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JAKKS Pacific 10-K 2009 Documents found in this filing:UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
(Mark One)
For
the transition period from ____________ to ____________
Commission
File Number 0-28104
JAKKS
PACIFIC, INC.
(Exact
name of registrant as specified in its charter)
Registrant’s
telephone number, including area code: (310) 456-7799
Securities
registered pursuant to Section 12(b) of the Exchange Act:
Securities
registered pursuant to Section 12(g) of the Exchange Act:
Title of
Class
Common
Stock, $.001 par value per share
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes ¨ No ý
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15 of the Act. Yes ¨ No ý
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes ý 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
of registrant’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 a check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (check
one):
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes ¨ No ý
The
aggregate market value of the voting and non-voting common equity (the only such
common equity being Common Stock, $.001 par value per share) held by
non-affiliates of the registrant (computed by reference to the closing sale
price of the Common Stock on February 27, 2009 of $12.67) is
$345,211,090.
The
number of shares outstanding of the registrant’s Common Stock, $.001 par value
(being the only class of its common stock), is 27,934,231 (as of February 27,
2009).
Documents
Incorporated by Reference
None.
JAKKS
PACIFIC, INC.
INDEX
TO ANNUAL REPORT ON FORM 10-K
For
the Fiscal Year ended December 31, 2008
Items
in Form 10-K
DISCLOSURE
REGARDING FORWARD-LOOKING STATEMENTS
This
report includes “forward-looking statements” within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934. For example, statements included in this report regarding our financial
position, business strategy and other plans and objectives for future
operations, and assumptions and predictions about future product demand, supply,
manufacturing, costs, marketing and pricing factors are all forward-looking
statements. When we use words like “intend,” “anticipate,” “believe,”
“estimate,” “plan” or “expect,” we are making forward-looking statements. We
believe that the assumptions and expectations reflected in such forward-looking
statements are reasonable, based on information available to us on the date
hereof, but we cannot assure you that these assumptions and expectations will
prove to have been correct or that we will take any action that we may presently
be planning. We have disclosed certain important factors that could cause our
actual results to differ materially from our current expectations elsewhere in
this report. You should understand that forward-looking statements made in this
report are necessarily qualified by these factors. We are not undertaking to
publicly update or revise any forward-looking statement if we obtain new
information or upon the occurrence of future events or otherwise.
1
Item 1. Business>
In this
report, “JAKKS,” the “Company,” “we,” “us” and “our” refer to JAKKS Pacific,
Inc. and its subsidiaries.
Company
Overview
We are a
leading multi-line, multi-brand toy company that designs, produces, markets and
distributes toys and related products, writing instruments and related products,
pet toys, consumables and related products, electronics and related products,
and other consumer products. We focus our business on acquiring or licensing
well-recognized trademarks and brand names, most with long product histories
(“evergreen brands”). We seek to acquire these evergreen brands because we
believe they are less subject to market fads or trends. We also develop
proprietary products marketed under our own trademarks and brand
names. Our products are typically lower-priced toys and accessories,
and include:
Traditional
Toys
Prior to
2007, we had accounted for seasonal and outdoor products as a separate category.
During 2007, we restructured our internal operations and have consolidated this
product group within the Traditional category. These products share key
characteristics, including common management, distribution and marketing
strategies. We have restated our prior segment reporting to reflect this
change.
Craft,
Activity and Writing Products
2
Pet
Products
We
continually review the marketplace to identify and evaluate evergreen brands
that we believe have the potential for significant growth. We endeavor to
generate growth within these brands by:
Our
Business Strategy
In
addition to developing our proprietary brands and marks, licensing popular
brands enables us to use these high-profile marks at a lower cost than we would
incur if we purchased these marks or developed comparable marks on our own. By
licensing marks, we have access to a far greater range of marks than would be
available for purchase. We also license technology produced by unaffiliated
inventors and product developers to improve the design and functionality of our
products.
We have
obtained an exclusive worldwide license for our joint venture with THQ Inc.
(“THQ”), which develops, publishes and distributes video games based on WWE characters and themes.
Since the joint venture’s first title release in 1999, it has released 41 new
titles. We have recognized approximately $110.4 million in profit from the joint
venture through December 31, 2008. We and the joint venture are named as
defendants in lawsuits commenced by WWE, pursuant to which WWE is seeking
treble, punitive and other damages (including disgorgement of profits) in an
undisclosed amount and a declaration that the video game license with the joint
venture and an amendment to our toy licenses with WWE are void and unenforceable
(see “Legal Proceedings”).
We sell
our products through our in-house sales staff and independent sales
representatives to toy and mass-market retail chain stores, department stores,
office supply stores, drug and grocery store chains, club stores, toy specialty
stores and wholesalers. Our three largest customers are Wal-Mart, Target and
Toys ‘R’ Us, which account for approximately 30.1%, 13.2% and 13.2%,
respectively, of our net sales in 2008. No other customer accounted for more
than 10.0% of our net sales in 2008.
Our
Growth Strategy
The
execution of our growth strategy has resulted in increased levels
of revenues and earnings. In 2007 and 2008, we generated net sales of
$857.1 million and $903.4 million, respectively, and net income of $89.0 million
and $76.1 million, respectively. Approximately 1.4% and 1.2% of our increased
net sales in 2007 and 2008, respectively, were attributable to our acquisitions
since 2006. Key elements of our growth strategy include:
3
• Expand
International Sales.> We believe that foreign markets,
especially Europe, Australia, Canada, Latin America and Asia, offer us
significant growth opportunities. In 2008, our sales generated outside the
United States were approximately $161.9 million, or 17.9% of total net sales. We
intend to continue to expand our international sales by establishing a sales
office and distribution center and capitalizing on our experience and our
relationships with foreign distributors and retailers. We expect these
initiatives to continue to contribute to our international growth in
2009.
• Capitalize On Our
Operating Efficiencies.> We believe that our current
infrastructure and operating model can accommodate significant growth without a
proportionate increase in our operating and administrative expenses, thereby
increasing our operating margins.
The
execution of our growth strategy, however, is subject to several risks and
uncertainties and we cannot assure you that we will continue to experience
growth in, or maintain our present level of, net sales (see “Risk Factors,”
beginning on page 12). For example, our growth strategy will place additional
demands on our management, operational capacity and financial resources and
systems. The increased demand on management may necessitate our recruitment and
retention of additional qualified management personnel. We cannot assure you
that we will be able to recruit and retain qualified personnel or expand and
manage our operations effectively and profitably. To effectively manage future
growth, we must continue to expand our operational, financial and management
information systems and to train, motivate and manage our work force. There can
be no assurance that our operational, financial and management information
systems will be adequate to support our future operations. Failure to expand our
operational, financial and management information systems or to train, motivate
or manage employees could have a material adverse effect on our business,
financial condition and results of operations.
Moreover,
implementation of our growth strategy is subject to risks beyond our control,
including competition, market acceptance of new products, changes in economic
conditions, our ability to obtain or renew licenses on commercially reasonable
terms and our ability to finance increased levels of accounts receivable and
inventory necessary to support our sales growth, if any.
Furthermore,
we cannot assure you that we can identify attractive acquisition candidates or
negotiate acceptable acquisition terms, and our failure to do so may adversely
affect our results of operations and our ability to sustain growth.
Finally,
our acquisition strategy involves a number of risks, each of which could
adversely affect our operating results, including difficulties in integrating
acquired businesses or product lines, assimilating new facilities and personnel
and harmonizing diverse business strategies and methods of operation; diversion
of management attention from operation of our existing business; loss of key
personnel from acquired companies; and failure of an acquired business to
achieve targeted financial results.
Recent
Acquisitions
On
October 7, 2008, we acquired substantially all of the assets of Tollytots
Limited. The total initial consideration of $25.5 million consisted
of $11.8 million in cash and the assumption of liabilities in the amount of
$13.7 million, and resulted in goodwill of $3.0 million. In addition, we agreed
to pay an earn-out of up to an aggregate amount of $5.0 million in cash over the
three calendar years following the acquisition based on the achievement of
certain financial performance criteria, which will be recorded as goodwill when
and if earned. Tollytots is a leading designer and producer of licensed baby
dolls and baby doll pretend play accessories based on well-known brands and was
included in our results of operations from the date of acquisition.
On
October 8, 2008, we acquired substantially all of the stock of Kids Only, Inc.
and a related Hong Kong company, Kids Only Limited (collectively, “Kids
Only”). The total initial consideration of $23.2 million consisted of
$20.3 million in cash and the assumption of liabilities in the amount of $2.9
million, and resulted in goodwill of $12.5 million. In addition, we agreed to
pay an earn-out of up to an aggregate amount of $5.6 million in cash over the
three calendar years following the acquisition based on the achievement of
certain financial performance criteria, which will be recorded as goodwill when
and if earned. Kids Only is a leading designer and producer of licensed indoor
and outdoor kids’ furniture, and has an extensive portfolio which also includes
baby dolls and accessories, room décor and a myriad of other children’s toy
products and was included in our results of operations from the date
of acquisition.
On
December 29, 2008, we acquired certain assets of Disguise, Inc. and a related
Hong Kong company, Disguise Limited (collectively, “Disguise”). The
total initial consideration of $61.9 million consisted of $39.9 million in cash
and the assumption of liabilities in the amount of $22.0 million, and resulted
in goodwill of $51.6 million. We have not finalized our purchase price
allocation for Disguise and will engage a third party to perform studies and
valuations to the estimated fair value of assets and liabilities
assumed. Disguise is a leading designer and producer of Halloween and
everyday costume play and was included in our results of operations from the
date of acquisition.
4
Industry
Overview
According
to Toy Industry Association, Inc., the leading toy industry trade group, the
United States is the world’s largest toy market, followed by Japan and Western
Europe. Total retail sales of toys, excluding video games, in the United States,
were approximately $21.6 billion in 2008. We believe the two largest United
States toy companies, Mattel and Hasbro, collectively hold a dominant share of
the domestic non-video toy market. In addition, hundreds of smaller companies
compete in the design and development of new toys, the procurement of character
and product licenses, and the improvement and expansion of previously introduced
products and product lines. In the United States video game segment, total
retail sales of video game software were approximately $11.0 billion in
2008.
Products
We focus
our business on acquiring or licensing well-recognized trademarks or brand
names, and we seek to acquire evergreen brands which are less subject to market
fads or trends. Generally, our license agreements for products and concepts call
for royalties ranging from 1% to 14% of net sales, and some may require minimum
guarantees and advances. Our principal products include:
Traditional
Toys
Electronics
Products
Our
electronic products category includes our Plug It In & Play TV Games,
EyeClops™ Bionic Eye products and Laser Challenge® product
lines. Our current Plug It In
& Play TV
Games titles include licenses from Namco®, Disney, Marvel® and Nickelodeon, and feature such
games as SpongeBob
SquarePants®, Dora the
Explorer, Disney
Princess®, Ms.
Pac-Man® and Pac-Man®.
We
regularly release new Plug It
In & Play TV
Games titles for the pre-school and leisure gamer segments including
Wheel of Fortune®,
Deal or No Deal®,
Jeopardy®, Sesame
Street® and Thomas the
Tank™.
Wheels
Division Products
Our toy
vehicle line includes toy and activity vehicles and other toys. We also produce
radio controlled vehicles. Our toy vehicle line is comprised of an assortment of
rugged die-cast and plastic vehicles that range in size from four-and
three-quarter inch to big-wheeled seventeen inch vehicles. The breadth of the
line is extensive, with themes ranging from emergency, fire, farm and
construction, to racing and jungle adventure.
The Road Champs product line
consists of highly detailed, die-cast replicas of new and classic cars, trucks,
motorcycles, emergency vehicles and service vehicles, primarily in 1/43 scale
(including police cars, fire trucks and ambulances), buses and aircraft. Through
licenses, we produce replicas of well-known vehicles including those from Ford®, Chevrolet® and Porsche®. We believe that
these licenses increase the perceived value of the products and enhance their
marketability.
Our
extreme sports offerings include our MXS line of motorcycles with
riders, off-road vehicles, personal watercraft, surfboards and skateboards,
which are sold individually and with playsets and accessories.
Action
Figures and Accessories
We have
an extensive toy license with the WWE pursuant to which we have the right, until
December 31, 2009, to develop and market a full line of toy products based on
the popular WWE
professional wrestlers. These wrestlers perform throughout the year at live
events that attract large crowds, many of which are broadcast on free and cable
television, including pay-per-view specials. We launched this product line in
1996 with various series of 6 inch articulated action figures that have movable
body parts. We continually expand and enhance this product line by using
technology in the development and in the products themselves. The 6 inch figures
currently make up a substantial portion of our overall WWE line, which has since
grown to include many other new products including playsets. Our strategy has
been to release new figures and accessories frequently and to offer many
exclusive programs to our retail partners to keep the line fresh and relevant to
WWE’s television programming, and to retain the interest of the
consumers.
5
We also
develop, manufacture and distribute other action figures and action figure
accessories including those based on the animated series Pokemon, and the
Disney feature film The Chronicles of Narnia: Prince Caspian. In 2009, we expect
to launch a line of action figures and accessories based on Ultimate Fighting
Championship and in 2010, a product line of action figures and accessories based
on TNA (“Total Non-stop Action”) wrestling.
Our line
of role-play and dress-up products features entertainment and consumer products
properties such as Disney
Princess, Hannah
Montana and Dora the
Explorer for girls and Black & Decker and Pirates of the Caribbean for
boys. These products generated a significant amount of sales in 2008, and we
expect that level of sales to continue in 2009.
