Annual Reports

  • 10-K (Mar 17, 2014)
  • 10-K (Mar 15, 2013)
  • 10-K (Mar 15, 2012)
  • 10-K (Mar 4, 2011)
  • 10-K (Mar 17, 2010)
  • 10-K (Mar 2, 2009)

 
Quarterly Reports

 
8-K

 
Other

JAKKS Pacific 10-K 2010
Unassociated Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 10-K

(Mark One)
x
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Fiscal Year Ended December 31, 2009
   
o
TRANSITION REPORT UNDER SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________

Commission File Number 0-28104
 
JAKKS PACIFIC, INC.
(Exact name of registrant as specified in its charter)

Delaware
95-4527222
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)

22619 Pacific Coast Highway
 
Malibu, California
90265
(Address of principal executive offices)
(Zip Code)

Registrant’s telephone number, including area code: (310) 456-7799

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

Title of each class
Name of each exchange
on which registered
Common Stock, $.001 par value per share
Nasdaq Global Select

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 x

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 x

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best 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,  a non-accelerated filer or a smaller reporting company. See the definition of “large accelerated filer,”  “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one):
 
¨    Large Accelerated Filer
x    Accelerated Filer
¨    Non-Accelerated Filer
¨    Smaller Reporting Company
     
(Do not check if a smaller Reporting Company)
  

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

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 March 15, 2010 of $12.97) is $355,780,926.

The number of shares outstanding of the registrant’s Common Stock, $.001 par value (being the only class of its common stock), is 27,900,319 (as of March 15, 2010).
 
Documents Incorporated by Reference

None.
 
 
 

 
 
JAKKS PACIFIC, INC.

INDEX TO ANNUAL REPORT ON FORM 10-K

For the Fiscal Year ended December 31, 2009

Items in Form 10-K

   
Page
 
PART I
 
Item 1.
Business
2
Item 1A.
Risk Factors
11
Item 1B.
Unresolved Staff Comments
None
Item 2.
Properties
16
Item 3.
Legal Proceedings
17
Item 4.
Reserved
 
 
PART II
 
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
19
Item 6.
Selected Financial Data
22
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
24
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
35
Item 8.
Financial Statements and Supplementary Data
37
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None
Item 9A.
Controls and Procedures
67
Item 9B.
Other Information
None
 
PART III
 
Item 10.
Directors, Executive Officers and Corporate Governance
69
Item 11.
Executive Compensation
71
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
82
Item 13.
Certain Relationships and Related Transactions, and Director Independence
84
Item 14.
Principal Accountant Fees and Services
84
 
PART IV
 
Item 15.
Exhibits and Financial Statement Schedules
86
Signatures
 
88
Certifications
 
 

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

 
 
PART I

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, kids indoor and outdoor furniture, 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, and have historically acquired complementary businesses to further grow our portfolio.  Our products include:

Traditional Toys

 
  •
Action figures and accessories, including licensed characters, principally based on Ultimate Fighting Champion (“UFC), Pokemon® and until December 31, 2009 World Wrestling Entertainment® (“WWE”) franchises;
 
 
  •
Toy vehicles, including Road Champs®, NASCAR®  and MXS®  toy vehicles and accessories;

 
  •
Electronics products, including Plug It In & Play TV Games™, EyeClops™ Bionic Eye products, and Laser Challenge®, as well as others based on Disney® and Discovery Kids® brands;

 
  •
Role-play, dress-up, pretend play and novelty products for boys and girls based on well known brands and entertainment properties such as Black & Decker®, McDonalds®, Dirt Devil®, Subway®, Pizza Hut® Disney Princess®, Disney Fairies®, Hannah Montana™, Barbie® and Dora the Explorer®, as well as those based on our own proprietary brands;

 
  •
Dolls and accessories, plush, infant and pre-school toys based on our Child Guidance®, TollyTots brands, as well as licenses, including Barney®, The Wiggles®, Disney Fairies®, Cabbage Patch Kids®, Taylor Swift, Fancy Nancy, Hello Kitty®, Hannah Montana, Puppy in My Pocket and Friends™, Disney Princess®, Disney Babies, Graco® and Fischer Price®;

 
  •
Indoor and outdoor kids’ furniture, room décor; kiddie pools and pool toys, kites, seasonal and outdoor products, including Kids Only!, Go Fly A Kite®, Funnoodle® and Laser Challenge;

 
  •
Halloween and everyday costumes for all ages based on licensed and proprietary non-licensed brands, including Spiderman® , Iron Man, Toy Story®, Sesame Street®, Power Rangers® and Disney Princesses® , and related Halloween accessories;

 
  •
Private label products as “exclusives” for a myriad of retail customers in many product categories.

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 Toy 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

 
  •
Food play, activity kits, reusable compounds, writing instruments and stationery products, including Girl Gourmet™, Creepy Crawlers™, The Spa Factory™, Flying Colors®, Blopens®, Vivid Velvet®, and Pentech®
 
 
2

 

Pet Products

 
  •
Pet products, including toys, consumables, beds, clothing and accessories, branded JAKKS Pets®, some of which also feature licenses, including American Kennel Club® and The Cat Fanciers’ Association™.

We continually review the marketplace to identify and evaluate popular and evergreen brands and product categories that we believe have the potential for growth. We endeavor to generate growth within these lines by:

 
  •
creating innovative products under our established licenses and brand names;

 
  •
adding new items to the branded product lines that we expect will enjoy greater popularity;

 
  •
infusing simple innovation and technology when appropriate to make them more appealing to today’s kids;

 
  •
linking them with our evergreen portfolio of brands; and

 
  •
focusing our marketing efforts to enhance consumer recognition and retailer interest.

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 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 accounted for approximately 27.3%, 16.9% and 11.4%, respectively, of our net sales in 2009. No other customer accounted for more than 10.0% of our net sales in 2009.

Our Growth Strategy

The execution of our growth strategy has normally resulted in increased levels of revenues and earnings. However, in 2009, we experienced a decline in sales mainly due to declines in a few key product lines and a challenging economy and had various one-time charges which resulted in a net loss for the year.  In 2008 and 2009, we generated net sales of $903.4 million and $803.7 million, respectively, and net income of $76.1 million and net loss of $385.5 million, respectively. Approximately 1.2% and 21.0% of our net sales in 2008 and 2009, respectively, were attributable to our acquisitions since 2008. Key elements of our growth strategy include:

•       Expand Core Products.>    We manage our existing and new brands through strategic product development initiatives, including introducing new products, modifying existing products and extending existing product lines to maximize their longevity. Our marketing teams and product designers strive to develop new products or product lines to offer added technological, aesthetic and functional improvements to our extensive portfolio. For example, we use multiple methods including real-scan technology, articulated joints and a flexible rubberized coating to enhance the life-like feel of our action figures, and feature special techniques such as vinyl and sound chips in our lines of dolls and figures. These innovations appeal to collectors and/or produce higher quality and better likenesses of the representative characters.


