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JAKKS PACIFIC INC - Quarter Report: 2002 September (Form 10-Q)

Jakks Pacific Form 10-Q
Table of Contents



SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-Q


(Mark one)

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002

OR

[   ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____________ TO ______________

Commission file number: 0-28104

JAKKS Pacific, Inc.
(Exact name of registrant as specified in its charter)

     
Delaware
(State or other jurisdiction of
incorporation or organization)
  95-4527222
(I.R.S. Employer
Identification No.)
     
22619 Pacific Coast Highway
Malibu, California
(Address of principal executive offices)
  90265
(Zip Code)

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


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X]          No [   ]


The number of shares outstanding of the issuer’s common stock is 24,376,128 (as of November 14, 2002).



 


TABLE OF CONTENTS

Condensed Consolidated Balance Sheets
Condensed Consolidated Statements of Operations (Unaudited)
Condensed Consolidated Statements of Cash Flows (Unaudited)
Notes to Condensed Consolidated Financial Statements (Unaudited)
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4. CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
EXHIBIT 99.1
EXHIBIT 99.2


Table of Contents

JAKKS PACIFIC, INC. AND SUBSIDIARIES
INDEX TO QUARTERLY REPORT ON FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2002

ITEMS IN FORM 10-Q

                 
            PAGE
           
Facing page                
Part I   FINANCIAL INFORMATION        
Item 1   Financial Statements.        
    Condensed consolidated balance sheets —        
    December 31, 2001 and September 30, 2002 (unaudited)     3  
    Condensed consolidated statements of operations for the three and nine months        
    ended September 30, 2001 and 2002 (unaudited)     4  
    Condensed consolidated statements of cash flows for the nine months ended        
    September 30, 2001 and 2002 (unaudited)     5  
    Notes to condensed consolidated financial statements (unaudited)     6  
Item 2   Management's Discussion and Analysis of Financial Condition and        
    Results of Operations     8  
Item 3   Quantitative and Qualitative Disclosures About Market Risk     13  
Item 4   Controls and Procedures     13  
Part II   OTHER INFORMATION        
Item 1   Legal Proceedings   None
Item 2   Changes in Securities and Use of Proceeds   None
Item 3   Defaults Upon Senior Securities   None
Item 4   Submission of Matters to a Vote of Security Holders     14  
Item 5   Other Information   None
Item 6   Exhibits and Reports on Form 8-K     14  
Signatures             15  

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 on information available to us on the date hereof, but we cannot assure you that these assumptions and expectations will prove to have been correct or that we will take any action that we may presently be planning. We are not undertaking to publicly update or revise any forward-looking statement if we obtain new information or upon the occurrence of future events or otherwise.

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JAKKS PACIFIC, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

ASSETS

                       
          December 31, 2001   September 30, 2002
         
 
          (*)   (unaudited)
Current assets
               
 
Cash and cash equivalents
  $ 25,036,203     $ 100,757,831  
 
Marketable securities
    37,119,071       583,282  
 
Accounts receivable, net of allowances for uncollectible accounts of $7,273,497 and $8,625,491, respectively
    52,888,452       89,395,015  
 
Inventory, net of reserves for potential product obsolescence of $2,590,099 and $4,964,081, respectively
    32,023,960       40,698,555  
 
Prepaid expenses and other current assets
    6,726,847       4,681,616  
 
Notes Receivable—Officers
    250,000       1,375,000  
 
   
     
 
   
Total current assets
    154,044,533       237,491,299  
 
   
     
 
Office furniture and equipment
    5,305,212       5,302,122  
Molds and tooling
    26,355,861       29,801,843  
Leasehold improvements
    1,854,501       2,191,114  
 
   
     
 
   
Total
    33,515,574       37,295,079  
Less accumulated depreciation and amortization
    17,762,905       23,317,077  
 
   
     
 
   
Property and equipment, net
    15,752,669       13,978,002  
Deferred income taxes
          11,598,503  
Notes Receivable—Officers
    1,974,000        
Investment in joint venture
    7,893,312       3,372,323  
Goodwill, net
    89,863,415       145,696,521  
Trademarks, net
    11,567,679       11,567,679  
Intangibles and deposits, net
    2,945,075       3,095,486  
 
   
     
 
     
Total assets
  $ 284,040,683     $ 426,799,813  
 
   
     
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities
               
 
Accounts payable and accrued expenses
  $ 35,714,430     $ 65,215,621  
 
Income taxes payable
    1,570,973       14,683,275  
 
Current portion of long term debt
    22,560       18,720  
 
   
     
 
   
Total current liabilities
    37,307,963       79,917,616  
 
   
     
 
Long term debt, net of current portion
    72,510       77,612  
Deferred income taxes
    2,256,817        
 
   
     
 
   
Total liabilities
    39,637,290       79,995,228  
 
   
     
 
Contingency
               
Minority interest
          5,577,720  
Stockholders’ equity
               
 
Common stock, $.001 par value; 100,000,000 shares authorized; 20,320,354 and 23,586,967 shares issued, respectively
    20,320       23,587  
 
Additional paid-in capital
    168,114,819       228,081,242  
 
Treasury stock, at cost; 1,493,600 and nil shares, respectively
    (12,911,483 )      
 
Retained earnings
    89,179,737       113,122,036  
 
   
     
 
   
Total stockholders’ equity
    244,403,393       341,226,865  
 
   
     
 
     
Total liabilities and stockholders’ equity
  $ 284,040,683     $ 426,799,813  
 
   
     
 

See accompanying notes to condensed consolidated financial statements.

(*) Derived from audited financial statements

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JAKKS PACIFIC, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

For the Three and Nine Months Ended September 30, 2001 and 2002 (Unaudited)
                                 
    Three Months Ended September 30,   Nine Months Ended September 30,
   
 
    2001   2002     2001       2002
   
 
 
 
Net sales
  $ 92,767,943     $ 102,639,835     $ 222,871,202     $ 241,526,804  
Cost of sales
    53,711,569       60,827,541       126,737,725       138,053,056  
 
   
     
     
     
 
Gross profit
    39,056,374       41,812,294       96,133,477       103,473,748  
Selling, general and administrative expenses
    24,155,145       22,917,492       63,936,204       65,125,608  
Acquisition shut-down and recall costs
    338,766             1,488,786       8,121,497  
 
   
     
     
     
 
Income from operations
    14,562,463       18,894,802       30,708,487       30,226,643  
Profit from joint venture
    (86,475 )     (611,774 )     (967,230 )     (2,580,639 )
Interest, net
    (600,685 )   (437,098 )     (1,532,127 )     (970,039 )
 
   
     
     
     
 
Income before provision for income taxes and minority interest
    15,249,623       19,943,674       33,207,844       33,777,321  
Provision for income taxes
    4,300,392       5,384,792       9,364,612       9,119,877  
 
   
     
     
     
 
Income before minority interest
    10,949,231     14,558,882       23,843,232       24,657,444  
Minority interest
        604,483             715,145  
 
   
     
     
     
 
Net income
  $ 10,949,231     $ 13,954,399     $ 23,843,232     $ 23,942,299  
 
   
     
     
     
 
Earnings per share — basic
  $ 0.60     $ 0.59     $ 1.32     $ 1.13  
 
   
     
     
     
 
Earnings per share — diluted
  $ 0.56     $ 0.58     $ 1.24     $ 1.09  
 
   
     
     
     
 

See accompanying notes to condensed consolidated financial statements.

