Edgar Filing: JAKKS PACIFIC INC

a50584069.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

x	ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the Fiscal Year Ended December 31, 2012

o	TRANSITION REPORT UNDER SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________

Commission File Number 0-28104

JAKKS PACIFIC, INC.

(Exact name of registrant as specified in its charter)

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

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

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

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

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

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

Title of Class

Common Stock, $.001 par value per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 of the Act. Yes o No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No 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,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one):

o Large Accelerated Filer	x Accelerated Filer	o Non-Accelerated Filer	o 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 29, 2012 of $16.01) is $350,398,959.

The number of shares outstanding of the registrant’s Common Stock, $.001 par value (being the only class of its common stock), is 22,307,838 (as of March 15, 2013).

Documents Incorporated by Reference

None.

JAKKS PACIFIC, INC.

INDEX TO ANNUAL REPORT ON FORM 10-K

For the Fiscal Year ended December 31, 2012

Items in Form 10-K

		Page
	PART I
Item 1.	Business	2
Item 1A.	Risk Factors	11
Item 1B.	Unresolved Staff Comments	None
Item 2.	Properties	16
Item 3.	Legal Proceedings	17
Item 4.	Mine Safety Disclosures	N/A
	PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	19
Item 6.	Selected Financial Data	23
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	38
Item 8.	Financial Statements and Supplementary Data	40
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	None
Item 9A.	Controls and Procedures	75
Item 9B.	Other Information	None
	PART III
Item 10.	Directors, Executive Officers and Corporate Governance	77
Item 11.	Executive Compensation	80
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	94
Item 13.	Certain Relationships and Related Transactions, and Director Independence	96
Item 14.	Principal Accountant Fees and Services	96
	PART IV
Item 15.	Exhibits and Financial Statement Schedules	98
Signatures		100
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. and its subsidiaries.

Company Overview

We are a leading multi-line, multi-brand toy company that designs, produces, markets and distributes toys and related products, 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 can be divided into two segments: (i) traditional toys and electronics and (ii) role play, novelty and seasonal toys. Segment information with respect to revenues, assets and profits or losses attributable to each segment is contained in Note 3 to the audited financial statements contained below in Item 8. Our products include:

Traditional Toys and Electronics

	●	Action figures and accessories, including licensed characters, principally based on Monsuno, Batman, Ultimate Fighting Champion (UFC), Total Non-Stop Action (TNA) wrestling and Pokémon® franchises;

	●	Toy vehicles, including Road Champs®, Fly Wheels® and MXS® toy vehicles and accessories;

	●	Electronics products, including SpyNet spy products, EyeClops™ Bionic Eye products, Laser Challenge® and Plug It In & Play TV Games™ based on Disney® brands and other popular brands;

	●	Dolls and accessories, including small dolls, large dolls, fashion dolls and baby dolls based on licenses, including Disney Princess®, Disney Fairies®, Cabbage Patch Kids®, Hello Kitty®, Graco® and Fisher Price® plush, infant and pre-school toys;

	●	Private label products as “exclusives” for a myriad of retail customers in many product categories; and

	●	Pet products, including toys, consumables, and accessories, branded JAKKS Pets®, some of which also feature licenses, including Kong®. In 2011, we launched our proprietary brand of assorted pet products under American Classics™.

Role Play, Novelty and Seasonal Toys

	●	Food play and activity kits, including, Creepy Crawlers™ and BloPens®,

	●	Role play, dress-up, pretend play and novelty products for boys and girls based on well known brands and entertainment properties such as Black & Decker®, 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; and

	●	Halloween and everyday costumes for all ages based on licensed and proprietary non-licensed brands, including Spiderman®, Iron Man, Toy Story®, Sesame Street®, Power Rangers®¸Hasbro® brands and Disney Princess®, and related Halloween accessories.

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:

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creating innovative products under our established licenses and brand names;

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

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

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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 18.1%, 16.2% and 12.5%, respectively, of our net sales in 2012. No other customer accounted for more than 10.0% of our net sales in 2012.

Our Growth Strategy

The execution of our growth strategy has normally resulted in increased levels of revenues and earnings. However, in 2011 and 2012, we experienced a decline in sales mainly due to declines in a few key product lines and a challenging economy. In 2011 and 2012, we generated net sales of $677.8 million and $666.8 million, respectively, and net income of $8.5 million and net loss of $104.8 million, respectively. Approximately 32.2% and 42.4% of our net sales in 2011 and 2012, respectively, were attributable to our acquisitions since 2008. Key elements of our growth strategy include:

● Expand Core Products. We manage our existing and new brands through strategic product development initiatives, including introducing new products, modifying existing products and extending existing product lines to maximize their longevity. Our marketing teams and product designers strive to develop new products or product lines to offer added technological, aesthetic and functional improvements to our extensive portfolio.

● 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 MTV Networks which owns Nickelodeon®.

● Pursue Strategic Acquisitions. We supplement our internal growth with selected strategic acquisitions. Most recently, in July 2012 we acquired the business of Maui, Inc., an Ohio corporation, Kessler Services, Inc., a Nevada corporation, and A.S. Design Limited, a Hong Kong corporation (collectively, “Maui”). Maui is a leading manufacturer and distributor of spring and summer activity toys and impulse toys. 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.

● 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, among others, we have license agreements with Nickelodeon, Disney®, UFC 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 2012, our sales generated outside the United States were approximately $132.0 million, or 19.8% of total net sales. We intend to continue to expand our international sales and in 2012 opened sales offices and expanded distribution agreements in Latin America and China to capitalize on our experience and our relationships with foreign distributors and retailers. We expect these initiatives to continue to contribute to our international growth in 2013.

● 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.

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 $16.5 billion in 2012. 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 14% 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, EyeClops™ Bionic Eye products and Laser Challenge® product lines. Our current Plug It In & Play TV Games® titles, geared to the pre-school and leisure gamer segments, include licenses from Namco®, Disney, Marvel® and Nickelodeon®, and feature such games as SpongeBob SquarePants®, Big Buck Hunter® Pro, Walking Dead, Dora the Explorer®, Disney Princess®, Ms. Pac-Man® and Pac-Man®.

In 2013, we expect to launch our EZ DJ Pro DJ platform enabling users to mix and match tunes as well as portable baby monitors.

Wheels Products

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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 2012, we launched our proprietary line of motorized trains and track sets under the brand Power Trains. In 2013, we expect to relaunch our proprietary line of rip cord powered action wheels, Fly Wheels.

Action Figures and Accessories

We currently develop, manufacture and distribute other action figures and action figure accessories including those based on the animated series Pokémon®, UFC® and TNA® wrestling and Batman®, capitalizing on the expertise we built in the action figure category. In 2011, we launched a line of action figures, playsets and accessories based on the Pirates of the Caribbean® and Real Steel® movie franchises; and figurines based on Smurfs® and Phineas and Ferb®.

In 2012, we launched a line of action figures, playsets and accessories based on the boys animated television show Monsuno, which premiered domestically on Nicktoons® in February 2012 and internationally in the fall of 2012. In 2013, we expect to expand our line of 31” figures to include Superman®, Power Rangers® and Star Wars®.

Dolls

Dolls and accessories include small dolls, large dolls, fashion dolls and baby dolls based on licenses, including Disney Princess®, Disney Fairies®, Cabbage Patch Kids®, Hello Kitty®, Graco® and Fisher Price®, 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.

Pet Products

We entered the Pet Products category with our acquisition of Pet Pal, whose products include pet toys, treats, beds, clothes and related pet products. These products are marketed under JAKKS Pets® and our own proprietary brand of assorted pet products under the brand American Classics™ as well as licenses including Kong® and numerous other entertainment and consumer product properties.

Role Play, Novelty & 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 Princess®, Disney Fairies®, Dora the Explorer®, and Black & Decker®. These products generated a significant amount of sales in 2011 and 2012, and we expect that level of sales to continue in 2013.

Seasonal/ Outdoor Products

We have a wide range of seasonal toys and outdoor and leisure products including our recently acquired Maui line of proprietary products including Sky Ball and Wave Hoop among other outdoor toys. Our Funnoodle pool toys include the 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®, Dora the Explorer®, 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®, Marvel®, Sesame Workshop®, Mattel®, and many others.