 
 
3

 
 


•       Capitalize On Our Operating Efficiencies.>    We believe that our current infrastructure and operating model can accommodate 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

In October 2008, we acquired substantially all of the assets of Tollytots Limited.  The total initial consideration of $26.8 million consisted of $12.0 million in cash and the assumption of liabilities in the amount of $14.8 million, and resulted in goodwill of $4.1 million, all of which has been determined to be impaired and was written off in the quarter ended June 30, 2009. 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.  In the first earn-out period ended December 31, 2009, no portion of the earn-out was 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.

In October 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 $23.8 million consisted of $20.4 million in cash and the assumption of liabilities in the amount of $3.4 million, and resulted in goodwill of $13.2 million, all of which has been determined to be impaired and was written off in the quarter ended June 30, 2009. 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. The first earn-out period ended September 30, 2009 is under review.  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.
 
 
4

 

In December 2008, we acquired certain assets of Disguise, Inc. and a related Hong Kong company, Disguise Limited (collectively, “Disguise”).  The total initial consideration of $60.6 million consisted of $38.6 million in cash and the assumption of liabilities in the amount of $22.0 million, and resulted in goodwill of $30.6 million, all of which has been determined to be impaired and was written off in the quarter ended June 30, 2009. We finalized our purchase price allocation for Disguise and engaged 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.
 
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 $21.5 billion in 2009. 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 $10.5 billion in 2009.

Over the past few years, the toy industry has experienced substantial consolidation among both toy companies and toy retailers. We believe that the ongoing consolidation of toy companies provides us with increased growth opportunities due to retailers’ desire to not be entirely dependent on a few dominant toy companies. Retailer concentration also enables us to ship products, manage account relationships and track retail sales more effectively and efficiently.

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®, Big Buck Hunter® Pro, 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®, Price Is Right®, Deal or No Deal®, Jeopardy® and Star Wars®.

Wheels Division Products

 
 •
Motorized and plastic toy vehicles and accessories.

Our extreme sports offerings include our MXS line of motorcycles with riders and other vehicles include GX™ cars, off-road vehicles and skateboards, which are sold individually and with playsets and accessories.

Action Figures and Accessories

We had an extensive toy license with the WWE pursuant to which we had the right, until December 31, 2009, to develop and market a full line of toy products based on the popular WWE professional wrestlers. At the end of 2009, we had a limited amount of inventory remaining which we expect to sell during the first quarter of 2010.
 
We also develop, manufacture and distribute other action figures and action figure accessories including those based on the animated series Pokemon.  In 2009, we launched a line of action figures and accessories based on Ultimate Fighting Championship and, in 2010, we expect to launch a product line of action figures and accessories based on TNA (“Total Non-stop Action”) wrestling, capitalizing on the expertise we built in the action figure category.
 
 
5

 

Role-play and Dress-up Products

Our line of role-play and dress-up products for boys and girls features entertainment and consumer products properties such as Disney Princess, Disney Fairies, Sesame Street, Hannah Montana, Dora the Explorer and Black & Decker.  These products generated a significant amount of sales in 2009, and we expect that level of sales to continue in 2010.

Infant and Pre-school Toys

Our pre-school toys include plush and electronic toys based on The Wiggles and  Barney licenses and more, some branded under Child Guidance® and others under Play Along®.

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, Taylor Swift and Disney Princess and Fairies 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.

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®, 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.  In 2010, we expect to launch a line of licensed molded kiddie pools.
 
Halloween and Everyday Costume Play

We produce an expansive and innovative line of Halloween costumes and accessories with 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®, Hasbro®, 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 food play, make and paint your own characters, jewelry making, art studios, posters, puzzles and other projects.  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 and The Cat Fanciers’ Association, as well as numerous other entertainment and consumer product properties.
 
 
6

 

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. Pursuant to a Settlement Agreement and Mutual Release dated December 22, 2009, the joint venture was terminated on December 31, 2009 and we will receive fixed payments from THQ of $6.0 million on each of June 30, 2010 and 2011 and $4.0 million on each of June 30, 2012 and 2013 which we will record as income on a cash basis over the term (see “Legal Proceedings”).
 
The joint venture published titles for the Sony, Nintendo and Microsoft consoles, Sony® and Nintendo® hand-held platforms, mobile/wireless and personal computers. It also published 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 were 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 for the five years ended December 31, 2009:
 
    
New Game Titles
     
Profit from
  
     
Console
Platforms
     
Hand-
held
Platforms
     
video
game joint
venture (1)
 
               
(In millions)
 
2005
   
3
     
1
    $
9.4
 
2006
   
2
     
1
     
13.2
 
2007
   
4
     
2
     
21.2
 
2008
   
4
     
2
     
17.1
 
2009
   
7
     
1
     
7.4
 (2)
 

 
(1)
Profit from the video game joint venture reflects our preferred return on joint venture revenue less certain costs incurred directly by us and payments made by us to THQ for their share of the profit on Plug It In & Play TV Games based on WWE content.
(2)
Excludes a cumulative reduction of $23.5 million to our accrued receivable from the joint venture that resulted from the arbitration setting the preferred return rate at 6%, instead of the 10% rate that had been accrued.
 
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 56.5% of our net sales in 2008 and 55.6% of our net sales in 2009. 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.

We contract the manufacture of most of our products to unaffiliated manufacturers located in The People’s Republic of China (“China”). We sell the finished products on a letter of credit basis or on open account to our customers, many of whom take title to the goods in Hong Kong or China. These methods allow us to reduce certain operating costs and working capital requirements. A portion of our sales originate in the United States, so we hold certain inventory in our warehouse and fulfillment facilities. To date, a significant portion of all of our sales has been to domestic customers. We intend to continue expanding distribution of our products into foreign territories and, accordingly, we have:

 
engaged representatives to oversee sales in certain territories,

 
engaged distributors in certain territories,

 
established direct relationships with retailers in certain territories, and
 
 
7

 

 
expanded in-house resources dedicated to product development and marketing of our lines internally.

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 $161.9 million, or 17.9% of our net sales, in 2008 and approximately $132.5 million, or 16.5% of our net sales, in 2009. We believe that foreign markets present an attractive opportunity, and we plan to intensify our marketing efforts and further expand our distribution channels abroad.
 
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 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 also 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 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.

Safety testing of our products is done at the manufacturers’ facilities by quality control personnel employed by us or by independent third-party contractors engaged by us. Safety testing is designed to meet or exceed regulations imposed by federal and state, as well as applicable international governmental authorities, our retail partners, licensors and the Toy Industry Association. We also closely monitor quality assurance procedures for our products for safety purposes. In addition, independent laboratories engaged by some of our larger customers and licensors test certain of our products.
 
