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EX-32.2 - EXHIBIT 32.2 - JAKKS PACIFIC INCa51771406ex32_2.htm
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EX-31.2 - EXHIBIT 31.2 - JAKKS PACIFIC INCa51771406ex31_2.htm
EX-31.1 - EXHIBIT 31.1 - JAKKS PACIFIC INCa51771406ex31_1.htm
EX-23.1 - EXHIBIT 23.1 - JAKKS PACIFIC INCa51771406ex23_1.htm
EX-21 - EXHIBIT 21 - JAKKS PACIFIC INCa51771406ex21.htm
EX-10.8.5 - EXHIBIT 10.8.5 - JAKKS PACIFIC INCa51771406ex10_85.htm

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



FORM 10-K
 
(Mark One)
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Fiscal Year Ended December 31, 2017
 
 
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ____________ to ____________
 
Commission File Number 0-28104
 
JAKKS PACIFIC, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
95-4527222
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
 
2951 28th St.
 
Santa Monica, California
90405
(Address of principal executive offices)
(Zip Code)
 
Registrant’s telephone number, including area code: (424) 268-9444
 
Securities registered pursuant to Section 12(b) of the Exchange Act:
 
Title of each class
Name of each exchange
on which registered
Common Stock, $.001 par value per share
Nasdaq Global Select
 
Securities registered pursuant to Section 12(g) of the Exchange Act:
 
Title of Class
 
Common Stock, $.001 par value per share
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes     No  
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 of the Act.  Yes      No  
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes  x    No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x    No  o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (check one):
 
    Large Accelerated Filer
    Accelerated Filer
    Non-Accelerated Filer
    Smaller Reporting Company
☐    Emerging growth company
  
  
(Do not check if a Smaller Reporting Company)
  
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o    No  x
 
The aggregate market value of the voting and non-voting common equity (the only such common equity being Common Stock, $.001 par value per share) held by non-affiliates of the registrant (computed by reference to the closing sale price of the Common Stock on June 30, 2017 of $4.00) is $107,392,952.
 
The number of shares outstanding of the registrant’s Common Stock, $.001 par value (being the only class of its common stock), is 29,159,324 as of March 15, 2018.
 
Documents Incorporated by Reference
 
None.


1

 
JAKKS PACIFIC, INC.
 
INDEX TO ANNUAL REPORT ON FORM 10-K
 
For the Fiscal Year ended December 31, 2017
 
Items in Form 10-K
 
 
 
Page
 
PART I
 
3
12
Item 1B.
Unresolved Staff Comments
None
18
19
20
 
PART II
 
21
24
26
36
37
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None
72
Item 9B.
Other Information
None
 
PART III
 
74
79
99
101
101
 
PART IV
 
103
105
 
106
Certifications
 
 
 
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
 
This report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. For example, statements included in this report regarding our financial position, business strategy and other plans and objectives for future operations, and assumptions and predictions about future product demand, supply, manufacturing, costs, marketing and pricing factors are all forward-looking statements. When we use words like “intend,” “anticipate,” “believe,” “estimate,” “plan” or “expect,” we are making forward-looking statements. We believe that the assumptions and expectations reflected in such forward-looking statements are reasonable, based upon information available to us on the date hereof, but we cannot assure you that these assumptions and expectations will prove to have been correct or that we will take any action that we may presently be planning. We have disclosed certain important factors that could cause our actual results to differ materially from our current expectations elsewhere in this report. You should understand that forward-looking statements made in this report are necessarily qualified by these factors. We are not undertaking to publicly update or revise any forward-looking statement if we obtain new information or upon the occurrence of future events or otherwise.
 

2

 
PART I
 
Item 1.  Business
 
In this report, “JAKKS,” the “Company,” “we,” “us” and “our” refer to JAKKS Pacific, Inc., its subsidiaries and our majority owned joint venture.
 
Company Overview
 
We are a leading multi-line, multi-brand toy company that designs, produces, markets and distributes toys and related products, consumables and related products, electronics and related products, kids indoor and outdoor furniture, and other consumer products. We focus our business on acquiring or licensing well-recognized trademarks and brand names, most with long product histories (“evergreen brands”). We seek to acquire these evergreen brands because we believe they are less subject to market fads or trends. We also develop proprietary products marketed under our own trademarks and brand names, and have historically acquired complementary businesses to further grow our portfolio. For accounting purposes, our products have been divided into three segments: (i) U.S. and Canada, (ii) International and (iii) Halloween. Segment information with respect to revenues, assets and profits or losses attributable to each segment is contained in Note 3 to the audited consolidated financial statements contained below in Item 8. Our products include:
 
Traditional Toys and Electronics
 
Action figures and accessories, including licensed characters, principally based on Batman®, Star Wars® and Nintendo® franchises;
 
 
Toy vehicles, including Max Tow®, Road Champs®, Fly Wheels® and MXS® toy vehicles and accessories;
   
Dolls and accessories, including small dolls, large dolls, fashion dolls and baby dolls based on licenses, including Disney’s Frozen, Disney Princess, Disney Fairies, infant and pre-school toys based on PBS’s Daniel Tiger’s Neighborhood®;
 
 
Private label products as “exclusives” for a myriad of retail customers in many product categories; and
 
 
Foot-to-floor ride-on toys based on Fisher Price®, Kawasaki®, and DC Comics®, inflatable environments, tents and wagons.
 
 
 
Role Play, Novelty and Seasonal Toys
 
Role play, dress-up, pretend play and novelty products for boys and girls based on well-known brands and entertainment properties such as Disney’s Frozen, Black & Decker®, McDonald’s®, Disney Princess and Disney Fairies, as well as those based on our own proprietary brands;
 
 
Indoor and outdoor kids’ furniture, activity trays and tables and room décor; kiddie pools, seasonal and outdoor products, including those based on Crayola®, Disney characters and more, and Funnoodle® pool floats;
 
 
Halloween and everyday costumes for all ages based on licensed and proprietary non-licensed brands, including Spiderman®, Toy Story, Sesame Street®, Power Rangers®¸Hasbro® brands and Disney’s Frozen, Disney Princess and related Halloween accessories; and
 
 
Junior sports and outdoor activity toys including Skyball® hyper-charged balls and sport sets and Wave Hoops® toy hoops marketed under our Maui ® brand.
 
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We continually review the marketplace to identify and evaluate popular and evergreen brands and product categories that we believe have the potential for growth. We endeavor to generate growth within these lines by:
 
 
creating innovative products under our established licenses and brand names;
 
 
adding new items to the branded product lines that we expect will enjoy greater popularity;
 
 
infusing innovation and technology when appropriate to make them more appealing to today’s kids; and
 
 
focusing our marketing efforts to enhance consumer recognition and retailer interest.
 
Our Business Strategy
 
In addition to developing our own proprietary brands and marks, licensing popular trademarks enables us to use these high-profile marks at a lower cost than we would incur if we purchased these marks or developed comparable marks on our own. By licensing trademarks, we have access to a far greater range of marks than would be available for purchase. We also license technology developed by unaffiliated inventors and product developers to enhance the design and functionality of our products.
 
We sell our products through our in-house sales staff and independent sales representatives to toy and mass-market retail chain stores, department stores, office supply stores, drug and grocery store chains, club stores, toy specialty stores and wholesalers. Our three largest customers are Wal-Mart, Target and Toys ‘R’ Us, which accounted for approximately 25.5%, 17.8% and 11.3%, respectively, of our net sales in 2017. No other customer accounted for more than 10.0% of our net sales in 2017.
 
Our Growth Strategy
 
 In 2016 and 2017, we generated net sales of $706.6 million and $613.1 million, respectively, and net income of $1.2 million in 2016 and a net loss of $83.1 million in 2017. Key elements of our growth strategy include:
 
●       Expand Core Products. We manage our existing and new brands through strategic product development initiatives, including introducing new products, modifying existing products and extending existing product lines to maximize their longevity. Our marketing teams and product designers strive to develop new products or product lines to offer added technological, aesthetic and functional improvements to our extensive portfolio.
 
●       Enter New Product Categories. We use our extensive experience in the toy and other consumer product industries to evaluate products and licenses in new product categories and to develop additional product lines. We began marketing licensed classic video games for simple plug-in use with television sets and expanded into several related categories by infusing additional technologies such as motion gaming and through the licensing of this category from our current licensors, such as Disney and Viacom which owns Nickelodeon®.
 
●      Pursue Strategic Acquisitions. We supplement our internal growth with selected strategic acquisitions. In October 2016, we acquired the operating assets of the C’est Moi™ performance makeup and youth skincare product lines whose distribution is limited primarily to Asia. We expect to launch a full line of makeup and skincare products branded under the C’est Moi name in the U.S. and Canada in the first quarter of 2018. We will continue focusing our acquisition strategy on businesses or brands that we believe have compatible product lines and/or offer valuable trademarks or brands.
4

●       Acquire Additional Character and Product Licenses. We have acquired the rights to use many familiar brand and character names and logos from third parties that we use with our primary trademarks and brands. Currently, among others, we have license agreements with Nickelodeon®, Disney and Warner Bros.®, as well as with the licensors of the many popular licensed children’s characters previously mentioned, among others. We intend to continue to pursue new licenses from these entertainment and media companies and other licensors. We also intend to continue to purchase additional inventions and product concepts through our existing network of inventors and product developers.
 
●       Expand International Sales. We believe that foreign markets, especially Europe, Australia, Canada, Latin America and Asia, offer us significant growth opportunities. In 2017, our sales generated outside the United States were approximately $134.0 million, or 21.9% of total net sales. We intend to continue to expand our international sales and further expand distribution agreements in Europe to capitalize on our experience and our relationships with foreign distributors and retailers. We expect these initiatives to contribute to our international growth in 2018.
 
●       Capitalize On Our Operating Efficiencies. We believe that our current infrastructure and operating model can accommodate growth without a proportionate increase in our operating and administrative expenses, thereby increasing our operating margins.
 
The execution of our growth strategy, however, is subject to several risks and uncertainties and we cannot assure you that we will continue to experience growth in, or maintain our present level of net sales (see “Risk Factors,” in Item 1A). For example, our growth strategy will place additional demands upon our management, operational capacity and financial resources and systems. The increased demand upon management may necessitate our recruitment and retention of additional qualified management personnel. We cannot assure you that we will be able to recruit and retain qualified personnel or expand and manage our operations effectively and profitably. To effectively manage future growth, we must continue to expand our operational, financial and management information systems and to train, motivate and manage our work force. While we believe that our operational, financial and management information systems will be adequate to support our future growth, no assurance can be given they will be adequate without significant investment in our infrastructure. Failure to expand our operational, financial and management information systems or to train, motivate or manage employees could have a material adverse effect on our business, financial condition and results of operations.
 
Moreover, implementation of our growth strategy is subject to risks beyond our control, including competition, market acceptance of new products, changes in economic conditions, our ability to obtain or renew licenses on commercially reasonable terms and our ability to finance increased levels of accounts receivable and inventory necessary to support our sales growth, if any.
 
Furthermore, we cannot assure you that we can identify attractive acquisition candidates or negotiate acceptable acquisition terms, and our failure to do so may adversely affect our results of operations and our ability to sustain growth.
 
Finally, our acquisition strategy involves a number of risks, each of which could adversely affect our operating results, including difficulties in integrating acquired businesses or product lines, assimilating new facilities and personnel and harmonizing diverse business strategies and methods of operation; diversion of management attention from operation of our existing business; loss of key personnel from acquired companies; and failure of an acquired business to achieve targeted financial results.
 

5

Industry Overview
 
According to Toy Industry Association, Inc., the leading toy industry trade group, the United States is the world’s largest toy market, followed by Japan and Western Europe. Total retail sales of toys, excluding video games, in the United States, were approximately $20.7 billion in 2017. We believe the two largest United States toy companies, Mattel and Hasbro, collectively hold a dominant share of the domestic non-video toy market. In addition, hundreds of smaller companies compete in the design and development of new toys, the procurement of character and product licenses, and the improvement and expansion of previously introduced products and product lines.
 
Over the past few years, the toy industry has experienced substantial consolidation among both toy companies and toy retailers. We believe that the ongoing consolidation of toy companies provides us with increased growth opportunities due to retailers’ desire to not be entirely dependent upon a few dominant toy companies. Retailer concentration also enables us to ship products, manage account relationships and track point of sale information more effectively and efficiently.
 
Products
 
We focus our business on acquiring or licensing well-recognized trademarks or brand names, and we seek to acquire evergreen brands which are less subject to market fads or trends. Generally, our license agreements for products and concepts call for royalties ranging from 1% to 21% of net sales, and some may require minimum guarantees and advances. Our principal products include:
 
Traditional Toys
 
Wheels Products
 
Motorized and plastic toy vehicles and accessories.
 
Our extreme sports offerings include our MXS® line of motorcycles with generic and well-known riders and other vehicles include off-road vehicles and skateboards, which are sold individually and with playsets and accessories. In 2014, we launched our proprietary line of motorized vehicles under the brand Max Tow®, and in 2015, we expanded the product line to include higher performance versions as well as mini size vehicles and play sets under the Max Tow®Mini line. In 2017, we launched Real Workin’ Buddies™ with Mr. Dusty, the talking cleaning dump truck.
 
Action Figures and Accessories
 
We currently develop, manufacture and distribute other action figures and action figure accessories including those based on Star Wars® and Batman®, capitalizing on the expertise we built in the action figure category.
 