DreamPlay Technology

In September 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 expect to launch a line of toy products which utilizes the technologies to enhance the play pattern of the toys as well as enhance the in-store experience of the consumer.

World Wrestling Entertainment Video Games

In June 1998, we formed a joint venture with THQ, a developer, publisher and distributor of interactive entertainment software for the leading hardware game platforms in the home video game market. The joint venture entered into a license agreement with the WWE under which it acquired the exclusive worldwide right to publish WWE video games on all hardware platforms. Pursuant to a Settlement Agreement and Mutual Release dated December 22, 2009, the joint venture was terminated on December 31, 2009 and we received and recorded as income as received fixed payments from THQ of $6.0 million in each of 2010 and 2011 and $3.0 million in 2012. An amended settlement agreement called for the payment of an additional $1.0 million October 30, 2012 (which we received) and $0.4 million each in ten consecutive monthly payments beginning February 28, 2013, on December 19, 2012, THQ filed voluntary petitions under Chapter 11 of the U.S. Bankruptcy Court, and on January 24, 2013 the US Bankruptcy Court approved the sale of most of THQ’s assets to multiple buyers. Given that the final payment received from THQ (in October 2012) was within 90 days of their filing for bankruptcy, we have not recognized this payment as revenue and have reserved the amount received pending the final settlement of THQ’s assets in accordance with bankruptcy law.

Sales, Marketing and Distribution

We sell all of our products through our own in-house sales staff and independent sales representatives to toy and mass-market retail chain stores, department stores, office supply stores, drug and grocery store chains, club stores, toy specialty stores and wholesalers. Our three largest customers are Wal-Mart, Target and Toys ‘R’ Us, which accounted for approximately 56.6% of our net sales in 2011 and 46.8% of our net sales in 2012. With the Pet Pal® 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 warehouse and fulfillment facilities. To date, a significant portion of all of our sales has been to domestic customers. We intend to continue expanding distribution of our products into foreign territories and, accordingly, we have:

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engaged representatives to oversee sales in certain territories,

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engaged distributors in certain territories,

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established direct relationships with retailers in certain territories,

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opened sales offices in Europe,

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opened sales offices and a distribution center in Canada, and

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

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 $108.5 million, or 16.0% of our net sales, in 2011 and approximately $132.0 million, or 19.8% of our net sales, in 2012. 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 do have the capability to create and develop products from inception to production, we also use third-parties to provide a portion of the sculpting, sample making, illustration and package design required for our products in order to accommodate our increasing product innovations and introductions. Typically, the development process takes from three to nine months from concept to production and shipment to our customers.

We employ a staff of designers for all of our product lines. We occasionally acquire our other product concepts from unaffiliated third parties. If we accept and develop a third party’s concept for new toys, we generally pay a royalty on the sale of the toys developed from this concept, and may, on an individual basis, guarantee a minimum royalty. In addition, we engage third-party developers to program our line of Plug it in & Play TV Games. Royalties payable to inventors and developers generally range from 1% to 5% of the wholesale sales price for each unit of a product sold by us. We believe that utilizing experienced third-party inventors gives us access to a wide range of development talent. We currently work with numerous toy inventors and designers for the development of new products and the enhancement of existing products.

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

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 $10.4 million in 2011 and $10.8 million in 2012. 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 2012, approximately 67.2% 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.

Government and Industry Regulation

Our products are subject to the provisions of the Consumer Product Safety Act (“CPSA”), the Federal Hazardous Substances Act (“FHSA”), the Flammable Fabrics Act (“FFA”) and the regulations promulgated thereunder. The CPSA and the FHSA enable the Consumer Products Safety Commission (“CPSC”) to exclude from the market consumer products that fail to comply with applicable product safety regulations or otherwise create a substantial risk of injury, and articles that contain excessive amounts of a banned hazardous substance. The FFA enables the CPSC to regulate and enforce flammability standards for fabrics used in consumer products. The CPSC may also require the repurchase by the manufacturer of articles. Similar laws exist in some states and cities and in various international markets. We maintain a quality control program designed to ensure compliance with all applicable laws.

Employees

As of February 28, 2013, we employed 828 persons, all of whom are full-time employees, including three executive officers. We employed 371 people in the United States, 10 people in Canada, 297 people in Hong Kong, 136 people in China, 12 people in the United Kingdom, 1 person in Spain, and 1 person in France. 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 22619 Pacific Coast Highway, Malibu, California 90265. Our telephone number is (310) 456-7799 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 Form 10-K.

Item 1A. Risk Factors

From time to time, including in this Annual Report on Form 10-K, we publish forward-looking statements, as disclosed in our Disclosure Regarding Forward-Looking Statements, beginning immediately following the Table of Contents of this Annual Report. We note that a variety of factors could cause our actual results and experience to differ materially from the anticipated results or other expectations expressed or anticipated in our forward-looking statements. The factors listed below are 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 product lines or products that we introduce will achieve any significant degree of market acceptance; or

●

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

Our failure to achieve any or all of the foregoing benchmarks may 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.

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.

We may not be able to sustain or manage our growth, which may prevent us from increasing our net revenues.

We have experienced rapid growth in our product lines which was achieved 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 2008 were approximately $218.5 million and $282.6 million, in 2011 and 2012, respectively, representing 32.2% and 42.4%, respectively, of our total revenues for those periods. As a result, comparing our period-to-period operating results may not be meaningful and results of operations from prior periods may not be indicative of future results. We cannot assure you that we will continue to experience growth in, or maintain our present level of, net sales.

Our growth strategy calls for us to continuously develop and diversify our toy business by acquiring other companies, entering into additional license agreements, refining our product lines and expanding into international markets, which will place additional demands 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 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; and

●

failure of an acquired business to achieve targeted financial results.

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 46.8% of our net sales in 2012. 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, 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. For the year ended December 31, 2012, sales to our international customers comprised approximately 19.8% of our net sales. We expect our sales to international customers to account for a greater portion of our revenues in future fiscal periods. Additionally, we utilize third-party manufacturers, located principally in China, and are subject to the risks normally associated with international operations, including:

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currency conversion risks and currency fluctuations;

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limitations, including taxes, on the repatriation of earnings;

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political instability, civil unrest and economic instability;

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

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

●

greater difficulty and expenses associated with recovering from natural disasters;

●

transportation delays and interruptions;

●

the potential imposition of tariffs; and

●

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

Our reliance 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 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.

Market conditions and other third-party conduct could negatively impact our margins and implementation of other business initiatives.

Economic conditions, such as rising fuel prices and decreased consumer confidence, may adversely impact our margins. In addition, general economic conditions were significantly and negatively affected by the September 11th terrorist attacks and could be similarly affected by any future attacks. Such a weakened economic and business climate, as well as consumer uncertainty created by such a climate, could adversely affect our sales and profitability. Other conditions, such as the unavailability of electronics components, may impede our ability to manufacture, source and ship new and continuing products on a timely basis. Significant and sustained increases in the price of oil could adversely impact the cost of the raw materials used in the manufacture of our products, such as plastic.

We may not have the funds necessary to purchase our outstanding convertible senior notes upon a fundamental change or other purchase date, as required by the indenture governing the notes.

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

We have a history of making acquisitions that result in material amounts of goodwill. Any future acquisitions may also result in material amounts of goodwill which, if impaired, would result in a reduction in our net income.

Goodwill is the amount by which the cost of an acquisition exceeds the fair value of the net assets we acquire. Current accounting standards require that goodwill not be amortized but instead be periodically evaluated for impairment based upon the fair value of the reporting unit. Goodwill currently on our books and any goodwill associated with future acquisitions are subject to the same impairment risk.

We have a full valuation allowance on the entire balance of 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 in the U.S. to realize the deferred tax assets. In the fourth quarter of 2012, we recognized an impairment of our deferred tax assets, resulting in a non-cash charge to income of $91.7 million. While we currently have no remaining deferred tax assets on our books, any future deferred tax assets are subject to the same impairment risk.

