Annual Reports

  • 10-K (Mar 16, 2017)
  • 10-K (Mar 15, 2016)
  • 10-K (Mar 16, 2015)
  • 10-K (Mar 17, 2014)
  • 10-K (Mar 15, 2013)
  • 10-K (Mar 15, 2012)

 
Quarterly Reports

 
8-K

 
Other

JAKKS Pacific 10-K 2017

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

 
FORM 10-K
 
(Mark One)
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Fiscal Year Ended December 31, 2016
 
 
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.)
 
2951 28th St.
 
Santa Monica, California
90405
(Address of principal executive offices)
(Zip Code)
 
Registrant’s telephone number, including area code: (424) 268-9444
 
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  
 
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  
 
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    o
 
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    x    No    o
 
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.  o
 
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”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one):
 
     Large Accelerated Filer
     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    o    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 June 30, 2016 of $7.91) is $176,823,818.
 
The number of shares outstanding of the registrant’s Common Stock, $.001 par value (being the only class of its common stock), is 23,208,535 as of March 15, 2017.
 
Documents Incorporated by Reference
 
None.

JAKKS PACIFIC, INC.
 
INDEX TO ANNUAL REPORT ON FORM 10-K
 
For the Fiscal Year ended December 31, 2016
 
Items in Form 10-K
 
 
 
Page
 
PART I
 
3
12
Item 1B.
Unresolved Staff Comments
None
17
18
19
 
PART II
 
20
23
24
36
38
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None
74
Item 9B.
Other Information
None
 
PART III
 
76
79
94
96
96
 
PART IV
 
98
100
 
101
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 upon 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.
 

PART I
 
Item 1.  Business
 
In this report, “JAKKS,” the “Company,” “we,” “us” and “our” refer to JAKKS Pacific, Inc., its subsidiaries and our majority owned joint venture.
 
Company Overview
 
We are a leading multi-line, multi-brand toy company that designs, produces, markets and distributes toys 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. For accounting purposes, our products have been divided into three segments: (i) U.S. and Canada, (ii) International and (iii) Halloween. Segment information with respect to revenues, assets and profits or losses attributable to each segment is contained in Note 3 to the audited consolidated financial statements contained below in Item 8. Our products include:
 
Traditional Toys and Electronics
 
Action figures and accessories, including licensed characters, principally based on Batman®, Star Wars® and Nintendo ® franchises;
 
 
Toy vehicles, including Max Tow™, Road Champs®, Fly Wheels® and MXS® toy vehicles and accessories;
 
 
Electronics products, including Spy Net® spy products, Plug It In & Play TV Games™ video games based on popular brands;
 
 
Dolls and accessories, including small dolls, large dolls, fashion dolls and baby dolls based on licenses, including Disney’s Frozen, Disney Princess, Disney Fairies, infant and pre-school toys based on PBS’s Daniel Tiger’s Neighborhood®;
 
 
Private label products as “exclusives” for a myriad of retail customers in many product categories;
 
 
Foot-to-floor ride-on toys based on Fisher Price®, Kawasaki®, and DC Comics®, inflatable environments, tents and wagons; and
 
 
Pet products, including toys, consumables, and accessories, branded JAKKS Pets® and American Classics™ , among others.
 
Role Play, Novelty and Seasonal Toys
 
Role play, dress-up, pretend play and novelty products for boys and girls based on well-known brands and entertainment properties such as Disney’s Frozen, Black & Decker®, McDonald’s®, Dirt Devil®, Disney Princess, Disney Fairies and Dora the Explorer®, as well as those based on our own proprietary brands;
 
 
Indoor and outdoor kids’ furniture, activity trays and tables and room décor; kiddie pools, seasonal and outdoor products, including those based on Crayola®, Disney characters and more, and Funnoodle® pool floats;
 
 
Halloween and everyday costumes for all ages based on licensed and proprietary non-licensed brands, including Spiderman®, Toy Story, Sesame Street®, Power Rangers®¸Hasbro® brands and Disney’s Frozen, Disney Princess and related Halloween accessories; and
 
 
Junior sports and outdoor activity toys including Skyball® hyper-charged balls and sport sets and Wave Hoops® toy hoops marketed under our Maui Toys® brand.
 
3

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 innovation and technology when appropriate to make them more appealing to today’s kids; and
 
 
focusing our marketing efforts to enhance consumer recognition and retailer interest.
 
Our Business Strategy
 
In addition to developing our own proprietary brands and marks, licensing popular trademarks 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 trademarks, we have access to a far greater range of marks than would be available for purchase. We also license technology developed by unaffiliated inventors and product developers to enhance 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 23.4%, 15.6% and 9.4%, respectively, of our net sales in 2016. No other customer accounted for more than 10.0% of our net sales in 2016.
 
Our Growth Strategy
 
 In 2015 and 2016, we generated net sales of $745.7 million and $706.6 million, respectively, and net income of $23.2 million in 2015 and $1.2 million in 2016. Approximately 8.6% and 9.5% of our net sales in 2015 and 2016, respectively, were attributable to our acquisitions since 2011. 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.
 
●       Enter New Product Categories. We use our extensive experience in the toy and other consumer product industries to evaluate products and licenses in new product categories and to develop additional product lines. We began marketing licensed classic video games for simple plug-in use with television sets and expanded into several related categories by infusing additional technologies such as motion gaming and through the licensing of this category from our current licensors, such as Disney and Viacom which owns Nickelodeon®.
 
●       Pursue Strategic Acquisitions. We supplement our internal growth with selected strategic acquisitions. In October 2016, we acquired the operating assets of the C’est Moi™ performance makeup and youth skincare product lines whose distribution is limited primarily to Asia. We expect to launch a full line of makeup and skincare products branded under the C’est Moi™ name in the U.S. and Canada in the fourth quarter of 2017 prior to which sales are anticipated to be nominal. We will continue focusing our acquisition strategy on businesses or brands that we believe have compatible product lines and/or offer valuable trademarks or brands.
 
4

●       Acquire Additional Character and Product Licenses. We have acquired the rights to use many familiar brand and character names and logos from third parties that we use with our primary trademarks and brands. Currently we have license agreements with Nickelodeon®, Disney and Warner Bros.®, as well as with the licensors of the many popular licensed children’s characters previously mentioned, among others. We intend to continue to pursue new licenses from these entertainment and media companies and other licensors. We also intend to continue to purchase additional inventions and product concepts through our existing network of inventors and product developers.
 
●       Expand International Sales. We believe that foreign markets, especially Europe, Australia, Canada, Latin America and Asia, offer us significant growth opportunities. In 2016, our sales generated outside the United States were approximately $162.5 million, or 23.0% of total net sales. We intend to continue to expand our international sales and in 2016 opened sales offices and further expanded distribution agreements in Europe to capitalize on our experience and our relationships with foreign distributors and retailers. We expect these initiatives to contribute to our international growth in 2017.
 
●       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 11). For example, our growth strategy will place additional demands upon our management, operational capacity and financial resources and systems. The increased demand upon 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. While we believe that our operational, financial and management information systems will be adequate to support our future growth, no assurance can be given they will be adequate without significant investment in our infrastructure. 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.
 
5

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 $20.4 billion in 2016. 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.
 
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 upon a few dominant toy companies. Retailer concentration also enables us to ship products, manage account relationships and track point of sale information 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 20% of net sales, and some may require minimum guarantees and advances. Our principal products include:
 
Traditional Toys and Electronics
 
Electronics Products
 
Our electronic products category includes our Plug It In & Play TV Games®, SpyNet® spy products and Laser Challenge® product lines. Our current Plug It In & Play TV Games® titles, geared to the leisure gamer segments, feature licensed brands such as Teenage Mutant Ninja Turtles®.
  
Wheels Products
 
Motorized and plastic toy vehicles and accessories.
 
Our extreme sports offerings include our MXS® line of motorcycles with generic and well-known riders and other vehicles include off-road vehicles and skateboards, which are sold individually and with playsets and accessories. In 2014, we launched our proprietary line of motorized vehicles under the brand Max Tow™, and in 2015, we expanded the product line to include higher performance versions as well as mini size vehicles and play sets under the Max TowMini line.
 
Action Figures and Accessories
 
We currently develop, manufacture and distribute other action figures and action figure accessories including those based on Star Wars® and Batman®, capitalizing on the expertise we built in the action figure category.
 
Our line of Big-Figs™ large scale action figures features an assortment of 20” figures, 31” figures, and 48” figures of characters including Superman®, Power Rangers®, Star Wars® and Teenage Mutant Ninja Turtles®.
 
6

Dolls
 
Dolls and accessories include small dolls, large dolls, fashion dolls and baby dolls based on licenses, including Disney’s Frozen, Disney Princess, Disney Fairies, including an extensive line of baby doll accessories that emulate real baby products that mothers today use; plush, infant and pre-school toys, and private label fashion dolls for other retailers and sold to Disney Stores and Disney Parks and Resorts. In 2016, we launched lines of dolls based on Disney’s animated feature Moana and animated television series Elena of Avalor.
 
Pet Products
 
Our Pet Products category includes pet toys, treats, beds, clothes and related pet products. These products are marketed under JAKKS Pets® and our own proprietary brands of assorted pet products as well as licenses including numerous entertainment and consumer product properties.
 
Role Play, Novelty and Seasonal
 
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’s Frozen, Disney Princess, Disney Fairies, Moana, Elena of Avalor and Black & Decker®. These products generated a significant amount of sales in 2014, 2015 and 2016.
 
Seasonal/ Outdoor Products
 
We have a wide range of seasonal toys and outdoor and leisure products including our Maui line of proprietary products including Sky Ball®, Sky Bouncer® and Wave Hoop® among other outdoor toys. Our Funnoodle® pool toys include basic Funnoodle® pool floats and a variety of other pool toys.
 
Indoor and Outdoor Kids’ Furniture
 
We produce an extensive array of licensed indoor and outdoor kids' furniture and activity tables, and room decor. Our licensed portfolio includes character licenses, including Crayola®, Disney Princess, Toy Story, Mickey Mouse, Paw Patrol®, and others. Products include children’s puzzle furniture, tables and chairs to activity sets, trays, stools and a line of licensed molded kiddie pools, among others.
 