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JAKKS PACIFIC, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2001 and 2002 (Unaudited)

                         
            Nine Months Ended September 30,
           
            2001   2002
           
 
CASH FLOWS FROM OPERATING ACTIVITIES
               
 
Net income
  $ 23,843,232     $ 23,942,299  
 
   
     
 
 
Adjustments to reconcile net income to net cash provided (used) by operating activities:
               
   
Depreciation and amortization
    8,994,025       7,145,067  
   
Earned Compensation from stock option grants
    1,475,707       (1,873,650 )
   
Profit from joint venture
    8,830,925       4,520,989  
   
Loss on disposal of property and equipment
          98,508  
   
Forgiveness of officer note receivable
          285,000  
   
Minority interest
          715,145  
   
Change in operating assets and liabilities
               
     
Accounts receivable
    (37,125,245 )     (35,143,384 )
     
Inventory
    504,074       (5,815,590 )
     
Prepaid expenses and other current assets
    2,637,036       2,235,192  
     
Accounts payable and accrued expenses
    21,390,097     16,238,863
     
Income taxes payable
    6,327,360       10,095,959  
     
Deferred income taxes
    (700,000 )     (401,149 )
     
Marketable securities
    (33,606,801 )     37,119,071  
 
   
     
 
       
Total adjustments
    (21,272,822 )     35,220,021  
 
   
     
 
       
Net cash provided by operating activities
    2,570,410       59,162,320  
 
   
     
 
CASH FLOWS FROM INVESTING ACTIVITIES
               
 
Cash paid for net assets acquired
    (4,500,000 )     (43,186,083 )
 
Purchase of property and equipment
    (3,212,464 )     (3,810,133 )
 
Other assets
     (252,477 )     928,982
 
Purchase of marketable securities
          (583,282 )
 
Repayment of Notes receivable from officers
    226,000       599,000  
 
   
     
 
       
Net cash used by investing activities
    (7,738,941 )     (46,051,516 )
 
   
     
 
CASH FLOWS FROM FINANCING ACTIVITIES
               
 
Net proceeds from sale of common stock
          59,990,219  
 
Proceeds from stock options and warrants exercised
    1,952,828       2,631,975  
 
Repayment of long term debt
    (300,000 )     (11,370 )
 
   
     
 
       
Net cash provided by financing activities
    1,652,828       62,610,824  
 
   
     
 
Net increase (decrease) in cash and cash equivalents
    (3,515,703 )     75,721,628
Cash and cash equivalents, beginning of period
    29,275,424       25,036,203  
 
   
     
 
Cash and cash equivalents, end of period
  $ 25,759,721     $ 100,757,831  
 
   
     
 
Supplemental disclosure of cash flow information:
               
Cash paid during the period for:
               
 
Income taxes
  $ 2,873,981     $ 194,769  
 
   
     
 
 
Interest
  $ 55,663     $ 63,141  
 
   
     
 
Non cash investing and financing activity:
               
 
In March 2002, the Company issued 646,384 shares of its common stock valued at approximately $12.1 million in connection with the acquisition of Toymax.
               

See accompanying notes to condensed consolidated financial statements.

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JAKKS PACIFIC, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2002

Note 1 — Basis of presentation

The accompanying 2001 and 2002 unaudited interim condensed consolidated financial statements included herein have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted pursuant to such rules and regulations. However, we believe that the disclosures are adequate to prevent the information presented from being misleading. These financial statements should be read in conjunction with the financial statements and the notes thereto included in our Form 10-K/A, which contains financial information for the three years in the period ended December 31, 2001.

The information provided in this report reflects all adjustments (consisting solely of normal recurring accruals) that are, in the opinion of management, necessary to present fairly the results of operations for this period. The results for this period are not necessarily indicative of the results to be expected for the full year.

The consolidated financial statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries.

Basic earnings per share has been computed using the weighted average number of common shares. Diluted earnings per share has been computed using the weighted average number of common shares and common share equivalents (which consist of warrants and options, to the extent they are dilutive).

Note 2 — Business Segments and Geographic Data

      JAKKS Pacific is a worldwide producer and marketer of children’s toys and related products, principally engaged in the design, development, production and marketing of traditional toys, including boys action figures, vehicles and playsets, craft and activity products, writing instruments, compounds, girls toys, and infant and preschool toys. Our reportable segments are North America Toys, International and Other.

      The North America Toys segment, which includes the United States and Canada, and the International toy segment, which includes sales to non-North American markets, include the design, development, production and marketing of children’s toys and related products. We also have an additional segment classified as Other, which sells various products to the specialty markets in the United States.

      Segment performance is measured at the operating income level. All sales are made to external customers, and general corporate expenses have been attributed to the North America Toy segment, which is a dominant segment. Segment assets are comprised of accounts receivable and inventories, net of applicable reserves and allowances.