Our line of Big-Figs™ large scale action figures features an assortment of 20” figures, 31” figures, and 48” figures of characters including Superman®, Power Rangers®, Star Wars® and Teenage Mutant Ninja Turtles®.

6

Dolls
 
Dolls and accessories include small dolls, large dolls, fashion dolls and baby dolls based on licenses, including Disney’s Frozen, Disney Princess, Disney Fairies, including an extensive line of baby doll accessories that emulate real baby products that mothers today use; plush, infant and pre-school toys, and private label fashion dolls for other retailers and sold to Disney Stores and Disney Parks and Resorts. In 2016, we launched lines of dolls based on Disney’s animated feature Moana and animated television series Elena of Avalor.
 
Role Play, Novelty & Seasonal
 
Role Play and Dress-up Products
 
Our line of role play and dress-up products for boys and girls features entertainment and consumer products properties such as Disney’s Frozen, Disney Princess, Disney Fairies, Moana, Elena of Avalor and Black & Decker®. These products generated a significant amount of sales in 2015, 2016 and 2017.
 
Seasonal/ Outdoor Products
 
We have a wide range of seasonal toys and outdoor and leisure products including our Maui® line of proprietary products including Sky Ball®, Sky Bouncer® and Wave Hoop® among other outdoor toys. Our Funnoodle® pool toys include basic Funnoodle® pool floats and a variety of other pool toys.
 
Indoor and Outdoor Kids’ Furniture
 
We produce an extensive array of licensed indoor and outdoor kids' furniture and activity tables, and room decor. Our licensed portfolio includes character licenses, including Crayola®, Disney Princess, Toy Story, Mickey Mouse, Paw Patrol®, and others. Products include children’s puzzle furniture, tables and chairs to activity sets, trays, stools and a line of licensed molded kiddie pools, among others.
 
Halloween and Everyday Costume Play
 
We produce an expansive and innovative line of Halloween costumes and accessories which includes a wide range of non-licensed Halloween costumes such as horror, pirates, historical figures and aliens to animals, vampires, angels and more, as well as popular licensed characters from top intellectual property owners including Disney, Hasbro®, Sesame Workshop®, Mattel®, and many others. In 2016, we launched new licenses including Lego® brands.

7

Sales, Marketing and Distribution
 
We sell all of our products through our own in-house sales staff and independent sales representatives to toy and mass-market retail chain stores, department stores, office supply stores, drug and grocery store chains, club stores, toy specialty stores and wholesalers. Our three largest customers are Wal-Mart, Target and Toys ‘R’ Us, which accounted for approximately 54.9% of our net sales in 2016 and 54.6% of our net sales in 2017. We generally sell products to our customers pursuant to letters of credit or, in some cases, on open account with payment terms typically varying from 30 to 90 days. From time to time, we allow our customers credits against future purchases from us in order to facilitate their retail markdown and sales of slow-moving inventory. We also sell our products through e-commerce sites, including Walmart.com, Target.com, Toysrus.com and Amazon.com.
 
We contract the manufacture of most of our products to unaffiliated manufacturers located in The People’s Republic of China (“China”). We sell the finished products on a letter of credit basis or on open account to our customers, many of whom take title to the goods in Hong Kong or China. These methods allow us to reduce certain operating costs and working capital requirements. A portion of our sales originate in the United States, so we hold certain inventory in our warehouses and fulfillment facilities. To date, a majority of all of our sales has been to domestic customers. We intend to continue expanding distribution of our products into foreign territories and, accordingly, we have:
 
 
entered into a joint venture in China,
 
 
engaged representatives to oversee sales in certain foreign territories,
 
 
engaged distributors in certain foreign territories,
 
 
established direct relationships with retailers in certain foreign territories,
 
 
opened sales offices in Europe and Mexico,
 
 
opened sales offices and a distribution center in Canada, and
 
 
expanded in-house resources dedicated to product development and marketing of our lines.
 

8

Outside of the United States, we currently sell our products primarily in Europe, Australia, Canada, Latin America and Asia. Sales of our products abroad accounted for approximately $134.0 million, or 21.9% of our net sales in 2017 and approximately $162.5 million, or 23.0% of our net sales in 2016. We believe that foreign markets present an attractive opportunity, and we plan to intensify our marketing efforts and further expand our distribution channels abroad.
 
We establish reserves for sales allowances, including promotional allowances and allowances for anticipated defective product returns, at the time of shipment. The reserves are determined as a percentage of net sales based upon either historical experience or upon estimates or programs agreed upon by our customers and us.
 
We obtain, directly, or through our sales representatives, orders for our products from our customers and arrange for the manufacture of these products as discussed below. Cancellations generally are made in writing, and we take appropriate steps to notify our manufacturers of these cancellations. We may incur costs or other losses as a result of cancellations.
 
We maintain a full-time sales and marketing staff, many of whom make on-site visits to customers for the purpose of showing product and soliciting orders for products. We also retain a number of independent sales representatives to sell and promote our products, both domestically and internationally. Together with retailers, we occasionally test the consumer acceptance of new products in selected markets before committing resources to large-scale production.
 
We publicize and advertise our products in trade and consumer magazines and other publications, market our products at international, national and regional toy and other specialty trade shows, conventions and exhibitions and carry on cooperative advertising programs with toy and mass market retailers and other customers which include the use of print and television ads and in-store displays. We also produce and broadcast television commercials for several of our product lines, if we expect that the resulting increase in our net sales will justify the relatively high cost of television advertising.
 
Product Development
 
Each of our product lines has an in-house manager responsible for product development. The in-house manager identifies and evaluates inventor products and concepts and other opportunities to enhance or expand existing product lines or to enter new product categories. In addition, we create proprietary products to fully exploit our concept and character licenses. Although we have the capability to create and develop products from inception to production, we also use third-parties to provide a portion of the sculpting, sample making, illustration and package design required for our products in order to accommodate our increasing product innovations and introductions. Typically, the development process takes from three to nine months from concept to production and shipment to our customers.
 
We employ a staff of designers for all of our product lines. We occasionally acquire our other product concepts from unaffiliated third parties. If we accept and develop a third party’s concept for new toys, we generally pay a royalty on the sale of the toys developed from this concept, and may, on an individual basis, guarantee a minimum royalty. Royalties payable to inventors and developers generally range from 1% to 5% of the wholesale sales price for each unit of a product sold by us. We believe that utilizing experienced third-party inventors gives us access to a wide range of development talent. We currently work with numerous toy inventors and designers for the development of new products and the enhancement of existing products.
 
Safety testing of our products is done at the manufacturers’ facilities by quality control personnel employed by us or by independent third-party contractors engaged by us. Safety testing is designed to meet or exceed regulations imposed by federal and state, as well as applicable international governmental authorities, our retail partners, licensors and the Toy Industry Association. We also closely monitor quality assurance procedures for our products for safety purposes. In addition, independent laboratories engaged by some of our larger customers and licensors test certain of our products.

9

Manufacturing and Supplies
 
Most of our products are currently produced by overseas third-party manufacturers, which we choose on the basis of quality, reliability and price. Consistent with industry practice, the use of third-party manufacturers enables us to avoid incurring fixed manufacturing costs, while maximizing flexibility, capacity and production technology. Substantially all of the manufacturing services performed overseas for us are paid for on open account with the manufacturers. To date, we have not experienced any material delays in the delivery of our products; however, delivery schedules are subject to various factors beyond our control, and any delays in the future could adversely affect our sales. Currently, we have ongoing relationships with over eighty different manufacturers. We believe that alternative sources of supply are available to us although we cannot be assured that we can obtain adequate supplies of manufactured products.
 
Although we do not conduct the day-to-day manufacturing of our products, we are extensively involved in the design of the product prototype and production tools, dyes and molds for our products and we seek to ensure quality control by actively reviewing the production process and testing the products produced by our manufacturers. We employ quality control inspectors who rotate among our manufacturers’ factories to monitor the production of substantially all of our products.
 
The principal raw materials used in the production and sale of our toy products are plastics, zinc alloy, plush, printed fabrics, paper products and electronic components, all of which are currently available at reasonable prices from a variety of sources. Although we do not manufacture our products, we own the majority of the tools, dyes and molds used in the manufacturing process, and these are transferable among manufacturers if we choose to employ alternative manufacturers. Tools, dyes and molds represent a substantial portion of our property and equipment with a net book value of $15.7 million in 2016 and $17.0 million in 2017; substantially all of these assets are located in China.
 
Trademarks and Copyrights
 
Most of our products are produced and sold under trademarks owned by or licensed to us. We typically register our properties, and seek protection under the trademark, copyright and patent laws of the United States and other countries where our products are produced or sold. These intellectual property rights can be significant assets. Accordingly, while we believe we are sufficiently protected, the loss of some of these rights could have an adverse effect on our business, financial condition and results of operations.
 
Competition
 
Competition in the toy industry is intense. Globally, certain of our competitors have greater financial resources, larger sales and marketing and product development departments, stronger name recognition, longer operating histories and benefit from greater economies of scale. These factors, among others, may enable our competitors to market their products at lower prices or on terms more advantageous to customers than those we could offer for our competitive products. Competition often extends to the procurement of entertainment and product licenses, as well as the marketing and distribution of products and the obtaining of adequate shelf space. Competition may result in price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. In each of our product lines we compete against one or both of the toy industry’s two dominant companies, Mattel and Hasbro. In addition, we compete in our Halloween costume lines with Rubies. We also compete with numerous smaller domestic and foreign toy manufacturers, importers and marketers in each of our product categories.
 
Seasonality and Backlog
 
In 2017, approximately 65.1% of our net sales were made in the third and fourth quarters. Generally, the first quarter is the period of lowest shipments and sales in our business and in the toy industry and therefore it is also the least profitable quarter due to various fixed costs. Seasonality factors may cause our operating results to fluctuate significantly from quarter to quarter. However, our seasonal products are primarily sold in the spring and summer seasons. Our results of operations may also fluctuate as a result of factors such as the timing of new products (and related expenses) introduced by us or our competitors, the advertising activities of our competitors, delivery schedules set by our customers and the emergence of new market entrants. We believe, however, that the low retail price of most of our products may be less subject to seasonal fluctuations than higher priced toy products.
 
We ship products in accordance with delivery schedules specified by our customers, who generally request delivery of products within three to six months of the date of their orders for orders shipped FOB China or Hong Kong and within three days for orders shipped domestically. Because customer orders may be canceled at any time, often without penalty, our backlog may not accurately indicate sales for any future period.
 
10

Government and Industry Regulation
 
Our products are subject to the provisions of the Consumer Product Safety Act (“CPSA”), the Federal Hazardous Substances Act (“FHSA”), the Flammable Fabrics Act (“FFA”) and the regulations promulgated there under. The CPSA and the FHSA enable the Consumer Products Safety Commission (“CPSC”) to exclude from the market consumer products that fail to comply with applicable product safety regulations or otherwise create a substantial risk of injury, and articles that contain excessive amounts of a banned hazardous substance. The FFA enables the CPSC to regulate and enforce flammability standards for fabrics used in consumer products. The CPSC may also require the repurchase by the manufacturer of articles. Similar laws exist in some states and cities and in various international markets. We maintain a quality control program designed to ensure compliance with all applicable laws.
 
Employees
 
As of February 28, 2018, we employed 751 people, all of whom are full-time employees, including three executive officers. We employed 409 people in the United States, 9 people in Canada, 4 people in Mexico, 203 people in Hong Kong, 100 people in China, 20 people in the United Kingdom, 3 people in France and 3 people in Germany. We believe that we have good relationships with our employees. None of our employees are represented by a union.
 
Environmental Issues
 
We are subject to legal and financial obligations under environmental, health and safety laws in the United States and in other jurisdictions where we operate. We are not currently aware of any material environmental liabilities associated with any of our operations.
 
Available Information
 
We make available free of charge on or through our Internet website, www.jakks.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The contents of our website are not incorporated in or deemed to be a part of any such report.
 
Our Corporate Information
 
We were formed as a Delaware corporation in 1995. Our principal executive offices are located at 2951 28th Street, Santa Monica, California 90405. Our telephone number is (424) 268-9444 and our Internet Website address is www.jakks.com. The contents of our website are not incorporated in or deemed to be a part of this Annual Report on Form 10-K.
 

11

 
Item 1A.  Risk Factors
 
From time to time, including in this Annual Report on Form 10-K, we publish forward-looking statements, as disclosed in our Disclosure Regarding Forward-Looking Statements, beginning immediately following the Table of Contents of this Annual Report. We note that a variety of factors could cause our actual results and experience to differ materially from the anticipated results or other expectations expressed or anticipated in our forward-looking statements. The factors listed below are risks and uncertainties that may arise and that may be detailed from time to time in our public announcements and our filings with the Securities and Exchange Commission, such as on Forms 8-K, 10-Q and 10-K. We undertake no obligation to make any revisions to the forward-looking statements contained in this Annual Report on Form 10-K to reflect events or circumstances occurring after the date of the filing of this report.
 
Our inability to redesign, restyle and extend our existing core products and product lines as consumer preferences evolve, and to develop, introduce and gain customer acceptance of new products and product lines, may materially and adversely impact our business, financial condition and results of operations.
 
