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EX-32.1 - EXHIBIT 32.1 - JAKKS PACIFIC INCa51217867ex32_1.htm
EX-31.1 - EXHIBIT 31.1 - JAKKS PACIFIC INCa51217867ex31_1.htm
EX-32.2 - EXHIBIT 32.2 - JAKKS PACIFIC INCa51217867ex32_2.htm
EX-31.2 - EXHIBIT 31.2 - JAKKS PACIFIC INCa51217867ex31_2.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, 2015

OR

o    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.)

 
2951 28TH Street
Santa Monica, California
90405
(Address of Principal Executive Offices)
(Zip Code)


Registrant’s Telephone Number, Including Area Code: (424) 268-9444
 

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 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
o
Accelerated filer
x
Non-accelerated filer
o
(Do not check if a smaller reporting company)
Smaller reporting company
o

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 number of shares outstanding of the issuer’s common stock is 22,373,094 as of November 6, 2015. 
 
 
1

 
 
 JAKKS PACIFIC, INC. AND SUBSIDIARIES

INDEX TO QUARTERLY REPORT ON FORM 10-Q
Quarter Ended September 30, 2015
ITEMS IN FORM 10-Q
 
 
 
 
3
 
4
 
5
 
6
21
31
31
     
 
32
33
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3.
Defaults Upon Senior Securities
None
Item 4.
Mine Safety Disclosures
None
Item 5.
Other Information
None
40
     
41
Exhibit 31.1
 
Exhibit 31.2
 
Exhibit 32.1
 
Exhibit 32.2
 
 
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

This report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. For example, statements included in this report regarding our financial position, business strategy and other plans and objectives for future operations, and assumptions and predictions about future product demand, supply, manufacturing, costs, marketing and pricing factors are all forward-looking statements. When we use words like “intend,” “anticipate,” “believe,” “estimate,” “plan,” “expect” or words of similar import, we are making forward-looking statements. We believe that the assumptions and expectations reflected in such forward-looking statements are reasonable and are based on information available to us on the date hereof, but we cannot assure you that these assumptions and expectations will prove to have been correct or that we will take any action that we may presently be planning. We are not undertaking to publicly update or revise any forward-looking statement if we obtain new information or upon the occurrence of future events or otherwise.
 
 
2

 
 
 PART I
 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

(In thousands, except share amounts)
 
Assets
 
December 31,
2014
(*)
   
September 30,
2015
(Unaudited)
 
Current assets
           
Cash and cash equivalents
 
$
71,525
   
$
81,211
 
Marketable securities
   
220
     
 
Accounts receivable, net of allowance for uncollectible accounts of $3,264 and $2,689, respectively
   
234,516
     
292,861
 
Inventory, net
   
78,827
     
81,404
 
Income taxes receivable
   
24,008
     
24,008
 
Deferred income taxes
   
3,358
     
3,358
 
Prepaid expenses and other
   
25,139
     
30,683
 
Total current assets
   
437,593
     
513,525
 
Property and equipment
               
Office furniture and equipment
   
14,440
     
15,064
 
Molds and tooling
   
87,360
     
95,431
 
Leasehold improvements
   
5,280
     
10,406
 
Total
   
107,080
     
120,901
 
Less accumulated depreciation and amortization
   
95,984
     
102,297
 
Property and equipment, net
   
11,096
     
18,604
 
Intangibles
   
48,904
     
43,997
 
Other long term assets
   
10,389
     
9,779
 
Investment in DreamPlay, LLC
   
7,000
     
7,000
 
Goodwill, net
   
44,492
     
44,344
 
Trademarks, net
   
2,308
     
2,308
 
Total assets
 
$
561,782
   
$
639,557
 
Liabilities and Stockholders’ Equity
               
Current liabilities
               
Accounts payable
 
$
56,113
   
$
94,631
 
Accrued expenses
   
86,974
     
70,903
 
Reserve for sales returns and allowances
   
24,477
     
26,616
 
Income taxes payable
   
23,784
     
24,797
 
Short term debt
   
     
25,000
 
Total current liabilities
   
191,348
     
241,947
 
Long term debt
   
215,000
     
215,000
 
Other liabilities
   
1,874
     
4,232
 
Income taxes payable
   
2,496
     
2,198
 
Deferred income taxes
   
5,980
     
5,980
 
Total liabilities
   
416,698
     
469,357
 
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; 22,682,295 and
22,599,061 shares issued and outstanding,
respectively
   
23
     
23
 
Treasury stock, at cost; 3,112,840 and 3,886,873 shares, respectively
   
(24,000)
     
(30,988)
 
Additional paid-in capital
   
202,051
     
203,503
 
Retained earnings (accumulated deficit)
   
(26,645)
     
5,939
 
Accumulated other comprehensive loss
   
(6,835)
     
(8,739)
 
Total JAKKS Pacific, Inc. stockholders’ equity
   
144,594
     
169,738
 
Non-controlling interests
   
490
     
462
 
Total stockholders’ equity
   
145,084
     
170,200
 
Total liabilities and stockholders’ equity
 
$
561,782
   
$
639,557
 
 
(*) Derived from audited financial statements
 
See accompanying notes to condensed consolidated financial statements.
 
 
3

 
 
  JAKKS PACIFIC, INC. AND SUBSIDIARIES

(In thousands, except per share data)

 
   
Three Months Ended
September 30,
(Unaudited)
   
Nine Months Ended
September 30,
(Unaudited)
 
   
2014
   
2015
   
2014
   
2015
 
                         
Net sales
 
$
349,362
   
$
337,027
   
$
556,044
   
$
582,334
 
Cost of sales
   
254,625
     
232,698
     
399,934
     
403,340
 
Gross profit
   
94,737
     
104,329
     
156,110
     
178,994
 
Selling, general and administrative expenses
   
50,925
     
59,701
     
132,041
     
141,573
 
Income from operations
   
43,812
     
44,628
     
24,069
     
37,421
 
Income from joint ventures
   
     
60
     
314
     
1,744
 
Other income
   
5,932
     
5,642
     
5,932
     
5,642
 
Interest income
   
32
     
16
     
89
     
51
 
Interest expense
   
(3,969)
     
(3,107)
     
(9,158)
     
(9,187)
 
Income before provision for income taxes
   
45,807
     
47,239
     
21,246
     
35,671
 
Provision for income taxes
   
1,738
     
1,375
     
2,535
     
3,115
 
Net income
   
44,069
     
45,864
     
18,711
     
32,556
 
Net income (loss) attributable to non-controlling interests
   
     
19
     
     
(28)
 
Net income attributable to JAKKS Pacific, Inc.
 
$
44,069
   
$
45,845
   
$
18,711
   
$
32,584
 
Earnings per share – basic
 
$
2.33
   
$
2.47
   
$
0.90
   
$
1.72
 
Earnings per share – diluted
 
$
1.03
   
$
1.12
   
$
0.61
   
$
0.89
 
Comprehensive income
 
$
43,821
   
$
43,984
   
$
18,952
   
$
30,680
 
 
 
4

 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES
 
(In thousands)
 
   
Nine Months Ended
September 30,
(Unaudited)
 
   
2014
   
2015
 
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net income
 
$
18,711
   
$
32,556
 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
Depreciation and amortization
   
16,134
     
14,220
 
Amortization of debt discount and issuance costs
   
2,243
     
1,464
 
Share-based compensation expense
   
997
     
1,452
 
(Gain) loss on disposal of property and equipment
   
18
     
(28)
 
Income from joint ventures
   
(314)
     
 
Changes in operating assets and liabilities:
               
Accounts receivable
   
(203,115)
     
(58,345)
 
Inventory
   
(41,992)
     
(2,577)
 
Prepaid expenses and other current assets
   
(2,018)
     
(6,294)
 
Accounts payable
   
90,348
     
38,518
 
Accrued expenses
   
11,280
     
(16,071)
 
Income taxes payable
   
4,796
     
715
 
Reserve for sales returns and allowances
   
(2,496)
     
2,139
 
Other liabilities
   
228
     
2,358
 
Total adjustments
   
(123,891)
     
(22,449)
 
Net cash provided by (used in) operating activities
   
(105,180)
     
10,107
 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Purchase of property and equipment
   
(8,714)
     
(15,593)
 
Sale of marketable securities
   
     
220
 
Change in other assets
   
453
     
(3,080)
 
Distribution from joint venture
   
332
     
60
 
Net cash used in investing activities
   
(7,929)
     
(18,393)
 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Common stock repurchased
   
(24,000)
     
(6,988)
 
Proceeds from credit facility borrowings
   
10,000
     
25,000
 
Repayment of credit facility borrowings
   
(10,000)
     
 
Proceeds from issuance of senior convertible notes
   
115,000
     
 
Issuance costs related to senior convertible notes
   
(4,594)
     
 
Credit facility costs
   
(1,851)
     
(188)
 
Net cash provided by financing activities
   
84,555
     
17,824
 
Effect of foreign currency translation
   
100
     
148
 
Net change in cash and cash equivalents
   
(28,454)
     
9,686
 
Cash and cash equivalents, beginning of period
   
117,071
     
71,525
 
Cash and cash equivalents, end of period
 
$
88,617
   
$
81,211
 
Cash paid (received) during the period for:
               
Income taxes
 
$
(2,331)
   
$
3,625
 
Interest
 
$
5,408
   
$
4,390
 
 
See Notes 9 and 10 for additional supplemental information to the condensed consolidated statements of cash flows.