      Results are not necessarily those that would be achieved were each segment an unaffiliated business enterprise. Information by segment and a reconciliation to reported amounts for the three and nine months ended September 30, 2001 and 2002 are as follows:

                                          
Three Months Ended September 30, Nine Months Ended September 30,


2001 2002 2001 2002




Net Sales
                             
North America Toys
  $ 84,178,218     $ 84,798,070     $ 204,583,958     $ 206,701,182  
International
    8,584,994       17,766,910       17,650,553       34,432,698  
Other
    4,731       74,855       636,691       392,924  
     
     
     
     
 
    $ 92,767,943     $ 102,639,835     $ 222,871,202     $ 241,526,804  
     
     
     
     
 
                                          
Three Months Ended September 30, Nine Months Ended September 30,


2001 2002 2001 2002




Operating Income
                             
North America Toys
  $ 13,214,071     $ 15,610,340     $ 28,110,823     $ 25,643,083  
International
    1,347,649       3,270,682       2,518,527       4,544,086  
Other
  743       13,780       79,137       39,474  
     
     
     
     
 
    $ 14,562,463     $ 18,894,802     $ 30,708,487     $ 30,226,643  
     
     
     
     
 
                 
September 30,

2001 2002


Assets
               
North America Toys
  $ 274,682,435     $ 354,677,524  
International
    28,013,745       74,312,011  
Other
    15,437       313,090  
     
     
   
    $ 302,711,617     $ 429,302,625  
     
     
   

     The following tables present information about the Company by geographic area as of and for the three and nine months ended September 30, 2001 and 2002:

                           
September 30,

2001 2002


Long-lived Assets
               
United States
  $ 93,740,128     $ 138,017,789  
Hong Kong
    11,479,463       33,143,814  
Europe
          595,009  
     
     
 
 
  $ 105,219,591     $ 171,756,612  
     
     
 
                                 
Three Months ended September 30, Nine Months Ended September 30,


2001 2002 2001 2002




Net Sales by Geographic Area
                           
United States
  $ 80,496,921     $ 81,998,508     $ 198,887,524     $ 201,843,274  
Europe
    3,386,585       14,238,316       7,224,594       29,100,239  
Canada
    2,960,236       2,874,417       5,274,448       5,250,832  
Hong Kong
    5,390,535       170,950       9,905,052       242,007  
Other
    533,666       3,357,644       1,579,584       5,090,452  
     
     
     
     
 
    $ 92,767,943     $ 102,639,835     $ 222,871,202     $ 241,526,804  
     
     
     
     
 

Note 3 — Inventories

     Net inventories include the ex-factory cost of goods and in-bound freight and are stated at the lower of cost (first-in, first-out) or market and consist of the following:

                 
    December 31,   September 30,
    2001   2002
   
 
Deposits and raw materials
  $ 318,999     $ 863,161  
Finished goods
    31,704,961       39,835,394  
 
   
     
 
 
  $ 32,023,960     $ 40,698,555  
 
   
     
 

Note 4 — Credit Facility

     In October 2001, we entered into a loan agreement with a consortium of banks led by Bank of America, N.A. This agreement expires on October 12, 2004 and permits us to borrow (and maintain obligations under outstanding letters of credit) up to an aggregate of $50,000,000. Available borrowings under the facility are determined by applying specified advance rates to eligible domestic accounts receivable and inventory.

     We are required to not have any outstanding borrowings in excess of $30,000,000 for a period of at least 30 consecutive days during this first fiscal quarter of each year of the agreement.

     This Credit facility is secured by a lien on substantially all of our assets and contains customary financial and non-financial covenants which require us to maintain a minimum net worth and limit our ability to incur additional indebtedness, pay cash dividends or make other distributions, sell assets and enter into certain mergers or acquisitions. Amounts outstanding under this credit facility bears interest at 0.25% plus the greater of the Prime Rate or Federal Funds Rate plus 0.5%, and is subject to adjustment based on certain financial ratios. As of September 30, 2002, we had no outstanding borrowings.

Note 5 — Earnings per share

     The following table is a reconciliation of the weighted average shares used in the computation of basic and diluted earnings per share for the periods presented:

                                                 
    THREE MONTHS ENDED SEPTEMBER 30,
   
    2001   2002
   
 
            WEIGHTED                   WEIGHTED        
            AVERAGE                   AVERAGE        
    INCOME   SHARES   PER-SHARE   INCOME   SHARES   PER-SHARE
   
 
 
 
 
 
Earnings per share — basic
Income available to common stockholders
  $ 10,949,231       18,272,932     $ 0.60     $ 13,954,399       23,585,722     $ 0.59  
 
   
     
     
     
     
     
 
Effect of dilutive securities
Options and warrants
          1,313,536                     472,877          
 
   
     
             
     
         
Earnings per share — diluted
Income available to common stockholders plus assumed exercises
  $ 10,949,231       19,586,468     $ 0.56     $ 13,954,399       24,058,599     $ 0.58  
 
   
     
     
     
     
     
 
                                                 
    NINE MONTHS ENDED SEPTEMBER 30,
   
    2001   2002
   
 
            WEIGHTED                   WEIGHTED        
            AVERAGE                   AVERAGE        
    INCOME   SHARES   PER-SHARE   INCOME   SHARES   PER-SHARE
   
 
 
 
 
 
Earnings per share — basic
Income available to common stockholders
  $ 23,843,232       18,110,329     $ 1.32     $ 23,942,299       21,215,793     $ 1.13  
 
   
     
     
     
     
     
 
Effect of dilutive securities
Options and warrants
          1,175,586                     842,690          
 
   
     
             
     
         
Earnings per share — diluted
Income available to common stockholders plus assumed exercises
  $ 23,843,232       19,285,915     $ 1.24     $ 23,942,299       22,058,483     $ 1.09  
 
   
     
     
     
     
     
 

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JAKKS PACIFIC, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
September 30, 2002

Note 6 — Common stock and preferred stock

     We have 105,000,000 authorized shares of stock consisting of 100,000,000 shares of $.001 par value common stock and 5,000,000 shares of $.001 par value preferred stock. On September 27, 2002, our stockholders approved increases in our authorized shares from 25,000,000 of common stock and 1,000,000 of preferred stock.

     Pursuant to an underwritten public offering, we sold 3,000,000 shares of our common stock on May 29, 2002 and 525,000 shares of our common stock on June 11, 2002 (to cover over-allotments by the underwriters), for total net proceeds of $59.3 million. We retired 1,493,600 shares of treasury stock for reissuance pursuant to this public offering.

      On March 11, 2002, we issued 646,384 shares of our common stock in connection with our acquisition of a controlling interest in Toymax International, Inc. (Toymax).

      In December 2001, we issued 308,992 shares of our common stock in connection with our acquisition of Kidz Biz Limited and an affiliated company.

Note 7 — Acquisitions

     In October 1999, we acquired all of the stock of Flying Colors Toys, Inc. (Flying Colors) for approximately $52.9 million. Consideration paid at closing was in cash. Contingent consideration included an earn-out in an amount of up to $4.5 million in each of the three 12-month periods following the closing, if gross profits of Flying Colors branded products achieved certain prescribed levels in each of such periods. The maximum earn-out of $4.5 million for each of the three 12-month earn-out periods ended September 30, 2000, 2001 and 2002 was earned by the sellers. The paid earn-outs have been recorded primarily as goodwill.