Our business and operating results depend largely upon the appeal of our products. Our continued success in the toy industry will depend upon our ability to redesign, restyle and extend our existing core products and product lines as consumer preferences evolve, and to develop, introduce and gain customer acceptance of new products and product lines. Several trends in recent years have presented challenges for the toy industry, including:
 
 
the phenomenon of children outgrowing toys at younger ages, particularly in favor of interactive and high technology products;
 
 
increasing use of technology;
 
 
shorter life cycles for individual products; and
 
 
higher consumer expectations for product quality, functionality and value.
 
We cannot assure you that:
 
 
our current products will continue to be popular with consumers;
 
 
the products that we introduce will achieve any significant degree of market acceptance;
 
 
the life cycles of our products will be sufficient to permit us to recover licensing, design, manufacturing, marketing and other costs associated with those products.
 
 
our inclusion of new technology will result in higher sales or increased profits.
 
Our failure to achieve any or all of the foregoing benchmarks may adversely affect our business, financial condition and results of operations.
 
The failure of our character-related and theme-related products to become and/or remain popular with children may materially and adversely impact our business, financial condition and results of operations.
 
The success of many of our character-related and theme-related products depends upon the popularity of characters in movies, television programs, live sporting exhibitions, and other media and events. We cannot assure you that:
 
 
media associated with our character-related and theme-related product lines will be released at the times we expect or will be successful;
 
 
the success of media associated with our existing character-related and theme-related product lines will result in substantial promotional value to our products;
 
 
we will be successful in renewing licenses upon expiration on terms that are favorable to us; or
 
 
we will be successful in obtaining licenses to produce new character-related and theme-related products in the future.
 
Our failure to achieve any or all of the foregoing benchmarks may cause the infrastructure of our operations to fail, thereby adversely affecting our business, financial condition and results of operations.
 
12

There are risks associated with our license agreements.
 
 
Our current licenses require us to pay minimum royalties
 
Sales of products under trademarks or trade or brand names licensed from others account for substantially all of our net sales. Product licenses allow us to capitalize on characters, designs, concepts and inventions owned by others or developed by toy inventors and designers. Our license agreements generally require us to make specified minimum royalty payments, even if we fail to sell a sufficient number of units to cover these amounts. In addition, under certain of our license agreements, if we fail to achieve certain prescribed sales targets, we may be unable to retain or renew these licenses.
 
 
Some of our licenses are restricted as to use
 
Under the majority of our license agreements, the licensors have the right to review and approve our use of their licensed products, designs or materials before we may make any sales. If a licensor refuses to permit our use of any licensed property in the way we propose, or if their review process is delayed, our development or sale of new products could be impeded.
 
 
New licenses are difficult and expensive to obtain
 
Our continued success will substantially depend upon our ability to obtain additional licenses. Intense competition exists for desirable licenses in our industry. We cannot assure you that we will be able to secure or renew significant licenses on terms acceptable to us. In addition, as we add licenses, the need to fund additional royalty advances and guaranteed minimum royalty payments may strain our cash resources.
 
 
A limited number of licensors account for a large portion of our net sales
 
We derive a significant portion of our net sales from a limited number of licensors. If one or more of these licensors were to terminate or fail to renew our license or not grant us new licenses, our business, financial condition and results of operations could be adversely affected.
 
The toy industry is highly competitive and our inability to compete effectively may materially and adversely impact our business, financial condition and results of operations.
 
The toy industry is highly competitive. Globally, certain of our competitors have financial and strategic advantages over us, including:
 
 
greater financial resources;
 
 
larger sales, marketing and product development departments;
 
 
stronger name recognition;
 
 
longer operating histories; and
 
 
greater economies of scale.
 
In addition, the toy industry has no significant barriers to entry. Competition is based primarily upon the ability to design and develop new toys, procure licenses for popular characters and trademarks and successfully market products. Many of our competitors offer similar products or alternatives to our products. Our competitors have obtained and are likely to continue to obtain licenses that overlap our licenses with respect to products, geographic areas and markets. We cannot assure you that we will be able to obtain adequate shelf space in retail stores to support our existing products, expand our products and product lines or continue to compete effectively against current and future competitors.
 

13

 
We may not be able to sustain or manage our product line growth, which may prevent us from increasing our net revenues.
 
Historically, we have experienced growth in our product lines through acquisitions of businesses, products and licenses. This growth in product lines has contributed significantly to our total revenues over the last few years. Even though we had no significant acquisitions since 2012, comparing our future period-to-period operating results may not be meaningful and results of operations from prior periods may not be indicative of future results. We cannot assure you that we will continue to experience growth in, or maintain our present level of, net sales.
 
Our growth strategy calls for us to continuously develop and diversify our toy business by acquiring other companies, entering into additional license agreements, refining our product lines and expanding into international markets, which will place additional demands upon our management, operational capacity and financial resources and systems. The increased demand upon management may necessitate our recruitment and retention of qualified management personnel. We cannot assure you that we will be able to recruit and retain qualified personnel or expand and manage our operations effectively and profitably. To effectively manage future growth, we must continue to expand our operational, financial and management information systems and to train, motivate and manage our work force. There can be no assurance that our operational, financial and management information systems will be adequate to support our future operations. Failure to expand our operational, financial and management information systems or to train, motivate or manage employees could have a material adverse effect on our business, financial condition and results of operations.
 
In addition, implementation of our growth strategy is subject to risks beyond our control, including competition, market acceptance of new products, changes in economic conditions, our ability to obtain or renew licenses on commercially reasonable terms, our ability to identify acquisition candidates and conclude acquisitions on acceptable terms, and our ability to finance increased levels of accounts receivable and inventory necessary to support our sales growth, if any. Accordingly, we cannot assure you that our growth strategy will be successful.
 
If we are unable to acquire and integrate companies and new product lines successfully, we will be unable to implement a significant component of our growth strategy.
 
Our growth strategy depends, in part, upon our ability to acquire companies and new product lines. Future acquisitions, if any, may succeed only if we can effectively assess characteristics of potential target companies and product lines, such as:
 
 
attractiveness of products;
 
 
suitability of distribution channels;
 
 
management ability;
 
 
financial condition and results of operations; and
 
 
the degree to which acquired operations can be integrated with our operations.
 
We cannot assure you that we can identify attractive acquisition candidates or negotiate acceptable acquisition terms, and our failure to do so may adversely affect our results of operations and our ability to sustain growth. Our acquisition strategy involves a number of risks, each of which could adversely affect our operating results, including:
 
 
difficulties in integrating acquired businesses or product lines, assimilating new facilities and personnel and harmonizing diverse business strategies and methods of operation;
 
 
diversion of management attention from operation of our existing business;
 
 
loss of key personnel from acquired companies;
 
 
failure of an acquired business to achieve targeted financial results; and
 
 
Limited capital to finance acquisitions.
 

14

 
A limited number of customers account for a large portion of our net sales, so that if one or more of our major customers were to experience difficulties in fulfilling their obligations to us, cease doing business with us, significantly reduce the amount of their purchases from us or return substantial amounts of our products, it could have a material adverse effect on our business, financial condition and results of operations.
 
Our three largest customers accounted for 54.6% of our net sales in 2017. Except for outstanding purchase orders for specific products, we do not have written contracts with or commitments from any of our customers and pursuant to the terms of certain of our vendor agreements, even some purchase orders may be cancelled without penalty up until delivery. A substantial reduction in or termination of orders from any of our largest customers could adversely affect our business, financial condition and results of operations. In addition, pressure by large customers seeking price reductions, financial incentives, and changes in other terms of sale or for us to bear the risks and the cost of carrying inventory could also adversely affect our business, financial condition and results of operations. If one or more of our major customers were to experience difficulties in fulfilling their obligations to us, cease doing business with us, significantly reduce the amount of their purchases from us or return substantial amounts of our products, it could have a material adverse effect on our business, financial condition and results of operations. In addition, the bankruptcy or other lack of success of one or more of our significant retailers could negatively impact our revenues and bad debt expense.

Liquidity problems or bankruptcy of our key customers, including the recent bankruptcy filing by Toys “R” Us, could have a significant adverse effect on our business, financial condition and results of operations.

Our sales to customers are typically made on credit without collateral. There is a risk that key customers will not pay, or that payment may be delayed, because of bankruptcy, concentration of credit availability to such customers, weak retail sales or other factors beyond our control, which could increase our exposure to losses from bad debts. In addition, if key customers were to cease doing business as a result of bankruptcy or significantly reduce the number of stores operated, it could have a significant adverse effect on our business, financial condition, and results of operations.

On September 18, 2017, Toys “R” Us, Inc. (“Toys R Us”), accounting for 11.3% and 12.8% of our net sales for the fiscal years ended December 31, 2017 and 2016, announced that certain of its U.S. subsidiaries and its Canadian subsidiary voluntarily filed for relief under Chapter 11 of the Bankruptcy Code in the U.S. and that its Canadian subsidiary also began parallel proceedings under the Companies’ Creditors Arrangement Act (“CCAA”) in Canada.

On March 15, 2018, Toys R Us filed a motion to conduct an orderly wind down of its operations in the U.S. and commence store closing sales at all 735 US stores. Our worldwide Toys R Us accounts receivable balance as of March 15, 2018 is $35.9 million (unaudited). Due to the evolving nature of this matter, it is too early to assess the impact on the collectibility of this receivable and on future revenues we generate from this customer relationship (See Notes 3 and 22).
 
We depend upon our Chief Executive Officer and any loss or interruption of his services could adversely affect our business, financial condition and results of operations.
 
Our success has been largely dependent upon the experience and continued services of Stephen G. Berman, our President and Chief Executive Officer. We cannot assure you that we would be able to find an appropriate replacement for Mr. Berman should the need arise, and any loss or interruption of the services of Mr. Berman could adversely affect our business, financial condition and results of operations.
 
We depend upon third-party manufacturers, and if our relationship with any of them is harmed or if they independently encounter difficulties in their manufacturing processes, we could experience product defects, production delays, cost overruns or the inability to fulfill orders on a timely basis, any of which could adversely affect our business, financial condition and results of operations.
 
We depend upon many third-party manufacturers who develop, provide and use the tools, dyes and molds that we generally own to manufacture our products. However, we have limited control over the manufacturing processes themselves. As a result, any difficulties encountered by the third-party manufacturers that result in product defects, production delays, cost overruns or the inability to fulfill orders on a timely basis could adversely affect our business, financial condition and results of operations.
 
We do not have long-term contracts with our third-party manufacturers. Although we believe we could secure other third-party manufacturers to produce our products, our operations would be adversely affected if we lost our relationship with any of our current suppliers or if our current suppliers’ operations or sea or air transportation with our overseas manufacturers were disrupted or terminated even for a relatively short period of time. Our tools, dyes and molds are located at the facilities of our third-party manufacturers.
 
Although we do not purchase the raw materials used to manufacture our products, we are potentially subject to variations in the prices we pay our third-party manufacturers for products, depending upon what they pay for their raw materials.
 
We have substantial sales and manufacturing operations outside of the United States, subjecting us to risks common to international operations.
 
We sell products and operate facilities in numerous countries outside the United States. Sales to our international customers comprised approximately 21.9% of our net sales for the year ended December 31, 2017 and approximately 23.0% of our net sales for the year ended December 31, 2016. We expect our sales to international customers to account for a greater portion of our revenues in future fiscal periods. Additionally, we utilize third-party manufacturers, located principally in China, and are subject to the risks normally associated with international operations, including:
 
 
currency conversion risks and currency fluctuations;
 
 
limitations, including taxes, on the repatriation of earnings;
 
 
political instability, civil unrest and economic instability;
 

15

 
 
greater difficulty enforcing intellectual property rights and weaker laws protecting such rights;
 
 
complications in complying with laws in varying jurisdictions and changes in governmental policies;
 
 
greater difficulty and expenses associated with recovering from natural disasters, such as earthquakes, hurricanes and floods;
 
 
transportation delays and interruption;
 
 
work stoppages;
 
 
the potential imposition of tariffs; and
 
 
the pricing of intercompany transactions may be challenged by taxing authorities in both foreign jurisdictions and the United States, with potential increases in income taxes.
 
Our reliance upon external sources of manufacturing can be shifted, over a period of time, to alternative sources of supply, should such changes be necessary. However, if we were prevented from obtaining products or components for a material portion of our product line due to medical, political, labor or other factors beyond our control, our operations would be disrupted while alternative sources of products were secured. Also, the imposition of trade sanctions by the United States against a class of products imported by us from, or the loss of “normal trade relations” status by, China could significantly increase our cost of products imported from that nation. Because of the importance of international sales and international sourcing of manufacturing to our business, our financial condition and results of operations could be significantly and adversely affected if any of the risks described above were to occur.
 
Our business is subject to extensive government regulation and any violation by us of such regulations could result in product liability claims, loss of sales, diversion of resources, damage to our reputation, increased warranty costs or removal of our products from the market, and we cannot assure you that our product liability insurance for the foregoing will be sufficient.
 
Our business is subject to various laws, including the Federal Hazardous Substances Act, the Consumer Product Safety Act, the Flammable Fabrics Act and the rules and regulations promulgated under these acts. These statutes are administered by the CPSC, which has the authority to remove from the market products that are found to be defective and present a substantial hazard or risk of serious injury or death. The CPSC can require a manufacturer to recall, repair or replace these products under certain circumstances. We cannot assure you that defects in our products will not be alleged or found. Any such allegations or findings could result in:
 
 
product liability claims;
 
 
loss of sales;
 
 
diversion of resources;
 
 
damage to our reputation;
 
 
increased warranty and insurance costs; and
 
 
removal of our products from the market.
 
