Edgar Filing: JAKKS PACIFIC INC

a50823769.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

x	ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the Fiscal Year Ended December 31, 2013

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

For the transition period from ____________ to ____________

Commission File Number 0-28104

JAKKS PACIFIC, INC.

(Exact name of registrant as specified in its charter)

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

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

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

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

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

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

Title of Class

Common Stock, $.001 par value per share

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

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

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by a check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definition of “large accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one):

o Large Accelerated Filer	x Accelerated Filer	o Non-Accelerated Filer	o Smaller Reporting Company
		(Do not check if a Smaller Reporting Company)

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

The aggregate market value of the voting and non-voting common equity (the only such common equity being Common Stock, $.001 par value per share) held by non-affiliates of the registrant (computed by reference to the closing sale price of the Common Stock on June 28, 2013 of $11.25) is $254,435,906.

The number of shares outstanding of the registrant’s Common Stock, $.001 par value (being the only class of its common stock), is 23,277,563 as of March14, 2014.

Documents Incorporated by Reference

None.

JAKKS PACIFIC, INC.

INDEX TO ANNUAL REPORT ON FORM 10-K

For the Fiscal Year ended December 31, 2013

Items in Form 10-K

		Page
	PART I
Item 1.	Business	2
Item 1A.	Risk Factors	11
Item 1B.	Unresolved Staff Comments	None
Item 2.	Properties	16
Item 3.	Legal Proceedings	17
Item 4.	Mine Safety Disclosures	N/A
	PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	19
Item 6.	Selected Financial Data	23
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	38
Item 8.	Financial Statements and Supplementary Data	40
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	None
Item 9A.	Controls and Procedures	76
Item 9B.	Other Information	None
	PART III
Item 10.	Directors, Executive Officers and Corporate Governance	78
Item 11.	Executive Compensation	81
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	96
Item 13.	Certain Relationships and Related Transactions, and Director Independence	98
Item 14.	Principal Accountant Fees and Services	98
	PART IV
Item 15.	Exhibits and Financial Statement Schedules	100
Signatures		102
Certifications

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

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

PART I

Item 1. Business

In this report, “JAKKS,” the “Company,” “we,” “us” and “our” refer to JAKKS Pacific, Inc. and its subsidiaries.

Company Overview

We are a leading multi-line, multi-brand toy company that designs, produces, markets and distributes toys and related products, pet toys, consumables and related products, electronics and related products, kids indoor and outdoor furniture, and other consumer products. We focus our business on acquiring or licensing well-recognized trademarks and brand names, most with long product histories (“evergreen brands”). We seek to acquire these evergreen brands because we believe they are less subject to market fads or trends. We also develop proprietary products marketed under our own trademarks and brand names, and have historically acquired complementary businesses to further grow our portfolio. For accounting purposes, our products can be divided into two segments: (i) traditional toys and electronics and (ii) role play, novelty and seasonal toys. Segment information with respect to revenues, assets and profits or losses attributable to each segment is contained in Note 3 to the audited 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 Road Champs®, Fly Wheels® and MXS® toy vehicles and accessories;

●	Electronics products, including Spy Net® spy products, Plug It In & Play TV Games ™ video games based on Disney® brands, and Duck Commander, and other popular brands;

●	Dolls and accessories, including small dolls, large dolls, fashion dolls and baby dolls based on licenses, including Disney Princess®, Disney Fairies®, Cabbage Patch Kids®, and Graco® and Fisher Price® plush, 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;

●	Foot-to-floor ride-on toys based on Fisher Price®, Kawasaki®, and DC Comics®, inflatable environments, tents and wagons; and

●	Pet products, including toys, consumables, and accessories, branded JAKKS Pets® and American Classics™, some of which also feature licenses, including Kong.

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 Black & Decker®, McDonald’s®, Dirt Devil®, Disney Princess®, Disney Fairies® and Dora the Explorer®, as well as those based on our own proprietary brands;

●	Indoor and outdoor kids’ furniture, activity trays and tables and room décor; kiddie pools, seasonal and outdoor products, including those based on Crayola®, Disney® characters and more, and Funnoodle® pool floats;

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

●	Junior sports and outdoor activity toys including Skyball® hyper-charged balls and sport sets and Wave Hoops® toy hoops marketed under our Maui Toys brand.

We continually review the marketplace to identify and evaluate popular and evergreen brands and product categories that we believe have the potential for growth. We endeavor to generate growth within these lines by:

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creating innovative products under our established licenses and brand names;

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

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

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focusing our marketing efforts to enhance consumer recognition and retailer interest.

Our Business Strategy

In addition to developing our own proprietary brands and marks, licensing popular trademarks enables us to use these high-profile marks at a lower cost than we would incur if we purchased these marks or developed comparable marks on our own. By licensing trademarks, we have access to a far greater range of marks than would be available for purchase. We also license technology developed by unaffiliated inventors and product developers to enhance the design and functionality of our products.

We sell our products through our in-house sales staff and independent sales representatives to toy and mass-market retail chain stores, department stores, office supply stores, drug and grocery store chains, club stores, toy specialty stores and wholesalers. Our three largest customers are Wal-Mart, Target and Toys ‘R’ Us, which accounted for approximately 21.4%, 15.6% and 10.8%, respectively, of our net sales in 2013. No other customer accounted for more than 10.0% of our net sales in 2013.

Our Growth Strategy

In 2012 and 2013, we generated net sales of $666.8 million and $632.9 million, respectively, and net loss of $104.8 million and $53.9 million, respectively. Approximately 42.4% and 47.2% of our net sales in 2012 and 2013, respectively, were attributable to our acquisitions since 2008. Key elements of our growth strategy include:

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

● Enter New Product Categories. We use our extensive experience in the toy and other consumer product industries to evaluate products and licenses in new product categories and to develop additional product lines. We began marketing licensed classic video games for simple plug-in use with television sets and expanded into several related categories by infusing additional technologies such as motion gaming and through the licensing of this category from our current licensors, such as Disney® and MTV Networks which owns Nickelodeon® .

● Pursue Strategic Acquisitions. We supplement our internal growth with selected strategic acquisitions. In July 2012 we acquired the business of Maui, Inc., an Ohio corporation, and A.S. Design Limited, a related Hong Kong corporation (collectively, “Maui”). Maui is a leading manufacturer and distributor of spring and summer activity toys and impulse toys. We will continue focusing our acquisition strategy on businesses or brands that we believe have compatible product lines and/or offer valuable trademarks or brands.

● Acquire Additional Character and Product Licenses. We have acquired the rights to use many familiar brand and character names and logos from third parties that we use with our primary trademarks and brands. Currently, among others, we have license agreements with Nickelodeon®, Disney®, 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 2013, our sales generated outside the United States were approximately $108.7 million, or 17.2% of total net sales. While our international sales declined in 2013 compared to 2012, we intend to continue to try to expand our international sales and in 2012 opened sales offices and expanded distribution agreements in Latin America and China to capitalize on our experience and our relationships with foreign distributors and retailers. We expect these initiatives to contribute to our international growth in 2014.

● Capitalize On Our Operating Efficiencies. We believe that our current infrastructure and operating model can accommodate growth without a proportionate increase in our operating and administrative expenses, thereby increasing our operating margins.

The execution of our growth strategy, however, is subject to several risks and uncertainties and we cannot assure you that we will continue to experience growth in, or maintain our present level of net sales (see “Risk Factors,” beginning on page 11). For example, our growth strategy will place additional demands upon our management, operational capacity and financial resources and systems. The increased demand upon management may necessitate our recruitment and retention of additional qualified management personnel. We cannot assure you that we will be able to recruit and retain qualified personnel or expand and manage our operations effectively and profitably. To effectively manage future growth, we must continue to expand our operational, financial and management information systems and to train, motivate and manage our work force. While we believe that our operational, financial and management information systems will be adequate to support our future growth, no assurance can be given they will be adequate without significant investment in our infrastructure. Failure to expand our operational, financial and management information systems or to train, motivate or manage employees could have a material adverse effect on our business, financial condition and results of operations.

Moreover, implementation of our growth strategy is subject to risks beyond our control, including competition, market acceptance of new products, changes in economic conditions, our ability to obtain or renew licenses on commercially reasonable terms and our ability to finance increased levels of accounts receivable and inventory necessary to support our sales growth, if any.

Furthermore, we cannot assure you that we can identify attractive acquisition candidates or negotiate acceptable acquisition terms, and our failure to do so may adversely affect our results of operations and our ability to sustain growth.

Finally, our acquisition strategy involves a number of risks, each of which could adversely affect our operating results, including difficulties in integrating acquired businesses or product lines, assimilating new facilities and personnel and harmonizing diverse business strategies and methods of operation; diversion of management attention from operation of our existing business; loss of key personnel from acquired companies; and failure of an acquired business to achieve targeted financial results.

Industry Overview

According to Toy Industry Association, Inc., the leading toy industry trade group, the United States is the world’s largest toy market, followed by Japan and Western Europe. Total retail sales of toys, excluding video games, in the United States, were approximately $16.3 billion in 2013. We believe the two largest United States toy companies, Mattel and Hasbro, collectively hold a dominant share of the domestic non-video toy market. In addition, hundreds of smaller companies compete in the design and development of new toys, the procurement of character and product licenses, and the improvement and expansion of previously introduced products and product lines.

Over the past few years, the toy industry has experienced substantial consolidation among both toy companies and toy retailers. We believe that the ongoing consolidation of toy companies provides us with increased growth opportunities due to retailers’ desire to not be entirely dependent upon a few dominant toy companies. Retailer concentration also enables us to ship products, manage account relationships and track point of sale information more effectively and efficiently.

Products

We focus our business on acquiring or licensing well-recognized trademarks or brand names, and we seek to acquire evergreen brands which are less subject to market fads or trends. Generally, our license agreements for products and concepts call for royalties ranging from 1% to 14% of net sales, and some may require minimum guarantees and advances. Our principal products include:

Traditional Toys and Electronics

Electronics Products

Our electronic products category includes our Plug It In & Play TV Games®, SpyNet Spy products and Laser Challenge® product lines. Our current Plug It In & Play TV Games® titles, geared to the pre-school and leisure gamer segments, include licenses from Namco®, Disney, Marvel® and Nickelodeon® , and feature such games as SpongeBob SquarePants®, Duck Commander®, Walking Dead®, Dora the Explorer®, Disney Princess®, Ms. Pac-Man® and Pac-Man®.