 
8

 

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 $19.6 million in 2008 and $12.9 million in 2009. Substantially all of these assets are located in China.
 
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®), in our Halloween costume lines with Rubies 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.

Seasonality and Backlog

In 2009, approximately 68.5% 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.
 
 
9

 

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 March 15, 2010, we employed 711 persons, all of whom are full-time employees, including three executive officers. We employed 338 people in the United States, 11 people in Canada, 255 people in Hong Kong, 104 people in China and 3 people 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.
 
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.
 
 
10

 

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 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.

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:

 
 •
The phenomenon of children outgrowing toys at younger ages, particularly in favor of interactive and high technology products;

 
 •
Increasing use of technology;

 
 •
Shorter life cycles for individual products; and

 
 •
Higher consumer expectations for product quality, functionality and value.

We cannot assure you that:

 
 •
our current products will continue to be popular with consumers;

 
 •
the product lines or products that we introduce will achieve any significant degree of market acceptance; or

 
 •
the life cycles of our products will be sufficient to permit us to recover licensing, design, manufacturing, marketing and other costs associated with those products.
 
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:

 
 •
media associated with our character-related and theme-related product lines will be released at the times we expect or will be successful;

 
 •
the success of media associated with our existing character-related and theme-related product lines will result in substantial promotional value to our products;

 
 •
we will be successful in renewing licenses upon expiration on terms that are favorable to us; or

 
 •
we will be successful in obtaining licenses to produce new character-related and theme-related products in the future.

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.
 
 
11

 

There are risks associated with our license agreements.

 
 •
Our current licenses require us to pay minimum royalties

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.
 
 
 •
Some of our licenses are restricted as to use

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.

 
 •
New licenses are difficult and expensive to obtain

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.

 
 •
A limited number of licensors account for a large portion of our net sales

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 expired 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:

 
 •
greater financial resources;

 
 •
larger sales, marketing and product development departments;
 
 
 •
stronger name recognition;

 
 •
longer operating histories; and

 
 •
greater economies of scale.

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.
 
 
12

 

We may not be able to sustain our 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 years, which was achieved through acquisitions of businesses, products and licenses. For example, revenues associated with companies we acquired since 2008 were approximately $10.5 million and $169.0 million, in 2008 and 2009, respectively, representing 1.2% and 21.0% 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.

 In addition, 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. Accordingly, we cannot assure you that our growth strategy will be successful.

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 2008 represented approximately 1.2% and 21.0% of our total revenues in 2008 and 2009, respectively. Future acquisitions will succeed only if we can effectively assess characteristics of potential target companies and product lines, such as:

 
 •
attractiveness of products;

 
 •
suitability of distribution channels;

 
 •
management ability;

 
 •
financial condition and results of operations; and

 
 •
the degree to which acquired operations can be integrated with our operations.

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:

 
 •
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.
 
 
13

 
 
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 55.6% of our net sales in 2009. 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 has been 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 and Chief Operating Officer. Effective April 1, 2010, Mr. Friedman is retiring as Co-Chief Executive Officer but will continue as our non-executive Chairman and will also serve in the newly created role of Chief Strategist. Mr. Berman is continuing as President and Chief Executive Officer. At this time, we do not believe Mr. Friedman’s retirement as Co-Chief Executive Officer will have a material adverse impact on our business, financial condition and results of operations. We cannot assure you that we would be able to find an appropriate replacement for Mr. Berman if the need should arise, and any loss or interruption of the services of Mr. Berman 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, 2009 sales to our international customers comprised approximately 16.5% 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:

 
currency conversion risks and currency fluctuations;

 
limitations, including taxes, on the repatriation of earnings;

 
political instability, civil unrest and economic instability;
 
 
14

 

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

 
complications in complying with laws in varying jurisdictions and changes in governmental policies;

 
greater difficulty and expenses associated with recovering from natural disasters;
 
 
transportation delays and interruptions;

 
the potential imposition of tariffs; and

 
the pricing of intercompany transactions may be challenged by taxing authorities in both Hong Kong and the United States, with potential increases in income taxes.

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 extensive government regulation and any violation by us of such regulations could result in product liability claims, loss of sales, diversion of resources, damage to our reputation, increased warranty costs or removal of our products from the market, and we cannot assure you that our product liability insurance for the foregoing will be sufficient.

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:

 
product liability claims;

 
loss of sales;

 
diversion of resources;

 
damage to our reputation;

 
increased warranty costs; and

 
removal of our products from the market.

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.

 
15

 

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.
 
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, holders of the remaining $20.3 million of our 4.625% 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. We intend to use the remaining proceeds from the offering of our 4.50% convertible senior notes issued on November 10, 2009 to repurchase the remaining $20.3 million of our 4.625% convertible senior notes in June 2010.

On November 10, 2009, we sold an aggregate of $100.0 million of 4.50% Convertible Senior Notes due 2014 (the “Notes”). The Notes are senior unsecured obligations of JAKKS, will pay interest semi-annually at a rate of 4.50% per annum and will mature on November 1, 2014. Prior to August 1, 2014, holders of the Notes may convert their Notes only upon specified events. Upon conversion, the Notes may be settled, at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock. Holders of the Notes may require us to repurchase for cash all or some of their Notes upon the occurrence of a fundamental change (as defined in the Notes).
 
Item 2. Properties>

The following is a listing of the principal leased offices maintained by us as of March 15, 2010:

Property
  
Location
  
Approximate
Square Feet
  
Lease Expiration
Date
Domestic
           
Corporate Office
 
Malibu, California
   
29,500
 
February 28, 2015
Design Center
 
Malibu, California
   
13,400
 
August, 31, 2015
Showroom
 
Santa Monica, California
   
18,400
 
August 31, 2015
Distribution Center
 
City of Industry, California
   
800,000
 
January 31, 2013
Sales Office / Showroom
 
New York, New York
   
11,700
 
November 1, 2015
Creative Designs Office
 
Trevose, Pennsylvania
   
14,700
 
June 30, 2011
Sales Office
 
Bentonville, Arkansas
   
9,000
 
September 30, 2014
Sales Office
 
Palatine, Illinois
   
2,100
 
March 31, 2010
Distribution Center
 
Newton, North Carolina
   
109,000
 
October, 9, 2011
Disguise Office
 
Poway, California
   
24,200
 
December 31, 2012
International
             
Distribution Center
 
Brampton, Ontario, Canada
   
105,700
 
December 31, 2014
Hong Kong Headquarters
 
Kowloon, Hong Kong
   
36,600
 
June 30, 2010
Hong Kong Showroom
 
Kowloon, Hong Kong
   
21,000
 
May 31, 2011
Production Inspection Office
 
Shanghai, China
   
1,200
 
April 30, 2010
Production Inspection and Testing Office
 
Shenzhen, China
   
5,400
 
May 14, 2010
Tollytots  Limited Warehouse
 
Tuen Mun, Hong Kong
   
5,500
 
October 9, 2011
Production Inspection Office
 
Nanjing, China
   
2,000
 
September 15, 2010



 
16

 