See accompanying notes to condensed consolidated financial statements.
 
 
5

 
 
  JAKKS PACIFIC, INC. AND SUBSIDIARIES

(Unaudited)
September 30, 2015
 
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, 2014.

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.
 
The condensed consolidated financial statements include the accounts of JAKKS Pacific, Inc. and its wholly-owned subsidiaries (collectively, “the Company”). The condensed consolidated financial statements also include the accounts of DreamPlay Toys, LLC, a joint venture between JAKKS Pacific, Inc. and NantWorks LLC, and JAKKS Meishing Trading (Shanghai) Limited, a joint venture between JAKKS Pacific, Inc. and Meishing Culture & Creative Corp.

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. In April 2015, the FASB issued for public comment a proposed ASU to defer the effective date of ASU 2014-09 and in July 2015, affirmed its proposal to defer the effective date of the new revenue standard for all entities by one year. The mandatory adoption date of ASC 606 for the Company is now January 1, 2018. There are two methods of adoption allowed, either: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). The Company is currently evaluating the impact of the pending adoption of ASU 2014-09 on the consolidated financial statements and has not yet determined the method by which the Company will adopt the standard in 2017.

In August 2014, the FASB amended the FASB Accounting Standards Codification and amended Subtopic 205-40, “Presentation of Financial Statements — Going Concern.” This amendment prescribes that an entity’s management should evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. The amendments will become effective for the Company’s annual and interim reporting periods beginning January 1, 2017. Upon adoption the Company will use this guidance to evaluate going concern.

In April 2015, the FASB issued Accounting Standards Update 2015-03, “Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs” (“ASU 2015-03”). ASU 2015-03 requires an entity to present debt issuance costs related to a recognized debt liability in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this update. The amendment will be effective for the Company’s annual and interim reporting periods beginning January 1, 2016 and should be applied on a retrospective basis. The adoption of ASU 2015-03 will not have any impact on the Company’s results of operations, but will result in debt issuance costs being presented as a direct reduction from the carrying amount of debt liabilities. This standard will not have a material impact on the Company’s consolidated financial statements.

In August 2015, the FASB issued Accounting Standards Update 2015-15, “Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements” (“ASU 2015-15”). ASU 2015-15 codifies an SEC staff announcement that entities are permitted to defer and present debt issuance costs related to line-of-credit arrangements as assets. The announcements were effective upon issuance. The adoption of ASU 2015-15 does not have any impact on the Company’s consolidated financial statements.

In July 2015, the FASB issued Accounting Standards Update 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory” (“ASU 2015-11”). ASU 2015-11 requires inventory accounted for under the FIFO or average cost method to be measured using the lower of cost and net realizable value. The amendments are effective prospectively for fiscal years and for interim periods beginning after December 15, 2016. The Company is currently evaluating the impact of the pending adoption of ASU 2015-11 on the consolidated financial statements.
 
 
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 of products. The Company’s reportable segments are Traditional Toys and Electronics, and Role Play, Novelty and Seasonal Toys, each of which includes worldwide sales.

The Traditional Toys and Electronics segment includes action figures, vehicles, playsets, plush products, dolls, accessories, electronic products, construction toys, infant and pre-school toys, foot to floor ride-on vehicles, wagons and pet treats and related products.

The Role Play, Novelty and Seasonal Toys segment includes role play and dress-up products, Halloween and everyday costume play, novelty toys, seasonal and outdoor products and indoor and outdoor kids’ furniture.

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 upon sales volumes. Segment assets are comprised of accounts receivable and inventories, net of applicable reserves and allowances, goodwill and other assets.
 
 
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)

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 for the three and nine months ended September 30, 2014 and 2015 and as of December 31, 2014 and September 30, 2015 are as follows (in thousands):
 
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
  
 
2014
   
2015
   
2014
   
2015
 
                         
Net Sales
                       
Traditional Toys and Electronics
 
$
173,785
   
$
204,332
   
$
258,872
   
$
332,737
 
Role Play, Novelty and Seasonal Toys
   
175,577
     
132,695
     
297,172
     
249,597
 
   
$
349,362
   
$
337,027
   
$
556,044
   
$
582,334
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
  
2014
 
2015
 
2014
 
2015
 
                 
Operating Income
               
Traditional Toys and Electronics
 
$
21,322
   
$
20,431
   
$
6,208
   
$
9,547
 
Role Play, Novelty and Seasonal Toys
   
22,490
     
24,197
     
17,861
     
27,874
 
   
$
43,812
   
$
44,628
   
$
24,069
   
$
37,421
 
 
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
  
 
2014
   
2015
   
2014
   
2015
 
                         
Depreciation and Amortization Expense
                       
Traditional Toys and Electronics
 
$
4,773
   
$
4,546
   
$
9,062
   
$
8,825
 
Role Play, Novelty and Seasonal Toys
   
3,859
     
2,833
     
7,072
     
5,395
 
   
$
8,632
   
$
7,379
   
$
16,134
   
$
14,220
 
 
   
December 31,
   
September 30,
 
   
2014
   
2015
 
Assets
           
Traditional Toys and Electronics
 
$
313,380
   
$
397,082
 
Role Play, Novelty and Seasonal Toys
   
248,402
     
242,475
 
   
$
561,782
   
$
639,557
 
 
 
7

 
 
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, 2014 and September 30, 2015 and for the three and nine months ended September 30, 2014 and 2015 (in thousands):
 
   
December 31,
2014
   
September 30,
2015
 
Long-lived Assets
           
China
 
$
8,816
   
$
10,201
 
United States
   
1,689
     
7,827
 
Hong Kong
   
591
     
576
 
   
$
11,096
   
$
18,604
 
 
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2014
   
2015
   
2014
   
2015
 
Net Sales by Customer Area
                       
United States
 
$
281,989
   
$
242,467
   
$
448,842
   
$
416,690
 
Europe
   
28,018
     
55,389
     
41,410
     
92,948
 
Canada
   
14,434
     
16,441
     
22,948
     
27,255
 
Hong Kong
   
1,354
     
414
     
2,095
     
1,210
 
Other
   
23,567
     
22,316
     
40,749
     
44,231
 
   
$
349,362
   
$
337,027
   
$
556,044
   
$
582,334
 

Major Customers

Net sales to major customers for the three and nine months ended September 30, 2014 and 2015 were as follows (in thousands, except for percentages):
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2014
   
2015
   
2014
   
2015
 
  
 
Amount
   
Percentage
of
Net Sales
   
Amount
   
Percentage
of
Net Sales
   
Amount
   
Percentage
of
Net Sales
   
Amount
   
Percentage
of
Net Sales
 
                                                 
Wal-Mart
 
81,731
     
23.4
%
 
77,240
     
22.9
%
 
115,295
     
20.7
%
 
126,743
     
21.7
%
Target
   
55,849
     
16.0
     
40,647
     
12.1
     
79,954
     
14.4
     
66,292
     
11.4
 
Toys ‘R’ Us 
   
33,770
     
9.7
     
27,292
     
8.1
     
61,063
     
11.0
     
50,620
     
8.7
 
   
$
171,350
     
49.1
%
 
$
145,179
     
43.1
%
 
$
256,312
     
46.1
%
 
243,655
     
41.8
%

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

At December 31, 2014 and September 30, 2015, the Company’s three largest customers accounted for approximately 29.8% and 33.0% 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.
 
 
8

 
 
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 capitalized warehouse costs, is valued at the lower of cost (first-in, first-out) or market, net of inventory obsolescence reserve, and consists of the following (in thousands):
 
   
December 31,
2014
   
September 30,
 2015
 
             
Raw materials
 
$
1,040
   
$
1,074
 
Finished goods
   
77,787
     
80,330
 
   
$
78,827
   
$
81,404
 

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 upon terms, provided there are no uncertainties regarding customer acceptance, the sales price is fixed or determinable and collectability is reasonably assured and not contingent upon resale.

Generally, the Company does not allow product returns. It provides its customers a negotiated allowance for breakage or defects, 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 based upon historic return amounts and management estimates. The Company occasionally grants 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 10% of gross sales, and are generally based upon product purchases or 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 $24.5 million as of December 31, 2014, compared to $26.6 million as of September 30, 2015. This increase is primarily due to higher sales for the first nine months of 2015 offset in part by certain customers taking their year-end allowances related to 2014 sales during 2015. 
 
 
9

 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 5 — Credit Facility

In March 2014, the Company and its domestic subsidiaries entered into a secured credit facility with General Electric Capital Corporation (the “GE Loan Agreement”). The GE Loan Agreement, as amended, provides for a $75.0 million revolving credit facility subject to availability based on prescribed advance rates on certain accounts receivable and inventory. The amounts outstanding under the revolving credit facility are payable in full upon maturity of the revolving credit facility on March 27, 2019. The revolving credit facility is secured by a security interest in favor of the lender covering a substantial amount of the assets of the Company. As of September 30, 2015, the amount of outstanding borrowings on the revolving credit facility is $25.0 million and outstanding stand-by letters of credit totaled $8.1 million; the total excess borrowing capacity is approximately $9.4 million.