Infant
and Pre-school Toys
Our
pre-school toys include plush and electronic toys based on Care Bears, The Wiggles,
Barney licenses and more, some branded under Child Guidance ® and others
under Play Along
®.
Our line
of children’s indoor slumber bags features Dora the Explorer, SpongeBob SquarePants and
Pokémon brands, in
addition to our own proprietary designs.
Dolls
Dolls
include large, fashion and mini dolls and related accessories based on Cabbage Patch Kids®, Hannah Montana, The Cheetah Girls, Puppy in My Pocket and
Friends, Hairspray the movie and Disney Princess dolls and
private label fashion dolls for other retailers and sold to Disney Stores and
Disney Parks and Resorts.
Seasonal/
Outdoor Products
We have a
wide range of seasonal toys and outdoor and leisure products. Our Go Fly A Kite product line
includes youth and adult kites and a wide array of decorative flags, windsocks,
and windwheels. Our Funnoodle pool toys include
the basic Funnoodle pool floats and a variety of other pool toys. Our The Storm product line
includes water guns, gliders and sport balls. Another outdoor product is our
Fly Wheels XPV and
Flight, extensions of
our original Fly Wheels
vehicle line.
Junior
Sports Products
Our
junior sports products include Gaksplat, toy paintball
products and The Storm,
which include a variety of mini sport balls and activity products.
Baby
Dolls and Baby Doll Pretend Play Accessories
We have
an extensive line of licensed baby dolls and baby doll pretend play accessories
based on Graco®, Fischer-Price®, Disney Princess® and other
known brands. The high-quality realistic-looking lines feature baby doll
strollers, high chairs, bouncers, play yards, doll swings, travel seats and
travel bags, along with other accessories that emulate real baby products that
mothers today use.
Indoor
and Outdoor Kids’ Furniture
We
produce licensed indoor and outdoor kids' furniture, with an extensive portfolio
which includes baby dolls and accessories and room decor. Our
licensed portfolio includes character licenses, including Disney Princesses® Toy
Story®, Mickey
Mouse®, High School
Musical®, SpongeBob
Squarepants®, Dora the
Explorer®, Batman® and many others, as well as
several licenses new to JAKKS' portfolio. Products include children’s puzzle
furniture, tables and chairs to activity sets, trays, stools and
more,
6
Halloween
and Everyday Costume Play
We
produce Halloween costume and décor with an expansive and innovative line which
includes non-licensed Halloween costumes based on everything from horror,
pirates, historical figures and aliens to animals, vampires, angels and more, as
well as popular licensed characters from top intellectual property owners
including Disney®,
Marvel®, Sesame
Workshop®, Mattel®, and many
others.
Craft,
Activity and Writing Products
We market
products into the toy activity category which contain a broad range of
activities, such as make and paint your own characters, jewelry making, art
studios, posters, puzzles and other projects. These activities, which feature
popular characters, such as Nickelodeon’s Dora the Explorer, among
others, have immediate visual appeal and brand recognition. Our product lines
also include stationery, back-to-school and office pens, pencils, markers,
notebooks and craft products such as Blopens and Vivid Velvet activities.
These products are primarily marketed under our Flying Colors and Pentech brands, in addition
to various private label and other brands.
Pet
Products
We
entered the Pet Products category with our acquisition of Pet Pal, whose
products include pet toys, treats, beds, clothes and related pet products. These
products are marketed under JAKKS Pets™ and licenses include American Kennel Club, The Cat Fanciers’
Association, Bratz®, Disney and Marvel, as well as numerous
other entertainment and consumer product properties.
World
Wrestling Entertainment Video Games
In June
1998, we formed a joint venture with THQ, a developer, publisher and distributor
of interactive entertainment software for the leading hardware game platforms in
the home video game market. The joint venture entered into a license agreement
with the WWE under which it acquired the exclusive worldwide right to publish
WWE video games on all
hardware platforms. The term of the license agreement expires on December 31,
2009, and the joint venture has a right to renew the license for an additional
five years provided that there is an absence of a material breach of the license
agreement and that certain royalty minimums are met. Those minimums have been
met. We and the joint venture are named as defendants in lawsuits commenced by
WWE, pursuant to which WWE is claiming that there have been material breaches
with respect to the video game license and is seeking treble, punitive and other
damages (including disgorgement of profits) in an undisclosed amount and a
declaration that the video game license with the joint venture and an extension
of our toy licenses with WWE are void and unenforceable (see “Legal
Proceedings”).
The joint
venture agreement provides for us to have received guaranteed preferred returns
through June 30, 2006 at varying rates of the joint venture’s net sales
depending on the cumulative unit sales and platform of each particular game. The
preferred return was subject to change after June 30, 2006 and was to be set for
the distribution period beginning July 1, 2006 and ending December 31, 2009 (the
“Next Distribution Period”). The agreement provides that the parties will
negotiate in good faith and agree to the preferred return not less than 180 days
prior to the start of the Next Distribution Period. It further provides that if
the parties are unable to agree on a preferred return, the preferred return will
be determined by arbitration. Since the parties have not reached an agreement
with respect to the preferred return for the Next Distribution Period, the
preferred return for the Next distribution Period is to be determined through
arbitration. The preferred return is accrued in the quarter in
which the licensed games are sold and the preferred return is
earned. Based on the same rates as set forth under the original joint
venture agreement, an estimated receivable of $52.8 million has been accrued for
the period from July 1, 2006 to December 31, 2008, pending the resolution of
this outstanding issue. JAKKS seeks to retain the same rates as set forth under
the original joint venture agreement, while THQ seeks to pay a substantially
lower rate. In the event the arbitration results in a lower rate to us, there
would be a material charge to earnings and reduction in the receivable from
THQ.
7
The joint
venture currently publishes titles for the Sony, Nintendo and Microsoft
consoles, Sony® and Nintendo® hand-held platforms, mobile/wireless and personal
computers. It will also publish titles for new hardware platforms when, and as
they are introduced to the market and have established a sufficient installed
base to support new software. These titles are marketed to our existing
customers as well as to game, electronics and other specialty stores, such as
Electronics Boutique and Best Buy.
The
following table presents our results with the joint venture since its
inception:
Wrestling
video games have demonstrated consistent popularity. We believe that the success
of WWE titles is
dependent on the graphic look and feel of the software, the depth and variation
of game play and the popularity of WWE. We believe that as a
franchise property, WWE
titles have brand recognition and sustainable consumer appeal, which may allow
the joint venture to use titles over an extended period of time through the
release of sequels and extensions and to re-release such products at different
price points in the future.
Sales,
Marketing and Distribution
We sell
all of our products through our own in-house sales staff and independent sales
representatives to toy and mass-market retail chain stores, department stores,
office supply stores, drug and grocery store chains, club stores, toy specialty
stores and wholesalers. Our three largest customers are Wal-Mart, Target and
Toys ‘R’ Us, which accounted for approximately 58.5% of our net sales in 2007
and 56.5% of our net sales in 2008. With the addition of the Pet Pal® product line, we
began to distribute pet products to key pet supply retailers Petco and Petsmart
in addition to many other pet retailers and our existing customers. Except for
purchase orders relating to products on order, we do not have written agreements
with our customers. Instead, we generally sell products to our customers
pursuant to letters of credit or, in some cases, on open account with payment
terms typically varying from 30 to 90 days. From time to time, we allow our
customers credits against future purchases from us in order to facilitate their
retail markdown and sales of slow-moving inventory. We also sell our products
through e-commerce sites, including Toysrus.com and Amazon.com.
Outside
of the United States, we currently sell our products primarily in Europe,
Australia, Canada, Latin America and Asia. Sales of our products abroad
accounted for approximately $126.1 million, or 14.7% of our net sales, in 2007
and approximately $161.9 million, or 17.9% of our net sales, in 2008. We believe
that foreign markets present an attractive opportunity, and we plan to intensify
our marketing efforts and further expand our distribution channels
abroad.
8
We
establish reserves for sales allowances, including promotional allowances and
allowances for anticipated defective product returns, at the time of shipment.
The reserves are determined as a percentage of net sales based upon either
historical experience or on estimates or programs agreed upon by our customers
and us.
We
obtain, directly, or through our sales representatives, orders for our products
from our customers and arrange for the manufacture of these products as
discussed below. Cancellations generally are made in writing, and we take
appropriate steps to notify our manufacturers of these cancellations. We may
incur costs or other losses as a result of cancellations.
We
maintain a full-time sales and marketing staff, many of whom make on-site visits
to customers for the purpose of showing product and soliciting orders for
products. We also retain a number of independent sales representatives to sell
and promote our products, both domestically and internationally. Together with
retailers, we occasionally test the consumer acceptance of new products in
selected markets before committing resources to large-scale
production.
We
publicize and advertise our products in trade and consumer magazines and other
publications, market our products at international, national and regional toy,
stationery and other specialty trade shows, conventions and exhibitions and
carry on cooperative advertising programs with toy and mass market retailers and
other customers which include the use of print and television ads and in-store
displays. We also produce and broadcast television commercials for several of
our product lines, including our WWE action figure line, Disney large role playsets,
Plug It In & Play
TV Games, Puppy in My Pocket and Friends,
EyeClops, Hannah Montana and Cabbage Patch Kids. We may
also advertise some of our other products on television, if we expect that the
resulting increase in our net sales will justify the relatively high cost of
television advertising.
Product
Development
Each of
our product lines has an in-house manager responsible for product development.
The in-house manager identifies and evaluates inventor products and concepts and
other opportunities to enhance or expand existing product lines or to enter new
product categories. In addition, we create proprietary products to fully exploit
our concept and character licenses. Although we do have the capability to create
and develop products from inception to production, we generally use
third-parties to provide a portion of the sculpting, sample making, illustration
and package design required for our products in order to accommodate our
increasing product innovations and introductions. Typically, the development
process takes from three to nine months from concept to production and shipment
to our customers.
We employ
a staff of designers for all of our product lines. We occasionally acquire our
other product concepts from unaffiliated third parties. If we accept and develop
a third party’s concept for new toys, we generally pay a royalty on the toys
developed from this concept that are sold, and may, on an individual basis,
guarantee a minimum royalty. In addition, we engage third party developers to
program our line of Plug it in
& Play TV Games. Royalties payable to inventors and developers
generally range from 1% to 2.5% of the wholesale sales price for each unit of a
product sold by us. We believe that utilizing experienced third-party inventors
gives us access to a wide range of development talent. We currently work with
numerous toy inventors and designers for the development of new products and the
enhancement of existing products.
Manufacturing
and Supplies
Most of
our products are currently produced by overseas third-party manufacturers, which
we choose on the basis of quality, reliability and price. Consistent with
industry practice, the use of third-party manufacturers enables us to avoid
incurring fixed manufacturing costs, while maximizing flexibility, capacity and
production technology. Substantially all of the manufacturing services performed
overseas for us are paid for on open account with the manufacturers. To date, we
have not experienced any material delays in the delivery of our products;
however, delivery schedules are subject to various factors beyond our control,
and any delays in the future could adversely affect our sales. Currently, we
have ongoing relationships with over eighty different manufacturers. We believe
that alternative sources of supply are available to us, although we cannot be
assured that we can obtain adequate supplies of manufactured
products.
Although
we do not conduct the day-to-day manufacturing of our products, we are
extensively involved in the design of the product prototype and production
tools, dyes and molds for our products and we seek to ensure quality control by
actively reviewing the production process and testing the products produced by
our manufacturers. We employ quality control inspectors who rotate among our
manufacturers’ factories to monitor the production of substantially all of our
products.
The
principal raw materials used in the production and sale of our toy products are
plastics, zinc alloy, plush, printed fabrics, paper products and electronic
components, all of which are currently available at reasonable prices from a
variety of sources. Although we do not manufacture our products, we own the
tools, dies and molds used in the manufacturing process, and these are
transferable among manufacturers if we choose to employ alternative
manufacturers. Tools, dyes and molds represent a substantial portion of our
property and equipment with a net book value of $14.4 million in 2007 and $19.6
million in 2008. Substantially all of these assets are located in
China.
9
Trademarks
and Copyrights
Most of
our products are produced and sold under trademarks owned by or licensed to us.
We typically register our properties, and seek protection under the trademark,
copyright and patent laws of the United States and other countries where our
products are produced or sold. These intellectual property rights can be
significant assets. Accordingly, while we believe we are sufficiently protected,
the loss of some of these rights could have an adverse effect on our business,
financial condition and results of operations.
Competition
Competition
in the toy industry is intense. Globally, certain of our competitors have
greater financial resources, larger sales and marketing and product development
departments, stronger name recognition, longer operating histories and benefit
from greater economies of scale. These factors, among others, may enable our
competitors to market their products at lower prices or on terms more
advantageous to customers than those we could offer for our competitive
products. Competition often extends to the procurement of entertainment and
product licenses, as well as to the marketing and distribution of products and
the obtaining of adequate shelf space. Competition may result in price
reductions, reduced gross margins and loss of market share, any of which could
have a material adverse effect on our business, financial condition and results
of operations. In each of our product lines we compete against one or both of
the toy industry’s two dominant companies, Mattel and Hasbro. In addition, we
compete in our Flying
Colors and Pentech product categories,
with Mega Brands (Rose Art®), Hasbro (Play-Doh®) and Binney & Smith
(Crayola®), and in our toy vehicle lines, with RC2. We also compete with
numerous smaller domestic and foreign toy manufacturers, importers and marketers
in each of our product categories. Our joint venture’s principal competitors in
the video game market are Electronic Arts and Activision.
Seasonality
and Backlog
In 2008,
approximately 69.4% of our net sales were made in the third and fourth quarters.
