Attached files

file filename
EX-32.2 - JAKKS PACIFIC INCv165232_ex32-2.htm
EX-32.1 - JAKKS PACIFIC INCv165232_ex32-1.htm
EX-31.1 - JAKKS PACIFIC INCv165232_ex31-1.htm
EX-31.2 - JAKKS PACIFIC INCv165232_ex31-2.htm
EX-31.3 - JAKKS PACIFIC INCv165232_ex31-3.htm
EX-32.3 - JAKKS PACIFIC INCv165232_ex32-3.htm

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

 
FORM 10-Q
 

 
(Mark one)                                                                                        
x          QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2009

OR

¨       TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to ______

Commission file number: 0-28104
 

 
JAKKS Pacific, Inc.
(Exact Name of Registrant as Specified in Its Charter)
 

 
Delaware
 
95-4527222
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)

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

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,”  “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):  
Large accelerated filer
x
 
Accelerated filer
o
 
Non-accelerated filer
¨
(Do not check if a smaller
reporting company)
 
Smaller reporting company
¨
 

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

  
The number of shares outstanding of the issuer’s common stock is 27,905,994 as of November 6, 2009.

 

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

INDEX TO QUARTERLY REPORT ON FORM 10-Q
Quarter Ended September 30, 2009

ITEMS IN FORM 10-Q
 
     
Page
       
Part I
FINANCIAL INFORMATION
   
Item 1.
Financial Statements
   
 
Condensed Consolidated Balance Sheets - December 31, 2008 and September 30, 2009 (unaudited)
 
2
 
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2008 and 2009 (unaudited)
 
3
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2009 (unaudited)
 
4
 
Notes to Condensed Consolidated Financial Statements (unaudited)
 
5
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
21
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
32
Item 4.
Controls and Procedures
 
32
       
Part II
OTHER INFORMATION
   
Item 1.
Legal Proceedings
 
33
Item 1A.
Risk Factors
 
36
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
None
Item 3.
Defaults Upon Senior Securities
 
None
Item 4.
Submission of Matters to a Vote of Security Holders
 
43
Item 5.
Other Information
 
None
Item 6.
Exhibits
 
44
       
Signatures      
   
45
Exhibit 31.1
     
Exhibit 31.2
     
Exhibit 31.3
     
Exhibit 32.1
     
Exhibit 32.2
     
Exhibit 32.3  
     

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

This report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. For example, statements included in this report regarding our financial position, business strategy and other plans and objectives for future operations, and assumptions and predictions about future product demand, supply, manufacturing, costs, marketing and pricing factors are all forward-looking statements. When we use words like “intend,” “anticipate,” “believe,” “estimate,” “plan”, “expect” or words of similar import, we are making forward-looking statements. We believe that the assumptions and expectations reflected in such forward-looking statements are reasonable and are based on information available to us on the date hereof, but we cannot assure you that these assumptions and expectations will prove to have been correct or that we will take any action that we may presently be planning. We are not undertaking to publicly update or revise any forward-looking statement if we obtain new information or upon the occurrence of future events or otherwise.

 
1

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
 
   
December 31,
2008
   
September 30,
2009
 
   
(*)
   
(Unaudited)
 
ASSETS
             
Current assets
             
Cash and cash equivalents
 
$
169,520
   
$
153,795
 
Marketable securities
   
195
     
201
 
Accounts receivable, net of allowances for uncollectible accounts of $2,005 and $2,599, respectively
   
147,587
     
251,631
 
Inventory
   
87,944
     
71,145
 
Prepaid expenses and other current assets
   
29,670
     
22,826
 
Income tax receivable
   
22,288
     
26,823
 
Deferred income taxes
   
17,993
     
83,884
 
Total current assets
   
475,197
     
610,305
 
Property and equipment
               
Office furniture and equipment
   
12,390
     
13,035
 
Molds and tooling
   
63,075
     
65,438
 
Leasehold improvements
   
5,947
     
7,383
 
Total
   
81,412
     
85,856
 
Less accumulated depreciation and amortization
   
52,914
     
60,117
 
Property and equipment, net
   
28,498
     
25,739
 
Investment in video game joint venture
   
53,184
     
527
 
Goodwill, net
   
427,693
     
 
Trademarks, net
   
10,491
     
2,308
 
Intangibles and other, net
   
33,061
     
42,727
 
Total assets
 
$
1,028,124
   
$
681,606
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities
               
Accounts payable
 
$
57,432
   
$
91,307
 
Accrued expenses
   
61,780
     
62,793
 
Reserve for sales returns and allowances
   
23,317
     
35,503
 
Capital lease obligation
   
417
     
246
 
Income taxes payable
   
7,190
     
 
Convertible senior notes
   
     
98,000
 
Total current liabilities
   
150,136
     
287,849
 
Deferred income taxes
   
26,237
     
17,135
 
Income tax payable
   
4,686
     
4,686
 
Other liabilities
   
2,112
     
6,732
 
Convertible senior notes
   
98,000
     
 
Total liabilities
   
281,171
     
316,402
 
Stockholders’ equity
               
Preferred stock, $.001 par value; 5,000,000 shares authorized; nil outstanding
   
     
 