In 2013, we launched our EZ Pro® DJ platform enabling users to mix and match tunes as well as portable baby monitors, and in 2014 we expect to launch Hero Portal ™ video games with collectible figurines that interact with an all-in-one video console.

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 2012, we launched our proprietary line of motorized trains and track sets under the brand Power Trains, and in 2014, we will expand the product line to include buildings, automobiles and freeways under the Power City™ brand. We relaunched our proprietary line of rip cord powered action wheels and propellers, Fly Wheels®.

Action Figures and Accessories

We currently develop, manufacture and distribute other action figures and action figure accessories including those based on the animated series El Chavo®, Star Wars®, and Batman®, capitalizing on the expertise we built in the action figure category.

In 2013, we expanded our line of 31” figures to include Superman®, Power Rangers® and Star Wars®. In 2014, we expect to expand the range of large figures to include an assortment of 20” figures.

Dolls

Dolls and accessories include small dolls, large dolls, fashion dolls and baby dolls based on licenses, including Disney Princess®, Disney Fairies®, Cabbage Patch Kids®, and, Graco®, 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 2013, we launched MiWorld™, a line of mall-based playhouse elements featuring Claire’s, Skechers and O.P.I. among others which incorporates DreamPlay technology adding a virtual experience to a physical toy.

PetProducts

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

Role Play, Novelty & Seasonal

Role play and Dress-up Products

Our line of role play and dress-up products for boys and girls features entertainment and consumer products properties such as Disney Princess®, Disney Fairies®, Dora the Explorer®, and Black & Decker®. These products generated a significant amount of sales in 2012 and 2013.

Seasonal/ Outdoor Products

We have a wide range of seasonal toys and outdoor and leisure products including our recently acquired Maui line of proprietary products including Sky Ball and Wave Hoop among other outdoor toys. Our Funnoodle® pool toys include the basic Funnoodle pool floats and a variety of other pool toys.

Indoor and Outdoor Kids’ Furniture

We produce an extensive array of licensed indoor and outdoor kids' furniture and activity tables, and room decor. Our licensed portfolio includes character licenses, including Crayola®, Disney Princess®, Toy Story®, Mickey Mouse®, Dora the Explorer®, and others. Products include children’s puzzle furniture, tables and chairs to activity sets, trays, stools and a line of licensed molded kiddie pools, among others.

Halloween and Everyday Costume Play

We produce an expansive and innovative line of Halloween costumes and accessories which includes a wide range of non-licensed Halloween costumes such as horror, pirates, historical figures and aliens to animals, vampires, angels and more, as well as popular licensed characters from top intellectual property owners including Disney®, Hasbro®, Marvel®, Sesame Workshop®, Mattel®, and many others.

DreamPlay Technology

In September 2012, we formed a joint venture with NantWorks LLC called DreamPlay Toys LLC to exploit their patented recognition technologies in conjunction with toy and consumer products. In 2013, we launched two lines of toy products which utilize the technologies to enhance the play pattern of the toys as well as enhance the in-store experience of the consumer. The first product line was based on Disney’s Little Mermaid followed by our propriety concept, MiWorld. Both product lines were accompanied by a software application which brings the toy products to life adding a rich virtual experience to a physical experience. In 2014, we expect to launch updates to these apps as well as launch several other toys with application based product lines.

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 46.8% of our net sales in 2012 and 47.8% of our net sales in 2013. With the JAKKS Pets® product line, we distribute pet products to key pet supply retailers Petco and Petsmart in addition to many other pet retailers and our existing customers. We generally sell products to our customers pursuant to letters of credit or, in some cases, on open account with payment terms typically varying from 30 to 90 days. From time to time, we allow our customers credits against future purchases from us in order to facilitate their retail markdown and sales of slow-moving inventory. We also sell our products through e-commerce sites, including Toysrus.com and Amazon.com.

We contract the manufacture of most of our products to unaffiliated manufacturers located in The People’s Republic of China (“China”). We sell the finished products on a letter of credit basis or on open account to our customers, many of whom take title to the goods in Hong Kong or China. These methods allow us to reduce certain operating costs and working capital requirements. A portion of our sales originate in the United States, so we hold certain inventory in our warehouse and fulfillment facilities. To date, a significant portion of all of our sales has been to domestic customers. We intend to continue expanding distribution of our products into foreign territories and, accordingly, we have:

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engaged representatives to oversee sales in certain territories,

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engaged distributors in certain territories,

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established direct relationships with retailers in certain territories,

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opened sales offices in Europe,

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opened sales offices and a distribution center in Canada, and

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

Outside of the United States, we currently sell our products primarily in Europe, Australia, Canada, Latin America and Asia. Sales of our products abroad accounted for approximately $132.0 million, or 19.8% of our net sales, in 2012 and approximately $108.7 million, or 17.2% of our net sales, in 2013. We believe that foreign markets present an attractive opportunity, and we plan to intensify our marketing efforts and further expand our distribution channels abroad.

We establish reserves for sales allowances, including promotional allowances and allowances for anticipated defective product returns, at the time of shipment. The reserves are determined as a percentage of net sales based upon either historical experience or upon estimates or programs agreed upon by our customers and us.

We obtain, directly, or through our sales representatives, orders for our products from our customers and arrange for the manufacture of these products as discussed below. Cancellations generally are made in writing, and we take appropriate steps to notify our manufacturers of these cancellations. We may incur costs or other losses as a result of cancellations.

We maintain a full-time sales and marketing staff, many of whom make on-site visits to customers for the purpose of showing product and soliciting orders for products. We also retain a number of independent sales representatives to sell and promote our products, both domestically and internationally. Together with retailers, we occasionally test the consumer acceptance of new products in selected markets before committing resources to large-scale production.

We publicize and advertise our products in trade and consumer magazines and other publications, market our products at international, national and regional toy and other specialty trade shows, conventions and exhibitions and carry on cooperative advertising programs with toy and mass market retailers and other customers which include the use of print and television ads and in-store displays. We also produce and broadcast television commercials for several of our product lines, if we expect that the resulting increase in our net sales will justify the relatively high cost of television advertising.

Product Development

Each of our product lines has an in-house manager responsible for product development. The in-house manager identifies and evaluates inventor products and concepts and other opportunities to enhance or expand existing product lines or to enter new product categories. In addition, we create proprietary products to fully exploit our concept and character licenses. Although we do have the capability to create and develop products from inception to production, we also use third-parties to provide a portion of the sculpting, sample making, illustration and package design required for our products in order to accommodate our increasing product innovations and introductions. Typically, the development process takes from three to nine months from concept to production and shipment to our customers.

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

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

Manufacturing and Supplies

Most of our products are currently produced by overseas third-party manufacturers, which we choose on the basis of quality, reliability and price. Consistent with industry practice, the use of third-party manufacturers enables us to avoid incurring fixed manufacturing costs, while maximizing flexibility, capacity and production technology. Substantially all of the manufacturing services performed overseas for us are paid for on open account with the manufacturers. To date, we have not experienced any material delays in the delivery of our products; however, delivery schedules are subject to various factors beyond our control, and any delays in the future could adversely affect our sales. Currently, we have ongoing relationships with over eighty different manufacturers. We believe that alternative sources of supply are available to us although we cannot be assured that we can obtain adequate supplies of manufactured products.

Although we do not conduct the day-to-day manufacturing of our products, we are extensively involved in the design of the product prototype and production tools, dyes and molds for our products and we seek to ensure quality control by actively reviewing the production process and testing the products produced by our manufacturers. We employ quality control inspectors who rotate among our manufacturers’ factories to monitor the production of substantially all of our products.

The principal raw materials used in the production and sale of our toy products are plastics, zinc alloy, plush, printed fabrics, paper products and electronic components, all of which are currently available at reasonable prices from a variety of sources. Although we do not manufacture our products, we own the majority of the tools, dyes and molds used in the manufacturing process, and these are transferable among manufacturers if we choose to employ alternative manufacturers. Tools, dyes and molds represent a substantial portion of our property and equipment with a net book value of $10.8 million in 2012 and $8.5 million in 2013; 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 2013, approximately 70.9% of our net sales were made in the third and fourth quarters. Generally, the first quarter is the period of lowest shipments and sales in our business and in the toy industry and therefore it is also the least profitable quarter due to various fixed costs. Seasonality factors may cause our operating results to fluctuate significantly from quarter to quarter. However, our seasonal products are primarily sold in the spring and summer seasons. Our results of operations may also fluctuate as a result of factors such as the timing of new products (and related expenses) introduced by us or our competitors, the advertising activities of our competitors, delivery schedules set by our customers and the emergence of new market entrants. We believe, however, that the low retail price of most of our products may be less subject to seasonal fluctuations than higher priced toy products.

We ship products in accordance with delivery schedules specified by our customers, who generally request delivery of products within three to six months of the date of their orders for orders shipped FOB China or Hong Kong and within three days for orders shipped domestically. Because customer orders may be canceled at any time without penalty, our backlog may not accurately indicate sales for any future period.

Government and Industry Regulation

Our products are subject to the provisions of the Consumer Product Safety Act (“CPSA”), the Federal Hazardous Substances Act (“FHSA”), the Flammable Fabrics Act (“FFA”) and the regulations promulgated 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, 2014, we employed 758 persons, all of whom are full-time employees, including three executive officers. We employed 355 people in the United States, 10 people in Canada, 266 people in Hong Kong, 114 people in China, 12 people in the United Kingdom, and 1 person in France. We believe that we have good relationships with our employees. None of our employees are represented by a union.

Environmental Issues

We are subject to legal and financial obligations under environmental, health and safety laws in the United States and in other jurisdictions where we operate. We are not currently aware of any material environmental liabilities associated with any of our operations.