Item 2. Properties

The following is a listing of the principal leased offices maintained by us as of February 28, 2013:

Property	Location	Approximate Square Feet		Lease Expiration Date
Domestic
Corporate Office	Malibu, California		29,500	February 28, 2015
Showroom and Design Center	Santa Monica, California		28,200	February 28, 2016
Distribution Center	City of Industry, California		800,000	April 30, 2018
Distribution Center	Newton, NC		109,000	August 31, 2013
Moose Mountain Office	Township of Parisippany-Troy Hills, NJ		2,100	March 31, 2014
Sales Office/Showroom	Bentonville, Arkansas		9,000	September 30, 2014
Showroom	Minneapolis, Minnesota		1,560	December 31, 2013
Kids Only Office	Westborough, MA		5,500	December 31, 2013
Disguise Office	Poway, California		24,200	December 31, 2015
Maui Toys Office/Warehouse	Youngstown, Ohio		73,000	Monthly
Maui Toys Office	Santa Monica, California		10,000	Monthly
International
Distribution Center	Brampton, Ontario, Canada		105,700	December 31, 2014
Europe Office	Berkshire, UK		2,215	February 25, 2015
Hong Kong Headquarters	Kowloon, Hong Kong		36,600	June 30, 2013
Hong Kong Showroom	Kowloon, Hong Kong		22,630	June 30, 2016
Production Inspection and Testing Office	Shenzhen, China		5,417	May 14, 2013
Production Inspection Office	Nanjing, China		2,000	September 15, 2013
Moose Mountain HK Office	Kowloon, Hong Kong		6,198	June 30, 2015
Moose Mountain China Office	Shenzhen, China		224	May 14, 2013
France Office	Paris, France		160	May 31, 2013

Item 3. Legal Proceedings

We are a party to, and certain of our property is the subject of, various other pending claims and legal proceedings that routinely arise in the ordinary course of our business, but we do not believe that any of these claims or proceedings will have a material effect on our business, financial condition or results of operations. See Note 21 to the consolidated financial statements for additional information on litigation.

Item 4. Mine Safety Disclosures

Not applicable.

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
2011:
First quarter	$	19.46	$	16.58
Second quarter		21.21		17.46
Third quarter		20.37		14.01
Fourth quarter		19.76		13.45
2012:
First quarter		17.70		13.29
Second quarter		19.39		15.10
Third quarter		16.74		14.01
Fourth quarter		14.24		11.83

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, 2007 in our common stock, the Russell 2000 and the peer group index over the period from January 1, 2008 to December 31, 2012.

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, except that RC2 Corp was not included in the performance peer group and EMak Worldwide Inc. and THQ Inc. were not included in the compensation peer group. Our peer group index includes the following companies: Activision, Inc., Electronic Arts, Inc., EMak Worldwide, Inc., Hasbro, Inc., Leapfrog Enterprises, Inc., Mattel, Inc., Kid Brands, Inc. and Take-Two Interactive, Inc. and THQ Inc.

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, 2008			December 31, 2009			December 31, 2010			December 31, 2011			December 31, 2012
JAKKS Pacific		(12.6	)%		(41.3	)%		50.4	%		(21.6	)%		(8.9	)%
Peer Group		(48.0	)		23.2			19.5			0.9			0.8
Russell 2000		(33.8	)		(27.2	)		26.9			(4.2	)		16.3

Indexed Returns

	January 1, 2007		December 31, 2008		December 31, 2009		December 31, 2010		December 31, 2011		December 31, 2012
JAKKS Pacific	$	100.0	$	87.4	$	51.3	$	77.2	$	60.5	$	55.2
Peer Group		100.0		52.0		64.1		76.5		77.2		77.8
Russell 2000		100.0		66.2		84.2		106.8		102.3		119.1

Security Holders

To the best of our knowledge, as of March 8, 2013, there were 115 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. During 2012, we paid total dividends per share of $0.40 to holders of our common stock. During 2012, the Board of Directors declared dividends on a quarterly basis on February 21, 2012, April 18, 2012, July 17, 2012, and October 22, 2012, and we paid the dividends during the subsequent quarter in which the dividends were declared. The payment of dividends on common stock is at the discretion of the Board of Directors and is subject to customary limitations. While no assurances can be given, it is the intention of our Board of Directors to continue authorizing the quarterly dividend to the extent the Board determines that we have sufficient funds available. Effective February 20, 2013, the dividend amount was reduced to $0.28 per share annually.

On March 5, 2012, our board of directors unanimously adopted a stockholder rights plan and declared a dividend of one right for each outstanding share of our common stock. The Board adopted the rights plan in response to Oaktree Capital Management's unsolicited and highly conditional indication of interest as well as a subsequent indication by Oaktree Capital Management that it may accumulate additional shares of our stock in the open market.

The rights plan was designed to protect against any potential coercive or abusive takeover techniques and to help ensure that our stockholders are not deprived of the opportunity to realize full and fair value on their investment. The plan, which was adopted following evaluation and consultation with our outside advisors, is similar to plans adopted by numerous publicly traded companies.

In connection with the adoption of the stockholder rights plan, our board of directors declared a dividend of one right for each share of our common stock held by stockholders of record as of the close of business on March 15, 2012. Initially, the rights were not exercisable and traded with the shares of the Company's common stock. Under the plan, the rights were to be exercisable only 10 business days either after a person or group becomes an "acquiring person" by acquiring beneficial ownership of 10% or more of the Company's common stock or if a person or group commences a tender or exchange offer which, if consummated, would result in a person owning 10% or more of our common stock. In addition, if a person or group acquired beneficial ownership of 10% or more of our common stock, each right would have generally entitled the holder, other than the acquiring person or group, to acquire, for the exercise price of $80.00 per right, shares of our common stock (or, in certain circumstances, other consideration) having a market value equal to twice the right's then-current exercise price. Our board of directors retained the option to redeem the rights at a price of $0.01 per right at any time up to ten business days after a person or group acquires beneficial ownership of 10% or more of our common stock.

The rights plan expired on March 4, 2013.

Equity Compensation Plan Information

The table below sets forth the following information as of the year ended December 31, 2012 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 release of restricted stock, 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 & b)) (c)
Equity compensation plans approved by security holders		134,644	$	19.82		803,976
Equity compensation plans not approved by security holders		―		―		—
Total		134,644	$	19.82		803,976

Equity compensation plans approved by our stockholders consists of the 2002 Stock Award and Incentive Plan. Additionally, 95,315 shares of restricted stock awards remained unvested as of December 31, 2012.

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,
	2008			2009			2010			2011			2012
	(In thousands, except per share data)
Consolidated Statement of Income Data:
Net sales	$	903,397		$	803,704		$	747,268		$	677,751		$	666,762
Cost of sales		582,184			600,776			502,318			483,761			468,825
Gross profit		321,213			202,928			244,950			193,990			197,937
Selling, general and administrative expenses		241,301			227,036			194,753			192,710			211,159
Write-down of intangible assets		9,076			8,221			—			―			―
Write-down of goodwill		—			407,125			—			―			―
Reorganization charges		—			12,994			—			―			―
Income (loss) from operations		70,836			(452,448	)		50,197			1,280			(13,222	)
Profit (loss) from video game joint venture		17,092			(16,128	)		6,000			6,000			3,000
Equity in net income/(loss) of Joint Venture		—			—			(56	)		(34	)		130
Interest income		3,396			318			333			412			671
Interest expense		(2,425	)		(7,930	)		(6,732	)		(8,196	)		(9,228	)
Income (loss) before provision (benefit) for income taxes		88,899			(476,188	)		49,742			(538	)		(18,649	)
Provision (benefit) for income taxes		12,842			(90,678	)		2,693			(9,010	)		86,151
Net income (loss)	$	76,057		$	(385,510	)	$	47,049		$	8,472		$	(104,800	)
Basic earnings (loss) per share	$	2.78		$	(14.02	)	$	1.71		$	0.32		$	(4.37	)
Diluted earnings (loss) per share	$	2.42		$	(14.02	)	$	1.52		$	0.32		$	(4.37	)
Dividends declared per common share		—			—			—		$	0.20		$	0.40

During the fourth quarter of 2012, we booked a charge of $91.7 million to provision for income taxes related to the establishment of a full valuation allowance on our deferred tax assets.

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”).

During the fourth quarter of 2011, we acquired Moose Mountain Toymakers Limited, a Hong Kong corporation, and Moose Mountain Marketing, Inc., a New Jersey Corporation (collectively, “Moose Mountain”).