Halloween and Everyday Costume Play
 
We produce an expansive and innovative line of Halloween costumes and accessories which includes a wide range of non-licensed Halloween costumes such as 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®, Sesame Workshop®, Mattel®, and many others. In 2016, we launched new licenses including Lego® brands.
 
DreamPlay Technology
 
 In 2012, we formed a joint venture with NantWorks LLC called DreamPlay Toys LLC to exploit their patented recognition technologies in conjunction with toy and consumer products. In 2013, we launched two lines of toy products which utilize the technologies to enhance the play pattern of the toys as well as enhance the in-store experience of the consumer. The first product line was based on Disney’s Little Mermaid followed by our propriety concept, miWorld®. Both product lines were accompanied by a software application which brings the toy products to life adding a rich virtual experience to a physical experience. In 2016, we released updates to these apps as well as launched several other toys with application based product lines, and in 2017, we expect to launch new product lines incorporating digital technology with the physical products as well as companion apps for other products.
 
7

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 44.4% of our net sales in 2015 and 48.4% of our net sales in 2016. With the JAKKS Pets® product line, we distribute pet products to key pet supply retailers Petco and PetSmart in addition to many other pet retailers and our existing customers. 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 warehouses and fulfillment facilities. To date, a majority 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:
 
 
entered into a joint venture in China,
 
 
engaged representatives to oversee sales in certain foreign territories,
 
 
engaged distributors in certain foreign territories,
 
 
established direct relationships with retailers in certain foreign territories,
 
 
opened sales offices in Europe,
 
 
opened sales offices and a distribution center in Canada, and
 
 
expanded in-house resources dedicated to product development and marketing of our lines.
 
8

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 $203.6 million, or 27.3% of our net sales in 2015 and approximately $162.5 million, or 23.0% of our net sales in 2016. 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 upon 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 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, 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 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 sale of the toys developed from this concept, and may, on an individual basis, as well as some of our DreamPlay apps, 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.
 
9

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 majority of the tools, dyes 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 $10.2 million in 2015 and $15.7 million in 2016; 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 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 Halloween costume lines with Rubies. We also compete with numerous smaller domestic and foreign toy manufacturers, importers and marketers in each of our product categories.
 
Seasonality and Backlog
 
In 2016, approximately 66.5% 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 in the toy industry, and, therefore, it is also the least profitable quarter due to various fixed costs. Seasonality factors may cause our operating results to fluctuate significantly from quarter to quarter. However, 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, who generally request delivery of products within three to six months of the date of their orders for orders shipped FOB China or Hong Kong and within three days for 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.
 
10

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 there under. The CPSA and the FHSA enable the Consumer Products Safety Commission (“CPSC”) to exclude from the market consumer products that fail to comply with applicable product safety regulations or otherwise create a substantial risk of injury, and articles that contain excessive amounts of a banned hazardous substance. The FFA enables the CPSC to regulate and enforce flammability standards for fabrics used in consumer products. The CPSC may also require the repurchase by the manufacturer of articles. Similar laws exist in some states and cities and in various international markets. We maintain a quality control program designed to ensure compliance with all applicable laws.
 
Employees
 
As of February 28, 2017, we employed 832 persons, all of whom are full-time employees, including three executive officers. We employed 427 people in the United States, 13 people in Canada, 4 people in Mexico, 253 people in Hong Kong, 113 people in China, 17 people in the United Kingdom, 1 person in France and 4 people in Germany. 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.jakks.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. The contents of our website are not incorporated in or deemed to be a part of any such report.
 
Our Corporate Information
 
We were formed as a Delaware corporation in 1995. Our principal executive offices are located at 2951 28th Street, Santa Monica, California 90405. Our telephone number is (424) 268-9444 and our Internet Website address is www.jakks.com. The contents of our website are not incorporated in or deemed to be a part of this Annual Report on Form 10-K.
 
11

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 upon 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 products that we introduce will achieve any significant degree of market acceptance;
 
 
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 inclusion of new technology will result in higher sales or increased profits.
 
Our failure to achieve any or all of the foregoing benchmarks may adversely affect 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 upon the popularity of characters in movies, television programs, live sporting exhibitions, and other media and events. 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.
 
12

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 substantially depend upon our ability to obtain additional licenses. Intense 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.
 
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 upon the ability to design and develop new toys, procure licenses for popular characters and trademarks and 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, expand our products and product lines or continue to compete effectively against current and future competitors.
 
13

We may not be able to sustain or manage our product line growth, which may prevent us from increasing our net revenues.
 
Historically, we have experienced growth in our product lines through acquisitions of businesses, products and licenses. This growth in product lines has contributed significantly to our total revenues over the last few years. For example, revenues associated with companies we acquired since 2011 were approximately $64.0 million and $67.2 million, in 2015 and 2016, respectively, representing approximately 8.6% and 9.5%, respectively, of our total revenues for those periods. As a result, even though we had no significant acquisitions since 2012, comparing our future 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 upon our management, operational capacity and financial resources and systems. The increased demand upon 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, our ability to identify acquisition candidates and conclude acquisitions on acceptable 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. Future acquisitions, if any, may 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;
 
 
failure of an acquired business to achieve targeted financial results; and
 
 
limited capital to finance acquisitions.
 
14

A limited number of customers account for a large portion of our net sales, so that if one or more of our major customers were to experience difficulties in fulfilling their obligations to us, cease doing business with us, significantly reduce the amount of their purchases from us or return substantial amounts of our products, it could have a material adverse effect on our business, financial condition and results of operations.
 
Our three largest customers accounted for 48.4% of our net sales in 2016. Except for outstanding purchase orders for specific products, we do not have written contracts with or commitments from any of our customers and pursuant to the terms of certain of our vendor agreements, even some purchase orders may be cancelled without penalty up until delivery. 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, and changes in other terms of sale or for us to bear the risks and the cost of carrying inventory could also 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 upon our Chief Executive Officer and any loss or interruption of his 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 Stephen G. Berman, our President and Chief Executive Officer. We cannot assure you that we would be able to find an appropriate replacement for Mr. Berman should the need 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 upon 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 upon many third-party manufacturers who develop, provide and use the tools, dyes and molds that we generally 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, dyes 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 upon 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. Sales to our international customers comprised approximately 23.0% of our net sales for the year ended December 31, 2016 and approximately 27.3% of our net sales for the year ended December 31, 2015. 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, and 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;
 
15

 
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, such as earthquakes, hurricanes and floods;
 
 
transportation delays and interruption;
 
 
work stoppages;
 
 
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 upon 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 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 and insurance 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 upon 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 upon 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 upon 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.
 
16

Market conditions and other third-party conduct could negatively impact our margins and implementation of other business initiatives.
 
Economic conditions, such as 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.
 
In June 2014, the Company sold an aggregate of $115.0 million principal amount of 4.875% convertible senior notes due on June 1, 2020, of which $113.0 million are currently outstanding (the “2020 Notes”). Holders of the 2020 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 2020 Notes). Holders of the 2020 Notes may convert their notes upon the occurrence of specified events. Upon conversion, the 2020 Notes will be settled in shares of the Company’s common stock. In July 2013, the Company sold an aggregate of $100.0 million principal amount of 4.25% convertible senior notes due on August 1, 2018, of which $93.9 million are currently outstanding (the “2018 Notes”). Holders of the 2018 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 2018 Notes). Holders of the 2018 Notes may convert their notes upon the occurrence of specified events. Upon conversion, the 2018 Notes will be settled in shares of the Company’s common stock. Restrictions on borrowings under or loss of our credit facility could have a material adverse effect on our financial condition including an adverse impact on our ability to pay the 2018 and 2020 Notes when due.
 
Restrictions under or the loss of availability under our credit facility could adversely impact our financial condition and our ability to pay our convertible senior notes when due.
 
In March 2014, we obtained a $75.0 million revolving line of credit. Any amounts borrowed under the revolving credit line are our senior secured obligations. All outstanding borrowings under the revolving credit line are accelerated and become immediately due and payable (and the revolving credit line terminates) in the event of a default which includes, among other things, failure to comply with financial ratio covenants or breach of representations contained in the credit line documents, defaults under other loans or obligations, involvement in bankruptcy proceedings, an occurrence of a change of control or an event constituting a material adverse effect on us (as such terms are defined in the credit line documents). We are also subject to negative covenants which, during the life of the credit line, prohibit and/or limit us from, among other things, incurring certain types of other debt, acquiring other companies, making certain expenditures or investments, changing the character of our business, and certain changes to our executive officers.
 
We have a full valuation allowance on the entire balance of net deferred taxes on our books since their future realization is uncertain.
 
Deferred tax assets are realized by prior and future taxable income of appropriate character. Current accounting standards require that a valuation allowance be recorded if it is not likely that sufficient taxable income of appropriate character will be generated to realize the deferred tax assets. We currently believe that based on the available information, it is more likely than not that our deferred tax assets will not be realized, and accordingly we have recorded a valuation allowance against our US federal and state deferred tax assets. Our net operating losses and tax credit carry-forwards can expire if unused, and their utilization could be substantially limited in the event of an "ownership change," as defined in Section 382 of the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code.
 
An adverse decision in litigation in which we have been named as a defendant could have a material adverse effect on our financial condition and results of operations.
 
We are defendants in a class action described herein and under “Legal Proceedings” in our periodic reports filed pursuant to the Securities Exchange Act of 1934 (see “Legal Proceedings”). No assurances can be given that the results of these litigation matters will be favorable to us or that an adverse decision in such litigation would not have a material adverse impact on our financial condition and results of operations.
 
