Edgar Filing: JAKKS PACIFIC INC

jakks10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

¨ TRANSITION REPORT PURSUANT TO 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 Incorporation or Organization)	(I.R.S. Employer Identification No.)

22619 Pacific Coast Highway Malibu, California	90265
(Address of Principal Executive Offices)	(Zip Code)

Registrant’s Telephone Number, Including Area Code: (310) 456-7799

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See the definitions 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

(Do not check if a smaller

reporting company)

Smaller reporting company

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

The number of shares outstanding of the issuer’s common stock is 27,911,076 as of August 6, 2010.

JAKKS PACIFIC, INC. AND SUBSIDIARIES

INDEX TO QUARTERLY REPORT ON FORM 10-Q

Quarter Ended June 30, 2010

ITEMS IN FORM 10-Q

		Page

Part I	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets - December 31, 2009 and June 30, 2010 (unaudited)	3
	Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2009 and 2010 (unaudited)	4
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2009 and 2010 (unaudited)	5
	Notes to Condensed Consolidated Financial Statements (unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28
Item 4.	Controls and Procedures	28

Part II	OTHER INFORMATION
Item 1.	Legal Proceedings	29
Item 1A.	Risk Factors	30
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	None
Item 3.	Defaults Upon Senior Securities	None
Item 4.	Reserved
Item 5.	Other Information	None
Item 6.	Exhibits	36

Signatures		37
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

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”, “expect” or words of similar import, we are making forward-looking statements. We believe that the assumptions and expectations reflected in such forward-looking statements are reasonable and are based on information available to us on the date hereof, but we cannot assure you that these assumptions and expectations will prove to have been correct or that we will take any action that we may presently be planning. We 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.

Index

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

	December 31, 2009			June 30, 2010
	(*)			(Unaudited)
ASSETS
Current assets
Cash and cash equivalents	$	254,837		$	248,752
Marketable securities		202			204
Accounts receivable, net of allowances for uncollectible accounts of $2,543, and $2,379, respectively		129,930			102,856
Inventory		34,457			47,384
Income Tax receivable		35,015			22,572
Deferred income taxes		19,467			22,791
Prepaid expenses and other current assets		34,259			35,907
Total current assets		508,167			480,466
Property and equipment
Office furniture and equipment		12,218			12,171
Molds and tooling		55,054			57,385
Leasehold improvements		6,540			6,722
Total		73,812			76,278
Less accumulated depreciation and amortization		52,598			53,910
Property and equipment, net		21,214			22,368
Deferred income taxes		53,502			56,308
Intangibles and other, net		40,604			37,382
Investment in video game Joint Venture		6,727			-
Goodwill, net		1,571			3,446
Trademarks, net		2,308			2,308
Total assets	$	634,093		$	602,278
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable	$	37,613		$	53,884
Accrued expenses		64,051			47,729
Reserve for sales returns and allowances		33,897			20,386
Capital lease obligation		155			41
Income Tax Payable		—			364
Convertible senior notes		20,262			5
Total current liabilities		155,978			122,409
Convertible Senior Notes, Net		86,728			88,092
Other Liabilities		2,490			2,866
Income taxes payable		16,788			16,926
Total liabilities		261,984			230,293
Stockholders’ equity
Preferred stock, $.001 par value; 5,000,000 shares authorized; nil outstanding		—			—
Common stock, $.001 par value; 100,000,000 shares authorized; 27,638,769 and 27,911,076 shares issued and outstanding, respectively		28			28
Additional paid-in capital		303,474			305,564
Retained earnings		72,835			70,653
Accumulated comprehensive loss		(4,228	)		(4,260)
Total stockholders’ equity		372,109			371,985
Total liabilities and stockholders’ equity	$	634,093		$	602,278

(*) Derived from audited financial statements

See notes to condensed consolidated financial statements.

Index

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

	Three Months Ended June 30, (Unaudited)					Six Months Ended June 30, (Unaudited)
	2009			2010		2009		2010

Net sales	$	144,809		$	123,255	$	253,494	$	200,600
Cost of sales		150,885			80,026		222,589		132,138
Gross profit (loss)		(6,076	)		43,229		30,905		68,462
Selling, general and administrative expenses		53,756			41,955		108,310		80,816
Write-down of intangible assets		8,221			-		8,221		-
Write-down of goodwill		407,125			-		407,125		-
Income (Loss) from operations		(475,178)			1,274		(492,751)		(12,354)
Profit (Loss) from video game joint venture		(22,901	)		6,000		(20,005)		6,000
Interest income		69			95		248		152
Interest expense, net of benefit		(1,266	)		(3,007)		(2,533)		(4,204)
Income (Loss) before provision (benefit) for income taxes		(499,276	)		4,362		(515,041)		(10,406)
Provision (Benefit) for income taxes		(92,714	)		1,387		(97,680)		(8,224)
Net income (loss)	$	(406,562	)	$	2,975	$	(417,361)	$	(2,182)
Income (Loss) per share – basic	$	(14.96	)	$	0.11	$	(15.35)	$	(0.08)
Income (Loss) per share – diluted	$	(14.96	)	$	0.11	$	(15.35)	$	(0.08)

See notes to condensed consolidated financial statements.

Index

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

	Six Months Ended June 30, (Unaudited)
	2009		2010

CASH FLOWS FROM OPERATING ACTIVITIES
Net Loss	$	(417,361)	$	(2,182)
Adjustments to reconcile net loss to net cash provided (used) by operating activities:
Depreciation and amortization		11,417		10,792
Share-based compensation expense		3,979		2,090
Loss (gain) on disposal of property and equipment		2,341		(35)
Deferred income taxes		(73,547)		(6,130)
Write-down of intangible assets		8,221		-
Write-down of goodwill		407,125		-
Write-down of deferred offering costs		-		495
Changes in operating assets and liabilities:
Accounts receivable		31,810		27,074
Inventory		8,742		(12,927)
Prepaid expenses and other current assets		1,342		(1,648)
Receivable from joint venture		18,332		6,727
Income tax receivable		(18,832)		12,443
Accounts payable		9,058		16,271
Accrued expenses		(6,942)		(16,322)
Income taxes payable		(7,190)		502
Reserve for sales returns and allowances		(7,524)		(13,511)
Other liabilities		4,481		375
Total adjustments		392,813		26,196
Net cash provided (used) by operating activities		(24,548)		24,014
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment		(10,912)		(6,570)
Change in other assets		2,068		(1,348)
Proceeds from sale of property and equipment		-		67
Cash paid for net assets of business acquired		(12,253)		(1,875)
Net purchase of marketable securities		(4)		(2)
Net cash used in investing activities		(21,101)		(9,728)
CASH FLOWS FROM FINANCING ACTIVITIES
Retirement of convertible notes		-		(20,257)
Common stock surrendered		(1,389)		-
Decrease in capital lease obligations		(76)		(114)
Net cash used in financing activities		(1,465)		(20,371)
Net decrease in cash and cash equivalents		(47,114)		(6,085)
Cash and cash equivalents, beginning of period		169,520		254,837
Cash and cash equivalents, end of period	$	122,406	$	248,752
Cash paid during the period for:
Income taxes	$	2,224	$	678
Interest	$	2,281	$	2,630

Non cash investing and financing activity:

In January 2009, two executive officers surrendered an aggregate of 74,836 shares of restricted stock at a value of $1.4 million to cover their income taxes due on the 2009 vesting of restricted shares granted to them in 2007 and 2008. This restricted stock was subsequently retired by the Company. Also in January 2009, an employee surrendered 551 shares of restricted stock at a value of $11,367 to cover his income taxes due on the December 31, 2008 vested shares.