Common stock, $.001 par value; 100,000,000 shares authorized; 27,521,278 and 27,908,711 shares issued and outstanding, respectively
   
28
     
28
 
Additional paid-in capital
   
292,809
     
294,711
 
Retained earnings
   
458,345
     
74,693
 
Accumulated comprehensive loss
   
(4,229
)
   
(4,228
)
Total stockholders’ equity
   
746,953
     
365,204
 
Total liabilities and stockholders’ equity
 
$
1,028,124
   
$
681,606
 
 

 
(*)       Derived from audited financial statements

See notes to condensed consolidated financial statements.

 
2

 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

   
Three Months Ended
September 30,
(Unaudited)
   
Nine Months Ended
September 30,
(Unaudited)
 
  
 
2008
   
2009
   
2008
   
2009
 
  
 
As Adjusted
(Note 13)
         
As Adjusted
(Note 13)
       
Net sales
 
$
357,824
   
$
351,438
   
$
634,050
   
$
604,932
 
 Cost of sales
   
231,145
     
235,729
     
405,949
     
458,318
 
Gross profit
   
126,679
     
115,709
     
228,101
     
146,614
 
Selling, general and administrative expenses
   
62,651
     
63,363
     
157,476
     
171,673
 
Write-down of intangible assets
   
9,076
     
     
9,076
     
8,221
 
Write-down of goodwill
   
     
     
     
407,125
 
Income (loss) from operations
   
54,952
     
52,346
     
61,549
     
(440,405
)
Profit (loss) from video game joint venture
   
743
     
(1,919
)
   
4,470
     
(21,924
)
Interest Income
   
709
     
28
     
2,802
     
277
 
Interest Expense, net of benefit
   
2,013
     
(1,267
   
(1,187
)
   
(3,800
)
Income (loss) before provision (benefit) for income taxes
   
58,417
     
49,188
     
67,634
     
(465,852
)
Provision (benefit) for income taxes
   
5,879
     
15,480
     
8,737
     
(82,200
)
Net income (loss)
 
$
52,538
   
$
33,708
   
$
58,897
   
$
(383,652
)
Earnings (loss) per share – basic
 
$
1.95
   
$
1.24
   
$
2.14
   
$
(14.11
)
Earnings (loss) per share – diluted
 
$
1.65
   
$
1.06
   
$
1.87
   
$
(14.11
)
 

 
See notes to condensed consolidated financial statements.

 
3

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
   
Nine Months Ended
September 30,
(Unaudited)
 
   
2008
   
2009
 
   
As Adjusted
(Note 13)
       
CASH FLOWS FROM OPERATING ACTIVITIES  
               
Net income (loss)
 
$
58,897
   
$
(383,652
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
Depreciation and amortization
   
19,670
     
27,026
 
Share-based compensation expense
   
6,026
     
3,302
 
(Profit) loss from video game joint venture
   
(4,801
)
   
52,403
 
Loss on disposal of property and equipment
   
51
     
2,377
 
Deferred income taxes
   
504
     
(74,993
)
Write-down of intangible assets
   
9,076
     
8,221
 
Write-down of goodwill
   
     
407,125
 
Changes in operating assets and liabilities:
               
Accounts receivable
   
(55,555
   
(104,044
Inventory
   
(35,342
)
   
14,160
 
Prepaid expenses and other current assets
   
(11,749
)
   
7,146
 
Income tax receivable
   
     
(4,535
)
Accounts payable
   
59,314
     
33,876
 
Accrued expenses
   
1,530
     
13,361
 
Income taxes payable
   
(20,832
)
   
(7,190
)
Reserve for sales returns and allowances
   
(8,555
)
   
12,186
 
Other liabilities
   
(4,380
   
4,620
 
Total adjustments
   
(45,043
)
   
395,041
 
Net cash provided by operating activities
   
13,854
     
11,389
 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Purchase of property and equipment
   
(17,608
)
   
(16,160
)
Change in other assets
   
143
     
2,876
 
Cash paid for net assets of business acquired
   
(15,193
)
   
(12,253
)
Net purchase of marketable securities
   
(5
)
   
(6
)
Net cash used in investing activities
   
(32,663
)
   
(25,543
)
CASH FLOWS FROM FINANCING ACTIVITIES
               
Net proceeds from stock options exercised
   
4,030
     
 
Common stock surrendered
   
(3,070
)
   
(1,400
)
Common stock repurchased
   
(30,002
)
   
 
Repayment of capital lease obligation
   
     
(171
Net cash used in financing activities
   
(29,042
)
   
(1,571
)
Effect of exchange rate changes on cash
   
(792
)
   
 
Net decrease in cash and cash equivalents
   
(48,643
)
   
(15,725
)
Cash and cash equivalents, beginning of period
   
241,250
     
169,520
 
Cash and cash equivalents, end of period
 
$
192,607
   
$
153,795
 
                 
Cash paid during the period for:
               
Income taxes
 
$
31,719
   
$
4,875
 
Interest
 
$
2,342
   
$
2,825
 

Non cash investing and financing activity:

In January and March 2008, two executive officers surrendered an aggregate of 122,202 shares of restricted stock at a value of $3.0 million to cover their income taxes due on the 2008 vesting of restricted shares granted to them in 2006, 2007 and 2008. This restricted stock was subsequently retired by the Company.