Item 2.  Properties
 
The following is a listing of the principal leased offices maintained by us as of February 28, 2017:
 
 
Property
 
Location
 
Approximate
Square Feet
 
Lease Expiration
Date
Domestic
 
 
 
 
 
 
Distribution Center
 
City of Industry, California
 
800,000
 
April 30, 2018
Distribution Center
 
Hickory, North Carolina
 
139,300
 
August 31, 2017
Sales Office/Showroom
 
Bentonville, Arkansas
 
9,000
 
September 30, 2019
Disguise Office
 
Poway, California
 
24,200
 
March 31, 2021
Sales Office
 
Hoffman Estates, Illinois
 
2,102
 
December 8, 2018
Corporate Office/Showroom
 
Santa Monica, California
 
65,858
 
January 31, 2024
Showroom
 
Glendale, California
 
5,830
 
January 31, 2020
International
 
 
 
 
 
 
Distribution Center
 
Brampton, Ontario, Canada
 
105,700
 
December 31, 2019
Europe Office
 
Berkshire, United Kingdom
 
4,746
 
February 25, 2018
Hong Kong Headquarters
 
Kowloon, Hong Kong
 
41,130
 
June 30, 2019
Production Inspection and Testing Office
 
Shenzhen, China
 
5,417
 
May 14, 2017
Production Inspection and Testing Lab
 
Kowloon, Hong Kong
 
34,400
 
October 31, 2018
 
17

Item 3. Legal Proceedings
 
On July 25, 2013, a purported class action lawsuit was filed in the United States District Court for the Central District of California captioned Melot v. JAKKS Pacific, Inc. et al., Case No. CV13-05388 (JAK) against Stephen G. Berman, Joel M. Bennett (collectively the “Individual Defendants”), and the Company (collectively, “Defendants”). On July 30, 2013, a second purported class action lawsuit was filed containing similar allegations against Defendants captioned Dylewicz v. JAKKS Pacific, Inc. et al., Case No. CV13-5487 (OON). The two cases (collectively, the “Class Action”) were consolidated on December 2, 2013 and a lead plaintiff appointed. A Third Amended Complaint (“TAC”) was filed on March 23, 2015 with similar allegations. The Company filed a motion to dismiss the TAC and that motion was argued on July 22, 2015; after argument it was taken on submission and dismissal with prejudice was ordered on November 18, 2016, and final judgment thereon of dismissal with prejudice was entered on December 12, 2016. The foregoing is a summary of the pleadings and is subject to the text of the pleadings which are on file with the Court.

On February 25, 2014, a shareholder derivative action was filed in the Central District of California by Advanced Advisors, G.P. against the Company, nominally, and against Messrs. Berman, Bennett, Miller, Skala, Glick, Ellin, Almagor, Poulsen and Reilly and Ms. Brodsky (Advanced Partners, G.P., v. Berman, et al., CV14-1420 (DSF)). On March 6, 2014, a second shareholder derivative action alleging largely the same claims against the same defendants was filed in the Central District of California by Louisiana Municipal Police Employees Retirement System (Louisiana Municipal Police Employees Retirement System v. Berman et al., CV14-1670 (GHF)). On April 17, 2014, the cases were consolidated under Case No. 2:14-01420-JAK (SSx) (the “Derivative Action”). On April 30, 2014, a consolidated amended complaint (“CAC”) was filed, which alleged (i) a claim for contribution under Sections 10(b) and 21(D) of the Securities Exchange Act related to allegations made in the Class Action; (ii) derivative and direct claims for alleged violations of Section 14 of the Exchange Act and Rule 14a-9 promulgated thereunder related to allegedly misleading statements about Mr. Berman’s compensation plan in the Company’s October 25, 2013 proxy statement; (iii) derivative claims for breaches of fiduciary duty related to the Company’s response to an unsolicited indication of interest from Oaktree Capital, stock repurchase, standstill agreement with the Clinton Group, and decisions related to the NantWorks joint venture; and (iv) claims against Messrs. Berman and Bennett for breach of fiduciary duty related to the Class Action. The CAC seeks compensatory damages, pre-judgment and post-judgment interest, and declaratory and equitable relief. The foregoing is a summary of the CAC and is subject to the text of the CAC, which is on file with the Court. A motion to dismiss the CAC or, in the alternative, to stay the CAC, was filed in May 2014. The Court granted the motion in part and denied the motion in part with leave for plaintiff to file an amended pleading. Plaintiff declined to do so. Accordingly, claims (i), (ii) and (iv) were dismissed and only the elements of claim (iii) not relating to the NantWorks joint venture remained. Thus, there were no surviving claims against Messrs. Poulsen, Reilly and Bennett and Ms. Brodsky and the Court approved the parties’ stipulation to strike their names as defendants in the CAC. Pleadings in response to the CAC were filed on October 30, 2014, which are on file with the Court. The matter was referred to mediation by the Court and the parties, at the mediation, reached an agreement in principle to resolve the action. Thereafter the parties entered into a memorandum of such agreement, subject to Court approval. A motion was filed seeking preliminary approval of the settlement and establishment of the procedure for final approval of the settlement; preliminary approval of the settlement was granted and a hearing regarding final approval of the proposed settlement and attorneys’ fees in connection therewith took place on November 2, 2015. At the hearing, the Judge indicated that he would approve the settlement with a formal order, and that was done in November 2016. The impact of the settlement has been reflected in the consolidated financial statements.

We are a party to, and certain of our property is the subject of, various 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

Item 4.  Mine Safety Disclosures
 
Not applicable.
 
19

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
 
2015:
           
First quarter
 
$
7.30
   
$
5.70
 
Second quarter
   
10.09
     
6.60
 
Third quarter
   
10.28
     
8.26
 
Fourth quarter
   
9.02
     
7.36
 
2016:
               
First quarter
   
7.97
     
6.17
 
Second quarter
   
8.02
     
6.94
 
Third quarter
   
9.75
     
7.57
 
Fourth quarter
   
9.15
     
4.63
 
 
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 on December 31, 2011 in our common stock, the Russell 2000 and the peer group index over the period from January 1, 2012 to December 31, 2016.
 
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. EMak Worldwide Inc. and THQ Inc. were excluded from the performance peer group in 2014, Kid Brands, Inc. was excluded in 2015 and Leapfrog Enterprises, Inc. was excluded in 2016. Deckers Outdoor Corporation was added in 2016 and our peer group index now is comprised of the following companies: Activision Blizzard, Inc., Deckers Outdoor Corporation, Electronic Arts, Inc., Hasbro, Inc., Mattel, Inc. and Take-Two Interactive, Inc.
 
20

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,
2012
   
December 31,
2013
   
December 31,
2014
   
December 31,
2015
   
December 31,
2016
 
JAKKS Pacific
   
(9.0
)%
   
(45.6
)%
   
1.2
%
   
17.1
%
   
(35.3
)%
New Peer Group
   
(3.0
)
   
55.6
     
11.7
     
39.4
     
7.0
 
Old Peer Group
   
1.0
     
52.5
     
11.3
     
44.2
     
6.8
 
Russell 2000
   
16.3
     
38.8
     
4.9
     
(4.4
)
   
21.3
 
 
 

Indexed Returns

 
 
January 1,
2012
   
December 31,
2012
   
December 31,
2013
   
December 31,
2014
   
December 31,
2015
   
December 31,
2016
 
JAKKS Pacific
 
$
100.0
   
$
91.0
   
$
49.5
   
$
50.1
   
$
58.7
   
$
38.0
 
New Peer Group
   
100.0
     
97.0
     
150.9
     
168.5
     
234.9
     
251.4
 
Old Peer Group
   
100.0
     
101.0
     
153.9
     
171.4
     
247.2
     
264.0
 
Russell 2000
   
100.0
     
116.3
     
161.5
     
169.4
     
162.0
     
196.5
 

 
 Security Holders
 
To the best of our knowledge, as of March 10, 2017, there were 95 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
 
In July 2011, we implemented a cash dividend program in the amount of $0.40 per share annually, payable on a quarterly basis to holders of record of our common stock. Effective February 20, 2013, the dividend amount was reduced to $0.28 per share annually and effective July 17, 2013, the dividend program was suspended. During 2012, we paid total dividends per share of $0.40 to holders of our common stock, and during 2013, we paid total dividends per share of $0.14. The payment of dividends on common stock is at the discretion of the Board of Directors and is subject to customary limitations. 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 common stock and/or retire some of our outstanding convertible senior notes.
 
21

Equity Compensation Plan Information
 
The table below sets forth the following information as of the year ended December 31, 2016 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
   
   
$
     
2,378,630
 
Equity compensation plans not approved by security holders
   
     
     
 
Total
   
   
$
     
2,378,630
 
 
Equity compensation plans approved by our stockholders consists of the 2002 Stock Award and Incentive Plan. An additional 1.4 million shares were added to the number of total issuable shares under the Plan and approved by the Board in 2013. Additionally, 196,453 shares of restricted stock awards remained unvested as of December 31, 2016. Disclosures with respect to equity issuable to certain of our executive officers pursuant to the terms of their employment agreements is disclosed below under Item 11.

Issuer Purchases of Equity Securities

There were no issuer purchases of equity securities in the fourth quarter of 2016.

In June 2015, and as subsequently increased, the Board of Directors authorized a security repurchase program, under which the Company could repurchase up to $35.0 million of the Company’s outstanding common stock and/or convertible senior notes from time to time. As of December 31, 2016, the Company completed the authorized repurchases of securities, and repurchased and retired 3,313,645 shares of its common stock at a total cost of $26.7 million; $2.0 million principal amount of its 2020 Notes at a cost of $1.9 million; and $6.1 million principal amount of its 2018 Notes at a cost of $6.1 million.
 
22

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” (included in Item 7) and our consolidated financial statements and the related notes (included in Item 8).
 
 
 
Years Ended December 31,
 
 
 
2012
   
2013
   
2014
   
2015
   
2016
 
 
 
(In thousands, except per share data)
 
Consolidated Statement of Operations Data:
                             
Net sales
 
$
666,762
   
$
632,925
   
$
810,060
   
$
745,741
   
$
706,603
 
Cost of sales
   
468,825
     
477,146
     
574,253
     
517,172
     
483,582
 
Gross profit
   
197,937
     
155,779
     
235,807
     
228,569
     
223,021
 
Selling, general and administrative expenses
   
211,159
     
195,296
     
203,326
     
198,039
     
205,915
 
Reorganization charges
   
     
5,015
     
1,154
     
     
 
Income (loss) from operations
   
(13,222
)
   
(44,532
)
   
31,327
     
30,530
     
17,106
 
Change in fair value of business combination liability
   
     
6,000
     
5,932
     
5,642
     
 
Profit from video game joint venture
   
3,000
     
     
     
2,701
     
174
 
Income (loss) from joint ventures
   
130
     
(3,148
)
   
314
     
60
     
715
 
Other income
   
     
     
     
     
305
 
Interest income
   
671
     
327
     
112
     
62
     
51
 
Interest expense
   
(9,228
)
   
(9,942
)
   
(12,461
)
   
(12,402
)
   
(12,975
)
Income (loss) before provision for income taxes
   
(18,649
)
   
(51,295
)
   
25,224
     
26,593
     
5,376
 
Provision for income taxes
   
86,151
     
2,611
     
3,715
     
3,423
     
4,127
 
Net income (loss)
   
(104,800
)
   
(53,906
)
   
21,509
     
23,170
     
1,249
 
Net income (loss) attributable to non-controlling interests
   
     
     
     
(84
)
   
6
 
Net income (loss) attributable to JAKKS Pacific, Inc.
 
