 Canyon Lakes WaySan Ramon , CA 9458 3

if to the Company : LeapFrog Enterprises, Inc .6401 Hollis Street, Suite 100Emeryville, CA 9460 8Attn : Vice President , Human Resource s

SECTION 9, MISCELLANEOUS .

9.1 Entire Agreement . This Agreement and the exhibits hereto and the agreements referenced herein embody the entire representations , warranties,covenants and agreements in relation to the subject matter hereof and supersede any previous agreement (including any prior draft or version of this Agreement),whether written or oral, between the Company and Executive . No other representations , warranties, covenants , understandings or agreements in relation heretoexist between the panics except as otherwise expressly provided herein .


9 .3 Applicable Law Choice of Forum . This Agreement has been made and executed under, and will be construed and interpreted in accordance with, thelaws of the State of California .

9 .4 Attorneys' Fees. The Company agrees to reimburse Executive for legal fees incurred in connection with the preparation and negotiation of thisAgreement up to a maximum of $12,500 . In any action or proceeding to enforce or interpret this Agreement, or arising out of this Agreement, the prevailingparty or parties are entitled to recover a reasonable allowance for fees and disbursements of counsel and costs of arbitration or suit, to be determined by the courtin which the action or proceeding is brought .

9 .5 Provisions Severable . Every provision of this Agreement is intended to be severable from every other provision of this Agreement . If any provision of

this Agreement is held to be void or unenforceable, in whole or in part, the remaining provisions will remain, in

full force and effect, unless the remaining provisions are so eviscerated by such holding that they do not reflect the intent of the panics in entering into thisAgreement . If any provision of this Agreement is held to be unreasonable or excessive in scope or duration, that provision will be enforced to the maximumextent permitted by law.

9.6 Non-Waiver of Rights and Breaches . Any waiver by a party of any breach of any provision of this Agreement will not be deemed to be a waiver ofany subsequent breach of that provision or of any breach of any other provision of this Agreement. No failure or delay in exercising any right, power, or privilegegranted to a party under any provision of this Agreement will be deemed a waiver of chat or any, other right, power or privilege . No single or partial exercise ofany right, power or privilege granted to a party under any provision of this Agreement will preclude any other or further exercise of that or any other right, poweror privilege .

9 .7 Interpretation of Agreement . Each of the parties has been represented by counsel in the negotiation and preparation of this Agreement . The pattiesagree that this Agreement is to be construed as jointly drafted, Accordingly, this Agreement will be construed according to the fair meaning of its language, andthe rule of construction that ambiguities are to be resolved against the drafting party will not be employed in the interpretation of this Agreement.

9 .8 Gender and Number . Concerning the words used in this Agreement, the singular form shall include the plural form, the masculine gender shall includethe feminine or neuter gender, and vice versa, as the context requires, and the word `person' shall include any natural person partnership, corporation,

association, trust, estate or other legal entity.

9.9 Headines . The headings of the Sections and Paragraphs of this Agreement am inserted for ease of reference only, and will have no effect in theconstruction or interpretation of this Agreement.

9.10 Counterparts. This Agreement and any amendment or supplement to this Agreement may be executed in two or more counterparts, each of which willconstitute an original but all of which will together constitute a single instrument . Transmission by facsimile of an executed counterpart signature page hereof by

a party hereto shall constitute due execution and delivery of this Agreement by such party .

9 .11 No Mitigation : Payment Oblieations Absolute . Executive shall not be required to mitigate damages or the amount of any payment provided for underthis Agreement by seeking other employment or otherwise, not shall the amount of any payment provided for under this Agreement be reduced by anycompensation earned by Executive as a result of employment by another employer . The Company's obligations to pay Executive the amounts providedhereunder shall be absolute and unconditional and shall not be affected by any circumstances, including, without limitation, any set-off, counterclaim,recoupment, defense or other right the Company may have against Executive, any of which may be asserted against Executive in a separate proceeding .

IN WITNESS WHEREOF, the part ies hereto have caused this Employment Agreement to be dully executed and delivered as of the date first abovewritten .

EXECUTIVE :

Isl Timothy Bende r

TIMOTHY BENDER

COMPANY :

LEAPFROG ENTERPRISES, INC.

/s/ Michael Woo d

MICHAEL WOODPRESIDENT & CEO

EMPLOYMENT AGREEMENTExhibit 10.28

THIS EMPLOYMENT AGREEMENT, effective as of February 10, 2004 ("Agreement"), is made between LeapFrog Enterprises, Inc ., a Delawarecorporation ((he "Company"), and Jerome Perez ("Employee") .

AGREEMENT :

NOW, THEREFORE, in consideration of the mutual promises and subject to the terms and conditions set forth herein, the parties hereto agree asfollows :

SECTION 1 . EMPLOYMENT.

1 .1 Position . Duties, Responsibilities, Authority . The Company hereby employs Employee as President, LeapFrog Enterprises, Inc ., on the termsand conditions hereinafter set forth. In such capacity, Employee shall have such duties and authority as are customary for, and commensurate with such position .Employee shall, to the best of Employee's ability, carry out such responsibilities and duties in an efficient, trustworthy, ethical, effective and businesslikemanner. Employee's performance of services under this Agreement shall be rendered in the San Francisco Bay Area, or at any other location or locations asEmployee and the Company's Board of Directors (the "Board") shall mutually agree from time to time . Employee shall perform Employee's responsibilitieshereunder for the Company and/or such affiliates of the Company as the Company's Chief Executive Officer (the "CEO") may designate from time to time .

1 .2 Exclusive Employment . While Employee is employed with the Company, Employee shall devote Employee's full business time to Employee'sduties and responsibilities set forth in this Section 1 . Without limiting the generality of the foregoing, Employee shall not, without the prior written approval ofthe Board, render services of a business, professional or commercial nature to any other person, firm or corporation, whether for compensation or otherwise,except that Employee may engage in civic, philanthropic and community service activities so long as such activities do not interfere with Employee's ability tocomply with this Agreement and are not otherwise in conflict with the policies or interests of the Company .

SECTION 2 . COMPENSATION AND OTFIER BENEFITS .

In consideration of Employee ' s employment , and except as otherwise provided herein, Employee shall receive from the Company the compensationand bene fits described in this Section 2 . Except as otherwise specified in this Agreement , the compensation and employee benefits payable to Employee pursuantto this Agreement may be changed only by the written agreement of the parties . Employee authorizes the Company to deduct and withhold from allcompensation to be paid to Employee any and all sums required to be deducted or withheld by the Company pursuant to the provisions of any federal, state, orlocal law, regulation , ruling, or ordinance , including, but not limited to, income tax withholding and payroll taxes .

2 .1 Base t . While Employee is employed with the Company, the Company shall pay to Employee, and Employee shall be entitled toreceive from the Company, as a fixed salary for the full time employment referred to in Section 1 hereof, compensation ("Base Compensation") at the rate ofTwenty Nine Thousand One Hundred and Sixty Six Dollars and 67/100 ($29,166 .67) per calendar month (a rate equivalent to $350,000 per annum), less standardpayroll deductions and tax withholdings . Said Base Compensation shall be payable in intervals not less than twice a month in accordance with Company paymentpolicy for executives in effect from time to time. Employee's Base Compensation will be subject to adjustment from time to time as determined by the Board .

2.2 Stock Options . Within forty-five (45) days following the effective date of this Agreement, the Company shall grant Employee an option topurchase 400,000 shares of the Company's common stock (the "Option"), pursuant to the terms of the Company's 2002 Equity Incentive Plan (the "Plan"). TheOption shall vest over a four year period, with 1/48eh of the option vesting monthly for Forty Eight (48) months, commencing on the Employee's first day ofemployment with the Company (the "Employment Date") . The Option shall he subject to the terms and conditions of the Plan and the corresponding stock optiongrant notice and stock option agreement ; provided, however, that in the event of any conflict between any provision of the Plan, the stock option agreement andthis Agreement relating to the Option, the provisions of this Agreement shall govern. In addition to being granted the Option, Employee shall be entitled toparticipate in any other stock option, stock incentive or similar plans as are available from time to time to other management personnel at the Company .