The Company’s ability to borrow under the GE Loan Agreement is also subject to its ongoing compliance with certain financial covenants, including that the Company and its domestic subsidiaries maintain a fixed charge coverage ratio of at least 1.2:1.0 based on the trailing four quarters.

The GE Loan Agreement allows the Company to borrow under the revolving credit facility at LIBOR or at a base rate, plus applicable margins of 225 basis point spread over LIBOR and 125 basis point spread on base rate loans. In addition to standard fees, the revolving credit facility has an unused line fee based on the unused amount of the credit facility, ranging from 25 to 50 basis points. As of September 30, 2015, the rate on the revolving credit facility was approximately 2.56%.

The GE 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 of the obligations of the Company and its subsidiaries under the GE 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 September 30, 2015, the Company was in compliance with the financial covenants under the GE Loan Agreement. In the event the Company fails to meet any of the financial covenants or any other covenants under the GE Loan Agreement in the future, the lender could declare an event of default, which could have a material adverse effect on the Company’s financial condition and results of operations.
 
 
10

 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
 
Note 6 — Convertible Senior Notes

 In November 2009, the Company sold an aggregate of $100.0 million principal amount of 4.50% Convertible Senior Notes due 2014 (the “2014 Notes”). The 2014 Notes were senior unsecured obligations of the Company, paid cash interest semi-annually at a rate of 4.50% per annum and matured on November 1, 2014.  In July 2013, the Company repurchased an aggregate of $61.0 million principal amount of the 2014 Notes at par plus accrued interest with a portion of the net proceeds from the issuance of $100.0 million principal amount of 4.25% convertible senior notes due 2018 resulting in a gain on extinguishment of $0.1 million, and as of November 1, 2014, the Company paid the outstanding balance of $39.0 million related to the 2014 Notes.
 
Accounting Standards Codification ("ASC") 470-20, “Debt with Conversion and Other Options,” requires the issuer of certain convertible debt instruments that may be settled in cash (or other assets) upon conversion to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuer's non-convertible debt borrowing rate. In accordance with ASC 470-20, the Company allocated $13.7 million of the original $100.0 million principal amount of the 2014 Notes to the equity component, which represented a discount to the debt that was amortized to interest expense through November 1, 2014. Interest expense associated with the amortization of the discount was $0.3 million for the three months ended September 30, 2014, and $0.8 million for the nine months ended September 30, 2014.

 In July 2013, the Company sold an aggregate of $100.0 million principal amount of 4.25% Convertible Senior Notes due 2018 (the “2018 Notes”).  The 2018 Notes are senior unsecured obligations of the Company paying interest semi-annually in arrears on August 1 and February 1 of each year at a rate of 4.25% per annum and will mature on August 1, 2018.  The initial conversion rate for the 2018 Notes is 114.3674 shares of JAKKS common stock per $1,000 principal amount of notes, equivalent to an initial conversion price of approximately $8.74 per share of common stock, subject to adjustment in certain events.   Upon conversion, the 2018 Notes will be settled in shares of the Company’s common stock.  Holders of the 2018 Notes may require that the Company repurchase for cash all or some of their notes upon the occurrence of a fundamental change (as defined in the 2018 Notes).  The Company used $61.0 million of the approximately $96.0 million in net proceeds from the offering to repurchase at par $61.0 million principal amount of the 2014 Notes. The remainder of the net proceeds has been, and will be, used for general corporate purposes.

 In June 2014, the Company sold an aggregate of $115.0 million principal amount of 4.875% Convertible Senior Notes due 2020 (the “2020 Notes”).  The 2020 Notes are senior unsecured obligations of the Company paying interest semi-annually in arrears on June 1 and December 1 of each year at a rate of 4.875% per annum and will mature on June 1, 2020.  The initial conversion rate for the 2020 Notes is 103.7613 shares of our common stock per $1,000 principal amount of notes, equivalent to an initial conversion price of approximately $9.64 per share of common stock, subject to adjustment in certain events.   Upon conversion, the 2020 Notes will be settled in shares of the Company’s common stock.  Holders of the 2020 Notes may require that the Company repurchase for cash all or some of their notes upon the occurrence of a fundamental change (as defined in the 2020 Notes).  The Company received net proceeds of approximately $110.4 million from the offering of which $24.0 million was used to repurchase 3.1 million shares of the Company’s common stock under a prepaid forward purchase contract and $39.0 million was used to redeem the remaining outstanding principal amount of the 2014 Notes at maturity. The remainder of the net proceeds will be used for general corporate purposes.

The fair value of the 2018 Notes as of December 31, 2014 and September 30, 2015 was approximately $96.3 million and $106.9 million, respectively, based upon the most recent quoted market price. The fair value of the 2020 Notes as of December 31, 2014 and September 30, 2015 was approximately $100.9 million and $118.2 million, respectively, based upon the most recent quoted market price. The fair value of the convertible senior notes is considered to be a Level 2 measurement on the fair value hierarchy.
 
 
11

 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 7 — Income Taxes

The Company’s income tax expense of $1.7 million for the three months ended September 30, 2014 reflects an effective tax rate of 3.8%. The Company’s income tax expense of $1.4 million for the three months ended September 30, 2015 reflects an effective tax rate of 2.9%. The majority of the provision relates to foreign taxes.
 
The Company’s income tax expense of $2.5 million for the nine months ended September 30, 2014 reflects an effective tax rate of 11.9%. The Company’s income tax expense of $3.1 million for the nine months ended September 30, 2015 reflects an effective tax rate of 8.7%. The majority of the provision relates to foreign taxes.
 
 
12

 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 8 — Earnings Per Share
 
The following table is a reconciliation of the weighted average shares used in the computation of earnings per share for the periods presented (in thousands, except per share data):
 
   
Three Months Ended September 30,
 
   
2014
   
2015
 
   
Income
   
Weighted
Average
Shares
   
Per-Share
   
Income
   
Weighted
Average
Shares
   
Per-
Share
 
Earnings per share – basic
                                   
Net income available to common stockholders
 
$
44,069
     
18,897
   
$
2.33
   
$
45,845
     
18,559
   
$
2.47
 
Effect of dilutive securities:
                                               
Convertible senior notes
   
2,442
     
26,055
             
1,779
     
23,369
         
Unvested performance stock grants
   
     
             
     
409
         
Unvested restricted stock grants
   
     
200
             
     
225
         
                                                 
Earnings per share – diluted
                                               
Net income available to common
stockholders plus assumed exercises and
conversion
 
$
46,511
     
45,152
   
$
1.03
   
$
47,624
     
42,562
   
$
1.12
 
 
   
Nine Months Ended September 30,
 
   
2014
   
2015
 
   
Income
   
Weighted
Average
Shares
   
Per-Share
   
Income
   
Weighted
Average
Shares
   
Per-
Share
 
Earnings per share – basic
                                   
Net income available to common stockholders
 
$
18,711
     
20,721
   
$
0.90
   
$
32,584
     
18,929
   
$
1.72
 
Effect of dilutive securities:
                                               
Convertible senior notes
   
5,456
     
19,063
             
5,516
     
23,369
         
Unvested performance stock grants
   
     
             
     
284
         
Unvested restricted stock grants
   
     
167
             
     
155
         
Earnings per share – diluted
                                               
Net income available to common
stockholders plus assumed exercises and
conversion
 
$
24,167
     
39,951
   
$
0.61
   
$
38,100
     
42,737
   
$
0.89
 

Basic earnings per share is calculated using the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated using the weighted average number of common shares and common share equivalents outstanding during the period (which consist of warrants, options and convertible debt to the extent they are dilutive). The weighted average number of common shares outstanding excludes shares repurchased pursuant to a prepaid forward share repurchase agreement (See Note 9). Common share equivalents that could potentially dilute basic earnings per share in the future, which were excluded from the computation of diluted earnings per share due to being anti-dilutive, totaled approximately 1,587,361 and 1,500,000 for the three months ended September 30, 2014 and 2015, respectively, and approximately 1,608,764 and 1,500,000 for the nine months ended September 30, 2014 and 2015, respectively.
 
 
13

 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 9 — 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 June 2014, the Company effectively repurchased 3,112,840 shares of its common stock at an average cost of $7.71 per share for an aggregate amount of $24.0 million pursuant to a prepaid forward share repurchase agreement entered into with Merrill Lynch International (“ML”). These repurchased shares are treated as retired for basic and diluted EPS purposes although they remain legally outstanding. The Company reflects the aggregate purchase price of its common shares repurchased as a reduction to stockholders’ equity classified as Treasury Stock. No shares have been delivered to the Company by ML as of September 30, 2015.
 
In January 2015, the Company issued an aggregate of 525,734 shares of restricted stock at a value of approximately $3.6 million to two executive officers, which vest, subject to certain company financial performance criteria and market conditions, over a one to three year period. In addition, an aggregate of 73,855 shares of restricted stock were issued to its five non-employee directors, which vest in January 2016, at an aggregate value of approximately $0.5 million.

In April 2015, the Company issued an aggregate of 135,234 shares of restricted stock at a value of approximately $0.9 million to an executive officer, which vest, subject to certain company financial performance criteria and market conditions, over a one to three year period.