$
(104,800
)
 
$
(53,906
)
 
$
21,509
   
$
23,254
   
$
1,243
 
Basic earnings (loss) per share
 
$
(4.37
)
 
$
(2.43
)
 
$
1.03
   
$
1.20
   
$
0.08
 
Diluted earnings (loss) per share
 
$
(4.37
)
 
$
(2.43
)
 
$
0.70
   
$
0.71
   
$
0.07
 
Dividends declared per common share
 
$
0.40
   
$
0.14
   
$
   
$
   
$
 
 
During the second quarter of 2016, we recorded income of $0.7 million related to Pacific Animation Partners and $0.2 million for funds received related to our former video game joint venture.

During the third quarter of 2015, we recorded income of $5.6 million related to the reversal of a portion of the Maui earn-out and during the second and fourth quarters of 2015 we recorded an aggregate of $2.7 million related to our former video game joint venture with THQ.

During the second quarter of 2014, we incurred restructuring charges of $1.2 million related to office space consolidations as part of the reorganization plan which commenced in the third quarter of 2013. During the third quarter of 2014, we recorded income of $5.9 million related to the reversal of a portion of the Maui earn-out. The Maui earn-out reversal was due to Maui not achieving the prescribed earn-out targets in 2014.
 
In 2013, we recorded a charge of $14.9 million related to the write-down of certain excess and impaired inventory. We also recorded a charge of $14.4 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 fourth quarter of 2013, we incurred restructuring charges of $5.0 million related to the office space consolidations given the decrease in sales in 2013, and recorded income of $6.0 million related to the reversal of a portion of the Maui earn-out. The Maui earn-out reversal was due to Maui not achieving the prescribed earn-out targets in 2013.
 
During the third quarter of 2012, we acquired Maui, Inc., an Ohio corporation, Kessler Services, Inc., a Nevada corporation, and A.S. Design Limited, a Hong Kong corporation (collectively, “Maui”).
 
   
At December 31,
 
 
 
  2012  
 
  2013  
 
 
2014 
 
 
 
2015 
 
 
 
2016 
 
 
(In thousands)
 
Consolidated Balance Sheet Data:
                   
Cash and cash equivalents
 
$
189,321
   
$
117,071
   
$
71,525
   
$
102,528
   
$
86,064
 
Working capital
   
186,581
     
136,337
     
246,245
     
254,967
     
236,569
 
Total assets
   
554,825
     
449,844
     
561,782
     
499,620
     
464,303
 
Short-term debt
   
70,710
     
38,098
     
     
     
10,000
 
Long-term debt
   
94,918
     
100,000
     
215,000
     
215,000
     
206,865
 
Total stockholders’ equity
   
207,220
     
148,685
     
145,084
     
153,406
     
135,200
 
 
23

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors. You should read this section in conjunction with our consolidated financial statements and the related notes (included in Item 8).
 
Critical Accounting Policies
 
The accompanying consolidated financial statements and supplementary information were prepared in accordance with accounting principles generally accepted in the United States of America. Significant accounting policies are discussed in Note 2 to the Consolidated Financial Statements, Item 8. Inherent in the application of many of these accounting policies is the need for management to make estimates and judgments in the determination of certain revenues, expenses, assets and liabilities. As such, materially different financial results can occur as circumstances change and additional information becomes known. The policies with the greatest potential effect on our results of operations and financial position include:
 
Allowance for Doubtful Accounts. Our allowance for doubtful accounts is based upon management’s assessment of the business environment, customers’ financial condition, historical collection experience, accounts receivable aging, customer disputes and the collectability of specific customer accounts. If there were a deterioration of a major customer’s creditworthiness, or actual defaults were higher than our historical experience, our estimates of the recoverability of amounts due to us could be overstated, which could have an adverse impact on our operating results. Our allowance for doubtful accounts is also affected by the time at which uncollectible accounts receivable balances are actually written off.
 
Major customers’ accounts are monitored on an ongoing basis; more in-depth reviews are performed based upon changes in a 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 determinable and collectability is reasonably assured. 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 and support customer promotions and we provide allowances for returns and defective merchandise. Such programs are primarily based upon 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.
 
Goodwill and other indefinite-lived intangible assets. Goodwill and indefinite-lived intangible assets are not amortized, but are tested for impairment at least annually at the reporting unit level.
 
Factors we consider important that 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 uncertainty related to our key assumptions. Any changes in our key projections or estimates could result in a reporting unit either passing or failing the first step of the impairment model, which could significantly change the amount of any impairment ultimately recorded.
 
Based upon 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. Goodwill is tested for impairment annually. 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. 
24

The Company assessed its goodwill for impairment as of April 1, 2016 for each of its reporting units by evaluating qualitative factors, including, but not limited to, the performance of each reporting unit, general economic conditions, access to capital, the industry and competitive environment, the interest rate environment. In prior years, the assessment had been performed as of October 1 of each year, however, as of March 31, 2016, the Company revised its reportable segments based on changes to how the businesses are managed and how resources are allocated to the businesses. In conjunction with the required reallocation of goodwill to the new reportable segments as of March 31, 2016, the Company performed its annual assessment as of April 1, 2016. Based on the seasonality of its businesses, the Company has determined that it is most appropriate to perform future annual assessments as of April 1 after completion of the business cycles of each of its reporting units. The Company prepared step-one of its impairment model. Based on the Company’s assessment, it determined that the fair values of its reporting units were not less than the carrying amounts. In addition, as a result of operating performance below expectations for the full year of 2016 that became apparent in December 2016, the Company performed a subsequent impairment assessment on goodwill as of December 31, 2016. Based on the Company’s assessment, it determined that the fair values of its reporting units were not less than the carrying amounts with excess coverage of fair value over the carrying value of each of the reporting units of 2.0%, 20.6% and 2.0% for U.S. and Canada, International, and Halloween, respectively. As such, the Company determined there was no impairment to be recorded in 2016. The amount of goodwill assigned to each of the three reporting units, U.S. and Canada, International, and Halloween, amounted to $29.5 million, $11.5 million, and $2.2 million, respectively.
 
Goodwill and intangible assets amounted to $78.9 million as of December 31, 2016.
 
Reserve for Inventory Obsolescence. We value our inventory at the lower of cost or market. Based upon a consideration of quantities on hand, actual and projected sales volume, anticipated product selling prices and product lines planned to be discontinued, slow-moving and obsolete inventory is written down to its net realizable value.
 
Failure to accurately predict and respond to consumer demand could result in us 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 Allocation for Income Taxes. Our annual income tax provision and related income tax assets and liabilities are based upon actual income as allocated to the various tax jurisdictions based upon our transfer pricing study, US and foreign statutory income tax rates and tax regulations and planning opportunities in the various jurisdictions in which we operate. Significant judgment is required in interpreting tax regulations in the U.S. and foreign jurisdictions, and in evaluating worldwide uncertain tax positions. Actual results could differ materially from those judgments, and changes from such judgments could materially affect our consolidated financial statements.
 
Income taxes and interest and penalties related to income tax payable. We do not file a consolidated return for our foreign subsidiaries. We file federal and state returns and our foreign subsidiaries each file returns in their respective jurisdictions, 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 bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some 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.
 
We must assess the likelihood that we will be able to recover our deferred tax assets. Deferred tax assets are reduced by a valuation allowance, if, based upon the weight of available evidence, it is more likely than not that we will not realize some portion or all of the deferred tax assets. We consider all available positive and negative evidence when assessing whether it is more likely than not that deferred tax assets are recoverable. We consider evidence such as our past operating results, the existence of cumulative losses in previous periods and our forecast of future taxable income. We believe this to be a critical accounting policy because should there be a change in our ability to recover our deferred tax assets, our tax provision would increase in the period in which we determine that the recovery is not likely, as well as decrease in the period in which the assessment of the recoverability of the deferred tax assets reverses, which could have a material impact on our results of operations.
 
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 upon management’s assessment of all relevant information and is periodically reviewed and adjusted as circumstances warrant. As of December 31, 2016, our income tax reserves were approximately $2.3 million and relates to the potential tax settlement in Hong Kong, adjustments in the area of withholding taxes, and state taxes.
 
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. Related to the stock option grants, 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. Related to the restricted stock award grants, we determine the value of each award based on the market value of the underlying common stock at the date of each grant and expense each award over the stipulated service period.
 
Recent Accounting Pronouncements.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. The standard is effective for annual periods beginning after December 15, 2017, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). We are currently evaluating the impact of our pending adoption of ASU 2014-09 on our consolidated financial statements and have not yet determined the method by which we will adopt the standard in 2018.
 
In July 2015, the FASB issued ASU 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory” (“ASU 2015-11”). ASU 2015-11 requires inventory accounted for under the FIFO or average cost method to be measured using the lower of cost and net realizable value. The amendments are effective prospectively for fiscal years and for interim periods beginning after December 15, 2016. We are currently evaluating the impact of the pending adoption of ASU 2015-11 on our consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”). The new guidance is intended to improve the recognition and measurement of financial instruments. The ASU is effective for fiscal years and interim periods within those years beginning after December 15, 2017. We are currently assessing the potential impact of this ASU on our consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, “Leases” (“ASU 2016-02”). ASU 2016-02 establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. We are currently evaluating the impact of the pending adoption of this new standard on our consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting,” (“ASU 2016-09”) which simplifies several aspects of the accounting for share-based payments, including income tax consequences and classification on the statement of cash flows. Under the new standard, all excess tax benefits and tax deficiencies will be recognized as income tax expense or benefit in the income statement as discrete items in the reporting period in which they occur. Additionally, excess tax benefits will be classified as an operating activity on the statement of cash flows. In regard to forfeitures, the entity can make an accounting policy election to either recognize forfeitures as they occur or estimate the number of awards expected to be forfeited. The guidance in ASU 2016-09 is effective for the fiscal year, and interim periods within that fiscal year, beginning after December 15, 2016. We are currently evaluating the impact of the adoption of this standard on our consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.” The new guidance is intended to reduce diversity in practice in how transactions are classified in the statement of cash flows. This ASU is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2017. The adoption of this standard is not expected to have a material impact on our consolidated financial statements.