2 .3 Bonuses .2 .3 .1 Incentive Bonuses. Employee is eligible to receive an annual discretionary bonus of up to 80% of Employee's then current annual

Base Compensation (the "Bonus"), based on the Company's performance and Employee's achievement of performance objectives established in writing by theCEO in consultation with Employee, which achievement will be determined by the Board in its sole good faith discretion . In calendar year 2004 only, Employeeshall receive a guaranteed bonus equal to 80% of Employee's then current annual Base Compensation, so long as Employee is an active employee of theCompany as of December 31, 2004. Except as provided in Section 3 .2 below, if Employee is not employed as of December 31 of the Bonus year, he will nothave earned the Bonus, or any pro-rata portion of the Bonus for that year . Payment of any Bonus shall be subject to standard payroll deductions and taxwithholdings. If the Company adopts a bonus plan under which Employee is eligible to participate, and the total amount of the annual bonus opportunity underthe new bonus plan is not less than the amount of the annual bonus opportunity under this Section 2 .3 and the criteria for receipt of the bonus under the newbonus plan are reasonable as compared to those previously established pursuant to this Section 2 .3, Employee shall participate in the new plan and shall no longerbe eligible to receive any Bonus under this Section 2.3 .

2 .3 .2 Signing Bonus . Employee shall receive a one-time signing bonus of Fifty Thousand Dollars ($50,000), less standard payrolldeductions and tax withholdings, payable to Employee on the first paycheck issued after the Employment Date . If Employee

voluntarily resigns his employment within two (2) years after the Employment Date, other than for Good Reason (as defined in Section 3 .2 below), Employeeshall repay to the Company the full signing bonus amount of Fifty Thousand Dollars ($50,000) on or before the last day of Employee's employment with theCompany (the "Separation Date") . Employee hereby agrees that, if any such signing bonus repayment amount due is not repaid in full by the Separation Date, the

Company may deduct the amount due from any expense reimbursements, severance or Consulting Fees owed to Employee .

2 .4 Other Benefits . Employee shall be entitled to standard Company employee benefits for senior management, including group medical and dentalinsurance coverage for Employee, Employee's spouse and dependent children, disability insurance coverage, and sick leave, pursuant to the Company's benefitsplans, policies and guidelines, including but not limited to contribution requirements for dependent coverage, as approved by the Board from time to time . In

addition, Employee shall be entitled to receive :

(i) Car Allowance. Automobile allowance of $650 per month, less standard payroll deductions and tax withholdings .

(ii) Vacation . Four (4) weeks of paid vacation time per calendar year, accrued in equal semi-monthly increments of 6 .67 hours, with the totalaccrued and unused vacation balance (including accrued vacation carried over from previous years) capped at seven (7) weeks . Vacation accrual will cease when

the maximum seven (7) week vacation balance is reached and will resume when the balance falls below the maximum amount .

(iii) Life Insurance . The Company shall contribute up to five thousand dollars ($5,000) each year during Employee's employment for the cost ofpremiums to obtain and maintain during the period of Employee's employment one or more policies of term life insurance providing an aggregate benefit in theamount of $1,000,000 . Employee shall have the right to designate the beneficiary or beneficiaries of the benefit payable upon death pursuant to such policy orpolicies and may transfer ownership of such policy or policies to any life insurance trust, family trust or other trust.

(iv) Moving and Temporary Living Expenses . Reimbursement of reasonable expenses associated with moving Employee's primary residence fromNew York to the San Francisco Bay Area, including but not limited to shipment of household goods from the New York residence to the Bay Area residenceusing the Company's standard carrier and the following expenses associated with the sale of Employee's New York residence and the purchase of Employee'sBay Area residence : customary real estate commission, reasonable attorney fees and/or escrow agent fees, notary and acknowledgement fees, excise stamps, taxcertificates, conveyance fees, recording fees, costs of required surveys and inspections, state and local real estate transfer taxes, title insurance, title search,mortgage application costs for up to two lending institutions, appraisal fees, credit report, recording of mortgage and deed ; and an amount sufficient to gross-upEmployee's tax on the reimbursement amount, In addition, the Company will reimburse Employee for the following temporary living expenses during his first

six months of employment with the Company : (a) reasonable coach airfare for one round-trip ticket per week

to New York ; (b) reasonable coach airfare for round trip tickets for Employee ' s spouse and children to make two v isits from New York to the Bay Area (c)lodging at Woodfin Suites; and (d) reasonable car re ntal expenses .

(v) Morteage Interest Payments . Upon Employee's purchase of a residence in the Bay Area, the Company shall pay Employee a monthlyreimbursement equal to the Mortgage Interest Payments (as hereinafter defined) until the Company's obligation to make such payment terminates as providedbelow . As used herein, the term "Mortgage Interest Payments" shall mean the lower of. (a) the sum of(]) Employee's monthly interest portion of the mortgagepayments on the portion of the Stipulated Mortgage Amount (as defined below) over $1,100,000, plus an amount sufficient to gross-up Employee's tax on suchreimbursement amount, plus (2) that amount which would be Employee's monthly interest portion of the first $1,100,000 of the Stipulated Mortgage Amountafter offsetting the value of any tax deduction that Employee would receive for such interest payments, and (b) the amounts resulting from the calculation inclause (a) above assuming that the Employee's mortgage is an Approved Mortgage (as defined below) . The Mortgage Interest Payments shall continue until andthen terminate on the earliest to occur of (A) Employee no longer being employed by the Company, or (B) Employee no longer making payments on a mortgageon his primary residence in the Bay Area, or (C) five (5) years after the Employee purchases a residence in the Bay Area . If Employee refinances and/or sells oneCalifornia residence and purchases another in California, the amount of the Mortgage Interest Payments shall not be recalculated, but shall continue unaffectedby such transaction .

As used herein , the following terms shall have the following meanings :"Stipulated Mortgage Amount" shall mean a mortgage principal amount equal to the difference between the Purchase Price and the Net Sales Proceeds ;

"Purchase Price" shall mean the lesser of (a) the purchase price of Employee's Bay Area residence or (b) Two Million Five hundred Thousand Dollars($2,500,000);

"Net Sales Proceeds " shall mean the greater of (a) the net sales proceeds from the sale of Employee ' s New York Residence or (b) Five Hundred ThousandDollars ($ 500,000) ; and

"Approved Mortgage " means a mo rt gage loan in a principal amount not to exceed $2,000,000, with an interest rate equal to the lowest of (a) the actualinterest rate under Employee's mortgage and (b) 7% per annum .


3 .1 Term and Termination . Employee's employment with Company is for unspecified duration and constitutes at -will employment within themeaning of Californ ia Labor Code Section 2922 . Accordingly , the employment relationship may be terminated at any time with or without Cause or GoodReason , by Company or by Employee, immediately upon delive ry of written notice. Except as otherwise specifi cally provided in Section 3 .2 below, upontermination of employment , Employee shall not be entitled to receive any compensation or benefits other than Base Compensation and accrued and unusedvacation earned through the Separation Date .

3 .2 Compensation and Benefits ilnon Termination . In the event Employee's employment terminates for any reason, the Company shall pay toEmployee : (1) all of his accrued and unused vacation and unpaid Base Compensation earned through the Separation Date, and (2) any bonus earned but unpaid asof the Separation Date (i .e ., in the event that Employee has worked through December 31 of the previous year and earned a bonus, but such bonus has not beenpaid as of the Separation Date) . If the Company terminates Employee's employment for any reason other than his death, disability, or Cause, or Employeevoluntarily resigns without Good Reason, and Employee provides the Company with the Release described below, Employee shall be entitled to receive thefollowing severance benefits (collectively, the "Severance Benefits") :

(i) Within First Year. If the Separation Date occurs within one (1) year after the Employment Date and Employee has not received Optionacceleration pursuant to Section 4 below, the Option shall accelerate vesting such that a total of 100,000 shares subject to the Option shall be fully exercisable asof the Separation Date . The remaining 300,000 unvested shares subject to the Option shall cease vesting and shall terminate as of the Separation Date .

(ii) After First Year. If the Separation Date occurs more than one (1) year after the Employment Date and Employee has not received Optionacceleration pursuant to Section 4 below, one-half (112) of the shares subject to the Option that have not otherwise vested as of the Separation Date shallaccelerate vesting and become fully exercisable as of the Separation Date . The remaining unvested shares subject to the Option shall cease vesting and shallterminate as of the Separation Date .