In January 2009, two executive officers surrendered an aggregate of 74,836 shares of restricted stock at a value of $1.4 million to cover their income taxes due on the 2009 vesting of restricted shares granted to them in 2007 and 2008. This restricted stock was subsequently retired by the Company.  Also in January 2009, an employee surrendered 551 shares of restricted stock at a value of $11,367 to cover his income taxes due on the December 31, 2008 vested shares.  In August 2009, certain employees surrendered an aggregate of 920 shares of restricted stock at a value of $10,608 to cover their income taxes due on the 2009 vesting of the restricted shares granted to them in 2006.

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

See notes to condensed consolidated financial statements.

 
4

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 2009

Note 1 — Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to prevent the information presented from being misleading. These financial statements should be read in conjunction with Management’s Discussion and Analysis of financial condition and results of operations and the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K, which contains audited financial information for the three years in the period ended December 31, 2008.

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

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

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

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

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

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

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

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

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

 
5

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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

Results are not necessarily those that would be achieved were each segment an unaffiliated business enterprise. Information by segment and a reconciliation to reported amounts as of December 31, 2008 and September 30, 2009 and for the three and nine months ended September 30, 2008 and 2009 are as follows (in thousands):

   
Three Months Ended
September 30,
   
Nine Months Ended 
September  30,
 
   
2008
   
2009
   
2008
   
2009
 
Net Sales
                       
Traditional Toys
 
$
332,395
   
$
324,092
   
$
583,040
   
$
548,142
 
Craft/Activity/Writing Products
   
20,616
     
23,787
     
37,274
     
46,165
 
Pet Products
   
4,813
     
3,559
     
13,736
     
10,625
 
   
$
357,824
   
$
351,438
   
$
634,050
   
$
604,932
 
 
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
  
 
2008
As Adjusted
(Note 13)
   
2009
   
2008
As Adjusted
(Note 13)
   
2009
 
Operating Income (Loss)
                       
Traditional Toys
 
$
50,877
   
 $
48,273
   
$
57,009
   
$
(341,451
)
Craft/Activity/Writing Products
   
3,304
     
3,543
     
3,667
     
(87,469
)
Pet Products
   
771
     
530
     
873
     
(11,485
)
   
$
54,952
   
 $
52,346
   
$
61,549
   
$
(440,405
)

   
Three Months Ended
September 30,
   
Nine Months Ended 
September 30,
 
  
 
2008
As Adjusted
(Note 13)
   
2009
   
2008 As
Adjusted
(Note 13)
   
2009
 
Depreciation and Amortization Expense
                       
Traditional Toys
 
$
9,010
   
$
14,133
   
$
18,665
   
 $
24,577
 
Craft/Activity/Writing Products
   
351
     
1,247
     
844
     
1,998
 
Pet Products
   
26
     
229
     
161
     
451
 
   
$
9,387
   
$
15,609
   
$
19,670
   
$
27,026
 
 
   
December 31,
   
September 30,
 
   
2008
   
2009
 
Assets
           
Traditional Toys
 
$
877,606
   
$
633,147
 
Craft/Activity/Writing Products
   
128,036
     
40,245
 
Pet Products
   
22,482
     
8,214
 
   
$
1,028,124
   
$
681,606
 
 
 
6

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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

The following tables present information about the Company by geographic area as of December 31, 2008 and September 30, 2009 and for the three and nine months ended September 30, 2008 and 2009 (in thousands):
  
   
December 31,
2008
   
September 30,
2009
 
Long-lived Assets
           
United States
  $ 26,179     $ 23,350  
Hong Kong
    2,319       2,389  
    $ 28,498     $ 25,739  

   
Three Months Ended
September 30,
   
Nine Months Ended 
September 30,
 
   
2008
   
2009
   
2008
   
2009
 
Net Sales by Geographic Area
                       
United States
 
$
280,523
   
$
288,320
   
$
500,775
     
499,199
 
Europe
   
22,383
     
16,473
     
38,825
     
28,761
 
Canada
   
19,495
     
15,732
     
28,783
     
25,700
 
Hong Kong
   
15,835
     
18,193
     
32,435
     
27,732
 
Other
   
19,588
     
12,720
     
33,232
     
23,540
 
   
$
357,824
   
$
351,438
   
$
634,050
   
$
604,932
 
 
Major Customers

Net sales to major customers for the three and nine months ended September 30, 2008 and 2009 were as follows (in thousands, except for percentages):

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2008
   
2009
   
2008
   
2009
 
  
 