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

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

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

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

During the fourth quarter of 2008, we acquired Tollytots, Kids Only and Disguise.

During the third quarter of 2008, we decided to discontinue the use of the “Toymax” and “Trendmaster” tradenames on products and market these products under the JAKKS Pacific trademark. Consequently, the intangible assets associated with these tradenames were written off to write-down of intangible assets, resulting in a charge of $3.5 million. Also, we adjusted the value of the Child Guidance trademark to reflect lower sales expectations for this tradename, resulting in a charge to Write-down of Intangible Assets of $5.6 million.

	At December 31,
	2008		2009		2010		2011		2012
	(In thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents	$	169,520	$	254,837	$	278,346	$	257,258	$	189,321
Working capital		325,061		352,189		387,252		374,652		186,581
Total assets		1,028,124		634,093		633,406		615,234		554,825
Short-term debt		—		20,262		—		―		70,710
Long-term debt		98,000		86,728		89,458		92,188		94,918
Total stockholders’ equity		746,953		372,109		412,408		393,591		207,220

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. 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. 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.

Goodwill and intangible assets amounted to $118.2 million as of December 31, 2012.

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 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.

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, which could have a material impact on our results of operations.

We have not provided for United States, federal income and foreign withholding taxes on the undistributed earnings of our foreign subsidiaries because we intend to reinvest such earnings indefinitely. Should we decide to remit this income to the U.S. in a future period, our provision for income taxes may increase materially in the period that our intent changes.

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, 2012, our income tax reserves were approximately $4.8 million and relate to the potential income tax audit adjustments, primarily in the areas of income allocation, foreign depreciation allowances 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.

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 Developments

During the second quarter of 2012, we amended the Settlement Agreement pursuant to which our joint venture with THQ was terminated as of December 31, 2009. In accordance with the original settlement agreement, we received and recorded as income $6.0 million in each of June 2010 and 2011. Although the amended settlement agreement called for the payment of an additional $1.0 million on October 30, 2012 (which we received) and $0.4 million each in ten consecutive monthly payments beginning February 28, 2013, on December 19, 2012, THQ filed voluntary petitions under Chapter 11 of the U.S. Bankruptcy Court, and on January 24, 2013 the US Bankruptcy Court approved the sale of most of THQ’s assets to multiple buyers. Given that the final payment received from THQ (in October 2012) was within 90 days of their filing for bankruptcy, we have not recognized this payment as revenue and have reserved the amount received pending the final settlement of THQ’s assets in accordance with bankruptcy law.

Acquisitions

On September 14, 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 an earn-out 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 has been accrued and recorded as goodwill as of December 31, 2012. We have not finalized our purchase price allocation for JKID. JKID is the developer of augmented reality technology that enhances the play patterns of toys and consumer products.

On July 26, 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 total initial consideration of $37.6 million consisted of $36.2 million in cash and the assumption of liabilities in the amount of $1.4 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 has been accrued and recorded as goodwill as of December 31, 2012.

On October 14, 2011, we acquired all of the stock of Moose Mountain Toymakers Limited, a Hong Kong company, and a related New Jersey company, Moose Mountain Marketing, Inc. (collectively, “Moose Mountain”). The total initial consideration of $31.5 million consisted of $16.0 million in cash and the assumption of liabilities in the amount of $15.5 million, and resulted in goodwill of $13.5 million. In addition, we agreed to pay an earn-out of up to an aggregate amount of $5.3 million in cash over the three calendar years following the acquisition based upon the achievement of certain financial performance criteria. The fair value of the expected earn-out was included in goodwill and assumed liabilities as of December 31, 2011. Moose Mountain is a leading designer and producer of foot to floor ride-ons, inflatable environments, wagons, pinball machines and tents and was included in our results of operations from the date of acquisition.

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,
	2010			2011			2012
Net Sales		100.0	%		100.0	%		100.0	%
Cost of Sales		67.2			71.4			70.3
Gross profit		32.8			28.6			29.7
Selling, general and administrative expenses		26.1			28.4			31.7
Income (loss) from operations		6.7			0.2			(2.0	)
Profit from video game joint venture		0.8			0.9			0.5
Interest income		—			0.1			0.1
Interest expense		(0.9	)		(1.2	)		(1.4	)
Income (loss) before provision (benefit) for income taxes		6.6			―			(2.8	)
Provision (benefit) for income taxes		0.3			(1.3	)		12.9
Net income (loss)		6.3	%		1.3	%		(15.7	)%

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

	Years Ended December 31,
	2010		2011		2012

Net Sales
Traditional Toys and Electronics	$	358,356	$	348,852	$	363,681
Role Play, Novelty and Seasonal Toys		388,912		328,899		303,081
		747,268		677,751		666,762
Cost of Sales
Traditional Toys and Electronics		238,157		247,951		249,860
Role Play, Novelty and Seasonal Toys		264,161		235,810		218,965
		502,318		483,761		468,825
Gross Margin
Traditional Toys and Electronics		120,199		100,901		113,821
Role Play, Novelty and Seasonal Toys		124,751		93,089		84,116
	$	244,950	$	193,990	$	197,937

Comparison of the Years Ended December 31, 2012 and 2011

Net Sales

Traditional Toys and Electronics. Net sales of our Traditional Toys and Electronics segment were $363.7 million in 2012, compared to $348.9 million in 2011, representing an increase of $14.8 million, or 4.2%. The increase in net sales was primarily due to the launch of Power Train, action figures based on the animation series Monsuno®, Disney® large dolls and accessories, Winx Club® dolls and sales contribution of our recently acquired Moose Mountain division. This was offset in part by decreases in unit sales of some products, including plush and action figures based on the Club Penguin® brand, Spy Net® and electronics based on the Plug it in and Play TV Games® brand.

Role Play, Novelties and Seasonal Products. Net sales of our Role Play, Novelties and Seasonal Products were $303.1 million in 2012, compared to $328.9 million in 2011, representing a decrease of $25.8 million, or 7.8%. The decrease in net sales was primarily due to decreases in unit sales of role play and dress-up toys, including those based on Disney Princess® and Disney Fairies®. This was partially offset by the sales contribution of our recently acquired Maui Toys division.

Cost of Sales

Traditional Toys and Electronics. Cost of sales of our Traditional Toys and Electronics segment was $249.9 million, or 68.7% of related net sales, in 2012, compared to $248.0 million, or 71.1% of related net sales, in 2011, representing an increase of $1.9 million, or 0.8%. This percentage cost of sales decrease was primarily due to charges in 2011 of $12.8 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, whereas 2012 charges related to the write-down of licenses was approximately $3.7 million. Excluding these charges, cost of sales was $235.2 million in 2011 and $246.2 million in 2012, representing an increase of $11.0 million, or 4.7%, this increase primarily consisted of an increase in product costs of $7.5 million, which is in line with the higher volume of sales. Excluding the license impairment charges, royalty expense for our Traditional Toys and Electronics segment increased by $3.7 million, which is in line with the higher volume of sales. Our depreciation of molds and tools was comparable year over year.

Role Play, Novelties and Seasonal Products. Cost of sales of our Role Play, Novelties and Seasonal Products segment was $219.0 million in 2012, or 72.2% of related net sales, compared to $235.8 million in 2011, or 71.7% of related net sales, representing a decrease of $16.8 million, or 7.1%. This percentage cost of sales increase was partially due to charges of $5.3 million and $3.6 million in 2011 and 2012, respectively, 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 charges, cost of sales was $215.4 million in 2012 and $230.5 million in 2011, representing a decrease of $15.1 million, or 6.6%. This decrease which primarily consisted of a decrease in product costs of $12.5 million, which is in line with the lower volume of sales. Excluding the license impairment charges, royalty expense decreased by $2.8 million, which is in line with the lower volume of sales. Royalty expense as a percentage of sales decreased 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 $211.2 million in 2012 and $192.7 million in 2011, constituting 31.7% and 28.4% of net sales, respectively. The overall increase of $18.5 million was primarily due to the incremental overhead of our recent acquisitions, Moose Mountain ($7.3 million) and Maui ($2.5 million). Additionally, increases in other direct selling expenses ($1.9 million), product development ($1.2 million), travel expenses ($1.2 million), legal and financial advising fees related to the unsolicited indication of interest to acquire our company ($1.0 million) and legal expenses ($0.6 million) contributed to the increase to selling, general and administrative expenses year over year. Advertising and tradeshow expenses increased as a result of new product line launches in 2012, such as Monsuno®, and the introduction of our DreamPlay® technology ($7.7 million). This was offset in part by decreases in amortization expense related to intangible assets other than goodwill ($1.3 million), bad debt recovery ($0.6 million), currency exchange gains ($1.0 million) and restricted stock compensation ($0.5 million).