There were no surrendered stock during 2010.

See Notes 8 and 9 for additional supplemental information to the condensed consolidated statements of cash flows.

See notes to condensed consolidated financial statements.

Index

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

June 30, 2010

Note 1 — Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to prevent the information presented from being misleading. These financial statements should be read in conjunction with Management’s Discussion and Analysis of financial condition and results of operations and the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K, which contains audited financial information for the three years in the period ended December 31, 2009.

The information provided in this report reflects all adjustments (consisting solely of normal recurring items) that are, in the opinion of management, necessary to present fairly the financial position and the results of operations for the periods presented. Interim results are not necessarily indicative of results to be expected for a full year.

Certain reclassifications have been made to prior year balances in order to conform to the current year presentation.

The condensed consolidated financial statements include the accounts of JAKKS Pacific, Inc. and its wholly-owned subsidiaries (collectively the “Company”).

Note 2 — Business Segments, Geographic Data, Sales by Product Group, and Major Customers

The Company is a worldwide producer and marketer of children’s toys and other consumer products, principally engaged in the design, development, production, marketing and distribution of its diverse portfolio. The Company’s reportable segments are Traditional Toys, Craft/Activity/Writing Products, and Pet Products, each of which includes worldwide sales.

The Traditional Toys segment includes action figures, vehicles, playsets, plush products, dolls, accessories, pretend play products including Halloween costumes and accessories, dress-up costumes and accessories, electronic products, novelty toys, collectibles, construction toys, compounds, infant and pre-school toys, water toys, kites, and related products.

Craft/Activity/Writing Products include do-it-yourself kits, pens, pencils, stationery products, crayons, markers, paints, and other related craft and activity products.

Pet Products include pet toys, treats, apparel and related pet products.

Segment performance is measured at the operating income level. All sales are made to external customers, and general corporate expenses have been attributed to the various segments based on sales volumes. Segment assets are comprised of accounts receivable and inventories, net of applicable reserves and allowances, goodwill and other assets.

Index

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 2 — Business Segments, Geographic Data, Sales by Product Group, and Major Customers - (continued)

Results are not necessarily those that would be achieved were each segment an unaffiliated business enterprise. Information by segment and a reconciliation to reported amounts as of December 31, 2009 and June 30, 2010 and for the three and six months ended June 30, 2009 and 2010 are as follows (in thousands):

	Three Months Ended June 30,					Six Months Ended June 30,
		2009			2010		2009			2010
Net Sales
Traditional Toys	$		126,458	$ 117,917		$		224,050	$		192,290
Craft/Activity/Writing Products			14,818	2,850				22,378				4,042
Pet Products			3,533	2,488				7,066				4,268
	$		144,809	$ 123,255		$		253,494	$			200,600

	Three Months Ended June 30,						Six Months Ended June 30,
	2009			2010			2009			2010
Operating Income/Loss
Traditional Toys	$	(373,944)	$		1,219	$		(389,724)	$		(11,842)
Craft/Activity/Writing Products		(89,790)			29			(91,012)			(249)
Pet Products		(11,444)			26			(12,015)			(263)
	$	(475,178)	$		1,274	$		(492,751)	$		(12,354)

	Three Months Ended June 30,				Six Months Ended June 30,
	2009		2010		2009		2010
Depreciation and Amortization Expense
Traditional Toys	$	5,886	$	6,054	$	10,444	$	10,510
Craft/Activity/Writing Products		573		30		751		73
Pet Products		130		122		222		209
	$	6,589	$	6,206	$	11,417	$	10,792

	December 31,		June 30,
	2009		2010
Assets
Traditional Toys	$	565,516	$	585,584
Craft/Activity/Writing Products		57,022		9,204
Pet Products		11,555		7,490
	$	634,093	$	602,278

Index

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 2 — Business Segments, Geographic Data, Sales by Product Group, and Major Customers - (continued)

The following tables present information about the Company by geographic area as of December 31, 2009 and June 30, 2010 and for the three and six months ended June 30, 2009 and 2010 (in thousands):

	December 31, 2009		June 30, 2010
Long-lived Assets
United States	$	19,917	$	21,325
Hong Kong		1,297		1,043
	$	21,214	$	22,368

	Three Months Ended June 30,					Six Months Ended June 30,
	2009		2010			2009			2010
Net Sales by Geographic Area
United States	$	120,807		$	104,445		$	210,879	$	168,920
Europe		6,152			6,895			12,288		12,053
Canada		5,563			4,062			9,968		7,189
Hong Kong		6,292			1,569			9,539		3,012
Other		5,995			6,284			10,820		9,426
	$	144,809		$	123,255		$	253,494	$	200,600

Major Customers

Net sales to major customers for the three and six months ended June 30, 2009 and 2010 were as follows (in thousands, except for percentages):

	Three Months Ended June 30,										Six Months Ended June 30,
	2009					2010					2009					2010
	Amount		Percentage of Net Sales			Amount		Percentage of Net Sales			Amount		Percentage of Net Sales			Amount		Percentage of NetSales

Wal-Mart	$	23,008		15.9	%	$	25,840		21.0	%	$	58,553		23.1	%	$	45,238		22.5	%
Toys ‘R’ Us		14,698		10.1			11,192		9.1			25,834		10.2			21,018		10.5
Target		34,235		23.6			23,881		19.3			49,932		19.7			36,281		18.1

	$	71,941		49.6	%	$	60,913		49.4	%	$	134,319		53.0	%	$	102,537		51.1	%

No other customer accounted for more than 10% of the Company’s total net sales.

At December 31, 2009 and June 30, 2010, the Company’s three largest customers accounted for approximately 50.7% and 51.5%, respectively, of net accounts receivable. The concentration of the Company’s business with a relatively small number of customers may expose the Company to material adverse effects if one or more of its large customers were to experience financial difficulty. The Company performs ongoing credit evaluations of its top customers and maintains an allowance for potential credit losses.

Index

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 3 — Inventory

Inventory, which includes the ex-factory cost of goods, in-bound freight, duty and warehouse costs, is stated at the lower of cost (first-in, first-out) or market and consists of the following (in thousands):

	December 31, 2009		June 30, 2010

Raw materials	$	6,995	$	8,424
Finished goods		27,462		38,960
	$	34,457	$	47,384

Note 4 — Revenue Recognition and Reserve for Sales Returns and Allowances

Revenue is recognized upon the shipment of goods to customers or their agents, depending on terms, provided that there are no uncertainties regarding customer acceptance, the sales price is fixed or determinable, and collectability is reasonably assured and not contingent upon resale.

Generally, the Company does not allow product returns. It provides a negotiated allowance for breakage or defects to its customers, which is recorded when the related revenue is recognized. However, the Company does make occasional exceptions to this policy and consequently accrues a return allowance in gross sales based on historic return amounts and management estimates. The Company also will occasionally grant credits to facilitate markdowns and sales of slow moving merchandise. These credits are recorded as a reduction of gross sales at the time of occurrence.