(iii) Three Year Post-Employment Consulting . If the Separation Date occurs within the first three (3) years after the Employment Date, Employeeshall immediately commence a consulting relationship with the Company under the terms set forth in this section (the "Consultancy") .

a . Consulting Period . The consulting relationship shall continue until the third anniversary of the Separation Date (the "Consulting Period"),unless Employee provides any services or assistance in any capacity to a Competitive Business (as defined below), in which event the consulting relationshipshall immediately terminate ("Early Termination"), the Company shall have no continuing obligation to pay any Consulting Fees, and Employee shall have nofurther obligation to provide consulting services . Nothing in this subsection 3 .2(iii)(a) shall restrict Employee from engaging in a Competitive Business at anytime after the Separation Date . The parties acknowledge and agree that this Agreement does not contain a covenant not to compete, nor any form of unlawfulrestraint against trade, and the parties covenant that they shall not challenge the enforceability of the Consultancy on the basis that it contains any covenant not tocompete or any form of unlawful restraint against trade. In the event that, notwithstanding the provisions of the previous sentence, a court of competentjurisdiction or an arbitrator determines that the Early Termination provision or the Consultancy is unenforceable or invalid in whole or

in part, the parties agree that the Company shall bear the risk thereof and that, regardless of whether or not Employee provides services or assistance to aCompetitive Business, so long as Employee abides by the other provisions under this Section 3 .2(iii), the Company shall pay the Consulting Fees to Employeeduring the Consulting Period .

b. Consulti a Services . Employee shall provide consulting services to the Company in any area of his expertise upon request by theCompany. Employee shall provide the consulting services off-site at a location of his choosing . Employee shall make himself available to perform suchconsulting services throughout the Consulting Period, at reasonable times, fora minimum often (10) hours per month, provided that the Company shall notrequire consulting services to be performed at a time or in a manner that would unreasonably interfere with Employee's ability to engage in any employment,consulting or work relationship other than his consulting work for the Company ("O(her Work Activity") . As part of his consulting services, Employee shall,within the first forty-five (45) days of the Consulting Period, provide the Company with a report providing briefing information, as reasonably requested by theCompany, on Company operations and activities (in which Employee had personal involvement or about which he had personal knowledge) pending as of theSeparation Date .

c . Consulting Fees . The Company shall pay Employee a monthly consulting fee equal to forty three thousand seven hundred fifty dollars($43,750) ((he "Consulting Fees") . If, after twenty-four (24) months after the Separation Date, Employee engages in Other Work Activity, and the relationship isnot with a Competitive Business, the consulting relationship with the Company shall continue but the Company shall, effective with payments with respect to thetwenty-fifth (25'h) month and thereafter, reduce the Consulting Fees by the gross amount of monetary compensation earned by Employee from the Other WorkActivity . Employee hereby agrees to promptly notify the Company in writing if he engages in any Other Work Activity during the Consulting Period, and toprovide documentation of such gross amount of monetary compensation earned thereby .

d . Taxes and Withholding. The Company will not withhold from the Consulting Fees any amount for taxes, social security or other payrolldeductions . Employee acknowledges that he will be solely responsible for, and will file, on a timely basis, all tax returns and payments required to be filed with,or made to, any tax authority with respect to the performance of services and receipt of Consulting Fees .

e . Expense Reimbursement . Pursuant to its regular business practice, the Company will reimburse Employee for all reasonable businessexpenses incurred during the Consulting Period .

f. Ownership of Work Product . Employee hereby assigns to the Company all right, title and interest in and to any work product created byEmployee, or to which Employee contributes, pursuant to the Consultancy (the "Work Product"), including all copyrights, trademarks and other intellectualproperty rights contained therein. Employee agrees to execute, at the Company's request and expense, all documents and other instruments necessary or desirableto confirm such assignment, including without limitation, a copyright assignment in

the form required by the Company ("Assignment of Copyright") . In the event that Employee does not, for any reason, execute such documents within areasonable time after the Company's request, Employee hereby irrevocably appoints the Company as his attorney-in-fact for the purpose of executing suchdocuments on his behalf, which appointment is coupled with an interest .

g . Artist's and Moral Rights. If Employee has any rights, including without limitation "artist's rights" or "moral rights," in the Work Productthat cannot be assigned, Employee agrees to waive enforcement worldwide of such rights against the Company . In the event that Employee has any such rightsthat cannot be assigned or waived, Employee hereby grants to the Company an exclusive, royalty-free, worldwide, irrevocable, perpetual license to use,reproduce, distribute, create derivative works of, publicly perform and publicly display the Work Product in any medium or format, whether now known or laterdeveloped .

h. Representations and Warranties . Employee represents and warrants that : (a) he has the right and unrestricted ability to assign the WorkProduct to the Company as set forth above, and (b) he will not create Work Product, which he knows or reasonably should have known (without being requiredto make an independent investigation), infringes upon any copyright, patent, trademark, right of publicity or privacy, or any other proprietary right of any person,whether contractual, statutory or common law . Employee agrees to indemnify the Company from any and all damages, costs, claims, expenses or other liability(including reasonable attorneys' fees) arising from or relating to the breach by Employee of the representations and warranties set forth in this section .

i . Indenendent Contractor Relationship. During the Consulting Period, Employee's relationship with the Company will be that of anindependent contractor, and nothing in the Consultancy is intended to, or should be construed to, create a partnership, agency, joint venture or employmentrelationship . Employee will not be entitled during the Consulting Period to any of the benefits that the Company may make available to its employees, including,but not limited to, life insurance, profit-sharing or retirement benefits . Employee shall, however, remain eligible to receive termination benefits pursuant to thisSection 3 .2 . Employee shall not be authorized during the Consulting Period to make any representation, contract or commitment on behalf of the Companyunless specifically requested or authorized in writing to do so by the CEO.

j . Competitive Business . For purposes of this Agreement, Competitive Business means Mattel, Inc ., Fisher-Price, Inc ., Hasbro, Inc. or anyof their affiliates, or any other entity that engages in the development, marketing or sale of educational learning products or educational toys, arts and crafts, baby

gear (e .g . high chairs, car seats, etc ., a category known in the retail industry as "juvenile products"), or infant or toddler toys .

(iv) Loss Reimbursement . If the Separation Dale occurs within the first three (3) years after the Employment Dale, and within twelve (l2) monthsafter the Separation Date Employee sells his Bay Area residence in a bona fide sale to an unaffiliated third party (the "Sale") for a price (the "Sale Price") whichis less than the Purchase Price (as defined in Section

2 .4(v) above), the Company shall reimburse Employee the lesser of (a) $750,000 or (b) the sum of (i) the amount of Employee's principal investment in the BayArea residence that Employee loses in connection with the Sale plus (ii) the amount, if any, paid by Employee to the mortgagor upon the Sale in excess of theSale Price (such lesser amount being defined as the "Loss Reimbursement"), if Employee has made best efforts to maintain the Bay Area residence and optimizethe Sale Price . The amount of the Loss Reimbursement shall be reduced by the amount of any insurance proceeds received by Employee for damage to the BayArea residence and not applied to the repair of such damage.

If Employee elects to sell the Bay Area residence within the time frame specified above and receives an unaffiliated third party offer to purchase the Bay Arearesidence which would entitle Employee to the Loss Reimbursement under this Section, and which unaffiliated third party offer Employee would otherwiseaccept (the "Third Party Offer"), the Company shall have the right of first refusal to match the Third Party Offer and acquire the Bay Area residence on the sameterms and conditions of the Third Party Offer, including but not limited to the price, date for close of escrow, and the terms of the purchase and sale agreement (ifEmployee has negotiated a purchase and sale agreement with the party making the Third Party Offer) . On receipt of a Third Party Offer, Employee shall deliverto the Company a copy of the Third Party Offer with a written statement signed by Employee that Employee intends to accept such offer . The Company shallhave three (3) business days after the date of delivery of such written statement to deliver written notice to Employee of the Company's election to purchase theBay Area residence on the same terms and conditions contained in the Third Party Offer, and upon receipt of such notice Employee shall be obligated to sell, andCompany shall be obligated to purchase, the Bay Area residence on the same terms and conditions contained in the Third Party Offer. Failure by the Company todeliver such notice to Employee within the required time period, or delivery of a notice stating that the Company declines to purchase the Bay Area residence,shall constitute a refusal ("Refusal") . Upon Refusal, Employee shall be free to convey the Bay Area residence to the party making the Third Party Offer .