In October 2016, the FASB issued ASU 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other than Inventory.” The amendments in this ASU reduces the complexity in the accounting standards by allowing the recognition of current and deferred income taxes for an intra-entity asset transfer, other than inventory, when the transfer occurs. Historically, recognition of the income tax consequence was not recognized until the asset was sold to an outside party. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted. We are currently evaluating the impact of this ASU on our consolidated financial statements.
 
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,
 
 
 
2014
   
2015
   
2016
 
Net Sales
   
100.0
%
   
100.0
%
   
100.0
%
Cost of Sales
   
70.9
     
69.4
     
68.4
 
Gross profit
   
29.1
     
30.6
     
31.6
 
Selling, general and administrative expenses
   
25.2
     
26.5
     
29.1
 
Income from operations
   
3.9
     
4.1
     
2.5
 
Change in fair value of business combination liability
   
0.7
     
0.8
     
 
Profit from video game joint venture
   
     
0.4
     
 
Income from joint ventures
   
     
     
0.1
 
Other income
   
     
     
 
Interest income
   
     
     
 
Interest expense
   
(1.5
)
   
(1.7
)
   
(1.8
)
Income before provision for income taxes
   
3.1
     
3.6
     
0.8
 
Provision for income taxes
   
0.4
     
0.5
     
0.6
 
Net income
   
2.7
     
3.1
     
0.2
 
Net income (loss) attributable to non-controlling interests
   
     
     
 
Net income attributable to JAKKS Pacific, Inc.
   
2.7
%
   
3.1
%
   
0.2
%
 
The following table summarizes, for the periods indicated, certain income statement data by segment (in thousands).
 
 
 
Years Ended December 31,
 
 
 
2014
   
2015
   
2016
 
 
                 
Net Sales
                 
U.S. and Canada
 
$
546,864
   
$
478,728
   
$
478,595
 
International
   
121,607
     
169,826
     
131,229
 
Halloween
   
141,589
     
97,187
     
96,779
 
 
   
810,060
     
745,741
     
706,603
 
Cost of Sales
                       
U.S. and Canada
   
384,548
     
334,989
     
322,721
 
International
   
84,055
     
110,174
     
89,187
 
Halloween
   
105,650
     
72,009
     
71,674
 
 
   
574,253
     
517,172
     
483,582
 
Gross Profit
                       
U.S. and Canada
   
162,316
     
143,739
     
155,874
 
International
   
37,552
     
59,652
     
42,042
 
Halloween
   
35,939
     
25,178
     
25,105
 
 
 
$
235,807
   
$
228,569
   
$
223,021
 
 
As of March 31, 2016 the Company realigned its segments to align more closely with how management evaluates the business performance of the Company. The products included in the realigned segments are detailed in Part I, Item 1 of the Company’s 10-K report. Prior period results have been conformed to the new segment reporting structure.
 
27

Comparison of the Years Ended December 31, 2016 and 2015
 
Net Sales
 
U.S. and Canada.  Net sales of our U.S. and Canada segment were $478.6 million in 2016, compared to $478.7 million in 2015, representing a decrease of $0.1 million. Net sales were flat year-over year primarily due to a decrease in unit sales of various products due to the suspension of shipments to a major U.S. customer and lower than expected unit sales of some movie licensed products, offset by higher unit sales of our Disney Tsum Tsum line of collectibles, Disney Princess and Alice Through the Looking Glass dolls, kids furniture and accessories, and our Big Figs line.
 
International.  Net sales of our International segment were $131.2 million in 2016, compared to $169.8 million in 2015, representing a decrease of $38.6 million, or 22.7%. The decrease in net sales was primarily driven by declines in unit sales of various products in the United Kingdom and Western Europe due to the reduced buying power of our customers stemming from the devaluation of the British Pound, and lower than expected unit sales of movie licensed product.

Halloween.  Net sales of our Halloween segment were $96.8 million in 2016, compared to $97.2 million in 2015, representing a decrease of $0.4 million, or 0.4%. The decrease in net sales was primarily due to a decrease in unit sales of a variety of products in 2016.

Cost of Sales
 
 U.S. and Canada.  Cost of sales of our U.S. and Canada segment was $322.7 million, or 67.4% of related net sales in 2016 compared to $335.0 million, or 70.0% of related net sales in 2015, representing a decrease of $12.3 million, or 3.7%. The decrease in cost of sales as a percentage of net sales, year over year, is due to reduced costing of legacy products and product mix, partially offset by increased product tooling driven by new product introductions in 2016. Depreciation of molds and tools for the segment increased slightly in 2016 due to new product tooling driven by product introductions in 2016.

International.  Cost of sales of our International segment was $89.2 million, or 68.0% of related net sales in 2016 compared to $110.2 million, or 64.9% of related net sales in 2015, representing a decrease of $21.0 million, or 19.1%. The decrease in cost of sales is a direct function of lower overall unit sales. The increase as a percentage of net sales, year-over-year, is due to the change in product mix to relatively higher cost product and an increase in the average royalty rate. The increase in royalties is driven by a shift in the product mix to products with relatively higher royalty rates and an increase in royalty rates on shipments made FOB China. Our depreciation of molds and tools for the segment showed a modest increase from 2015 due to increased product tooling driven by new product introductions in 2016.

Halloween.  Cost of sales of our Halloween segment was $71.7 million, or 74.1% of related net sales for 2016 compared to $72.0 million, or 74.1% of related net sales in 2015, representing a decrease of $0.3 million, or 0.4%. The percentage of net sales in 2016 is comparable to 2015.

Selling, General and Administrative Expenses
 
Selling, general and administrative expenses were $205.9 million in 2016 and $198.0 million in 2015, constituting 29.1% and 26.5% of net sales, respectively. Selling, general and administrative expenses increased by $7.9 million driven by higher marketing expenses ($6.7 million), higher product development costs in support of increased product launches ($2.5 million), and increased depreciation and amortization ($1.6 million), partially offset by a decrease in general and administrative expenses ($2.9 million). 
28

Profit from Video Game Joint Venture
 
We recognized $0.2 million of income for funds received in 2016 related to our former video game joint venture in partial settlement of amounts owed to the Company when our joint venture partner was liquidated pursuant to their 2012 bankruptcy filing. In 2015, we recognized $2.7 million in income related to our former video game joint venture. It is not known if any additional funds will be received by us.
 
Income from Joint Ventures
 
We recognized $0.7 million of income for funds received in 2016 related to Pacific Animation Partners compared to $0.1 million received in 2015.
 
Other Income
 
We recognized income of $0.2 million for funds received in 2016 related to the disgorgement of short swing trading profits from a shareholder, net of legal fees and a $0.1 million gain on extinguishment of convertible senior notes.
 
Interest Income
 
Interest income in 2016 was $0.1 million, comparable to $0.1 million in 2015.
 
Interest Expense
 
Interest expense was $13.0 million in 2016, as compared to $12.4 million in 2015. In 2016, we recorded interest expense of $11.7 million related to our convertible senior notes payable, $0.9 million related to our revolving credit facility and $0.4 million related to the interest component of our Maui acquisition earn-out. In 2015, we recorded interest expense of $11.5 million related to our convertible senior notes payable and $0.9 million related to our revolving credit facility.
 
29

Provision for Income Taxes
 
Our income tax expense, which includes federal, state and foreign income taxes and discrete items, was $4.1 million, or an effective tax rate of 76.8% for 2016. During 2015, the income tax expense was $3.4 million, or an effective tax rate of 12.9%.
 
The 2016 tax expense of $4.1 million included a discrete tax benefit of $0.1 million primarily comprised of return to provision adjustments. Absent these discrete tax benefits, our effective tax rate for 2016 was 79.2%, primarily due to US federal alternative minimum tax, various state taxes and taxes on foreign income.

The 2015 tax expense of $3.4 million included a discrete tax expense of $0.9 million primarily comprised of return to provision adjustments. Absent these discrete tax expenses, our effective tax rate for 2015 was 9.5%, primarily due to a full valuation allowance on the Company's United States deferred tax assets and the foreign rate differential, and is impacted by the proportion of Hong Kong earnings to overall earnings and is expected to vary depending on the level of consolidated earnings.

We assess the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets by jurisdiction. Based on our evaluation of all positive and negative evidence, as of December 31, 2016, a valuation allowance of $49.3 million has been recorded against the deferred tax assets that more likely than not will not be realized. The net deferred tax liabilities of $2.0 million represent the net deferred tax liabilities in the foreign jurisdiction, where we are in a cumulative income position.

As of December 31, 2016, we had net deferred tax liabilities of approximately $2.0 million related to foreign jurisdictions.

 Comparison of the Years Ended December 31, 2015 and 2014
 
Net Sales
 
U.S. and Canada.  Net sales of our U.S. and Canada segment were $478.7 million in 2015, compared to $546.9 million in 2014, representing a decrease of $68.2 million, or 12.5%. The decrease in net sales was primarily due to lower unit sales given the difficult annual comparable with the relative strength of the performance of the Frozen and Marvel brands in 2014.
 
International.  Net sales of our International segment were $169.8 million in 2015, compared to $121.6 million in 2014, representing an increase of $48.2 million, or 39.6%. The increase in net sales was primarily driven by the international expansion both in terms of markets with new offices in Mexico and Germany, as well as the increase of licensed rights for international markets.

Halloween.  Net sales of our Halloween segment were $97.2 million in 2015, compared to $141.6 million in 2014, representing a decrease of $44.4 million, or 31.4%. The decrease in net sales was primarily due to lower unit sales given the difficult annual comparable with the relative strength of the performance of the Frozen and Marvel brands in 2014.