Amount
   
Percentage of
Net Sales
   
Amount
   
Percentage of
Net Sales
   
Amount
   
Percentage of 
Net Sales
   
Amount
   
Percentage
of
Net Sales
 
                                                                 
Wal-Mart
 
$
90,733
     
25.4
%  
 
$
93,521
     
26.6
%  
 
$
171,670
     
27.0
%  
 
$
152,074
     
25.1
%
Toys ‘R’ Us 
   
50,612
     
14.1
     
39,111
     
11.1
     
72,933
     
11.5
     
64,945
     
10.7
 
Target
   
29,617
     
8.3
     
50,956
     
14.5
     
75,234
     
11.9
     
100,888
     
16.7
 
                                                                 
   
$
170,962
     
47.8
%
 
$
183,588
     
52.2
%
 
$
319,837
     
50.4
%
 
$
317,907
     
52.5
%

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

At December 31, 2008 and September 30, 2009, the Company’s three largest customers accounted for approximately 74.0% and 49.8%, respectively, of net accounts receivable. The concentration of the Company’s business with a relatively small number of customers may expose the Company to material adverse effects if one or more of its large customers were to experience financial difficulty. The Company performs ongoing credit evaluations of its top customers and maintains an allowance for potential credit losses.

 
7

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 3 — Inventory

Inventory, which includes the ex-factory cost of goods, in-bound freight, duty and warehouse costs, is stated at the lower of cost (first-in, first-out) or market and consists of the following (in thousands):
 
   
December 31,
2008
   
September 30,
2009
 
             
Raw materials
 
$
3,778
   
$
6,035
 
Finished goods
   
  84,166
     
65,110
 
   
$
87,944
   
$
71,145
 

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

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

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

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

The Company’s reserve for sales returns and allowances amounted to $23.3 million as of December 31, 2008, compared to $35.5 million as of September 30, 2009. This increase was primarily due to additional allowances booked for returns and markdowns for certain products and the timing of when deductions are taken by customers.

Note 5 — Convertible Senior Notes

In June 2003, the Company sold an aggregate of $98.0 million of 4.625% Convertible Senior Notes due June 15, 2023 and received net proceeds of approximately $94.4 million. The notes are convertible into shares of the Company’s common stock at an initial conversion price of $20.00 per share, or 50 shares per note, subject to certain circumstances. The notes may be converted in each quarter subsequent to any quarter in which the closing price of the Company’s common stock is at or above a prescribed price for at least 20 trading days in the last 30 trading day period of the quarter. The prescribed price for the conversion trigger is $24.00 through June 30, 2010, and increases nominally each quarter thereafter. Cash interest is payable at an annual rate of 4.625% of the principal amount at issuance, from the issue date to June 15, 2010, payable on June 15 and December 15 of each year. After June 15, 2010, interest will accrue on the outstanding notes until maturity. At maturity, the Company will redeem the notes at their accreted principal amount, which will be equal to $1,811.95 (181.195%) per $1,000 principal amount at issuance, unless redeemed or converted earlier. The notes were not convertible as of September 30, 2009 and are not convertible during the fourth quarter of 2009.

 
8

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 5 — Convertible Senior Notes (continued)

The Company may redeem the notes at its option in whole or in part beginning on June 15, 2010, at 100% of their accreted principal amount plus accrued and unpaid interest, if any, payable in cash. Holders of the notes may also require the Company to repurchase all or part of their notes on June 15, 2010, for cash, at a repurchase price of 100% of the principal amount per note plus accrued and unpaid interest, if any.  Accordingly, the notes have been reclassified as a short-term liability as of September 30, 2009.  Holders of the notes may also require the Company to repurchase all or part of their notes on June 15, 2013 and June 15, 2018 at a repurchase price of 100% of the accreted principal amount per note plus accrued and unpaid interest, if any, and may be paid in cash, in shares of common stock or a combination of cash and shares of common stock. See Note 17 – Subsequent Events for additional information on the Company’s convertible senior notes.

  Note 6 — Income Taxes

The Company’s income tax benefit, which includes federal, state and foreign income taxes, and discrete items, was $82.2 million, or an effective tax benefit rate of 17.6% for the nine months ended September 30, 2009. During the comparable period in 2008, the income tax provision was $8.7 million, or an effective tax provision rate of 12.9%.  

In 2009, the impairment of goodwill and trademarks, totaling $64.5 million, the THQ/Jakks joint venture settlement of $9.1 million, and uncertain tax positions, were reductions to the tax benefit rate realized.    Exclusive of the discrete items, the third quarter 2009 effective tax benefit rate would be 57.4%. In 2008, the discrete adjustments were mainly the 2007 income tax provision to the actual income tax liability of $4.0 million, and the recognition of a previously recorded potential income tax liability of $9.3 million for uncertain tax positions that are no longer subject to audit due to the closure of the audit period.  Exclusive of the discrete items, the third quarter 2008 effective tax provision rate would be 35.4%.

As of September 30, 2009, the Company had net deferred tax assets of approximately $66.7 million for which an allowance of $3.6 million has been provided since, in the opinion of management, realization of the future benefit is uncertain.
 