Available Information

We make available free of charge on or through our Internet website, www.jakks.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The contents of our website are not incorporated in or deemed to be a part of any such report.

Our Corporate Information

We were formed as a Delaware corporation in 1995. Our principal executive offices are located at 22619 Pacific Coast Highway, Malibu, California 90265. Our telephone number is (310) 456-7799 and our Internet Website address is www.jakks.com. The contents of our website are not incorporated in or deemed to be a part of this Annual Report on Form 10-K.

Item 1A. Risk Factors

From time to time, including in this Annual Report on Form 10-K, we publish forward-looking statements, as disclosed in our Disclosure Regarding Forward-Looking Statements, beginning immediately following the Table of Contents of this Annual Report. We note that a variety of factors could cause our actual results and experience to differ materially from the anticipated results or other expectations expressed or anticipated in our forward-looking statements. The factors listed below are risks and uncertainties that may arise and that may be detailed from time to time in our public announcements and our filings with the Securities and Exchange Commission, such as on Forms 8-K, 10-Q and 10-K. We undertake no obligation to make any revisions to the forward-looking statements contained in this Annual Report on Form 10-K to reflect events or circumstances occurring after the date of the filing of this report.

Our inability to redesign, restyle and extend our existing core products and product lines as consumer preferences evolve, and to develop, introduce and gain customer acceptance of new products and product lines, may materially and adversely impact our business, financial condition and results of operations.

Our business and operating results depend largely upon the appeal of our products. Our continued success in the toy industry will depend upon our ability to redesign, restyle and extend our existing core products and product lines as consumer preferences evolve, and to develop, introduce and gain customer acceptance of new products and product lines. Several trends in recent years have presented challenges for the toy industry, including:

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the phenomenon of children outgrowing toys at younger ages, particularly in favor of interactive and high technology products;

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increasing use of technology;

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shorter life cycles for individual products; and

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higher consumer expectations for product quality, functionality and value.

We cannot assure you that:

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our current products will continue to be popular with consumers;

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the product lines or products that we introduce will achieve any significant degree of market acceptance;

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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.

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our inclusion of new technology will result in higher sales or increase 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:

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media associated with our character-related and theme-related product lines will be released at the times we expect or will be successful;

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the success of media associated with our existing character-related and theme-related product lines will result in substantial promotional value to our products; or

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we will be successful in renewing licenses upon expiration on terms that are favorable to us; or

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we will be successful in obtaining licenses to produce new character-related and theme-related products in the future.

Our failure to achieve any or all of the foregoing benchmarks may cause the infrastructure of our operations to fail, thereby adversely affecting our business, financial condition and results of operations.

There are risks associated with our license agreements.

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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.

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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.

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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.

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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:

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greater financial resources;

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larger sales, marketing and product development departments;

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stronger name recognition;

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longer operating histories; and

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greater economies of scale.

In addition, the toy industry has no significant barriers to entry. Competition is based primarily upon the ability to design and develop new toys, procure licenses for popular characters and trademarks and successfully market products. Many of our competitors offer similar products or alternatives to our products. Our competitors have obtained and are likely to continue to obtain licenses that overlap our licenses with respect to products, geographic areas and markets. We cannot assure you that we will be able to obtain adequate shelf space in retail stores to support our existing products, expand our products and product lines or continue to compete effectively against current and future competitors.

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

Historically, we have experienced growth in our product lines through acquisitions of businesses, products and licenses. This growth in product lines has contributed significantly to our total revenues over the last few years. For example, revenues associated with companies we acquired since 2008 were approximately $282.6 million and $298.5 million, in 2012 and 2013, respectively, representing 42.4% and 47.2%, respectively, of our total revenues for those periods. As a result, even though we had no acquisitions in 2013, comparing our period-to-period operating results may not be meaningful and results of operations from prior periods may not be indicative of future results. We cannot assure you that we will continue to experience growth in, or maintain our present level of, net sales.

Our growth strategy calls for us to continuously develop and diversify our toy business by acquiring other companies, entering into additional license agreements, refining our product lines and expanding into international markets, which will place additional demands upon our management, operational capacity and financial resources and systems. The increased demand upon management may necessitate our recruitment and retention of qualified management personnel. We cannot assure you that we will be able to recruit and retain qualified personnel or expand and manage our operations effectively and profitably. To effectively manage future growth, we must continue to expand our operational, financial and management information systems and to train, motivate and manage our work force. There can be no assurance that our operational, financial and management information systems will be adequate to support our future operations. Failure to expand our operational, financial and management information systems or to train, motivate or manage employees could have a material adverse effect on our business, financial condition and results of operations.

In addition, implementation of our growth strategy is subject to risks beyond our control, including competition, market acceptance of new products, changes in economic conditions, our ability to obtain or renew licenses on commercially reasonable terms and our ability to finance increased levels of accounts receivable and inventory necessary to support our sales growth, if any. Accordingly, we cannot assure you that our growth strategy will be successful.

If we are unable to acquire and integrate companies and new product lines successfully, we will be unable to implement a significant component of our growth strategy.

Our growth strategy depends, in part, upon our ability to acquire companies and new product lines. Future acquisitions, if any, may succeed only if we can effectively assess characteristics of potential target companies and product lines, such as:

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attractiveness of products;

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suitability of distribution channels;

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management ability;

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financial condition and results of operations; and

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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:

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difficulties in integrating acquired businesses or product lines, assimilating new facilities and personnel and harmonizing diverse business strategies and methods of operation;

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diversion of management attention from operation of our existing business;

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loss of key personnel from acquired companies;

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failure of an acquired business to achieve targeted financial results; and

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Limited capital to finance acquisitions.

A limited number of customers account for a large portion of our net sales, so that if one or more of our major customers were to experience difficulties in fulfilling their obligations to us, cease doing business with us, significantly reduce the amount of their purchases from us or return substantial amounts of our products, it could have a material adverse effect on our business, financial condition and results of operations.

Our three largest customers accounted for 47.8% of our net sales in 2013. 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.

We depend upon our Chief Executive Officer and any loss or interruption of his services could adversely affect our business, financial condition and results of operations.

Our success has been largely dependent upon the experience and continued services of Stephen G. Berman, our President and Chief Executive Officer. We cannot assure you that we would be able to find an appropriate replacement for Mr. Berman should the need arise, and any loss or interruption of the services of Mr. Berman could adversely affect our business, financial condition and results of operations.

We depend upon third-party manufacturers, and if our relationship with any of them is harmed or if they independently encounter difficulties in their manufacturing processes, we could experience product defects, production delays, cost overruns or the inability to fulfill orders on a timely basis, any of which could adversely affect our business, financial condition and results of operations.

We depend upon many third-party manufacturers who develop, provide and use the tools, dyes and molds that we generally own to manufacture our products. However, we have limited control over the manufacturing processes themselves. As a result, any difficulties encountered by the third-party manufacturers that result in product defects, production delays, cost overruns or the inability to fulfill orders on a timely basis could adversely affect our business, financial condition and results of operations.

We do not have long-term contracts with our third-party manufacturers. Although we believe we could secure other third-party manufacturers to produce our products, our operations would be adversely affected if we lost our relationship with any of our current suppliers or if our current suppliers’ operations or sea or air transportation with our overseas manufacturers were disrupted or terminated even for a relatively short period of time. Our tools, dyes and molds are located at the facilities of our third-party manufacturers.

Although we do not purchase the raw materials used to manufacture our products, we are potentially subject to variations in the prices we pay our third-party manufacturers for products, depending upon what they pay for their raw materials.

We have substantial sales and manufacturing operations outside of the United States, subjecting us to risks common to international operations.

We sell products and operate facilities in numerous countries outside the United States. For the year ended December 31, 2013, sales to our international customers comprised approximately 17.2% of our net sales. We expect our sales to international customers to account for a greater portion of our revenues in future fiscal periods. Additionally, we utilize third-party manufacturers, located principally in China, and are subject to the risks normally associated with international operations, including:

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currency conversion risks and currency fluctuations;

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limitations, including taxes, on the repatriation of earnings;

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political instability, civil unrest and economic instability;

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

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

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greater difficulty and expenses associated with recovering from natural disasters;

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transportation delays and interruptions;

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the potential imposition of tariffs; and

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

Our reliance upon external sources of manufacturing can be shifted, over a period of time, to alternative sources of supply, should such changes be necessary. However, if we were prevented from obtaining products or components for a material portion of our product line due to medical, political, labor or other factors beyond our control, our operations would be disrupted while alternative sources of products were secured. Also, the imposition of trade sanctions by the United States against a class of products imported by us from, or the loss of “normal trade relations” status by, China could significantly increase our cost of products imported from that nation. Because of the importance of international sales and international sourcing of manufacturing to our business, our financial condition and results of operations could be significantly and adversely affected if any of the risks described above were to occur.

Our business is subject to extensive government regulation and any violation by us of such regulations could result in product liability claims, loss of sales, diversion of resources, damage to our reputation, increased warranty costs or removal of our products from the market, and we cannot assure you that our product liability insurance for the foregoing will be sufficient.

Our business is subject to various laws, including the Federal Hazardous Substances Act, the Consumer Product Safety Act, the Flammable Fabrics Act and the rules and regulations promulgated under these acts. These statutes are administered by the CPSC, which has the authority to remove from the market products that are found to be defective and present a substantial hazard or risk of serious injury or death. The CPSC can require a manufacturer to recall, repair or replace these products under certain circumstances. We cannot assure you that defects in our products will not be alleged or found. Any such allegations or findings could result in:

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product liability claims;

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loss of sales;

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diversion of resources;

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damage to our reputation;

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increased warranty costs; and

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removal of our products from the market.

Any of these results may adversely affect our business, financial condition and results of operations. There can be no assurance that our product liability insurance will be sufficient to avoid or limit our loss in the event of an adverse outcome of any product liability claim.

We depend upon our proprietary rights and our inability to safeguard and maintain the same, or claims of third parties that we have violated their intellectual property rights, could have a material adverse effect on our business, financial condition and results of operations.