(v) Two Year Post-Employment Consulting . If the Separation Date occurs more than three (3) years after the Employment Date, Employee shallimmediately commence the Consultancy under the terms set forth in Section 3 .2(iii) above, except that the Consulting Period shall continue for twenty-four (24)months (rather than three (3) years) after the Separation Date, unless Employee provides any services or assistance in any capacity to a Competitive Business (asdefined above), in which event the consulting relationship shall immediately terminate and the Company shall have no continuing obligation to pay anyConsulting Fees .

(vi) Pro Rata Bonus . Employee shall receive a pro rata portion of any bonus that Employee would, but for the termination, otherwise have beenentitled to receive in the year of the Separation Date, subject to required payroll deductions and withholdings, as and when otherwise payable under thisAgreement or any bonus plan . For purpose of further clarification of this section 3 .2(vi), to the extent that the earning of such bonus is based on Employeeachievement of objectives and/or Company performance during a certain bonus period (the "Bonus Period"), Employee's right to receive a bonus pursuant to thisSection shall be based on the results from the entire Bonus Period, and Employee shall be entitled to receive a pro-rata portion of such bonus based on thepercentage of the Bonus Period during which the Employee was employed .

(vii) Health Reimbursements . If Employee timely elects to continue his Company-provided group health insurance coverage pursuant to federalCOBRA law and, if applicable, state insurance laws, during the period that Employee performs consulting services for the Company as set forth in thisAgreement, the Company shall reimburse Employee for the cost of Employee's COBRA premiums for him and his dependents (if applicable) to continue healthinsurance coverage at the same level of coverage for him and his dependents (if applicable) in effect as of the Separation Date and, when Employee is no longereligible for continued coverage under COBRA or applicable state insurance laws, the Company shall reimburse employee for the cost of premiums for him andhis dependents (if applicable) for an individual policy to continue health insurance coverage at the same level of coverage for him and his dependents (ifapplicable) in effect as of the Separation Date . Employee's entitlement to such reimbursement shall cease upon the earlier of . (a) the date Employee becomeseligible for group health insurance coverage with a subsequent employer or (b) the date Employee's consulting relationship with the Company pursuant to thisAgreement ends. Employee shall notify the Company's vice president of Human Resources in writing immediately upon becoming eligible for health insurancecoverage with a subsequent employer.

As a condition of receipt of the Severance Benefits, Employee shall : (a) prior to his receipt of any of the Severance Benefits, provide the Company with aneffective general release of known and unknown claims against the Company and its officers, directors, employees, shareholders, parents, subsidiaries,successors, agents, and affiliates, in a form reasonably required by the Company and consistent with the tenns of this Agreement (the "Release"), and (b) at anytime during which he is receiving Severance Benefits (including Consulting Fees pursuant to a consulting relationship) (the "Severance Period"), respond fully inwriting to any Company inquiry regarding his Other Work Activities, subject, however, to any duties of confidentiality that Employee has to any third partieswith respect to such Other Work Activities .

In no event will Employee vest in any stock options or other similar rights, other than as described in Sections 3 .2 (i) and (ii), during the Severance Period .

3 .3 Definitions. For purposes of this Agreement, the following definitions shall apply :3 .3 .1 Disability . The term "disability" shall mean a physical or mental disability that renders Employee unable to perform one or more of the

essential functions of his job, as determined by the Board, for a period of 120 consecutive days or more than 180 days in any consecutive 12-month period .

3 .3 .2 Cause . The tens "Cause" shall mean (i) Employee's commission of any of fraud, embezzlement or misappropriation involving theCompany; (ii) Employee's conviction of or enter of a plea of guilty or no contest to any felony involving moral turpitude or dishonesty ; (iii) Employee's action,or failure to commit an act, involving the Company which

amounts to willful misconduct, wanton misconduct, gross negligence or a breach of this Agreement, and which is materially and demonstrably harmful to theCompany; or (iv) Employee's willful failure to perform his responsibilities and duties to the Company following receipt of written notice from the Companywhich specifically describes past instances of such willful failure (other than any such failure resulting from his incapacity due to disability) . With respect to atermination for Cause arising out of conduct described in clauses (i), (iii) or (iv) of this paragraph, a termination shall not be considered for Cause for purposes ofthis Agreement unless there shall have been delivered to the Employee a copy of a resolution duly adopted by affirmative vote of not less than a majority of theentire Board, at a meeting of the Board called and held for that purpose (after reasonable notice to Employee and an opportunity for Employee, together with hiscounsel or other advisors, to be heard at such meeting), finding that .in the good faith opinion of the Board the Employee had engaged in conduct described inclause (i), (iii) or (iv) above and specifying the particulars thereof in detail .

3 .3 .3 Good Reason . Employee shall have "Good Reason" for termination of his employment if he resigns within sixty (60) days after theoccurrence of one of the following events without his consent : (i) any removal of Employee from his position as President of the Company unless the removaloccurs solely as a result of a merger into a larger entity (other than Mattel, Inc . or Fisher Price, Inc .) such that Employee retains the same authority for divisionaloperations that are substantially identical to the Company's previous operations as an independent entity ; (ii) any material diminution of Employee's role,responsibilities and authority as President of the Company except to the extent that the authority of Employee is reduced solely as a result of a merger into alarger entity (other than Mattel, Inc . or Fisher Price, Inc.) such that Employee retains the same authority for divisional operations that are substantially identicalto the Company's previous operations as an independent entity ; (iii) reduction of Employee's Base Compensation in an amount greater than ten percent (10%) ofEmployee's initial Base Compensation under this Agreement, unless the base compensation of other senior level executive officers of the Company isaccordingly reduced ; (iv) any material reduction in the aggregate level of benefits to which Employee is entitled on the effective date of this Agreement or thetaking of any action which would adversely affect Employee's accrued benefits under any such employee benefit plans, unless a similar reduction is made for allsenior level executive officers of the Company; (v) a demand by the Company to Employee that Employee relocate to any place that exceeds a fifty (50) mileradius beyond the primary location of the Company as of the date of this Agreement ; or (vi) a material breach by the Company of any of its obligations under thisAgreement. In the event that Employee intends to assert that he has grounds for terminating his employment for Good Reason, Employee shall give the Companyat least two (2) days' notice in the case of clause (i) or thirty (30) days' notice in the case of clauses (ii) through (vi) . The Company shall have the opportunityduring the applicable notice period to cure the event which Employee asserts constitutes Good Reason (provided that this event is not a reoccurrence of the sameor substantially similar event that occurred during the prior six (6) months) and, if the Company does so, then Employee shall not be entitled to terminate hisemployment for Good Reason .

3 .3 .4 Chance of Control . "Change of Control" " means the occurrence in a single transaction or in a series of related transactions of any oneor more of the following events :

(a) any person (within the meaning of Section 13(d) or 14(d) of the Securities Exchange Act of 1934, as amended) becomes the owner,directly or indirectly , of securities of the Company representing more than fifty percent (50%) of the combined voting power of the Company's then outstandingsecuri ties other than by virtue of a merger, consolidation or similar transaction ;

(b) there .is consummated a merger, consolidation or similar transaction involving (directly or indirectly) the Company and, immediatelyafter the consummation of such merger, consolidation or similar transaction, the stockholders of the Company immediately prior thereto do not own, directly orindirectly, outstanding voting securities representing more than fifty percent (50%) of the combined outstanding voting power of the surviving entity in suchmerger, consolidation or similar transaction or more than fitly percent (50%) of the combined outstanding voting power of the parent of the surviving entity insuch merger, consolidation or similar transaction ;

(c) the stockholders of the Company approve or the Board approves a plan of complete dissolution or liquidation of the Company; or

(d) there is consummated a sale, lease, license or other disposition of all or substantially all of the consolidated assets of the Company andits subsidiaries, other than a sale, lease, license or other disposition of all or substantially all of the consolidated assets of the Company and its subsidiaries to anentity, more than fifty percent (50%) of the combined voting power of the voting securities of which are owned by stockholders of the Company in substantiallythe same proportions as their ownership of the Company immediately prior to such sale, lease, license or other disposition .