Generally, the first quarter is the period of lowest shipments and sales in our
business and the toy industry generally and therefore the least profitable due
to various fixed costs. Seasonality factors may cause our operating results to
fluctuate significantly from quarter to quarter. However, our writing instrument
and activity products generally are counter-seasonal to the traditional toy
industry seasonality due to the higher volume generally shipped for
back-to-school beginning in the second quarter. In addition, our seasonal
products are primarily sold in the spring and summer seasons. Our results of
operations may also fluctuate as a result of factors such as the timing of new
products (and related expenses) introduced by us or our competitors, the
advertising activities of our competitors, delivery schedules set by our
customers and the emergence of new market entrants. We believe, however, that
the low retail price of most of our products may be less subject to seasonal
fluctuations than higher priced toy products.
We ship
products in accordance with delivery schedules specified by our customers, which
usually request delivery of their products within three to six months of the
date of their orders for orders shipped FOB China or Hong Kong and within three
days on orders shipped domestically. Because customer orders may be canceled at
any time without penalty, our backlog may not accurately indicate sales for any
future period.
Government
and Industry Regulation
Our
products are subject to the provisions of the Consumer Product Safety Act
(“CPSA”), the Federal Hazardous Substances Act (“FHSA”), the Flammable Fabrics
Act (“FFA”) and the regulations promulgated thereunder. The CPSA and the FHSA
enable the Consumer Products Safety Commission (“CPSC”) to exclude from the
market consumer products that fail to comply with applicable product safety
regulations or otherwise create a substantial risk of injury, and articles that
contain excessive amounts of a banned hazardous substance. The FFA enables the
CPSC to regulate and enforce flammability standards for fabrics used in consumer
products. The CPSC may also require the repurchase by the manufacturer of
articles. Similar laws exist in some states and cities and in various
international markets. We maintain a quality control program designed to ensure
compliance with all applicable laws.
Employees
As of
February 27, 2009, we employed 998 persons, all of whom are full-time employees,
including three executive officers. We employed 503 people in the United States,
359 people in Hong Kong, 135 people in China and 1 person in the United Kingdom.
We believe that we have good relationships with our employees. None of our
employees are represented by a union.
Environmental
Issues
We are
subject to legal and financial obligations under environmental, health and
safety laws in the United States and in other jurisdictions where we operate. We
are not currently aware of any material environmental liabilities associated
with any of our operations.
10
Available
Information
We make
available free of charge on or through our Internet website,
www.jakkspacific.com, our annual report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K, and amendments to these reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934 as soon as reasonably practicable after we electronically file such
material with, or furnish it to, the SEC.
Our
Corporate Information
We were
formed as a Delaware corporation in 1995. Our principal executive offices are
located at 22619 Pacific Coast Highway, Malibu, California 90265. Our telephone
number is (310) 456-7799 and our Internet Website address is
www.jakkspacific.com. The contents of our website are not incorporated in or
deemed to be a part of this Annual Report or Form 10-K.
Item 1A. Risk
Factors>
From time
to time, including in this Annual Report on Form 10-K, we publish
forward-looking statements, as disclosed in our Disclosure Regarding
Forward-Looking Statements, beginning immediately following the Table of
Contents of this Annual Report. We note that a variety of factors could cause
our actual results and experience to differ materially from the anticipated
results or other expectations expressed or anticipated in our forward-looking
statements. The factors listed below are illustrative of the risks and
uncertainties that may arise and that may be detailed from time to time in our
public announcements and our filings with the Securities and Exchange
Commission, such as on Forms 8-K, 10-Q and 10-K. We undertake no obligation to
make any revisions to the forward-looking statements contained in this Annual
Report on Form 10-K to reflect events or circumstances occurring after the date
of the filing of this report.
The
outcome of litigation in which we have been named as a defendant is
unpredictable and a materially adverse decision in any such matter could have a
material adverse affect on our financial position and results of
operations.
We are
defendants in litigation matters, as described under “Legal Proceedings” in our
periodic reports filed pursuant to the Securities Exchange Act of 1934,
including the lawsuit commenced by WWE and the purported securities class action
and derivative action claims stemming from the WWE lawsuit (see “Legal
Proceedings”). These claims may divert financial and management resources that
would otherwise be used to benefit our operations. Although we believe that we
have meritorious defenses to the claims made in each and all of the litigation
matters to which we have been named a party, and intend to contest each lawsuit
vigorously, no assurances can be given that the results of these matters will be
favorable to us. A materially adverse resolution of any of these lawsuits could
have a material adverse effect on our financial position and results of
operations.
Our
inability to redesign, restyle and extend our existing core products and product
lines as consumer preferences evolve, and to develop, introduce and gain
customer acceptance of new products and product lines, may materially and
adversely impact our business, financial condition and results of
operations.
Our
business and operating results depend largely upon the appeal of our products.
Our continued success in the toy industry will depend on our ability to
redesign, restyle and extend our existing core products and product lines as
consumer preferences evolve, and to develop, introduce and gain customer
acceptance of new products and product lines. Several trends in recent years
have presented challenges for the toy industry, including:
We cannot
assure you that:
11
Our
failure to achieve any or all of the foregoing benchmarks may cause the
infrastructure of our operations to fail, thereby adversely affecting our
business, financial condition and results of operations.
The
failure of our character-related and theme-related products to become and/or
remain popular with children may materially and adversely impact our business,
financial condition and results of operations.
The
success of many of our character-related and theme-related products depends on
the popularity of characters in movies, television programs, live wrestling
exhibitions, auto racing events and other media. We cannot assure you
that:
Our
failure to achieve any or all of the foregoing benchmarks may cause the
infrastructure of our operations to fail, thereby adversely affecting our
business, financial condition and results of operations.
There
are risks associated with our license agreements.
Sales of
products under trademarks or trade or brand names licensed from others account
for substantially all of our net sales. Product licenses allow us to capitalize
on characters, designs, concepts and inventions owned by others or developed by
toy inventors and designers. Our license agreements generally require us to make
specified minimum royalty payments, even if we fail to sell a sufficient number
of units to cover these amounts. In addition, under certain of our license
agreements, if we fail to achieve certain prescribed sales targets, we may be
unable to retain or renew these licenses.
Under the
majority of our license agreements the licensors have the right to review and
approve our use of their licensed products, designs or materials before we may
make any sales. If a licensor refuses to permit our use of any licensed property
in the way we propose, or if their review process is delayed, our development or
sale of new products could be impeded.
Our
continued success will depend substantially on our ability to obtain additional
licenses. Intensive competition exists for desirable licenses in our industry.
We cannot assure you that we will be able to secure or renew significant
licenses on terms acceptable to us. In addition, as we add licenses, the need to
fund additional royalty advances and guaranteed minimum royalty payments may
strain our cash resources.
We derive
a significant portion of our net sales from a limited number of licensors. If
one or more of these licensors were to terminate or fail to renew our license or
not grant us new licenses, our business, financial condition and results of
operations could be adversely affected. Our toy license with the WWE expires on
December 31, 2009.
The
toy industry is highly competitive and our inability to compete effectively may
materially and adversely impact our business, financial condition and results of
operations.
The toy
industry is highly competitive. Globally, certain of our competitors have
financial and strategic advantages over us, including:
12
In
addition, the toy industry has no significant barriers to entry. Competition is
based primarily on the ability to design and develop new toys, to procure
licenses for popular characters and trademarks and to successfully market
products. Many of our competitors offer similar products or alternatives to our
products. Our competitors have obtained and are likely to continue to obtain
licenses that overlap our licenses with respect to products, geographic areas
and markets. We cannot assure you that we will be able to obtain adequate shelf
space in retail stores to support our existing products or to expand our
products and product lines or that we will be able to continue to compete
effectively against current and future competitors.
An
adverse outcome in the litigation commenced against us and against our video
game joint venture with THQ by WWE, or a decline in the popularity of WWE, could
adversely impact our interest in that joint venture.
The joint
venture with THQ depends entirely on a single license, which gives the venture
exclusive worldwide rights to produce and market video games based on World
Wrestling Entertainment characters and themes. An adverse outcome against us,
THQ or the joint venture in the lawsuit commenced by WWE, or an adverse outcome
against THQ or the joint venture in the lawsuit commenced by WWE against THQ and
the joint venture (see the first Risk Factor, above, and “Legal Proceedings”),
would adversely impact our rights under the joint venture’s single license,
which would adversely affect the joint venture’s and our business, financial
condition and results of operation.
Furthermore,
the popularity of professional wrestling, in general, and World Wrestling
Entertainment, in particular, is subject to changing consumer tastes and
demands. The relative popularity of professional wrestling has fluctuated
significantly in recent years. A decline in the popularity of World Wrestling
Entertainment could adversely affect the joint venture’s and our business,
financial condition and results of operations.
The
termination of THQ’s manufacturing licenses and the inability of the joint
venture to otherwise obtain these licenses from other manufacturers would
materially adversely affect the joint venture’s and our business, financial
condition and results of operations.
The joint
venture relies on hardware manufacturers and THQ’s non-exclusive licenses with
them for the right to publish titles for their platforms and for the manufacture
of the joint venture’s titles. If THQ’s manufacturing licenses were to terminate
and the joint venture could not otherwise obtain these licenses from other
manufacturers, the joint venture would be unable to publish additional titles
for these manufacturers’ platforms, which would materially adversely affect the
joint venture’s and our business, financial condition and results of
operations.
The
failure of the joint venture or THQ to perform as anticipated could have a
material adverse affect on our financial position and results of
operations.
The joint
venture’s failure to timely develop titles for new platforms that achieve
significant market acceptance, to maintain net sales that are commensurate with
product development costs or to maintain compatibility between its personal
computer CD-ROM titles and the related hardware and operating systems would
adversely affect the joint venture’s and our business, financial condition and
results of operations.
Furthermore,
THQ controls day-to-day operations of the joint venture and all of its product
development and production operations. Accordingly, the joint venture relies
exclusively on THQ to manage these operations effectively. THQ’s failure to
effectively manage the joint venture would have a material adverse effect on the
joint venture’s and our business and results of operations. We are also
dependent upon THQ’s ability to manage cash flows of the joint venture. If THQ
is required to retain cash for operations, or because of statutory or
contractual restrictions, we may not receive cash payments for our share of
profits, on a timely basis, or at all.
The
amount of preferred return that we now receive from the joint venture is subject
to change, which could adversely affect our results of operations.
The joint
venture agreement provides for us to have received guaranteed preferred returns
through June 30, 2006 at varying rates of the joint venture’s net sales
depending on the cumulative unit sales and platform of each particular game. The
preferred return was subject to change after June 30, 2006 and was to be set for
the distribution period beginning July 1, 2006 and ending December 31, 2009 (the
“Next Distribution Period”). The agreement provides that the parties will
negotiate in good faith and agree to the preferred return not less than 180 days
prior to the start of the Next Distribution Period. It further provides that if
the parties are unable to agree on a preferred return, the preferred return will
be determined by arbitration. Since the parties have not reached an agreement
with respect to the preferred return for the Next Distribution Period, the
preferred return for the Next Distribution Period is to be determined through
arbitration. The preferred return is accrued in the quarter in which
the licensed games are sold and the preferred return is earned. Based
on the same rates as set forth under the original joint venture agreement, an
estimated receivable of $52.8 million has been accrued for the period from July
1, 2006 to December 31, 2008, pending the resolution of this outstanding issue.
JAKKS seeks to retain the same rates as set forth under the original joint
venture agreement, while THQ seeks to pay a substantially lower rate. In the
event the arbitration results in a lower rate to us, there would be a material
charge to earnings and reduction in the receivable from THQ.
13
Any
adverse change to the preferred return for the next distribution period as well
as the ongoing performance of the joint venture may result in our experiencing
reduced net income, which would adversely affect our results of
operations.
We
may not be able to sustain or manage our rapid growth, which may prevent us from
continuing to increase our net revenues.
We have
experienced rapid growth in our product lines resulting in higher net sales over
the last six years, which was achieved through acquisitions of businesses,
products and licenses. For example, revenues associated with companies we
acquired since 2006 were approximately $11.8 million and $10.5 million, in 2007
and 2008, respectively, representing 1.4% and 1.2% of our total revenues for
those periods. As a result, comparing our period-to-period operating results may
not be meaningful and results of operations from prior periods may not be
indicative of future results. We cannot assure you that we will continue to
experience growth in, or maintain our present level of, net sales.
Our
growth strategy calls for us to continuously develop and diversify our toy
business by acquiring other companies, entering into additional license
agreements, refining our product lines and expanding into international markets,
which will place additional demands on our management, operational capacity and
financial resources and systems. The increased demand on management may
necessitate our recruitment and retention of qualified management personnel. We
cannot assure you that we will be able to recruit and retain qualified personnel
or expand and manage our operations effectively and profitably. To effectively
manage future growth, we must continue to expand our operational, financial and
management information systems and to train, motivate and manage our work force.
There can be no assurance that our operational, financial and management
information systems will be adequate to support our future operations. Failure
to expand our operational, financial and management information systems or to
train, motivate or manage employees could have a material adverse effect on our
business, financial condition and results of operations.
If
we are unable to acquire and integrate companies and new product lines
successfully, we will be unable to implement a significant component of our
growth strategy.