We rely upon trademark, copyright and trade secret protection, nondisclosure agreements and licensing arrangements to establish, protect and enforce our proprietary rights in our products. The laws of certain foreign countries may not protect intellectual property rights to the same extent or in the same manner as the laws of the United States. We cannot assure you that we or our licensors will be able to successfully safeguard and maintain our proprietary rights. Further, certain parties have commenced legal proceedings or made claims against us based upon our alleged patent infringement, misappropriation of trade secrets or other violations of their intellectual property rights. We cannot assure you that other parties will not assert intellectual property claims against us in the future. These claims could divert our attention from operating our business or result in unanticipated legal and other costs, which could adversely affect our business, financial condition and results of operations.

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

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

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

On July 24, 2013, the Company sold an aggregate of $100.0 million principal amount of 4.25% Convertible Senior Notes due on August 1, 2018 (the “2018 Notes”). Holders of the 2018 Notes may convert their notes upon the occurrence of specified events. Upon conversion, the 2018 Notes will be settled in shares of the Company’s common stock. The Company used $61.0 million of the approximate $96.0 million in net proceeds from the offering to repurchase at par $61.0 million principal amount of the aggregate of $100.0 million principal amount of 4.50% Convertible Senior Notes due 2014 originally sold on November 10, 2009 (the “2014 Notes”). The 2014 Notes are senior unsecured obligations of JAKKS, which pay interest semi-annually at a rate of 4.50% per annum and mature on November 1, 2014. Prior to August 1, 2014, holders of the 2014 Notes may convert their notes only upon specified events. Upon conversion, the 2014 Notes may be settled, at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock. Holders of the 2014 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 2014 Notes).

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

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

We have a full valuation allowance on the entire balance of deferred taxes on our books since their future realization is uncertain.

Deferred tax assets are realized by prior and future taxable income of appropriate character. Current accounting standards require that a valuation allowance be recorded if it is not likely that sufficient taxable income of appropriate character will be generated to realize the deferred tax assets. In the fourth quarter of 2012, we established a full valuation allowance against our United States deferred tax assets, resulting in a non-cash charge to income of $91.7 million.

Item 2. Properties

The following is a listing of the principal leased offices maintained by us as of February 28, 2014:

Property	Location	Approximate Square Feet	Lease Expiration Date
Domestic
Corporate Office	Malibu, California	29,500	February 28, 2015
Showroom and Design Center	Santa Monica, California	28,200	February 28, 2016
Distribution Center	City of Industry, California	800,000	April 30, 2018
Distribution Center	Hickory, NC	139,438	August 31, 2014
Moose Mountain/Kids Only Office	Parisippany-Troy Hills, NJ	2,100	March 31, 2014
Sales Office/Showroom	Bentonville, Arkansas	9,000	September 30, 2014
Showroom	Minneapolis, Minnesota	1,560	December 31, 2014
Disguise Office	Poway, California	24,200	December 31, 2015
Maui Toys Office/Warehouse	Youngstown, Ohio	73,000	Month-to-month
Maui Toys Office	Santa Monica, California	10,000	December 31, 2014
Sales Office	Hoffman Estates, II	3,071	August 31, 2015
Design Office	Culver City, California	28,758	January 31, 2016
International
Distribution Center	Brampton, Ontario, Canada	105,700	December 31, 2014
Europe Office	Berkshire, UK	2,215	February 25, 2015
Hong Kong Headquarters	Kowloon, Hong Kong	36,600	June 30, 2016
Hong Kong Showroom	Kowloon, Hong Kong	22,630	June 30, 2016
Production Inspection and Testing Office	Shenzhen, China	5,417	May 14, 2014
Production Inspection Office	Nanjing, China	501	August 18, 2014
Moose Mountain HK Office	Kowloon, Hong Kong	6,198	June 30, 2015
Production Inspection and Testing Lab	Guangdong, Hong Kong	23,200	December 31, 2014
Tollytots Office	Zhejiang, China	120	April 19, 2014
Tollytots Office	Zhejiang, China	147	April 19, 2014
Moose Mountain Warehouse	Shatin, Hong Kong	1,407	November 30, 2014
Moose Mountain Tooling Office	Guangdong, Hong Kong	792	December 31, 2014

Item 3. Legal Proceedings

In or about the end of July 2013 two purported class action lawsuits were filed in the United States District Court for the Central District of California: (1) Melot v. JAKKS PACIFIC, INC. et al, Case No. CV13-05388 (JAK) (filed on July 25, 2013); and (2) Dylewicz v. JAKKS PACIFIC, INC. et al, Case No.CV13-5487 (OON) (filed on July 30, 2013) (collectively, the “Class Action”). The complaints in the Class Action alleged that the Company made false and/or misleading statements concerning the extent of the negative impact that the shift in children’s preference for electronic devices was having on sales of the Company’s more traditional toys, and the extent of the negative impact from poor sales of various of the Company’s licensed products, and/or that the Company’s financial statements were materially false and misleading. These allegations make reference to matters contained in the July 17, 2013 Press Release. The Class Period in the Class Action is from July 17, 2012 –July 17, 2013. The Class Action sought compensatory and other damages in an undisclosed amount, and alleged violations of Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 promulgated thereunder by each of the defendants (namely the Company and Messrs. Berman and Bennett), and violations of Section 20(a) of the Exchange Act by Messrs. Berman and Bennett. The Court appointed a lead plaintiff and selected Class Counsel. An amended complaint (the “FAC”) was filed which alleged the same Class Period and causes of action and the Company has filed a motion to dismiss the FAC. Briefing is in progress with respect to that motion. We believe that the claims in the Class Action are without merit and we intend to defend vigorously against them. However, because the Class Action is in a preliminary stage, we cannot assure you as to its outcome, or that an adverse decision in such action would not have a material adverse effect on our business, financial condition or results of operations.

On February 25, 2014, a shareholder derivative action was filed in the Central District of California by Advisors, G.P. against the Company, nominally, and against Messrs. Berman, Bennett, Miller, Skala, Glick, Ellin, Almagor, Poulsen and Reilly and Ms. Brodsky (Advanced Partners, G.P.,v. Berman, et al., CV14-1420 DSF) (the “Derivative Action”). The Derivative Action seeks to hold the individual defendants liable for damages allegedly caused to the Company by their actions and, in particular, to hold Messrs. Berman and Bennett liable on contribution and breach of fiduciary duty theories with respect to any liability the Company incurs in connection with the Class Action; to hold the individual defendants other than Bennett (the “Director Defendants”) then serving as directors liable for alleged violation of Rule 14a-9 in connection with the October 25, 2013 Proxy Statement statements with respect to Berman’s compensation; and to hold certain of the Director Defendants liable for alleged breaches of their fiduciary duties in connection with the Company’s repurchase of stock, transactions with Dr. Patrick Soon, and Berman’s compensation. On March 6, 2014 a shareholder derivative action was filed in the Central District of California by Louisiana municipal Police Employees Retirement System against the Company, nominally, and against the same defendants as in the First Derivative Action (Louisiana Municipal Police Employees Retirement System v, Berman et al , CV14-1670 (GHF) (the “Second Derivative Action”). The Second Derivative Action makes substantially the same claims as set forth above in connection with the First Derivative Action.

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

Item 4. Mine Safety Disclosures

Not applicable.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our common stock is traded on the Nasdaq Global Select exchange under the symbol “JAKK.” The following table sets forth, for the periods indicated, the range of high and low sales prices for our common stock on this exchange.

	Price Range of Common Stock
	High		Low
2012:
First quarter	$	17.70	$	13.29
Second quarter		19.39		15.10
Third quarter		16.74		14.01
Fourth quarter		14.24		11.83
2013:
First quarter		13.67		10.00
Second quarter		11.35		9.46
Third quarter		11.75		4.45
Fourth quarter		7.24		4.50

Performance Graph

The graph and tables below display the relative performance of our common stock, the Russell 2000 Price Index (the “Russell 2000”) and a peer group index, by comparing the cumulative total stockholder return (which assumes reinvestment of dividends, if any) on an assumed $100 investment on December 31, 2007 in our common stock, the Russell 2000 and the peer group index over the period from January 1, 2008 to December 31, 2013.

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 2013. Our peer group index includes the following companies: Activision Blizzard, Inc., Electronic Arts, Inc. Hasbro, Inc. Leapfrog Enterprises, Inc., Mattel, Inc., Kid Brands, Inc. and Take-Two Interactive, Inc.

The historical performance data presented below may not be indicative of the future performance of our common stock, any reference index or any component company in a reference index.

Annual Return Percentage

	December 31, 2009			December 31, 2010			December 31, 2011			December 31, 2012			December 31, 2013
JAKKS Pacific		(41.3	)%		50.3	%		(21.6	)%		(9.0	)%		(45.6	)%
Peer Group		23.2			19.5			1.85			0.9			52.4
Russell 2000		(27.1	)		26.8			(4.2	)		16.3			38.8

Indexed Returns

	January 1, 2008		December 31, 2009		December 31, 2010		December 31, 2011		December 31, 2012		December 31, 2013
JAKKS Pacific	$	100.0	$	58.8	$	88.3	$	69.2	$	63.0	$	34.3
Peer Group		100.0		123.2		147.1		149.8		151.2		230.3
Russell 2000		100.0		127.1		161.2		154.4		179.8		249.5

Security Holders

To the best of our knowledge, as of March 17, 2014, there were 115 holders of record of our common stock. We believe there are numerous beneficial owners of our common stock whose shares are held in “street name.”

Dividends

In July 2011, we implemented a cash dividend program in the amount of $0.40 per share annually, payable on a quarterly basis to holders of record of our common stock. Effective February 20, 2013, the dividend amount was reduced to $0.28 per share annually and effective July 17, 2013, the dividend program was suspended. During 2012, we paid total dividends per share of $0.40 to holders of our common stock, and during 2013, we paid total dividends per share of $0.14. During 2012, the Board of Directors declared dividends on a quarterly basis on February 21, 2012, April 18, 2012, July 17, 2012, and October 22, 2012. During 2013, dividends were declared on a quarterly basis on February 20, 2013 and April 24, 2013. We paid the dividends during the subsequent quarter in which the dividends were declared. The payment of dividends on common stock is at the discretion of the Board of Directors and is subject to customary limitations.