Reorganization Charges

We incurred reorganization charges in 2009 to consolidate and stream-line our existing business functions. This was necessary given the decreased volume of consolidated sales in 2009 from 2008 and the added general and administrative expenses from the three acquisitions made at the end of 2008. Restructuring charges relate to the termination of lease obligations, one-time severance termination benefits, fixed asset write-offs and other contract terminations and are accounted for in accordance with “Exit and Disposal Cost Obligations”, ASC 420-10. We establish a liability for a cost associated with an exit or disposal activity when a liability is incurred, rather than at the date we commit to an exit plan.

The components of the reorganization charges are as follows (in thousands):

	Accrued Balance						Accrued Balance
	December 31, 2011		Accrual		Actual		December 31, 2012
Lease abandonment costs	$	3,484	$	—	$	1,243	$	2,241

Total reorganization charges	$	3,484	$	—	$	1,243	$	2,241

Profit from Video Game Joint Venture

We recognized $6.0 million in 2011 and $3.0 million in 2012 in income related to our video game joint venture. Pursuant to a Settlement Agreement and Mutual Release dated December 22, 2009, the joint venture was terminated on December 31, 2009 and we received and recorded as income as received fixed payments from THQ of $6.0 million in 2011 and $3.0 million in 2012. Although an amended settlement agreement called for the payment of an additional $1.0 million October 30, 2012 (which we received) and $0.4 million each in ten consecutive monthly payments beginning February 28, 2013, on December 19, 2012, THQ filed voluntary petitions under Chapter 11 of the U.S. Bankruptcy Court, and on January 24, 2013 the US Bankruptcy Court approved the sale of most of THQ’s assets to multiple buyers. Given that the final payment received from THQ (in October 2012) was within 90 days of their filing for bankruptcy, we have not recognized this payment as revenue and have reserved the amount received pending the final settlement of THQ’s assets in accordance with bankruptcy law.

Interest Income

Interest income in 2012 was $0.7 million, comparable to $0.4 million in 2011.

Interest Expense

Interest expense was $9.2 million in 2012, as compared to $8.2 million in 2011. In 2012, we recorded interest expense of $8.0 million related to our convertible senior notes payable, $0.8 million related to our credit facility and $0.4 million related to the interest component of our Maui acquisition earn out payment. In 2011, we recorded interest expense of $8.0 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 and discrete items, was $86.2 million, or an effective tax rate of (462%) for 2012. During 2011, the income tax benefit was $9.0 million, or an effective tax rate of 1,671%.

Included in the tax expense of $86.2 million are discrete tax expenses of $92.5 million comprised of expense of $91.7 million relating to the establishment of a 100% valuation allowance against our U.S. deferred tax assets, $0.4 million benefit related to reduction of uncertain tax positions due to statute expiration, $0.5 million expense related to state tax apportionment changes and $0.7 million expense related to income tax audit settlement. (see Note 13 of the Notes to Consolidated Financial Statements). Absent these discrete tax expenses, our effective tax rate for 2012 was 34.2%, primarily due to the foreign rate differential between the United States and Hong Kong. The foreign rate differential 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, 2012, we were in a cumulative pre-tax loss position in the U.S. On the basis of this evaluation, as of December 31, 2012, a valuation allowance of $91.7 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 $3.1 million represent the net deferred tax liabilities in the foreign jurisdiction, where we are in a cumulative income position.

In 2011, included in the tax benefit of $9.0 million were discrete tax benefits of $2.1 million. These tax benefits were comprised of $1.7 million related to state tax apportionment changes and an adjustment to record various outstanding state tax refunds and $0.3 million reduction of uncertain tax positions related to foreign depreciation due to statute expiration. Absent these discrete tax benefits, our effective tax rate for 2011 would have been 1,288%, due to the foreign rate differential between the United States and Hong Kong. The foreign rate differential is impacted by the proportion of Hong Kong earnings to overall earnings and is expected to vary depending upon the level of consolidated earnings.

As of December 31, 2012, we had net deferred tax liabilities of approximately $3.1 million.

Comparison of the Years Ended December 31, 2011 and 2010

Net Sales

Traditional Toys and Electronics. Net sales of our Traditional Toys and Electronics segment were $348.9 million in 2011, compared to $358.4 million in 2010, representing a decrease of $9.5 million, or 2.7%. The decrease in net sales was primarily due to lower unit sales of our UFC® and TNA® action figures and accessories, JAKKS™ dolls based on Taylor Swift®, JAKKS™ dolls based on Disney Fairies® and Disney Princess®, electronics based on TV Games and EyeClops® brands, and other JAKKS products, including Real Construction™ activity products , Girl Gourmet® and pet toy products. This was offset in part by increases in unit sales of some products, including In My Pocket & Friends™, Cabbage Patch Kids®, Smurfs® and Pokémon® figures and accessories.

Role Play, Novelties and Seasonal Products. Net sales of our Role Play, Novelties and Seasonal Products were $328.9 million in 2011, compared to $388.9 million in 2010, representing a decrease of $60.0 million, or 15.4%. The decrease in net sales was primarily due to decreases in unit sales of our Halloween costumes and accessories, and role play and dress-up toys, including those based on Disney Princess® and Disney Fairies®.

Cost of Sales

Traditional Toys and Electronics. Cost of sales of our Traditional Toys and Electronics segment was $248.0 million, or 71.1% of related net sales, in 2011, compared to $238.2 million, or 66.5% of related net sales in 2010, representing an increase of $9.8 million, or 4.1%. This percentage cost of sales increase was primarily due to charges in 2011 of $12.8 million related to the write-down of license advances and minimum guarantees that are not expected to be earned through sales of that licensed product. Excluding these charges, cost of sales was $235.2 million in 2011, representing a decrease of $3.0 million in 2011 , or 1.3%, which primarily consisted of a decrease in product costs of $4.6 million, which is in line with the lower volume of sales. Product costs as a percentage of sales increased primarily due to the mix of the product sold and higher sales of closeout product. Excluding the license impairment charges, royalty expense for our Traditional Toys and Electronics segment increased by $3.0 million and increased as a percentage of net sales due to changes in the product mix to more products with higher royalty rates from products with lower royalty rates or proprietary products with no royalty rates. Our depreciation of molds and tools decreased by $1.4 million primarily due to decreased purchases of molds and tools in this segment.

Role Play, Novelties and Seasonal Products. Cost of sales of our Role Play, Novelties and Seasonal Products segment was $235.8 million, or 71.7% of related net sales in 2011, compared to $264.2 million, or 67.9% of related net sales in 2010, representing a decrease of $28.4 million, or 10.7%. This percentage cost of sales increase was partially due to charges in 2011of $5.3 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 was $230.5 million, representing a decrease of $33.7 million in 2011, or 12.8%, which primarily consisted of a decrease in product costs of $28.0 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. Excluding the one-time charges, royalty expense decreased by $5.8 million, which is in line with the lower volume of sales. Royalty expense as a percentage of net sales was comparable year over year. Our depreciation of molds and tools was comparable year over year.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $192.7 million in 2011 and $194.8 million in 2010, constituting 28.4% and 26.1% of net sales, respectively. The overall decrease of $2.1 million in such costs was primarily due to decreases in direct selling expenses ($5.5 million), stock based compensation ($2.8 million), and depreciation and amortization ($1.4 million), offset by increases in general and administrative expenses ($6.5 million), and product development ($1.1 million). The increase in general and administrative expenses was primarily due to increases in legal and financial advising fees related to the unsolicited indication of interest to acquire our company ($3.7 million), legal expense ($1.6 million), other professional fees ($0.7 million) and travel expenses ($1.2 million), and employee relocation expenses ($0.5 million), offset in part by decreases in donation expenses ($0.9 million) and insurance expense ($0.4 million). Product development expenses increased as a result of new product line launches in 2012 such as Monsuno™ and Winx Club®. The decrease in direct selling expenses was primarily due to decreases in variable selling expenses related to the lower volume of sales in 2011. The decrease in depreciation and amortization was mainly due to a decrease in amortization expense related to intangible assets other than goodwill ($0.9 million).