Our
growth strategy depends in part upon our ability to acquire companies and new
product lines. Revenues associated with our acquisitions since 2006 represented
approximately 1.4% and 1.2% of our total revenues in 2007 and 2008,
respectively. Future acquisitions will succeed only if we can effectively assess
characteristics of potential target companies and product lines, such
as:
We cannot
assure you that we can identify attractive acquisition candidates or negotiate
acceptable acquisition terms, and our failure to do so may adversely affect our
results of operations and our ability to sustain growth. Our acquisition
strategy involves a number of risks, each of which could adversely affect our
operating results, including:
14
A
limited number of customers account for a large portion of our net sales, so
that if one or more of our major customers were to experience difficulties in
fulfilling their obligations to us, cease doing business with us, significantly
reduce the amount of their purchases from us or return substantial amounts of
our products, it could have a material adverse effect on our business, financial
condition and results of operations.
Our three
largest customers accounted for 56.5% of our net sales in 2008. Except for
outstanding purchase orders for specific products, we do not have written
contracts with or commitments from any of our customers. A substantial reduction
in or termination of orders from any of our largest customers could adversely
affect our business, financial condition and results of operations. In addition,
pressure by large customers seeking price reductions, financial incentives,
changes in other terms of sale or for us to bear the risks and the cost of
carrying inventory also could adversely affect our business, financial condition
and results of operations. If one or more of our major customers were to
experience difficulties in fulfilling their obligations to us, cease doing
business with us, significantly reduce the amount of their purchases from us or
return substantial amounts of our products, it could have a material adverse
effect on our business, financial condition and results of operations. In
addition, the bankruptcy or other lack of success of one or more of our
significant retailers could negatively impact our revenues and bad debt
expense.
We
depend on our key personnel and any loss or interruption of either of their
services could adversely affect our business, financial condition and results of
operations.
Our
success is largely dependent upon the experience and continued services of Jack
Friedman, our Chairman and Co-Chief Executive Officer, and Stephen G. Berman,
our President and Co-Chief Executive Officer. We cannot assure you that we would
be able to find an appropriate replacement for Mr. Friedman or Mr. Berman if the
need should arise, and any loss or interruption of Mr. Friedman’s or Mr.
Berman’s services could adversely affect our business, financial condition and
results of operations.
We
depend on third-party manufacturers, and if our relationship with any of them is
harmed or if they independently encounter difficulties in their manufacturing
processes, we could experience product defects, production delays, cost overruns
or the inability to fulfill orders on a timely basis, any of which could
adversely affect our business, financial condition and results of
operations.
We depend
on many third-party manufacturers who develop, provide and use the tools, dies
and molds that we own to manufacture our products. However, we have limited
control over the manufacturing processes themselves. As a result, any
difficulties encountered by the third-party manufacturers that result in product
defects, production delays, cost overruns or the inability to fulfill orders on
a timely basis could adversely affect our business, financial condition and
results of operations.
We do not
have long-term contracts with our third-party manufacturers. Although we believe
we could secure other third-party manufacturers to produce our products, our
operations would be adversely affected if we lost our relationship with any of
our current suppliers or if our current suppliers’ operations or sea or air
transportation with our overseas manufacturers were disrupted or terminated even
for a relatively short period of time. Our tools, dies and molds are located at
the facilities of our third-party manufacturers.
Although
we do not purchase the raw materials used to manufacture our products, we are
potentially subject to variations in the prices we pay our third-party
manufacturers for products, depending on what they pay for their raw
materials.
We
have substantial sales and manufacturing operations outside of the United States
subjecting us to risks common to international operations.
We sell
products and operate facilities in numerous countries outside the United States.
For the year ended December 31, 2008 sales to our international customers
comprised approximately 17.9% of our net sales. We expect our sales to
international customers to account for a greater portion of our revenues in
future fiscal periods. Additionally, we utilize third-party manufacturers
located principally in China which are subject to the risks normally associated
with international operations, including:
15
Our
reliance on external sources of manufacturing can be shifted, over a period of
time, to alternative sources of supply, should such changes be necessary.
However, if we were prevented from obtaining products or components for a
material portion of our product line due to medical, political, labor or other
factors beyond our control, our operations would be disrupted while alternative
sources of products were secured. Also, the imposition of trade sanctions by the
United States against a class of products imported by us from, or the loss of
“normal trade relations” status by China, could significantly increase our cost
of products imported from that nation. Because of the importance of our
international sales and international sourcing of manufacturing to our business,
our financial condition and results of operations could be significantly and
adversely affected if any of the risks described above were to
occur.
Our
business is subject to various laws, including the Federal Hazardous Substances
Act, the Consumer Product Safety Act, the Flammable Fabrics Act and the rules
and regulations promulgated under these acts. These statutes are administered by
the CPSC, which has the authority to remove from the market products that are
found to be defective and present a substantial hazard or risk of serious injury
or death. The CPSC can require a manufacturer to recall, repair or replace these
products under certain circumstances. We cannot assure you that defects in our
products will not be alleged or found. Any such allegations or findings could
result in:
Any of
these results may adversely affect our business, financial condition and results
of operations. There can be no assurance that our product liability insurance
will be sufficient to avoid or limit our loss in the event of an adverse outcome
of any product liability claim.
We
depend on our proprietary rights and our inability to safeguard and maintain the
same, or claims of third parties that we have violated their intellectual
property rights, could have a material adverse effect on our business, financial
condition and results of operations.
We rely
on trademark, copyright and trade secret protection, nondisclosure agreements
and licensing arrangements to establish, protect and enforce our proprietary
rights in our products. The laws of certain foreign countries may not protect
intellectual property rights to the same extent or in the same manner as the
laws of the United States. We cannot assure you that we or our licensors will be
able to successfully safeguard and maintain our proprietary rights. Further,
certain parties have commenced legal proceedings or made claims against us based
on our alleged patent infringement, misappropriation of trade secrets or other
violations of their intellectual property rights. We cannot assure you that
other parties will not assert intellectual property claims against us in the
future. These claims could divert our attention from operating our business or
result in unanticipated legal and other costs, which could adversely affect our
business, financial condition and results of operations.
Market
conditions and other third-party conduct could negatively impact our margins and
implementation of other business initiatives.
Economic
conditions, such as rising fuel prices and decreased consumer confidence, may
adversely impact our margins. In addition, general economic conditions were
significantly and negatively affected by the September 11th terrorist attacks
and could be similarly affected by any future attacks. Such a weakened economic
and business climate, as well as consumer uncertainty created by such a climate,
could adversely affect our sales and profitability. Other conditions, such as
the unavailability of electronics components, may impede our ability to
manufacture, source and ship new and continuing products on a timely basis.
Significant and sustained increases in the price of oil could adversely impact
the cost of the raw materials used in the manufacture of our products, such as
plastic.
16
We
may not have the funds necessary to purchase our outstanding convertible senior
notes upon a fundamental change or other purchase date, as required by the
indenture governing the notes.
On June
15, 2010, June 15, 2013 and June 15, 2018, holders of our convertible senior
notes may require us to purchase their notes, which repurchase may be made for
cash. In addition, holders may also require us to purchase their notes for cash
upon the occurrence of certain fundamental changes in our board composition or
ownership structure, if we liquidate or dissolve under certain circumstances or
if our common stock ceases being quoted on an established over-the-counter
trading market in the United States. If we do not have, or have access to,
sufficient funds to repurchase the notes, then we could be forced into
bankruptcy. In fact, we expect that we would require third-party financing, but
we cannot assure you that we would be able to obtain that financing on favorable
terms or at all.
Goodwill
is the amount by which the cost of an acquisition accounted for using the
purchase method exceeds the fair value of the net assets we acquire. Current
accounting standards require that goodwill no longer be amortized but instead be
periodically evaluated for impairment based on the fair value of the reporting
unit. As of December 31, 2008, we have not had any impairment of Goodwill, which
is reviewed on a quarterly basis and formally evaluated on an annual
basis.
At
December 31, 2008, approximately $427.7 million, or 41.6%, of our total assets
represented goodwill. Declines in our profitability may impact the fair value of
our reporting units, which could result in a write-down of our goodwill.
Reductions in our net income caused by the write-down of goodwill would
adversely affect our results of operations.
17
Item 2. Properties>
The
following is a listing of the principal leased offices maintained by us as of
February 27, 2009:
Item
3. Legal Proceedings
On
October 19, 2004, we were named as defendants in a lawsuit commenced by WWE in
the U.S. District Court for the Southern District of New York concerning our toy
licenses with WWE and the video game license between WWE and the joint venture
company operated by THQ and us, encaptioned World Wrestling Entertainment, Inc.
v. JAKKS Pacific, Inc., et al., 1:04-CV-08223-KMK (the “WWE Action”). The
complaint also named as defendants THQ, the joint venture, certain of our
foreign subsidiaries, Jack Friedman (our Chairman and Chief Executive Officer),
Stephen Berman (our Executive Vice President and Chief Operating Officer,
President and Secretary and a member of our Board of Directors), Joel Bennett
(our Chief Financial Officer), Stanley Shenker and Associates, Inc., Bell
Licensing, LLC, Stanley Shenker and James Bell.
WWE
sought treble, punitive and other damages (including disgorgement of profits) in
an undisclosed amount and a declaration that the video game license with the
joint venture, which is scheduled to expire in 2009 (subject to the joint
venture’s right to extend that license for an additional five years), and an
amendment to our toy licenses with WWE, which are scheduled to expire in 2009,
are void and unenforceable. This action alleged violations by the defendants of
the Racketeer Influenced and Corrupt Organization Act (“RICO”) and the
anti-bribery provisions of the Robinson-Patman Act, and various claims under
state law.
On
February 16, 2005, we filed a motion to dismiss the WWE Action. On March 30,
2005, the day before WWE’s opposition to our motion was due, WWE filed an
Amended Complaint seeking, among other things, to add the Chief Executive
Officer of THQ as a defendant and to add a claim under the Sherman Act. The
Court allowed the filing of the Amended Complaint and ordered a two-stage
resolution of the viability of the Complaint, with motions to dismiss the
federal jurisdiction claims based on certain threshold issues to proceed and all
other matters to be deferred for consideration if the Complaint survived
scrutiny with respect to the threshold issues. The Court also stayed discovery
pending the determination of the motions to dismiss.
The
motions to dismiss the Amended Complaint based on these threshold issues were
fully briefed and argued and, on March 31, 2006, the Court granted the part of
our motion seeking dismissal of the Robinson-Patman Act and Sherman Act claims
and denied the part of our motion seeking to dismiss the RICO claims on the
basis of the threshold issue that was briefed (the “March 31
Order”).
On
April 7, 2006, we sought certification to appeal from the portion of the March
31 Order denying our motion to dismiss the RICO claim on the one ground that was
briefed. Shortly thereafter, WWE filed a motion for reargument with respect to
the portion of the March 31 Order that dismissed the Sherman Act claim and,
alternatively, sought judgment with respect to the Sherman Act claim so that it
could pursue an immediate appeal. At a court conference on April 26, 2006 the
Court deferred the requests for judgment and for certification and set up
briefing schedules with respect to our motion to dismiss the RICO claim on
grounds that were not the subject of the first round of briefing, and our motion
to dismiss the action based on the release contained in a January 15, 2004
Settlement Agreement and General Release between WWE and the Company (the
“Release”). The Court also established a briefing schedule for WWE’s motion for
reargument of the dismissal of the Sherman Act claim. These motions were argued
and submitted in September 2006. Discovery remained stayed.
18
On
November 30, 2007, the Court indicated that the WWE Action would be dismissed.
On December 21, 2007 the Court dismissed the WWE Action with prejudice (the
"December 2007 Order") based on (1) the failure to plead RICO injury; (2) the
bar of the RICO statute of limitations; (3) the denial of WWE’s motion for
reconsideration of the Sherman Act claim; and (4) the lack of subject matter
jurisdiction with respect to the pendent state law claims. Thereafter, WWE filed
an appeal to the Second Circuit Court of Appeals. We filed a motion for
reconsideration of the part of the December 2007 Order that stated that the
Release did not bar the WWE Action. That motion was fully briefed and submitted
to the Court. In September 2008, the Court granted the motion and held that the
applicability of a January 2004 release executed by WWE in favor of the Company
would not be determined in connection with the motion to dismiss the action. We
also filed a cross-appeal based on the Court's earlier order denying our request
to dismiss based on the lack of a cognizable enterprise and based on the
December 2007 Order's statement with respect to the Release. WWE moved to
dismiss our cross-appeal. It has been withdrawn without prejudice to our right
to argue these issues as grounds for affirmance of the December 2007 Order. The
appeal briefing has been completed and argument will be scheduled.
In
November 2004, several purported class action lawsuits were filed in the United
States District Court for the Southern District of New York: (1) Garcia v. JAKKS
Pacific, Inc. et al., Civil Action No. 04-8807 (filed on November 5, 2004), (2)
Jonco Investors, LLC v. JAKKS Pacific, Inc. et al., Civil Action No. 04-9021
(filed on November 16, 2004), (3) Kahn v. JAKKS Pacific, Inc. et al., Civil
Action No. 04-8910 (filed on November 10, 2004), (4) Quantum Equities L.L.C. v.
JAKKS Pacific, Inc. et al., Civil Action No. 04-8877 (filed on November 9,
2004), and (5) Irvine v. JAKKS Pacific, Inc. et al., Civil Action No. 04-9078
(filed on November 16, 2004) (the “Class Actions”). The complaints in the Class
Actions alleged that defendants issued positive statements concerning increasing
sales of our WWE licensed products which were false and misleading because the
WWE licenses had allegedly been obtained through a pattern of commercial
bribery, our relationship with the WWE was being negatively impacted by the
WWE’s contentions and there was an increased risk that the WWE would either seek
modification or nullification of the licensing agreements with us. Plaintiffs
also alleged that we misleadingly failed to disclose the alleged fact that the
WWE licenses were obtained through an unlawful bribery scheme. The plaintiffs in
the Class Actions were described as purchasers of our common stock, who
purchased from as early as October 26, 1999 to as late as October 19, 2004. The
Class Actions sought compensatory and other damages in an undisclosed amount,
alleging violations of Section 10(b) of the Securities Exchange Act of 1934 (the
“Exchange Act”) and Rule 10b-5 promulgated thereunder by each of the defendants
(namely the Company and Messrs. Friedman, Berman and Bennett), and violations of
Section 20(a) of the Exchange Act by Messrs. Friedman, Berman and Bennett. On
January 25, 2005, the Court consolidated the Class Actions under the caption In
re JAKKS Pacific, Inc. Shareholders Class Action Litigation, Civil Action No.