Cost of Sales
 
U.S. and Canada.  Cost of sales of our U.S. and Canada segment was $335.0 million, or 70.0% of related net sales for 2015 compared to $384.5 million, or 70.3% of related net sales in 2014, representing a decrease of $49.5 million, or 12.9%. The decrease in the cost of sales is a direct function of lower unit sales. The decrease in cost of sales as a percentage of net sales, year over year, is due to reduced costing of legacy products and product mix, partially offset by increased product tooling driven by new product introductions in 2015. Depreciation of molds and tools for the segment increased slightly in 2015 due to new product tooling driven by product introductions in 2015.
 
International.  Cost of sales of our International segment was $110.2 million, or 64.9% of related net sales for 2015 compared to $84.0 million, or 69.1% of related net sales in 2014, representing an increase of $26.2 million, or 31.2%. The increase in cost of sales is a direct function of higher overall unit sales. The decrease in cost of sales as a percentage of net sales, year over year, is due to reduced costing of legacy products and product mix.

Halloween.  Cost of sales of our Halloween segment was $72.0 million, or 74.1% of related net sales for 2015 compared to $105.7 million, or 74.6% of related net sales in 2014, representing a decrease of $33.7 million, or 31.9%. The decrease in cost of sales is a direct function of lower overall unit sales. The decrease in cost of sales percentage was driven by better product costing on legacy items, stronger margins on new products in 2015 and the absence of lower selling prices of Marvel Halloween costumes in 2014.

Selling, General and Administrative Expenses
 
Selling, general and administrative expenses were $198.0 million in 2015 and $204.5 million in 2014, constituting 26.5% and 25.2% of net sales, respectively. The overall relative decrease of selling, general and administrative expenses as a percentage of Net Sales in 2015 is the result of the comparative decrease in net sales in 2015 compared to 2014. The overall decrease of $6.5 million is primarily due to lower advertising spend in 2015 partially offset by increased salaries and benefits in 2015 versus 2014.
 
30

Profit from Video Game Joint Venture
 
In 2015, we recognized $2.7 million of income related to our former video game joint venture.
 
Income from Joint Ventures
 
We recognized $0.1 million of income for funds received in 2015 related to Pacific Animation Partners. In 2014, we recognized $0.3 million for funds received from Pacific Animation Partners.

Interest Income
 
Interest income in 2015 was $0.1 million, comparable to $0.1 million in 2014 due to lower cash balances in 2015 offset by a higher proportion of investible cash.
 
Interest Expense
 
Interest expense was $12.4 million in 2015, as compared to $12.5 million in 2014. In 2015, we recorded interest expense of $11.5 million related to our convertible senior notes payable and $0.9 million related to our revolving credit facility. In 2014, we recorded interest expense of $11.3 million related to our convertible senior notes payable, $0.8 million related to our credit facility, $0.2 million of uncertain tax expense and $0.2 million related to the interest component of our Maui acquisition earn-out payment.
 
31

Provision for Income Taxes
 
Our income tax expense, which includes federal, state and foreign income taxes and discrete items, was $3.4 million, or an effective tax rate of 12.9% for 2015. During 2014, the income tax expense was $3.7 million, or an effective tax rate of 14.7%.

The 2015 tax expense of $3.4 million included a discrete tax expense of $0.9 million primarily comprised of return to provision adjustments. Absent these discrete tax expenses, our effective tax rate for 2015 was 9.5%, primarily due to a full valuation allowance on the Company's United States deferred tax assets and the foreign rate differential, and is impacted by the proportion of Hong Kong earnings to overall earnings and is expected to vary depending on the level of consolidated earnings.
  
The 2014 tax expense of $3.7 million included a discrete tax benefit of $0.3 million comprised of adjustments from closed tax audits (see Note 13 of the Notes to Consolidated Financial Statements). Absent these discrete tax expenses, our effective tax rate for 2014 was 13.6%, primarily due to a full valuation allowance on the Company’s United States deferred tax assets and the foreign rate differential, and is impacted by the proportion of Hong Kong earnings to overall earnings and is expected to vary depending on the level of consolidated earnings.

We assess the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets by jurisdiction. For the three-year period ended December 31, 2015, we were in a cumulative pre-tax loss position in the U.S. On the basis of this evaluation, as of December 31, 2015, a valuation allowance of $100.9 million has been recorded against the U.S. deferred tax assets that more likely than not will not be realized. The net deferred tax liabilities of $2.3 million represent the net deferred tax liabilities in the foreign jurisdiction, where we are in a cumulative income position.

As of December 31, 2015, we had net deferred tax liabilities of approximately $2.3 million related to foreign jurisdictions.
 
32

Quarterly Fluctuations and Seasonality
 
We have experienced significant quarterly fluctuations in operating results and anticipate these fluctuations in the future. The operating results for any quarter are not necessarily indicative of results for any future period. Our first quarter is typically expected to be the least profitable as a result of lower net sales but substantially similar fixed operating expenses. This is consistent with the performance of many companies in the toy industry.
 
The following table presents our unaudited quarterly results for the years indicated. The seasonality of our business is reflected in this quarterly presentation.
 
 
 
2015
   
2016
 
  
 
First
   
Second
   
Third
   
Fourth
   
First
   
Second
   
Third
   
Fourth
 
(unaudited)     
 
Quarter
   
Quarter
   
Quarter
   
Quarter
   
Quarter
   
Quarter
   
Quarter
   
Quarter
 
 
                                               
Net sales
 
$
114,201
   
$
131,106
   
$
337,027
   
$
163,407
   
$
95,809
   
$
140,977
   
$
302,791
   
167,026
 
As a % of full year
   
15.3
%
   
17.6
   
45.2
%
   
21.9
%
   
13.6
%
   
20.0
%
   
42.8
%
   
23.6
%
Gross Profit
 
$
35,378
   
$
39,287
   
$
104,329
   
$
49,575
   
$
31,183
   
$
44,800
   
$
94,933
   
52,105
 
As a % of full year
   
15.5
%
   
17.2
   
45.6
%
   
21.7
%
   
14.0
%
   
20.1
%
   
42.5
%
   
23.4
%
As a % of net sales
   
31.0
%
   
30.0
   
31.0
%
   
30.3
%
   
32.5
%
   
31.8
%
   
31.4
%
   
31.2
%
Income (loss) from operations
 
$
(4,199
)
 
$
(3,008
 
$
44,628
   
$
(6,891
)
 
$
(13,816
)
 
$
(1,100
)
 
$
34,413
   
(2,391
)
As a % of full year
   
(13.8
)%
   
(9.8
)%     
146.2
%
   
(22.6
)%
   
(80.8
)%
   
(6.4
)%
   
201.2
%
   
(14.0
)%
As a % of net sales
   
(3.7
)%
   
(2.3
)%     
13.2
%
   
(4.2
)%
   
(14.4
)%
   
(0.8
)%
   
11.4
%
   
(1.4
)%
Income (loss) before provision
(benefit) for income taxes
 
$
(7,154
)
 
$
(4,414
 
$
47,239
   
$
(9,078
)
 
$
(16,951
)
 
$
(3,441
)
 
$
31,612
   
(5,844
)
As a % of net sales
   
(6.3
)%
   
(3.4
)%     
14.0
%
   
(5.6
)%
   
(17.7
)%
   
(2.4
)%
   
10.4
%
   
(3.5
)%
Net income (loss)
 
$
(7,581
)
 
$
(5,727
 
$
45,864
   
$
(9,386
)
 
$
(17,383
)
 
$
(4,145
)
 
$
30,529
   
(7,752
)
As a % of net sales
   
(6.6
)%
   
(4.4
)%     
13.6
%
   
(5.7
)%
   
(18.1
)%
   
(2.9
)%
   
10.1
%
   
(4.6
)%
Net income (loss) attributable to non-controlling interests
 
$
   
$
(47
 
$
19
   
$
(56
)
 
$
32
   
$
224
   
$
(83
)
 
(167
)
As a % of net sales
   
%
   
   
%
   
%
   
%
   
0.2
%
   
%
   
(0.1
)%
Net income (loss) attributable to JAKKS Pacific, Inc.
 
$
(7,581
)
 
$
(5,680
 
$
45,845
   
$
(9,330
)
 
$
(17,415
)
 
$
(4,369
)
 
$
30,612
   
(7,585
)
As a % of net sales
   
(6.6
)%
   
(4.3
)%     
13.6
%
   
(5.7
)%
   
(18.2
)%
   
(3.1
)%
   
10.1
%
   
(4.5
)%
Diluted earnings (loss) per share
 
$
(0.40
)
 
$
(0.30
 
$
1.12
   
$
(0.50
)
 
$
(1.01
)
 
$
(0.27
)
 
$
0.82
   
(0.47
)
Weighted average shares and
equivalents outstanding
   
19,090
     
19,108
     
42,562
     
18,781
     
17,218
     
16,402
     
39,504
     
16,098
 

Consistent with the seasonality of our business, first and second quarters of 2015 and 2016 and fourth quarter of 2016, experienced seasonally low sales which coupled with fixed overhead resulted in significant net losses.
 
In the third quarter of 2015, income of $5.6 million was recognized in connection with the change in fair value of the Maui acquisition liability.
 
Quarterly and year-to-date computations of income (loss) per share amounts are made independently. Therefore, the sum of the per share amounts for the quarters may not agree with the per share amounts for the year.
 
33

Debt with Conversion and Other Options
 
In July 2013, we sold an aggregate of $100.0 million principal amount of 4.25% convertible senior notes due 2018 (the “2018 Notes”). The 2018 Notes, which are senior unsecured obligations, pay interest semi-annually in arrears on August 1 and February 1 of each year at a rate of 4.25% per annum and will mature on August 1, 2018. The initial and still conversion rate for the 2018 Notes is 114.3674 shares of our common stock per $1,000 principal amount of notes, equivalent to an initial conversion price of approximately $8.74 per share of common stock, subject to adjustment in certain events. Upon conversion, the 2018 Notes will be settled in shares of the Company’s common stock. Holders of the 2018 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 2018 Notes). In 2016, we repurchased and retired $6.1 million principal amount of the 2018 Notes.