      In December 2001, we acquired all of the outstanding capital stock of Kidz Biz Limited, a United Kingdom company, and an affiliated Hong Kong company, Kidz Biz Far East Limited, collectively referred to as Kidz Biz, for an aggregate purchase price of approximately $12.4 million. Total consideration was paid on the closing of the transaction in cash in the amount of $6.4 million and the issuance of 308,992 shares of our common stock at a value of $6.0 million. In addition, we agreed to pay an earn-out for each of fiscal 2002, 2003, 2004 and 2005, based on the year over year increase in Kidz Biz sales, payable by delivery of up to 25,749 shares of our common stock.

     On March 11, 2002, we acquired 8,100,065 shares of common stock of Toymax primarily from four of its stockholders, which, with the 132,754 shares we previously purchased in the open market for approximately $227,000, represents approximately 66.8% of its outstanding shares. Consideration paid for the stock was approximately $3.00 in cash and .0798 shares of our common stock per share of Toymax stock, for an aggregate purchase price of approximately $24,300,000 in cash and 646,384 shares of our common stock. The second phase of the acquisition was completed on October 25, 2002, when we purchased the remaining approximately 4,100,000 outstanding shares of Toymax in a merger transaction. Consideration paid was $3.00 per share in cash for a total amount of $12.4 million and approximately 520,000 shares of our common stock. (See Note 10)

The following unaudited pro forma information represents our consolidated results of operations as if the acquisitions of Kidz Biz and Toymax had occurred on January 1, 2001 and after giving effect to certain adjustments including the elimination of intercompany sales and other income and expense items not attributable to on-going operations, interest and depreciation expense, and related tax effects. Such pro forma information does not purport to be indicative of operating results that would have been reported had the acquisitions of Kidz Biz and Toymax occurred on January 1, 2001 or future operating results.

                                         
    Three Months Ended September 30,   Nine Months Ended September 30,
   
 
    2001   2002   2001   2002
   
 
 
 
Net Sales   $ 135,696,731     $ 102,639,835     $ 305,365,699     $ 250,185,352  




Net income   $ 12,963,784     $ 13,954,399     $ 19,687,914     $ 20,710,609  




Earnings per share — basic   $ 0.67     $ 0.59     $ 1.03     $ 0.98  

   

   
Weighted average shares outstanding — basic     19,228,308       23,585,722       19,065,705       21,215,793  




Earnings per share — diluted   $ 0.63     $ 0.58     $ 0.97     $ 0.94  




Weighted average shares and equivalents outstanding — diluted     20,541,844       24,058,599       20,241,291       22,058,483  




Note 8 — Notes Receivable From Officers

     As of September 30, 2002, there were notes receivable from two of our officers totaling $1,375,000 issued at interest rates of 6.5% each, with interest payable on each April 28 and October 28 of each year, and principal payable at maturity on April 28, 2003. Additionally, there was a third note receivable from an officer for $250,000 issued at an interest rate of 7.0%, with interest and principal payable at maturity on May 12, 2002. As set forth in this officer's employment agreement, all of the indebtedness under this third note receivable was forgiven because the employment of this officer continued through such date.

Note 9 — Recent Accounting Pronouncements

     In July 2001, the FASB issued Statement of Financial Accounting Standards No. 141, “Business Combinations” (SFAS 141) and Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (SFAS 142). SFAS 141 is effective for business combinations initiated after June 30, 2001. SFAS 141 requires that all business combinations completed after its adoption be accounted for under the purchase method of accounting and establishes specific criteria for the recognition of intangible assets separately from goodwill. SFAS 142 was effective for us on January 1, 2002 and primarily addresses the accounting for goodwill and intangible assets subsequent to their acquisition. With our adoption of SFAS 142, goodwill and other intangible assets are no longer amortized and will be tested for impairment at least annually at the reporting unit level. As of September 30, 2002, there was no impairment to the underlying value of the assets.

     The effect of adoption of SFAS No. 142 on the reported net income for the current and comparative prior period is as follows:

                                                  
      For Three Months Ended September 30,   For Nine Months Ended September 30,
     
 
      2001   2002   2001   2002
     
 
 
 
Reported net income
  $ 10,949,231     $ 13,954,399     $ 23,843,232     $ 23,942,299    
Add back: Amortization of goodwill and other intangibles, net of tax effect
    582,828             1,795,961        
 
   
     
     
     
 
Net income, as adjusted
  $ 11,532,059     $ 13,954,399     $ 25,639,193     $ 23,942,299  
 
   
     
     
     
 
Earnings per share — basic:
                               
Reported net income
  $ 0.60     $ 0.59     $ 1.32     $ 1.13  
Add back: Amortization of goodwill and other intangibles, net of tax effect
    0.03             0.10        
 
   
     
     
     
 
Net income, as adjusted
  $ 0.63     $ 0.59     $ 1.42     $ 1.13  
 
   
     
     
     
 
Earnings per share — diluted:
                               
Reported net income
  $ 0.56     $ 0.58     $ 1.24     $ 1.09  
Add back: Amortization of goodwill and other intangibles, net of tax effect
    0.03             0.09        
 
   
     
     
     
 
Net income, as adjusted
  $ 0.59     $ 0.58     $ 1.33     $ 1.09  
 
   
     
     
     
 

     In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.” SFAS No. 143 requires the fair value of a liability for an asset retirement obligation to be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. We believe the adoption of this statement will have no material impact on the financial statements.

Note 10 — Subsequent Events

     On October 25, 2002, we completed our acquisition of Toymax. On the closing of the merger, we paid $12,425,000 in cash and issued approximately 520,000 shares of our common stock at an aggregate value of $5,949,000. Toymax became wholly-owned on this date. In addition, we exchanged 598,697 options with a value of approximately $3.2 million to purchase our common stock.

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JAKKS PACIFIC, INC. AND SUBSIDIARIES

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of financial condition and results of operations should be read together with our Condensed Consolidated Financial Statements and Notes thereto which appear elsewhere herein.

OVERVIEW

     JAKKS was founded to design, develop, produce and market children’s toys and related products. We commenced business operations in 1995 when we assumed operating control over the toy business of Justin Products, which consisted primarily of fashion dolls and accessories and electronic products for children.

     One of our key strategies has been to grow through the acquisition or licensing of product lines, concepts and characters. Since our founding, we expanded our product lines to include many diverse products including some based on licensed characters and properties, such as World Wrestling Entertainment action figures and accessories.

     We acquired Road Champs with its line of die-cast collectible and toy vehicles in February 1997. In October 1997, we acquired the Child Guidance trademark for infant and pre-school electronic products and the Remco trademark for toy vehicles. In June 1999, we acquired Berk with its lines of educational toy foam puzzle mats and activity sets. In October 1999, we acquired Flying Colors, whose product lines include licensed and non-licensed activity kits, play clay compound playsets and lunch boxes as well as other related products. In July 2000, we acquired Pentech whose product lines include pens, markers, pencils, and other writing instruments, crafts and activity kits, and related stationery products.