The Company also participates in cooperative advertising arrangements with some customers, whereby it allows a discount from invoiced product amounts in exchange for customer purchased advertising that features the Company’s products. Typically, these discounts range from 1% to 6% of gross sales, and are generally based on product purchases or on specific advertising campaigns. Such amounts are accrued when the related revenue is recognized or when the advertising campaign is initiated. These cooperative advertising arrangements are accounted for as direct selling expenses.

The Company’s reserve for sales returns and allowances amounted to $33.9 million as of December 31, 2009, compared to $20.4 million as of June 30, 2010. This decrease was primarily due to certain customers taking their year-end allowances related to 2009 during 2010.

Index

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 5 — Convertible Senior Notes

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

The Company used a portion of the net proceeds from the offering to repurchase $77.7 million of its 4.625% convertible senior notes due in 2023 and repurchased virtually all of the remaining $20.3 million of its 4.625% convertible senior notes at par plus accrued interest in June 2010.

In June 2003, the Company sold an aggregate of $98.0 million of 4.625% Convertible Senior Notes due June 15, 2023 of which $5,000 remain outstanding. Cash interest was payable at an annual rate of 4.625% of the principal amount at issuance, from the issue date to June 15, 2010, payable on June 15 and December 15 of each year. After June 15, 2010, interest accrues at the same rate on the outstanding notes. At maturity, the Company will redeem any outstanding notes at their accreted principal amount, which will be equal to $1,811.95 (181.195%) per $1,000 principal amount at issuance, unless redeemed or converted earlier.

Convertible Senior Notes Consist of the Following (in thousands):

		December 31, 2009		June 30, 2010
Current Liabilities
4.625% Convertible senior notes	$	20,262	$	5
Long Term Liabilities
4.50% Convertible senior notes	$	100,000	$	100,000
Unamortized discounts		(13,272)		(11,908)
Net carrying amount of 4.50% convertible senior notes	$	86,728	$	88,092

Note 6 — Income Taxes

The Company’s income tax benefit of $8.2 million for the six months ended June 30, 2010 reflects an effective tax benefit of 79.0%. Included in the tax benefit of $8.2 million is a tax benefit of $4.9 million related to a reduction in tax reserves resulting from the effective settlement of tax audits of the Company’s 2003 through 2006 income tax returns. Absent this discrete tax benefit, the Company’s effective tax rate for the six months ended June 30, 2010 is 31.7%. The Company’s tax benefit for the six months ended June 30, 2009 was $97.7 million and reflected an effective tax rate of 19.0%.

Index

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 7 — Earnings/(Loss) Per Share

The following table is a reconciliation of the weighted average shares used in the computation of earnings and loss per share for the periods presented (in thousands, except per share data):

	Three Months Ended June 30,
	2009					2010
	Income/(Loss)		Weighted Average Shares	Per-Share		Income/(Loss)		Weighted Average Shares		Per-Share

Earnings/(Loss) per share – basic
Income available to common stockholders	$	(406,562)	27,175	$	(14.96)	$	2,975	27,382		$	0.11
Effect of dilutive securities:
Convertible senior notes		-	-				-		-
Options and warrants		-	-				-	28
Unvested restricted stock grants		-	-				-	262
Earnings/(Loss) per share – diluted
Income available to common stockholders plus assumed exercises and conversion	$	(406,562)	27,175	$	(14.96)	$	2,975	27,672		$	0.11

	Six Months Ended June 30,
	2009						2010
	Income / (Loss)		Weighted Average Shares		Per-Share		Income / (Loss)		Weighted Average Shares		Per-Share

Loss per share - basic
Income available to common stockholders	$	(417,361)		27,187	$	(15.35)	$	(2,182)		27,388	$	(0.08)
Loss per share - diluted
Income available to common stockholders plus assumed exercises and conversion	$	(417,361)		27,187	$	(15.35)	$	(2,182)		27,388	$	(0.08)

Index

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 7 — Earnings/(Loss) Per Share (continued)

Basic earnings/loss per share has been computed using the weighted average number of common shares outstanding. Diluted loss per share has been computed using the weighted average number of common shares and common share equivalents outstanding (which consist of warrants, options and convertible debt to the extent they are dilutive). For the three months and six months ended June 30, 2010, the convertible notes interest and related common share equivalent of 7,165,160 and 7,249,585 respectively, and diluted options and unvested restricted stock grants outstanding of 525,835 and 514,844 respectively were excluded from the diluted loss per share calculation because they were anti-dilutive. Potentially dilutive stock options of 441,444 and 319,852 for the three months ended June 30, 2009 and 2010, respectively, were excluded from the computation of diluted loss per share as the average market price of the Company’s common stock did not exceed the weighted average exercise price of such options and to have included them would have been anti-dilutive. Potentially dilutive stock options of 399,318 and 342,145 for the six months ended June 30, 2009 and 2010, respectively, were excluded from the computation of diluted loss per share as the average market price of the Company’s common stock did not exceed the weighted average exercise price of such options and to have included them would have been anti-dilutive. Potentially dilutive unvested restricted stock of 209,692 and nil for the three months ended June 30, 2009 and 2010, respectively, were excluded from the computation of loss per share as to have included them would have been anti-dilutive. Potentially dilutive unvested restricted stock of 174,332 and 207,253 for the six months ended June 30, 2009 and 2010, respectively, were excluded from the computation of loss per share as to have included them would have been anti-dilutive.

Note 8 — Common Stock and Preferred Stock

The Company has 105,000,000 authorized shares of stock consisting of 100,000,000 shares of $.001 par value common stock and 5,000,000 shares of $.001 par value preferred stock.

In January 2010, the Company issued an aggregate of 240,000 shares of restricted stock at an aggregate value of approximately $2.9 million to two of its executive officers, which vest, subject to certain Company financial performance criteria, in January 2011, and an aggregate of 40,950 shares of restricted stock to its five non-employee directors, which vest in January 2011, at an aggregate value of approximately $0.5 million.

In April 2010, the Company issued 5,507 shares of restricted stock to a non-employee director, which vests in January 2011, at a value of approximately $0.1 million. However, following the death of such non-employee director our board of directors determined to accelerate the vesting with respect to the 5,057 restricted shares issued to him. Also, the company issued 5,000 shares of restricted stock at a value of approximately $0.1 million to an employee, which vests over a three-year period. Additionally, the company issued 5,000 shares of restricted stock at a value of approximately $0.1million to an employee, which vests over a five-year period.

All issuances of common stock, including those issued pursuant to stock option and warrant exercises, restricted stock grants and acquisitions, are issued from the Company’s authorized but not issued and outstanding shares.

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JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 9 — Business Combinations

The Company acquired the following entities to further enhance its existing product lines and to continue diversification into other toy categories and seasonal businesses:

In October 2008, the Company acquired substantially all of the assets of Tollytots Limited. The total initial consideration of $26.8 million consisted of $12.0 million in cash and the assumption of liabilities in the amount of $14.8 million, and resulted in goodwill of $4.1 million, of which $3.1 million has been determined to be impaired and was written off in the quarter ended June 30, 2009. In addition, the Company agreed to pay an earn-out of up to an aggregate amount of $5.0 million in cash over the three calendar years following the acquisition based on the achievement of certain financial performance criteria, which will be recorded as goodwill when and if earned. In the first earn-out period ended December 31, 2009, no portion of the earn-out was earned. Tollytots is a leading designer and producer of licensed baby dolls and baby doll pretend play accessories based on well-known brands, and was included in its results of operations from the date of acquisition.