Any of these results may adversely affect our business, financial condition and results of operations. There can be no assurance that our product liability insurance will be sufficient to avoid or limit our loss in the event of an adverse outcome of any product liability claim.
 
We depend upon our proprietary rights and our inability to safeguard and maintain the same, or claims of third parties that we have violated their intellectual property rights, could have a material adverse effect on our business, financial condition and results of operations.
 
We rely upon trademark, copyright and trade secret protection, nondisclosure agreements and licensing arrangements to establish, protect and enforce our proprietary rights in our products. The laws of certain foreign countries may not protect intellectual property rights to the same extent or in the same manner as the laws of the United States. We cannot assure you that we or our licensors will be able to successfully safeguard and maintain our proprietary rights. Further, certain parties have commenced legal proceedings or made claims against us based upon our alleged patent infringement, misappropriation of trade secrets or other violations of their intellectual property rights. We cannot assure you that other parties will not assert intellectual property claims against us in the future. These claims could divert our attention from operating our business or result in unanticipated legal and other costs, which could adversely affect our business, financial condition and results of operations.
 

16

 
Market conditions and other third-party conduct could negatively impact our margins and implementation of other business initiatives.
 
Economic conditions, such as decreased consumer confidence, may adversely impact our margins. In addition, general economic conditions were significantly and negatively affected by the September 11th terrorist attacks and could be similarly affected by any future attacks. Such a weakened economic and business climate, as well as consumer uncertainty created by such a climate, could adversely affect our sales and profitability. Other conditions, such as the unavailability of electronics components, may impede our ability to manufacture, source and ship new and continuing products on a timely basis. Significant and sustained increases in the price of oil could adversely impact the cost of the raw materials used in the manufacture of our products, such as plastic.
 
We may not have the funds necessary to purchase our outstanding convertible senior notes upon a fundamental change or other purchase date, as required by the indenture governing the notes.
 
In June 2014 we sold an aggregate of $115.0 million principal amount of 4.875% convertible senior notes due on June 1, 2020, of which $113.0 million are currently outstanding (the “2020 Notes”). In July 2013, we sold an aggregate of $100.0 million principal amount of 4.25% convertible senior notes due on August 1, 2018, of which $21.2 million are currently outstanding (the “2018 Notes”) and $21.5 million were extended to November 1, 2020 (the “3.25% 2020 Notes” and collectively with the 2018 Notes and 2020 Notes, the “Notes”). Holders of the Notes may require us to repurchase for cash all or some of their notes upon the occurrence of a fundamental change (as defined in the Notes). Holders of the Notes may convert their notes upon the occurrence of specified events. Upon conversion, the Notes will be settled in shares of our common stock and/or in cash. Restrictions on borrowings under or loss of our credit facility could have a material adverse effect on our financial condition including an adverse impact on our ability to pay the Notes when due.
 
Restrictions under or the loss of availability under our credit facility could adversely impact our financial condition and our ability to pay our convertible senior notes when due.
 
In March 2014, we obtained a $75.0 million revolving line of credit. Any amounts borrowed under the revolving credit line are our senior secured obligations. All outstanding borrowings under the revolving credit line are accelerated and become immediately due and payable (and the revolving credit line terminates) in the event of a default which includes, among other things, failure to comply with financial ratio covenants or breach of representations contained in the credit line documents, defaults under other loans or obligations, involvement in bankruptcy proceedings, an occurrence of a change of control or an event constituting a material adverse effect on us (as such terms are defined in the credit line documents). We are also subject to negative covenants which, during the life of the credit line, prohibit and/or limit us from, among other things, incurring certain types of other debt, acquiring other companies, making certain expenditures or investments, changing the character of our business, and certain changes to our executive officers.
 
We have a valuation allowance on the deferred taxes on our books since their future realization is uncertain.

Deferred tax assets are realized by prior and future taxable income of appropriate character. Current accounting standards require that a valuation allowance be recorded if it is not likely that sufficient taxable income of appropriate character will be generated to realize the deferred tax assets. We currently believe that based on the available information, it is more likely than not that our deferred tax assets will not be realized, and accordingly we have recorded a valuation allowance against our US federal and state deferred tax assets. Our net operating losses and tax credit carry-forwards can expire if unused, and their utilization could be substantially limited in the event of an "ownership change," as defined in Section 382 of the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code.
 
An adverse decision in litigation in which we have been named as a defendant could have a material adverse effect on our financial condition and results of operations. 
 
We are defendants in a class action described herein and under “Legal Proceedings” in our periodic reports filed pursuant to the Securities Exchange Act of 1934 (see “Legal Proceedings”). No assurances can be given that the results of these litigation matters will be favorable to us or that an adverse decision in such litigation would not have a material adverse impact on our financial condition and results of operations.
 
We rely extensively on information technology in our operations, and any material failure, inadequacy, interruption, or security breach of that technology could have a material adverse impact on our business.
 
We rely extensively on information technology systems across our operations, including for management of our supply chain, sale and delivery of our products and services, reporting our results of operations, collection and storage of consumer data, personal data of customers, employees and other stakeholders, and various other processes and transactions. Many of these systems are managed by third-party service providers. We use third-party technology and systems for a variety of reasons, including, without limitation, encryption and authentication technology, employee email, content delivery to customers, back-office support, and other functions. A small and growing volume of our consumer products and services are web-based, and some are offered in conjunction with business partners or such third-party service providers. We, our business partners and third-party service providers collect, process, store and transmit consumer data, including personal information, in connection with those products and services. Failure to follow applicable regulations related to those activities, or to prevent or mitigate data loss or other security breaches, including breaches of our business partners’ technology and systems could expose us or our customers to a risk of loss or misuse of such information, which could adversely affect our operating results, result in regulatory enforcement, other litigation and could be a potential liability for us, and otherwise harm our business. Our ability to effectively manage our business and coordinate the production, distribution, and sale of our products and services depends significantly on the reliability and capacity of these systems and third-party service providers. Although we have developed systems and processes that are designed to protect customer information and prevent data loss and other security breaches, including systems and processes designed to reduce the impact of a security breach at a third party provider, such measures cannot provide absolute security. We have exposure to similar security risks faced by other large companies that have data stored on their information technology systems. To our knowledge, we have not experienced any material breach of our cybersecurity systems. If we or our third-party service providers systems fail to operate effectively or are damaged, destroyed, or shut down, or there are problems with transitioning to upgraded or replacement systems, or there are security breaches in these systems, any of the aforementioned could occur as a result of natural disasters, software or equipment failures, telecommunications failures, loss or theft of equipment, acts of terrorism, circumvention of security systems, or other cyber-attacks, including denial-of-service attacks, we could experience delays or decreases in product sales, and reduced efficiency of our operations. Additionally, any of these events could lead to violations of privacy laws, loss of customers, or loss, misappropriation or corruption of confidential information, trade secrets or data, which could expose us to potential litigation, regulatory actions, sanctions or other statutory penalties, any or all of which could adversely affect our business, and cause it to incur significant losses and remediation costs.
17

 
Item 2.  Properties
 
The following is a listing of the principal leased offices maintained by us as of February 28, 2018:
 
 
Property
Location
 
Approximate
Square Feet
 
Lease Expiration
Date
US and Canada *
 
     
   
Distribution Center
City of Industry, California
   
800,000
 
April 30, 2023
Distribution Center
Hickory, North Carolina
   
139,300
 
August 31, 2018
Sales Office/Showroom
Bentonville, Arkansas
   
9,000
 
September 30, 2019
Disguise Office
Poway, California
   
24,200
 
March 31, 2021
Sales Office
Hoffman Estates, Illinois
   
2,102
 
December 31, 2018
Corporate Office/Showroom
Santa Monica, California
   
65,858
 
January 31, 2024
Showroom
Glendale, California
   
5,830
 
January 31, 2020
Distribution Center
Brampton, Ontario, Canada
   
105,700
 
December 31, 2019
                
International *
 
       
   
Europe Office
Berkshire, United Kingdom
   
4,746
 
January 19, 2027
Hong Kong Headquarters
Kowloon, Hong Kong
   
41,130
 
June 30, 2019
Production Inspection and Testing Office
Shenzhen, China
   
5,417
 
May 14, 2019
Production Inspection and
Testing Lab
Kowloon, Hong Kong
   
34,400
 
October 31, 2018
                
 *The Halloween segment is included in the properties listed above.


18

 
Item 3. Legal Proceedings
 
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

 
Item 4.  Mine Safety Disclosures
 
Not applicable.


20

PART II
 
Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Market Information
 
Our common stock is traded on the Nasdaq Global Select exchange under the symbol “JAKK.” The following table sets forth, for the periods indicated, the range of high and low sales prices for our common stock on this exchange.
 
 
 
Price Range of
Common Stock
 
 
 
High
   
Low
 
2016:
           
First quarter
 
$
7.97
   
$
6.17
 
Second quarter
   
8.02
     
6.94
 
Third quarter
   
9.75
     
7.57
 
Fourth quarter
   
9.15
     
4.63
 
2017:
               
First quarter
   
5.85
     
4.78
 
Second quarter
   
5.55
     
3.80
 
Third quarter
   
4.20
     
2.68
 
Fourth quarter
   
3.55
     
2.20
 
 
Performance Graph
 
The graph and tables below display the relative performance of our common stock, the Russell 2000 Price Index (the “Russell 2000”) and a peer group index, by comparing the cumulative total stockholder return (which assumes reinvestment of dividends, if any) on an assumed $100 investment on December 31, 2012 in our common stock, the Russell 2000 and the peer group index over the period from January 1, 2013 to December 31, 2017.
 
In accordance with recently enacted regulations implemented by the Securities and Exchange Commission, we retained the services of an expert compensation consultant. In the performance of its services, such consultant used a peer group index for its analysis of our compensation policies. We believe that these companies represent a cross-section of publicly-traded companies with product lines and businesses similar to our own throughout the comparison period and, accordingly, we are using the same peer group for purposes of the performance graph. EMak Worldwide Inc. and THQ Inc. were excluded from the performance peer group in 2014, Kid Brands, Inc. was excluded in 2015 and Leapfrog Enterprises, Inc. was excluded in 2016. Deckers Outdoor Corporation was added in 2016 and our peer group index now is comprised of the following companies: Activision Blizzard, Inc., Deckers Outdoor Corporation, Electronic Arts, Inc., Hasbro, Inc., Mattel, Inc. and Take-Two Interactive, Inc.
21

The historical performance data presented below may not be indicative of the future performance of our common stock, any reference index or any component company in a reference index.
 
 
 
Annual Return Percentage
 
 
 
December 31,
2013
   
December 31,
2014
   
December 31,
2015
   
December 31,
2016
   
December 31,
2017
 
JAKKS Pacific
   
(45.6
)%
   
1.2
%
   
17.1
%
   
(35.3
)%
   
(54.4
)%
Peer Group
   
55.6
     
11.7
     
39.4
     
7.0
     
42.8
 
Russell 2000
   
38.8
     
4.9
     
(4.4
)
   
21.3
     
14.7
 
 
 

Indexed Returns

 
 
January 1,
2013
   
December 31,
2013
   
December 31,
2014
   
December 31,
2015
   
December 31,
2016
   
December 31,
2017
 
JAKKS Pacific
 
$
100.0
   
$
54.4
   
$
55.1
   
$
64.4
   
$
41.7
   
$
19.0
 
Peer Group
   
100.0
     
155.6
     
173.8
     
242.2
     
259.2
     
370.6
 
Russell 2000
   
100.0
     
138.8
     
145.6
     
139.2
     
168.9
     
193.6
 

 
 Security Holders
 
To the best of our knowledge, as of March 6, 2018, there were 109 holders of record of our common stock. We believe there are numerous beneficial owners of our common stock whose shares are held in “street name.”
 
Dividends
 
The payment of dividends on common stock is at the discretion of the Board of Directors and is subject to customary limitations. We currently intend to retain our future earnings, if any, to finance the growth and development of our business and/or buy back in the market some of our common stock and/or retire some of our outstanding convertible senior notes.


22

Equity Compensation Plan Information
 
The table below sets forth the following information as of the year ended December 31, 2017 for (i) all compensation plans previously approved by our stockholders and (ii) all compensation plans not previously approved by our stockholders, if any:
 
(a)  the number of securities to be issued upon the exercise of outstanding options, warrants and rights;
 
(b)  the weighted-average exercise price of such outstanding options, warrants and rights; and
 
(c)  other than securities to be issued upon the exercise of such outstanding options, warrants and rights, the number of securities remaining available for future issuance under the plans.
 
Plan Category
 
Number of
Securities to
be Issued
Upon
Exercise of
Outstanding
Options,
Warrants
and Rights
(a)
   
Weighted-
Average Exercise
Price of
Outstanding
Options,
Warrants and
Rights
(b)
   
Number of
Securities
Remaining
Available for
Future Issuance
Under
Equity
Compensation
Plans, Excluding
Securities Reflected
in
Column (a)
(c)
 
Equity compensation plans approved by security holders
   
   
$
     
3,539,848
 
Equity compensation plans not approved by security holders
   
     
     
 
Total
   
   
$
     
3,539,848
 
 
Equity compensation plans approved by our stockholders consists of the 2002 Stock Award and Incentive Plan. An additional 1.4 million and 2.5 million shares were added to the number of total issuable shares under the Plan and approved by the Board in 2013 and 2017, respectively. Additionally, 981,208 shares of restricted stock awards remained unvested as of December 31, 2017. Disclosures with respect to equity issuable to certain of our executive officers pursuant to the terms of their employment agreements is disclosed below under Item 11.