In June 2014, the Company sold an aggregate of $115.0 million principal amount of 4.875% convertible senior notes due 2020 (the “2020 Notes”). The 2020 Notes are senior unsecured obligations of the Company paying interest semi-annually in arrears on June 1 and December 1 of each year at a rate of 4.875% per annum and will mature on June 1, 2020. The initial and still conversion rate for the 2020 Notes is 103.7613 shares of our common stock per $1,000 principal amount of notes, equivalent to an initial conversion price of approximately $9.64 per share of common stock, subject to adjustment in certain events. Upon conversion, the 2020 Notes will be settled in shares of the Company’s common stock. Holders of the 2020 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 2020 Notes). In 2016, we repurchased and retired $2.0 million principal amount of the 2020 Notes.
 
Liquidity and Capital Resources
 
As of December 31, 2016, we had working capital of $236.6 million compared to $255.0 million as of December 31, 2015. The decrease was primarily attributable to the repurchase of our common stock and convertible senior notes, offset in part by net income.
 
Operating activities used net cash of $79.0 million and provided net cash of $65.8 million and $16.7 million for the years ended December 31, 2014, 2015 and 2016, respectively. Net cash was favorably impacted primarily by decreases in advance royalty payments and an increase in accounts payable, partially offset by increases in accounts receivable and inventory and a decrease in accrued expenses. Our accounts receivable turnover as measured by days sales for the quarter outstanding in accounts receivable was 83 days, 90 days, and 96 days as of December 31, 2014, 2015 and 2016, respectively. Other than open purchase orders issued in the normal course of business, we have no obligations to purchase finished goods from our manufacturers. As of December 31, 2016, we had cash and cash equivalents of $86.1 million.
 
Investing activities used net cash of $13.0 million, $21.7 million and $15.1 million for the years ended December 31, 2014, 2015 and 2016, respectively. Cash used in 2016 consisted primarily of $14.8 million cash paid for the purchase of office furniture, equipment and molds and tooling used in the manufacturing of our products. Cash used in 2015 consisted primarily of $17.8 million cash paid for leasehold improvements, the purchase of office furniture, equipment and molds and tooling used in the manufacturing of our products. Cash used in 2014 consisted primarily of $10.5 million cash paid for the purchase of office furniture, equipment and molds and tooling used in the manufacturing of our products. As part of our strategy to develop and market new products, we have entered into various character and product licenses with royalties generally ranging from 1% to 20% payable on net sales of such products. As of December 31, 2016, these agreements required future aggregate minimum guarantees of $92.3 million, exclusive of $13.8 million in advances already paid. Of this $92.3 million future minimum guarantee, $52.0 million is due over the next twelve months.
 
Financing activities provided net cash of $46.0 million and used net cash of $13.4 million and $12.0 million for the years ended December 31, 2014, 2015 and 2016, respectively. The cash used in 2016 consists primarily of the repurchase of our common stock and convertible senior notes.

The following is a summary of our significant contractual cash obligations for the periods indicated that existed as of December 31, 2016 and is based upon information appearing in the notes to the consolidated financial statements (in thousands):
 
 
 
Less than
1 year
   
1 – 3
years
   
3 – 5
years
   
More Than
5 years
   
Total
 
Long-term debt
 
$
   
$
206,865
   
$
   
$
   
$
206,865
 
Interest on debt
   
9,440
     
15,640
     
     
     
25,080
 
Operating leases
   
12,030
     
15,698
     
8,236
     
9,184
     
45,148
 
Minimum guaranteed license/royalty payments
   
51,950
     
40,315
     
     
     
92,265
 
Employment contracts
   
8,226
     
13,109
     
     
     
21,335
 
Total contractual cash obligations
 
$
81,646
   
$
291,627
   
$
8,236
   
$
9,184
   
$
390,693
 
 
The above table excludes any potential uncertain income tax liabilities that may become payable upon examination of our income tax returns by taxing authorities. Such amounts and periods of payment cannot be reliably estimated. See Note 13 to the consolidated financial statements for further explanation of our uncertain tax positions.
 
34

In July 2012, we acquired all of the stock of Maui, Inc., an Ohio corporation, Kessler Services, Inc., a Nevada corporation, and A.S. Design Limited, a Hong Kong corporation (collectively, “Maui”). The initial cash consideration totaled $36.2 million. In addition, we agreed to pay an earn-out of up to an aggregate amount of $18.0 million in cash over the three calendar years following the acquisition based upon the achievement of certain financial performance criteria, which was accrued and recorded as goodwill as of December 31, 2012. All changes to the earn-out liability were charged to income. In 2013, 2014 and 2015, the earn-outs were not achieved and the related liability of $6.0 million, $5.9 million and $5.6 million, respectively, was reversed to other income. Maui is a leading manufacturer and distributor of spring and summer activity toys and impulse toys and was included in our results of operations from the date of acquisition.
 
In September 2012, we acquired all of the stock of JKID, LTD., a United Kingdom corporation for an initial cash consideration of $1.1 million and deferred cash payments of $5.5 million payable in five semi-annual payments of $1.1 million each. In addition, we agreed to pay compensation of up to an aggregate amount of $4.4 million in cash over the two year period of 2015 through 2016, based upon the achievement of certain financial performance criteria, which was to be charged to expense when earned. The financial performance criteria were not met in 2015 or 2016. Accordingly, none of the earn-out was paid. JKID is the developer of augmented reality technology that enhances the play patterns of toys and consumer products.

In October 2016, we acquired the operating assets of the C’est Moi brand of performance makeup and youth skincare products whose distribution is currently limited primarily to Asia. We expect to launch a full line of makeup and skincare products branded under the C’est Moi name in the U.S. and Canada in the fourth quarter of 2017 prior to which sales are anticipated to be nominal.
 
35

In November 2009, the Company sold an aggregate of $100.0 million principal amount of the 2014 Notes. The 2014 Notes, which were senior unsecured obligations of the Company, paid cash interest semi-annually at a rate of 4.50% per annum and matured on November 1, 2014. In July 2013, the Company repurchased an aggregate of $61.0 million principal amount of these notes at par plus accrued interest with a portion of the net proceeds from the issuance of $100.0 million principal amount of 4.25% convertible senior notes due 2018 resulting in a gain on extinguishment of $0.1 million. The remainder of these notes were redeemed at par at maturity on November 1, 2014.

We believe that our cash flows from operations and cash and cash equivalents will be sufficient to meet our working capital and capital expenditure requirements and provide us with adequate liquidity to meet our anticipated operating needs for at least the next 12 months. We expect our capital expenditures to be approximately $14.0 million in 2017. Although operating activities are expected to provide cash, to the extent we make any acquisitions or grow significantly in the future, our operating and investing activities may use cash and, consequently, any acquisitions or growth may require us to obtain additional sources of financing. There can be no assurance that any necessary additional financing will be available to us on commercially reasonable terms, if at all. We intend to finance our long-term liquidity requirements out of net cash provided by operations and net cash and cash equivalents. As of December 31, 2016, we do not have any off-balance sheet arrangements.
 
We have cumulative undistributed earnings of non-U.S. subsidiaries outside the U.S. Should those earnings be repatriated to the U.S., we would incur additional tax expense. Other than for short-term financing needs of our U.S. parent company, we do not intend to repatriate those earnings to the U.S. The amount of cash and short term investments held by our foreign subsidiaries was $91.7 million and $72.2 million as of December 31, 2015 and 2016, respectively.
 
During the last three fiscal years ending December 31, 2016, we do not believe that inflation has had a material impact on our net sales and revenues and on income from continuing operations.

Subsequent Events
 
During January and February 2017, the Company entered into exchange transactions with holders of its 4.25% convertible senior notes (due 2018) to exchange at par an aggregate of approximately $39.1 million principal amount of such notes for 2.9 million shares of its common stock and approximately $24.1 million in cash. After these exchanges, the remaining balance of the principal amount of the 2018 Notes was reduced to approximately $54.7 million.
 
In March 2017, we entered into an agreement with Hongkong Meisheng Culture Company Ltd. ("Meisheng Culture Company") to sell 3,660,891 shares of our common stock to Meisheng Culture Company for a total purchase price of $19.3 million. The transaction is subject to approval by the shareholders of Meisheng Culture Company's parent company (Meisheng Culture & Creative Corp., Ltd.), and regulatory filings in China by Meisheng Culture Company. Meisheng Culture & Creative Corp., Ltd. is one of our joint venture partners (see Note 2 of the Notes to Consolidated Financial Statements).
Exchange Rates
 
Sales from our United States and Hong Kong operations are denominated in U.S. dollars and our manufacturing costs are denominated in either U.S. or Hong Kong dollars. Local sales (other than in Hong Kong) and operating expenses of our operations in Hong Kong, the United Kingdom, Germany, France, Spain, Canada, Mexico and China are denominated in local currency, thereby creating exposure to changes in exchange rates. Changes in the various exchange rates against the U.S. dollar may positively or negatively affect our operating results. The exchange rate of the Hong Kong dollar to the U.S. dollar has been fixed by the Hong Kong government since 1983 at HK$7.80 to US$1.00 and, accordingly, has not represented a currency exchange risk to the U.S. dollar. We cannot assure you that the exchange rate between the United States and Hong Kong currencies will continue to be fixed or that exchange rate fluctuations between the United States and Hong Kong or all other currencies will not have a material adverse effect on our business, financial condition or results of operations.

 
Item 7A.  Quantitative and Qualitative Disclosures About Market Risk
 
Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and rates. We are exposed to market risk in the areas of changes in United States and international borrowing rates and changes in foreign currency exchange rates. In addition, we are exposed to market risk in certain geographic areas that have experienced or remain vulnerable to an economic downturn, such as China. We purchase substantially all of our inventory from companies in China, and, therefore, we are subject to the risk that such suppliers will be unable to provide inventory at competitive prices. While we believe that, should such events occur we would be able to find alternative sources of inventory at competitive prices, we cannot assure you that we would be able to do so. These exposures are directly related to our normal operating and funding activities. To date, we have not used derivative instruments or engaged in hedging activities to minimize our market risk.
 
36

Interest Rate Risk
 
In July 2013, we issued convertible senior notes payable of $100.0 million with a fixed interest rate of 4.25% per annum, of which $93.9 million remain outstanding as of December 31, 2016. In addition, in June 2014, we issued convertible senior notes payable of $115.0 million principal amount with a fixed interest rate of 4.875% per annum, of which $113.0 million remain outstanding as of December 31, 2016. As the interest rates on the notes are at fixed rates, we are not generally subject to any direct risk of loss related to these notes arising from changes in interest rates.
 