Item 3. Legal Proceedings

On October 12, 2006, World Wrestling Entertainment, Inc. (“WWE”) commenced a lawsuit in Connecticut state court against THQ/JAKKS Pacific LLC, alleging that sales of WWE video games in Japan and other countries in Asia were not lawful (the “Connecticut Action”).  The lawsuit sought, among other things, a declaration that WWE is entitled to terminate the video game license and monetary damages. In 2007, WWE filed an amended complaint in the Connecticut Action to add the principal part of the state law claims present in the action filed by WWE in the Southern District of New York (the “WWE Action”) to the Connecticut Action; the WWE Action was finally dismissed in 2009. THQ filed a cross-complaint that asserted claims by THQ and Mr. Farrell, THQ’s Chief Executive Officer, for indemnification from the Company in the event that WWE prevailed on its claims against THQ and Farrell and also asserted claims by THQ that the Company breached its fiduciary duties to THQ in connection with the videogame license between WWE and the THQ/Jakks Pacific joint venture and sought equitable and legal relief, including substantial monetary and exemplary damages against the Company in connection with its claim.  Thereafter, the WWE claims and the THQ cross-claims in the Connecticut Action were all dismissed with prejudice pursuant to settlement agreements that the Company entered into with WWE and THQ dated December 22, 2009 (the “Settlements”).
 
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 notified the Court that an agreement to resolve this action was reached.  In November 2009, a motion was filed by plaintiffs’ counsel for preliminary approval of this agreement, which provides for the matter to be settled for $3.9 million, without any admission of liability on the part of the Company, or its officers and directors.

 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. Agreement to resolve the Derivative Actions has been reached, but it is also subject to Court approval. A Company insurer has agreed to provide the $4.1 million that will be used to settle the Class Action and the Derivative Actions.
 
 
17

 

In order to exercise the joint venture's right to renew the WWE videogame license for the renewal period running from January 1, 2010 through December 31, 2014, the Company, on behalf of the joint venture, sent out a Notice of Renewal to WWE on June 30, 2009 (the “Renewal Notice”).  THQ commenced an action in California Superior Court (the “California Action”) seeking a declaratory judgment that JAKKS could not renew the videogame license without THQ's consent and that THQ was not obligated to consent.  THQ also sought a declaratory judgment that the restrictive covenant contained in the joint venture agreement was unenforceable.  The Company filed a demurrer in the California Action which was fully briefed and ready for argument. THQ brought a summary judgment motion seeking a declaration that the restrictive covenant was not enforceable. In the event that the demurrer would be denied, the Company sought an adjournment of THQ’s summary judgment motion pending discovery. WWE also commenced an action in California seeking the same relief as THQ, namely, to declare THQ’s restrictive covenant unenforceable, and the Company filed a demurrer seeking to dismiss the action on the grounds that WWE had no standing and the relief was otherwise not available. THQ also filed an arbitration in California seeking a declaratory judgment that the same restrictive covenant was unenforceable (the “California Arbitration”).  The Company commenced an arbitration in New York  (the “New York Arbitration”) seeking, among other things, a declaratory judgment that (a) it was empowered to serve the Renewal Notice and (b) THQ’s restrictive covenant was enforceable. In the New York Arbitration, the Company also sought to hold THQ liable for its breach of fiduciary duty with respect to its dealings with the Company and the LLC.  The Company also commenced an action in New York Supreme Court to enjoin the California Arbitration.  The application to enjoin the California Arbitration was argued.  The Company requested of the American Arbitration Association that the New York Arbitration proceed and the California Arbitration not proceed and those proceedings were successively adjourned by stipulation between the parties.  As set forth above, all of these proceedings were, pursuant to the Settlements, dismissed with prejudice.

The settlement agreement with THQ provides for payments to the Company of $6.0 million, $6.0 million, $4.0 million and $4.0 million in 2010, 2011, 2012 and 2013, respectively.

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.


 
18

 
 
PART II

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.

   
Price Range of
Common Stock
  
   
High
   
Low
 
2008:
           
First quarter
 
$
29.70
   
$
20.18
 
Second quarter
   
30.55
     
21.65
 
Third quarter
   
27.12
     
20.10
 
Fourth quarter
   
25.99
     
15.46
 
2009:
               
First quarter
   
21.30
     
10.17
 
Second quarter
   
14.24
     
10.66
 
Third quarter
   
15.15
     
10.55
 
Fourth quarter
   
16.26
     
10.99
 

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, 2005 to December 31, 2009.

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., Mattel, Inc., Kid Brands, Inc., RC2 Corp., Take-Two Interactive, Inc. and THQ Inc.  Please note that our peer group no longer includes Marvel Enterprises, Inc. inasmuch as it was acquired during 2009 and has been consolidated into the acquiring entity and Russ Berrie and Company, Inc. changed its name during 2009 to Kid Brands, Inc.
 
 
19

 
 
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
 
    
December 31,
2005
     
December 31,
2006
     
December 31,
2007
     
December 31,
2008
     
December 31,
2009
 
JAKKS Pacific
   
(5.3
)%
   
4.3
 %
   
8.1
%
   
(12.6
)%
   
(41.3
)%
Peer Group
   
(9.5
   
16.02
     
10.2
     
(48.2
   
23.3
 
Russell 2000
   
4.6
     
18.4
     
(1.6
   
(33.8
)
   
(27.2
)
 
Indexed Returns

    
January 1,
2005
     
December 31,
2005
     
December 31,
2006
     
December 31,
2007
     
    December 31,
2008
     
December 31,
2009
  
JAKKS Pacific
 
$
100.00
   
$
94.7
   
$
98.8
   
$
106.8
   
$
93.3
   
$
54.8
 
Peer Group
   
100.00
     
90.5
     
105.0
     
115.7
     
60.0
     
73.9
 
Russell 2000
   
100.00
     
104.6
     
123.8
     
121.8
     
80.7
     
102.6
 
  
Security Holders

To the best of our knowledge, as of March 12, 2010, there were 148 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.
 
 
20

 
 
Equity Compensation Plan Information

The table below sets forth the following information as of the year ended December 31, 2009 for (i) all compensation plans previously approved by our stockholders and (ii) all compensation plans not previously approved by our stockholders, if any:

(a) the number of securities to be issued upon the exercise of outstanding options, warrants and rights;

(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.