      On March 11, 2002, we acquired approximately 66.8% of the outstanding common stock of Toymax International, Inc. (“Toymax”), which represents a controlling interest in Toymax. On October 25, 2002, we purchased the remaining shares of Toymax. Toymax is a developer and marketer of toys and related products, including brand name products such as Laser Challenge, Creepy Crawlers, Funnoodle and Go Fly a Kite. These product lines further diversify, as well as complement our own product lines, and we expect to benefit from efficiencies through combining our operations. On October 25, 2002, we acquired the remainder of Toymax’s outstanding shares of common stock in a merger transaction for consideration of approximately $12.4 million in cash and 520,000 shares of our common stock.

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     Our products currently include (1) action figures and accessories featuring licensed characters, principally from the World Wrestling Entertainment license, (2) Flying Colors molded plastic activity sets, compound playsets and lunch boxes, (3) Wheels division products, including Road Champs die-cast collectible and toy vehicles and Remco toy vehicles and role-play toys and accessories, (4) Child Guidance infant and pre-school electronic toys, educational toy foam puzzle mats and blocks, activity sets and outdoor products, (5) Pentech pens, markers, pencils, and other writing instruments and craft products, (6) fashion and mini dolls and related accessories, (7) Toymax activity products, radio controlled vehicles and other electronic toys, (8) Funnoodle pool and outdoor toys, and (9) Go Fly a Kite kites, weather vanes and related products.

     We employ a staff of designers for all of our product lines. We occasionally acquire products or product concepts from others or engage unaffiliated third parties to develop our own products, thus minimizing operating costs. Royalties payable to our developers generally range from 1% to 6% of the wholesale price for each unit of a product sold by us. We expect that outside inventors will continue to be a source of new products in the future. We also generate internally new product concepts, for which we pay no royalties.

     In June 1998, we formed a joint venture with THQ Inc., a developer, publisher and distributor of interactive entertainment software, and the joint venture licensed the rights from World Wrestling Entertainment to publish World Wrestling Entertainment electronic video game software on all platforms. The first games produced under this license were released in November 1999. Through June 30, 2006, we are entitled to receive a guaranteed preferred return at varying rates on the net sales of the video games depending on the cumulative unit sales and hardware platform of each particular game, and THQ is entitled to receive the balance of the profits generated by the joint venture. After June 30, 2006, the amount of our preferred return from the joint venture will be subject to renegotiation between THQ and us. The minimum preferred return to be distributed to us by the joint venture in each of the years in the period ending December 31, 2003 is $2.6 million per year. We expect our aggregate return over this period to be significantly in excess of this amount, although we cannot predict with certainty that expected levels of return will be achieved and, in any case, we anticipate substantial fluctuations in the amount of the preferred return distributed to us from year to year.

     We contract the manufacture of most of our products to unaffiliated manufacturers located in China. We sell a substantial portion of the finished products on a letter of credit basis or on open account to our customers, who take title to the goods in Hong Kong. These methods allow us to reduce certain operating costs and working capital requirements. A portion of our sales, primarily sales of our Road Champs, Flying Colors and Pentech products, originate in the United States, so we hold certain inventory in our warehouse and fulfillment facilities. In addition, we hold inventory of other products from time to time in support of promotions or other domestic programs with retailers. To date, substantially all of our sales have been to domestic customers. We intend to expand distribution of our products into foreign territories and, accordingly, we have (1) acquired Kidz Biz, a United Kingdom based distributor of toys and related products that will serve as our European headquarters, (2) engaged representatives to oversee sales in certain territories, such as Funtastic Ltd. in Australia, (3) engaged distributors in certain territories, and (4) established direct relationships with retailers in certain territories.

     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 on estimates or programs agreed upon by our customers.

     Our cost of sales consists primarily of the cost of goods produced for us by unaffiliated third-party manufacturers, royalties earned by licensors on the sale of these goods and amortization of the tools, dies and molds owned by us that are used in the manufacturing process. Other costs include inbound freight and provisions for obsolescence. Significant factors affecting our cost of sales as a percentage of net sales include (1) the proportion of net sales generated by various products with disparate gross margins, (2) the proportion of net sales made domestically, which typically carry higher gross margins than sales made in Hong Kong, (3) the proportion of net sales generated by various products with varying royalty rates to non-royalty proprietary items, and (4) the effect of amortizing the fixed cost components of cost of sales, primarily amortization of tools, dies and molds, over varying levels of net sales.

     Selling, general and administrative expenses include costs directly associated with the selling process, such as sales commissions, advertising and travel expenses, as well as general corporate expenses, goodwill and trademark amortization and product development. We have recorded goodwill of approximately $145.7 million and trademarks of approximately $11.6 million in connection with acquisitions made to date. Through December 31, 2001, goodwill was being amortized over a 30-year period, while trademark acquisition costs were being amortized over periods ranging from 5 to 30 years. Beginning in fiscal 2002, goodwill and certain intangible assets are not being amortized, but will be written down on an impairment basis where losses in value will be recorded when and as material impairment has occurred in the underlying assets.

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RESULTS OF OPERATIONS

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

                                 
    THREE MONTHS ENDED   NINE MONTHS ENDED
    SEPTEMBER 30,   SEPTEMBER 30,
   
 
    2001   2002   2001   2002
   
 
 
 
Net sales
    100.0 %     100.0 %     100.0 %     100.0 %
Cost of sales
    57.9       59.3       56.9       57.2  
 
   
     
     
     
 
Gross profit
    42.1       40.7       43.1       42.8  
Selling, general and administrative expenses
    26.0       22.3       28.6       26.9  
Acquisition shut-down and recall costs
    0.4             0.7       3.4  
 
   
     
     
     
 
Income from operations
    15.7       18.4       13.8       12.5  
Profit from joint venture
    (0.1 )     (0.6 )     (0.4 )     (1.1 )
Interest, net
    (0.6 )     (0.4 )     (0.7 )     (0.4 )
 
   
     
     
     
 
Income before income taxes and minority interest
    16.4       19.4       14.9       14.0  
Provision for income taxes
    4.6       5.2       4.2       3.8  
 
   
     
     
     
 
Income before minority interest
    11.8       14.2       10.7       10.2  
 
   
     
     
     
 
Minority interest
          0.6             0.3  
Net income
    11.8 %     13.6 %     10.7 %     9.9 %
 
   
     
     
     
 

THREE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001

     Net Sales. Net sales were $102.6 million in 2002 compared to $92.8 million in 2001 representing an increase of 10.6%. The contribution to net sales by Toymax and the continuing growth in sales of our Flying Colors and Dolls products was offset in part by a decrease in sales of our Wheels division, consisting primarily of our Road Champs die-cast toy and collectible vehicles with its extreme sports products.