04-8807. On May 11, 2005, the Court appointed co-lead counsels and provided
until July 11, 2005 for an amended complaint to be filed; and a briefing
schedule thereafter with respect to a motion to dismiss. The motion to dismiss
was fully briefed and argument occurred on November 30, 2006. The motion was
granted in January 2008 to the extent that the Class Actions were dismissed
without prejudice to plaintiffs’ right to seek leave to file an amended
complaint based on statements that the WWE licenses were obtained from the WWE
as a result of the long-term relationship with WWE. A motion seeking leave to
file an amended complaint was granted and an amended complaint filed. Briefing
was completed with respect to a motion to dismiss that was scheduled for
argument in October 2008. The Court adjourned the argument date. The
parties have notified the Court that an agreement in principle to resolve this
action has been reached. The agreement, which is subject to
documentation and Court approval, will settle the matter for $3.9 million,
without any admission of liability on the part of the Company, or its officers
and directors.
We
believe that the claims in the WWE Action are without merit and we intend to
continue to defend vigorously against the WWE Action. However, because the WWE
Action is on appeal, we cannot assure you as to the outcome of it, nor can we
estimate the range of our potential losses.
On
December 2, 2004, a shareholder derivative action was filed in the Southern
District of New York by Freeport Partner, LLC against us, nominally, and against
Messrs. Friedman, Berman and Bennett, Freeport Partners v. Friedman, et al.,
Civil Action No. 04-9441 (the “Derivative Action”). The Derivative Action seeks
to hold the individual defendants liable for damages allegedly caused to us by
their actions and in particular to hold them liable on a contribution theory
with respect to any liability we incur in connection with the Class Actions. On
or about February 10, 2005, a second shareholder derivative action was filed in
the Southern District of New York by David Oppenheim against us, nominally, and
against Messrs. Friedman, Berman, Bennett, Blatte, Glick, Miller and Skala,
Civil Action 05-2046 (the “Second Derivative Action”). The Second Derivative
Action seeks to hold the individual defendants liable for damages allegedly
caused to us by their actions as a result of alleged breaches of their fiduciary
duties. On or about March 16, 2005, a third shareholder derivative action was
filed. It is captioned Warr v. Friedman, Berman, Bennett, Blatte, Glick, Miller,
Skala, and JAKKS (as a nominal defendant), and it was filed in the Superior
Court of California, Los Angeles County (the “Third Derivative Action”). The
Third Derivative Action seeks to hold the individual defendants liable for (1)
damages allegedly caused to us by their alleged breaches of fiduciary duty,
abuse of control, gross mismanagement, waste of corporate assets and unjust
enrichment; and (2) restitution to us of profits, benefits and other
compensation obtained by them. Stays/and or extensions of time to answer are in
place with respect to the derivative actions.
On March
1, 2005, we delivered a Notice of Breach of Settlement Agreement and Demand for
Indemnification to WWE (the “Notification”). The Notification asserted that
WWE’s filing of the WWE Action violated a Covenant Not to Sue contained in a
January 15, 2004 Settlement Agreement and General Release (“General Release”)
entered into between WWE and us and, therefore, that we were demanding
indemnification, pursuant to the Indemnification provision contained in the
General Release, for all losses that the WWE’s actions have caused or will cause
to us and our officers, including but not limited to any losses sustained by us
in connection with the Class Actions. On March 4, 2005, in a letter from its
outside counsel, WWE asserted that the General Release does not cover the claims
in the WWE Action.
19
On March
30, 2006, WWE’s counsel wrote a letter alleging breaches by the joint venture of
the video game agreement relating to the manner of distribution and the payment
of royalties to WWE with respect to sales of the WWE video games in Japan. WWE
has demanded that the alleged breaches be cured within the time periods provided
in the video game license, while reserving all of its rights, including its
alleged right of termination of the video game license.
On April
28, 2006 the joint venture responded, asserting, among other things, that WWE
had acquiesced in the manner of distribution in Japan and the payment of
royalties with respect to such sales and, in addition, had separately released
the joint venture from any claims with respect to such matter, including the
payment of royalties with respect to such sales, and that there is therefore no
basis for an allegation of a breach of the license agreement. While the joint
venture does not believe that WWE has a valid claim, it tendered a protective
“cure” of the alleged breaches with a full reservation of rights. WWE “rejected”
that cure and reserved its rights.
On
October 12, 2006, WWE commenced a lawsuit in Connecticut state court against THQ
and THQ/JAKKS Pacific LLC (the “LLC”), involving a claim set forth above
concerning allegedly improper sales of WWE video games in Japan and other
countries in Asia (the “Connecticut Action”). The lawsuit seeks, among other
things, a declaration that WWE is entitled to terminate the video game license
and monetary damages and raised Connecticut Unfair Trade Practices Act (“CUTPA”)
and contract claims against THQ and the LLC. A motion to strike the CUTPA claim
was denied in May 2007.
In March
2007, WWE filed a motion seeking leave to amend its complaint in the Connecticut
Action to add the principal part of the state law claims present in the WWE
Action to the Connecticut Action. That motion further sought, inter alia, to add
our Company and Messrs. Friedman, Berman and Bennett (the “Individual
Defendants”) as defendants in the Connecticut Action. The motion was argued on
May 8, 2007 and was granted from the bench, subject to a decision that the
schedule was suspended and no discovery matters would be addressed until
pleading motions were resolved. In June 2007, our Company and the Individual
Defendants moved for a stay of the Connecticut Action, inter alia , based on the
pendency of the WWE Action. On July 30, 2007, in light of the pending motion to
dismiss in the WWE Action, the Court ordered a 120-day stay of the Connecticut
Action (the "Stay"). In November 2007 we moved for a continuation of the Stay.
WWE served discovery and sought leave to file an amended complaint alleging the
state law claims from the WWE Action. Thereafter we moved for a conference and a
stay of discovery. A conference was held on January 14, 2008 at which WWE was
allowed to amend its complaint to assert the state law claims set forth in the
WWE Action and a briefing schedule was established with respect to a combined
motion to strike and a motion for summary judgment (the "Dispositive Motion").
This motion was briefed and argument was held on May 19, 2008. WWE cross-moved
for partial summary judgment striking our Release defense. In August 2008, the
Dispositive Motion was granted. WWE filed a motion for reargument which was
denied. THQ filed a cross-complaint which asserts claims by THQ and Mr. Farrell
for indemnification from the Company in the event that WWE prevails on any of
its claims against THQ and Farrell and also asserts claims by THQ that the
Company breached its fiduciary duties to THQ in connection with the videogame
license between WWE and THQ/JAKKS Pacific LLC and seeks equitable and legal
relief, including substantial monetary and exemplary damages against the Company
in connection with this claim. The Company has requested that THQ revise its
claims and THQ objected to this request. This matter has not yet been
resolved. Discovery is currently proceeding in this matter. The Company intends
to contest all of these claims vigorously.
We
believe that the claims in the Connecticut Action are without merit and we
intend to defend vigorously against them. However, because this action is
subject to appeal, we cannot assure you as to the outcome of the action, nor can
we estimate the range of our potential losses. THQ and the LLC have stated that
they believe the claims in the Connecticut Action prior to the additional claims
in the amended complaint are without merit and have filed an opposition to WWE’s
motion for partial summary judgment and filed a motion for summary judgment
dismissing the remaining claims in the Connecticut Action as a matter of law on
multiple grounds and they intend to continue to defend themselves vigorously.
However, because this action is in its preliminary stage, we cannot assure you
as to the outcome, nor can we estimate the range of our potential losses, if
any.
Our
agreement with THQ provides for payment of a preferred return to us in
connection with our joint venture. The preferred return is subject to change
after June 30, 2006 and is to be set for the distribution period beginning July
1, 2006 and ending December 31, 2009 (the “Next Distribution Period”). The
agreement provides that the parties will negotiate in good faith and agree to
the preferred return not less than 180 days prior to the start of the Next
Distribution Period. It further provides that if the parties are unable to agree
on a preferred return, the preferred return will be determined by arbitration.
The parties have not reached an agreement with respect to the preferred return
for the Next Distribution Period and the preferred return is to be determined
through arbitration. On April 30, 2007, THQ filed an action in the Superior
Court, Los Angeles County, to compel arbitration and to appoint an arbitrator
pursuant to the relevant provisions of the agreement. An order was issued that
identified five potential arbitrators. The parties did not agree on an
arbitrator. The Company served notices of disqualification on four of the
potential arbitrators; THQ objected; the Court struck the disqualification
notices and appointed an arbitrator, who was then stricken by JAKKS. The Company
appealed the Court’s order with respect to the disclosure and disqualification
process and the appellate court took the appeal and stayed the proceedings. The
Court rendered a decision on the matter on February 28, 2008 which affirmed the
lower court's decision ruling that disclosure was not required until after the
arbitrator was nominated to serve by the Court. The matter was remanded for
further proceedings and the parties agreed on an arbitrator and the
baseball-style arbitration is scheduled to be concluded by April
2009. JAKKS seeks to retain the same rates as set forth under the
original joint venture agreement while THQ seeks to pay a substantially lower
rate.
20
All
matters in connection with the application by Jax, Ltd. for registration of the
trademark JAX with respect to "board games" in class 28 with the United States
Patent and Trademark Office ("PTO"), and the Jax, Ltd. counterclaim seeking
cancellation of the Company's registration for the mark JAKKS PACIFIC have been
dismissed with prejudice.
We are a
party to, and certain of our property is the subject of, various other pending
claims and legal proceedings that routinely arise in the ordinary course of our
business, but we do not believe that any of these claims or proceedings will
have a material effect on our business, financial condition or results of
operations.
21
Item 5. Market for
Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities>
Market
Information
Our
common stock is traded on the Nasdaq Global Select exchange under the symbol
“JAKK.” The following table sets forth, for the periods indicated, the range of
high and low sales prices for our common stock on this exchange.
Performance
Graph
The graph
and tables below display the relative performance of our common stock, the
Russell 2000 Price Index (the “Russell 2000”) and a peer group index, by
comparing the cumulative total stockholder return (which assumes reinvestment of
dividends, if any) on an assumed $100 investment in our common stock, the
Russell 2000 and the peer group index over the period from January 1, 2004 to
December 31, 2008.
In
accordance with recently enacted regulations implemented by the Securities and
Exchange Commission, we retained the services of an expert compensation
consultant. In the performance of its services, such consultant used
a peer group index for its analysis of our compensation
policies. We believe that these companies represent a
cross-section of publicly-traded companies with product lines and businesses
similar to our own throughout the comparison period and, accordingly, we are
using the same peer group for purposes of the performance graph. Our peer group
index includes the following companies: Activision, Inc., Electronic Arts,
Inc., EMak Worldwide, Inc., Hasbro, Inc., Leapfrog Enterprises, Inc., Marvel
Enterprises, Inc., Mattel, Inc., Russ Berrie and Company, Inc., RC2 Corp.,
Take-Two Interactive, Inc. and THQ Inc.
22
The
historical performance data presented below may not be indicative of the future
performance of our common stock, any reference index or any component company in
a reference index.
 Annual
Return Percentage
Indexed
Returns
Security
Holders
To the
best of our knowledge, as of February 27, 2009,there were 151 holders of record
of our common stock. We believe there are numerous beneficial owners of our
common stock whose shares are held in “street name.”
Dividends
We have
never paid any cash dividends on our common stock. We currently intend to retain
our future earnings, if any, to finance the growth and development of our
business and/or buy back in the market some of our outstanding common stock, but
may consider implementing a plan to pay cash dividends on our common stock in
the future.
23
Equity
Compensation Plan Information
The table
below sets forth the following information as of the year ended December 31,
2008 for (i) all compensation plans previously approved by our stockholders and
(ii) all compensation plans not previously approved by our stockholders, if
any:
(b) the
weighted-average exercise price of such outstanding options, warrants and
rights; and
(c) other
than securities to be issued upon the exercise of such outstanding options,
warrants and rights, the number of securities remaining available for future
issuance under the plans.
Equity
compensation plans approved by our stockholders consists of the 2002 Stock Award
and Incentive Plan. Equity compensation plans not approved by our security
holders consist of a fully-vested warrant issued by us in 2003 (and expiring in
2013) in connection with license costs relating to our video game joint
venture.
24
Item 6. Selected
Financial Data>
You
should read the financial data set forth below in conjunction with “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” and
our consolidated financial statements and the related notes (included in Item
8).
During
the fourth quarter of 2008, we acquired Tollytots, Kids Only and
Disguise.
During
the third quarter of 2008, we decided to discontinue the use of the “Toymax” and
“Trendmaster” tradenames on products and market these products under the JAKKS
Pacific trademark . Consequently, the intangible assets associated with these
tradenames were written off to write-down of intangible assets, resulting in a
charge of $3.5 million. Also, we adjusted the value of the Child Guidance
trademark to reflect lower sales expectations for this tradename, resulting in a
charge to Write-down of Intangible Assets of $5.6 million.