Issuer Purchases of Equity Securities

There were no issuer purchases of equity securities in the fourth quarter of 2017.

Issuer Unregistered Sale of Equity Securities

There were no issuer sales of unregistered equity securities in the fourth quarter of 2017.

23

Item 6.  Selected Financial Data
 
You should read the financial data set forth below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (included in Item 7) and our consolidated financial statements and the related notes (included in Item 8).
 
 
 
Years Ended December 31,
 
 
 
2013
 
2014
   
2015
   
2016
   
2017
 
 
 
(In thousands, except per share data)
 
Consolidated Statement of Operations Data:
                             
Net sales
 
$
632,925
   
$
810,060
   
$
745,741
   
$
706,603
   
$
613,111
 
Cost of sales
   
477,146
     
574,253
     
517,172
     
483,582
     
457,430
 
Gross profit
   
155,779
     
235,807
     
228,569
     
223,021
     
155,681
 
Selling, general and administrative expenses
   
195,296
     
203,326
     
198,039
     
205,915
     
206,303
 
Goodwill and other intangibles impairment
   
     
     
     
     
13,536
 
Reorganization charges
   
5,015
     
1,154
     
     
     
 
Income (loss) from operations
   
(44,532
)
   
31,327
     
30,530
     
17,106
     
(64,158
)
Change in fair value of business combination liability
   
6,000
     
5,932
     
5,642
     
     
 
Income (loss) from joint ventures
   
(3,148
)
   
314
     
2,761
     
889
     
105
 
Other income
   
     
     
     
305
     
342
 
Loss on extinguishment of convertible senior notes
   
     
     
     
     
(919
)
Write-off of investment in DreamPlay, LLC
   
     
     
     
     
(7,000
)
Interest income
   
327
     
112
     
62
     
51
     
37
 
Interest expense
   
(9,942
)
   
(12,461
)
   
(12,402
)
   
(12,975
)
   
(9,829
)
Income (loss) before provision for income taxes
   
(51,295
)
   
25,224
     
26,593
     
5,376
     
(81,422
)
Provision for income taxes
   
2,611
     
3,715
     
3,423
     
4,127
     
1,606
 
Net income (loss)
   
(53,906
)
   
21,509
     
23,170
     
1,249
     
(83,028
)
Net income (loss) attributable to non-controlling interests
   
     
     
(84
)
   
6
     
57
 
Net income (loss) attributable to JAKKS Pacific, Inc.
 
$
(53,906
)
 
$
21,509
   
$
23,254
   
$
1,243
   
$
(83,085
)
Basic earnings (loss) per share
 
$
(2.43
)
 
$
1.03
   
$
1.20
   
$
0.08
   
$
(3.89
)
Diluted earnings (loss) per share
 
$
(2.43
)
 
$
0.70
   
$
0.71
   
$
0.07
   
$
(3.89
)
Dividends declared per common share
 
$
0.14
   
$
   
$
   
$
   
$
 
 
During the third quarter of 2017, we recorded impairment charges of $8.3 million to write off goodwill, $2.9 million to write off the remaining unamortized technology rights related to DreamPlay, LLC, and $2.3 million to write down several underutilized trademarks and trade names that were determined to have no value. Additionally, we wrote off our investment in DreamPlay, LLC in the amount of $7.0 million. During the third and fourth quarters of 2017, we recorded a charge of $9.6 million related to the write-down of certain excess and impaired inventory, recognized a bad debt write-off of $8.9 million related to the Toys “R” Us bankruptcy filing on September 18, 2017, and recorded a charge of $20.5 million related to the write-down of license advances and minimum guarantees that are not expected to be earned through sales of that licensed product. During the fourth quarter of 2017, we recognized a $0.6 million loss related to the extinguishment of $21.5 million face amount of our 4.25% convertible senior notes due in 2018 and we recognized a $0.3 million loss related to the fair market value adjustment for the 3.25% convertible senior notes due in 2020.

During the second quarter of 2016, we recorded income of $0.7 million related to Pacific Animation Partners and $0.2 million for funds received related to our former video game joint venture, which is included in income (loss) from joint ventures.

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

During the second quarter of 2014, we incurred restructuring charges of $1.2 million related to office space consolidations as part of the reorganization plan which commenced in the third quarter of 2013. During the third quarter of 2014, we recorded income of $5.9 million related to the reversal of a portion of the Maui earn-out. The Maui earn-out reversal was due to Maui not achieving the prescribed earn-out targets in 2014.
 
24

In 2013, we recorded a charge of $14.9 million related to the write-down of certain excess and impaired inventory. We also recorded a charge of $14.4 million related to the write-down of license advances and minimum guarantees that are not expected to be earned through sales of that licensed product. During the fourth quarter of 2013, we incurred restructuring charges of $5.0 million related to the office space consolidations given the decrease in sales in 2013, and recorded income of $6.0 million related to the reversal of a portion of the Maui earn-out. The Maui earn-out reversal was due to Maui not achieving the prescribed earn-out targets in 2013.

 
 
At December 31,
 
 
2013
 
2014
 
2015
 
2016
 
2017
 
 
(In thousands)
Consolidated Balance Sheet Data:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
117,071
 
 
$
71,525
 
 
$
102,528
 
 
$
86,064
 
 
$
64,977
 
Working capital
 
 
136,337
 
 
 
246,245
 
 
 
254,967
 
 
 
236,569
 
 
 
146,911
 
Total assets
 
 
449,844
 
 
 
561,782
 
 
 
499,620
 
 
 
464,303
 
 
 
370,349
 
Short-term debt
 
 
38,098
 
 
 
 
 
 
 
 
 
10,000
 
 
 
26,178
 
Long-term debt
 
 
100,000
 
 
 
215,000
 
 
 
215,000
 
 
 
206,865
 
 
 
135,469
 
Total stockholders' equity
 
 
148,685
 
 
 
145,084
 
 
 
153,406
 
 
 
135,200
 
 
 
94,513
 

 

25

 
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors. You should read this section in conjunction with our consolidated financial statements and the related notes (included in Item 8).
 
Critical Accounting Policies
 
The accompanying consolidated financial statements and supplementary information were prepared in accordance with accounting principles generally accepted in the United States of America. Significant accounting policies are discussed in Note 2 to the Consolidated Financial Statements, Item 8. Inherent in the application of many of these accounting policies is the need for management to make estimates and judgments in the determination of certain revenues, expenses, assets and liabilities. As such, materially different financial results can occur as circumstances change and additional information becomes known. The policies with the greatest potential effect on our results of operations and financial position include:
 
Allowance for Doubtful Accounts. Our allowance for doubtful accounts is based upon management’s assessment of the business environment, customers’ financial condition, historical collection experience, accounts receivable aging, customer disputes and the collectability of specific customer accounts. If there were a deterioration of a major customer’s creditworthiness, or actual defaults were higher than our historical experience, our estimates of the recoverability of amounts due to us could be overstated, which could have an adverse impact on our operating results. Our allowance for doubtful accounts is also affected by the time at which uncollectible accounts receivable balances are actually written off.
 
Major customers’ accounts are monitored on an ongoing basis; more in-depth reviews are performed based upon changes in a customer’s financial condition and/or the level of credit being extended. When a significant event occurs, such as a bankruptcy filing by a specific customer, and on a quarterly basis, the allowance is reviewed for adequacy and the balance or accrual rate is adjusted to reflect current risk prospects.
 
Revenue Recognition. Our revenue recognition policy is to recognize revenue when persuasive evidence of an arrangement exists, title transfer has occurred (product shipment), the price is fixed or determinable and collectability is reasonably assured. Sales are recorded net of sales returns and discounts, which are estimated at the time of shipment based upon historical data. JAKKS routinely enters into arrangements with its customers to provide sales incentives and support customer promotions and we provide allowances for returns and defective merchandise. Such programs are primarily based upon customer purchases, customer performance of specified promotional activities and other specified factors such as sales to consumers. Accruals for these programs are recorded as sales adjustments that reduce gross revenue in the period the related revenue is recognized.
 
Goodwill and other indefinite-lived intangible assets. Goodwill and indefinite-lived intangible assets are not amortized, but are tested for impairment at least annually at the reporting unit level.
 
Factors we consider important that could trigger an impairment review include the following:
 
 
significant underperformance relative to expected historical or projected future operating results;
 
significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and
 
significant negative industry or economic trends.

Due to the subjective nature of the impairment analysis, significant changes in the assumptions used to develop the estimate could materially affect the conclusion regarding the future cash flows necessary to support the valuation of long-lived assets, including goodwill. The valuation of goodwill involves a high degree of judgment and uncertainty related to our key assumptions. Any changes in our key projections or estimates could result in a reporting unit either passing or failing the first step of the impairment model, which could significantly change the amount of any impairment ultimately recorded.
 
Based upon the assumptions underlying the valuation, impairment is determined by estimating the fair value of a reporting unit and comparing that value to the reporting unit’s book value. Goodwill is tested for impairment annually, and on an interim basis if certain events or circumstances indicate that an impairment loss may have been incurred. If the fair value is more than the carrying value of the reporting unit, an impairment loss is not indicated. If a reporting unit's carrying value exceeds its fair value, an impairment charge would be recognized for the excess amount, not to exceed the carrying amount of goodwill.

26

 
We performed our annual assessment of goodwill for impairment as of our annual testing date being April 1, 2017 for each of our reporting units by evaluating qualitative factors, including, but not limited to, the performance of each reporting unit, general economic conditions, access to capital, the industry and competitive environment, and the interest rate environment. We prepared step-one of our impairment model. Based on our assessment, we determined that the fair values of our reporting units were not less than the carrying amounts. In addition, as a result of operating performance below expectations for the full year of 2017 that became apparent in September 2017, we performed a subsequent impairment assessment on goodwill as of September 30, 2017. Based on our assessment, we determined that the fair values of two of our reporting units were less than the carrying amounts, resulting in an aggregate impairment charge of $8.3 million. The amount of goodwill assigned to each of the three reporting units, U.S. and Canada, International, and Halloween, amounted to $23.8 million, $11.6 million, and nil, respectively, after the impairment charge.
 
Goodwill and intangible assets amounted to $57.6 million as of December 31, 2017.
 
Reserve for Inventory Obsolescence. We value our inventory at the lower of cost or market. Based upon a consideration of quantities on hand, actual and projected sales volume, anticipated product selling prices and product lines planned to be discontinued, slow-moving and obsolete inventory is written down to its net realizable value.
 
Failure to accurately predict and respond to consumer demand could result in us under-producing popular items or overproducing less popular items. Furthermore, significant changes in demand for our products would impact management’s estimates in establishing our inventory provision.
 
Management estimates are monitored on a quarterly basis and a further adjustment to reduce inventory to its net realizable value is recorded, as an increase to cost of sales, when deemed necessary under the lower of cost or market standard.
 
Income Allocation for Income Taxes. Our annual income tax provision and related income tax assets and liabilities are based upon actual income as allocated to the various tax jurisdictions based upon our transfer pricing study, US and foreign statutory income tax rates and tax regulations and planning opportunities in the various jurisdictions in which we operate. Significant judgment is required in interpreting tax regulations in the U.S. and foreign jurisdictions, and in evaluating worldwide uncertain tax positions. Actual results could differ materially from those judgments, and changes from such judgments could materially affect our consolidated financial statements.
 
Income taxes and interest and penalties related to income tax payable. We do not file a consolidated return for our foreign subsidiaries. We file federal and state returns and our foreign subsidiaries each file returns in their respective jurisdictions, as applicable. Deferred taxes are provided on a liability method, whereby deferred tax assets are recognized as deductible temporary differences and operating loss and tax credit carry-forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
 
We must assess the likelihood that we will be able to recover our deferred tax assets. Deferred tax assets are reduced by a valuation allowance, if, based upon the weight of available evidence, it is more likely than not that we will not realize some portion or all of the deferred tax assets. We consider all available positive and negative evidence when assessing whether it is more likely than not that deferred tax assets are recoverable. We consider evidence such as our past operating results, the existence of cumulative losses in previous periods and our forecast of future taxable income. We believe this to be a critical accounting policy because should there be a change in our ability to recover our deferred tax assets, our tax provision would increase in the period in which we determine that the recovery is not likely, as well as decrease in the period in which the assessment of the recoverability of the deferred tax assets reverses, which could have a material impact on our results of operations.
 
We accrue a tax reserve for additional income taxes and interest, which may become payable in future years as a result of audit adjustments by tax authorities. The reserve is based upon management’s assessment of all relevant information and is periodically reviewed and adjusted as circumstances warrant. As of December 31, 2017, our income tax reserves were approximately $1.3 million and relates to the potential tax settlement in Hong Kong, adjustments in the area of withholding taxes, and state taxes.
 
We recognize current period interest expense and the reversal of previously recognized interest expense that has been determined to not be assessable due to the expiration of the related audit period or other compelling factors on the income tax liability for unrecognized tax benefits as interest expense, and penalties and penalty reversals related to the income taxes payable as other expense in our consolidated statements of operations.