     Gross Profit. Gross profit increased $2.8 million, or 7.1%, to $41.8 million, or 40.7% of net sales, in 2002 from $39.1 million, or 42.1% of net sales, in 2001. The overall increase in gross profit was attributable to the increase in net sales, though partially offset by a decrease in gross profit margin. The decrease in gross profit margin of 1.4% of net sales was due to lower margins for Toymax products, which was partially offset by a decrease in amortization expense of molds and tools used in the manufacture of our products and a decrease in royalty expense as a percentage of net sales due to changes in the product mix resulting from the sale of more products with lower royalty rates or proprietary products with no royalties.

     Selling, General and Administrative Expenses. Selling, general and administrative expenses were $22.9 million in 2002 and $24.2 million in 2001, constituting 22.3% and 26.0% of net sales, respectively. The overall decrease of $1.2 million in such costs was due to costs incurred in support of our Kidz Biz and Toymax acquisitions, though offset in part by a decrease in other direct selling expenses and Goodwill amortization expense based on the implementation of SFAS 142. We produced and aired television commercials in support of several of our products, including World Wrestling Entertainment action figures and Flying Colors products, in 2001 and 2002. From time to time, we may increase our advertising efforts, if we deem it appropriate for particular products.

     Acquisition Shut-down and Recall Costs. Acquisition shut-down costs in 2002 relate to shut-down costs, including lease termination, fixed asset abandonment and other costs, of certain operations of Toymax and Kidz Biz, and such costs in 2001 relate to shut-down costs of certain operations of Pentech, acquired in 2000. Operations impacted by these shut-downs were sales, design, distribution and administration. The integration of Pentech was completed in 2001 and the integration of Toymax and Kidz Biz is expected to be completed by the end of 2002. In June 2002, we accrued $1.5 million for a recall of one of our products.

     The components of the acquisition shut-down and recall costs are as follows:

                                 
    Accrued Balance           Accrued Balance
    June 30, 2002   Accrual   Actual   September 30, 2002
   
 
 
 
Lease abandonment costs   $ 5,205,802     $     $ (381,320 )   $ 4,824,482  
Other     23,370             (23,370 )      
Recall     1,500,000             (921,858 )     578,142  
   
   
   
   
Total acquisition shut-down and recall costs   $ 6,729,172     $     $ (1,326,548 )   $ 5,402,624  
   
   
   
   

     Profit from Joint Venture. Profit from joint venture increased by $0.5 million in 2002 due to increased sales of carryover titles compared to 2001.

     Interest, Net. Interest income resulting from higher average cash balances during 2002 than in 2001 was partially offset by lower interest rates.

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     Provision for Income Taxes. Provision for income taxes included Federal, state and foreign income taxes in 2001 and 2002, at effective tax rates of 28.2% in 2001 and 27.0% in 2002, benefiting from a flat 16.5% Hong Kong Corporation Tax on our income arising in, or derived from, Hong Kong. As of September 30, 2002, we had deferred tax assets of approximately $14.1 million for which no allowance has been provided since, in the opinion of management, realization of the future benefit is probable. In making this determination, management considered all available evidence, both positive and negative, as well as the weight and importance given to such evidence.

NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001

     Net Sales. Net sales were $241.5 million in 2002 compared to $222.9 million in 2001 representing an increase of 8.4%. The contribution to net sales by Toymax and the continuing growth in sales of our Flying Colors and Dolls products was offset in part by a decrease in sales of our Wheels division, consisting primarily of our Road Champs die-cast toy and collectible vehicles with its extreme sports products.

     Gross Profit. Gross profit increased $7.3 million, or 7.6%, to $103.5 million, or 42.8% of net sales, in 2002 from $96.1 million, or 43.1% of net sales, in 2001. The overall increase in gross profit was attributable to the increase in net sales, though partially offset by a decrease in gross profit margin. The decrease in gross profit margin of 0.3% of net sales was due to lower margins for Toymax products, which is partially offset by decrease in royalty expense as a percentage of net sales due to changes in the product mix resulting from the sale of more products with lower royalty rates or proprietary products with no royalties, and a decrease in amortization expense of molds and tools used in the manufacture of our products.

     Selling, General and Administrative Expenses. Selling, general and administrative expenses were $65.1 million in 2002 and $63.9 million in 2001, constituting 26.9% and 28.6% of net sales, respectively. The overall increase of $1.2 million in such costs was due to costs incurred in support of our Kidz Biz and Toymax acquisitions and increased media buys for our Flying Colors products, though offset in part by a decrease in Goodwill amortization expense based on the implementation of SFAS 142. We produced and aired television commercials in support of several of our products, including World Wrestling Entertainment action figures and Flying Colors products, in 2001 and 2002. From time to time, we may increase our advertising efforts, if we deem it appropriate for particular products.

     Acquisition Shut-down and Recall Costs. Acquisition shut-down costs in 2002 relate to shut-down costs, including lease termination, fixed asset abandonment and other costs, of certain operations of Toymax and Kidz Biz, and such costs in 2001 relate to shut-down costs of certain operations of Pentech, acquired in 2000. Operations impacted by these shut-downs were sales, design, distribution and administration. The integration of Pentech was completed in 2001 and the integration of Toymax and Kidz Biz is expected to be completed by the end of 2002. In June 2002, we accrued $1.5 million for a recall of one of our products.

     The components of the acquisition shut-down and recall costs are as follows:

                                 
    Accrued Balance           Accrued Balance
    December 31, 2001   Accrual   Actual   September 30, 2002
   
 
 
 
Lease abandonment costs   $     $ 5,801,980     $ (977,498 )   $ 4,824,482  
Fixed asset write-off           260,142       (260,142 )      
Other           559,375       (559,375 )      
Recall           1,500,000       (921,858 )     578,142  
   
   
   
   
Total acquisition shut-down and recall costs   $     $ 8,121,497      $ (2,718,873 )   $ 5,402,624  
   
   
   
   

     Profit from Joint Venture. Profit from joint venture increased by $1.6 million in 2002 because the joint venture had sales of only carryover titles in 2001 compared to releasing a new Microsoft Xbox title in addition to having sales of carryover titles in 2002. New releases typically generate higher unit sales resulting in higher overall sales as compared to carryover titles.