In June 2015, the Board of Directors authorized the repurchase of up to an aggregate of $30.0 million of the Company’s outstanding common stock and/or convertible notes (collectively, “securities”). The Company intends to retire any repurchased securities. As of September 30, 2015, the Company repurchased 774,033 shares of its common stock at an aggregate value of $7.0 million.

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.
 
 
14

 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 10 — Business Combinations

In July 2012, the Company acquired all of the stock of Maui, Inc., an Ohio corporation, and related entities (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, the Company 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 on the achievement of certain financial performance criteria. The fair value of the expected earn-out of $16.0 million was accrued and recorded as goodwill as of the acquisition date. All future changes to the earn-out liability are to be credited to income. Maui did not achieve the prescribed earn-out targets for 2013 or 2014, therefore, $6.0 million and $5.9 million, respectively, was credited to other income in the fourth quarter of 2013 and third quarter of 2014. In addition, as of September 30, 2015, it was determined that Maui will not achieve the prescribed earn-out targets for 2015, accordingly, $5.6 million was credited to income in the third quarter of 2015. Maui is a leading manufacturer and distributor of spring and summer activity toys and impulse toys and was included in the Company’s results of operations from the date of acquisition.
 
 
15

 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 11 — Joint Ventures
 
The Company owns a fifty percent interest in a joint venture (“Pacific Animation Partners”) with the U.S. entertainment subsidiary of a leading Japanese advertising and animation production company. The joint venture was created to develop and produce a boys’ animated television show, which it licenses worldwide for television broadcast as well as consumer products. The Company produces and markets toys based upon the television program under a license from the joint venture, which has also licensed certain other merchandising rights to third parties. The Company is responsible for fifty percent of the operating expenses of the joint venture and thirty-one percent of the production costs of the television show. The joint venture completed and delivered 65 episodes of the show, which began airing in February 2012, and has since ceased production of the television show. The Company’s investment is being accounted for using the equity method. For the three months ended September 30, 2014 and 2015, the Company recognized income of nil and $0.1 million from the joint venture, respectively, including producer fees and royalty income from the joint venture in the amount of nil for both periods. For the nine months ended September 30, 2014 and 2015, the Company recognized income of $0.3 million and $0.1 million from the joint venture, respectively, including producer fees and royalty income from the joint venture in the amount of nil for both periods.
 
 As of December 31, 2014 and September 30, 2015, the balance of the investment in the Pacific Animation Partners joint venture includes the following components (in thousands):
 
   
December 31,
   
September 30,
 
   
2014
   
2015
 
Capital contributions
 
$
3,856
   
$
3,856
 
Equity in cumulative net loss
   
(3,856
)
   
(3,856
)
Investment in joint venture
 
$
   
$
 
 
 In September 2012, the Company entered into a joint venture (“DreamPlay Toys”) with NantWorks LLC (“NantWorks”) in which it owns a fifty percent interest. Pursuant to the operating agreement of DreamPlay Toys, the Company paid to NantWorks cash in the amount of $8.0 million and issued NantWorks a warrant to purchase 1.5 million shares of the Company’s common stock at a value of $7.0 million in exchange for the exclusive right to arrange for the provision of the NantWorks recognition technology platform for toy products. The Company has classified these rights as an intangible asset and is amortizing the asset over the anticipated revenue stream from the exploitation of these rights. The joint venture entered into a Toy Services Agreement (the “TSA”) with NantWorks with an initial term of three years expiring on October 1, 2015 and a renewal period at the option of the Company expiring October 1, 2018, subject to the achievement of certain financial targets, to develop and produce toys utilizing recognition technologies owned by NantWorks. Under the terms of the TSA, NantWorks is entitled to receive a preferred return based upon net sales of DreamPlay Toys product sales and third-party license fees. Pursuant to an amendment, the TSA was renewed to September 30, 2018 in exchange for $1.2 million payable to NantWorks over a two-year period, subject to the achievement of certain financial targets. The accrued preferred return for NantWorks was approximately $530,789 and $295,457 for the three months ended September 30, 2014 and 2015, respectively, and $614,753 and $359,452 for the nine months ended September 30, 2014 and 2015, respectively. The Company retains the financial risk of the joint venture and is responsible for the day-to-day operations, including development, sales and distribution, for which it is entitled to receive any remaining profit or is responsible for any losses, and the results of operations of the joint venture are consolidated with the Company’s results.
 
 In addition, the Company purchased for $7.0 million in cash a five percent economic interest in a related entity, DreamPlay, LLC, that will exploit the proprietary recognition technologies in non-toy consumer product categories. NantWorks has the right to repurchase the Company’s interest for $7.0 million. The Company has classified this investment as a long term asset on its balance sheet and is accounting for it using the cost method. As of September 30, 2015 the Company determined that the value of this investment will be realized and that no impairment has occurred.

In November 2014, the Company entered into a joint venture with Meisheng Culture & Creative Corp., for the purpose of providing certain JAKKS licensed and non-licensed toys and consumer products to agreed-upon territories of the People’s Republic of China. The joint venture includes a subsidiary in the Shanghai Free Trade Zone that is expected to sell, distribute and market these products, which can include dolls, plush, role play products, action figures, costumes, seasonal items, technology and app-enhanced toys among others. The Company owns fifty-one percent of the joint venture.

In May 2015, the Company recognized $1.7 million of income for funds received in 2015 related to a former video game joint venture in partial settlement of amounts owed to the Company when the joint venture partner was liquidated pursuant to their 2012 bankruptcy filing.  It is not known if any additional funds will be received by the Company.
 
 
16

 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 12 — Goodwill

The changes to the carrying amount of goodwill as of December 31, 2014 and September 30, 2015 are as follows (in thousands):

   
Traditional
Toys and
Electronics
   
Role Play,
Novelty
and Seasonal
Toys
   
Total
 
Balance at December 31, 2014
 
$
24,881
   
$
19,611
   
$
44,492
 
Adjustments to goodwill for foreign currency translation
   
(148)
     
     
(148)
 
Balance, September 30, 2015
 
$
24,733
   
$
19,611
   
$
44,344
 
 
The Company applies a fair value-based impairment test to the carrying 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. There was no goodwill impairment during the nine months ended September 30, 2014 and 2015.
 
 
17

 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 13 — Intangible Assets Other Than Goodwill and Other Assets

Intangible assets other than goodwill and other assets consist primarily of licenses, product lines, customer relationships and trademarks. Amortized intangible assets are included in Intangibles in the accompanying balance sheets. Trademarks are disclosed separately in the accompanying balance sheets. Debt offering costs from the issuance of the Company’s convertible senior notes are included in Other Long Term Assets in the accompanying balance sheets. Intangible assets and debt issuance costs as of December 31, 2014 and September 30, 2015 are as follows (in thousands, except for weighted useful lives):
 
     
December 31, 2014
   
September 30, 2015
 
 
 Weighted
 
Gross
               
Gross
             
 
 Useful
 
Carrying
   
Accumulated
   
Net
   
Carrying
   
Accumulated
   
Net
 
 
Lives
 
Amount
   
Amortization
   
Amount
   
Amount
   
Amortization
   
Amount
 
 
(Years)
                                   
                                       
Amortized Intangible Assets:
                                     
Licenses
4.96
 
$
91,488
   
(85,113
 
6,375
   
$
91,488
   
$
(86,816
)
 
$
4,672
 
Product lines
5.82
   
66,594
     
(27,235
)
   
39,359
     
67,794
     
(30,799
)
   
36,995
 
Customer relationships
5.21
   
9,348
     
(7,831
   
1,517
     
9,348
     
(8,246
)
   
1,102
 
Trade names
5.00
   
3,000
     
(1,450
)
   
1,550
     
3,000
     
(1,849
)
   
1,151
 
Non-compete/Employment contracts
3.90
   
3,333
     
(3,230
)
   
103
     
3,333
     
(3,256
)
   
77
 
Total amortized intangible assets
     
173,763
     
(124,859
   
48,904
     
174,963
     
(130,966
)
   
43,997
 
Deferred Costs:
                                                 
Debt issuance costs
4.00
   
14,923
     
(6,418
   
8,505
     
15,110
     
(7,882
)
   
7,228
 
Unamortized Intangible Assets:
                                                 
Trademarks
     
2,308
     
     
2,308
     
2,308
     
     
2,308
 
 Total Intangible Assets
   
$
190,994
   
$
(131,277
 
$
59,717
   
$
192,381
   
$
(138,848
)
 
$
53,533
 
 
Amortization expense related to limited life intangible assets and debt issuance costs was $3.7 million and $2.7 million for the three months ended September 30, 2014 and 2015, respectively, and $8.3 million and $7.6 million for the nine months ended September 30, 2014 and 2015, respectively.
 