Plan Category
  
Number of
Securities to
be Issued
upon
Exercise of
Outstanding
Options,
Warrants
and Rights
(a)
     
Weighted-
Average Exercise
Price of
Outstanding
Options,
Warrants and
Rights
(b)
     
Number of 
Securities
Remaining 
Available for
Future Issuance 
Under
Equity 
Compensation
Plans (Excluding
Securities Reflected 
in
Column (a))
(c)
 
Equity compensation plans approved by security holders
   
444,715
   
$
19.63
     
560,919
 
Equity compensation plans not approved by security holders
   
100,000
     
11.35
     
 
Total
   
544,715
   
$
18.11
     
560,919
 

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.
 
 
21

 
 
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 7).

   
Years Ended December 31,
 
   
2005
   
2006
   
2007
   
2008
   
2009
 
   
(In thousands, except per share data)
 
Consolidated Statement of Income Data:
                             
Net sales
 
$
661,536
   
$
765,386
   
$
857,085
   
$
903,397
   
$
803,704
 
Cost of sales
   
394,829
     
470,592
     
533,435
     
582,184
     
600,776
 
Gross profit
   
266,707
     
294,794
     
323,650
     
321,213
     
202,928
 
Selling, general and administrative expenses
   
178,722
     
202,482
     
216,652
     
241,301
     
227,036
 
Write-down of intangible assets
   
     
     
     
9,076
     
8,221
 
Write-down of goodwill
   
     
     
     
     
407,125
 
Reorganization charges
   
     
     
     
     
12,994
 
Income (loss) from operations
   
87,985
     
92,312
     
106,998
     
70,836
     
(452,248
Profit (loss) from video game joint venture
   
9,414
     
13,226
     
21,180
     
17,092
     
(16,128
Other expense
   
(1,401
   
     
     
     
 
Interest income
   
5,183
     
4,930
     
6,819
     
3,396
     
318
 
Interest expense
   
(4,544
)
   
(4,533
)
   
(5,456
)
   
(2,425
)
   
(7,930
)
Income (loss) before provision (benefit) for income taxes
   
96,637
     
105,935
     
129,541
     
88,899
     
(476,188
Provision (benefit) for income taxes
   
33,144
     
33,560
     
40,550
     
12,842
     
(90,678
Net income (loss)
 
$
63,493
   
$
72,375
   
$
88,991
   
$
76,057
   
$
(385,510
Basic earnings (loss) per share
 
$
2.37
   
$
2.66
   
$
3.22
   
$
2.78
   
$
(14.02
Basic weighted average shares outstanding
   
26,738
     
27,227
     
27,665
     
27,379
     
27,502
 
Diluted earnings (loss) per share
 
$
2.06
   
$
2.30
   
$
2.77
   
$
2.42
   
$
(14.02
Diluted weighted average shares and equivalents outstanding
   
32,193
     
32,714
     
33,149
     
32,637
     
27,502
 

During the fourth quarter of 2009, we incurred reorganization charges of $13.0 million related to office space consolidations and headcount reductions to right-size our general and administrative expenses, given the decrease in sales in 2009.

During the second and third quarters of 2009, we booked an aggregate cumulative write-down of $23.5 million related to our Preferred Return Receivable from our THQ joint venture as a result of the arbitration ruling which lowered the preferred return payment from a rate of 10% of net sales of the WWE video games sold by the joint venture to a rate of 6% of net sales.

During the second quarter of 2009, we booked a charge of $24.0 million related to the write-down of certain excess and impaired inventory.  We also booked a charge of $33.2 million related to the write-down of license advances and minimum guarantees that are not expected to be earned through sales of that licensed product.

During the second quarter of 2009, we determined that the tradenames “Child Guidance,”  “Play Along” and certain tradenames associated with our Crafts and Activities product lines would either be discontinued, or were under-performing.   Consequently, the intangible assets associated with these tradenames were written off to “Write-down of Intangible Assets”, resulting in a non-cash charge of $8.2 million.  During the second quarter of 2009, we determined that the significant decline in our market capitalization is likely to be sustained.   Our market capitalization did not change significantly despite the dismissals subject to appeal of the WWE lawsuit, and the lower revenue expectations for 2009 versus 2008 were factors that indicated that an interim goodwill impairment test was required. As a result, we determined that $407.1 million, or all of the goodwill related to previous acquisitions, including the acquisition of Disguise in December 2008, was impaired. This amount is included in “Write-down of Goodwill” in the accompanying condensed consolidated statements of operations.
 
 
22

 

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 the new share-based compensation guidance, which required the expensing of share-based compensation.

In June 2005, we acquired the Pet Pal line of products.
  
   
At December 31,
 
   
2005
   
2006
   
2007
   
2008
   
2009
 
   
(In thousands)
 
Consolidated Balance Sheet Data:
                             
Cash and cash equivalents
 
$
240,238
   
$
184,489
   
$
241,250
   
$
169,520
   
$
254,837
 
Working capital
   
301,454
     
280,363
     
352,452
     
325,061
     
349,365
 
Total assets
   
753,955
     
881,894
     
983,664
     
1,028,124
     
634,093
 
Short-term debt
   
     
     
     
     
20,262
 
Long-term debt
   
98,000
     
98,000
     
98,000
     
98,000
     
86,728
 
Total stockholders’ equity
   
524,651
     
609,288
     
690,997
     
746,953
     
372,109
 
 
 
23

 
 

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 7. 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.

Revenue Recognition. >Our revenue recognition policy is to recognize revenue when persuasive evidence of an arrangement exists, title transfer has occurred (product shipment), the price is fixed or readily determinable, and collectability is probable. Sales are recorded net of sales returns and discounts, which are estimated at the time of shipment based upon historical data. JAKKS routinely enters into arrangements with its customers to provide sales incentives, support customer promotions, and provide allowances for returns and defective merchandise. Such programs are based primarily on customer purchases, customer performance of specified promotional activities, and other specified factors such as sales to consumers. Accruals for these programs are recorded as sales adjustments that reduce gross revenue in the period the related revenue is recognized.


Factors we consider important which could trigger an impairment review include the following:
 
·
significant underperformance relative to expected historical or projected future operating results;
 
·
significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and
 
·
significant negative industry or economic trends.

Due to the subjective nature of the impairment analysis significant changes in the assumptions used to develop the estimate could materially affect the conclusion regarding the future cash flows necessary to support the valuation of long-lived assets, including goodwill. The valuation of goodwill involves a high degree of judgment and consists of a comparison of the fair value of a reporting unit with its book value. Based on the assumptions underlying the valuation, impairment is determined by estimating the fair value of a reporting unit and comparing that value to the reporting unit’s book value. If the implied fair value is more than the book value of the reporting unit, an impairment loss is not indicated. If impairment exists, the fair value of the reporting unit is allocated to all of its assets and liabilities excluding goodwill, with the excess amount representing the fair value of goodwill. An impairment loss is measured as the amount by which the book value of the reporting unit’s goodwill exceeds the estimated fair value of that goodwill.
 