The U.S. Tax Cuts and Jobs Act (the Act) was signed into law on December 22, 2017 and introduces significant changes to the Internal Revenue Code. Effective for tax years beginning after December 31, 2017, the Act reduces the U.S. statutory tax rate from 35% to 21% and creates new taxes on certain foreign-sourced earnings and related-party payments, which are referred to as the global intangible low-taxed income and the base erosion and anti-abuse tax, respectively. In addition, the Act includes a one-time transition tax as of December 31, 2017 on accumulated foreign subsidiary earnings that were previously tax deferred. Due to the timing of the enactment and the complexity involved in applying the provisions of the Act, the SEC issued guidance on December 22, 2017 to address the application of US GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete the accounting for certain income tax effects of the Act. In accordance with this guidance, we have made reasonable estimates of the effects of the Act and recorded provisional amounts in our financial statements as of December 31, 2017. For the items for which we determined a reasonable estimate, we recognized a provisional amount of $34.3 million, which is included as a component of income tax expense from continuing operations and partially reduced by fully-valued tax attribute carryforwards. As we collect and prepare necessary data, and interpret the Act and any additional guidance issued by the U.S. Treasury Department, the IRS, and other standard-setting bodies, we may make adjustments to the provisional amounts. Those adjustments may materially impact our provision for income taxes and effective tax rate in the period in which the adjustments are made. The accounting for the tax effects of the Act will be completed in 2018.
 

27

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

In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606)”, which supersedes the revenue recognition requirements in Accounting Standard Codification (“ASC”) 605, (Topic 605), and most industry-specific guidance. Under the new model, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, the new standard requires that reporting companies disclose the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. In August 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers – Deferral of the Effective Date”, which defers the effective date of ASU 2014-09 to annual reporting periods beginning after December 15, 2017, and interim periods therein. In 2016, the FASB issued ASU 2016-08, “Principal versus Agent Considerations (Reporting Revenue Gross versus Net)”, ASU 2016-10, “Identifying Performance Obligations and Licensing”, and ASU 2016-12, “Revenue from Contracts with Customers - Narrow-Scope Improvements and Practical Expedients”. Entities have the choice to adopt these updates using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a modified retrospective approach with the cumulative effect of these standards recognized at the date of the adoption.

Our approach to analyze the impact of the standard on our revenue contracts included a review of existing contracts with customers, an evaluation of the specific terms of those contracts and the appropriate treatment under the new standards, and a comparison of that new treatment to our existing accounting policies to identify differences. We will adopt the requirements of the new standard on January 1, 2018 using the modified retrospective approach.

We identified the same performance obligation (sale of our products) under Topic 606 as compared with deliverables and separate units of account previously identified under Topic 605.
 
We do offer certain types of variable consideration to customers such as discounts, pricing allowances and collaborative marketing arrangements. The standard requires us to estimate these amounts. We anticipate that the timing and measurement of revenue will be consistent with our current revenue recognition although our approach to revenue recognition will now be based on the transfer of control. As a result, there will be no impact on our consolidated financial statements on our adoption of the new standard as of January 1, 2018.

We established new key controls within our financial reporting infrastructure specific to our adoption of ASC 606. Furthermore, additional disclosures will be required to enable users to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Beginning in the first quarter of 2018, additional disclosures will include, but are not limited to, significant judgments and practical expedients elected in the adoption of Topic 606.
 
In January 2016, the FASB issued ASU 2016-01, “Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”). The new guidance is intended to improve the recognition and measurement of financial instruments. The ASU is effective for fiscal years and interim periods within those years beginning after December 15, 2017. The adoption of this standard is not expected to have a material impact on our consolidated financial statements.

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

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

In October 2016, the FASB issued ASU 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other than Inventory.” The amendments in this ASU reduces the complexity in the accounting standards by allowing the recognition of current and deferred income taxes for an intra-entity asset transfer, other than inventory, when the transfer occurs. Historically, recognition of the income tax consequence was not recognized until the asset was sold to an outside party. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on our consolidated financial statements.

In May 2017, the FASB issued ASU 2017-09, “Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting”, which clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. ASU 2017-09 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The adoption of this standard is not expected to have a material impact on our consolidated financial statements.


28

Results of Operations
 
The following table sets forth, for the periods indicated, certain statement of operations data as a percentage of net sales.
 
 
 
Years Ended December 31,
 
 
 
2015
   
2016
   
2017
 
Net Sales
   
100.0
%
   
100.0
%
   
100.0
%
Cost of Sales
   
69.4
     
68.4
     
74.6
 
Gross profit
   
30.6
     
31.6
     
25.4
 
Selling, general and administrative expenses
   
26.5
     
29.1
     
33.7
 
Goodwill and other intangibles impairment
   
     
     
2.2
 
Income (loss) from operations
   
4.1
     
2.5
     
(10.5
)
Change in fair value of business combination liability
   
0.8
     
     
 
Income from joint ventures
   
0.4
     
0.1
     
 
Other income
   
     
     
0.1
 
Loss on extinguishment of convertible senior notes
   
     
     
(0.2
)
Write-off of investment in DreamPlay, LLC
   
     
     
(1.1
)
Interest income
   
     
     
 
Interest expense
   
(1.7
)
   
(1.8
)
   
(1.6
)
Income (loss) before provision for income taxes
   
3.6
     
0.8
     
(13.3
)
Provision for income taxes
   
0.5
     
0.6
     
0.2
 
Net income (loss)
   
3.1
     
0.2
     
(13.5
)
Net income attributable to non-controlling interests
   
     
     
0.1
 
Net income (loss) attributable to JAKKS Pacific, Inc.
   
3.1
%
   
0.2
%
   
(13.6
)%
 
The following table summarizes, for the periods indicated, certain income statement data by segment (in thousands).
 
 
 
Years Ended December 31,
 
 
 
2015
   
2016
   
2017
 
 
                 
Net Sales
                 
U.S. and Canada
 
$
478,728
   
$
478,595
   
$
406,411
 
International
   
169,826
     
131,229
     
107,231
 
Halloween
   
97,187
     
96,779
     
99,469
 
 
   
745,741
     
706,603
     
613,111
 
Cost of Sales
                       
U.S. and Canada
   
334,989
     
322,721
     
297,115
 
International
   
110,174
     
89,187
     
81,381
 
Halloween
   
72,009
     
71,674
     
78,934
 
 
   
517,172
     
483,582
     
457,430
 
Gross Profit
                       
U.S. and Canada
   
143,739
     
155,874
     
109,296
 
International
   
59,652
     
42,042
     
25,850
 
Halloween
   
25,178
     
25,105
     
20,535
 
 
 
$
228,569
   
$
223,021
   
$
155,681
 

 
29

 
Comparison of the Years Ended December 31, 2017 and 2016
 
Net Sales
 
U.S. and Canada.  Net sales of our U.S. and Canada segment were $406.4 million in 2017, compared to $478.6 million in 2016, representing a decrease of $72.2 million, or 15.1%. The decrease in net sales was primarily due to decreases in unit sales in our Disney Tsum Tsum, Disney Frozen, XPV radio controlled vehicles, Graco, and Star Wars product lines partially offset by higher unit sales in our Moana, Squish-Dee-Lish, Beauty and the Beast Live Action, Tangled – the Series, and Real Workin’ Buddies – Mr. Dusty product lines.
 
International.  Net sales of our International segment were $107.2 million in 2017, compared to $131.2 million in 2016, representing a decrease of $24.0 million, or 18.3%. The decrease in net sales was primarily driven by declines in unit sales in our Disney Frozen, Star Wars, and Sofia the First product lines, partially offset by higher unit sales in our Moana, Elena of Avalor, Beauty & the Beast Live Action product lines.
 
Halloween.  Net sales of our Halloween segment were $99.5 million in 2017, compared to $96.8 million in 2016, representing an increase of $2.7 million, or 2.8%. The increase in net sales was due to an increase in unit sales of a variety of products in 2017.

Cost of Sales
 
U.S. and Canada.  Cost of sales of our U.S. and Canada segment was $297.1 million, or 73.1% of related net sales in 2017 compared to $322.7 million, or 67.4% of related net sales in 2016, representing a decrease of $25.6 million, or 7.9%. The decrease in cost of sales is due to lower overall unit sales in 2017, partially offset by minimum guarantee shortfalls. The increase as a percentage of net sales, year over year, is primarily due to increased charges recorded for minimum guarantee shortfalls and inventory impairment.

International.  Cost of sales of our International segment was $81.4 million, or 75.9% of related net sales in 2017 compared to $89.2 million, or 68.0% of related net sales in 2016, representing a decrease of $7.8 million, or 8.7%. The decrease in cost of sales is due to lower overall unit sales in 2017, partially offset by minimum guarantee shortfalls. The increase as a percentage of net sales, year-over-year, is primarily due to increased charges recorded for minimum guarantee shortfalls and inventory impairment.

Halloween.  Cost of sales of our Halloween segment was $78.9 million, or 79.3% of related net sales for 2017 compared to $71.7 million, or 74.1% of related net sales in 2016, representing an increase of $7.2 million, or 10.0%. The increase in cost of sales is due to higher overall unit sales in 2017 and minimum guarantee shortfalls. The increase as a percentage of net sales, year-over-year, is primarily due to increased charges for minimum guarantee shortfalls, changes in product mix and inventory impairment.

Selling, General and Administrative Expenses
 
Selling, general and administrative expenses were $206.3 million in 2017 and $205.9 million in 2016, constituting 33.7% and 29.1% of net sales, respectively. Selling, general and administrative expenses increased by $0.4 million, primarily due to bad debt write-offs of $11.2 million, offset by lower marketing expense and other general and administrative costs. The increases as a percentage of net sales, year over year is due to the lower net sales in 2017 coupled with comparable costs. 

Goodwill and Other Intangibles Impairment

Goodwill and other intangibles impairment was $13.5 million for 2017, as compared to nil in the prior year period. In 2017, we recorded impairment charges of $8.3 million for goodwill, $2.9 million to write-off the remaining unamortized technology rights related to DreamPlay, LLC and $2.3 million to write down several underutilized trademarks and trade names that were determined to have no value.

Income from Joint Ventures
 
We recognized $0.1 million of income for funds received in 2017 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. In 2016, we recognized $0.2 million of income for funds received related to our former video game joint venture and $0.7 million of income for funds received related to Pacific Animation Partners.

Other Income
 
We recognized income of $0.1 million for funds received in 2017 related to the disgorgement of short swing trading profits from a shareholder, net of legal fees and a $0.1 million gain on extinguishment of convertible senior notes. We recognized income of $0.2 million for funds received in 2016 related to the disgorgement of short swing trading profits from a shareholder, net of legal fees and a $0.1 million gain on extinguishment of convertible senior notes.

Loss on Extinguishment of Convertible Senior Notes
 
In 2017, we recognized a $0.6 million loss related to the extinguishment of $21.5 million face amount of our 4.25% convertible senior notes due in 2018. In 2017, we also recognized a $0.3 million loss related to the fair market value adjustment for the 3.25% convertible senior notes due in 2020.
 
30

 
Interest Income
 
Interest income in 2017 was $37,000, comparable to $51,000 in 2016.

Interest Expense

Interest expense was $9.8 million in 2017, as compared to $13.0 million in the prior year period. In 2017, we recorded interest expense of $9.4 million related to our convertible senior notes payable due in 2018 and 2020 and $0.4 million related to our revolving credit facility. In 2016, we recorded interest expense of $11.7 million related to our convertible senior notes payable, $0.9 million related to our revolving credit facility and $0.4 million related to the interest component of our Maui acquisition earn-out. The overall decrease in 2017 is due to a lower average debt.

Provision for Income Taxes
 
Our income tax expense, which includes federal, state and foreign income taxes and discrete items, was $1.6 million, or an effective tax rate of (2.0%) for 2017. During 2016, the income tax expense was $4.1 million, or an effective tax rate of 76.8%.
 
The 2017 tax expense of $1.6 million included a discrete tax benefit of $0.6 million primarily comprised of return to provision and uncertain tax position adjustments. Absent these discrete tax benefits, our effective tax rate for 2017 was (2.8%), primarily due to the US federal transition tax, various state taxes and taxes on foreign income.

The 2016 tax expense of $4.1 million included a discrete tax benefit of $0.1 million primarily comprised of return to provision adjustments. Absent these discrete tax expenses, our effective tax rate for 2016 was 79.2%, primarily due to US federal alternative minimum tax, various state taxes and taxes on foreign income.

We assess the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets by jurisdiction. Based on our evaluation of all positive and negative evidence, as of December 31, 2017, a valuation allowance of $89.7 million has been recorded against the deferred tax assets that more likely than not will not be realized. The net deferred tax liabilities of $0.8 million consists of the net deferred tax liabilities in the foreign jurisdiction, where we are in a cumulative income position, partially offset by the deferred tax assets in the US related to the AMT carryforward, which are fully realizable.

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

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

Cost of Sales
 
U.S. and Canada.  Cost of sales of our U.S. and Canada segment was $322.7 million, or 67.4% of related net sales in 2016 compared to $335.0 million, or 70.0% of related net sales in 2015, representing a decrease of $12.3 million, or 3.7%. The decrease in cost of sales as a percentage of net sales, year over year, is due to reduced costing of legacy products and product mix, partially offset by increased product tooling driven by new product introductions in 2016. Depreciation of molds and tools for the segment increased slightly in 2016 due to an increase in new product tooling driven by product introductions in 2016.
31


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

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

Selling, General and Administrative Expenses
 
Selling, general and administrative expenses were $205.9 million in 2016 and $198.0 million in 2015, constituting 29.1% and 26.5% of net sales, respectively. Selling, general and administrative expenses increased by $7.9 million driven by higher marketing expenses ($6.7 million), higher product development costs in support of increased product launches ($2.5 million), and increased depreciation and amortization ($1.6 million), partially offset by a decrease in general and administrative expenses ($2.9 million). 
  