In October 2008, the Company acquired all of the stock of Kids Only, Inc. and a related Hong Kong company, Kids Only Limited (collectively, “Kids Only”). The total initial consideration of $23.8 million consisted of $20.4 million in cash and the assumption of liabilities in the amount of $3.4 million, and resulted in goodwill of $13.2 million, of which $12.7 million has been determined to be impaired and was written off in the quarter ended June 30, 2009. In addition, the Company agreed to pay an earn-out of up to an aggregate amount of $5.6 million in cash over the three calendar years following the acquisition based on the achievement of certain financial performance criteria, which will be recorded as goodwill when and if earned. The first earn-out period ended September 30, 2009 and the full earn-out amount of $1.9 million was paid in April 2010. Kids Only is a leading designer and producer of licensed indoor and outdoor kids’ furniture, and has an extensive portfolio which also includes baby dolls and accessories, room decor and a myriad of other children’s toy products, and was included in its results of operations from the date of acquisition.

In December 2008, the Company acquired certain assets of Disguise, Inc. and a related Hong Kong company, Disguise Limited (collectively, “Disguise”). The total initial consideration of $60.6 million consisted of $38.6 million in cash and the assumption of liabilities in the amount of $22.0 million, and resulted in goodwill of $30.6 million, all of which has been determined to be impaired and was written off in the quarter ended June 30, 2009. Disguise is a leading designer and producer of Halloween and everyday costume play and was included in our results of operations from the date of acquisition.

Refer to Note 11 for information on the write-down of goodwill.

Note 10 — Joint Venture

The Company owned a fifty percent interest in a joint venture with THQ Inc. (“THQ”), which developed, published and distributed interactive entertainment software for the leading hardware game platforms in the home video game market. Pursuant to a Settlement Agreement and Mutual Release dated December 22, 2009, the joint venture was terminated on December 31, 2009 and THQ is obligated to pay the Company an aggregate of $20.0 million in fixed payments of $6.0 million on each of June 30, 2010 and 2011 and $4.0 million on each of June 30, 2012 and 2013 which the Company will record as income on a cash basis when received (see Note 14). The $6.0 million payment due on June 30, 2010 was received in the second quarter of 2010.

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JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 10 — Joint Venture (continued)

As of December 31, 2009 and June 30, 2010, the balance of the investment in the video game joint venture includes the following components (in thousands):

	December 31		June 30,
	2009		2010
Preferred return receivable	$	6,727	$	-

	$	6,727	$	-

Note 11 — Goodwill

The changes in the carrying amount of goodwill for the six months ended June 30, 2010 are as follows (in thousands):

	Traditional Toys
Balance at beginning of the period	$	1,571
Adjustments to goodwill during the period		1,875

Balance at end of the period	$	3,446

The Company applies a fair value-based impairment test to the net book value of goodwill and indefinite-lived intangible assets on an annual basis and, if certain events or circumstances indicate that an impairment loss may have been incurred, on an interim basis. The analysis of potential impairment of goodwill requires a two-step process. The first step is the estimation of fair value. If step one indicates that an impairment potentially exists, the second step is performed to measure the amount of impairment, if any. Goodwill impairment exists when the estimated fair value of goodwill is less than its carrying value.

During the second quarter of 2009, the Company determined that the significant decline in its market capitalization was likely to be sustained and that an interim goodwill impairment test was required. As a result of such testing, the Company determined that $407.1 million, substantially all of the goodwill related to previous acquisitions, including the acquisition of Disguise in December 2008, was impaired. This amount was charged to expense in Write-down of Goodwill in the second quarter of 2009.

At December 31, 2009, the Company recorded deferred tax liabilities related to the Tollytots and Kids Only acquisitions that resulted in Goodwill of $1.6 million.

As of June 30, 2010, the Company had made an earn-out payment in the amount of $1.9 million related to its Kids Only, Inc. acquisition.

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JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 12 — Intangible Assets Other Than Goodwill

Intangible assets consist primarily of licenses, product lines, customer relationships, debt offering costs from the issuance of the Company’s convertible senior notes and trademarks. Amortized intangible assets are included in the Intangibles and other, net, in the accompanying balance sheets. Trademarks are disclosed separately in the accompanying balance sheets. Intangible assets are as follows (in thousands, except for weighted useful lives):

			December 31, 2009							June 30, 2010
	Weighted Useful Lives		Gross Carrying Amount		Accumulated Amortization			Net Amount		Gross Carrying Amount			Accumulated Amortization		Net Amount
	(Years)

Amortized Intangible Assets:
Acquired order backlog		.50	$	2,393	$	(2,393	)	$	—	$	2,393	$	(2,393)	$	-
Licenses		4.84		85,788		(57,396	)		28,392		85,788		(60,468)		25,320
Product lines		3.62		19,100		(18,285	)		815		19,100		(18,393)		707
Customer relationships		5.32		6,296		(2,912	)		3,384		6,296		(3,324)		2,972
Non-compete/Employment contracts		3.84		3,133		(2,823	)		310		3,133		(2,887)		246
Debt offering costs		5.00		4,444		(372	)		4,072		3,678		(488)		3,190
Total amortized intangible assets				121,154		(84,181	)		36,973		120,388		(87,953)		32,435
Unamortized Intangible Assets:
Trademarks				2,308					2,308		2,308				2,308
			$	123,462	$	(84,181	)	$	39,281	$	122,696	$	(87,953)	$	34,743

Amortization expense related to limited life intangible assets was $2.3 million and $2.5 million for the three months ended June 30, 2009 and 2010, respectively. Amortization expense related to limited life intangible assets was $3.9 million and $4.0 million for the six months ended June 30, 2009 and 2010, respectively.

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

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JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 13 — Comprehensive Income (Loss)

The table below presents the components of the Company’s comprehensive loss for the three and six months ended June 30, 2009 and 2010 (in thousands):

	Three Months Ended June 30,					Six Months Ended June 30,
	2009			2010		2009			2010

Net income (loss)	$	(406,562	)	$	2,975	$	(417,361	)	$	(2,182)
Other comprehensive income (loss):
Foreign currency translation adjustment		6			(32)		—			(32)
Comprehensive income (loss)	$	(406,556	)	$	2,943	$	(417,361)		$	(2,214)

Note 14— Litigation

On October 12, 2006, World Wrestling Entertainment, Inc. (“WWE”) commenced a lawsuit in Connecticut state court against THQ/JAKKS Pacific LLC, alleging that sales of WWE video games in Japan and other countries in Asia were not lawful (the “Connecticut Action”). The lawsuit sought, among other things, a declaration that WWE is entitled to terminate the video game license and monetary damages. In 2007, WWE filed an amended complaint in the Connecticut Action to add the principal part of the state law claims present in the action filed by WWE in the Southern District of New York (the “WWE Action”) to the Connecticut Action; the WWE Action was finally dismissed in 2009. THQ filed a cross-complaint that asserted claims by THQ and Mr. Farrell, THQ’s Chief Executive Officer, for indemnification from the Company in the event that WWE prevailed on its claims against THQ and Farrell and also asserted claims by THQ that the Company breached its fiduciary duties to THQ in connection with the videogame license between WWE and the THQ/JAKKS Pacific joint venture and sought equitable and legal relief, including substantial monetary and exemplary damages against the Company in connection with its claim. Thereafter, the WWE claims and the THQ cross-claims in the Connecticut Action were all dismissed with prejudice pursuant to settlement agreements that the Company entered into with WWE and THQ dated December 22, 2009 (the “Settlements”). The settlement agreement with THQ provides for payments to the Company in the aggregate amount of $20.0 million payable $6.0 million, $6.0 million, $4.0 million and $4.0 million on June 30, 2010, 2011, 2012 and 2013, respectively. The $6.0 million payment due on June 30, 2010 was received in the second quarter of 2010.