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

The rights plan expired on March 4, 2013.

Equity Compensation Plan Information

The table below sets forth the following information as of the year ended December 31, 2013 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		127,144	$	20.20		1,225,058
Equity compensation plans not approved by security holders		―		―		—
Total		127,144	$	20.20		1,225,058

Equity compensation plans approved by our stockholders consists of the 2002 Stock Award and Incentive Plan. An additional 1.4 million shares were added to the number of total issuable shares under the Plan and approved by the Board in 2013. Additionally, 721,752 shares of restricted stock awards remained unvested as of December 31, 2013.

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,
	2009			2010			2011			2012			2013
	(In thousands, except per share data)
Consolidated Statement of Operations Data:
Net sales	$	803,704		$	747,268		$	677,751		$	666,762		$	632,925
Cost of sales		600,776			502,318			483,761			468,825			477,146
Gross profit		202,928			244,950			193,990			197,937			155,779
Selling, general and administrative expenses		227,036			194,753			192,710			211,159			195,296
Write-down of intangible assets		8,221			—			―			―			―
Write-down of goodwill		407,125			—			―			―			―
Reorganization charges		12,994			—			―			―			5,015
(Loss) income from operations		(452,448	)		50,197			1,280			(13,222	)		(44,532	)
Change in fair value of business combination liability		—			―			―			―			6,000
(Loss) profit from video game joint venture		(16,128	)		6,000			6,000			3,000			―
Equity in net (loss) income of Joint Venture		—			(56	)		(34	)		130			(3,148	)
Interest income		318			333			412			671			327
Interest expense		(7,930	)		(6,732	)		(8,196	)		(9,228	)		(9,942	)
(Loss) income before provision (benefit) for income taxes		(476,188	)		49,742			(538	)		(18,649	)		(51,295	)
Provision (benefit) for income taxes		(90,678	)		2,693			(9,010	)		86,151			2,611
Net (loss) income	$	(385,510	)	$	47,049		$	8,472		$	(104,800	)	$	(53,906	)
Basic (loss) earnings per share	$	(14.02	)	$	1.71		$	0.32		$	(4.37	)	$	(2.43	)
Diluted (loss) earnings per share	$	(14.02	)	$	1.52		$	0.32		$	(4.37	)	$	(2.43	)
Dividends declared per common share		—			—		$	0.20		$	0.40		$	0.14

In 2013, we booked a charge of $14.9 million related to the write-down of certain excess and impaired inventory. We also booked 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 was due to Maui not achieving the prescribed earn-out targets in 2013.

During the third quarter of 2012, we acquired Maui, Inc., an Ohio corporation, Kessler Services, Inc., a Nevada corporation, and A.S. Design Limited, a Hong Kong corporation (collectively, “Maui”).

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

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

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

	At December 31,
	2009		2010		2011		2012		2013
	(In thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents	$	254,837	$	278,346	$	257,258	$	189,321	$	117,071
Working capital		352,189		387,252		374,652		186,581		136,337
Total assets		634,093		633,406		615,234		554,825		449,844
Short-term debt		20,262		—		―		70,710		38,098
Long-term debt		86,728		89,458		92,188		94,918		100,000
Total stockholders’ equity		372,109		412,408		393,591		207,220		148,685

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. If the implied fair value is more than the book value of the reporting unit, an impairment loss is not indicated. If impairment exists, the fair value of the reporting unit is allocated to all of its assets and liabilities excluding goodwill, with the excess amount representing the fair value of goodwill. An impairment loss is measured as the amount by which the book value of the reporting unit’s goodwill exceeds the estimated fair value of that goodwill.

The Company assessed its goodwill for impairment as of October 1, 2013 for each of its 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, the interest rate environment. Utilizing the aforementioned, the Company reviewed step-one of its impairment model and determined that it was not more likely than not that the fair value of its reporting units were less than the carrying amounts. As such, the Company determined there was no indication of impairment to be recorded.

The amount of goodwill assigned to each of the two reporting units, traditional toys and electronics and role play, novelty and seasonal toys, amounted to $25.3 million and $19.6 million, respectively. Goodwill and intangible assets amounted to $104.6 million as of December 31, 2013.

Goodwill and intangible assets amounted to $104.6 million as of December 31, 2013.

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

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

We accrue a tax reserve for additional income taxes and interest, which may become payable in future years as a result of audit adjustments by tax authorities. The reserve is based upon management’s assessment of all relevant information and is periodically reviewed and adjusted as circumstances warrant. As of December 31, 2013, our income tax reserves were approximately $2.6 million and relate to the potential income tax audit adjustments, primarily in the areas of income allocation, foreign depreciation allowances and state taxes.

We recognize current period interest expense and the reversal of previously recognized interest expense that has been determined to not be assessable due to the expiration of the related audit period or other compelling factors on the income tax liability for unrecognized tax benefits as interest expense, and penalties and penalty reversals related to the income taxes payable as other expense in our consolidated statements of operations.

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

New Accounting Pronouncements. In March 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-05, Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity, which requires the release of a cumulative translation adjustment into net income when a parent ceases to have a controlling financial interest in a subsidiary or group of assets within a consolidated foreign entity and the sale or transfer results in the complete or substantially complete liquidation of the foreign entity. ASU 2013-05 will be effective for interim and annual reporting periods beginning after December 15, 2013. The Company has not completed its evaluation of ASU 2013-05, but does not expect the adoption of ASU 2013-05 to have a material effect on its operating results or financial position.

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,
	2011			2012			2013
Net Sales		100.0	%		100.0	%		100.0	%
Cost of Sales		71.4			70.3			75.4
Gross profit		28.6			29.7			24.6
Selling, general and administrative expenses		28.4			31.7			31.6
Income (loss) from operations		0.2			(2.0	)		(7.0	)
Profit (loss) from joint venture		0.9			0.5			(0.5	)
Change in fair value of business combination liability		―			―			0.9
Interest income		0.1			0.1			0.1
Interest expense		(1.2	)		(1.4	)		(1.6	)
Loss before provision (benefit) for income taxes		―			(2.8	)		(8.1	)
Provision (benefit) for income taxes		(1.3	)		12.9			0.4
Net income (loss)		1.3	%		(15.7	)%		(8.5	)%

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

	Years Ended December 31,
	2011		2012		2013

Net Sales
Traditional Toys and Electronics	$	348,852	$	363,681	$	320,565
Role Play, Novelty and Seasonal Toys		328,899		303,081		312,360
		677,751		666,762		632,925
Cost of Sales
Traditional Toys and Electronics		247,951		249,860		244,183
Role Play, Novelty and Seasonal Toys		235,810		218,965		232,963
		483,761		468,825		477,146
Gross Margin
Traditional Toys and Electronics		100,901		113,821		76,382
Role Play, Novelty and Seasonal Toys		93,089		84,116		79,397
	$	193,990	$	197,937	$	155,779

Comparison of the Years Ended December 31, 2013 and 2012

Net Sales

Traditional Toys and Electronics. Net sales of our Traditional Toys and Electronics segment were $320.6 million in 2013, compared to $363.7 million in 2012, representing a decrease of $43.1 million, or 11.9%. The decrease in net sales was primarily due to decreases in unit sales of our action figures based on the animation series Monsuno®, and Pokemon®. This was offset in part by increases in unit sales of some products, 31 inch action figures based on Star Wars® characters, and action figures, plush, and playsets based on the Smurfs®.

Role Play, Novelties and Seasonal Products. Net sales of our Role Play, Novelties and Seasonal Products were $312.4 million in 2013, compared to $303.1 million in 2012, representing an increase of $9.3 million, or 3.1%. The increase in net sales was primarily due to sales contribution of our recently acquired Maui Toys division.

Cost of Sales

Traditional Toysand Electronics. Cost of sales of our Traditional Toys and Electronics segment was $244.2 million, or 76.2% of related net sales, in 2013, compared to $249.9 million, or 68.7% of related net sales, in 2012, representing a decrease of $5.7 million, or 2.3%. This percentage cost of sales increase was primarily due to charges in 2013 of $9.4 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, whereas 2012 charges related to the write-down of licenses was approximately $3.7 million. Excluding these charges, cost of sales was $234.8 million in 2013 and $246.2 million in 2012, representing a decrease of $11.4 million, or 4.6%, this decrease primarily consisted of an increase in product costs of $5.8 million, which is in line with the lower volume of sales. Excluding the license impairment charges, royalty expense for our Traditional Toys and Electronics segment decreased by $3.9 million, which is in line with the lower volume of sales. Our depreciation of molds and tools expense decreased by $1.7 million from 2012 to 2013. This is due to a decrease in new products from 2012.

Role Play, Novelties and Seasonal Products. Cost of sales of our Role Play, Novelties and Seasonal Products segment was $233.0 million in 2013, or 74.6% of related net sales, compared to $219.0 million in 2012, or 72.2% of related net sales, representing an increase of $14.0 million, or 6.4%. This percentage cost of sales increase was partially due to charges of $4.0 million and $3.6 million in 2013 and 2012, respectively, related to the write-down of license advances and minimum guarantees that are not expected to be earned out through sales of that licensed product. Excluding these charges, cost of sales was $229.0 million in 2013 and $215.4 million in 2012, representing an increase of $13.6 million, or 6.3%. This increase primarily consisted of an increase in product costs of $12.3 million, which is in line with the higher volume of sales. Excluding the license impairment charges, royalty expense increased by $1.2 million, which is in line with the higher volume of sales. Our depreciation of molds and tools expense is comparable year over year.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $200.3 million in 2013 and $211.2 million in 2012, constituting 31.6% and 31.7% of net sales, respectively. The overall decrease of $10.9 million was primarily due to legal and financial advising fees related to the unsolicited indication of interest to acquire our company ($4.0 million), salary and employee benefits ($1.4 million), travel expenses ($1.6 million), advertising ($15.5 million), and tradeshow expenses ($0.6 million), and commission expenses ($1.1 million). This was offset in part by increases in amortization expense related to intangible assets other than goodwill ($2.4 million), legal expenses ($1.7 million), rent expense ($1.2 million), bad debt recovery ($0.9 million), currency exchange gains ($1.5 million), temporary help ($0.7 million) and reorganization charges ($5.0 million).