Income from Joint Ventures
 
We recognized $0.2 million of income for funds received in 2016 related to our former video game joint venture in partial settlement of amounts owed to the Company when our joint venture partner was liquidated pursuant to their 2012 bankruptcy filing and $0.7 million of income for funds received in 2016 related to Pacific Animation Partners. In 2015, we recognized $2.7 million in income related to our former video game joint venture and $0.1 million of income for funds received related to Pacific Animation Partners.
 
Other Income
 
We recognized income of $0.2 million for funds received in 2016 related to the disgorgement of short swing trading profits from a shareholder, net of legal fees and a $0.1 million gain on extinguishment of convertible senior notes.
 
Interest Income
 
Interest income in 2016 was $51,000, comparable to $62,000 in 2015.
 
Interest Expense
 
Interest expense was $13.0 million in 2016, as compared to $12.4 million in 2015. In 2016, we recorded interest expense of $11.7 million related to our convertible senior notes payable, $0.9 million related to our revolving credit facility and $0.4 million related to the interest component of our Maui acquisition earn-out. In 2015, we recorded interest expense of $11.5 million related to our convertible senior notes payable and $0.9 million related to our revolving credit facility.
 
Provision for Income Taxes
 
Our income tax expense, which includes federal, state and foreign income taxes and discrete items, was $4.1 million, or an effective tax rate of 76.8% for 2016. During 2015, the income tax expense was $3.4 million, or an effective tax rate of 12.9%.
 
The 2016 tax expense of $4.1 million included a discrete tax benefit of $0.1 million primarily comprised of return to provision adjustments. Absent these discrete tax benefits, our effective tax rate for 2016 was 79.2%, primarily due to US federal alternative minimum tax, various state taxes and taxes on foreign income.

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

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

As of December 31, 2016, we had net deferred tax liabilities of approximately $2.0 million related to foreign jurisdictions.
 
32

Quarterly Fluctuations and Seasonality
 
We have experienced significant quarterly fluctuations in operating results and anticipate these fluctuations in the future. The operating results for any quarter are not necessarily indicative of results for any future period. Our first quarter is typically expected to be the least profitable as a result of lower net sales but substantially similar fixed operating expenses. This is consistent with the performance of many companies in the toy industry.
 
The following table presents our unaudited quarterly results for the years indicated. The seasonality of our business is reflected in this quarterly presentation.

 
2016
   
2017
 
 
First
   
Second
   
Third
   
Fourth
   
First
   
Second
   
Third
   
Fourth
 
(unaudited)
 
Quarter
   
Quarter
   
Quarter
   
Quarter
   
Quarter
   
Quarter
   
Quarter
   
Quarter
 
 
                                               
Net sales
 
$
95,809
   
$
140,977
   
$
302,791
   
$
167,026
   
$
94,505
   
$
119,565
   
$
262,413
   
$
136,628
 
As a % of full year
   
13.6
%
   
20.0
%
   
42.8
%
   
23.6
%
   
15.4
%
   
19.5
%
   
42.8
%
   
22.3
%
Gross Profit
 
$
31,183
   
$
44,800
   
$
94,933
   
$
52,105
   
$
30,021
   
$
33,719
   
$
61,781
   
$
30,160
 
As a % of full year
   
14.0
%
   
20.1
%
   
42.5
%
   
23.4
%
   
19.3
%
   
21.7
%
   
39.7
%
   
19.3
%
As a % of net sales
   
32.5
%
   
31.8
%
   
31.4
%
   
31.2
%
   
31.8
%
   
28.2
%
   
23.5
%
   
22.1
%
Income (loss) from operations
 
$
(13,816
)
 
$
(1,100
)
 
$
34,413
   
$
(2,391
)
 
$
(15,724
)
 
$
(14,108
)
 
$
(7,746
)
 
$
(26,580
)
As a % of full year
   
(80.8
)%
   
(6.4
)%
   
201.2
%
   
(14.0
)%
   
24.5
%
   
22.0
%
   
12.1
%
   
41.4
%
As a % of net sales
   
(14.4
)%
   
(0.8
)%
   
11.4
%
   
(1.4
)%
   
(16.6
)%
   
(11.8
)%
   
(3.0
)%
   
(19.5
)%
Income (loss) before provision
(benefit) for income taxes
 
$
(16,951
)
 
$
(3,441
)
 
$
31,612
   
$
(5,844
)
 
$
(18,629
)
 
$
(16,371
)
 
$
(16,651
)
 
$
(29,771
)
As a % of net sales
   
(17.7
)%
   
(2.4
)%
   
10.4
%
   
(3.5
)%
   
(19.7
)%
   
(13.7
)%
   
(6.3
)%
   
(21.8
)%
Net income (loss)
 
$
(17,383
)
 
$
(4,145
)
 
$
30,529
   
$
(7,752
)
 
$
(18,285
)
 
$
(16,687
)
 
$
(17,569
)
 
$
(30,487
)
As a % of net sales
   
(18.1
)%
   
(2.9
)%
   
10.1
%
   
(4.6
)%
   
(19.3
)%
   
(14.0
)%
   
(6.7
)%
   
(22.3
)%
Net income (loss) attributable to non-controlling interests
 
$
32
   
$
224
   
$
(83
)
 
$
(167
)
 
$
31
   
$
55
   
$
45
   
$
(74
)
As a % of net sales
   
%
   
0.2
%
   
%
   
(0.1
)%
   
%
   
%
   
%
   
(0.1
)%
Net income (loss) attributable to JAKKS Pacific, Inc.
 
$
(17,415
)
 
$
(4,369
)
 
$
30,612
   
$
(7,585
)
 
$
(18,316
)
 
$
(16,742
)
 
$
(17,614
)
 
$
(30,413
)
As a % of net sales
   
(18.2
)%
   
(3.1
)%
   
10.1
%
   
(4.5
)%
   
(19.4
)%
   
(14.0
)%
   
(6.7
)%
   
(22.3
)%
Diluted earnings (loss) per share
 
$
(1.01
)
 
$
(0.27
)
 
$
0.82
   
$
(0.47
)
 
$
(1.01
)
 
$
(0.77
)
 
$
(0.77
)
 
$
(1.33
)
Weighted average shares and
equivalents outstanding
   
17,218
     
16,402
     
39,504
     
16,098
     
18,104
     
21,616
     
22,772
     
22,799
 
 
Consistent with the seasonality of our business, first and second quarters of 2016 and 2017 and fourth quarter of 2017, experienced seasonally low sales which coupled with fixed overhead resulted in significant net losses.

Quarterly and year-to-date computations of income (loss) per share amounts are made independently. Therefore, the sum of the per share amounts for the quarters may not agree with the per share amounts for the year.
 
33

 
Debt with Conversion and Other Options
 
In July 2013, we sold an aggregate of $100.0 million principal amount of 4.25% convertible senior notes due 2018 (the “2018 Notes”). The 2018 Notes, which are senior unsecured obligations, pay interest semi-annually in arrears on August 1 and February 1 of each year at a rate of 4.25% per annum and will mature on August 1, 2018. The initial and still conversion rate for the 2018 Notes is 114.3674 shares of our common stock per $1,000 principal amount of notes, equivalent to an initial conversion price of approximately $8.74 per share of common stock, subject to adjustment in certain events. Upon conversion, the 2018 Notes will be settled in shares of our common stock. Holders of the 2018 Notes may require us to repurchase for cash all or some of their notes upon the occurrence of a fundamental change (as defined in the 2018 Notes). In 2016, we repurchased and retired $6.1 million principal amount of the 2018 Notes. In 2017, we exchanged and retired an aggregate of $51.1 million principal amount of the 2018 Notes at par for $35.6 million in cash and approximately 3.0 million shares of our common stock, and the maturity of $21.5 million principal amount of the 2018 Notes was extended to November 1, 2020 along with a reduction in the interest rate to 3.25% per annum if paid in cash and a reduction in the conversion price to $3.05 per share.

In June 2014, we sold an aggregate of $115.0 million principal amount of 4.875% convertible senior notes due 2020 (the “2020 Notes”). The 2020 Notes are senior unsecured obligations of the Company paying interest semi-annually in arrears on June 1 and December 1 of each year at a rate of 4.875% per annum and will mature on June 1, 2020. The initial and still conversion rate for the 2020 Notes is 103.7613 shares of our common stock per $1,000 principal amount of notes, equivalent to an initial conversion price of approximately $9.64 per share of common stock, subject to adjustment in certain events. Upon conversion, the 2020 Notes will be settled in shares of our common stock. Holders of the 2020 Notes may require us to repurchase for cash all or some of their notes upon the occurrence of a fundamental change (as defined in the 2020 Notes). In 2016, we repurchased and retired $2.0 million principal amount of the 2020 Notes.
 
Liquidity and Capital Resources
 
As of December 31, 2017, we had working capital of $146.9 million compared to $236.6 million as of December 31, 2016. The decrease was primarily attributable to the reclassification of $21.1 million of the 2018 convertible senior notes to current liabilities, the exchange and retirement of convertible senior notes, and the net loss, partially offset by proceeds from the issuance of common stock to a Hong Kong affiliate of our China joint venture partner during the second quarter of 2017.
 
Operating activities provided net cash of $65.8 million, $16.7 million and $11.4 million for the years ended December 31, 2015, 2016 and 2017, respectively. Net cash was favorably impacted primarily by decreases in accounts receivable and inventory. Our accounts receivable turnover as measured by days sales for the quarter outstanding in accounts receivable was 90 days, 96 days, and 96 days as of December 31, 2015, 2016 and 2017, respectively. Other than open purchase orders issued in the normal course of business, we have no obligations to purchase finished goods from our manufacturers. As of December 31, 2017, we had cash and cash equivalents of $65.0 million.
 
Investing activities used net cash of $21.7 million, $15.1 million and $14.8 million for the years ended December 31, 2015, 2016 and 2017, respectively. Cash used in 2017 consisted primarily of $14.9 million cash paid for the purchase of molds and tooling used in the manufacture of our products. Cash used in 2016 consisted primarily of $14.8 million cash paid for the purchase of office furniture, equipment, and molds and tooling used in the manufacturing of our products. Cash used in 2015 consisted primarily of $17.8 million cash paid for leasehold improvements, the purchase of office furniture, equipment and molds and tooling used in the manufacturing of our products. 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 21% payable on net sales of such products. As of December 31, 2017, these agreements required future aggregate minimum guarantees of $57.1 million, exclusive of $23.4 million in advances already paid. Of this $57.1 million future minimum guarantee, $40.7 million is due over the next twelve months.
 
Financing activities used net cash of $13.4 million, $12.0 million and $21.4 million for the years ended December 31, 2015, 2016 and 2017, respectively. The cash used in 2017 consists primarily of the cash portion of $35.6 million in the exchange of $51.1 million principal amount of our 2018 convertible senior notes, partially offset by the issuance of approximately 3.7 million shares of common stock for cash in the amount of $19.3 million. The cash used in 2016 consists primarily of the repurchase of our common stock and convertible senior notes. The cash used in 2015 consists primarily of the repurchase of our common stock.

The following is a summary of our significant contractual cash obligations for the periods indicated that existed as of December 31, 2017 and is based upon information appearing in the notes to the consolidated financial statements (in thousands):
 
 
 
Less than
1 year
   
1 – 3
years
   
3 – 5
years
   
More Than
5 years
   
Total
 
Short-term debt
 
$
26,178
   
$
   
$
   
$
   
$
26,178
 
Long-term debt
   
     
135,469
     
     
     
135,469
 
Interest on debt
   
6,734
     
9,088
     
     
     
15,822
 
Operating leases
   
13,403
     
21,396
     
18,884
     
7,121
     
60,804
 
Minimum guaranteed license/royalty payments
   
40,725
     
16,408
     
     
     
57,133
 
Employment contracts
   
8,936
     
10,312
     
     
     
19,248
 
Total contractual cash obligations
 
$
95,976
   
$
192,673
   
$
18,884
   
$
7,121
   
$
314,654
 
 `
The above table excludes any potential uncertain income tax liabilities that may become payable upon examination of our income tax returns by taxing authorities. Such amounts and periods of payment cannot be reliably estimated. See Note 13 to the consolidated financial statements for further explanation of our uncertain tax positions.
 

34

In October 2016, we acquired the operating assets of the C’est Moi brand of performance makeup and youth skincare products whose distribution is currently limited primarily to Asia. We expect to launch a full line of makeup and skincare products branded under the C’est Moi name in the U.S. and Canada in the first quarter of 2018 prior to which sales are anticipated to be nominal.
 
We believe that our cash flows from operations and cash and cash equivalents will be sufficient to meet our working capital and capital expenditure requirements and provide us with adequate liquidity to meet our anticipated operating needs for at least the next 12 months from the issuance of this annual report. We expect our capital expenditures to be approximately $14.0 million in 2018. Although operating activities are expected to provide cash, to the extent we make any acquisitions or grow significantly in the future, our operating and investing activities may use cash and, consequently, any acquisitions or growth may require us to obtain additional sources of financing. There can be no assurance that any necessary additional financing will be available to us on commercially reasonable terms, if at all. We intend to finance our long-term liquidity requirements out of net cash provided by operations and net cash and cash equivalents. As of December 31, 2017, we do not have any off-balance sheet arrangements.
 
