Summary of LEAPFROG ENTERPRISES INC

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

The following management's discussion and analysis of financial condition and results of operations ("MD&A") is intended to help the reader understand the results of operations and financial condition of LeapFrog Enterprises, Inc. This MD&A is provided as a supplement to, and should be read in conjunction with, our Consolidated Financial Statements and the accompanying Notes to the Consolidated Financial Statements ("Notes") in Part I, Item 1 of this report.

Our Business

We design, develop and market a family of innovative technology-based learning platforms and related proprietary content for children of all ages at home and in schools around the world. We have created more than 150 interactive software titles, covering important subjects such as phonics, reading, writing and math. In addition, we have a broad line of stand-alone educational products, or toys, that do not require the separate purchase of software and are generally targeted at infants through five year olds. Our products are available in six languages and are sold globally through retailers, distributors and directly to schools. Our goal is to create educational products that kids love, parents trust and teachers value.

We generate revenue from developing, manufacturing, and selling platform hardware including: our Tag reading system, our classic Leapster, Leapster2 and Didj educational gaming platforms, and Clickstart: My First Computer learning system, along with a range of learning toys. We also generate revenue from developing and licensing a wide range of content for our platforms.

Our products compete most directly in the toy industry in the pre-school toy and electronic learning aids categories, both in the United States and in selected international markets. The educational toy category continues to attract new entrants as well as new innovative products, and competition is significant. We believe the principal methods of competition in our industry focus on performance, features, quality, brand recognition, learning content and price. We believe our learning toys, reading system, gaming platforms, and the related games and books, compete favorably on these bases.

Our business is highly seasonal with a significant portion of our revenues occurring in the second half of the year. Given relatively low sales volumes in the first half of the calendar year and the relatively fixed nature of many of our operating expenses which occur fairly evenly throughout the year, our results of operations are generally stronger in our third and fourth quarters relative to our first and second quarters. Conversely, our historical cash flow from operations tends to be highest in the first quarter of the year when we collect the majority of our accounts receivable related to the prior year's fourth quarter sales and lowest in our third quarter as we begin building inventory in preparation for the fourth quarter holiday season.

The global economic crisis led to a severe decline in sales in the fourth quarter of 2008 resulting in a departure from our normal seasonal pattern described above. Our sales for the fourth quarter were significantly below our expectations and constituted a substantially smaller percentage of our annual sales than they have in previous years. Given the seasonality of our business, declines in sales in the third and fourth quarters generally have a disproportionate impact on our annual operating results as well as our cash flows from operations at the beginning of the following year. This has proved to be the case so far in 2009 with sales well below historical levels.

We continue to reduce our cost structure by eliminating unnecessary expenditures, improving efficiency in our operations. This effort has included headcount reductions and migration of certain aspects of our product development cycle to external parties. In the fourth quarter of 2008, we completed a restructuring that involved the closure of some of our offices and a company-wide reduction in force. In 2009, we have continued the effort to streamline our cost structure by implementing further process improvements to create additional efficiencies. For example, we have continued to adjust our staffing levels to reduce overhead, and we currently plan to spend less on non-targeted advertising. We intend to focus our resources on building out our core product lines and adding to our content library, as well as further reducing other expenditures, particularly those related to selling, general and administrative activities, to correspond to our best ongoing estimates of consumer spending trends.

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We continue to invest in research and development ("R&D") of existing and new lines of business that we believe may contribute to our long-term growth. We also invest in R&D of advanced technologies for future hardware platforms and content, providing for standalone and online experiences. We believe delivering innovative and high-value solutions through our platforms and online experiences is the key to meeting customer needs and to our future growth.

We face significant risks associated with the economic downturn and continuing uncertainty through at least 2009. Weak sales in the fourth quarter of 2008 meant that retailers built up inventories of our products, which negatively impacted our sales in the first quarter of 2009, a trend that is likely to continue in subsequent quarters. In addition, an increasing number of retailers have encountered liquidity problems. If any of our most significant retailers suspend or reduce payments to us, become insolvent or file for bankruptcy, the resulting bad debt expense we would incur would likely have a material adverse effect on our results of operations. Further, continued deterioration in economic conditions could trigger events or circumstances indicating goodwill impairment has more likely than not occurred. We considered the need to update our most recent annual Goodwill annual impairment test as of March 31, 2009, and concluded that it was not necessary as we believe the assumptions used during the year end assessment remained appropriate. The potential business risk for us from macroeconomic conditions anticipated for 2009 is discussed further in Part
II. Item 1A.-Risk Factors-"The current economic crisis has had a material adverse effect on our sales, and we cannot be certain when sales will recover," "Retailer liquidity problems could harm our liquidity and financial results," "Our liquidity may be insufficient to meet the long-term or periodic needs of our business" and "Our net loss would be increased and our assets would be reduced if we are required to record impairment charges related to the value of our intangible assets.

Our strategic priorities for 2009 and beyond remain investing in the core categories of reading, educational gaming, our standalone toy line and our Learning Path "ecosystem." Our marketing will be oriented to increasing consumer sales in these categories, to drive a higher percentage of content sales, and to catalyze new growth in the learning category. We plan to launch new connected products and content in our reading and gaming categories, as well as our learning toy line in 2009. Importantly, we also intend to expand our standalone learning toy line, including our attractively-priced Scout line of plush learning toys, content and accessories and the Zippity learning system, a gaming system featuring full body-movement controls, which is our first co-branded product with Disney.