Approximately $2.1 million of United States based and $0.8 million of Hong Kong based unrecognized tax positions (UTPs) were recognized in the quarter ended September 30, 2009. These UTPs are primarily a result of the ongoing audits.  The Company has also recognized an additional liability of $1.1 million for penalties and $0.5 million for interest on the potential tax liability.  The tax years 2000 through 2006 are still subject to examination in Hong Kong. Tax years 2003 and 2005 through 2008 are still subject to examination in the United States and tax years 2005 through 2008 are still subject to examination in California.

Current interest on previously booked uncertain income tax liabilities is recognized as interest expense in the consolidated statement of operations. During the nine months ended September 30, 2009, the Company recognized $0.4 million of current year interest expense.

 
9

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 7 — Earnings Per Share

The following table is a reconciliation of the weighted average shares used in the computation of basic and diluted earnings per share for the periods presented (in thousands, except per share data):
 
   
Three Months Ended September 30,
  
  
  
2008 As Adjusted (Note 13)
  
  
2009
  
  
  
Income
  
  
Weighted
Average
Shares
  
  
Per-Share
  
  
Income /
(Loss)
  
  
Weighted
Average
Shares
  
  
Per-Share
  
                                     
Earnings per share - basic
                                   
Income available to common stockholders
 
$
52,538
     
26,981
   
$
1.95
   
$
33,708
     
27,183
   
$
1.24
 
Effect of dilutive securities:
                                               
Convertible senior notes
   
737
     
4,900
             
  737
     
4,900
         
Options and warrants
   
  —
     
119
             
     
14
         
Unvested restricted stock grants
   
  —
     
257
             
     
408
         
Earnings per share - diluted
                                               
Income available to common stockholders plus assumed exercises and conversion
 
$
53,275
     
32,257
   
$
1.65
   
$
34,445
     
32,505
   
$
1.06
 
 
   
Nine Months Ended September 30,
 
  
  
2008 As Adjusted (Note 13)
   
2009
 
  
  
Income
   
Weighted
Average
Shares
   
Per-Share
   
Income /
(Loss)
   
Weighted
Average
Shares
   
Per-Share
 
                                     
Earnings (loss) per share - basic
                                   
Income available to common stockholders
 
$
58,897
     
27,465
   
$
2.14
   
$
(383,652
)
   
27,193
   
$
(14.11
)
Effect of dilutive securities:
                                               
Convertible senior notes
   
2,210
     
4,900
             
     
         
Options and warrants
   
     
161
             
     
         
Unvested restricted stock grants
   
     
202
             
     
         
Earnings (loss) per share - diluted
                                               
Income available to common stockholders plus assumed exercises and conversion
 
$
61,107
     
32,728
   
$
1.87
   
$
(383,652
)
   
27,193
   
$
(14.11
)

 
10

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 7 — Earnings Per Share (continued)

Basic earnings per share has been computed using the weighted average number of common shares outstanding. Diluted earnings per share has been computed using the weighted average number of common shares and common share equivalents outstanding (which consist of warrants, options and convertible debt to the extent they are dilutive). For the nine months ended September 30, 2009, the convertible notes interest and related common share equivalent of 4,900,000, diluted options and warrants of 26,121 and unvested restricted stock grants outstanding of 352,315 were excluded from the diluted earnings per share calculation because they were anti-dilutive.  Potentially dilutive stock options of 12,250 and 439,792 for the three months ended September 30, 2008 and 2009, respectively, were excluded from the computation of diluted earning per share as the average market price of the Company’s common stock did not exceed the weighted average exercise price of such options and to have included them would have been anti-dilutive.  Potentially dilutive stock options of 3,257 and 397,780 for the nine months ended September 30, 2008 and 2009, respectively, were excluded from the computation of diluted earning per share as the average market price of the Company’s common stock did not exceed the weighted average exercise price of such options and to have included them would have been anti-dilutive.

Note 8 — Common Stock and Preferred Stock

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

In January 2009, the Company issued an aggregate of 240,000 shares of restricted stock at an aggregate value of approximately $5.0 million to two of its executive officers, which vest, subject to certain Company financial performance criteria,  in January 2010, an aggregate of 30,340 shares of restricted stock to its five non-employee directors, which vest in January 2010, at an aggregate value of approximately $0.6 million, and an aggregate of 206,500 shares of restricted stock to its employees at an aggregate value of approximately $3.8 million, which vest over a three to five-year period. Additionally, 74,836 shares of restricted stock previously received by two executive officers were surrendered at a value of $1.4 million to cover their income taxes due on the 2009 vesting of the restricted stock granted to them in 2007 and 2008.  This restricted stock was subsequently retired by the Company.  Also, in January 2009, an employee surrendered 551 shares of restricted stock at a value of $11,367 to cover his income taxes due on the December 31, 2008 vested shares.  In February 2009, the Company issued 3,000 shares of restricted stock at a value of approximately $0.05 million to an employee, which vest over a five-year period. In June 2009, the Company issued 2,500 shares of restricted stock at a value of approximately $0.03 million to an employee, which vest over a five-year period.  In August 2009, certain employees surrendered an aggregate of 920 shares of restricted stock at a value of $10,608 to cover their income taxes due on the 2009 vesting of the restricted shares granted to them in 2006.