 
18

 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 14 — Comprehensive Income

The table below presents the components of the Company’s comprehensive income for the three and nine months ended September 30, 2014 and 2015 (in thousands):
 
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2014
   
2015
   
2014
   
2015
 
Net Income
 
$
44,069
   
 $
45,845
   
 $
18,711
   
 $
32,584
 
Other comprehensive income (loss):
                               
Foreign currency translation adjustment
   
(248)
     
(1,861)
     
241
     
(1,904)
 
Comprehensive income
 
$
43,821
   
$
43,984
   
$
18,952
   
$
30,680
 

Note 15 — Litigation
 
On July 25, 2013, a purported class action lawsuit was filed in the United States District Court for the Central District of California captioned Melot v. JAKKS Pacific, Inc. et al., Case No. CV13-05388 (JAK) against Stephen G. Berman, Joel M. Bennett (collectively the “Individual Defendants”), and the Company (collectively, “Defendants”). On July 30, 2013, a second purported class action lawsuit was filed containing similar allegations against Defendants captioned Dylewicz v. JAKKS Pacific, Inc. et al., Case No. CV13-5487 (OON). The two cases (collectively, the “Class Action”) were consolidated on December 2, 2013 under Case No. CV13-05388 JAK (SSx) and lead plaintiff and lead counsel appointed. On January 17, 2014, Plaintiff filed a consolidated class action complaint (the “First Amended Complaint”) against Defendants which alleged that the Company violated Section 10(b) of the Securities Exchange Act and Rule 10b-5 promulgated thereunder by making false and/or misleading statements concerning Company financial projections and performance as part of its public filings and earnings calls from July 17, 2012 through July 17, 2013. Specifically, the First Amended Complaint alleged that the Company’s forward looking statements, guidance and other public statements were false and misleading for allegedly failing to disclose (i) certain alleged internal forecasts, (ii) the Company's alleged quarterly practice of laying off and rehiring workers, (iii) the Company's alleged entry into license agreements with guaranteed minimums the Company allegedly knew it was unable to meet; and (iv) allegedly poor performance of the Monsuno and Winx lines of products after their launch. The First Amended Complaint also alleged violations of Section 20(a) of the Exchange Act by Messrs. Berman and Bennett. The First Amended Complaint sought compensatory and other damages in an undisclosed amount as well as attorneys’ fees and pre-judgment and post-judgment interest. The Company filed a motion to dismiss the First Amended Complaint on February 17, 2014, and the motion was granted, with leave to replead. A Second Amended Complaint (“SAC”) was filed on July 8, 2014 and it set forth similar allegations to those in the First Amended Complaint about discrepancies between internal projections and public forecasts and the other allegations except that the claim with respect to guaranteed minimums that the Company allegedly knew it was unable to meet was eliminated. The Company filed a motion to dismiss the SAC and that motion was granted with leave to replead.  A Third Amended Complaint (“TAC”) was filed on March 23, 2015 with similar allegations. The Company filed a motion to dismiss the TAC and that motion was argued on July 22, 2015; after argument it was taken on submission and a decision has not been issued.  The foregoing is a summary of the pleadings and is subject to the text of the pleadings which are on file with the Court.  We believe that the claims in the Class Action are without merit, and we intend to defend vigorously against them. However, because the Class Action is in a preliminary stage, we cannot assure you as to its outcome, or that an adverse decision in such action would not have a material adverse effect on our business, financial condition or results of operations.

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

We are a party to, and certain of our property is the subject of, various pending claims and legal proceedings that routinely arise in the ordinary course of our business, but we do not believe that any of these claims or proceedings will have a material effect on our business, financial condition or results of operations.
 
 
19

 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 16 — Share-Based Payments

The Company’s 2002 Stock Award and Incentive Plan (the “Plan”) provides for the awarding of stock options and restricted stock to employees, officers and non-employee directors. Under the Plan, the Company grants directors, certain executives and other key employees restricted common stock, with vesting contingent upon completion of specified service periods ranging from one to five years. The Company also grants certain executives performance-based awards, with vesting contingent upon the Company’s achievement of specified financial goals. The Plan is more fully described in Notes 15 and 18 to the Consolidated Financial Statements in the Company’s 2014 Annual Report on Form 10-K.

The following table summarizes the total share-based compensation expense and related tax benefits recognized for the three and nine months ended September 30, 2014 and 2015 (in thousands):
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2014
   
2015
   
2014
   
2015
 
Restricted stock compensation expense
 
$
359
   
$
508
   
$
997
   
$
1,452
 
Tax benefit related to restricted stock compensation
 
$
   
$
   
$
   
$
 

 Stock option activity pursuant to the Plan for the nine months ended September 30, 2015 is summarized as follows:
 
   
Plan Stock Options
 
   
Number of
Shares
   
Weighted
Average
Exercise
Price
 
Outstanding and Exercisable, December 31, 2014
   
75,000
   
$
20.69
 
Granted
   
     
 
Exercised
   
     
 
Cancelled
   
(75,000)
     
20.69
 
Outstanding and Exercisable, September 30, 2015
   
   
$
 
 
Restricted stock award activity pursuant to the Plan for the nine months ended September 30, 2015 is summarized as follows:
 
   
Restricted Stock Awards
 
         
Weighted
 
         
Average
 
   
Number of
   
Grant
 
   
Shares
   
Price
 
             
Outstanding, December 31, 2014
    568,057     $ 6.54  
Awarded
    734,822       5.41  
Released
    (80,794 )     7.10  
Forfeited
    (42,930 )     6.32  
Outstanding, September 30, 2015
    1,179,155     $ 5.80  
 
 
20

 
 
 
The following discussion and analysis of financial condition and results of operations should be read together with our Condensed Consolidated Financial Statements and Notes thereto, which appear elsewhere herein.
 
Critical Accounting Policies and Estimates
 
The accompanying consolidated financial statements and supplementary information were prepared in accordance with accounting principles generally accepted in the United States of America. Significant accounting policies are discussed in Note 2 to the Consolidated Financial Statements set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014. 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 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 readily determinable and collectability is probable. Sales are recorded net of sales returns and discounts, which are estimated at the time of shipment based upon historical data. We routinely enter into arrangements with our 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 in which 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.
 
 
21

 
 
Goodwill, Trademarks (net) and Intangible assets amounted to $90.6 million as of September 30, 2015 and $95.7 million as of December 31, 2014.
 
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 over-producing less popular items. Furthermore, significant changes in demand for our products would impact management’s estimates in establishing our inventory provision.
 
Management’s 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.
 
Discrete Items for Income Taxes. A discrete tax expense of $606,000 related to the conclusion of the California income tax audits for the tax years 2008 to 2010, an adjustment in the overpayment account for Wisconsin, and a return to provision adjustment for state taxes was recognized during the nine months ended September 30, 2015. During this same period in 2014, we recognized a discrete tax benefit of $44,000 related to a reduction in the tax reserves resulting from closed statutes of limitation and a discrete tax expense of $15,000 related to a New York State income tax audit.
 
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 as required. Deferred taxes are provided on an asset and liability method, whereby deferred tax assets are recognized as deductible temporary differences and operating loss and tax credit carry-forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax 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.
 
Management employs a threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Tax benefits that are subject to challenge by tax authorities are analyzed and accounted for in the income tax provision. 
 
We accrue a tax reserve for additional income taxes, which may become payable in future years as a result of audit adjustments by tax authorities. The reserve is based upon management’s assessment of all relevant information and is periodically reviewed and adjusted as circumstances warrant. As of September 30, 2015 and December 31, 2014, our income tax reserves were approximately $2.2 million and $2.5 million, respectively. The $2.2 million balance primarily relates to the potential tax settlement in Hong Kong and adjustments in the area of withholding taxes.
 
 
22

 
 
Share-Based Compensation. We grant restricted stock awards to our employees (including officers) and to non-employee directors under our 2002 Stock Award and Incentive Plan (the “Plan”), which incorporated the shares remaining under our Third Amended and Restated 1995 Stock Option Plan. The benefits provided under the Plan are share-based payments. We amortize over a requisite service period, the net total deferred restricted stock expense based upon the fair value of the stock on the date of the grants. In certain instances, the service period may differ from the period in which each award will vest. Additionally, certain groups of grants are subject to an expected forfeiture rate calculation.
 
New Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. In April 2015, the FASB issued for public comment a proposed ASU to defer the effective date of ASU 2014-09 and in July 2015, affirmed its proposal to defer the effective date of the new revenue standard for all entities by one year. The mandatory adoption date of ASC 606 is now January 1, 2018. There are two methods of adoption allowed, either: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). We are currently evaluating the impact of our pending adoption of ASU 2014-09 on our consolidated financial statements and has not yet determined the method by which we will adopt the standard in 2017.

In August 2014, the FASB amended the FASB Accounting Standards Codification and amended Subtopic 205-40, “Presentation of Financial Statements — Going Concern.” This amendment prescribes that an entity’s management should evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. The amendments will become effective for our annual and interim reporting periods beginning January 1, 2017. Upon adoption we will use this guidance to evaluate going concern.
 
In April 2015, the FASB issued Accounting Standards Update 2015-03, “Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs” (“ASU 2015-03”). ASU 2015-03 requires an entity to present debt issuance costs related to a recognized debt liability in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this update. The amendment will be effective for our annual and interim reporting periods beginning January 1, 2016 and should be applied on a retrospective basis. The adoption of ASU 2015-03 will not have any impact on our results of operations, but will result in debt issuance costs being presented as a direct reduction from the carrying amount of debt liabilities. This standard will not have a material impact on our consolidated financial statements.