3 .4 Limitation on Payments. If any payment or benefit Employee would receive pursuant to this Agreement ("Payment") would (i) constitute a"parachute payment" within the meaning of Section 280G of the Internal Revenue Code of 1986, as amended (the "Code"), and (ii) but for this sentence, besubject to the excise tax imposed by Section 4999 of the Code (the "Excise Tax"), then such Payment shall be reduced to the Reduced Amount . The "ReducedAmount" shall be either (x) the largest portion of the Payment that would result in no portion of the Payment being subject to the Excise Tax or (y) the largestportion, up to and including the total, of the Payment, whichever amount, after taking into account all applicable federal, state and local employment taxes,income taxes, and the Excise Tax (all computed at the highest applicable marginal rate), results in the Executive's receipt, on an after-lax basis, of the greateramount of the Payment . If a reduction in payments or benefits constituting "parachute payments" is necessary so that the Payment equals the Reduced Amount,reduction shall occur in the following order unless Employee elects in writing a different order (provided, however, that such election shall be subject toCompany approval if made on or after the date on which the event that triggers the Payment occurs) : reduction of cash payments ; cancellation of accelerated

vesting of stock options ; reduction of employee benefits . In the event that acceleration of vesting of stock option compensation is to be reduced, such accelerationof vesting shall be cancelled in the reverse order of the date of grant of Employee's stock options unless Employee elects in writing a different order forcancellatio n

The accounting firm engaged by the Company for general audit purposes as of the day prior to the Separation Date shall perform the foregoing calculations . The

Company shall bear all expenses with respect to the determinations by such accounting firm required to be made hereunder .

The accounting firm engaged to make the determinations hereunder shall provide its calculations, together with detailed supporting documentation, to theCompany and Employee within fifteen (15) calendar days after the date on which Employee's right to a Payment is triggered (if requested at that time by theCompany or Employee) or such other time as requested by the Company or Employee . If the accounting firm determines that no Excise Tax is payable withrespect to a Payment, either before or after the application of the Reduced Amount, it shall furnish the Company and Employee with an opinion reasonablyacceptable to Employee that no Excise Tax will be imposed with respect to such Payment . Any good faith determinations of the accounting firm made hereundershall be final, binding and conclusive upon the Company and Employee .

SECTION 4. CHANGE OF CONTRO L

In the event of a Change of Control (as defined in Section 3 .3 .4 above), Employee shall be entitled to receive the following :

(i) Within First Year . If the Change of Control occurs within one (1) year after the Employment Date, the Option shall accelerate vesting such that a totalof 100,000 shares subject to the Option shall be fully exercisable immediately upon the effective date of the Change of Control . The remaining 300,000 unvestedshares subject to the Option shall continue to vest pursuant to the terms of the Plan and corresponding stock option grant notice and stock option agreement .

(ii) After First Year . If the Change of Control occurs more than one (1) year after the Employment Date, one-half (112) of the shares subject to the Optionthat have not otherwise vested as of the effective date of the Change of Control shall accelerate vesting and become fully exercisable immediately upon theeffective date of the Change of Control. The remaining unvested shares subject to the Option shall continue to vest pursuant to the terms of the Plan andcorresponding stock option grant notice and stock option agreement .

SECTION 5 . BUSINESS, EXPENSE S

The Company shall pay for or reimburse Employee for all reasonable business expenses incurred by Employee in the performance of Employee'sduties hereunder, upon submission to the Company, in accordance with Company policy, a written accounting of such expenses, which accounting shall includean itemized list of all expenses incurred, the business purposes for which such expenses were incurred, and such receipts as Employee reasonably has been ableto obtain .

SECTION 6 . PROPRIETARY INFORMATION AND INVENTIONS AGREEMEN T

Employee shall execute and abide by the Company's Proprietary Information and Inventions Agreement attached hereto as Exhibit A ("ProprietaryInformation Agreement"). Employee acknowledges that his obligations under the Proprietary Information Agreement shall survive the termination of his

-employment with the Company .

SECTION 7 . COMPANY POLICIE SEmployee agrees that at all times during Employee's employment hereunder, Employee shall comply with the Company's employee policies and

procedures established by the Company from time to time . Employee further agrees that he shall acknowledge in writing that he has read and will abide by theCompany's Employee Handbook.

SECTION 8 . OTHER ACTIVITIES.

8 .1 Non-coin e rn ition. During the period of Employee's employment by the Company, Employee will not, directly or indirectly, either by himself orby assisting others, compete with the Company or prepare to compete with the Company.

8 .2 Non-solicitation. During the period of Employee's employment by the Company, and for three (3) years after the Separation Date, Employeewill not, either directly or indirectly, solicit, induce, or encourage or attempt to solicit, induce, or encourage any employee, consultant or independent contractorof the Company to terminate his or her relationship with the Company to become an employee, consultant or independent contractor to or for any other person orentity .

8 .3 Cooperation . Employee agrees that during his employment with the Company and for a period of three (3) years following the Separation Date,Employee shall, upon Company's reasonable request and in good faith and with Employee's best efforts, subject to Employee's reasonable availability, cooperatewith, and voluntarily (without subpoena or other legal compulsion) provide complete and accurate information to the Company in any dispute, controversy, orlitigation in which Company may be involved and with respect to which Employee obtained knowledge while employed by the Company or any of its affiliates,successors, or assigns, including, but not limited to, making himself available to provide testimony in legal proceedings, providing factual information toCompany attorneys, or signing

truthful affidavits. Any such activities shall be scheduled, to the extent reasonably possible, to accommodate Employee's business and personal obligations . TheCompany shall promptly pay Employee's reasonable travel and incidental out-of-pocket expenses incurred in connection with any such cooperation .

8 .4 Remedies. Employee agrees that the Company would be irreparably harmed in the event that Sections 8 .1 or 8 .2 of the Agreement are violatedand, therefore, in the event of any actual or threatened violation of either of these Sections, the Company will be entitled in addition to any other remedies towhich it may be entitled, at law or in equity, to a temporary restraining order and preliminary and permanent injunctive relief and to specifically enforce theterms and provisions hereof without the necessity of posting bond or proving damages .

SECTION 9 . R PRESENTATIONS BY EMPLOYEE AND AGREEMENT TO ABIDE BY OBLIGATIONS TO THIRD PARTIES .

Employee represents and warrants , to the best of his knowledge , that Employee is free to enter into and perform each of the terms and conditions ofthis Agreement ; and, to the best of his knowledge , that Employee ' s execution and/or performance of al l Employee 's obligations under this Agreement does notand will not violate or breach any other agreement between Employee and any other person or entity, including (without limitation ) the Employee Secrecy andInvention Agreement between Employee and Fisher Price (the "Fisher Price Agreement") . Employee acknowledges that but for this representation and warranty,the Company would not agree to enter into this Agreement . Employee agrees that he will not undertake any activities or actions that, in his sole discretion, mayviolate or potentially violate any agreement between Employee and any third par ty, including (without limitation ) the Fisher P rice Agreement, and the Companyagrees that it will not require Employee to undertake any such activities .


This Agreement is binding upon and inures to the benefit of the parties and their respective heirs, executors , administrators , personal representatives,successors and assigns . The Company may assign its rights or delegate its duties under this Agreement at any time and from time to time . However, the partiesacknowledge that the availability of Employee to perform services and the covenants provided by Employee hereunder are personal to Employee and have been amaterial consideration for the Company to enter into this Agreement . Accordingly, Employee may not assign any of Employee ' s rights or delegate any ofEmployee ' s duties under this Agreement , either voluntarily or by operation of law, without the prior written consent of the Company, which may be given orwithheld by the Company in its sole and absolute discretion .

14

SECTION 11 . NOTICES .

Notices under this Agreement shall be sufficient only if mailed by certified or registered United States mail, retu rn receipt requested; delivered byexpress mail (e.g ., Federal Express) ; or personally delivered, to the parties at their addresses set forth on the signature page hereof or as amended by noticepursuant to this subsection. Notice by mail shall be deemed received two (2) days after the date of mailing .