Reorganization Charges

We incurred reorganization charges in 2013 to consolidate and stream-line our existing business functions. This was necessary given the decreased volume of consolidated sales in 2013 from 2012. Restructuring charges relate to the termination of lease obligations, one-time severance termination benefits, and other contract terminations and are accounted for in accordance with “Exit and Disposal Cost Obligations,” ASC 420-10. We establish a liability for a cost associated with an exit or disposal activity when a liability is incurred, rather than at the date we commit to an exit plan.

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

	Accrued Balance							Accrued Balance
	December 31, 2012		Accrual		Actual			December 31, 2013
2013 lease abandonment costs	$	—	$	2,962	$	—		$	2,962
2009 lease abandonment costs		2,241		—		(1,022	)		1,219
Total reorganization charges	$	2,241	$	2,962	$	(1,022	)	$	4,181

Profit from Video Game Joint Venture

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

Interest Income

Interest income in 2013 was $ 0.3 million, comparable to $0.7 million in 2012. The decrease in interest income is due to lower cash balances in 2013.

Interest Expense

Interest expense was $9.9 million in 2013, as compared to $9.2 million in 2012. The increase is due to the additional interest expense related to our convertible senior notes payable due in 2018 and the interest expense attributed to our Maui acquisition. In 2013, we recorded interest expense of $8.1 million related to our convertible senior notes payable, $0.9 million related to our credit facility and $0.8 million related to the interest component of our Maui acquisition earn out payment. In 2012, we recorded interest expense of $8.0 million related to our convertible senior notes payable, $0.8 million related to our credit facility and $0.4 million related to the interest component of our Maui acquisition earn out payment.

Provision for Income Taxes

Our income tax expense, which includes federal, state and foreign income taxes and discrete items, was $2.6 million, or an effective tax rate of (5.1%) for 2013. During 2012, the income tax expense was $86.2 million, or an effective tax rate of (462%).

The 2013 tax expense of $2.6 million included a discrete tax benefit of $0.3 million comprised of uncertain tax positions and return to provision true-ups (see Note 13 of the Notes to Consolidated Financial Statements.) Absent these discrete tax expenses, our effective tax rate for 2013 was (5.8%), primarily due to a full valuation allowance on the Company's United States deferred tax assets and the foreign rate differential between the United States and Hong Kong. The foreign rate differential is impacted by the proportion of Hong Kong earnings to overall earnings and is expected to vary depending on the level of consolidated earnings.

The 2012 tax expense of $86.2 million are discrete tax expenses of $92.5 million comprised of expense of $91.7 million relating to the establishment of a 100% valuation allowance against our U.S. deferred tax assets, $0.4 million benefit related to reduction of uncertain tax positions due to statute expiration, $0.5 million expense related to state tax apportionment changes and $0.7 million expense related to income tax audit settlement (see Note 13 of the Notes to Consolidated Financial Statements). Absent these discrete tax expenses, our effective tax rate for 2012 was 34.2%, primarily due to the foreign rate differential between the United States and Hong Kong. The foreign rate differential is impacted by the proportion of Hong Kong earnings to overall earnings and is expected to vary depending on the level of consolidated earnings.

We assess the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets by jurisdiction. For the three-year period ended December 31, 2013, we were in a cumulative pre-tax loss position in the U.S. On the basis of this evaluation, as of December 31, 2013, a valuation allowance of $108.3 million has been recorded against the U.S. deferred tax assets that more likely than not will not be realized. The net deferred tax liabilities of $3.0 million represent the net deferred tax liabilities in the foreign jurisdiction, where we are in a cumulative income position.

As of December 31, 2013, we had net deferred tax liabilities of approximately $3.0 million related to foreign jurisdictions.

Comparison of the Years Ended December 31, 2012 and 2011

Net Sales

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

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

Cost of Sales

Traditional Toysand Electronics. Cost of sales of our Traditional Toys and Electronics segment was $249.9 million, or 68.7% of related net sales, in 2012, compared to $248.0 million, or 71.1% of related net sales, in 2011, representing an increase of $1.9 million, or 0.8%. This percentage cost of sales decrease was primarily due to charges in 2011 of $12.8 million related to the write-down of license advances and minimum guarantees that are not expected to be earned through sales of that licensed product, whereas 2012 charges related to the write-down of licenses was approximately $3.7 million. Excluding these charges, cost of sales was $235.2 million in 2011 and $246.2 million in 2012, representing an increase of $11.0 million, or 4.7%, this increase primarily consisted of an increase in product costs of $7.5 million, which is in line with the higher volume of sales. Excluding the license impairment charges, royalty expense for our Traditional Toys and Electronics segment increased by $3.7 million, which is in line with the higher volume of sales. Our depreciation of molds and tools was comparable year over year.

Role Play, Novelties and Seasonal Products. Cost of sales of our Role Play, Novelties and Seasonal Products segment was $219.0 million in 2012, or 72.2% of related net sales, compared to $235.8 million in 2011, or 71.7% of related net sales, representing a decrease of $16.8 million, or 7.1%. This percentage cost of sales increase was partially due to charges of $5.3 million and $3.6 million in 2011 and 2012, respectively, related to the write-down of license advances and minimum guarantees that are not expected to be earned out through sales of that licensed product. Excluding these charges, cost of sales was $215.4 million in 2012 and $230.5 million in 2011, representing a decrease of $15.1 million, or 6.6%. This decrease which primarily consisted of a decrease in product costs of $12.5 million, which is in line with the lower volume of sales. Excluding the license impairment charges, royalty expense decreased by $2.8 million, which is in line with the lower volume of sales. Royalty expense as a percentage of sales decreased due to changes in the product mix to more products with lower royalty rates or proprietary products with no royalty rates from products with higher royalty rates.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $211.2 million in 2012 and $192.7 million in 2011, constituting 31.7% and 28.4% of net sales, respectively. The overall increase of $18.5 million was primarily due to the incremental overhead of our recent acquisitions, Moose Mountain ($7.3 million) and Maui ($2.5 million). Additionally, increases in other direct selling expenses ($1.9 million), product development ($1.2 million), travel expenses ($1.2 million), legal and financial advising fees related to the unsolicited indication of interest to acquire our company ($1.0 million) and legal expenses ($0.6 million) contributed to the increase to selling, general and administrative expenses year over year. Advertising and tradeshow expenses increased as a result of new product line launches in 2012, such as Monsuno®, and the introduction of our DreamPlay® technology ($7.7 million). This was offset in part by decreases in amortization expense related to intangible assets other than goodwill ($1.3 million), bad debt recovery ($0.6 million), currency exchange gains ($1.0 million) and restricted stock compensation ($0.5 million).

Reorganization Charges

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

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

	Accrued Balance							Accrued Balance
	December 31, 2011		Accrual		Actual			December 31, 2012
Lease abandonment costs 2009	$	3,484	$	—	$	(1,243	)	$	2,241

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

Profit from Video Game Joint Venture

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

Interest Income

Interest income in 2012 was $0.7 million, comparable to $0.4 million in 2011. The decrease in interest income is due to lower cash balances in 2012.

Interest Expense

Interest expense was $9.2 million in 2012, as compared to $8.2 million in 2011. In 2012, we recorded interest expense of $8.0 million related to our convertible senior notes payable, $0.8 million related to our credit facility and $0.4 million related to the interest component of our Maui acquisition earn out payment. In 2011, we recorded interest expense of $8.0 million related to our convertible senior notes payable and net interest expense of $0.2 million related to uncertain tax positions taken or expected to be taken in a tax return.

Provision for Income Taxes

Our income tax expense, which includes federal, state and foreign income taxes and discrete items, was $86.2 million, or an effective tax rate of (462%) for 2012. During 2011, the income tax benefit was $9.0 million, or an effective tax rate of 1,671%.

Included in the tax expense of $86.2 million are discrete tax expenses of $92.5 million comprised of expense of $91.7 million relating to the establishment of a 100% valuation allowance against our U.S. deferred tax assets, $0.4 million benefit related to reduction of uncertain tax positions due to statute expiration, $0.5 million expense related to state tax apportionment changes and $0.7 million expense related to income tax audit settlement. (see Note 13 of the Notes to Consolidated Financial Statements). Absent these discrete tax expenses, our effective tax rate for 2012 was 34.2%, primarily due to the foreign rate differential between the United States and Hong Kong. The foreign rate differential is impacted by the proportion of Hong Kong earnings to overall earnings and is expected to vary depending on the level of consolidated earnings

We assess the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets by jurisdiction. For the three-year period ended December 31, 2012, we were in a cumulative pre-tax loss position in the U.S. On the basis of this evaluation, as of December 31, 2012, a valuation allowance of $91.7 million has been recorded against the U.S. deferred tax assets that more likely than not will not be realized. The net deferred tax liabilities of $3.1 million represent the net deferred tax liabilities in the foreign jurisdiction, where we are in a cumulative income position.

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

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

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.