     Interest, Net. Interest income resulting from higher average cash balances during 2002 than in 2001 was partially offset by lower interest rates.

     Provision for Income Taxes. Provision for income taxes included Federal, state and foreign income taxes in 2001 and 2002, at effective tax rates of 28.2% in 2001 and 27.0% in 2002, benefiting from a flat 16.5% Hong Kong Corporation Tax on our income arising in, or derived from, Hong Kong. As of September 30, 2002, we had deferred tax assets of approximately $14.1 million for which no allowance has been provided since, in the opinion of management, realization of the future benefit is probable. In making this determination, management considered all available evidence, both positive and negative, as well as the weight and importance given to such evidence.

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SEASONALITY AND BACKLOG

     The retail toy industry is inherently seasonal. Generally, in the past, our sales have been highest during the third and fourth quarters, and collections for those sales have been highest during the succeeding fourth and first fiscal quarters. Sales of writing instrument products are likewise seasonal with sales highest during the second and third quarters as are our Go Fly a Kite and Funnoodle outdoor products which are largely sold in the first and second quarters. Our working capital needs have been highest during the third and fourth quarters.

     While we have taken steps to level sales over the entire year, sales are expected to remain heavily influenced by the seasonality of our toy products. The result of these seasonal patterns is that operating results and demand for working capital may vary significantly by quarter. Orders placed with us for shipment are cancelable until the date of shipment. The combination of seasonal demand and the potential for order cancellation makes accurate forecasting of future sales difficult and causes us to believe that backlog may not be an accurate indicator of our future sales. Similarly, financial results for a particular quarter may not be indicative of results for the entire year.

LIQUIDITY AND CAPITAL RESOURCES

     As of September 30, 2002, we had working capital of $157.6 million, as compared to $116.7 million as of December 31, 2001. This increase was primarily attributable to the receipt of net proceeds from the public sale of our common stock, our operating results and the receipt of the preferred return from our joint venture with THQ, though offset in part by disbursements related to our acquisition of Toymax.

     Operating activities provided net cash of $59.2 million in 2002 including $37.1 million provided from the sale of marketable securities, as compared to $2.6 million in 2001 including $33.6 million used for the purchase of marketable securities. Net cash was provided primarily by net income and non-cash charges, such as depreciation and amortization, earned compensation from stock option grants, loss on disposal of property and equipment, forgiveness of an officer note receivable and minority interest, as well as decreases in the preferred return from THQ joint venture, prepaid expenses and other current operating assets, the sale of marketable securities and increases in accounts payable and accrued expenses, income taxes payable, which were offset by an increase in accounts receivable and inventory and a decrease in deferred income taxes. As of September 30, 2002, we had cash and cash equivalents of $100.8 million and marketable securities of $0.6 million.

     Our investing activities used net cash of $46.1 million in 2002, as compared to $7.7 million in 2001, consisting primarily of cash paid for net assets acquired in the Toymax acquisition, plus the $4.5 million in goodwill relating to the 2002 earn-out for Flying Colors, the purchase of office furniture and equipment and molds and tooling used in the manufacture of our products, the purchase of marketable securities available for sale, offset by a decrease in other assets and the repayment of notes receivable from officers. In 2001, our investing activities consisted primarily of the $4.5 million in goodwill relating to the 2001 earn-out for Flying Colors, the purchase of warehouse equipment and leasehold improvements and an increase in other assets offset by the repayment of notes receivable from officers. As part of our strategy to develop and market new products, we have entered into various character and product licenses with royalties ranging from 1% to 12% payable on net sales of such products. As of September 30, 2002, these agreements required future aggregate minimum guarantees of $18.1 million, exclusive of $0.9 million in advances already paid.

     Our financing activities provided net cash of $62.6 million in 2002, consisting primarily of proceeds from the sale of our common stock and from the exercise of stock options and warrants, partially offset by the repayment of long-term debt. In 2001, financing activities provided net cash of $1.7 million, consisting primarily of proceeds from the exercise of stock options and warrants, partially offset by the repayment of long term debt.

     Effective April 1, 2002, subsequent to the disbursement of funds related to our acquisition of Toymax and receipt of proceeds from the public offering from the sale of our common stock, we changed our investment strategy to invest excess funds with a new investment manager and are now classifying the investments as available for sale securities, instead of trading securities.

     In October 1999, we acquired Flying Colors Toys. At the closing we paid approximately $34.7 million for the stock and paid off approximately $17.6 million of indebtedness. We also agreed to pay an earn-out of up to $4.5 million in each of the three 12-month periods following the closing if gross profits of Flying Colors branded products achieve certain prescribed levels during each such period. The sellers of Flying Colors earned the maximum of $4.5 million in each of the three earn-out periods ended September 30, 2000, 2001 and 2002.

      In December 2001, we acquired all of the outstanding capital stock of Kidz Biz Limited, a United Kingdom company, and an affiliated Hong Kong company, Kidz Biz Far East Limited, for an aggregate purchase price of approximately $12.4 million. Total consideration was paid on the closing of the transaction in cash in the amount of $6.4 million and the issuance of 308,992 shares of our common stock at a value of $6.0 million. In addition, we agreed to pay an earn-out for each of fiscal 2002, 2003, 2004 and 2005, based on the year over year increase in Kidz Biz sales, payable by delivery of up to 25,749 shares of our common stock.

      On March 11, 2002, we purchased 8,100,065 shares of the common stock of Toymax primarily from four of its stockholders. The aggregate purchase price for these shares was approximately $24.3 million in cash and 646,384 shares of our common stock. Prior to that date, we had acquired 132,754 shares of Toymax common stock, so that, as of March 31, 2002, we owned 8,232,819 shares of Toymax common stock, representing approximately 66.8% of the outstanding shares of Toymax common stock. The second phase of the acquisition was completed on October 25, 2002, when we purchased the remaining approximately 4,100,000 outstanding shares of Toymax in a merger transaction. Consideration paid for each share of Toymax owned was $3.00 per share in cash for a total amount of $12.4 million and approximately 520,000 shares of our common stock.

      In October 2001, we secured a syndicated line of credit totaling $50.0 million with a consortium of banks led by Bank of America, N.A. (“Line of Credit”). The Line of Credit will be available for future acquisitions and working capital and is secured by a lien on substantially all of our assets and contains customary financial and non-financial covenants which require us to maintain a minimum net worth and limit our ability to incur additional indebtedness, pay cash dividends or make distributions, sell assets and enter into certain mergers or acquisitions. We are required to not have any outstanding borrowings in excess of $30.0 million for a period of at least 30 consecutive days during the first fiscal quarter of each year of the agreement. Amounts outstanding under this facility bear interest at 0.25% plus the greater of the Prime Rate or the Federal Funds Rate plus 0.5%, subject to adjustment based on certain financial ratios. As of September 30, 2002, we had no outstanding borrowings.