During the last three fiscal years ending December 31, 2017, we do not believe that inflation has had a material impact on our net sales and revenues and on income from continuing operations.

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


35

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk
 
Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and rates. We are exposed to market risk in the areas of changes in United States and international borrowing rates and changes in foreign currency exchange rates. In addition, we are exposed to market risk in certain geographic areas that have experienced or remain vulnerable to an economic downturn, such as China. We purchase substantially all of our inventory from companies in China, and, therefore, we are subject to the risk that such suppliers will be unable to provide inventory at competitive prices. While we believe that, should such events occur we would be able to find alternative sources of inventory at competitive prices, we cannot assure you that we would be able to do so. These exposures are directly related to our normal operating and funding activities. To date, we have not used derivative instruments or engaged in hedging activities to minimize our market risk.
 
Interest Rate Risk
 
As of December 31, 2017, we have outstanding convertible senior notes payable of $21.2 million principal amount due August 2018 with a fixed interest rate of 4.25% per annum, $113.0 million principal amount due June 2020 with a fixed interest rate of 4.875% per annum, and $21.5 million principal amount due November 2020 with a fixed interest rate of 3.25% per annum if paid in cash. As the interest rates on the notes are at fixed rates, we are not generally subject to any direct risk of loss related to these notes arising from changes in interest rates.
 
Our exposure to market risk includes interest rate fluctuations in connection with our revolving credit facility (see Note 11 - Credit Facility in the accompanying notes to the consolidated financial statements for additional information). Borrowings under the revolving credit facility bear interest at a variable rate based on Prime Lending Rate or LIBOR Rate at the option of the Company. For Prime Lending Rate loans, the interest rate is equal to the highest of (i) the Federal Funds Rate plus a margin of 0.50%, (ii) the rate last quoted by The Wall Street Journal as the “Prime Rate,” or (iii) the sum of a LIBOR rate plus 1.00%, plus a margin of 2.25%. For LIBOR rate loans, the interest rate is equal to a LIBOR rate plus a margin of 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 year ended December 31, 2017, the maximum amount borrowed under the revolving credit facility was $20.0 million and the average amount of borrowings outstanding was $5.7 million. As of December 31, 2017, the amount of total borrowings outstanding under the revolving credit facility was $5.0 million. If the prevailing market interest rates relative to these borrowings increased by 10%, our interest expense during the period ended December 31, 2017 would have increased by less than $0.1 million.
 
Foreign Currency Risk
 
We have wholly-owned subsidiaries in Hong Kong, China, the United Kingdom, Germany, France, Spain, Canada and Mexico. Sales are generally made by these operations on FOB China or Hong Kong terms and are denominated in U.S. dollars. However, purchases of inventory and Hong Kong operating expenses are typically denominated in Hong Kong dollars and local operating expenses in the United Kingdom, Germany, France, Spain, Canada, Mexico and China are denominated in local currency, thereby creating exposure to changes in exchange rates. Changes in the U.S. dollar exchange rates may positively or negatively affect our gross margins, operating income and retained earnings. The exchange rate of the Hong Kong dollar to the U.S. dollar has been fixed by the Hong Kong government since 1983 at HK$7.80 to US$1.00 and, accordingly, has not represented a currency exchange risk to the U.S. dollar. We do not believe that near-term changes in these exchange rates, if any, will result in a material effect on our future earnings, fair values or cash flows. Therefore, we have chosen not to enter into foreign currency hedging transactions. We cannot assure you that this approach will be successful, especially in the event of a significant and sudden change in the value of these foreign currencies.
 

36

Item 8.  Consolidated Financial Statements and Supplementary Data
 
Report of Independent Registered Public Accounting Firm
 
Shareholders and Board of Directors
JAKKS Pacific, Inc.
Santa Monica, California
 
Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of JAKKS Pacific, Inc. (the “Company") and subsidiaries as of December 31, 2017 and 2016 and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2017, and the related notes and financial statement schedule listed in the accompanying index (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiaries at December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated March 16, 2018 expressed an unqualified opinion thereon.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
 
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.


/S/ BDO USA, LLP
 

We have served as the Company’s auditor since 2006.

Los Angeles, California
March 16, 2018
 
37

 
JAKKS PACIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
 
 
December 31,
 
 
 
2016
   
2017
 
 
 
(In thousands, except
 
 
 
share data)
 
Assets
           
Current assets
           
Cash and cash equivalents
 
$
86,064
   
$
64,977
 
Accounts receivable, net of allowance for uncollectible accounts of $2,864 and $10,940 in 2016 and 2017, respectively
   
173,599
     
142,457
 
Inventory, net
   
75,435
     
58,432
 
Income taxes receivable
   
1,204
     
1,880
 
Prepaid expenses and other assets
   
17,077
     
14,923
 
Total current assets
   
353,379
     
282,669
 
Property and equipment
               
Office furniture and equipment
   
14,345
     
15,043
 
Molds and tooling
   
103,128
     
115,378
 
Leasehold improvements
   
10,927
     
10,936
 
Total
   
128,400
     
141,357
 
Less accumulated depreciation and amortization
   
105,559
     
118,130
 
Property and equipment, net
   
22,841
     
23,227
 
Intangible assets, net
   
33,111
     
22,190
 
Other long term assets
   
2,156
     
6,579
 
Investment in DreamPlay, LLC
   
7,000
     
 
Goodwill
   
43,208
     
35,384
 
Trademarks
   
2,608
     
300
 
Total assets
 
$
464,303
   
$
370,349
 
Liabilities and Stockholders’ Equity
               
Current liabilities
               
Accounts payable
 
$
51,741
   
$
49,916
 
Accrued expenses
   
38,645
     
42,145
 
Reserve for sales returns and allowances
   
16,424
     
17,622
 
Short term debt
   
10,000
     
5,000
 
Convertible senior notes, net
   
     
21,075
 
Total current liabilities
   
116,810
     
135,758
 
Convertible senior notes, net
   
203,007
     
133,497
 
Other liabilities
   
5,004
     
4,537
 
Income taxes payable
   
2,248
     
1,261
 
Deferred income taxes, net
   
2,034
     
783
 
Total liabilities
   
329,103
     
275,836
 
Commitments and Contingencies
               
Stockholders’ equity
               
Preferred stock, $.001 par value; 5,000,000 shares authorized; nil outstanding
   
     
 
Common stock, $.001 par value; 100,000,000 shares authorized; 19,376,773 and 26,957,354 shares issued and outstanding in 2016 and 2017, respectively
   
19
     
27
 
Treasury stock, at cost; 3,112,840 shares
   
(24,000
)
   
(24,000
)
Additional paid-in capital
   
177,624
     
215,809
 
Accumulated deficit
   
(2,148
)
   
(85,233
)
Accumulated other comprehensive loss
   
(17,207
)
   
(13,059
)
Total JAKKS Pacific, Inc. stockholders’ equity
   
134,288
     
93,544
 
Non-controlling interests
   
912
     
969
 
Total stockholders’ equity
   
135,200
     
94,513
 
Total liabilities and stockholders’ equity
 
$
464,303
   
$
370,349
 
 
See accompanying notes to consolidated financial statements.
 

38


JAKKS PACIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

 
 
 
Years Ended December 31,
 
 
 
2015
   
2016
   
2017
 
 
 
(In thousands, except per share amounts)
 
Net sales
 
$
745,741
   
$
706,603
   
$
613,111
 
Cost of sales
   
517,172
     
483,582
     
457,430
 
Gross profit
   
228,569
     
223,021
     
155,681
 
Selling, general and administrative expenses
   
198,039
     
205,915
     
206,303
 
Goodwill and other intangibles impairment
   
     
     
13,536
 
Income (loss) from operations
   
30,530
     
17,106
     
(64,158
)
Change in fair value of business combination liability
   
5,642
     
     
 
Income from joint ventures
   
2,761
     
889
     
105
 
Other income
   
     
305
     
342
 
Loss on extinguishment of convertible senior notes
   
     
     
(919
)
Write-off of investment in DreamPlay, LLC
   
     
     
(7,000
)
Interest income
   
62
     
51
     
37
 
Interest expense
   
(12,402
)
   
(12,975
)
   
(9,829
)
Income (loss) before provision for income taxes
   
26,593
     
5,376
     
(81,422
)
Provision for income taxes
   
3,423
     
4,127
     
1,606
 
Net income (loss)
   
23,170
     
1,249
     
(83,028
)
Net income (loss) attributable to non-controlling interests
   
(84
)
   
6
     
57
 
Net income (loss) attributable to JAKKS Pacific, Inc.
 
$
23,254
   
$
1,243
   
$
(83,085
)
Basic earnings (loss) per share
 
$
1.20
   
$
0.08
   
$
(3.89
)
Basic weighted number of shares
   
19,435
     
16,542
     
21,341
 
Diluted earnings (loss) per share
 
$
0.71
   
$
0.07
   
$
(3.89
)
Diluted weighted number of shares
   
43,321
     
16,665
     
21,341
 
 
See accompanying notes to consolidated financial statements.
 

39


 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
 
 
 
     
Years Ended December 31,
 
     
2015 
     
2016 
     
2017 
 
              (In thousands)          
                         
Net income (loss)
 
$
23,170
 
 
$
1,249
 
 
$
(83,028
)
Other comprehensive income (loss):
                       
Foreign currency translation adjustment
   
(3,216
)
   
(7,156
)
 
 
4,148
 
Comprehensive income (loss)
 
 
19,954
 
 
 
(5,907
)
 
 
(78,880
)
Less: Comprehensive income (loss) attributable to non-controlling interests
 
 
(84
)
 
 
6
 
 
 
57
 
Comprehensive income (loss) attributable to JAKKS Pacific, Inc.
 
$
20,038
 
 
$
(5,913
)
 
$
(78,937
)
 
See accompanying notes to consolidated financial statements.
 

40


 
 
JAKKS PACIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2015, 2016 AND 2017
(In thousands)


 
 
Common Stock
                     
Accumulated
   
JAKKS
             
 
             
Additional
         
Other
   
Pacific, Inc.
   
Non-
   
Total
 
 
 
Number
         
Treasury
   
Paid-in
   
Accumulated
   
Comprehensive
   
Stockholders’
   
Controlling
   
Stockholders’
 
 
 
of Shares
   
Amount
   
Stock
   
Capital
   
Deficit
   
Loss
   
Equity
   
Interests
   
Equity
 
Balance, January 1, 2015
   
22,682
   
$
22
   
$
(24,000
)
 
$
202,052
   
$
(26,645
)
 
$
(6,835
)
 
$
144,594
   
$
490
   
$
145,084
 
Restricted stock grants
   
71
     
1
     
     
1,561
     
     
     
1,562
     
     
1,562
 
Retirement of restricted stock
   
(52
)
   
(1
)
   
     
     
     
     
(1
)
   
     
(1
)
Repurchase of common stock
   
(1,547
)
   
(1
)
   
(13,192
)
   
     
     
     
(13,193
)
   
     
(13,193
)
Retirement of treasury stock
   
     
(1
)
   
8,870
     
(8,869
)
   
     
     
     
     
 
Net income
   
     
     
     
     
23,254
     
     
23,254
     
(84
)
   
23,170
 
Foreign currency translation adjustment
   
     
     
     
     
     
(3,216
)
   
(3,216
)
   
     
(3,216
)
Balance, December 31, 2015
   
21,154
     
20
     
(28,322
)
   
194,744
     
(3,391
)
   
(10,051
)
   
153,000
     
406
     
153,406
 
Contributions from non-controlling interests
   
     
     
     
     
     
     
     
500
     
500
 
Restricted stock grants
   
65
     
1
     
     
1,620
     
     
     
1,621
     
     
1,621
 
Retirement of restricted stock
   
(25
)
   
     
     
     
     
     
     
     
 
Repurchase of common stock
   
(1,766
)
   
     
(13,506
)
   
     
     
     
(13,506
)
   
     
(13,506
)
Repurchase of common stock for employee tax withholding
   
(51
)
   
     
     
(1,462
)
   
     
     
(1,462
)
   
     
(1,462
)
Retirement of treasury stock
   
     
(2
)
   
17,828
     
(17,826
)
   
     
     
     
     
 
Excess tax benefit on vesting of restricted stock
   
     
     
     
548
     
     
     
548
     
     
548
 
Net income
   
     
     
     
     
1,243
     
     
1,243
     
6
     
1,249
 
Foreign currency translation adjustment
   
     
     
     
     
     
(7,156
)
   
(7,156
)
   
     
(7,156
)
Balance, December 31, 2016
   
19,377
     
19
     
(24,000
)
   
177,624
     
(2,148
)
   
(17,207
)
   
134,288
     
912
     
135,200
 
Restricted stock grants
   
981
     
1
     
     
3,111
     
     
     
3,112
     
     
3,112
 
Retirement of restricted stock
   
(9
)
   
     
     
     
     
     
     
     
 
Shares issued in exchange for convertible notes
   
2,977
     
3
     
     
15,521
     
     
     
15,524
     
     
15,524
 
Repurchase of common stock for employee tax withholding
   
(30
)
   
     
     
(79
)
   
     
     
(79
)
   
     
(79
)
Issuance of common stock to Hongkong Meisheng
   
3,661
     
4
     
     
19,307
     
     
     
19,311
     
     
19,311
 
Adjustment to additional paid in capital
                           
325
                     
325
     
     
325
 
Net income (loss)
   
     
     
     
     
(83,085
)