The Company is a party to, and certain of its property is the subject of, various other pending claims and legal proceedings that routinely arise in the ordinary course of its business. The Company does not believe that any of these claims or proceedings will have a material effect on its business, financial condition or results of operations.

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JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 15 — Share-Based Payments

The Company’s 2002 Stock Award and Incentive Plan (the “Plan”) provides for the awarding of stock options and restricted stock to employees, officers and non-employee directors. The Plan is more fully described in Notes 14 and 16 to the Consolidated Financial Statements in the Company’s 2009 Annual Report on Form 10-K.

The following table summarizes the total share-based compensation expense and related tax benefits recognized for the three and six months ended June 30, 2009 and 2010 (in thousands):

	Three Months Ended June 30,					Six Months Ended June 30,
	2009			2010		2009		2010

Stock option compensation expense	$	(23	)	$	(262)	$	86	$	(223)
Tax benefit related to stock option compensation	$	(4	)	$	(96)	$	34	$	(82)
Restricted stock compensation expense	$	2,008		$	1,172	$	3,893	$	2,313
Tax benefit related to restricted stock compensation	$	759		$	441	$	1,477	$	872

Stock option activity pursuant to the Plan for Six months ended June 30, 2010 is summarized as follows:

	Plan Stock Options (*)
	Number of Shares		Weighted Average Exercise Price
Outstanding, December 31, 2009		444,715	$	19.63
Granted		-		-
Exercised		-		-
Cancelled		(57,400)		21.20
Outstanding, June 30, 2010		387,315	$	19.39

* The stock option activity excludes 100,000 of fully vested warrants issued during 2003 with an initial exercise price of $11.35 per share, which expire August 14, 2013 and are outstanding at June 30, 2010.

Restricted stock award activity pursuant to the Plan for the six months ended June 30, 2010 is summarized as follows:

	Restricted Stock Awards
	Number of Shares			Weighted Average Price on grant date

Outstanding, December 31, 2009		436,443		$	20.24
Awarded		290,950		$	12.22
Vested		(178,526	)	$	23.11
Forfeited		(24,150	)	$	17.98
Outstanding, June 30 2010		524,717		$	14.92

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of financial condition and results of operations should be read together with our Condensed Consolidated Financial Statements and Notes thereto which appear elsewhere herein.

Critical Accounting Policies and Estimates

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 set forth in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009. 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 on 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. The 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 on changes in customer’s financial condition and/or the level of credit being extended. When a significant event occurs, such as a bankruptcy filing by a specific customer, and on a quarterly basis, the allowance is reviewed for adequacy and the balance or accrual rate is adjusted to reflect current risk prospects.

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

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 which could trigger an impairment review include the following:

●

significant underperformance relative to expected historical or projected future operating results;

●

significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and

●

significant negative industry or economic trends.

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

Index

As of June 30, 2009, the Company determined that the significant decline in its market capitalization is likely to be sustained. The Company’s market capitalization was not significantly affected by the substantial resolution of the WWE lawsuit, and the lower revenue expectations for 2009 versus 2008 were factors that indicated that an interim goodwill impairment test was required. As a result, the Company determined that $407.1 million, or all of the goodwill related to previous acquisitions, including the acquisition of Disguise in December 2008, was impaired. This amount is included in “Write-down of Goodwill” in the accompanying consolidated statements of operations.

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

Goodwill and Intangible assets amounted to $38.2 million as of June 30, 2010.

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 the Company under producing popular items or over producing 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 quarterly income tax provision and related income tax assets and liabilities are based on estimated annual 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 the Company operates. Significant judgment is required in interpreting tax regulations in the US 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.

Discrete Items for Income Taxes. A discrete tax benefit of $4.9 million was recognized during the six months ended June 30, 2010 related to a reduction in tax reserves resulting from the effective settlement of tax audits of the Company’s 2003 through 2006 income tax returns.

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

Management employs a threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Tax benefits that are subject to challenge by tax authorities are analyzed and accounted for in the income tax provision.

We accrue a tax reserve for additional income taxes, which may become payable in future years as a result of audit adjustments by tax authorities. The reserve is based on management’s assessment of all relevant information, and is periodically reviewed and adjusted as circumstances warrant. As of June 30, 2010, our income tax reserves are approximately $16.9 million and relate to the potential income tax audit adjustments, primarily in the areas of income allocation and transfer pricing.

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Share-Based Compensation . We grant restricted stock and options to purchase our common stock to our employees (including officers) and non-employee directors under our 2002 Stock Award and Incentive Plan (the “Plan”), which incorporated the shares remaining under our Third Amended and Restated 1995 Stock Option Plan. The benefits provided under the Plan are share-based payments. We estimate the value of share-based awards on the date of grant using the Black-Scholes option-pricing model. The determination of the fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price, as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, cancellations, terminations, risk-free interest rates and expected dividends.

Recent Developments

In October 2008, the Company acquired all of the stock of Kids Only, Inc. and a related Hong Kong company, Kids Only Limited (collectively, “Kids Only”). The total initial consideration of $23.8 million consisted of $20.4 million in cash and the assumption of liabilities in the amount of $3.4 million, and resulted in goodwill of $13.2 million, of which $12.7 million has been determined to be impaired and was written off in the quarter ended June 30, 2009. In addition, the Company agreed to pay an earn-out of up to an aggregate amount of $5.6 million in cash over the three calendar years following the acquisition based on the achievement of certain financial performance criteria, which will be recorded as goodwill when and if earned. The first earn-out period ended September 30, 2009 and the full earn-out amount of $1.9 million was paid in April 2010. Kids Only is a leading designer and producer of licensed indoor and outdoor kids’ furniture, and has an extensive portfolio which also includes baby dolls and accessories, room décor and a myriad of other children’s toy products, and was included in its results of operations from the date of acquisition.