SECTION 12 . ARBITRATION .

To ensure the timely and economical resolution of disputes that arise in connection with Employee's employment with the Company, Employee andthe Company agree that any and all disputes, claims, or causes of action arising from or relating to the enforcement, breach, performance, negotiation, execution,or interpretation of this Agreement, Employee's employment, or the termination of Employee's employment, shall be resolved to the fullest extent permitted bylaw by final, binding and confidential arbitration, by a single arbitrator, in San Francisco, California, conducted by Judicial Arbitration and Mediation Services,Inc . ("JAMS") under the then applicable JAMS employment rules. By agreeing to this arbitration procedure , both Employee and the Company waive theright to resolve any such dispute through a trial by jury or judge or administrative proceeding . The arbitrator shall : (a) have the authority to compeladequate discovery for the resolution of the dispute and to award such relief as would otherwise be permitted by law ; and (b) issue a written arbitration decision,to include the arbitrator's essential findings and conclusions and a statement of the award . The arbitrator shall be authorized to award any or all remedies thatEmployee or the Company would be entitled to seek in a court of law. The Company shall pay all JAMS' arbitration fees in excess of the amount of court feesthat would be required if the dispute were decided in a court of law . Nothing in this Agreement is intended to prevent either Employee or the Company fromobtaining injunctive relief in court to prevent irreparable harm pending the conclusion of any such arbitration. Notwithstanding the foregoing, Executive and theCompany shall each have the right to resolve any issue or dispute involving Company trade secrets or proprietary information or the Company's or Employee'sintellectual property rights by court action instead of arbitration,

SECTION 13 . MISCELLANEOUS .

13 .1 Entire Aerecmcnt . This Agreement contains the full, complete , and exclusive embodiment of the entire agreement of the parties with regard tothe subject matter hereof and supersedes all prior communications , representations , or agreements, oral or written, and all negotiations , conversations ordiscussions between or among the parties relating to this Agreement and all past course of dealing or indust ry custom. Employee has not entered into thisAgreement or employment relationship in reliance on any representations , written or oral, other than those contained herein.


13 .3 Applicable Law: Choice of Forum . This Agreement has been made and executed under, and will be construed and interpreted in accordancewith, the laws of the State of California .

13 .4 Attorneys' Fees. In any action or proceeding to enforce or interpret this Agreement, or arising out of this Agreement, the prevailing party orparties are entitled to recover a reasonable allowance for fees and disbursements of counsel and costs of arbitration or suit, to be determined by the arbitrator orthe court in which the action or proceeding is brought .

13 .5 Provisions Severable . Every provision of this Agreement is intended to be severable from every other provision of this Agreement . If anyprovision of this Agreement is held to be invalid, illegal or unenforceable, in whole or in part, such invalidity, illegality or unenforceability shall not affect theother provisions of this Agreement ; and this Agreement shall be construed as if such invalid, illegal or unenforceable provision had never been contained hereinexcept to the extent that such provision may be construed and modified so as to render it valid, lawful, and enforceable in a manner consistent with the intent ofthe parties to the extent compatible with the applicable law as it shall then appear .

13 .6 Non-Waiver of Ri is and Breaches . Any waiver by a party of any breach of any provision of this Agreement will not be deemed to be awaiver of any subsequent breach of that provision, or of any breach of any other provision of this Agreement . No failure or delay in exercising any right, power,or privilege granted to a party under any provision of this Agreement will be deemed a waiver of that or any other right, power or privilege . No single or partial

exercise of any right, power or privilege granted to a party under any provision of this Agreement will preclude any other or further exercise of that or any otherright, power or privilege.

13 .7 Gender and Number. Concerning the words used in this Agreement, the singular form shall include the plural form, the masculine gender shallinclude the feminine-or neuter gender, and vice versa, as the context requires, and the word "person" shall include any natural person, partnership, corporation,association, trust, estate or other legal entity .

13 .8 Headings . The headings of the Sections and Paragraphs of this Agreement are inserted for ease of reference only, and will have no effect in theconstruction or interpretation of this Agreement .

16

1 ~

13 .9 Counteroarls . This Agreement and any amendment or supplement to this Agreement may be executed in two or more counterparts, each o f

which will constitute an original but all of which will together constitute a single instrument . Transmission by facsimile of an executed counterpart signaturepage hereof by a party hereto shall constitute due execution and delivery of this Agreement by such party .

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and delivered as of the date first above written .

LEAPFROG ENTERPRISES, INC . :

By ; Is/ Michael C . Wood

Name: Michael C. Wood

Title : President and CEO

Address :

6401 1lollis Street, Suite 150Emeryville, CA 94608

JEROME PEREZ :

/s! Jerome Perez

Address :

17

EXHIBIT A

EMPLOYEE PROPRIETARY INFORMATION AND INVENTIONS AGREEMEN T

In consideration of my employment or continued employment by LEAPFROG ENTERPRISES, INC . (the "Company" ), and the compensation now and hereafter

paid to me, I hereby agree as follows :

1 . NONDISCLOSURE.

1 .1 Recognition of Company's Rights ; Nondisclosure . At all times during my employment and thereafter, I will hold in strictest confidence and will notdisclose, use, lecture upon or publish any of the Company's Proprietary Information (defined below), except as such disclosure, use or publication may berequired in connection with my work for the Company, or unless an officer of the Company expressly authorizes such in writing . I will obtain Company's written

approval before publishing or submitting for publication any material (written, verbal, or otherwise) that relates to my work at Company and/or incorporates anyProprietary Information, I hereby assign to the Company any rights I may have or acquire in such Proprietary information and recognize that all Proprietary

Information shall be the sole property of the Company and its assigns .

1 .2 Proprietary Information. The tens "Proprietary Information " shall mean any and all confidential and/or proprietary knowledge, data or

information of the Company . By way of illustration but not limitation, "Proprietary Information" includes (a) trade secrets, inventions, mask works, ideas,processes, formulas, source and object codes, data, programs, other works of authorship, know-how, improvements, discoveries, developments, designs and

techniques (hereinafter collectively referred to as "Inventions"); and (b) information regarding plans for research, development, new products, training,marketing and selling, business plans, budgets and unpublished financial statements, licenses, prices and costs, suppliers and customers ; and (c) information

regarding the skills and compensation of other employees of the Company.

1 .3 Third Party Information . I understand, in addition, that the Company has received and in the future will receive from third parties confidential orproprietary information ("Third Party Information") subject to a duty on the Company's part to maintain the confidentiality of such information and to use it

only for certain limited purposes . During the term of my employment and thereafter, I will hold Third Party Information in the strictest confidence and will notdisclose to anyone (other than Company personnel who need to know such information in connection with their work for the Company) or use, except inconnection with my work for the Company, Third Party information unless expressly authorized by an officer of the Company in writing .

1 .4 No Improper Use of Information of Prior Employers and Others. During my employment by the Company I will not improperly use or discloseany confidential information or trade secrets, if any, of any former employer or any other third party to whom T have an obligation of confidentiality, and 1 willnot bring onto the premises of the Company any unpublished documents or any property belonging to any former employer or any other third party to whom Ihave an obligation of confidentiality unless consented to in writing by that former employer or person . I will use in the performance of my duties only

information which is generally known and used by persons with training and experience comparable to my own, which is common knowledge in the industry orotherwise legally in the public domain, or which is otherwise provided or developed by the Company .

2 . ASSIGNMENT OF INVENTIONS,

2 .1 Proprietary Rights. The term "Proprietary Rights" shall mean all trade secret, patent, copyright, mask work and other intellectual property rights

throughout the world.