In January 2008, the Company issued an aggregate of 240,000 shares of restricted stock at an aggregate value of approximately $5.7 million to two of its executive officers, which vested 50% in each of January 2009 and 2010 and an aggregate of 25,340 shares of restricted stock to its five non-employee directors, which vested in January 2009, at an aggregate value of approximately $0.6 million. In February 2008, the Company issued an aggregate of 41,134 shares of restricted stock as 2007 bonus compensation to two of its executive officers, which vested immediately, at an aggregate value of approximately $1.0 million. In February 2008, the Company issued 3,593 shares of restricted stock as 2007 bonus compensation at a value of approximately $0.1 million to an executive officer, which vests 50% on each of March 1, 2009 and 2010. During the nine months ended June 30, 2008, the Company also issued 208,871 shares of common stock on the exercise of options at a value of $2.8 million, and 122,202 shares of restricted stock previously received by two executive officers were surrendered at a value of $3.0 million to cover their income taxes due on the 2008 vesting of the restricted shares granted to them in 2006, 2007 and 2008. This surrendered restricted stock was subsequently retired by the Company. In February 2008, the Company’s Board of Directors authorized it to repurchase up to $30.0 million of its common stock. In April and May 2008, the Company repurchased an aggregate of 1,259,300 shares of its common stock at an average price of $23.82 per share for a total cost of $30.0 million. The repurchased stock represented approximately 4.4% of the Company’s then outstanding shares of common stock at the time of the repurchase and was subsequently retired by the Company.  In July 2008, the Company issued 7,500 shares of restricted stock at a value of $0.2 million to an employee, which vests 15% on July 1, 2008, 15% on each of December 2008 and 2009, 25% on December 31, 2010, and 30% on December 2011. This employee surrendered 489 shares at a value of $10,484 to cover his income taxes due on the July 1, 2008 vested shares. In August 2008, certain employees surrendered an aggregate of 2,299 shares of restricted stock at a value of $54,854 to cover their income taxes due on the 2008 vesting of the restricted shares granted to them in 2006.

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

 
11

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 9 — Business Combinations

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

In October 2008, the Company acquired substantially all of the assets of Tollytots Limited.  The total initial consideration of $25.7 million consisted of $12.0 million in cash and the assumption of liabilities in the amount of $13.7 million, and resulted in goodwill of $3.1 million. In addition, the Company agreed to pay an earn-out of up to an aggregate amount of $5.0 million in cash over the three calendar years following the acquisition based on the achievement of certain financial performance criteria, which will be recorded as goodwill when and if earned.  Tollytots is a leading designer and producer of licensed baby dolls and baby doll pretend play accessories based on well-known brands, and was included in its results of operations from the date of acquisition.  Pro forma results of operations are not provided since the amounts are not material to the consolidated results of operations.

In October 2008, the Company acquired all of the stock of Kids Only, Inc. and a related Hong Kong company, Kids Only Limited (collectively, “Kids Only”).  The total initial consideration of $23.3 million consisted of $20.4 million in cash and the assumption of liabilities in the amount of $2.9 million, and resulted in goodwill of $12.7 million. In addition, the Company agreed to pay an earn-out of up to an aggregate amount of $5.6 million in cash over the three calendar years following the acquisition based on the achievement of certain financial performance criteria, which will be recorded as goodwill when and if earned.  Kids Only is a leading designer and producer of licensed indoor and outdoor kids’ furniture, and has an extensive portfolio which also includes baby dolls and accessories, room décor and a myriad of other children’s toy products, and was included in its results of operations from the date of acquisition.  Pro forma results of operations are not provided since the amounts are not material to the consolidated results of operations.

In December 2008, the Company acquired certain assets of Disguise, Inc. and a related Hong Kong company, Disguise Limited (collectively, “Disguise”).  The total initial consideration of $60.6 million consisted of $38.6 million in cash and the assumption of liabilities in the amount of $22.0 million, and resulted in goodwill of $30.6 million. The Company has not finalized its purchase price allocation for Disguise and has engaged a third party to perform studies and valuations of the estimated fair value of assets and liabilities assumed.  Disguise is a leading designer and producer of Halloween and everyday costume play and was included in our results of operations from the date of acquisition.  Pro forma results of operations are not provided since the amounts are not material to the consolidated results of operations.