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.
 
 
24

 

During the second quarter of 2009, the Company determined that the significant decline in its market capitalization is likely to be sustained.   The Company’s market capitalization was not significantly affected by the substantial resolution of the WWE lawsuit, and the lower revenue expectations for 2009 versus 2008 were factors that indicated that an interim goodwill impairment test was required. As a result, the Company determined that $407.1 million, or all of the goodwill related to previous acquisitions, including the acquisition of Disguise in December 2008, was impaired. This amount is included in Write-down of Goodwill in the accompanying consolidated statements of operations.

During the second quarter of 2009, the Company determined that the tradenames “Child Guidance” and “Play Along” and certain tradenames associated with our Craft and Activity product lines would either be discontinued, or were under performing.   Consequently, the intangible assets associated with these tradenames were written off to Write-down of Intangible Assets, resulting in a non-cash charge of $8.2 million.
 
Goodwill and intangible assets amounted to $40.9 million as of December 31, 2009.


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.


Income taxes and interest and penalties related to income tax payable.  > We do not file a consolidated return with our foreign subsidiaries.  We file federal and state returns and our foreign subsidiaries each file Hong Kong returns, as applicable.  Deferred taxes are provided on a liability method whereby deferred tax assets are recognized as deductible temporary differences and operating loss and tax credit carry-forwards and deferred tax liabilities are recognized for taxable temporary differences.  Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.  Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

As of January 1, 2007, we adopted 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 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, 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, 2009, our income tax reserves are approximately $16.8 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.
 
 
25

 

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. 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.
 
Recent Developments
 
In October 2008, we acquired substantially all of the assets of Tollytots Limited.  The total initial consideration of $26.8 million consisted of $12.0 million in cash and the assumption of liabilities in the amount of $14.8 million, and resulted in goodwill of $4.1 million, all of which has been determined to be impaired and was written off in the quarter ended June 30, 2009. 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. In the first earn-out period ended December 31, 2009, no portion of the earn-out was 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.

In October 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 $23.8 million consisted of $20.4 million in cash and the assumption of liabilities in the amount of $3.4 million, and resulted in goodwill of $13.2 million, all of which has been determined to be impaired and was written off in the quarter ended June 30, 2009. 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. The first earn-out period ended September 30, 2009 is under review.  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.

In December 2008, we acquired certain assets of Disguise, Inc. and a related Hong Kong company, Disguise Limited (collectively, “Disguise”).  The total initial consideration of $60.6 million consisted of $38.6 million in cash and the assumption of liabilities in the amount of $22.0 million, and resulted in goodwill of $30.6 million, all of which has been determined to be impaired and was written off in the quarter ended June 30, 2009. We finalized our purchase price allocation for Disguise and engaged 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

On November 10, 2009, we sold an aggregate of $100.0 million of 4.50% Convertible Senior Notes due 2014 (the “Notes”). The Notes are senior unsecured obligations of JAKKS, will pay interest semi-annually at a rate of 4.50% per annum and will mature on November 1, 2014. The conversion rate will initially be 63.2091 shares of our common stock per $1,000 principal amount of notes (equivalent to an initial conversion price of approximately $15.82 per share of common stock), subject to adjustment in certain circumstances. Prior to August 1, 2014, holders of the Notes may convert their Notes only upon specified events. Upon conversion, the Notes may be settled, at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock. Holders of the Notes may require us to repurchase for cash all or some of their Notes upon the occurrence of a fundamental change (as defined in the Notes).

We used a portion of the net proceeds from the offering to repurchase $77.7 million of our 4.625% convertible senior notes due in 2023 and intend to repurchase the remaining $20.3 million of our 4.625% convertible senior notes in June 2010.
 
On December 22, 2009 we entered into a Settlement Agreement and Mutual Release pursuant to which our joint venture with THQ was terminated as of December 31, 2009 and we will receive fixed payments from THQ of $6.0 million on each of June 30, 2010 and 2011 and $4.0 million on each of June 30, 2012 and 2013 which we will record as income on a cash basis over the term.
 
 
26

 
 
Results of Operations

The following table sets forth, for the periods indicated, certain statement of operations data as a percentage of net sales.

   
Years Ended December 31,
 
   
2007
   
2008
   
2009
 
Net Sales
   
100.0
%
   
100.0
%
   
100.0
%
Cost of Sales
   
62.2
     
64.4
     
74.8
 
Gross profit
   
37.8
     
35.6
     
25.2
 
Selling, general and administrative expenses
   
25.3
     
26.7
     
28.2
 
Write-down of intangible assets
   
     
1.0
     
1.0
 
Write-down of goodwill
   
     
     
50.7
 
Reorganization charges
   
     
     
1.6
 
Income (loss) from operations
   
12.5
     
7.9
     
(56.3
Profit (loss) from video game joint venture
   
2.5
     
1.9
     
(2.0
Other expense
   
     
     
 
Interest income
   
0.7
     
0.4
     
 
Interest expense
   
(0.6
)
   
(0.3
)
   
(1.0
)
Income (loss) before provision (benefit) for income taxes
   
15.1
     
9.9
     
(59.3
Provision (benefit) for income taxes
   
4.7
     
1.4
     
(11.3
Net income (loss)
   
10.4
%
   
8.5
%
   
(48.0
)%

The following table summarizes, for the periods indicated, certain income statement data by segment (in thousands).
 
    
Years Ended December 31,
 
   
2007
   
2008
   
2009
 
                   
Net Sales
                 
Traditional Toys
 
$
792,998
   
$
816,852
   
$
713,984
 
Craft/Activity/Writing Products
   
39,632
     
65,888
     
73,513
 
Pet Products
   
24,455
     
20,657
     
16,207
 
     
857,085
     
903,397
     
803,704
 
Cost of Sales
                       
Traditional Toys
   
490,279
     
526,989
     
531,647
 
Craft/Activity/Writing Products
   
26,970
     
38,693
     
54,652
 
Pet Products
   
16,186
     
16,502
     
14,477
 
     
533,435
     
582,184
     
600,776
 
Gross Margin
                       
Traditional Toys
   
302,719
     
289,862
     
182,337
 
Craft/Activity/Writing Products
   
12,662
     
27,196
     
18,861
 
Pet Products
   
8,269
     
4,155
     
1,730
 
   
$
323,650
   
$
321,213
   
$
202,928
 

Comparison of the Years Ended December 31, 2009 and 2008

Net Sales  

Traditional Toys.   Net sales of our Traditional Toys segment were $714.0 million in 2009, compared to $816.9 million in 2008, representing a decrease of $102.9 million, or 12.6%.  The decrease in net sales was primarily due to lower unit sales of our WWE®, Narnia® and Pokemon® action figures and accessories, JAKKS™ dolls based on Hannah Montana® and Camp Rock™, electronics based on JAKKS™ Plug It In & Play TV Games™, G2 Game Girl™, Ultimotion™ and EyeClops® brands, role-play and dress-up toys, including those based on Disney characters Hannah Montana®, classic princesses and fairies, and other JAKKS products, including Neopets®, Doodle Bears® and Care Bears® plush, Cabbage Patch Kids®, In My Pocket & Friends™ and junior sports products. This was offset in part by increases in unit sales of some products, including Club Penguin™, Hello Kitty®, Smurfs® and Skelanimals™ plush, SpongeBob SquarePants®, Lucky BeeBee™ activities, Fly Wheels®, JAKKS vehicles and Discovery Kids® toys and the contribution to sales from our Tollytots, Kids Only and Disguise acquisitions of $169.0 million.
 