2 .2 Prior Inventions. Inventions, if any, patented or unpatented, which I made prior to the commencement of my employment with the Company are

excluded from the scope of this Agreement . To preclude any possible uncertainty, I have set forth on Exhibit B (Previous Inventions) attached hereto a completelist of all Inventions that I have, alone or jointly with others, conceived, developed or reduced to practice or caused to be conceived, developed or reduced topractice prior to the commencement of my employment with the Company, that I consider to be my property or the property of third parties and that I wish tohave excluded from the scope of this Agreement (collectively referred to as "Prior Inventions") . If disclosure of any such Prior Invention would cause me to

violate any prior confidentiality agreement, I understand that I am not to list such Prior Inventions in Exhibit B but am only to disclose a cursory name for each

such invention, a listing of the party(ies) to whom it belongs and the fact that full disclosure as to such

inventions has not been made for that reason . A space is provided on Exhibit B for such purpose. If no such disclosure is attached, I represent that there are noPrior Inventions . If, in the course of my employment with the Company, I incorporate a Prior Invention into a Company product, process or machine, theCompany is hereby granted and shall have a nonexclusive, royalty-free, irrevocable, perpetual, worldwide license (with rights to sublicense through multipletiers of sublicensees) to make, have made, modify, use and sell such Prior Invention . Notwithstanding the foregoing, I agree that I will not incorporate, or permitto be incorporated, Prior Inventions in any Company inventions without the Company's prior written consent .

2 .3 Assignment of Inventions . Subject to Sections 2 .4, and 2 .6, I hereby assign and agree to assign in the future (when any such Inventions or ProprietaryRights are first reduced to practice or first fixed in a tangible medium, as applicable) to the Company all my right, title and interest in and to any and allInventions (and all Proprietary Rights with respect thereto) whether or not patentable or registrable under copyright or similar statutes, made or conceived orreduced to practice or learned by me, either alone or jointly with others, during the period of my employment with the Company . Inventions assigned to theCompany, or to a third party as directed by the Company pursuant to this Section 2, are hereinafter referred to as "Company Inventi ons ."

2 .4 Nonassignable Inventions . This Agreement does not apply to an Invention which qualifies fully as a nonassignable Invention under Section 2870 ofthe California Labor Code (hereinafter "Section 2870") . I have reviewed the notification on Exhibit A (Limited Exclusion Notification) and agree that my

signature acknowledges receipt of the notification .

2 .5 Obligation to Keep Company Informed . During the period of my employment and for six (6) months after termination of my employment with theCompany, I will promptly disclose to the Company fully and in writing all Inventions authored, conceived or reduced to practice by me, either alone or jointlywith others . In addition, I will promptly disclose to the Company all patent applications filed by me or on my behalf within a year after termination o femployment . Al the time of each such disclosure, I will advise the Company in writing of any Inventions that I believe fully qualify for protection under Section2870; and I will at that time provide to the Company in writing all evidence necessary to substantiate that belief. The Company will keep in confidence and willnot use for any purpose or disclose to third parties without my consent any confidential information disclosed in writing to the Company pursuant to thisAgreement relating to Inventions that qualify fully for protection under the provisions of Section 2870. 1 will preserve the confidentiality of any Invention thatdoes not fully qualify for protection under Section 2870 .

2 .6 Government or Third Party. I also agree to assign all my right, title and interest in and to any particular Company Invention to a third party,including without limitation the United States, as directed by the Company .

2 .7 Works for Hire. I acknowledge that all original works of authorship which are made by me (solely or jointly with others) within the scope of myemployment and which are protectable by copyright are "works made for hire, " pursuant to United States Copyright Act (17 U . S .C ., Section 101) .

2 .8 Enforcement of Proprietary Rights. I will assist the Company in every proper way to obtain, and from time to time enforce, United States andforeign Proprietary Rights relating to Company Inventions in any and all countries . To that end I will execute, verify and deliver such documents and performsuch other acts (including appearances as a witness) as the Company may reasonably request for use in applying for, obtaining, perfecting, evidencing, sustainingand enforcing such Proprietary Rights and the assignment thereof, In addition, I will execute, verify and deliver assignments of such Proprietary Rights to theCompany or its designee. My obligation to assist the Company with respect to Proprietary Rights relating to such Company Inventions in any and all countriesshall continue beyond the termination of my employment, but the Company shall compensate me at a reasonable rate after my termination for the time actuallyspent by meat the Company's request on such assistance .

In the event the Company is unable for any reason, after reasonable effort, to secure my signature on any document needed in connection with the actionsspecified in the preceding paragraph, I hereby irrevocably designate and appoint the Company and its duly authorized officers and agents as my agent andattorney in fact, which appointment is coupled with an interest, to act for and in my behalf to execute, verify and file any such documents and to do all otherlawfully permitted acts to further the purposes of the preceding paragraph with the same legal force and effect as if executed by me . I hereby waive and quitclaimto the Company any and all claims, of any nature whatsoever, which I now or may hereafter have for infringement of any Proprietary Rights assigned hereunderto the Company.

3 . RECORDS, I agree to keep and maintain adequate and current records (in the form of notes, sketches, drawings and in any other form that may be required bythe Company) of all Proprietary Information developed by me and all Inventions made by me during the period of my employment at the Company, whichrecords shall be available to and remain the sole property of the Company at all times .

4. ADDITIONAL ACTIVITIES. I agree that during the period of my employment by the Company I will not, without the Company's express written consent, engagein any employment or business activity which is competitive with, or would otherwise conflict with, my employment by the Company . I agree further that for theperiod of my employment by the Company and for one (1) year after the date of termination of my employment by the Company I will not, either directly orthrough others, solicit or attempt to solicit any employee, independent contractor or consultant of the company to terminate his or her relationship with theCompany in order to become an employee, consultant or independent contractor to or for any other person or entity . I agree further that for the period of myemployment with the Company and for one (1) year after the date of termination of my employment with the Company I will not in any manner discourage anyclient or customer of the Company from continuing its business relationship with the Company .

5 . No CONFLICTING OBLIGATION . I represent that my performance of all the terms of this Agreement and as an employee of the Company does not and will notbreach any agreement to keep in confidence information acquired by me in confidence or in trust prior to my employment by the Company . I have not enteredinto, and I agree I will not enter into, any agreement either written or oral in conflict herewith .

6. RETURN OF COMPANY DOCUMENTS, When I leave the employ of the Company, I will deliver to the Company any and all drawings, notes, memoranda,specifications, devices, formulas, and documents, together with all copies thereof, and any other material containing or disclosing any Company Inventions,Third Party Information or Proprietary information of the Company . I further agree that any property situated on the Company's premises and owned by theCompany, including disks and other storage media, filing cabinets or other work areas, is subject to inspection by Company personnel at any time with or withoutnotice .

7 . LEGM. AND EQUITABLE REMEDIES. Because my services are personal and unique and because I may have access to and become acquainted with the ProprietaryInformation of the Company, the Company shall have the right to enforce this Agreement and any of its provisions by injunction, specific performance or otherequitable relief, without bond and without prejudice to any other rights and remedies that the Company may have for a breach of this Agreement .

S . NOTICES. Any notices required or permitted hereunder shall be given to the appropriate party at the address specified below or at such other address as theparty shall specify in writing . Such notice shall be deemed given upon personal delivery, or express mail (e .g ., Federal Express) delivery, to the appropriateaddress or if sent by certified or registered mail, three (3) days after the date of mailing .

9 . NOTIFICATION OF New EMPLOYER. In the event that I leave the employ of the Company, I hereby consent to the notification of my new employer of my rightsand obligations under this Agreement .

10, GENERAL PROVISION S

10.1 Governing Law; Consent to Personal Jurisdiction . This Agreement will be governed by and construed according to the laws of the State ofCalifornia, as such laws are applied to agreements entered into and to be performed entirely within California between California residents . I hereby expresslyconsent to the personal jurisdiction of the state and federal courts located in Alameda County, California for any lawsuit filed there against me by Companyarising from or related to this Agreement .

10.2 Severability. In case any one or more of the provisions contained in this Agreement shall, for any reason, be held to be invalid, illegal orunenforceable in any respect, such invalidity, illegality or unenforceability shall not affect the other provisions of this Agreement ; this Agreement shall beconstrued as if such invalid, illegal or unenforceable provision had never been contained herein ; and such provision shall be construed and modified so as torender it valid, lawful, and enforceable in a manner consistent with the intent of the parties to the extent compatible with the applicable law as it shall thenappear .

10 .3 Successors and Assigns. This Agreement will be binding upon my heirs, executors, administrators and other legal representatives and will be for thebenefit of the Company, its successors, and its assigns .