In November 2009, we sold an aggregate of $100.0 million of 4.50% Convertible Senior Notes due 2014 (the “Notes”). The Notes are senior unsecured obligations of JAKKS, will pay interest semi-annually at a rate of 4.50% per annum and will mature on November 1, 2014. The conversion rate will initially be 63.2091 shares of our common stock per $1,000 principal amount of notes (equivalent to an initial conversion price of approximately $15.82 per share of common stock), subject to adjustment in certain circumstances. Prior to August 1, 2014, holders of the Notes may convert their Notes only upon specified events. Upon conversion, the Notes may be settled, at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock. Holders of the Notes may require us to repurchase for cash all or some of their Notes upon the occurrence of a fundamental change (as defined in the Notes). We used a portion of the net proceeds from the offering to repurchase $77.7 million of our 4.625% convertible senior notes due in 2023 in November 2009 and we redeemed all but $5,000 of the remaining $20.3 million of notes in June 2010.

In December 2009 we entered into a Settlement Agreement and Mutual Release pursuant to which our joint venture with THQ was terminated as of December 31, 2009 and we will receive fixed payments in the aggregate amount of $20.0 million from THQ payable $6.0 million on each of June 30, 2010 and 2011 and $4.0 million on each of June 30, 2012 and 2013 which we will record as income on a cash basis over the term. The $6.0 million payment due on June 30, 2010 was received by us in the second quarter of 2010.

Index

Results of Operations

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

	Three Months Ended June 30,				Six Months Ended June 30,
	2009		2010		2009			2010

Net sales		100.0%		100.0%		100.0	%		100.0	%
Cost of sales		104.2		64.9		87.8			65.9
Gross profit (loss)		(4.2)		35.1		12.2			34.1
Selling, general and administrative expenses		37.1		34.0		42.8			40.3
Write-down of intangible assets		5.7		-		3.2			-
Write-down of goodwill		281.1		-		160.6			-
Income (loss) from operations		(328.1)		1.1		(194.4)			(6.2)
Profit (loss) from video game joint venture		(15.8)		4.9		(7.9)			3.0
Interest income		-		0.1		0.1			0.1
Interest expense, net of benefit		(0.9)		(2.4)		(1.0)			(2.1)
Income (loss) before provision (benefit) for income taxes		(344.8)		3.7		(203.2)			(5.2)
Provision (benefit) for income taxes		(64.0)		1.1		(38.5)			(4.1)
Net income (loss)		(280.8)		2.6		(164.7)			(1.1)

The following unaudited table summarizes, for the periods indicated, certain income statement data by segment (in thousands).

	Three Months Ended June 30,				Six Months Ended June 30,
	2009		2010		2009		2010

Net Sales
Traditional Toys	$	126,458	$	117,917	$	224,050	$	192,290
Craft/Activity/Writing Products		14,818		2,850		22,378		4,042
Pet Products		3,533		2,488		7,066		4,268
		144,809		123,255		253,494		200,600
Cost of Sales
Traditional Toys		132,880		76,242		196,088		120,595
Craft/Activity/Writing Products		13,784		2,015		18,991		8,501
Pet Products		4,221		1,769		7,510		3,042
		150,885		80,026		222,589		132,138
Gross Profit (Loss)
Traditional Toys		(6,422)		41,675		27,962		63,827
Craft/Activity/Writing Products		1,034		835		3,387		3,409
Pet Products		(688)		719		(444)		1,226
	$	(6,076)	$	43,229	$	30,905	$	68,462

Index

Comparison of the Three Months Ended June 30, 2010 and 2009

Net Sales

Traditional Toys. Net sales of our Traditional Toys segment were $117.9 million in 2010, compared to $126.5 million in 2009, representing a decrease of $8.6 million, or 6.8%. The decrease in net sales was primarily due to lower unit sales of our WWE® and Pokemon® action figures and accessories, and other JAKKS products, including Eyeclops®, Cabbage Patch Kids®, In My Pocket & Friends® , JAKKS™ dolls and pretend play products based on Hannah Montana®, and NASCAR® vehicles, and the elimination of our Kite product line. This was offset in part by increases in unit sales of some products, including UFC® and TNA® action figures and accessories, SpongeBob SquarePants® toys, Spynet™, role-play, dress-up toys and dolls, including those based on classic Disney Princesses® and Disney Fairies® characters, large baby dolls and accessories, and kids indoor and outdoor furniture.

Craft/Activity/Writing Product. Net sales of our Craft/Activity/Writing Products were $2.8 million in 2010, compared to $14.8 million in 2009, representing a decrease of $12.0 million, or 81.1%. The decrease in net sales was primarily due to decreases in unit sales of our Girl Gourmet® and Spa Factory® activity toys and our Flying Colors® and Vivid Velvet® activities products and the elimination of our writing instrument product line principally marketed under the Pentech brand.

Pet Products. Net sales of our Pet Products were $2.5 million in 2010, compared to $3.5 million in 2009, representing a decrease of $1.0 million, or 28.6%. The decrease is mainly attributable to the less available shelf space for pet products at some of our major customer retail stores, and lower unit sales of consumable pet products. Sales of pet products were led by our AKC licensed line of products.

Cost of Sales

Traditional Toys. Cost of sales of our Traditional Toys segment was $76.2 million, or 64.6% of related net sales, in 2010, compared to $132.9 million, or 105.1% of related net sales, in 2009, representing a decrease of $56.7 million, or 42.7%. This dollar decrease is primarily due to charges in 2009 of $18.8 million related to the write-down of certain excess and impaired inventory and $32.6 million related to the write-down of license advances and minimum guarantees that were not expected to be earned out through sales of that licensed product. Excluding these one time charges, cost of sales decreased by $5.3 million, which primarily consisted of a decrease in product costs of $2.2 million, which is in line with the lower volume of sales. Product costs as a percentage of sales increased primarily due to the mix of the product sold with higher product cost. Furthermore, royalty expense for our Traditional Toys segment decreased by $2.2 million and as a percentage of net sales due to lower volume of sales and to changes in the product mix. Our depreciation of molds and tools decreased by $0.9 million primarily due to decreased purchases of molds and tools in this segment.

Craft/Activity/Writing Products. Cost of sales of our Craft/Activity/Writing Products segment was $2.0 million, or 71.4% of related net sales, in 2010, compared to $13.8 million, or 93.3% of related net sales, in 2009, representing a decrease of $11.8 million, or 85.5%. This dollar decrease is primarily due to charges in 2009 of $4.5 million related to the write-down of certain excess and impaired inventory and $0.3 million related to the write-down of license advances and minimum guarantees that are not expected to be earned out through sales of that licensed product. Excluding these one time charges, cost of sales decreased by $7.0 million, which primarily consisted of a decrease in product costs of $6.6 million, which is in line with the lower volume of sales. Product costs as a percentage of net sales increased primarily due to the mix of the product sold and higher sales of closeout product. Royalty expense decreased by $0.2 million and as a percentage of net sales due to changes in the product mix to more products with lower royalty rates or proprietary products with no royalty rates from products with higher royalty rates.

Pet Product. Cost of sales of our Pet Pal line of products was $1.8 million, or 72.0% of related net sales, in 2010, compared to $4.2 million, or 120.0% of related net sales, in 2009, representing a decrease of $2.4 million, or 57.2%. This dollar decrease is primarily due to charges of $0.8 million related to the write-down of certain excess and impaired inventory and $0.4 million related to the write-down of license advances and minimum guarantees that were not expected to be earned out through sales of that licensed product. Excluding these one time charges, cost of sales decreased by $1.3 million, or 41.9%. Product costs decreased by $1.3 million, which is in line with the lower volume of sales. Product costs as a percentage of net sales decreased primarily due to the mix of the product sold and sell-off of closeout product in 2009. Royalty expense decreased by $0.1 million and as a percentage of sales due to changes in the product mix to products with lower royalty rates or proprietary products with no royalty rates from more products with higher royalty rates.