 
27

 

Craft/Activity/Writing Products.  Net sales of our Craft/Activity/Writing Products were $73.5 million in 2009, compared to $65.9 million in 2008, representing an increase of $7.6 million, or 11.5%.  The increase in net sales was primarily due to increases in unit sales of our Girl Gourmet™ and JAKKS activity toys, offset in part by decreases in unit sales of our Spa Factory™ line of products, Creepy Crawlers® activities products, our Spinz™ writing instruments and our Pentech™ and Color Workshop® writing instruments and related products.

Pet Products.  Net sales of our Pet Products were $16.2 million in 2009, compared to $20.7 million in 2008, representing a decrease of $4.5 million, or 21.7%.  The decrease is mainly attributable to the less available shelf space for pet products at some of our major customer retail stores, and lower unit sales of consumable pet products. Sales of pet products were led by our AKC® licensed line of products.
 
Cost of Sales
 
Traditional Toys.  Cost of sales of our Traditional Toys segment was $531.6 million, or 74.5% of related net sales, in 2009, compared to $527.0 million, or 64.5% of related net sales, in 2008, representing an increase of $4.6 million, or 0.9%.  This percentage margin increase is primarily due to charges of $18.8 million related to the write-down of certain excess and impaired inventory and $32.6 million related to the write-down of license advances and minimum guarantees that are not expected to be earned through sales of that licensed product. Excluding these one time charges, cost of sales decreased by $46.8 million to $480.3 million, or 67.3% of net sales, which primarily consisted of a decrease in product costs of $34.0 million, which is in line with the lower volume of sales.  Product costs as a percentage of sales increased primarily due to the mix of the product sold and higher sales of closeout product.  Excluding the one time charges, royalty expense for our Traditional Toys segment decreased by $14.4 million due to lower volume of sales and 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.  Royalty expense as a percentage of net sales was comparable year-over-year. Our depreciation of molds and tools increased by $1.7 million primarily due to increased purchases of molds and tools in this segment.

Craft/Activity/Writing Products.  Cost of sales of our Craft/Activity/Writing Products segment was $54.7 million, or 74.4% of related net sales, in 2009, compared to $38.7 million, or 58.7% of related net sales, in 2008, representing an increase of $16.0 million, or 41.3%.  This percentage margin increase is partially due to charges of $4.5 million related to the write-down of certain excess and impaired inventory and $0.3 related to the write-down of license advances and minimum guarantees that are not expected to be earned out through sales of that licensed product.  Excluding these one time charges, cost of sales increased by $11.2 million to $49.9 million, or 67.9% of net sales, which primarily consisted of an increase in product costs of $5.1 million, which is in line with the higher volume of sales and higher sales of closeout product.  Product costs as a percentage of net sales increased primarily due to the mix of the product sold and higher sales of closeout product.  Excluding the one time charges, royalty expense increased by $4.5 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. Our depreciation of molds and tools increased by $1.6 million primarily due to increased purchases of molds and tools in this segment.

Pet Products.  Cost of sales of our Pet Pal line of products was $14.5 million, or 89.5% of related net sales, in 2009, compared to $16.5 million, or 79.9% of related net sales, in 2008, representing a decrease of $2.0 million, or 12.1%.  This percentage margin increase is primarily due to charges of $0.8 million related to the write-down of certain excess and impaired inventory and $0.4 related to the write-down of license advances and minimum guarantees that are not expected to be earned out through sales of that licensed product.  Excluding these one time charges, cost of sales decreased by $3.2 million to $13.4 million, or 82.7% of net sales, which primarily consisted of a decrease in product costs of $2.7 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 higher sales of closeout product.  Royalty expense decreased by $0.7 million due to the lower volume of sales and as a percentage of 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 $0.2 million primarily due to increased purchases of molds and tools in this segment.

Selling, General and Administrative Expenses
 
Selling, general and administrative expenses were $227.0 million in 2009 and $241.3 million in 2008, constituting 28.2% and 26.7% of net sales, respectively.  The overall decrease of $14.3 million in such costs was primarily due to decreases in general and administrative expenses ($18.8 million), product development ($9.9 million), share-based compensation ($2.9 million) and direct selling expenses ($25.3 million), off set in part by the addition of overhead related to the operations of Tollytots, Kids Only and Disguise ($40.5 million) and an increase in depreciation and amortization ($2.1million).   The decrease in general and administrative expenses is primarily due to decreases in bonus expense ($9.0 million), travel and entertainment expense ($3.0 million), temporary help expense ($2.6 million), donations expense ($3.2 million) and legal expense ($3.6 million), net of insurance reimbursements, offset in part by increases in, the reversal of penalty reserves ($1.9 million) in 2008 with no such reversals in 2009, a loss incurred from disposal of molds and tools used for production of our inventory ($2.3 million) and foreign currency expense ($1.9 million).  Product development expenses decreased as a result of tighter control of spending on product development, offset in part by higher product testing expenses.  The decrease in direct selling expenses is primarily due to decreases in advertising and promotional expenses of $16.2 million in 2009 in support of several of our product lines, sales commissions ($1.9 million) and other direct selling expenses of $7.3 million that support our domestic operations.  From time to time, we may increase or decrease our advertising efforts, if we deem it appropriate for particular products.  The increase in depreciation and amortization is mainly due to an increase in amortization expensed related to intangible assets other than goodwill ($3.6 million), offset in part by a decrease in depreciation of tangible assets.  

 
28

 
 
Write-down of Intangible Assets
 
As of June 30, 2009, we determined that the tradenames “Child Guidance,” “Play Along” and certain tradenames associated with our Crafts and Activities product lines would either be discontinued, or were under-performing. Consequently, the intangible assets associated with these tradenames were written off to “Write-down of Intangible Assets”, resulting in a non-cash charge of $8.2 million. During the third quarter of 2008, the Company discontinued 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, the Company 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.