10.4 Survival. The provisions of this Agreement shall survive the termination of my employment and the assignment of this Agreement by the Companyto any successor in interest or other assignee .

10 .5 Employment. I agree and understand that nothing in this Agreement shall confer any right with respect to continuation of employment by theCompany, nor shall it interfere in any way with my right or the Company's right to terminate my employment at any time, with or without cause or advancenotice, which rights are hereby expressly reserved.

10 .6 Waiver. No waiver by the Company of any breach of this Agreement shall be a waiver of any preceding or succeeding breach . No waiver by theCompany of any right under this Agreement shall be construed as a waiver of any other right . The Company shall not be required to give notice to enforce strictadherence to all terms of this Agreement .

10.7 Entire Agreement . The obligations pursuant to Sections l and 2 (except Section 2 .7) of this Agreement shall apply to any time during which I waspreviously engaged, or am in the future engaged, by the Company as a consultant if no other agreement governs nondisclosure and assignment of inventionsduring such period . This Agreement is the final, complete and exclusive agreement of the parties with respect to the subject matter hereof and supersedes andmerges all prior discussions between us . No modification of or amendment to this Agreement, nor any waiver of any rights under this Agreement, will beeffective unless in writing and signed by the party to be charged . Any subsequent change or changes in my duties, salary or compensation will not affect thevalidity or scope of this Agreement .

This Agreement shall be effective as of the first day of my employment with the Company .

I HAVE READ T HI S AGREEMENT CAREFULLY, UNDERSTAND ITS TERMS, AND AGREE THERETO . I HAVE COMPLETELY FILLED OUT EXHIBIT B TO THIS AGREEMENT ,

Date d

(Signature )

(Printed Name )

ACCEPTED AND AGREED TO :


By:

Title :

(Address)

Dated :

EXHIBIT A

LIMITED EXCLUSION NOTIFICATIO N

THIS Is To NOTIFY you in accordance with Section 2872 of the California Labor Code that the foregoing Agreement between you and the Company doesnot require you to assign or offer to assign to the Company any invention that you developed entirely on your own time without using the Company's equipment,supplies, facilities or trade secret information except for those inventions that either :

1 . Relate at the time of conception or reduction to practice of the invention to the Company's business, or actual or demonstrably anticipated research ordevelopment of the Company; or

2 . Result from any work performed by you for the Company .

To the extent a provision in the foregoing Agreement purports to require you to assign an invention otherwise excluded from the preceding paragraph, theprovision is against the public policy of this state and is unenforceable .

This limited exclusion does not apply to any patent or invention covered by a contract between the Company and the United States or any of its agenciesrequiring full title to such patent or invention to be in the United States .

I ACKNOWLEDGE RECEIPT of a copy of this notification .

By :

(PRINTED NAME OF EMPLOYEE )

Date:

WITNESSED BY :

(PRINTED NAME OF REPRESENTATIVE)

A-1

EXHIBIT B

TO : LEAPFROG ENTERPRISES, INC.

FROM

DATE :

SUBJECT : Previous Invention s1 . Except as listed in Section 2 below, the following is a complete list of all inventions or improvements relevant to the subject matter of my employment byLeapFrog Enterprises, Inc. (the "Company") that have been made or conceived or first reduced to practice by one alone or jointly with others prior to my

engagement by the Company :

❑ No inventions or improvements .

❑ See below :

❑ Additional sheets attached .

2 . Due to a prior confidentiality agreement, I cannot complete the disclosure under Section I above with respect to inventions or improvements generally listedbelow, the proprietary rights and duty of confidentiality with respect to which I owe to the following party(ies) :

Invention or Improvement Party(ies) Relationship

1 .

3.

❑ Additional sheets attached .

Exhibit 21 .01

Subsidiary

Subsidiaries of the Registrant

Jurisdiction of Incorporation or organization

LeapFrog Canada, Inc. CanadaLeapfrog (H .K.) Limited Hong Kon gLeap Frog Toys (UK) Limited England and WalesLF France, SAS Franc eLF Macao Commercial Offshore Limited MacauLeapFrog International Research Company Cayman IslandsLeapFrog Mexico S .A. de C .V, Mexico

Exhibit 23.0 1

Consent of Ernst & Young LLP, Independent Auditor s

We consent to the incorporation by reference in the Registration Statement on Form S-8 (No . 333-97061) pertaining to the 2002 Equity Incentive Plan,2002 Non-Employee Directors' Stock Option. Plan of our report dated February 4, 2004 with respect to the consolidated financial statements and schedule ofLeapFrog Enterprises, Inc . included in the Annual Report on Form 10-K for the year ended December 3 1 , 2003 .

!s/ Ernst & Young LL P

San Francisco, CaliforniaMarch 8, 2004

Exhibit 31 .0 1

CERTIFICATION S

1, Thomas J . Kalieske, certify that :

I . I have reviewed this annual report on Form 10-K of LeapFrog Enterprises, Inc . ;


3 . Based on my knowledge , the financial statements , and other financial info rotation included in this report, fairly present in all material respects the financialcondition , results of operations and cash flows of the registrant as of, and for, the periods presented in this report ;

4. The registrant 's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in ExchangeAct Rules 13a-15(e) and 15d-15(e)) for the registrant and have :

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensurethat material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared ;

b) [intentionally omitted ]

c) Evaluated the effectiveness of the regis(rant's disclosure controls and procedures and presented in this report our conclusions about the effectivenessof the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; an d

d) Disclosed in this report any change in the registrant ' s internal control over financial reporting that occurred du ring the registrant's most recent fiscalquarter (the registrant 's fourth fiscal quarter in the case of an annual report ) that has materi ally affected, or is reasonably likely to materially affect,the registrant' s internal control over financial reporting ; and

5 . The registrant 's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant 's auditors and the audit committee of registrant 's board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the registrant's ability to record, process, summarize and report financial information ; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control overfinancial reporting.

Date : March 10, 2004 /s/ Thomas J . Kalinsk e

Thomas J . KalinskeChief Executive Officer

Exhibit 31 .0 2

CERTIFICATIONS

I, James P. Curley, certify that :

1 . I have reviewed this annual report on Form IO-K of LeapFrog Enterprises, Inc . ;

2 . Based on my knowledge, this report does not contain any untrue statement of a material factor omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report ;

3 . Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report ;

4 . The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange .Act Rules I3a- 15(e) and 15d--I 5(e)) for the registrant and have :

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensurethat material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared ;

b) [intentionally omi(ted]

c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectivenessof the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation ; and

d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscalquarter ((he registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect,the regis(rant's internal control over financial reporting ; and

The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions) :

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the registrant's ability to record, process, summarize and report financial information; an d

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control overfinancial reporting .

Date: March 10, 2004 Isf James P. Curley

James P . CurleyChief Financial Officer

Exhibit 32 .01

CERTIFICATION PURSUANT TO SECTION 906 OF THE PUBLIC COMPANYACCOUNTING REFORM AND INVESTOR PROTECTION ACT OF 200 2

(18 U .S . C . § 1350 , AS ADOPTED )

Pursuant to Section 906 of the Public Company Accounting Reform and Investor Protection Act of 2002 (18 U .S .C . § 1350, as adopted, the "Sarbanes-Oxley

Act"), Thomas J . Kalinske, the Chief Executive Officer of LeapFrog Enterprises, Inc . (the "Company"), and James P . Curley, the Chief Financial Officer of the

Company, each hereby certifies that, to the best of his knowledge :

The Company' s Annual Report on Form 10-K for the period ended December 31, 2003, to which this Certification is attached as Exhibit 32 .01 (the"Annual Report"), fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended ; and

The information contained in the Annual Report fairly presents, in all material respects, the financial condition of the Company at the end of the periodcovered by the Annual Report and results of operations of the Company for the period covered by the Annual Report .

Dated : March 10, 2004

Is/ Thomas J . Kalinkse /sl James P . Curley

Thomas J. Kalinske James P. Curle yChief Executive Officer Chief Financial Officer

Note: This certification accompanies the Annual Report pursuant to § 906 of the Sarbanes -Oxley Act and shall not be deemed "filed" by the Company for

purposes of Section 18 of the Securities Exchange Act of 1934, as amended.

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