Index

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $42.0 million in 2010 and $53.8 million in 2009, constituting 34.0% and 37.1% of net sales, respectively. The overall decrease of $11.8 million in such costs was primarily due to the favorable effect of cost controls and restructuring initiatives. The decrease in general and administrative expenses is primarily due to decreases in legal expense ($3.4 million), rent expense ($1.0 million) and temporary help ($0.6 million). Product development expenses decreased as a result of tighter control of spending on product development ($1.6 million), offset in part by an increase in product testing ($1.2 million). The decrease in direct selling expenses is primarily due to a decrease in advertising and promotional expenses of $1.3 million in 2010 and other direct selling expenses of $3.2 million due to the lower sales volume.

Write-down of Intangible Assets

Write-down of Goodwill

As of June 30, 2009, we determined that the significant decline in our market capitalization was likely to be sustained and that an interim goodwill impairment test was required. As a result of such testing, we determined that $407.1 million, or all of the goodwill related to previous acquisitions, including the acquisition of Disguise in December 2008, was impaired. This amount was charged to expense in “Write-down of Goodwill” during the second quarter of 2009.

Profit from Video Game Joint Venture

We did not incur any income from our video game joint venture in 2010, as compared to a loss of $22.9 million in 2009. Pursuant to a Settlement Agreement and Mutual Release dated December 22, 2009, the joint venture was terminated on December 31, 2009. On June 30, 2010 we received a fixed payment from THQ in the amount of $6.0 million, which was recognized as income during the quarter. Additionally, we will receive future payments in the amount of $6.0 million on June 30, 2011 and $4.0 million on each of June 30, 2012 and 2013 which we will record as income on a cash basis over the term (see “Legal Proceedings”).

Interest Income

Interest income in the three months ended June 30, 2010 was $0.1 million, comparable to $0.1 million in the three months ended June 30, 2009.

Interest Expense

Interest expense was $3.0 million in the three months ended June 30, 2010, as compared to $1.3 million in the prior period. In the three months ended June 30, 2010, we booked interest expense of $2.7 million related to our convertible senior notes payable, and net interest expense of $0.3 million related to uncertain tax positions taken or expected to be taken in a tax return. In the three months ended June 30, 2009, we booked interest expense of $1.1 million related to our convertible senior notes payable and net interest expense of $0.2 million related to uncertain tax positions taken or expected to be taken in a tax return.

Provision for Income Taxes

Our income tax expense, which includes federal, state and foreign income taxes was $1.4 million, reflecting an effective tax benefit rate of 32.2% for the three months ended June 30, 2010. During the comparable period in 2009, the income tax expense was $92.7 million, or an effective tax benefit rate of 18.6%.

Index

Comparison of the Six Months Ended June 30, 2010 and 2009

Net Sales

Traditional Toys. Net sales of our Traditional Toys segment were $192.3 million in 2010, compared to $224.1million in 2009, representing a decrease of $31.8 million, or 14.2%. The decrease in net sales was primarily due to lower unit sales of our WWE®, Pokemon® action figures and accessories, and other JAKKS™ products, including Eyeclops, Discovery Kids®, Smurfs®, Cabbage Patch Kids®, NASCAR® vehicles, JAKKS™ dolls and pretend play products based on Hannah Montana®. This was offset in part by increases in unit sales of some products, including Spynet™ , dolls, role-play and dress-up toys, including those based on classic Disney Princesses® and Disney Fairies® characters, large baby dolls and accessories, and kids indoor and outdoor furniture.

Craft/Activity/Writing Product. Net sales of our Craft/Activity/Writing Products were $4.0 million in 2010, compared to $22.4 million in 2009, representing a decrease of $18.4 million, or 82.2%. The decrease in net sales was primarily due to decreases in unit sales of our Girl Gourmet™ and Spa Factory™ activity toys.

Pet Products. Net sales of our Pet Products were $4.3 million in 2010, compared to $7.1 million in 2009, representing a decrease of $2.8 million, or 39.4%. The decrease is mainly attributable to the less available shelf space for pet products at some of our major customer retail stores, and lower unit sales of consumable pet products. Sales of pet products were led by our AKC licensed line of products.

Cost of Sales

Traditional Toys. Cost of sales of our Traditional Toys segment was $126.7 million, or 65.9% of related net sales, in 2010, compared to $196.1 million, or 87.5% of related net sales, in 2009, representing a decrease of $69.4 million, or 35.4%. This dollar decrease is primarily due to charges in 2009 of $18.8 million related to the write-down of certain excess and impaired inventory and $32.6 million related to the write-down of license advances and minimum guarantees that were not expected to be earned through sales of that licensed product. Excluding these one time charges, cost of sales decreased by $18.0 million, which is in line with the lower volume of sales. Product costs as a percentage of sales increased primarily due to the mix of the product sold with higher product cost. Furthermore, royalty expense for our Traditional Toys segment decreased by $3.5 million due to lower volume of sales. Royalty expense as a percentage of sales is comparable year over year. Our depreciation of molds and tools decreased by $1.4 million primarily due to decreased purchases of molds and tools in this segment.

Craft/Activity/Writing Products. Cost of sales of our Craft/Activity/Writing Products segment was $2.4 million, or 60.0% of related net sales, in 2010, compared to $19.0 million, or 84.8% of related net sales, in 2009, representing a decrease of $16.6 million, or 87.4%. This decrease is in part due to charges in 2009 of $4.5 million related to the write-down of certain excess and impaired inventory and $0.3 million related to the write-down of license advances and minimum guarantees that were not expected to be earned out through sales of that licensed product. Excluding these one time charges, cost of sales decreased by $11.8 million, which primarily consisted of a decrease in product costs of $10.0 million, which is in line with the lower volume of sales. Product costs as a percentage of net sales decreased primarily due to the mix of the product sold and higher sales of closeout product in 2009. Royalty expense decreased by $1.5 million and as a percentage of net sales due to changes in the product mix to more products with lower royalty rates or proprietary products with no royalty rates from products with higher royalty rates.

Pet Product. Cost of sales of our Pet Pal line of products was $3.0 million, or 69.8% of related net sales, in 2010, compared to $7.5 million, or 105.6% of related net sales, in 2009, representing a decrease of $4.5 million, or 60.0%. This decrease is primarily due to charges in 2009 of $0.8 million related to the write-down of certain excess and impaired inventory and $0.4 million related to the write-down of license advances and minimum guarantees that were not expected to be earned out through sales of that licensed product. Excluding these one time charges, cost of sales decreased by $3.4 million, or 53.1%. Product costs decreased by $3.0 million, which is in line with the lower volume of sales. Product costs as a percentage of net sales decreased in part due to the mix of the product sold and sell-off of closeout product in 2009. Royalty expense decreased by $0.4 million, and decreased as a percentage of sales due to changes in the product mix to more products with lower royalty rates or proprietary products with no royalty rates from products with higher royalty rates.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $80.8 million in 2010 and $108.3 million in 2009, constituting 40.3% and 42.7% of net sales, respectively. The overall decrease of $27.5 million in such costs was primarily due to the favorable effect of cost controls and restructuring initiatives. The decrease in general and administrative expenses is primarily due to decreases in legal expense ($4.1 million), rent expense ($2.2 million), salary and employee benefits ($4.2 million), and temporary help ($1.1 million). Product development expenses decreased by $5.0 million as a result of tighter control of spending on product development, offset in part by higher product testing expenses. The decrease in direct selling expenses is primarily due to a decrease in advertising and promotional expenses of $2.3 million in 2010 and other direct selling expenses of $5.7 million due to the lower sales volume.