Write-down of Goodwill
 
During the three months ended June 30, 2009, we determined that the significant decline in our market capitalization is likely to be sustained.   Our market capitalization did not change significantly despite the dismissals subject to appeal of the WWE lawsuit, and the lower revenue expectations for 2009 versus 2008 were factors that indicated that an interim goodwill impairment test was required. As a result, we determined that $407.1 million, or all of the goodwill related to previous acquisitions, including the acquisition of Disguise in December 2008, was impaired. This amount is included in “Write-down of Goodwill” in the accompanying condensed consolidated statements of operations.
 
Reorganization Charges

We incurred reorganization charges in 2009 to consolidate and stream-line our existing business functions.  This was especially necessary given the decreased volume of consolidated sales in 2009 from 2008 and the added general and administrative expenses from the three acquisitions made at the end of 2008.  We had no reorganization charges in 2008.  Restructuring charges relate to the termination of lease obligations, one-time severance termination benefits, fixed asset write-offs and other contract terminations and are accounted for in accordance with “Exit and Disposal Cost Obligations”, ASC 420-10.  We established a liability for a cost associated with an exit or disposal activity when a liability is incurred, rather than at the date we commit to an exit plan.

These reorganization charges relate to our Traditional segment and are included in Reorganization Charges in the consolidated statements of operations.  The components of the reorganization charges are as follows (in thousands):
 
   
Accrued Balance
               
Accrued Balance
 
  
 
December 31, 2008
   
Accrual
   
Actual
   
December 31, 2009
 
Lease abandonment costs
  $     $ 10,164     $ (322 )   $ 9,842  
Employee severance
      —         1,541       (1,538 )       3  
Fixed asset write-off
          1,017       (883 )     134  
Other
      —         272       (107 )       165  
Total reorganization charges
  $     $ 12,994     $ (2,850 )   $ 10,144  
 
Profit from Video Game Joint Venture
 
We incurred a loss from our video game joint venture in 2009 of $16.1 million, as compared to a profit of $17.1 million in 2008, primarily due to a cumulative $23.5 million write-down as a result of the arbitration ruling which lowered the preferred return payment from a rate of 10% of net sales of the WWE video games sold by the joint venture to a rate of 6% of net sales and to legal fees of $3.7 million which was partially offset by profit of $11.1 million.   Net profit for 2009 was $7.4 million before the cumulative write-down to the receivable.  Pursuant to a Settlement Agreement and Mutual Release dated December 22, 2009, the joint venture was terminated on December 31, 2009 and we will receive fixed payments from THQ of $6.0 million on each of June 30, 2010 and 2011 and $4.0 million on each of June 30, 2012 and 2013 which we will record as income on a cash basis over the term (see “Legal Proceedings”).
 
 
29

 

Interest Income
 
Interest income in 2009 was $0.3 million, as compared to $3.4 million in 2008.  The decrease is due to lower interest rates during 2009 compared to 2008 and lower average cash balances.
 
Interest Expense
 
Interest expense was $7.9 million in 2009, as compared to $2.4 million in 2008. In 2009, we booked interest expense of $7.1 million related to our convertible senior notes payable and net interest expense of $0.8 million related to uncertain tax positions taken or expected to be taken in a tax return.  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 uncertain tax positions taken or expected to be taken in a tax return.

Provision for Income Taxes
 
Our income tax benefit, which includes federal, state and foreign income taxes, and discrete items, was $90.7 million, or an effective tax benefit rate of 19.0% for 2009. During 2008, the income tax provision was $12.8 million, or an effective tax provision rate of 14.4%.  

In 2009, the impairment of goodwill and trademarks, totaling $90.7 million, the correction of purchase accounting of $6.2 million, and write-down of NOLs and tax credits of $6.1 million were reductions to the tax benefit rate realized, partially offset by discrete adjustments for uncertain tax positions of $3.2 million (see Note 12 of the Notes to Condensed Consolidated Financial Statements, supra).  Exclusive of the discrete items, the 2009 effective tax benefit rate would be 40.1%. In 2008, the discrete adjustments were mainly the 2007 income tax provision to the actual income tax liability of $4.0 million, and the recognition of a previously recorded potential income tax liability of $9.3 million for uncertain tax positions that are no longer subject to audit due to the closure of the audit period.  Exclusive of the discrete items, the 2008 effective tax provision rate would be 30.5%.

As of December 31, 2009, we had net deferred tax assets of approximately $73.0 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.

Comparison of the Years Ended December 31, 2008 and 2007

Net Sales

Traditional Toy.  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.
 
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 AKC 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.
 
 
30

 

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”).
 
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.
 
 
31

 

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.
 
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.
  
     
 
2008
   
2009
 
  
 
First
   
Second
   
Third
   
Fourth
   
First
   
Second
   
Third
   
Fourth
 
     
 
Quarter
   
Quarter
   
Quarter
   
Quarter
   
Quarter
   
Quarter
   
Quarter
   
Quarter
 
                                                 
Net sales
 
$
130,935
   
$
145,291
   
$
357,824
   
$
269,347
   
$
108,685
   
$
144,809
   
 $
351,438
   
 $
198,772
 
As a % of full year
   
14.5
%
   
16.1
%
   
39.6
%
   
29.8
%
   
13.5
%
   
18.1
%
   
43.7
%
   
24.7
%
Gross Profit
   
47,441
     
52,058
     
129,065
     
92,649
     
36,981
     
(6,076
   
115,709
     
56,314
 
As a % of full year
   
14.8
%
   
16.2
%
   
40.2
%
   
28.8
%
   
18.2
%
   
(3.0
)%
   
57.0
%
   
27.8
%
As a % of net sales
   
36.2
%
   
35.8
%
   
36.1
%
   
34.4
%
   
34.0
%
   
(4.2
)%
   
32.9
%
   
28.3
%
Income (loss) from operations
   
(894
)
   
5,568
     
57,338
     
8,824
     
(17,573
)
   
(475,178
   
52,346
     
(12,043
As a % of full year
   
(1.3
)%
   
7.9
%
   
80.9
%
   
12.5
%
   
3.9
%
   
105.0
%
   
(11.6
)%
   
2.7
%
As a % of net sales
   
(0.7
)%
   
3.8
%
   
16.0
%
   
3.3
%
   
(16.2
)%
   
(328.1
)%
   
14.9
%
   
(6.1
)%
Income (loss) before provision (benefit) for income taxes
   
1,300
     
5,994
     
60,803
     
20,802
     
(15,765
   
(499,276
   
49,188
     
(10,335
As a % of net sales
   
1.0
%
   
4.1
%
   
17.0
%
   
7.7
%
   
(14.5
)%
   
(344.8
)%
   
14.0
%
   
(5.2
)%
Net income (loss)
   
877
     
4,156
     
54,145
     
16,879
     
(10,799
   
(406,562
   
33,708
     
(1,857
As a % of net sales