	2012									2013
	First			Second		Third		Fourth		First			Second		Third		Fourth
(unaudited)	Quarter			Quarter		Quarter		Quarter		Quarter			Quarter		Quarter		Quarter

Net sales	$	73,405		145,359		314,491		133,507		$	78,069		106,232		310,894		137,730
As a % of full year		11.0	%	21.8	%	47.2	%	20.0	%		12.3	%	16.8	%	49.1	%	21.8	%
Gross Profit		23,566		46,893		96,712		30,766		$	23,379		2,238		91,395		38,767
As a % of full year		11.9	%	23.7	%	48.9	%	15.5	%		15.0	%	1.4	%	58.7	%	24.9	%
As a % of net sales		32.1	%	32.3	%	30.8	%	23.0	%		29.9	%	2.1	%	29.4	%	28.1	%
(Loss) income from operations		(19,410	)	107		37,296		(31,215	)		(23,845	)	(44,288	)	39,653		(16,052	)
As a % of full year		146.8	%	(0.8	)%	(282.1	)%	236.1	%		53.5	%	99.5	%	(89.0	)%	36.0	%
As a % of net sales		(26.4	)%	0.1	%	11.9	%	(23.4	)%		(30.5	)%	(41.7	)%	12.8	%	(11.7	)%
(Loss) income before provision (benefit) for income taxes		(21,192	)	288		36,426		(34,171	)		(27,262	)	(47,018	)	36,875		(13,890	)
As a % of net sales		(28.9	)%	0.2	%	11.6	%	(25.6	)%		(34.9	)%	(44.3	)%	11.9	%	(10.1	)%
Net (loss) income		(16,000	)	214		30,443		(119,457	)		(27,562	)	(46,873	)	36,597		(16,068	)
As a % of net sales		(21.8	)%	0.1	%	9.7	%	(89.5	)%		(35.3	)%	(44.1	)%	11.8	%	(11.7	)%
Diluted (loss) earnings per share	$	(0. 62	)	0.01		1.10		(5.45	)	$	(1.26	)	(2.14	)	1.11		(0.73	)
Weighted average shares and equivalents outstanding		25,831		25,870		28,933		21,923			21,873		21,290		34,283		22,073

Consistent with the seasonality of our business, first quarter 2012 and 2013 experienced seasonally low sales which coupled with fixed overhead including incremental overhead from the 2012 acquisition of Moose Mountain, resulted in significant net losses.

In the fourth quarter of 2013, income of $6.0 million was recognized in connection with the change in fair value of the Maui acquisition liability.

In the fourth quarter of 2012 and the second quarter of 2013, we experienced poor performance of some of our products which coupled with advertising commitments, license royalty shortfalls and retailer markdowns due to lower than anticipated sales and sell-through, resulted in significant net losses.

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

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

Debt with Conversion and Other Options

The provisions of ASC 470-20, “Debt with Conversion and Other Options” are applicable to the 4.5% convertible notes, see Note 12, Convertible Senior Notes. ASC 470-20 requires that we separately account for the liability (debt) and equity (conversion feature) components of the Notes in a manner that reflects our nonconvertible debt borrowing rate at the date of issuance when interest cost is recognized in subsequent periods. We allocated $13.7 million of the $100.0 million principal amount of the Notes to the equity component, which represents a discount to the debt and will be amortized into interest expense through November 1, 2014. Accordingly, our effective annual interest rate on the Notes will be approximately 7.3%. The Notes are classified as short-term debt in the balance sheet at December 31, 2013 based on their November 1, 2014 maturity date. The Company repurchased $61.0 million of the 2014 Notes during the quarter ended September 30, 2013 as discussed below, with $2.8 million of the price allocated to the repurchase of the related equity component. In addition, approximately $2.2 million of the unamortized debt discount and $0.6 million of debt issuance costs were written off in connection with the repurchase of the 2014 Notes. The balance of the unamortized debt discount was $5.1 million and $0.9 million at December 31, 2012 and December 31, 2013, respectively.

On July 24, 2013, the Company sold an aggregate of $100.0 million principal amount of 4.25% Convertible Senior Notes due 2018 (the “2018 Notes”). The 2018 Notes are senior unsecured obligations of the Company paying interest semi-annually in arrears on August 1 and February 1 of each year at a rate of 4.25% per annum and will mature on August 1, 2018. The initial conversion rate for the 2018 Notes will be 114.3674 shares of our common per $1,000 principal amount of notes, equivalent to an initial conversion price of approximately $8.74 per share of common stock, subject to adjustment in certain events. Holders of the 2018 Notes may convert their notes upon the occurrence of specified events. Upon conversion, the 2018 Notes will be settled in shares of the Company’s common stock. The Company used $61.0 million of the approximate $96.0 million in net proceeds from the offering to repurchase at par $61.0 million principal amount of the 2014 Notes. The remainder of the net proceeds will be used for general corporate purposes.

Liquidity and Capital Resources

As of December 31, 2013, we had working capital of $136.3 million, compared to $186.6 million as of December 31, 2012. This decrease was primarily attributable to the reclassification of long term debt to short term debt of $39.0 million, and changes in our tax positions of $10.7 million.

Operating activities provided net cash of $44.3 million and $24.2 million and used $22.5 million for the years ended December 31, 2011, 2012 and 2013, respectively. Net cash was impacted primarily by our net loss, adjusted for non-cash items such as deferred income taxes, depreciation and amortization. Our accounts receivable turnover as measured by days sales for the quarter outstanding in accounts receivable was 67 days, 73 days, and 68 days as of December 31, 2011, 2012, and 2013, 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, 2013, we had cash and cash equivalents of $117.1 million.

Cash used in investing activities totaled $36.3 million, $72.7 million and $10.8 million for the years ended December 31, 2011, 2012, and 2013, respectively. Cash used in 2013 consisted primarily of $10.1 million cash paid for the purchase of office furniture and equipment and molds and tooling used in the manufacturing of our products. Cash used in 2012 consisted primarily of $36.2 million cash paid and liabilities incurred for the Maui acquisition, $13.1 million cash paid for the purchase of office furniture and equipment and molds and tooling used in the manufacture of our products, the $10.9 million investment in JKID, $8.0 million cash paid to NantWorks LLC for recognition technology exclusivity rights, and the $7.0 million paid to NantWorks LLC for our ownership interest in DreamPlay LLC. In 2011, our investing activities consisted primarily of cash paid for the Moose Mountain Acquisition of $16.0 million, Tollytots earn-out of $1.7 million, Kids Only earn-out of $3.7 million, and $12.5 million cash paid for the purchase of office furniture and equipment and molds and tooling used in the manufacture of our products. As part of our strategy to develop and market new products, we have entered into various character and product licenses with royalties generally ranging from 1% to 14% payable on net sales of such products. As of December 31, 2013, these agreements required future aggregate minimum guarantees of $59.2 million, exclusive of $30.4 million in advances already paid. Of this $59.2 million future minimum guarantee, $34.2 million is due over the next twelve months.

Cash used in financing activities totaled $29.1 million, $19.4 million and $39.0 million for the years ended December 31, 2011, 2012 and 2013, respectively. The cash used relates to payment of the credit facility, and partial retirement of existing notes, offset by net proceeds.

The following is a summary of our significant contractual cash obligations for the periods indicated that existed as of December 31, 2013 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	$	39,000	$	—	$	—	$	—	$	39,000
Long-term debt		—		—		100,000		—		100,000
Interest on debt		5,713		8,500		6,729		—		20,942
Operating leases		15,662		20,604		6,675		92		43,033
Minimum guaranteed license/royalty payments		34,195		23,178		1,874		―		59,247
Employment contracts		7,843		6,975		2,605		—		17,423
Total contractual cash obligations	$	102,413	$	59,257	$	117,883	$	92	$	279,645

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.

In September 2012, we acquired all of the stock of JKID, LTD., a United Kingdom corporation for an initial cash consideration of $1.1 million and deferred cash payments of $5.5 million payable in five semi-annual payments of $1.1 million each. In addition, we agreed to pay compensation of up to an aggregate amount of $4.4 million in cash over the two year period of 2015 through 2016, based upon the achievement of certain financial performance criteria, which will be charged to expense when earned. JKID is the developer of augmented reality technology that enhances the play patterns of toys and consumer products.

In July 2012, we acquired all of the stock of Maui, Inc., an Ohio corporation, Kessler Services, Inc., a Nevada corporation, and A.S. Design Limited, a Hong Kong corporation (collectively, “Maui”). The initial cash consideration totaled $36.2 million. In addition, we agreed to pay an earn-out of up to an aggregate amount of $18.0 million in cash over the three calendar years following the acquisition based upon the achievement of certain financial performance criteria, which has been accrued and recorded as goodwill as of December 31, 2012. All future changes to the earn-out liability will be charged to income. In 2013, the earn-out was not achieved and the related liability of $6.0 million was reversed to other income. Maui is a leading manufacturer and distributor of spring and summer activity toys and impulse toys and was included in our results of operations from the date of acquisition.

In October 2011, we acquired all of the stock of Moose Mountain Toymakers Limited, a Hong Kong company, and a related New Jersey company, Moose Mountain Marketing, Inc. (collectively, “Moose Mountain”). The total initial consideration of $31.5 million consisted of $16.0 million in cash and the assumption of liabilities in the amount of $15.5 million, and resulted in goodwill of $13.5 million. In addition, we agreed to pay an earn-out of up to an aggregate amount of $5.3 million in cash over the three calendar years following the acquisition based upon the achievement of certain financial performance criteria. We have paid $1.75 million for the earn-out related to the year ended 2012 and $1.75 million for the earn-out related to the year ended 2013. The fair value of the expected earn-out was included in goodwill and assumed liabilities as of December 31, 2011. Moose Mountain is a leading designer and producer of foot to floor ride-ons, inflatable environments, wagons, pinball machines and tents and was included in our results of operations from the date of acquisition.

In September 2012, we entered into a secured credit facility with Wells Fargo Bank, National Association (the “Loan Agreement”). The Loan Agreement provided for a $75 million working capital revolving credit facility. The amounts outstanding under the revolving credit facility were originally payable in full upon maturity of the credit facility on April 30, 2013. The amount outstanding on the credit facility at December 31, 2012 was $70.7 million.

By amendment to the Loan Agreement dated March 28, 2013 the Bank granted an over advance of up to $30.0 million of which $29.0 million was advanced on March 29, 2013. In addition, the maturity date was changed to April 2, 2013, on which date we paid off the credit facility in full. We are in the process of obtaining a replacement credit facility. If we are unable to obtain a replacement facility our operations and growth prospects may be adversely affected, and we might need to seek additional equity or debt financing. There is no assurance that such alternative would be available on acceptable terms at all. Furthermore, any equity financing could result in dilution to existing stockholders and any debt financing might include restrictive covenants that could impede on ability to effectively operate and grow our business in the future.