Reorganization Charges

The components of the reorganization charges are as follows (in thousands):

	Accrued Balance						Accrued Balance
	December 31, 2010		Accrual		Actual		December 31, 2011
Lease abandonment costs	$	5,264	$	—	$	(1,780)	$	3,484

Total reorganization charges	$	5,264	$	—	$	(1,780)	$	3,484

Profit from Video Game Joint Venture

We recognized $6.0 million in each of 2010 and 2011 in income related to our video game joint venture. Pursuant to a Settlement Agreement and Mutual Release dated December 22, 2009, the joint venture was terminated on December 31, 2009 and we received and recorded as income as received fixed payments from THQ of $6.0 million in each of 2010 and 2011. Although an amended settlement agreement called for the payment of an additional $4.0 million during 2012 ($3.0 million of which we received) and $0.4 million each in ten consecutive monthly payments beginning February 28, 2013, on December 19, 2012, THQ filed voluntary petitions under Chapter 11 of the U.S. Bankruptcy Court, and on January 24, 2013 the US Bankruptcy Court approved the sale of most of THQ’s assets to multiple buyers. Given that the final payment received from THQ ($1.0 million in October 2012) was within 90 days of their filing for bankruptcy, we have not recognized this payment as revenue and have reserved the amount received pending the final settlement of THQ’s assets in accordance with bankruptcy law.

Interest Income

Interest income in 2011 was $0.4 million, compared to $0.3 million in 2010.

Interest Expense

Interest expense was $8.2 million in 2011, compared to $6.7 million in 2010. In 2011, we recorded interest expense of $8.0 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. In 2010, we recorded interest expense of $8.9 million related to our convertible senior notes payable and offset in part by a net benefit of $1.6 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, was $9.0 million, or an effective tax rate of 1,671% for 2011. During 2010, the income tax expense was $2.7 million, or an effective tax provision rate of 5.41%.

Included in the tax benefit of $9.0 million were discrete tax benefits of $2.1 million. These tax benefits were comprised of $0.3 million reduction of uncertain tax positions related to foreign depreciation due to statute expiration, $1.7 million benefit related to state tax apportionment changes and an adjustment to record various outstanding state tax refunds. (see Note 13 of the Notes to Condensed Consolidated Financial Statements). Absent these discrete tax benefits, our effective tax rate for 2011 was 1,288%, primarily due to the foreign rate differential between the United States and Hong Kong. The foreign rate differential is impacted by the proportion of Hong Kong earnings to overall earnings and is expected to vary depending upon the level of consolidated earnings.

In 2010, included in the tax expense of $2.7 million were discrete tax benefits of $10.3 million. These tax benefits were comprised of $4.7 million reduction of uncertain tax positions due to settlement of 2003-2006 IRS exams and statute expirations, $4.0 million benefit related to a refund received from the IRS for previously filed amended returns, and $1.7 million benefit attributable to a transfer pricing adjustment. Absent these discrete tax benefits, our effective tax rate for 2010 would have been 26.2%.

As of December 31, 2011, we had net deferred tax assets of approximately $81.6 million.

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.

	2011												2012
	First			Second			Third			Fourth			First			Second		Third			Fourth
(unaudited)	Quarter			Quarter			Quarter			Quarter			Quarter			Quarter		Quarter			Quarter

Net sales	$	72,323			131,930			332,419			141,079		$	73,405		145,359			314,491			133,507
As a % of full year		10.7	%		19.5	%		49.0	%		20.8	%		11.0	%	21.8	%		47.2	%		20.0	%
Gross Profit		24,271			45,092			105,670			18,957			23,566		46,893			96,712			30,766
As a % of full year		12.5	%		23.2	%		54.5	%		9.8	%		11.9	%	23.7	%		48.9	%		15.5	%
As a % of net sales		33.6	%		34.2	%		31.8%			13.4	%		32.1	%	32.3	%		30.8	%		23.0	%
Income (loss) from operations		(14,790	)		1,998			50,068			(35,996	)		(19,410	)	107			37,296			(31,215	)
As a % of full year		(1,155.5	)%		156.1	%		3,911.6	%		(2,812.2	)%		146.8	%	(0.8	)%		(282.1	)%		236.1	%
As a % of net sales		(20.4	)%		1.5	%		15.1	%		(25.5	)%		(26.4	)%	0.1	%		11.9	%		(23.4	)%
Income (loss) before provision (benefit) for income taxes		(16,716	)		6,087			48,081			(37,990	)		(21,192	)	288			36,426			(34,171	)
As a % of net sales		(23.1	)%		4.6	%		14.5	%		(26.9	)%		(28.9	)%	0.2	%		11.6	%		(25.6	)%
Net income (loss)		(10,575	)		4,240			34,825			(20,018	)		(16,000	)	214			30,443			(119,457	)
As a % of net sales		(14.6	)%		3.2	%		10.5	%		(14.2	)%		(21.8)	)%	0.1	%		9.7	%		(89.5	)%
Diluted (loss) earnings per share	$	(0.39	)		0.16			1.10			(0.77	)	$	(0.62	)	0.01			1.10			(5.45	)
Weighted average shares and equivalents outstanding		27,217			27,096			32,922			25,839			25,831		25,870			28,933			21,923

Consistent with the seasonality of our business, first quarter 2011 and 2012 experienced seasonally low sales which coupled with fixed overhead including incremental overhead from the 2011 acquisition of Moose Mountain, resulted in significant net losses.

In the fourth quarter of 2011 and 2012, we experienced poor performance of some of our products which coupled with advertising commitments, license royalty shortfalls and retailer markdowns due to lower than anticipated sales and sell-through, resulted in significant net losses.

In the third quarter of 2012, we repurchased 4.0 million shares of our outstanding common stock resulting in lower weighted average shares outstanding in the third and fourth quarters of 2012.

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.

Debt with Conversion and Other Options

The provisions of ASC 470-20, “Debt with Conversion and Other Options” are applicable to the 4.5% convertible notes, see Note 12, Convertible Senior Notes. ASC 470-20 requires that we separately account for the liability (debt) and equity (conversion feature) components of the Notes in a manner that reflects our nonconvertible debt borrowing rate at the date of issuance when interest cost is recognized in subsequent periods. We allocated $13.7 million of the $100.0 million principal amount of the Notes to the equity component, which represents a discount to the debt and will be amortized into interest expense through November 1, 2014. Accordingly, our effective annual interest rate on the Notes will be approximately 7.9%. The Notes are classified as long-term debt in the balance sheet at December 31, 2011 based on their November 1, 2014 maturity date. Debt issuance costs of approximately $3.7 million are being amortized to interest expense over the five year term of the Notes.

Liquidity and Capital Resources

As of December 31, 2012, we had working capital of $186.6 million, compared to $374.7 million as of December 31, 2011. This decrease was primarily attributable to the incurrence of short term debt of $70.7 million, a decrease in cash and cash equivalents of $67.9 million and changes in our tax positions of $38.3 million.

Operating activities provided net cash of $24.2 million, $44.3 million and $67.5 million for the years ended December 31, 2012, 2011 and 2010, respectively. Net cash was impacted primarily by our net loss, adjusted for non-cash items such as deferred income taxes. Our accounts receivable turnover as measured by days sales for the quarter outstanding in accounts receivable was 73 days, 67 days and 56 days as of December 31, 2012, 2011 and 2010, 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, 2012, we had cash and cash equivalents of $189.3 million.