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Write-down of Intangible Assets

As of June 30, 2009, we determined that the tradenames “Child Guidance,” “Play Along” and certain tradenames associated with our Crafts and Activities product lines would either be discontinued, or were under-performing. Consequently, the intangible assets associated with these tradenames were written off to “Write-down of Intangible Assets”, resulting in a non-cash charge of $8.2 million. During the third quarter of 2008, the Company discontinued the use of the “Toymax” and “Trendmaster” tradenames on products and market these products under the JAKKS Pacific trademark. Consequently, the intangible assets associated with these tradenames were written off to “Write-down of Intangible Assets”, resulting in a charge of $3.5 million. Also, the Company adjusted the value of the Child Guidance trademark to reflect lower sales expectations for this tradename, resulting in a charge to “Write-down of Intangible Assets” of $5.6 million.

Write-down of Goodwill

Profit from Video Game Joint Venture

We did not incur any income from our video game joint venture in 2010, as compared to a loss of $20.0 million in 2009. Pursuant to a Settlement Agreement and Mutual Release dated December 22, 2009, the joint venture was terminated on December 31, 2009. On June 30, 2010 we received a fixed payment from THQ in the amount of $6.0 million, which was recognized as income during the quarter. Additionally, we will receive future payments in the amount of $6.0 million on June 30, 2011 and $4.0 million on each of June 30, 2012 and 2013 which we will record as income on a cash basis over the term (see “Legal Proceedings”).

Interest Income

Interest income in the six months ended June 30, 2010 was $0.2 million, comparable to $0.2 million in the six months ended June 30, 2009.

Interest Expense

Interest expense was $4.2 million in 2010, as compared to $2.5 million in 2009. In 2010, we booked interest expense of $4.9 million related to our convertible senior notes payable offset in part by a net benefit of $0.8 million related to uncertain tax positions taken or expected to be taken in a tax return. In 2009, we booked interest expense of $2.2 million related to our convertible senior notes payable and net interest expense of $0.3 million related to uncertain tax positions taken or expected to be taken in a tax return.

Provision for Income Taxes

Our income tax benefit, which includes federal, state and foreign income taxes, and discrete items, was $8.2 million, or an effective tax rate benefit of 79.0% for the six months ended June 30, 2010. During the comparable period in 2009, the income tax expense was $97.7 million, or an effective tax provision rate of 19.0%.

The income tax benefit for the six months ended June 30, 2010 included a discrete benefit of $4.9 million related to a reduction in tax reserves resulting from the effective settlement of tax audits of the Company’s 2003 through 2006 income tax returns (see Note 6 of the Notes to Condensed Consolidated Financial Statements, supra.). Exclusive of the discrete items, the June 30, 2010 effective tax provision rate would be 32.2%.

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Seasonality and Backlog

The retail toy industry is inherently seasonal. Generally, our sales have been highest during the third and fourth quarters, and collections for those sales have been highest during the succeeding fourth and first fiscal quarters. Our working capital needs have been highest during the third and fourth quarters.

While we have taken steps to level sales over the entire year, sales are expected to remain heavily influenced by the seasonality of our toy and Halloween products. The result of these seasonal patterns is that operating results and demand for working capital may vary significantly by quarter. Orders placed with us for shipment are cancelable until the date of shipment. The combination of seasonal demand and the potential for order cancellation makes accurate forecasting of future sales difficult and causes us to believe that backlog may not be an accurate indicator of our future sales. Similarly, financial results for a particular quarter may not be indicative of results for the entire year.

Liquidity and Capital Resources

As of June 30, 2010, we had working capital of $358.1 million, compared to $352.1 million as of December 31, 2009. The increase was primarily attributable to seasonal accounts payable, inventory and prepaid expense balances offset partially by lower accrued expenses and accounts receivable balances.

Operating activities provided net cash of $24.0 million in the first six months of 2010, as compared to a net cash use of $24.5 million in the prior year period. Net cash was provided primarily from receipt of payments for outstanding receivables. Our accounts receivable turnover as measured by days sales for the quarter outstanding in accounts receivable was 76 days as of June 30, 2010, an increase from 72 days as of June 30, 2009. 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 June 30, 2010, we had cash and cash equivalents of $248.8 million.

Our investing activities used net cash of $9.7 million in the six months ended June 30, 2010, as compared to $21.1 million in the prior year period, consisting primarily of cash paid for the Kids Only earn-out of $1.9 million and the purchase of office furniture and equipment and molds and tooling of $6.6 million used in the manufacture 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 14% payable on net sales of such products. As of June 30, 2010, these agreements required future aggregate minimum guarantees of $79.7 million, exclusive of $60.6 million in advances already paid. Of this $79.7 million future minimum guarantee, $57.8 million is due over the next twelve months.

Our financing activities used net cash of $20.3 million in the six months ended June 30, 2010, as compared to $1.5 million in the prior year period, consisting primarily of cash paid to redeem the majority of our 4.625% convertible senior notes due 2023.

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In October 2008, we acquired substantially all of the assets of Tollytots Limited. The total initial consideration of $26.8 million consisted of $12.0 million in cash and the assumption of liabilities in the amount of $14.8 million, and resulted in goodwill of $4.1 million, of which $3.1 million has been determined to be impaired and was written off in the quarter ended June 30, 2009. In addition, we agreed to pay an earn-out of up to an aggregate amount of $5.0 million in cash over the three calendar years following the acquisition based on the achievement of certain financial performance criteria, which will be recorded as goodwill when and if earned. In the first earn-out period ended December 31, 2009, no portion of the earn-out was earned. Tollytots is a leading designer and producer of licensed baby dolls and baby doll pretend play accessories based on well-known brands and was included in our results of operations from the date of acquisition.

In October 2008, we acquired substantially all of the stock of Kids Only, Inc. and a related Hong Kong company, Kids Only Limited (collectively, “Kids Only”). The total initial consideration of $23.5 million consisted of $20.4 million in cash and the assumption of liabilities in the amount of $3.4 million, and resulted in goodwill of $13.2 million, of which $12.7 million has been determined to be impaired and was written off in the quarter ended June 30, 2009. In addition, we agreed to pay an earn-out of up to an aggregate amount of $5.6 million in cash over the three calendar years following the acquisition based on the achievement of certain financial performance criteria, which will be recorded as goodwill when and if earned. The first earn-out period ended September 30, 2009 and the full earn-out amount of $1.9 million was paid in April 2010. Kids Only is a leading designer and producer of licensed indoor and outdoor kids’ furniture, and has an extensive portfolio which also includes baby dolls and accessories, room décor and a myriad of other children’s toy products and was included in our results of operations from the date of acquisition.