In
February 2006, we acquired Creative Designs. Also, effective January
1, 2006, we implemented SFAS 123R, which requires the expensing of share-based
compensation.
In June
2005, we acquired the Pet
Pal line of products.
In June
2004, we acquired Play Along.
25
The
following Management’s Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those anticipated
in these forward-looking statements as a result of various factors. You should
read this section in conjunction with our consolidated financial statements and
the related notes (included in Item 8).
Critical
Accounting Policies
The
accompanying consolidated financial statements and supplementary information
were prepared in accordance with accounting principles generally accepted in the
United States of America. Significant accounting policies are discussed in Note
2 to the Consolidated Financial Statements, Item 8. Inherent in the application
of many of these accounting policies is the need for management to make
estimates and judgments in the determination of certain revenues, expenses,
assets and liabilities. As such, materially different financial results can
occur as circumstances change and additional information becomes known. The
policies with the greatest potential effect on our results of operations and
financial position include:
Major
customers’ accounts are monitored on an ongoing basis; more in depth reviews are
performed based on changes in customer’s financial condition and/or the level of
credit being extended. When a significant event occurs, such as a bankruptcy
filing by a specific customer, and on a quarterly basis, the allowance is
reviewed for adequacy and the balance or accrual rate is adjusted to reflect
current risk prospects.
Factors
we consider important which could trigger an impairment review include the
following:
FAS 142
requires that goodwill be allocated to various reporting units, which are either
at the operating segment level or one reporting level below the operating
segment, for purposes of evaluating whether goodwill is impaired. For 2008,
JAKKS' reporting units are: Traditional Toys, Craft and Writing, and Pet
products. Goodwill is allocated within JAKKS' reporting units based on an
allocation of brand-specific goodwill to the reporting units selling those
brands. As of October 1, 2008, JAKKS performed the annual impairment test
required by FAS 142 and determined that its goodwill was not impaired. There
were no events or circumstances that indicated the impairment test should be
performed again at December 31, 2008.
26
During
the third quarter of 2008, we decided to discontinue the use of the “Toymax” and
“Trendmaster” tradenames on products and market these products under the JAKKS
Pacific trademark . Consequently, the intangible assets associated with these
tradenames were written off to Write-down of Intangible Assets, resulting in a
charge of $3.5 million. Also, we adjusted the value of the Child Guidance
trademark to reflect lower sales expectations for this tradename, resulting in a
charge to Write-down of Intangible Assets of $5.6 million.
To
determine the fair value of our reporting units, we generally use a present
value technique (discounted cash flow) corroborated by market multiples when
available and as appropriate. The factor most sensitive to change with respect
to our discounted cash flow analyses is the estimated future cash flows of each
reporting unit which is, in turn, sensitive to our estimates of future revenue
growth and margins for these businesses. If actual revenue growth and/or margins
are lower than our expectations, the impairment test results could differ. We
applied what we believe to be the most appropriate and consistent valuation
methodology for each of the reporting units. If we had established different
reporting units or utilized different valuation methodologies, the impairment
test results could differ.
Goodwill
and intangible assets amounted to $463.4 million as of December 31,
2008.
Failure
to accurately predict and respond to consumer demand could result in the Company
under producing popular items or overproducing less popular items. Furthermore,
significant changes in demand for our products would impact management’s
estimates in establishing our inventory provision.
Management
estimates are monitored on a quarterly basis and a further adjustment to reduce
inventory to its net realizable value is recorded, as an increase to cost of
sales, when deemed necessary under the lower of cost or market
standard.
As of
January 1, 2007, we adopted the provisions of FASB Interpretation No. 48 (“FIN
48”), Accounting for
Uncertainty in Income Taxes , which prescribes a recognition threshold
and measurement process for recording in the financial statements uncertain tax
positions taken or expected to be taken in a tax return. As of the
date of adoption, tax benefits that are subject to challenge by tax authorities
are analyzed and accounted for in the income tax provision. The
cumulative effect of the potential liability for unrecognized tax benefits prior
to the adoption of FIN 48, along with the associated interest and penalties, are
recognized as a reduction in the January 1, 2007 balance of retained
earnings.
We
accrue a tax reserve for additional income taxes and interest, which may become
payable in future years as a result of audit adjustments by tax
authorities. The reserve is based on management’s assessment of all
relevant information, and is periodically reviewed and adjusted as circumstances
warrant. As of December 31, 2008, our income tax reserves are
approximately $11.9 million and relate to the potential income tax audit
adjustments, primarily in the areas of income allocation, foreign depreciation
allowances and transfer pricing.
We
recognize current period interest expense and the reversal of previously
recognized interest expense that has been determined to not be assessable due to
the expiration of the related audit period or other compelling factors on the
income tax liability for unrecognized tax benefits as interest expense, and
penalties and penalty reversals related to the income taxes payable as other
expense in our consolidated statements of operations.
Share-Based
Compensation>. We grant restricted stock and options to purchase our
common stock to our employees (including officers) and non-employee directors
under our 2002 Stock Award and Incentive Plan (the “Plan”), which incorporated
the shares remaining under our Third Amended and Restated 1995 Stock Option
Plan. The benefits provided under the Plan are share-based payments subject to
the provisions of revised Statement of Financial Accounting Standards No. 123
(Revised) (FAS 123R), Share-Based Payment .
Effective January 1, 2006, we began to use the fair value method to apply the
provisions of FAS 123R. We estimate the value of share-based awards on the date
of grant using the Black-Scholes option-pricing model. The determination of the
fair value of share-based payment awards on the date of grant using an
option-pricing model is affected by our stock price, as well as assumptions
regarding a number of complex and subjective variables. These variables include
our expected stock price volatility over the term of the awards, actual and
projected employee stock option exercise behaviors, cancellations, terminations,
risk-free interest rates and expected dividends.
27
Recent
Developments
On
October 7, 2008, we acquired substantially all of the assets of Tollytots
Limited. The total initial consideration of $25.5 million consisted
of $11.8 million in cash and the assumption of liabilities in the amount of
$13.7 million, and resulted in goodwill of $3.0 million. In addition, we agreed
to pay an earn-out of up to an aggregate amount of $5.0 million in cash over the
three calendar years following the acquisition based on the achievement of
certain financial performance criteria, which will be recorded as goodwill when
and if earned. Tollytots is a leading designer and producer
of licensed baby dolls and baby doll pretend play accessories based
on well-known brands and was included in our results of operations from the date
of acquisition.
On
October 8, 2008, we acquired substantially all of the stock of Kids Only, Inc.
and a related Hong Kong company, Kids Only Limited (collectively, “Kids
Only”). The total initial consideration of $23.2 million consisted of
$20.3 million in cash and the assumption of liabilities in the amount of $2.9
million, and resulted in goodwill of $12.5 million. In addition, we agreed to
pay an earn-out of up to an aggregate amount of $5.6 million in cash over the
three calendar years following the acquisition based on the achievement of
certain financial performance criteria, which will be recorded as goodwill when
and if earned. Kids Only is a leading designer and producer of licensed indoor
and outdoor kids’ furniture, and has an extensive portfolio which also includes
baby dolls and accessories, room décor and a myriad of other children’s toy
products and was included in our results of operations from the date
of acquisition.
On
December 29, 2008, we acquired certain assets of Disguise, Inc. and a related
Hong Kong company, Disguise Limited (collectively, “Disguise”). The
total initial consideration of $61.9 million consisted of $39.9 million in cash
and the assumption of liabilities in the amount of $22.0 million, and resulted
in goodwill of $51.6 million. We have not finalized our purchase price
allocation for Disguise and will engage a third party to perform studies and
valuations to the estimated fair value of assets and liabilities
assumed. Disguise is a leading designer and producer of Halloween and
everyday costume play and was included in our results of operations from the
date of acquisition
28
Results
of Operations
The
following table sets forth, for the periods indicated, certain statement of
operations data as a percentage of net sales.
The
following table summarizes, for the periods indicated, certain income statement
data by segment (in thousands).
Comparison
of the Years Ended December 31, 2008 and 2007
Net
Sales
Traditional
Toys. Net sales of our Traditional Toys segment were $816.9
million in 2008, compared to $793.0 million in 2007, representing an increase of
$23.9 million, or 3.0%. The increase in net sales was primarily due
to the contribution to sales from our Tollytots and Kids Only acquisitions of
$10.4 million and strong sales of JAKKS™ dolls based on Hannah Montana®, Camp
Rock™, Puppy In My Pocket & Friends™ and Narnia®, electronics based on
JAKKS’ Eye Clops®, G2 Game Girl™ and UltiMotion™ brands, role-play and dress-up
toys, including those based on Disney characters Hannah Montana® and classic
princesses, and other products including Neopets® plush, offset in part by
decreases in sales of some products, including WWE® and Pokemon® action figures
and accessories, and other JAKKS products, including Plug It In & Play TV
Games™, Fly Wheels® XPV products®, Doodle Bears®, Care Bears®, Cabbage Patch
Kids®, Speedstacks®, The Cheetah Girls™ toys and junior sports
products.
29
Craft/Activity/Writing
Product. Net sales of our Craft/Activity/Writing Products were
$65.9 million in 2008, compared to $39.6 million in 2007, representing an
increase of $26.3 million, or 66.4%. The increase in net sales was
primarily due to increases in sales of our Girl Gourmet™ and Spa Factory™
activity toys and our Spinz™ writing instruments, offset in part by decreases in
sales of our Flying Colors® and Vivid Velvet® activities products and our
Pentech™ and Color Workshop® writing instruments and related
products.
Pet Products. Net
Sales of our Pet Products were $20.7 million in 2008, compared to $24.5 million
in 2007, representing a decrease of $3.8 million, or 15.5%. The
decrease is mainly attributable to the less available shelf space for pet
products at some of our major customer retail stores, and lower sales of
consumable pet products. Sales of pet products were led by our AKG licensed line
of products.
Cost of
Sales
Traditional
Toys. Cost of sales of our Traditional Toys segment was $527.0
million, or 64.5% of related net sales, in 2008, compared to $490.3 million, or
61.8% of related net sales, in 2007, representing an increase of $36.7 million,
or 7.5%. The increase primarily consisted of an increase in product
costs of $26.9 million, which is in line with the higher volume of
sales. Product costs as a percentage of sales increased primarily due
to the mix of the product sold with higher product cost. Furthermore,
royalty expense for our Traditional Toys segment increased by $3.6 million, but
remained consistent as a percentage of net sales. Our depreciation of
molds and tools increased by $6.2 million due to the increased number of new
products being sold in this segment in 2008.
Craft/Activity/Writing
Products . Cost of sales of our Craft/Activity/Writing
Products segment was $38.7 million, or 58.7% of related net sales, in 2008,
compared to $27.0 million, or 68.1% of related net sales, in 2007, representing
an increase of $11.7 million, or 43.3%. Product costs increased by
$13.7 million, which is in line with the higher volume of
sales. Product costs as a percentage of net sales decreased primarily
due to the mix of the product sold and lower sales of closeout
product. Royalty expense decreased by $2.3 million and as a
percentage of net sales due to changes in the product mix to more products with
lower royalty rates or proprietary products with no royalty rates from products
with higher royalty rates. Our depreciation of molds and tools increased by $0.4
million due to the increased number of new products being sold in this segment
in 2008.
Pet Products
. Cost of sales of our Pet Pal line of products was $16.5 million, or
79.9% of related net sales, in 2008, compared to $16.2 million, or 66.2% of
related net sales, in 2007, representing an increase of $0.3 million, or
1.9%. Product costs as a percentage of net sales increased
primarily due to the mix of the product sold and sell-off of closeout
product. Royalty expense decreased by $0.1 million and as a
percentage of sales. Additionally, our depreciation of molds and tools decreased
by $0.3 million in 2008 due to less new products requiring molds and
tools.
Selling, General and
Administrative Expenses
Selling,
general and administrative expenses were $241.3 million in 2008 and $216.7
million in 2007, constituting 26.7% and 25.3% of net sales,
respectively. The overall increase of $24.6 million in such costs was
primarily due to the addition of overhead related to the operations of
Tollytots, Kids Only and Disguise ($3.4 million) and increases in general and
administrative expenses ($5.3 million), product development ($11.4 million), and
other selling expenses ($11.0 million), offset in part by decreases in
amortization expense related to intangible assets other than goodwill ($5.1
million) and share-based compensation expense ($1.8 million). The
increase in general and administrative expenses is primarily due to increases in
salary and payroll taxes ($4.7 million) to support our growing business, travel
and entertainment expense ($1.1 million), legal expense ($5.7 million), net of
insurance reimbursements, bad debt expense ($1.0 million) due to refunds in 2007
of customer bankruptcies that had been previously written off and rent expense
($1.1 million), offset in part by offset in part by the reversal of FIN 48
penalty reserves ($1.4 million) related to income taxes and bonus expense ($9.1
million) due to the Company achieving a lower EPS growth. The increase in direct
selling expenses is primarily due to an increase in advertising and promotional
expenses of $7.5 million in 2008 in support of several of our product lines and
other direct selling expenses of $4.4 million to support the increase in
domestic sales, offset in part by decreases in sales commissions ($1.0
million). From time to time, we may increase or decrease our
advertising efforts, if we deem it appropriate for particular
products.
Write-down of Intangible
Assets
Write-down
of intangible assets was $9.1 million in 2008, as compared to nil in 2007. We
decided to discontinue the use of the “Toymax” and “Trendmaster” tradenames on
products and market these products under the JAKKS Pacific trademark.