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

Note 10 — Joint Venture

The Company owns a fifty percent interest in a joint venture with THQ Inc. (“THQ”) which develops, publishes and distributes interactive entertainment software for the leading hardware game platforms in the home video game market. The joint venture has entered into a license agreement with an initial license period expiring December 31, 2009 and a renewal period at the option of the joint venture expiring December 31, 2014 under which it acquired the exclusive worldwide right to publish video games based on the WWE franchise on all hardware platforms. The Company’s investment is accounted for using the cost method due to the financial and operating structure of the venture and its lack of significant influence over the joint venture. The Company’s basis consists primarily of organizational costs, license costs and recoupable advances and is being amortized over the term of the initial license period. The joint venture agreement provides for the Company to receive guaranteed preferred returns through June 30, 2006 at varying rates of the joint venture’s net sales depending on the cumulative unit sales and platform of each particular game. The preferred return is accrued in the quarter in which the licensed games are sold and the preferred return is earned.  The preferred return was subject to change after June 30, 2006 and was to be set for the distribution period beginning July 1, 2006 and ending December 31, 2009 (the “Next Distribution Period”). The agreement provides that the parties will negotiate in good faith and agree to the preferred return not less than 180 days prior to the start of the Next Distribution Period. It further provides that if the parties are unable to agree on a preferred return, the preferred return will be determined by arbitration. The parties did not reach an agreement with respect to the preferred return for the Next Distribution Period and the preferred return for the Next Distribution Period was determined through arbitration (see Note 16).  On July 24, 2009 a decision was rendered by the arbitrator setting the preferred return rate at 6 %.  Based on this lower rate, a cumulative adjustment in the amount of $23.5 million was made and $33.5 million was paid by THQ for the cumulative preferred return for the period from July 1, 2006 to June 30, 2009. As of December 31, 2008 and September 30, 2009, the balance of the investment in the video game joint venture includes the following components (in thousands):
 
 
12

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 10 — Joint Venture (continued)

   
December 31,
   
September 30,
 
   
2008
   
2009
 
Preferred return receivable
 
$
52,845
   
$
442
 
Investment costs, net
   
339
     
85
 
   
$
53,184
   
$
527
 

The Company’s joint venture partner retains the financial risk of the joint venture and is responsible for the day-to-day operations, including development, sales and distribution, for which they are entitled to any remaining profits. During the three months ended September 30, 2008 and 2009, the Company earned a profit of $0.7 million and incurred a loss of $1.9 million, respectively, from the joint venture.  During the nine months ended September 30, 2008 and 2009, the Company earned a profit of $4.5 million and incurred a loss of $21.9 million, respectively, from the joint venture.  The losses in 2009 were due to the reduction from approximately $56.2 million to approximately $32.7 million in the accrual of the receivable from the joint venture that resulted from the arbitration setting the preferred return rate at 6%, instead of the 10% rate that had been accrued.

Note 11 — Goodwill

The changes in the carrying amount of goodwill for the nine months ended September 30, 2009 are as follows (in thousands):

  
 
Traditional
Toys
  
  
Craft/Activity/
Writing Products
  
  
Pet
Products
  
Total
 
Balance at beginning of the period
 
$
335,083
   
$
82,826
   
$
9,784
   
$
427,693
 
Adjustments to goodwill during the period
   
(20,568
)
   
     
     
(20,568
)
Write-down of goodwill
   
(314,515
)
   
(82,826
)
   
(9,784
)
   
(407,125
)
Balance at end of the period
 
$
   
$
   
$
   
$
 

As of June 30, 2009, the Company reclassified $21.0 million from goodwill to intangibles and other assets for its Disguise acquisition.  The Company is in the process of finalizing its purchase price allocation for its Disguise Acquisition and is working with a third party to perform studies and valuations to the estimated fair value of assets and liabilities assumed.  Furthermore, the Company paid out an additional working capital adjustment of $0.9 million for its Disguise acquisition.
 
The Company applies a fair value-based impairment test to the net book value of goodwill and indefinite-lived intangible assets on an annual basis and, if certain events or circumstances indicate that an impairment loss may have been incurred, on an interim basis. The analysis of potential impairment of goodwill requires a two-step process. The first step is the estimation of fair value. If step one indicates that an impairment potentially exists, the second step is performed to measure the amount of impairment, if any. Goodwill impairment exists when the estimated fair value of goodwill is less than its carrying value.
 
As of June 30, 2009, the Company determined that the significant decline in its market capitalization is likely to be sustained.   The Company’s market capitalization was not significantly affected by the 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, the Company determined that $407.1 million, or all of the goodwill related to previous acquisitions, including the acquisition of Disguise in December 2008, was impaired. This amount is included in “Write-down of Goodwill” in the accompanying condensed consolidated statements of operations.