Our exposure to market risk includes interest rate fluctuations in connection with our revolving credit facility (see Note 11 - Credit Facility in the accompanying notes to the consolidated financial statements for additional information). Borrowings under the revolving credit facility bear interest at a variable rate based on Prime Lending Rate or LIBOR Rate at the option of the Company. For Prime Lending Rate loans, the interest rate is equal to the highest of (i) the Federal Funds Rate plus a margin of 0.50%, (ii) the rate last quoted by The Wall Street Journal as the “Prime Rate,” or (iii) the sum of a LIBOR rate plus 1.00%, plus a margin of 2.25%. For LIBOR rate loans, the interest rate is equal to a LIBOR rate plus a margin of 3.25%. Borrowings under the revolving credit facility are therefore subject to risk based upon prevailing market interest rates. Interest rate risk may result from many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors that are beyond our control. During the year ended December 31, 2016, the maximum amount borrowed under the revolving credit facility was $19.0 million and the average amount of borrowings outstanding was $4.5 million. As of December 31, 2016, the amount of total borrowings outstanding under the revolving credit facility was $10.0 million. If the prevailing market interest rates relative to these borrowings increased by 10%, our interest expense during the period ended December 31, 2016 would have increased by less than $0.1 million.
 
Foreign Currency Risk
 
We have wholly-owned subsidiaries in Hong Kong, China, the United Kingdom, Germany, France, Spain, Canada and Mexico. Sales are generally made by these operations on FOB China or Hong Kong terms and are denominated in U.S. dollars. However, purchases of inventory and Hong Kong operating expenses are typically denominated in Hong Kong dollars and local operating expenses in the United Kingdom, Germany, France, Spain, Canada, Mexico and China are denominated in local currency, thereby creating exposure to changes in exchange rates. Changes in the U.S. dollar exchange rates may positively or negatively affect our gross margins, operating income and retained earnings. The exchange rate of the Hong Kong dollar to the U.S. dollar has been fixed by the Hong Kong government since 1983 at HK$7.80 to US$1.00 and, accordingly, has not represented a currency exchange risk to the U.S. dollar. We do not believe that near-term changes in these exchange rates, if any, will result in a material effect on our future earnings, fair values or cash flows. Therefore, we have chosen not to enter into foreign currency hedging transactions. We cannot assure you that this approach will be successful, especially in the event of a significant and sudden change in the value of these foreign currencies.
 
37

Item 8.  Consolidated Financial Statements and Supplementary Data
 
Report of Independent Registered Public Accounting Firm
 
The Board of Directors and Stockholders
JAKKS Pacific, Inc.
Santa Monica, California
 
We have audited the accompanying consolidated balance sheets of JAKKS Pacific, Inc. ("the Company") as of December 31, 2015 and 2016 and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule (Schedule II) listed in the accompanying index. The consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of JAKKS Pacific, Inc. at December 31, 2015 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 12 to the consolidated financial statements, the Company changed its method of presentation of debt issuance costs in 2016 due to the adoption of Financial Accounting Standards Board Accounting Standards Update (“ASU”) 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. This change was applied retrospectively to all periods presented. Also, as discussed in Note 13 to the consolidation financial statements, the Company changed its method of presentation of deferred tax assets and liabilities in 2016 due to the adoption of ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. This change was applied retrospectively to all periods presented.
 
Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), JAKKS Pacific, Inc.'s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 16, 2017 expressed an unqualified opinion thereon.
 
/s/ BDO USA, LLP
 
BDO USA, LLP
Los Angeles, California
March 16, 2017
 
38

JAKKS PACIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
 
 
December 31,
 
 
 
2015
   
2016
 
 
 
(In thousands, except
 
 
 
share data)
 
Assets
           
Current assets
           
Cash and cash equivalents
 
$
102,528
   
$
86,064
 
Accounts receivable, net of allowance for uncollectible accounts of $2,714 and $2,864 in 2015 and 2016, respectively
   
163,387
     
173,599
 
Inventory, net
   
60,544
     
75,435
 
Income taxes receivable
   
24,008
     
1,204
 
Prepaid expenses and other assets
   
31,901
     
17,077
 
Total current assets
   
382,368
     
353,379
 
Property and equipment
               
Office furniture and equipment
   
15,141
     
14,345
 
Molds and tooling
   
86,307
     
103,128
 
Leasehold improvements
   
10,640
     
10,927
 
Total
   
112,088
     
128,400
 
Less accumulated depreciation and amortization
   
93,653
     
105,559
 
Property and equipment, net
   
18,435
     
22,841
 
Intangibles, net
   
42,185
     
33,111
 
Other long term assets
   
3,125
     
2,156
 
Investment in DreamPlay LLC
   
7,000
     
7,000
 
Goodwill, net
   
44,199
     
43,208
 
Trademarks, net
   
2,308
     
2,608
 
Total assets
 
$
499,620
   
$
464,303
 
Liabilities and Stockholders’ Equity
               
Current liabilities
               
Accounts payable
 
$
34,986
   
$
51,741
 
Accrued expenses
   
54,081
     
38,645
 
Reserve for sales returns and allowances
   
17,267
     
16,424
 
Income taxes payable
   
21,067
     
 
Short term debt
   
     
10,000
 
Total current liabilities
   
127,401
     
116,810
 
Convertible senior notes, net of debt issuance costs of $5,834 and $3,858 in 2015 and 2016, respectively
   
209,166
     
203,007
 
Other liabilities
   
5,155
     
5,004
 
Income taxes payable
   
2,199
     
2,248
 
Deferred income taxes, net
   
2,293
     
2,034
 
Total liabilities
   
346,214
     
329,103
 
Commitments and Contingencies
               
Stockholders’ equity
               
Preferred stock, $.001 par value; 5,000,000 shares authorized; nil outstanding
   
     
 
Common stock, $.001 par value; 100,000,000 shares authorized; 21,153,878 and 19,376,773 shares issued and outstanding in 2015 and 2016, respectively
   
21
     
20
 
Treasury stock at cost; 3,660,201 and 3,112,840 shares in 2015 and 2016, respectively
   
(28,322
)
   
(24,000
)
Additional paid-in capital
   
194,743
     
177,623
 
Accumulated deficit
   
(3,391
)
   
(2,148
)
Accumulated other comprehensive loss
   
(10,051
)
   
(17,207
)
Total JAKKS Pacific, Inc. stockholders’ equity
   
153,000
     
134,288
 
Non-controlling interests
   
406
     
912
 
Total stockholders’ equity
   
153,406
     
135,200
 
Total liabilities and stockholders’ equity
 
$
499,620
   
$
464,303
 
 
See accompanying notes to consolidated financial statements.
 
39

JAKKS PACIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

 
 
 
Years Ended December 31,
 
 
 
2014
   
2015
   
2016
 
 
 
(In thousands, except per share amounts)
 
Net sales
 
$
810,060
   
$
745,741
   
$
706,603
 
Cost of sales
   
574,253
     
517,172
     
483,582
 
Gross profit
   
235,807
     
228,569
     
223,021
 
Selling, general and administrative expenses
   
204,480
     
198,039
     
205,915
 
Income from operations
   
31,327
     
30,530
     
17,106
 
Change in fair value of business combination liability
   
5,932
     
5,642
     
 
Profit from video game joint venture
   
     
2,701
     
174
 
Income from joint ventures
   
314
     
60
     
715
 
Other income
   
     
     
305
 
Interest income
   
112
     
62
     
51
 
Interest expense
   
(12,461
)
   
(12,402
)
   
(12,975
)
Income before provision for income taxes
   
25,224
     
26,593
     
5,376
 
Provision for income taxes
   
3,715
     
3,423
     
4,127
 
Net income
   
21,509
     
23,170
     
1,249
 
Net income (loss) attributable to non-controlling interests
   
     
(84
)
   
6
 
Net income attributable to JAKKS Pacific, Inc.
 
$
21,509
   
$
23,254
   
$
1,243
 
Basic earnings per share
 
$
1.03
   
$
1.20
   
$
0.08
 
Basic weighted number of shares
   
20,948
     
19,435
     
16,542
 
Diluted earnings per share
 
$
0.70
   
$
0.71
   
$
0.07
 
Diluted weighted number of shares
   
41,516
     
43,321
     
16,665
 
 
See accompanying notes to consolidated financial statements.
 
40

JAKKS PACIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
 
 
Years Ended December 31,
 
2014
 
2015
2016
 
(In thousands)
 
 
 
 
 
 
 
Net income
 
$
21,509
 
 
$
23,170
 
 
$
1,249
 
Other comprehensive income (loss):
                       
Foreign currency translation adjustment
   
(2,986
)
   
(3,216
)
   
(7,156
)
Comprehensive income (loss)
 
 
 18,523
 
 
 
19,954
 
 
 
(5,907
)
Less: Comprehensive income (loss) attributable to non-controlling interests
 
 
   
 
(84
)
 
 
6
 
Comprehensive income (loss) attributable to JAKKS Pacific, Inc.
 
$
18,523
 
 
$
20,038
 
 
$
(5,913
)
 
See accompanying notes to consolidated financial statements.
 
41

JAKKS PACIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2014, 2015 AND 2016
(In thousands)


 
 
Common Stock
                     
Accumulated
   
JAKKS
             
 
             
Additional
         
Other
   
Pacific, Inc.
   
Non-
   
Total
 
 
 
Number
         
Treasury
   
Paid-in
   
Accumulated
   
Comprehensive
   
Stockholders’
   
Controlling
   
Stockholders’
 
 
 
of Shares
   
Amount
   
Stock
   
Capital
   
Deficit
   
Loss
   
Equity
   
Interests
   
Equity
 
Balance, December 31, 2013
   
22,669
   
$
23
   
$
   
$
200,665
   
$
(48,154
)
 
$
(3,849
)
 
$
148,685
   
$
   
$
148,685
 
Excess tax deficiency on vesting of restricted stock
   
     
     
     
(85
)
   
     
     
(85
)
   
     
(85
)
Restricted stock grants
   
65
     
1
     
     
1,472
     
     
     
1,473
     
     
1,473
 
Retirement of restricted stock
   
(52
)
   
(1
)