In August 2015, the FASB issued Accounting Standards Update 2015-15, “Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements” (“ASU 2015-15”). ASU 2015-15 codifies an SEC staff announcement that entities are permitted to defer and present debt issuance costs related to line-of-credit arrangements as assets. The announcements were effective upon issuance. The adoption of ASU 2015-15 does not have any impact on our consolidated financial statements.

In July 2015, the FASB issued Accounting Standards Update 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory” (“ASU 2015-11”). ASU 2015-11 requires inventory accounted for under the FIFO or average cost method to be measured using the lower of cost and net realizable value. The amendments are effective prospectively for fiscal years and for interim periods beginning after December 15, 2016. We are currently evaluating the impact of the pending adoption of ASU 2015-11 on the consolidated financial statements.
 
 
23

 

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

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
  
 
2014
   
2015
   
2014
   
2015
 
                         
Net sales
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%
Cost of sales
   
72.9
     
69.0
     
71.9
     
69.3
 
Gross profit
   
27.1
     
31.0
     
28.1
     
30.7
 
Selling, general and administrative expenses
   
14.6
     
17.7
     
23.8
     
24.3
 
Income from operations
   
12.5
     
13.3
     
4.3
     
6.4
 
Income from joint ventures
   
     
     
0.1
     
0.3
 
Other income
   
1.7
     
1.6
     
1.1
     
1.0
 
Interest income
   
     
     
     
 
Interest expense
   
(1.1
)
   
(0.9
)
   
(1.6
)
   
(1.6
)
Income before provision for income taxes
   
13.1
     
14.0
     
3.9
     
6.1
 
Provision for income taxes
   
0.5
     
0.4
     
0.5
     
0.5
 
Net income
   
12.6
     
13.6
     
3.4
     
5.6
 
Net income (loss) attributable to non-controlling interests
   
     
     
     
 
Net income attributable to JAKKS Pacific, Inc.
   
12.6
%
   
13.6
%
   
3.4
%
   
5.6
%
 
The following unaudited table summarizes, for the periods indicated, certain income statement data by segment (in thousands).
 
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
  
 
2014
   
2015
   
2014
   
2015
 
                         
Net Sales
                       
  Traditional Toys and Electronics
 
$
173,785
   
$
204,332
   
$
258,872
   
$
332,737
 
  Role Play, Novelty and Seasonal Toys
   
175,577
     
132,695
     
297,172
     
249,597
 
     
349,362
     
337,027
     
556,044
     
582,334
 
Cost of Sales
                               
   Traditional Toys and Electronics
   
124,299
     
144,405
     
185,614
     
235,252
 
   Role Play, Novelty and Seasonal Toys
   
130,326
     
88,293
     
214,320
     
168,088
 
     
254,625
     
232,698
     
399,934
     
403,340
 
Gross Profit
                               
   Traditional Toys and Electronics
   
49,486
     
59,927
     
73,258
     
97,485
 
   Role Play, Novelty and Seasonal Toys
   
45,251
     
44,402
     
82,852
     
81,509
 
   
$
94,737
   
$
104,329
   
$
156,110
   
$
178,994
 
 
 
24

 
 
Comparison of the Three Months Ended September 30, 2014 and 2015
 
Net Sales
 
Traditional Toys and Electronics. Net sales of our Traditional Toys and Electronics segment were $204.3 million for the three months ended September 30, 2015 compared to $173.8 million for the prior year period, representing an increase of $30.5 million, or 17.5%. The increase in net sales was primarily driven by an increase in unit sales of Disney Frozen® toddler dolls, Nintendo plush toys and figures, and Star Wars figures.
 
Role Play, Novelty and Seasonal Toys. Net sales of our Role Play, Novelty and Seasonal Toys were $132.7 million for the three months ended September 30, 2015 compared to $175.6 million for the prior year period, representing a decrease of $42.9 million, or 24.4%. The decrease in net sales was primarily due to lower unit sales of Marvel Halloween costumes, and lower unit sales of Frozen® role play and dress-up, and Halloween costumes.
 
Cost of Sales
 
Traditional Toys and Electronics. Cost of sales of our Traditional Toys and Electronics segment was $144.4 million, or 70.7% of related net sales for the three months ended September 30, 2015 compared to $124.3 million, or 71.5% of related net sales for the prior year period, representing an increase of $20.1 million, or 16.2%. The increase in cost of sales is directly a function of higher net sales, while the decrease as a percentage of net sales, year over year, is due to lower cost of goods partially offset by higher royalties and slightly higher depreciation of molds and tooling. The increase in royalties is driven by a shift in the product mix to products with relatively higher royalty rates. Our depreciation of molds and tools for the segment showed a slight increase from 2014 due to increased product tooling driven by new product introductions.
 
Role Play, Novelty and Seasonal Toys. Cost of sales of our Role Play, Novelty and Seasonal Toys segment was $88.3 million, or 66.5% of related net sales for the three months ended September 30, 2015 compared to $130.3 million, or 74.2% of related net sales for the prior year period, representing a decrease of $42.0 million, or 32.2%. The decrease in cost of sales is directly a function of lower net sales. The decrease as a percentage of net sales, year-over-year, is due to improved costing and a lower royalty percentage. The decrease in royalties is driven by a shift in the product mix to products with relatively lower royalty rates. Our depreciation of molds and tools for the segment showed a decline from 2014 due to leveraging of existing tooling.

Selling, General and Administrative Expenses
 
Selling, general and administrative expenses were $59.7 million for the three months ended September 30, 2015 and $50.9 million for the prior year period constituting 17.7% and 14.6% of net sales, respectively. Selling, general and administrative expenses increased by $8.8 million from the prior year period driven by increases in contractual media spend, bonus expense, cooperative advertising, legal and temporary labor.
 
 
25

 
 
Income from joint ventures

We recognized $60,380 of income for funds received in 2015 related to our Pacific Animation Partners’ joint venture.

Other Income

We recognized $5.6 million of income related to the adjustment in the Maui earnout liability resulting from earnout targets not being met in 2015. In 2014 Maui earnout targets were not met and we recognized $5.9 million of income. No Maui earnout liabilities remain after December 31, 2015.
 
Interest Expense
 
Interest expense was $3.1 million in the three months ended September 30, 2015, as compared to $4.0 million in the prior period. The decrease is due to the repayment of our convertible senior notes payable due in 2014.  In the three months ended September 30, 2015, we booked interest expense of $2.7 million related to our convertible senior notes payable due in 2018 and 2020, and $0.4 million related to our revolving credit facility. In the three months ended September 30, 2014, we booked interest expense of $3.7 million related to our convertible senior notes payable due in 2014, 2018 and 2020, $0.2 million related to our revolving credit facility, $0.1 million related to the interest component of our Maui acquisition earn out payment
 
Provision for Income Taxes
 
Our income tax expense, which includes federal, state and foreign income taxes and discrete items, was $1.4 million, or an effective tax rate of 2.9%, for the three months ended September 30, 2015. During the comparable period in 2014, our income tax expense was $1.7 million, or an effective tax rate of 3.8%.

 
 Comparison of the Nine Months Ended September 30, 2014 and 2015
 
Net Sales
 
Traditional Toys and Electronics. Net sales of our Traditional Toys and Electronics segment were $332.7 million for the nine months ended September 30, 2015 compared to $258.9 million for the prior year period, representing an increase of $73.8 million, or 28.5%. The increase in net sales was primarily driven by an increase in unit sales of Disney Frozen® toddler dolls, Nintendo plush toys and figures, Star Wars figures, Disney Princess dolls, Cinderella and Fairies, Funnoodle water toys and licensed foot-to-floor ride-ons and wagons.
 
Role Play, Novelty and Seasonal Toys. Net sales of our Role Play, Novelty and Seasonal Toys were $249.6 million for the nine months ended September 30, 2015 compared to $297.2 million for the prior year period, representing a decrease of $47.6 million, or 16.0%. The decrease in net sales was primarily driven by lower unit sales of Marvel Halloween costumes, and lower unit sales of Frozen® role play and dress-up, and Halloween costumes.
 
Cost of Sales
 
Traditional Toys and Electronics. Cost of sales of our Traditional Toys and Electronics segment was $235.3 million, or 70.7% of related net sales for the nine months ended September 30, 2015 compared to $185.6 million, or 71.7% of related net sales for the prior year period, representing an increase of $49.7 million, or 26.8%. The increase in cost of sales is directly a function of higher net sales, while the decrease as a percentage of net sales is due to savings in product costing, offset in part by higher royalties in the first nine months of 2015 compared to the prior year. The increase in royalties is driven by a shift in the product mix to products with relatively higher royalty rates. Our depreciation of molds and tools for the segment showed a slight increase from 2014 due an increase in products.
 
Role Play, Novelty and Seasonal Toys. Cost of sales of our Role Play, Novelty and Seasonal Toys segment was $168.1 million, or 67.3% of related net sales for the nine months ended September 30, 2015 compared to $214.3 million, or 72.1% of related net sales for the prior year period, representing a decrease of $46.2 million, or 21.6%. The decrease in cost of sales is directly a function of lower net sales, while the decrease as a percentage of net sales is due to savings in product costing in 2015, lower royalties and competitively priced products sold in 2014. The decrease in royalties is driven by the drop-off of the Marvel license and shift in the product mix to products with relatively lower royalty rates. Our depreciation of molds and tools for the segment showed a decrease from 2014 due to lower unit sales.