Consequently, the intangible assets associated with these tradenames were
written off to Write-down of Intangible Assets, resulting in a charge of $3.5
million. Also, we adjusted the value of the Child Guidance trademark to reflect
lower sales expectations for this tradename, resulting in a charge to write-down
of intangible assets of $5.6 million.
Profit from Video Game Joint
Venture
Profit
from our video game joint venture in 2008 decreased to $17.1 million, as
compared to $21.2 million in 2007, due to the lower sales of video
games. In 2008, the Smackdown vs. Raw 2008 game and video games on
the new WII game platform were introduced. The amount of the
preferred return we will receive from the joint venture after June 30, 2006
became subject to change (see “Risk Factors” and “World Wrestling Entertainments
Video Games” ).
30
Interest
Income
Interest
income in 2008 was $3.4 million, as compared to $6.8 million in
2007. The decrease is due to lower interest rates during 2008
compared to 2007 and lower average cash balances.
Interest
Expense
Interest
expense was $2.4 million in 2008, as compared to $5.5 million in 2007. In 2008,
we booked interest expense of $4.5 million related to our convertible senior
notes payable, off set in part by a net benefit of $2.2 million related to FIN
48 pursuant to our January 1, 2007 adoption of the provisions of FIN 48. In
2007, we booked interest expense of $4.5 million related to our convertible
senior notes payable and net interest expense $0.9 million related to FIN 48
pursuant to our January 1, 2007 adoption of the provisions of FIN
48.
Provision for Income
Taxes
Provision
for income taxes includes federal, state and foreign income taxes at effective
tax rates of 31.3% in 2007, and 14.4% in 2008, benefiting from a flat tax rate
of 17.5% and 16.5% for 2007 and 2008, respectively, on the Company’s income
arising in, or derived from, Hong Kong. The decrease in the effective
rate in 2008 is primarily due to the recognition of certain discrete income tax
adjustments recognized in the quarter ended September 30, 2008 and a change in
the federal tax code which reduced the amount of foreign income includible on
the federal income tax return. These discrete adjustments included the
reconciliation of the 2007 income tax provision to the actual income tax
liability as reflected in the Company’s income tax return in the amount of $5.0
million, and the reduction in income tax expense due to the recognition of a
previously recorded potential income tax liability for uncertain tax positions
that are no longer subject to audit due to the closure of the audit
period. As of December 31, 2008, the Company had net deferred tax
liability of approximately $8.2 million, inclusive of an allowance of
$0.9 million that has been provided since, in the opinion of management,
realization of the future benefit is uncertain.
Net
Sales
Traditional
Toys. Net sales of our Traditional Toys segment were $793.0
million in 2007, compared to $692.5 million in 2006, representing an increase of
$100.5 million, or 14.5%. The increase in net sales was primarily due
to impact of sales related to our Creative Designs line of products for the full
twelve months ended December 31, 2007, as compared to only a part of the twelve
months ended December 31, 2006 (as a result of the February 2006 acquisition of
Creative Designs), which had incremental sales of $17.4 million, and increases
in sales of WWE and Pokemon action figures and accessories, role-play and
dress-up toys, Bio Bytes ™, Eye Clops™ Bionic Eye, Child Guidance pre-school
toys, Hannah Montana dolls and accessories, In My Pocket toys,
Cheetah Girls toys, Sweet Secrets toys, Funnoodle pool toys and our Fly Wheels
XPV® toys, offset in part by decreases in sales of Dragonball Z® action figures,
JAKKS™ dolls, Plug It In & Play TV Games, wheels products, Telestory®,
Vmigo®, Sky Dancers®, Doodle Bears® Dragon Flyz™, Trolls™, Care Bears®, Cabbage
Patch Kids®, Speedstacks®, Snugglers™, RC Flight toys and our Go Fly A Kite® and
junior sports products.
Craft/Activity/Writing
Products. Net Sales of our Craft/Activity/Writing Products
were $39.6 million in 2007, compared to $52.8 million in 2006, representing a
decrease of $13.2 million, or 25.0%. The decrease in net sales was
primarily due to decreases in sales of our Flying Colors and Vivid Velvet
activities products and our Pentech and Color Workshop writing instruments and
related products.
Pet Products. Net
Sales of our Pet Pal line of products were $24.5 million in 2007, compared to
$20.1 million in 2006, representing an increase of $4.4 million, or
21.9%. The increase is attributable to the expanding line of products
and expanding distribution.
Cost of
Sales
Traditional
Toys. Cost of sales of our Traditional Toys segment was $490.3
million, or 61.8% of related net sales, in 2007, compared to $429.4 million, or
62.0% of related net sales, in 2006, representing an increase of $60.9 million,
or 14.2%. The increase primarily consisted of an increase in product
costs of $41.1 million, which is in line with the higher volume of
sales. Product costs as a percentage of sales decreased primarily due
to the mix of the product sold with lower product cost. Furthermore,
royalty expense for our Traditional Toys segment increased by $16.9 million and
as a percentage of net sales due to changes in the product mix to more products
with higher royalty rates from products with lower royalty rates or proprietary
products with no royalty rates. Additionally, certain royalty
advances and guarantees were written off for licensed product whose sell-off
period had expired or was projected to not recoup the advances through future
sales or meet its contractual minimum guaranty. Our depreciation of
molds and tools increased by $2.9 million due to the increased number of new
products being sold in this segment in 2007.
Craft/Activity/Writing
Products. Cost of sales of our Craft/Activity/Writing Products
segment was $27.0 million, or 68.1% of related net sales, in 2007, compared to
$29.0 million, or 55.0% of related net sales, in 2006, representing a decrease
of $2.0 million, or 6.9%. The decrease consisted of a decrease in
product costs of $2.2 million, which is in line with the lower volume of
sales. Product costs as a percentage of net sales increased primarily
due to the mix of the product sold and sell-off of closeout
product. Royalty expense increased by $0.3 million and as a
percentage of net sales due to changes in the product mix to more products with
higher royalty rates from products with lower royalty rates or proprietary
products with no royalty rates. Additionally, certain royalty advances and
guarantees were written off for licensed product whose sell-off period had
expired or was projected to not recoup the advances through future sales or meet
its contractual minimum guaranty. Our depreciation of molds and tools
decreased by $0.2 million in 2007 due to lower level of product in this segment
requiring molds and tools.
31
Pet Products. Cost
of sales of our Pet Pal line of products was $16.2 million, or 66.2% of related
net sales, in 2007, compared to $12.1 million, or 60.5% of related net sales, in
2006, representing an increase of $4.1 million, or 33.9%. The
increase primarily consisted of an increase in product costs of $3.5 million,
which is in line with the higher volume of sales. Product costs as a
percentage of net sales increased primarily due to the mix of the product
sold. Royalty expense increased by $0.4 million, which was in line
with the higher volume of sales. Additionally, our depreciation of
molds and tools was comparable year-over-year.
Selling, General and
Administrative Expenses
Selling,
general and administrative expenses were $216.7 million in 2007 and $202.5
million in 2006, constituting 25.3% and 26.5% of net sales,
respectively. The overall increase of $14.2 million in such costs was
primarily due to increases in general and administrative expenses ($16.8
million), the incremental overhead related to a full quarter impact of
operations of Creative Designs ($1.5 million) for the three months ended March
31, 2007 (as compared to a partial quarter of operations for the three months
ended March 31, 2006 as a result of the February 2006 acquisition thereof),
product development ($2.2 million) and stock based compensation ($2.6 million),
offset in part by decreases in other selling expenses ($7.0
million), and amortization expense related to intangible assets other
than goodwill ($1.9 million). The increase in general and
administrative expenses is primarily due to an increase in salary and payroll
taxes ($5.8 million) to support our growing business which includes a lower
allocation of JAKKS’ overhead to the video game joint venture ($1.2 million),
bonus expense ($10.6 million) based on a stronger EPS growth in 2007 compared to
2006, donations expense (2.1 million), rent expense ($1.1 million) and travel
and entertainment expense ($0.8 million), offset in part by decreases in other
expenses as a result of the reversal of FIN 48 penalties related to income taxes
payable ($0.6 million) and the buyout of our New York showroom lease ($1.3
million) and legal and other professional fees ($1.4
million). The decrease in direct selling expenses is primarily
due to a decrease in advertising and promotional expenses of $10.9 million in
2007 in support of several of our product lines, offset in part by an increase
in sales commissions ($1.2 million) and other direct selling expenses ($2.7
million). From time to time, we may increase or decrease our
advertising efforts, if we deem it appropriate for particular
products.
Profit from Video Game Joint
Venture
Profit
from our video game joint venture in 2007 increased to $21.1 million, as
compared to $13.2 million in 2006, due to the strong performance of the new
Smackdown vs. Raw 2007 game and stronger sales of existing titles in 2007
compared to 2006. Furthermore, we devoted and allocated $1.2 million less of
JAKKS’ overhead to the video game joint venture. The amount of the
preferred return we will receive from the joint venture after June 30, 2006
became subject to change (see “Risk Factors”, infra, and Note 4 of the
Notes to Consolidated Financial Statements, supra ).
Interest
Income
Interest
income in 2007 was $6.8 million, as compared to $4.9 million in
2006. The increase is due to higher average cash balances and higher
interest rates during 2007 compared to 2006.
Interest
Expense
Interest
expense was $5.5 million and $4.5 million for 2007 and 2006, respectively. The
increase is due to net interest accrued pursuant to our January 1, 2007 adoption
of the provisions of FIN 48. Interest expense of $4.5 million related to our
convertible senior notes payable were comparable in 2007 and 2006.
Provision for Income
Taxes
Provision
for income taxes includes federal, state and foreign income taxes at effective
tax rates of 31.7% in 2006, and 31.3% in 2007, benefiting from a flat 17.5% tax
rate on the Company’s income arising in, or derived from, Hong Kong for each of
2006 and 2007. The effective rate in 2007 reflects the recognition of
certain discrete income tax adjustments recognized in the quarter ended
September 30, 2007. These adjustments included the reconciliation of
the 2006 income tax provision to the actual income tax liability as reflected in
the Company’s income tax return, and the reduction in income tax expense due to
the recognition of a previously recorded potential income tax liability for
uncertain tax positions that are no longer subject to audit due to the closure
of the audit period. These discrete items resulted in approximately a
2.1% reduction in the effective income tax rate for the twelve months ended
December 31, 2007. As of December 31, 2007, the Company had net
deferred tax assets of approximately $7.3 million for which an allowance of $0.9
million has been provided since, in the opinion of management, realization of
the future benefit is uncertain.
32
Quarterly
Fluctuations and Seasonality
We have
experienced significant quarterly fluctuations in operating results and
anticipate these fluctuations in the future. The operating results for any
quarter are not necessarily indicative of results for any future period. Our
first quarter is typically expected to be the least profitable as a result of
lower net sales but substantially similar fixed operating expenses. This is
consistent with the performance of many companies in the toy
industry.
The
following table presents our unaudited quarterly results for the years
indicated. The seasonality of our business is reflected in this quarterly
presentation.
During
2007, we recorded net interest expense of $0.9 million related to FIN
48
During
the third quarter of 2008, we decided to discontinue the use of the “Toymax” and
“Trendmaster” tradenames on products and market these products under the JAKKS
Pacific trademark . Consequently, the intangible assets associated with these
tradenames were written off to Write-down of Intangible Assets, resulting in a
charge of $3.5 million. Also, we adjusted the value of the Child Guidance
trademark to reflect lower sales expectations for this tradename, resulting in a
charge to Write-down of Intangible Assets of $5.6 million.
Recent
Accounting Standards
In
December 2007, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 141 (Revised) (“FAS 141(R)”), Business
Combinations. This statement contains specific guidance
regarding the accounting for costs of business acquisitions and for estimating
contingent consideration provisions at the time of acquisition. This new
guidance replaces the previous guidance in FAS 141. We will adopt FAS 141(R) in
calendar year 2009.
In
September 2006, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 157 (“FAS 157”) Fair Value Measurements .
This standard provides new definitions for fair value and establishes a
framework for measuring fair value in financial statements. FAS 157 became
effective for us as of January 1, 2008 and the effect of the adoption of FAS 157
has been immaterial to our financial statements.
33
Liquidity
and Capital Resources
As of
December 31, 2008, we had working capital of $325.1 million, compared to $352.5
million as of December 31, 2007. This decrease was primarily attributable to
acquisitions of Tollytots, Kids Only and Disguise, the repurchase of common
stock, offset in part by net cash provided by our operating
activities.
Operating
activities provided net cash of $60.8 million in 2008, as compared to $91.9
million in 2007. Net cash was provided primarily by net income and non-cash
charges, offset in part by changes in working capital. Our accounts receivable
turnover as measured by days sales for the quarter outstanding in accounts
receivable for the three months ended December 31, 2008 decreased from
approximately 55 days as of December 31, 2007 to approximately 49 days as of
December 31, 2008. Other than open purchase orders issued in the normal course
of business, we have no obligations to purchase finished goods from our
manufacturers. As of December 31, 2008, we had cash and cash equivalents of
$169.5 million.