Cash used in investing activities totaled $72.7 million, $36.3 million and $13.2 million for the years ended December 31, 2012, 2011 and 2010, respectively. Cash used in 2012 consisted primarily of $36.2 million cash paid and liabilities incurred for the Maui acquisition, $13.1 million cash paid for the purchase of office furniture and equipment and molds and tooling used in the manufacture of our products, the $10.9 million investment in JKID, $8.0 million cash paid to NantWorks LLC for recognition technology exclusivity rights, and the $7.0 million paid to NantWorks LLC for our ownership interest in DreamPlay LLC. In 2011, our investing activities consisted primarily of cash paid for the Moose Mountain Acquisition of $16.0 million, Tollytots earn-out of $1.7 million, Kids Only earn-out of $3.7 million, and $12.5 million cash paid for the purchase of office furniture and equipment and molds and tooling used in the manufacture of our products. In 2010, our investing activities consisted 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 used in the manufacture of our products of $11.6 million. As part of our strategy to develop and market new products, we have entered into various character and product licenses with royalties generally ranging from 1% to 14% payable on net sales of such products. As of December 31, 2012, these agreements required future aggregate minimum guarantees of $26.5 million, exclusive of $22.0 million in advances already paid. Of this $26.5 million future minimum guarantee, $14.6 million is due over the next twelve months.

Cash used in financing activities totaled $19.4 million, $29.1 million and $30.8 million for the years ended December 31, 2012, 2011 and 2010, respectively. Cash used in 2012 consisted primarily of $80.0 million cash paid for the repurchase of our common stock and $9.6 million cash paid as dividends to our shareholders, offset by $70.7 million cash provided by the asset based loan we secured in September 2012.

The following is a summary of our significant contractual cash obligations for the periods indicated that existed as of December 31, 2012 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	$	—	$	100,000	$	―	$	—	$	100,000
Interest on long-term debt		4,500		3,878		―		—		8,378
Operating leases		13,112		24,340		4,743		—		42,195
Minimum guaranteed license/royalty payments		14,573		10,885		1,000		―		26,458
Employment contracts		9,551		10,575		2,605		—		22,731
Revolving credit facility		70,710		—		—		—		70,710
Total contractual cash obligations	$	112,446	$	149,678	$	8,348	$	—	$	270,472

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 financial statements for further explanation of our uncertain tax positions.

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 an earn-out 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 has been accrued and recorded as goodwill as of December 31, 2012. All future changes to the earn-out liability will be charged to income. JKID is the developer of augmented reality technology that enhances the play patterns of toys and consumer products.

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 has been accrued and recorded as goodwill as of December 31, 2012. All future changes to the earn-out liability will be charged to 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 October 2011, we acquired all of the stock of Moose Mountain Toymakers Limited, a Hong Kong company, and a related New Jersey company, Moose Mountain Marketing, Inc. (collectively, “Moose Mountain”). The total initial consideration of $31.5 million consisted of $16.0 million in cash and the assumption of liabilities in the amount of $15.5 million, and resulted in goodwill of $13.5 million. In addition, we agreed to pay an earn-out of up to an aggregate amount of $5.3 million in cash over the three calendar years following the acquisition based upon the achievement of certain financial performance criteria. The fair value of the expected earn-out was included in goodwill and assumed liabilities as of December 31, 2011. Moose Mountain is a leading designer and producer of foot to floor ride-ons, inflatable environments, wagons, pinball machines and tents and was included in our results of operations from the date of acquisition.

In October 2010, our Board of Directors authorized us to repurchase up to $30.0 million of our common stock. As of December 31, 2011, we completed the authorization and purchased 1,771,633 shares at an aggregate cost of approximately $30.0 million.

In October 2008, we acquired substantially all of the assets of Tollytots Limited. The total initial consideration of $26.8 million consisted of $12.0 million in cash and the assumption of liabilities in the amount of $14.8 million, and resulted in goodwill of $4.1 million, all of which has been determined to be impaired and was written off in the quarter ended June 30, 2009. In addition, we agreed to pay an earn-out of up to an aggregate amount of $5.0 million in cash over the three calendar years following the acquisition based upon 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, while $1.7 million was earned for each of the second and third earn-out periods ended December 31, 2010 and 2011. 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 all of the stock of Kids Only, Inc. and a related Hong Kong company, Kids Only Limited (collectively, “Kids Only”). The total initial consideration of $23.8 million consisted of $20.4 million in cash and the assumption of liabilities in the amount of $3.4 million, and resulted in goodwill of $13.2 million, all of which has been determined to be impaired and was written off in the quarter ended June 30, 2009. In addition, we agreed to pay an earn-out of up to an aggregate amount of $5.6 million in cash over the three calendar years following the acquisition based upon the achievement of certain financial performance criteria, which will be recorded as goodwill when and if earned. For the earn-out periods ended September 30, 2009, 2010 and 2011, $1.9 million, $1.9 million and $1.8 million were earned, respectively. Kids Only is a leading designer and producer of licensed indoor and outdoor kids’ furniture, and has an extensive portfolio which also includes baby dolls and accessories, room décor and a myriad of other children’s toy products and was included in our results of operations from the date of acquisition.

On September 27, 2012, we entered into a secured credit facility with Wells Fargo Bank, National Association (the “Loan Agreement”). The Loan Agreement provides for a $75 million working capital revolving credit facility. The amounts outstanding under the revolving credit facility are payable in full upon maturity of the credit facility on April 30, 2013. The credit facility is secured by a substantial amount of our assets. The amount outstanding on the credit facility at December 31, 2012 was $70.7 million; the total borrowing capacity was approximately $53.2 million based on applicable advance rates applied to our accounts receivable and inventory.

Our ability to borrow under the Loan Agreement is subject to our ongoing compliance with certain financial covenants, including that we (a) maintain and earn on a consolidated basis as of the last day of each fiscal quarter, for the rolling four quarter period ending on such date, consolidated Net Profit (as defined in the Loan Agreement) equal to or greater than $1 (one dollar); (b) maintain a ratio of consolidated total funded debt to consolidated EBITDA (the “consolidated leverage ratio”) of not greater than (i) 4.00:1.0 on September 30, 2012, (ii) 3.00:1.0 on December 31, 2012 and thereafter; and (c) maintain Liquidity (as defined in the Loan Agreement) of at least $100.0 million.

The Loan Agreement allows us to borrow under the credit facility at LIBOR or at a base rate, plus applicable margins based upon the funded debt to EBITDA leverage ratio for the most recent twelve month rolling quarter end. Applicable margins vary between a 150 to 200 basis point spread over LIBOR and between a negative 50 to zero basis point spread on base rate loans. As of December 31, 2012, the rate on the credit facility was 3.25%. In addition, the credit facility has an unused line fee, ranging from 12.5 to 25 basis points based upon the unused amount of the credit facility.

The Loan Agreement also contains customary events of default, including a cross default provision and a change of control provision. In the event of a default, all obligations under the Loan Agreement may be declared immediately due and payable. For certain events of default relating to insolvency and receivership, all outstanding obligations become due and payable.

As of December 31, 2012, we were not in compliance with two of the three financial covenants under the Loan Agreement, but were in compliance with all of the remaining covenants. At December 31, 2012, we had consolidated Net Profit of negative $22.8 million, a consolidated leverage ratio of 17.66 and Liquidity of $189.5 million. We were required to obtain waivers from our lender to avoid breaches of financial covenants for the period ending December 31, 2012. Based upon current internal financial forecasts for the first quarter of 2013, we may not comply with the consolidated Net Profit covenant required under the Loan Agreement for the period ending March 31, 2013.

Accordingly, as a result of the failure to meet any of these financial covenants or any other covenants under the Loan Agreement, the lender may declare an event of default, which would have a material adverse effect on our financial condition and results of operations. We would be required to obtain amendments and/or waivers or renegotiate the Loan Agreement with our lender; however, there is no assurance that the lender will grant any waiver or agree to an amendment or renegotiation of the Loan Agreement. Any such amendment or waiver will likely require payment of a fee, result in higher interest rates on outstanding loan amounts and/or impose other restrictions. If the lender does not agree to a waiver and/or amendment and determines that an event of default has occurred, the lender may accelerate all obligations under the Loan Agreement, demand immediate repayment of all obligations and/or terminate all commitments to extend further credit under the Loan Agreement. If access to our credit facility is limited or terminated, liquidity would be constrained, affecting our operations and growth prospects and requiring that we seek additional equity or debt financing. There is no assurance that such alternative financing will be available on acceptable terms or at all. Furthermore, any equity financing may result in dilution to existing stockholders and any debt financing may include restrictive covenants that could impede our ability to effectively operate and grow our business in the future.