Selling, General and Administrative Expenses
 
Selling, general and administrative expenses were $141.6 million for the nine months ended September 30, 2015 and $132.0 million for the same period in 2014 constituting 24.3% and 23.8% of net sales, respectively. Selling, general and administrative expenses increased by $9.6 million from the prior year period primarily due to higher bonus expense, higher temporary labor cost, and higher expenses related to the move into new corporate offices in 2015, as well as increases in contractual media spend, cooperative advertising and legal expense.
 
 
26

 
 
Income from joint ventures

We recognized $1.7 million of income for funds received in 2015 related to our former video game joint venture in partial settlement of amounts owed to the Company when our joint venture partner was liquidated pursuant to their 2012 bankruptcy filing. It is not known if any additional funds will be received by us.

Other Income

We recognized $5.6 million of income related to the adjustment in the Maui earnout liability resulting from earnout targets not being met in 2015. In 2014 Maui earnout targets were not met and we recognized $5.9 million of income. No Maui earnout liabilities remain after December 31, 2015.
  
Interest Income
 
Interest income was $0.1 million for the nine months ended September 30, 2015 and 2014.

Interest Expense
 
Interest expense was $9.2 million in the nine months ended September 30, 2015, as compared to $9.2 million in the prior period. In the nine months ended September 30, 2015, we booked interest expense of $8.5 million related to our convertible senior notes payable due in 2018 and 2020 and $0.7 million related to our revolving credit facility. In the nine months ended September 30, 2014, we booked interest expense of $8.2 million related to our convertible senior notes payable due in 2014, 2018 and 2020, $0.6 million related to our revolving credit facility, $0.2 million related to the interest component of our Maui acquisition earn out payment and $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 $3.1 million, or an effective tax rate of 8.7%, for the nine months ended September 30, 2015. During the comparable period in 2014, our income tax expense was $2.5 million, or an effective tax rate of 11.9%.
 
 
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Seasonality and Backlog
 
The retail toy industry is inherently seasonal. Generally, our sales have been highest during the third and fourth quarters, and collections for those sales have been highest during the succeeding fourth and first quarters. Our working capital needs have been highest during the third and fourth quarters.
 
While we have taken steps to level sales over the entire year, sales are expected to remain heavily influenced by the seasonality of our toy and Halloween products. The result of these seasonal patterns is that operating results and the demand for working capital may vary significantly by quarter. Orders placed with us are generally cancelable until the date of shipment. The combination of seasonal demand and the potential for order cancellation makes accurate forecasting of future sales difficult and causes us to believe that backlog may not be an accurate indicator of our future sales. Similarly, financial results for a particular quarter may not be indicative of results for the entire year.

Liquidity and Capital Resources

As of September 30, 2015 we had working capital of $271.6 million, compared to $246.2 million as of December 31, 2014. The increase was primarily attributable to operating income for the nine months ended September 30, 2015 and a seasonably higher accounts receivable balance, partially offset by a higher accounts payable balance.
 
    Operating activities provided net cash of $10.1 million in the nine months ended September 30, 2015, as compared to using net cash of $105.2 million in the prior year period. Net cash was primarily impacted by an increase in accounts receivable and a decrease in accrued expenses, partially offset by an increase in accounts payable.  Our accounts receivable turnover as measured by days sales for the quarter outstanding in accounts receivable was 80 days as of September 30, 2015, compared to 80 days as of September 30, 2014. 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 September 30, 2015, we had cash and cash equivalents of $81.2 million.
 
    Our investing activities used net cash of $18.4 million in the nine months ended September 30, 2015, as compared to $7.9 million in the prior year period, consisting primarily of cash paid for leasehold improvements and furniture for our new corporate headquarters ($5.5 million) and the purchase of molds and tooling used in the manufacture of our products ($8.1 million). As of September 30, 2015, we received $3.0 million in reimbursements for tenant improvements and have received an additional $0.3 million in October 2015. Such reimbursements are treated as free rent for accounting purposes and amortized over the term of the lease. 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 16% payable on net sales of such products. As of September 30, 2015, these agreements required future aggregate minimum guarantees of $77.8 million, exclusive of $17.5 million in advances already paid. Of this $77.8 million future minimum guarantee, $29.1 million is due over the next twelve months.
 
    Our financing activities provided net cash of $17.8 million in the nine months ended September 30, 2015, as compared to providing $84.6 million of cash in the prior year period, primarily consisting of proceeds from credit facility borrowings.
 
 
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In July 2012, we acquired all of the stock of Maui, Inc., an Ohio corporation, and related entities (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 the acquisition date. All future changes to the earn-out liability will be credited to income. Maui did not achieve the prescribed earn-out targets for 2013 and 2014, therefore, $6.0 million and $5.9 million, respectively, was credited to other income in the fourth quarter of 2013 and the third quarter of 2014, respectively. In addition, as of September 30, 2015, it was determined that Maui will not achieve the prescribed earn-out targets for 2015, accordingly, $5.6 million was credited to income in the third quarter of 2015. 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 March 2014, we, and our domestic subsidiaries, entered into a secured credit facility with General Electric Capital Corporation (the “GE Loan Agreement”). The GE Loan Agreement, as amended, provides for a $75.0 million revolving credit facility subject to availability based on prescribed advance rates on certain accounts receivable and inventory. The amounts outstanding under the revolving credit facility are payable in full upon maturity of the revolving credit facility on March 27, 2019. The revolving credit facility is secured by a security interest in favor of the lender covering a substantial amount of the assets of the Company. As of September 30, 2015, the amount outstanding borrowings on the revolving credit facility are $25.0 million and outstanding stand-by letters of credit totaled $8.1 million; the total excess borrowing capacity was approximately $9.4 million.
 
 
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In November 2009, we sold an aggregate principal amount of $100.0 million of 4.50% Convertible Senior Notes (the “2014 Notes”) due 2014. The 2014 Notes, which were senior unsecured obligations and paid interest semi-annually at a rate of 4.50% per annum matured on November 1, 2014. The Company repurchased $61.0 million of the 2014 Notes during the quarter ended September 30, 2013 and as of November 1, 2014, we paid the outstanding balance of $39.0 million related to the 2014 Notes.

In July 2013, we sold an aggregate of $100.0 million principal amount of 4.25% Convertible Senior Notes due 2018 (the “2018 Notes”). The 2018 Notes, which are senior unsecured obligations, pay interest semi-annually in arrears on August 1 and February 1 of each year at a rate of 4.25% per annum and will mature on August 1, 2018. The initial conversion rate for the 2018 Notes will be 114.3674 shares of our common per $1,000 principal amount of notes, equivalent to an initial conversion price of approximately $8.74 per share of common stock, subject to adjustment in certain events. Upon conversion, the 2018 Notes will be settled in shares of the Company’s common stock. Holders of the 2018 Notes may require us to repurchase for cash all or some of their notes upon the occurrence of a fundamental change (as defined in the 2018 Notes). We used $61.0 million of the approximate $96.0 million in net proceeds from the offering to repurchase at par $61.0 million principal amount of 2014 Notes. The remainder of the net proceeds will be used for general corporate purposes.

In June 2014, the Company sold an aggregate of $115.0 million principal amount of 4.875% Convertible Senior Notes due 2020 (the “2020 Notes”). The 2020 Notes are senior unsecured obligations of the Company paying interest semi-annually in arrears on June 1 and December 1 of each year at a rate of 4.875% per annum and will mature on June 1, 2020. The initial conversion rate for the 2020 Notes is 103.7613 shares of our common per $1,000 principal amount of notes, equivalent to an initial conversion price of approximately $9.64 per share of common stock, subject to adjustment in certain events. Upon conversion, the 2020 Notes will be settled in shares of the Company’s common stock. Holders of the 2020 Notes may require us to repurchase for cash all or some of their notes upon the occurrence of a fundamental change (as defined in the 2020 Notes). The Company received net proceeds of approximately $110.4 million from the offering of which $24.0 million was used to repurchase 3.1 million shares of the Company’s common stock under a prepaid forward purchase contract and $39.0 million was used to redeem the remaining outstanding principal amount of the 2014 Notes at maturity. The remainder of the net proceeds will be used for general corporate purposes.

We believe that our cash flows from operations, cash and cash equivalents on hand and the availability under our credit facility 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. Although operating activities are expected to provide cash, to the extent we grow significantly in the future and due to the seasonality of our business, 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. As of December 31, 2014 and September 30, 2015, we held cash and short term investments held by our foreign subsidiaries of $60.8 million and $70.6 million, respectively. Although a significant portion of our cash is held by our foreign subsidiaries off-shore, we intend to finance our long-term liquidity requirements out of net cash provided by operations and net cash and cash equivalents and availability under our credit facility. As of September 30, 2015, we do not have any off-balance sheet arrangements.
 
 
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Interest Rate Risk
 
We issued convertible senior notes in principal amount of $100.0 million with a fixed interest rate of 4.25% per annum in July 2013 and $115.0 million principal amount of senior notes with a fixed interest rate of 4.875% per annum in June 2014, all of which remain outstanding as of September 30, 2015. Accordingly, we are not generally subject to any direct risk of loss arising from changes in interest rates on these issuances.