 
13

 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 12 — Intangible Assets Other Than Goodwill

Intangible assets consist primarily of licenses, product lines, customer relationships, debt offering costs from the issuance of the Company’s convertible senior notes and trademarks. Amortized intangible assets are included in the Intangibles and other, net, in the accompanying balance sheets. Trademarks are disclosed separately in the accompanying balance sheets. Intangible assets are as follows (in thousands, except for weighted useful lives):
 
         
December 31, 2008
  
  
September 30, 2009
  
  
  
Weighted
Useful
Lives
  
  
Gross
Carrying
Amount
  
  
Accumulated
Amortization
  
  
Net
Amount
  
  
Gross
Carrying
Amount
  
  
Accumulated
Amortization
  
  
Net
Amount
 
   
(Years)
                                     
                                           
Amortized Intangible Assets:
 
 
         
 
   
 
   
 
   
 
   
 
 
Acquired order backlog
   
0.50
   
$
2,393
   
$
(2,165
)
 
$
228
   
$
2,393
   
$
(2,393
)
 
$
 
Licenses
   
4.84
     
67,088
     
(46,638
)
   
20,450
     
85,788
     
(55,090
)
   
30,698
 
Product lines
   
3.62
     
17,700
     
(17,700
)
   
     
19,100
     
(18,267
)
   
833
 
Customer relationships
   
5.33
     
4,096
     
(2,301
)
   
1,795
     
6,796
     
(3,258
)
   
3,538
 
Non-compete/Employment contracts
   
4.56
     
2,748
     
(2,703
)
   
45
     
3,133
     
(2,789
)
   
344
 
Debt offering costs
   
20.00
     
3,705
     
(1,033
)
   
2,672
     
3,705
     
(1,172
)
   
2,533
 
Total amortized intangible assets
           
97,730
     
(72,540
)
   
25,190
     
120,915
     
(82,969
)
   
37,946
 
Unamortized Intangible Assets:
                                                       
Trademarks
 
indefinite
     
10,491
     
     
10,491
     
2,308
     
     
2,308
 
           
$
108,221
   
$
(72,540
)
 
$
35,681
   
$
123,223
   
$
(82,969
)
 
$
40,254
 

Amortization expense related to limited life intangible assets was $2.1 million and $6.5 million for the three months ended September 30, 2008 and 2009, respectively.  Amortization expense related to limited life intangible assets was $6.4 million and $10.4 million for the nine months ended September 30, 2008 and 2009, respectively.

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

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

Note 13 — Property and Equipment

Property and equipment have historically been stated at cost and are being depreciated using the straight-line method over their estimated useful lives as follows:

Office equipment
5 years
Automobiles
5 years
Furniture and fixtures
5 - 7 years
Molds and tooling
2  years
Leasehold improvements
Shorter of length of lease or 10 years

 
14

 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 13 — Property and Equipment (continued)

Effective January 1, 2009, the Company changed its depreciation methodology for molds and tools used in the manufacturing of its products from a straight-line basis to a usage basis, which is more closely correlated to production of goods.  While both methods of depreciation allocation are acceptable, the Company believes that the usage method more accurately matches costs with revenues.  Furthermore, the useful estimated life of molds and tools was maintained at two years.  The following financial statement line items for the three and nine months ended September 30, 2008 were affected by the change in accounting principle:

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
 
   
Three Months Ended
September 30, 2008
   
Nine Months Ended
September 30, 2008
  
  
  
As
Computed
under
usage
method
   
As
Reported
under
Straight-
line method
   
Effect of
Change
   
As
Computed
under
usage
method
   
As
Reported
under
Straight-
line method
   
Effect of
Change
 
Net sales
 
$
357,824
   
$
357,824
   
$
   
$
634,050
   
$
634,050
   
$
 
Cost of sales
   
231,145
     
228,759
     
2,386
     
405,949
     
405,486
     
463
 
Gross Margin
 
$
126,679
   
$
129,065
   
$
(2,386
)
 
$
228,101
   
$
228,564
   
$
(463
)
Income from operations
 
$
54,952
   
$
57,338
   
$
(2,386
)
 
$
61,549
   
$
62,012
   
$
(463
)
Income before provision for income taxes
 
$
58,417
   
$
60,803
   
$
(2,386
)
 
$
67,634
   
$
68,097
   
$
(463
)
Provision for income taxes
   
5,879
     
6,658
     
(779
)
   
8,737
     
8,919
     
(182
)
Net income
 
$
52,538
   
$
54,145
   
$
(1,607
)
 
$
58,897
   
$
59,178
   
$
(281
)
Earnings per share – basic
 
$
1.95
   
$
2.01
   
$
(0.06
)
 
$
2.14
   
$
2.15
   
$
(0.01
)
Earnings per share - diluted
 
$
1.65
   
$
1.70
   
$
(0.05
)
 
$
1.87
   
$
1.88
   
$
(0.01
)
 
15

 
JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 13 — Property and Equipment (continued)

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)

   
As of September 30, 2008
  
  
  
As
Computed
under
usage
method
  
  
As
Reported
under
Straight-
line method
  
  
Effect of
Change
 
Property and Equipment
                       
Office furniture and equipment
 
$
10,953
   
$
10,953
   
$
 
Molds and tooling
   
59,293
     
59,293
     
 
Leasehold improvements
   
5,298
     
5,298
     
 
Total
   
75,544
     
75,544
     
 
Less accumulated depreciation and amortization
   
49,364
     
48,901
     
463
 
Property and equipment, net
 
$
26,180
   
 $
26,643
   
$
(463
Income taxes payable
 
$
1,164
   
$
1,346