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 the Company, will pay interest semi-annually at a rate of 4.50% per annum and will mature on November 1, 2014. The initial conversion rate was 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. As a result of the cash dividend of $0.10 per share declared by the Board of Directors and paid on October 3, 2011, January 3, 2012, April 2, 2012, July 2, 2012, October 1, 2012 and January 2, 2013 the new conversion rate will be 67.9486 shares of JAKKS common stock per $1,000 principal amount of notes (or approximately $14.72 per share). 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 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 2013. Although operating activities are expected to provide cash, to the extent we grow significantly in the future, our operating and investing activities may use cash and, consequently, this growth may require us to obtain additional sources of financing. There can be no assurance that any necessary additional financing will be available to us on commercially reasonable terms, if at all. We intend to finance our long-term liquidity requirements out of net cash provided by operations and net cash and cash equivalents. As of December 31, 2012, we do not have any off-balance sheet arrangements.

We have cumulative undistributed earnings of non-U.S. subsidiaries that we consider to be permanently reinvested 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 $182.6 million and $207.4 million for the years ended December 31, 2012 and 2011, respectively.

During the last three fiscal years ending December 31, 2012, we do not believe that inflation has had a material impact on our net sales and revenues and on income from continuing operations.

Exchange Rates

Sales from our United States and Hong Kong operations are denominated in U.S. dollars and our manufacturing costs are denominated in either U.S. or Hong Kong dollars. Operations and operating expenses of all of our operations are denominated in local currency, thereby creating exposure to changes in exchange rates. Changes in the Hong Kong dollar/U.S. dollar exchange rate may positively or negatively affect our operating results. The exchange rate of the Hong Kong dollar to the U.S. dollar has been fixed by the Hong Kong government since 1983 at HK$7.80 to US$1.00 and, accordingly, has not represented a currency exchange risk to the U.S. dollar. We cannot assure you that the exchange rate between the United States and Hong Kong currencies will continue to be fixed or that exchange rate fluctuations between the United States and Hong Kong currencies will not have a material adverse effect on our business, financial condition or results of operations.

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.

Interest Rate Risk

In November 2009, we issued convertible senior notes payable of $100.0 million with a fixed interest rate of 4.50% per annum which remain outstanding as of December 31, 2012. Accordingly, 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 daily weighted average federal funds rate on overnight transactions plus 1.5%, (ii) Wells Fargo’s prime rate and (iii) a one month LIBOR rate plus 1.5%, in each case there is an additional margin ranging from negative 0.50% to nil based on certain conditions. For LIBOR rate loans, the interest rate is equal to a LIBOR rate plus a margin ranging from 1.50% to 2.00% based on certain conditions. 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. At December 31, 2012, the maximum amount borrowed under the Credit Facility was $70.7 million and the average amount of borrowings outstanding was $64.3 million. If the prevailing market interest rates relative to these borrowing increased by 10%, our interest expense during the period ended December 31, 2012 would have increased by less than $0.1 million.

Foreign Currency Risk

We have wholly-owned subsidiaries in Hong Kong, China, the United Kingdom, France, Spain, France and Canada. 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 China are denominated in local currency, thereby creating exposure to changes in exchange rates. Changes in the Chinese Yuan or Hong Kong dollar/U.S. dollar exchange rates may positively or negatively affect our gross margins, operating income and retained earnings. 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. Our mainland China operations are funded in Chinese Yuan. 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 the Hong Kong dollar or Chinese Yuan.

Item 8. Consolidated Financial Statements and Supplementary Data

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

JAKKS Pacific, Inc.

Malibu, California

We have audited the accompanying consolidated balance sheets of JAKKS Pacific, Inc. as of December 31, 2012 and 2011 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, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of JAKKS Pacific, Inc. at December 31, 2012 and 2011, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.

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, 2012, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 15, 2013 expressed an unqualified opinion thereon.

/s/ BDO USA, LLP
BDO USA, LLP
Los Angeles, California
March 15, 2013

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	December 31,
	2011			2012
	(In thousands, except
	share data)
Assets
Current assets
Cash and cash equivalents	$	257,258		$	189,321
Marketable securities		214			218
Accounts receivable, net of allowance for uncollectible accounts of $3,069 and $2,536, at December 31, 2011 and 2012 respectively		103,637			105,455
Inventory, net		47,019			59,690
Income tax receivable		24,166			24,008
Deferred income taxes		34,505			7,058
Prepaid expenses and other		30,686			20,306
Total current assets		497,485			406,056
Property and equipment
Office furniture and equipment		13,606			14,268
Molds and tooling		61,005			73,487
Leasehold improvements		6,788			7,044
Total		81,399			94,799
Less accumulated depreciation and amortization		65,213			78,973
Property and equipment, net		16,186			15,826
Deferred income taxes		47,081			—
Intangibles		21,753			67,054
Other long term assets		3,670			4,584
Investment in DreamPlay		—			7,000
Investment in joint venture		2,736			3,161
Goodwill, net		24,015			48,836
Trademarks, net		2,308			2,308
Total assets	$	615,234		$	554,825
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable	$	26,430		$	37,793
Accrued expenses		50,780			63,677
Reserve for sales returns and allowances		43,440			34,373
Income taxes payable		2,183			12,922
Short term debt		—			70,710
Total current liabilities		122,833			219,475
Convertible senior notes, net		92,188			94,918
Other liabilities		1,630			18,345
Income taxes payable		4,992			4,687
Deferred income taxes		—			10,180
Total liabilities		221,643			347,605
Commitments and Contingencies
Stockholders’ equity
Preferred shares, $.001 par value; 5,000,000 shares authorized; nil outstanding		—			—
Common stock, $.001 par value; 100,000,000 shares authorized; 25,943,214 and 21,969,355 shares issued in 2011 and 2012 respectively; 25,943,214 and 21,969,355 shares outstanding, respectively		26			22
Additional paid-in capital		274,532			202,577
Retained earnings		123,174			8,836
Accumulated other comprehensive loss		(4,141	)		(4,215	)
Total stockholders’ equity		393,591			207,220
Total liabilities and stockholders’ equity	$	615,234		$	554,825

See accompanying notes to consolidated financial statements.

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

	Years Ended December 31,
	2010			2011			2012
	(In thousands, except per share amounts)
Net sales	$	747,268		$	677,751		$	666,762
Cost of sales		502,318			483,761			468,825
Gross profit		244,950			193,990			197,937
Selling, general and administrative expenses		194,753			192,710			211,159
Income (loss) from operations		50,197			1,280			(13,222	)
Profit from video game joint venture		6,000			6,000			3,000
Equity in net income/(loss) of joint venture		(56	)		(34	)		130
Interest income		333			412			671
Interest expense		(6,732	)		(8,196	)		(9,228	)
Income (loss) before provision (benefit) for income taxes		49,742			(538	)		(18,649	)
Provision (benefit) for income taxes		2,693			(9,010	)		86,151
Net income (loss)	$	47,049		$	8,472		$	(104,800	)
Basic earnings (loss) per share	$	1.71		$	0.32		$	(4.37	)
Basic weighted number of shares		27,491			26,760			23,963
Diluted earnings (loss) per share	$	1.52		$	0.32		$	(4.37	)
Diluted weighted number of shares		34,513			26,893			23,963

See accompanying notes to consolidated financial statements.

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

	Years Ended December 31,
	2010			2011		2012
	(In thousands)

Net income (loss)	$	47,049		$	8,472	$	(104,800	)
Other comprehensive income (loss):
Foreign currency translation adjustment		(60	)		147		(74	)
Comprehensive income (loss)	$	46,989		$	8,619	$	(104,874	)

See accompanying notes to consolidated financial statements.

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

YEARS ENDED DECEMBER 31, 20010, 2011 AND 2012

(In thousands)

Common Stock

Accumulated

Additional

Other

Total

Number

Treasury

Paid-in

Retained

Comprehensive

Stockholders’

of Shares

Amount

Stock

Capital

Earnings

Loss

Equity

Balance, December 31, 2009

27,639

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