In November 2009, the Company sold an aggregate of $100.0 million principal amount of 4.50% Convertible Senior Notes due 2014 (the “2014 Notes”). The 2014 Notes, which are senior unsecured obligations of the Company, pay cash interest semi-annually at a rate of 4.50% per annum and will mature on November 1, 2014. The initial conversion rate was 63.2091 shares of JAKKS common stock per $1,000 principal amount of notes (equivalent to an initial conversion price of approximately $15.82 per share of common stock), subject to adjustment under certain circumstances. As a result of the cash dividend of $0.10 per share declared by the Board of Directors paid October 3, 2011, January 3, 2012, April 2, 2012, July 2, 2012, October 1, 2012 and January 2, 2013 and of $0.07 per share declared by the Board paid April 1, 2013 and July 1, 2013 and the above-market self-tender offer in July 2012 (see Note 15 – Common Stock and Preferred Stock), the new conversion rate is 68.8564 shares of JAKKS common stock per $1,000 principal amount of notes (or approximately $14.52 per share). Prior to August 1, 2014, holders of the 2014 Notes may convert their notes only upon the occurrence of specified events. Upon conversion, the 2014 Notes may be settled, at the Company’s election, in cash, shares of its common stock or a combination of cash and shares of its common stock. Holders of the 2014 Notes may require that the Company repurchase for cash all or some of their notes upon the occurrence of a fundamental change (as defined). On July 24, 2013, the Company repurchased an aggregate of $61.0 million principal amount of these notes at par plus accrued interest with a portion of the net proceeds from the issuance of $100.0 million principal amount of 4.25% convertible senior notes due 2018 resulting in a gain on extinguishment of $0.1 million.

We believe that our cash flows from operations and cash and cash equivalents will be sufficient to meet our working capital and capital expenditure requirements and provide us with adequate liquidity to meet our anticipated operating needs for at least the next 12 months. We expect our capital expenditures to be approximately $12.0 million in 2014. 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, 2013, we do not have any off-balance sheet arrangements.

We have cumulative undistributed earnings of non-U.S. subsidiaries that we consider to be permanently reinvested outside the U.S. Should those earnings be repatriated to the U.S., we would incur additional tax expense. Other than for short-term financing needs of our U.S. parent company, we do not intend to repatriate those earnings to the U.S. The amount of cash and short term investments held by our foreign subsidiaries was $182.6 million and $77.7 million for the years ended December 31, 2012 and 2013, respectively.

During the last three fiscal years ending December 31, 2013, we do not believe that inflation has had a material impact on our net sales and revenues and on income from continuing operations.

Exchange Rates

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

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and rates. We are exposed to market risk in the areas of changes in United States and international borrowing rates and changes in foreign currency exchange rates. In addition, we are exposed to market risk in certain geographic areas that have experienced or remain vulnerable to an economic downturn, such as China. We purchase substantially all of our inventory from companies in China, and, therefore, we are subject to the risk that such suppliers will be unable to provide inventory at competitive prices. While we believe that, should such events occur we would be able to find alternative sources of inventory at competitive prices, we cannot assure you that we would be able to do so. These exposures are directly related to our normal operating and funding activities. To date, we have not used derivative instruments or engaged in hedging activities to minimize our market risk.

Interest Rate Risk

In November 2009, we issued convertible senior notes payable of $100.0 million with a fixed interest rate of 4.50% per annum, of which $39.0 million remain outstanding as of December 31, 2013. In addition, on July 24, 2013, we issued convertible senior notes payable of $100.0 million principal amount with a fixed interest rate of 4.25% per annum, which remain outstanding as of December 31, 2013. 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.

Foreign Currency Risk

We have wholly-owned subsidiaries in Hong Kong, China, the United Kingdom, France, Spain, France and Canada. Sales are generally made by these operations on FOB China or Hong Kong terms and are denominated in U.S. dollars. However, purchases of inventory and Hong Kong operating expenses are typically denominated in Hong Kong dollars and local operating expenses in China are denominated in local currency, thereby creating exposure to changes in exchange rates. Changes in the Chinese Yuan or Hong Kong dollar/U.S. dollar exchange rates may positively or negatively affect our gross margins, operating income and retained earnings. The exchange rate of the Hong Kong dollar to the U.S. dollar has been fixed by the Hong Kong government since 1983 at HK$7.80 to US$1.00 and, accordingly, has not represented a currency exchange risk to the U.S. dollar. Our mainland China operations are funded in Chinese Yuan. We do not believe that near-term changes in these exchange rates, if any, will result in a material effect on our future earnings, fair values or cash flows. Therefore, we have chosen not to enter into foreign currency hedging transactions. We cannot assure you that this approach will be successful, especially in the event of a significant and sudden change in the value of the Hong Kong dollar or Chinese Yuan.

Item 8. Consolidated Financial Statements and Supplementary Data

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

JAKKS Pacific, Inc.

Malibu, California

We have audited the accompanying consolidated balance sheets of JAKKS Pacific, Inc. as of December 31, 2012 and 2013 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, 2013. In connection with our audits of the financial statements, we have also audited the financial statement schedule (Schedule II) listed in the accompanying index. The financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of JAKKS Pacific, Inc. at December 31, 2012 and 2013, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America.

Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), JAKKS Pacific, Inc.'s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control – Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 17, 2014 expressed an unqualified opinion thereon.

/s/ BDO USA, LLP
BDO USA, LLP
Los Angeles, California
March 17, 2014

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	December 31,
	2012			2013
	(In thousands, except
	share data)
Assets
Current assets
Cash and cash equivalents	$	189,321		$	117,071
Marketable securities		218			220
Accounts receivable, net of allowance for uncollectible accounts of $2,536 and $2,928, at December 31, 2012 and 2013 respectively		105,455			101,223
Inventory, net		59,690			46,784
Income tax receivable		24,008			24,008
Deferred income taxes		7,058			3,953
Prepaid expenses and other		20,306			27,673
Total current assets		406,056			320,932
Property and equipment
Office furniture and equipment		14,268			14,312
Molds and tooling		73,487			78,096
Leasehold improvements		7,044			4,917
Total		94,799			97,325
Less accumulated depreciation and amortization		78,973			86,229
Property and equipment, net		15,826			11,096
Intangibles		67,054			57,439
Other long term assets		4,584			6,175
Investment in DreamPlay LLC		7,000			7,000
Investment in joint venture		3,161			18
Goodwill, net		48,836			44,876
Trademarks, net		2,308			2,308
Total assets	$	554,825		$	449,844
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable	$	37,793		$	25,275
Accrued expenses		63,677			69,086
Reserve for sales returns and allowances		34,373			31,374
Income taxes payable		12,922			20,762
Short term debt		70,710			38,098
Total current liabilities		219,475			184,595
Convertible senior notes, net		94,918			100,000
Other liabilities		18,345			7,021
Income taxes payable		4,687			2,597
Deferred income taxes		10,180			6,946
Total liabilities		347,605			301,159
Commitments and Contingencies
Stockholders’ equity
Preferred shares, $.001 par value; 5,000,000 shares authorized; nil outstanding		—			—
Common stock, $.001 par value; 100,000,000 shares authorized; 21,969,355 and 22,668,680 shares issued and outstanding in 2012 and 2013, respectively		22			23
Additional paid-in capital		202,577			200,665
Retained earnings (accumulated deficit)		8,836			(48,154	)
Accumulated other comprehensive loss		(4,215	)		(3,849	)
Total stockholders’ equity		207,220			148,685
Total liabilities and stockholders’ equity	$	554,825		$	449,844

See accompanying notes to consolidated financial statements.

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

	Years Ended December 31,
	2011			2012			2013
	(In thousands, except per share amounts)
Net sales	$	677,751		$	666,762		$	632,925
Cost of sales		483,761			468,825			477,146
Gross profit		193,990			197,937			155,779
Selling, general and administrative expenses		192,710			211,159			200,311
Income (loss) from operations		1,280			(13,222	)		(44,532	)
Profit from joint ventures		6,000			3,000			--
Change in fair value of business combination liability		--			--			6,000
Equity in net income (loss) of joint venture		(34	)		130			(3,148	)
Interest income		412			671			327
Interest expense		(8,196	)		(9,228	)		(9,942	)
Loss before provision (benefit) for income taxes		(538	)		(18,649	)		(51,295	)
(Benefit) provision for income taxes		(9,010	)		86,151			2,611
Net income (loss)	$	8,472		$	(104,800	)	$	(53,906	)
Basic earnings (loss) per share	$	0.32		$	(4.37	)	$	(2.43	)
Basic weighted number of shares		26,760			23,963			22,200
Diluted earnings (loss) per share	$	0.32		$	(4.37	)	$	(2.43	)
Diluted weighted number of shares		26,893			23,963			22,200

See accompanying notes to consolidated financial statements.

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

	Years Ended December 31,
	2011		2012			2013
	(In thousands)

Net income (loss)	$	8,472	$	(104,800	)	$	(53,906	)
Other comprehensive income (loss):
Foreign currency translation adjustment		147		(74	)		366
Comprehensive income (loss)	$	8,619	$	(104,874	)	$	(53,540	)

See accompanying notes to consolidated financial statements.

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

YEARS ENDED DECEMBER 31, 2011, 2012 AND 2013

(In thousands)

	Common Stock														Accumulated
									Additional						Other			Total
	Number					Treasury			Paid-in			Retained			Comprehensive			Stockholders’
	of Shares		Amount			Stock			Capital			Earnings			Loss			Equity
Balance, December 31, 2010	27,611		$	28		$	(5,641	)	$	302,425		$	119,884		$	(4,288	)	$	412,408
Exercise of options	18			―			―			276			―			―			276
Exercise of warrants	100			―			―			1,135			―			―			1,135
Excess tax benefit on stock options	―			―			―			363			―			―			363
Restricted stock grants	141			―			―			1,594			―			―			1,594
Dividends declared	―			―			―			―			(5,182	)		―			(5,182	)
Retirement of common stock	(1,772	)		(2	)		5,641			(29,998	)		―			―			(24,359	)
Retirement of restricted stock	(155	)		―			―			(1,263	)		―			―			(1,263	)
Net income	―			―			―			―			8,472			―			8,472
Foreign currency translation adjustment	―			―			―