Our
investing activities used net cash of $104.9 million in 2008, as compared to
$37.9 million in 2007, consisting primarily of cash paid for the Creative
Designs earn-out of $6.7 million, the Play Along earn-out of $6.7 million, the
Pet Pal earn-out of $1.7 million, and goodwill and other intangibles assets
purchased in the acquisition of Tollytots for $10.1million, Kids Only
for $17.0 million, and Disguise for $37.9 million; and the purchase
of office furniture and equipment and molds and tooling of $22.3 million used in
the manufacture of our products and other assets. In 2007, our investing
activities consisted primarily of cash paid for the Creative Designs earn-out of
$6.7 million, the Play Along earn-out of $6.7 million, the Pet Pal earn-out of
$2.0 million and the purchase of office furniture and equipment and molds and
tooling of $18.1 million used in the manufacture of our products and other
assets. As part of our strategy to develop and market new products, we have
entered into various character and product licenses with royalties generally
ranging from 1% to 14% payable on net sales of such products. As of December 31,
2008, these agreements required future aggregate minimum guarantees of $57.9
million, exclusive of $38.6 million in advances already paid. Of this $57.9
million future minimum guarantee, $22.2 million is due over the next twelve
months.
Our
financing activities used net cash of $27.6 million in 2008, consisting of cash
paid for the repurchase of our common stock and restricted shares, partially
offset by proceeds from the exercise of stock options and the tax benefit from
the stock options exercised. In 2007, financing activities provided net cash of
$2.8 million, consisting of proceeds from the exercise of stock options and the
tax benefit from the stock options exercised.
.
The above
table excludes any potential uncertain income tax liabilities that may become
payable upon examination of the Company’s income tax returns by taxing
authorities. Such amounts and periods of payment cannot be reliably estimated.
See Note 12 to the financial statements for further explanation of the Company’s
uncertain tax positions. The above table also excludes our contractual
obligation with one of our executives regarding his retirement plan. Such
amounts and periods of payment cannot be reliably estimated. See Note 15 to the
financial statements for further explanation of the Company’s retirement plan
commitment.
In
October 2004, we were named as a defendant in a lawsuit commenced by WWE (the
“WWE Action”). The complaint also named as defendants, among others, the joint
venture with THQ Inc., certain of our foreign subsidiaries and our three
executive officers. The complaint was dismissed and an appeal has been filed
with respect to the Judgment dismissing the WWE Action. In November 2004,
several purported class action lawsuits were filed in the United States District
Court for the Southern District of New York, alleging damages associated with
the facts alleged in the WWE Action. In January 2008, the complaint was
dismissed without prejudice to seeking leave to file an amended complaint. Such
leave was sought in February 2008. Three shareholder derivative actions have
also been filed against us, nominally, and against certain of our Board members
(the “Derivative Actions”). The Derivative Actions seek to hold the individual
defendants liable for damages allegedly caused to our Company by their actions,
and, in one of the Derivative Actions, seeks restitution to our Company of
profits, benefits and other compensation obtained by them. In October
2006, WWE commenced a lawsuit against THQ and the joint venture concerning
allegedly improper sales of WWE video games in Japan and other countries in
Asia, seeking among other things, a declaration that WWE is entitled to
terminate its video games license with the joint venture and monetary damages
(the “Connecticut Action”). In spring 2007, WWE amended the complaint in the
Connecticut Action to allege the matters set forth in the WWE Action.
Thereafter, WWE amended the complaint in the Connecticut Action to allege state
claim laws that had been alleged in the WWE Action. WWE submitted a proposed
case management order in February 2008 and it provided for a trial on or after
October 2009. On February 22, 2008, we submitted a response in which we
requested that no case management order be adopted prior to the determination of
the motion to strike and for summary judgment (the
“Dispositive Motion”) because it would moot such a case management order
but that if a case management order is to be adopted it should provide for a
trial, if the matter is not fully dismissed, not before June 2010. The
Dispositive Motion was made and granted and WWE is now appealing the dismissal
with respect to the state law causes of action from the WWE Action. See “Legal
Proceedings.”
34
In June
2005, we purchased substantially all of the operating assets and assumed certain
liabilities relating to the Pet Pal line of pet products, including toys, treats
and related pet products. The total initial purchase price of $10.6 million was
paid in cash. In addition, we agreed to pay an earn-out of up to an aggregate
amount of $25.0 million in cash over the three years ending June 30, 2008
following the acquisition based on the achievement of certain financial
performance criteria, which will be recorded as goodwill when and if
earned. During the years ended December 31, 2006 and 2007, $1.5
million and $2.0 million, respectively, of the earn-out was earned and recorded
as goodwill. Goodwill of $4.6 million arose from this transaction,
which represents the excess of the purchase price over the fair value of assets
acquired less liabilities assumed. This acquisition expands our product
offerings and distribution channels. Our results of operations have included Pet
Pal from the date of acquisition.
In
February 2006, we acquired substantially all of the assets of Creative Designs.
The total initial purchase price of $111.1 million consisted of $101.7 million
in cash, 150,000 shares of our common stock at a value of approximately $3.3
million and the assumption of liabilities in the amount of $6.1 million. In
addition, we agreed to pay an earn-out of up to an aggregate amount of $20.0
million in cash over the three calendar years following the acquisition based on
the achievement of certain financial performance criteria, which will be
recorded as goodwill when and if earned. For the years ended December 31, 2006,
2007 and 2008, $6.9 million, $6.7 million and $5.7 million, respectively, of the
earn-out was earned and recorded as goodwill. Creative Designs is a
leading designer and producer of dress-up and role-play toys and is included in
our results of operations from the date of acquisition.
In
February 2008, our Board of Directors authorized us to repurchase up to $30.0
million of our common stock. In April and May 2008, we repurchased a total of
1,259,300 shares of our common stock at an average price of $23.82 per share for
a total cost of $30.0 million. The stock repurchased represents approximately
4.4% of our outstanding shares of common stock.
In February 2009, parties to our class action lawsuit notified
the Court that an agreement in principle to settle this matter has been
reached. The agreement, which is subject to documentation and Court
approval, will settle the matter for $3.9 million, without any admission of
liability on the part of the Company, or its officers and directors. The
Company expects for a significant portion of this settlement to be covered by
insurance. See “Legal Proceedings.”
On
October 8, 2008, we acquired substantially all of the stock of Kids Only, Inc.
and a related Hong Kong company, Kids Only Limited (collectively, “Kids
Only”). The total initial consideration of $23.2 million consisted of
$20.3 million in cash and the assumption of liabilities in the amount of $2.9
million, and resulted in goodwill of $12.5 million. In addition, we agreed to
pay an earn-out of up to an aggregate amount of $5.6 million in cash over the
three calendar years following the acquisition based on the achievement of
certain financial performance criteria, which will be recorded as goodwill when
and if earned. Kids Only is a leading designer and producer of licensed indoor
and outdoor kids’ furniture, and has an extensive portfolio which also includes
baby dolls and accessories, room décor and a myriad of other children’s toy
products and was included in our results of operations from the date
of acquisition.
On
December 29, 2008, we acquired certain assets of Disguise, Inc. and a related
Hong Kong company, Disguise Limited (collectively, “Disguise”). The
total initial consideration of $61.9 million consisted of $39.9 million in cash
and the assumption of liabilities in the amount of $22.0 million, and resulted
in goodwill of $51.6 million. We have not finalized our purchase price
allocation for Disguise and will engage a third party to perform studies and
valuations to the estimated fair value of assets and liabilities
assumed. Disguise is a leading designer and producer of Halloween and
everyday costume play and was included in our results of operations from the
date of acquisition
In June
2003, we sold an aggregate of $98.0 million of 4.625% Convertible Senior Notes
due June 15, 2023. The notes may be converted into shares of our common stock at
an initial conversion price of $20.00 per share, or 50 shares per note, subject
to certain circumstances. The notes may be converted in each quarter subsequent
to any quarter in which the closing price of our common stock is at or above a
prescribed price for at least 20 trading days in the last 30 trading day period
of the quarter. The prescribed price for the conversion trigger is
$24.00 through June 30, 2010, and increases nominally each quarter
thereafter. Cash interest is payable at an annual rate of 4.625% of
the principal amount at issuance, from the issue date to June 15, 2010, payable
on June 15 and December 15 of each year, commencing on December 15, 2003. After
June 15, 2010, interest will accrue at the same rate on the outstanding notes
until maturity. At maturity, we will redeem the notes at their accreted
principal amount, which will be equal to $1,811.95 (181.195%) per $1,000
principal amount at issuance, unless redeemed or converted
earlier. The notes were not convertible as of December 31, 2008, and
are not convertible in the first quarter of 2009.
35
We may
redeem the notes at our option in whole or in part beginning on June 15, 2010,
at 100% of their accreted principal amount plus accrued and unpaid interest, if
any, payable in cash. Holders of the notes may also require us to repurchase all
or part of their notes on June 15, 2010, for cash, at a repurchase price of 100%
of the principal amount per note plus accrued and unpaid interest, if any.
Holders of the notes may also require us to repurchase all or part of their
notes on June 15, 2013 and June 15, 2018 at a repurchase price of 100% of the
accreted principal amount per note plus accrued and unpaid interest, if any. Any
repurchases at June 15, 2013 and June 15, 2018 may be paid in cash, in shares of
common stock or a combination of cash and shares of common stock.
We
believe that our cash flows from operations and cash and cash equivalents will
be sufficient to meet our working capital and capital expenditure requirements
and provide us with adequate liquidity to meet our anticipated operating needs
for at least the next 12 months. Although operating activities are expected to
provide cash, to the extent we grow significantly in the future, our operating
and investing activities may use cash and, consequently, this growth may require
us to obtain additional sources of financing. There can be no assurance that any
necessary additional financing will be available to us on commercially
reasonable terms, if at all. We intend to finance our long-term liquidity
requirements out of net cash provided by operations and net cash and cash
equivalents. As of December 31, 2008, we do not have any off-balance
sheet arrangements.
Exchange
Rates
Sales
from our United States and Hong Kong operations are denominated in U.S. dollars
and our manufacturing costs are denominated in either U.S. or Hong Kong dollars.
Operations and operating expenses of all of our operations are denominated in
local currency, thereby creating exposure to changes in exchange rates. Changes
in the Hong Kong dollar/U.S. dollar exchange rate may positively or negatively
affect our operating results. The exchange rate of the Hong Kong dollar to the
U.S. dollar has been fixed by the Hong Kong government since 1983 at HK$7.80 to
US$1.00 and, accordingly, has not represented a currency exchange risk to the
U.S. dollar. We cannot assure you that the exchange rate between the United
States and Hong Kong currencies will continue to be fixed or that exchange rate
fluctuations between the United States and Hong Kong currencies will not have a
material adverse effect on our business, financial condition or results of
operations.
Market
risk represents the risk of loss that may impact our financial position, results
of operations or cash flows due to adverse changes in financial and commodity
market prices and rates. We are exposed to market risk in the areas of changes
in United States and international borrowing rates and changes in foreign
currency exchange rates. In addition, we are exposed to market risk in certain
geographic areas that have experienced or remain vulnerable to an economic
downturn, such as China. We purchase substantially all of our inventory from
companies in China, and, therefore, we are subject to the risk that such
suppliers will be unable to provide inventory at competitive prices. While we
believe that, if such an event were to occur we would be able to find
alternative sources of inventory at competitive prices, we cannot assure you
that we would be able to do so. These exposures are directly related to our
normal operating and funding activities. To date, we have not used derivative
instruments or engaged in hedging activities to minimize our market
risk.
Interest
Rate Risk
In June
2003, we issued convertible senior notes payable of $98.0 million with a fixed
interest rate of 4.625% per annum, which remain outstanding as of December 31,
2008. Accordingly, we are not generally subject to any direct risk of loss
arising from changes in interest rates.
We have
wholly-owned subsidiaries in Hong Kong and China. Sales are made by these
operations on FOB China or Hong Kong terms and are denominated in U.S. dollars.
However, purchases of inventory and Hong Kong operating expenses are typically
denominated in Hong Kong dollars and local operating expenses in China are
denominated in local currency, thereby creating exposure to changes in exchange
rates. Changes in the Chinese Yuan or Hong Kong dollar/U.S. dollar exchange
rates may positively or negatively affect our gross margins, operating income
and retained earnings. A gain in Hong Kong dollars gave rise to the
other comprehensive loss in the balance sheet at December 31, 2007. The exchange
rate of the Hong Kong dollar to the U.S. dollar has been fixed by the Hong Kong
government since 1983 at HK$7.80 to US$1.00 and, accordingly, has not
represented a currency exchange risk to the U.S. dollar. We do not believe that
near-term changes in these exchange rates, if any, will result in a material
effect on our future earnings, fair values or cash flows, and therefore, we have
chosen not to enter into foreign currency hedging transactions. We cannot assure
you that this approach will be successful, especially in the event of a
significant and sudden change in the value of the Hong Kong dollar or Chinese
Yuan.
36
Item 8. Consolidated
Financial Statements and Supplementary Data>
Report
of Independent Registered Public Accounting Firm
The Board
of Directors and Stockholders
JAKKS
Pacific, Inc.
Malibu,
California
We have
audited the accompanying consolidated balance sheets of JAKKS Pacific, Inc. (the
“Company”) as of December 31, 2008 and 2007 and the related consolidated
statements of income, other comprehensive income, stockholders’ equity and cash
flows for each of the three years in the period ended December 31, 2008. These
financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits 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 significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of JAKKS Pacific, Inc. as of December
31, 2008 and 2007, and the results of its operations and its cash flows for each
of the three years in the period ended December 31, 2008, in conformity with
accounting principles generally accepted in the United States of
America.
As more
fully described in Note 2 to the consolidated financial statements, effective
January 1, 2007, the Company changed the manner in which it accounts for
uncertain tax positions, due to the adoption of FASB Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement
No. 109.”
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), JAKKS Pacific, Inc.’s internal control over
financial reporting as of December 31, 2008, based on criteria established in
Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) and our report dated February 28, 2009 expressed an
unqualified opinion thereon.
37
JAKKS
PACIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
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