Our exposure to market risk includes interest rate fluctuations in connection with our revolving credit facility (see Note 5 - Credit Facility in the accompanying notes to the consolidated financial statements for additional information). Borrowings under the revolving credit facility bear interest at a variable rate based on Prime Lending Rate or LIBOR Rate at the option of the Company. For Prime Lending Rate loans, the interest rate is equal to the highest of (i) the Federal Funds Rate plus a margin of 0.50%, (ii) the rate last quoted by The Wall Street Journal as the “Prime Rate,” or (iii) the sum of a LIBOR rate plus 1.00%, plus a margin of 2.25%. For LIBOR rate loans, the interest rate is equal to a LIBOR rate plus a margin of 2.25%. Borrowings under the revolving credit facility are therefore subject to risk based upon prevailing market interest rates. Interest rate risk may result from many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors that are beyond our control. During the nine months ended September 30, 2015, the maximum amount borrowed under the revolving credit facility was $25.0 million and the average amount of borrowings outstanding was $5.0 million. As of September 30, 2015, the amount of total borrowings outstanding under the revolving credit facility was $25.0 million. If the prevailing market interest rates relative to these borrowings increased by 10%, our interest expense during the period ended September 30, 2015 would have increased by less than $0.1 million.
 
Foreign Currency Risk
 
We have wholly-owned subsidiaries in Hong Kong, China, Canada, Spain, France and the United Kingdom. Sales made by the Hong Kong subsidiaries are denominated in U.S. dollars. However, purchases of inventory are typically denominated in Hong Kong dollars or Chinese Yuan and local operating expenses are denominated in the local currency of the subsidiary, thereby creating exposure to changes in exchange rates. Changes in the local currency/U.S. dollar exchange rates may positively or negatively affect our operating results. 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, and, 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 relative to the U.S. dollar. Our subsidiaries in the United Kingdom, Spain and France have limited operations and, therefore, we have a nominal currency translation risk at this time.
 
 
Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Report, have concluded that as of that date, our disclosure controls and procedures were effective. There has been no change in our internal control over financial reporting identified in connection with the evaluation required by Exchange Act Rule 13a-15(d) that occurred during the period covered by this Report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
 
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On July 25, 2013, a purported class action lawsuit was filed in the United States District Court for the Central District of California captioned Melot v. JAKKS Pacific, Inc. et al., Case No. CV13-05388 (JAK) against Stephen G. Berman, Joel M. Bennett (collectively the “Individual Defendants”), and the Company (collectively, “Defendants”). On July 30, 2013, a second purported class action lawsuit was filed containing similar allegations against Defendants captioned Dylewicz v. JAKKS Pacific, Inc. et al., Case No. CV13-5487 (OON). The two cases (collectively, the “Class Action”) were consolidated on December 2, 2013 under Case No. CV13-05388 JAK (SSx) and lead plaintiff and lead counsel appointed. On January 17, 2014, Plaintiff filed a consolidated class action complaint (the “First Amended Complaint”) against Defendants which alleged that the Company violated Section 10(b) of the Securities Exchange Act and Rule 10b-5 promulgated thereunder by making false and/or misleading statements concerning Company financial projections and performance as part of its public filings and earnings calls from July 17, 2012 through July 17, 2013. Specifically, the First Amended Complaint alleged that the Company’s forward looking statements, guidance and other public statements were false and misleading for allegedly failing to disclose (i) certain alleged internal forecasts, (ii) the Company's alleged quarterly practice of laying off and rehiring workers, (iii) the Company's alleged entry into license agreements with guaranteed minimums the Company allegedly knew it was unable to meet; and (iv) allegedly poor performance of the Monsuno and Winx lines of products after their launch. The First Amended Complaint also alleged violations of Section 20(a) of the Exchange Act by Messrs. Berman and Bennett. The First Amended Complaint sought compensatory and other damages in an undisclosed amount as well as attorneys’ fees and pre-judgment and post-judgment interest. The Company filed a motion to dismiss the First Amended Complaint on February 17, 2014, and the motion was granted, with leave to replead. A Second Amended Complaint (“SAC”) was filed on July 8, 2014 and it set forth similar allegations to those in the First Amended Complaint about discrepancies between internal projections and public forecasts and the other allegations except that the claim with respect to guaranteed minimums that the Company allegedly knew it was unable to meet was eliminated. The Company filed a motion to dismiss the SAC and that motion was granted with leave to replead.  A Third Amended Complaint (“TAC”) was filed on March 23, 2015 with similar allegations. The Company filed a motion to dismiss the TAC and that motion was argued on July 22, 2015; after argument it was taken on submission and a decision has not been issued.  The foregoing is a summary of the pleadings and is subject to the text of the pleadings which are on file with the Court.  We believe that the claims in the Class Action are without merit, and we intend to defend vigorously against them. However, because the Class Action is in a preliminary stage, we cannot assure you as to its outcome, or that an adverse decision in such action would not have a material adverse effect on our business, financial condition or results of operations.

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

We are a party to, and certain of our property is the subject of, various pending claims and legal proceedings that routinely arise in the ordinary course of our business, but we do not believe that any of these claims or proceedings will have a material effect on our business, financial condition or results of operations.
 
 
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From time to time, including in this Quarterly Report on Form 10-Q, we publish forward-looking statements, as disclosed in our Disclosure Regarding Forward-Looking Statements beginning immediately following the Table of Contents of this 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 Report 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:

 
age compression: 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;
     
 
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; or
     
 
our inclusion of new technology will result in higher sales or increased profits.
 
Our failure to achieve any or all of the foregoing benchmarks may adversely affect our business, financial condition and results of operations.
 
The failure of our character-related and theme-related products to become and/or remain popular with children may materially and adversely impact our business, financial condition and results of operations.
 
The success of many of our character-related and theme-related products depends upon the popularity of characters in movies, television programs, auto racing events and other media. We cannot assure you that:
 
 
media associated with our character-related and theme-related product lines will be released at the times we expect or will be successful;
     
 
the success of media associated with our existing character-related and theme-related product lines will result in substantial promotional value to our products;
 
 
we will be successful in renewing licenses upon expiration on terms that are favorable to us; or
     
 
we will be successful in obtaining licenses to produce new character-related and theme-related products in the future.
 
Our failure to achieve any or all of the foregoing benchmarks may cause the infrastructure of our operations to fail, thereby adversely affecting our business, financial condition and results of operations. 
 
 
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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.
 
 
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We may not be able to sustain or manage our product line growth, which may prevent us from increasing our net revenues.

Historically, we have experienced growth in our product lines through acquisitions of businesses, products and licenses. This growth in product lines has contributed significantly to our total revenues over the last few years. For example, revenues associated with companies we acquired since 2008 were approximately $422.2 million for the year ended December 31, 2014, and $351.1 million for the nine months ended September 30, 2015, respectively, representing 52.1% and 60.3% of our total revenues for those periods. As a result, comparing our period-to-period operating results may not be meaningful and results of operations from prior periods may not be indicative of future results. We cannot assure you that we will continue to experience growth in, or maintain our present level of, net sales.

Our growth strategy calls for us to continuously develop and diversify our toy business by acquiring other companies, entering into additional license agreements, refining our product lines and expanding into international markets, which will place additional demands on our management, operational capacity and financial resources and systems. The increased demand on management may necessitate our recruitment and retention of qualified management personnel. We cannot assure you that we will be able to recruit and retain qualified personnel or expand and manage our operations effectively and profitably. To effectively manage future growth, we must continue to expand our operational, financial and management information systems and 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 with 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;
     
 
failure of an acquired business to achieve projected financial results; and
     
 
limited capital to finance acquisitions.
 
 
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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 47.4% and 41.8% of our net sales for the year ended December 31, 2014 and the nine months ended September 30, 2015, respectively. 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 Mr. Berman’s services 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, dies 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. Product defects could lead to recalls and personal injury claims which could be costly and harmful to our business reputation.
 
We do not have long-term contracts with our third-party manufacturers. Although we believe we could secure other third-party manufacturers to produce our products, our operations would be adversely affected if we lost our relationship with any of our current suppliers or if our current suppliers’ operations or sea or air transportation with our overseas manufacturers were disrupted or terminated even for a relatively short period of time. Our tools, dies and molds are located at the facilities of our third-party manufacturers.

Although we do not purchase the raw materials used to manufacture our products, we are potentially subject to variations in the prices we pay our third-party manufacturers for products, depending upon what they pay for their raw materials.
 
 
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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, 2014 and nine months ended September 30, 2015, sales to our international customers comprised approximately 19.3% and 28.4%, respectively, 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:

 
currency conversion risks and currency fluctuations;
     
 
limitations, including taxes, on the repatriation of earnings;
     
 
political instability, civil unrest and economic instability;
     
 
greater difficulty enforcing intellectual property rights and weaker laws protecting such rights;
     
 
complications in complying with laws in varying jurisdictions and changes in governmental policies;
     
 
greater difficulty and expenses associated with recovering from natural disasters, such as earthquakes, hurricanes and floods;
     
 
transportation delays and interruptions;
     
 
the potential imposition of tariffs; and