     We believe that our cash flow from operations, cash and cash equivalents on hand, marketable securities and the availability under our Line of Credit will be sufficient to meet our working capital and capital expenditure requirements and provide us with adequate liquidity to meet our anticipated operating needs for at least the next 12 months. Although operating activities are expected to provide cash, to the extent we grow significantly in the future, our operating and investing activities may use cash and, consequently, this growth may require us to obtain additional sources of financing. There can be no assurance that any necessary additional financing will be available to us on commercially reasonable terms, if at all.

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ITEM 3. 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, if such an event were to 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. Historically and as of September 30, 2002, we have not used derivative instruments or engaged in hedging activities to minimize our market risk.

INTEREST RATE RISK

     As of September 30, 2002, we do not have any outstanding balances on our Line of Credit and we have only nominal interest-bearing obligations. Accordingly, we are not generally subject to any direct risk of loss arising from changes in interest rates.

FOREIGN CURRENCY RISK

     We have wholly-owned subsidiaries in Hong Kong and in the United Kingdom. Sales by these operations made on a FOB China or Hong Kong basis are denominated in U.S. dollars. However, purchases of inventory and Hong Kong operating expenses are typically denominated in Hong Kong dollars and domestic sales and operating expenses made in the United Kingdom are typically denominated in British Pounds, thereby creating exposure to changes in exchange rates. Changes in the British Pound 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. We do not believe that near-term changes in these exchange rates, if any, will result in a material effect on our future earnings, fair values or cash flows, and therefore, we have chosen not to enter into foreign currency hedging transactions. We cannot assure you that this approach will be successful, especially in the event of a significant and sudden change in the value of the Hong Kong dollar or British Pound.

ITEM 4. CONTROLS AND PROCEDURES

     (a)  Evaluation of disclosure controls and procedures.

     Our chief executive officer and our chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(c) and 15-d-14(c) as of a date within 90 days of the filing date of the quarterly report (the “Evaluation Date”) have concluded that as of the Evaluation Date, our disclosure controls and procedures were adequate and effective to ensure that material information relating to us and our consolidated subsidiaries would be made known to them by others within those entities, particularly during the period in which this quarterly report was being prepared.

     (b)  Changes in internal controls.

     There were no significant changes in our internal controls or in other factors that could significantly affect our disclosure controls and procedures subsequent to the Evaluation Date, nor any significant deficiencies or material weaknesses in such disclosure controls and procedures requiring corrective actions. As a result, no corrective actions were taken.

 

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PART II. OTHER INFORMATION

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS

     A Proxy Statement was mailed on or about August 30, 2002 to stockholders of record of the Company as of August 27, 2002 in connection with the Company’s 2002 Annual Meeting of Stockholders, which was held on September 27, 2002 at the Sherwood Country Club, 320 West Stafford Road, Thousand Oaks, California. At the Meeting, the stockholders voted on four matters, all of which were approved.

     The first matter was the election of the members of the Board of Directors. The six directors elected and the tabulation of the votes (both in person and by proxy) were as follows:

                         
Nominees for Director   For   Against   Withheld

 
 
 
Jack Friedman
    18,220,018       0       3,282,625  
Stephen G. Berman
    17,989,613       0       3,513,030  
David C. Blatte
    20,727,242       0       775,401  
Robert E. Glick
    20,512,887       0       989,756  
Michael G. Miller
    20,513,337       0       989,306  
Murray L. Skala
    20,225,798       0       1,276,845  

     There were no broker held non-voted shares represented at the Meeting with respect to this matter.

          The second matter upon which the stockholders voted was the proposal to ratify and approve the amendment of the Company’s certificate of incorporation (i) to increase the number of authorized shares of the Company’s common stock, par value $0.001 per share, from 25,000,000 shares to 100,000,000 shares; (ii) to increase the number of authorized shares of the Company’s preferred stock, par value $0.001 per share, from 1,000,000 shares, to 5,000,000 shares; and (iii) to implement changes to reflect recent changes to Delaware law and that remove or revise certain obsolete provisions. The tabulation of the votes (both in person and by proxy) was as follows:

                     
For   Against   Abstentions

 
 
12,542,788 4,946,006 17,359

          There were 3,996,490 broker non-voted shares with respect to this matter.

     The third matter upon which the stockholders voted was the proposal to ratify the appointment by the Board of Directors of PKF Certified Public Accountants, A Professional Corporation, as independent certified public accountants for the Company for 2002. The tabulation of the votes (both in person and by proxy) was as follows:

                     
For   Against   Abstentions

 
 
21,108,987 386,964 6,692

     There were no broker held non-voted shares represented at the Meeting with respect to this matter.

     The fourth matter upon which the stockholders voted was the proposal to ratify and approve the Company’s 2002 Stock Award and Incentive Plan. The tabulation of the votes (both in person and by proxy) was as follows:

                     
For   Against   Abstentions

 
 
10,116,116 5,664,748 1,725,290

     There were 3,996,489 broker held non-voted shares represented at the Meeting with respect to this matter.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

     
NUMBER   DESCRIPTION

 
3.1.1   Restated Certificate of Incorporation of the Company(1)
 
3.1.2   Certificate of Amendment of Restated Certificate of Incorporation of the Company(2)
 
3.2.1   By-Laws of the Company(1)
 
3.2.2   Amendment to By-Laws of the Company(3)
 
99.1   Certification of Chief Executive Officer(4)
 
99.2   Certification of Chief Financial Officer(4)


(1)   Filed previously as an exhibit to the Company’s Registration Statement on Form SB-2 (Reg. No. 333-2048-LA), effective May 1, 1996, and incorporated herein by reference.
(2)   Filed previously as exhibit 4.1.2 of the Company’s Registration Statement on Form S-3 (Reg. No. 333-74717), filed on March 9, 1999, and incorporated herein by reference.
(3)   Filed previously as an exhibit to the Company’s Registration Statement on Form SB-2 (Reg. No. 333-22583), effective May 1, 1997, and incorporated herein by reference.
(4)   Filed herewith.

(b)    Reports on Form 8-K

     We filed a Current Report on Form 8-K on September 4, 2002 relating to the Company’s extending the deadline to complete its acquisition of Toymax.

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SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

  Registrant:
     
  JAKKS PACIFIC, INC.
 
 
Date: November 14, 2002 By:  /s/ Joel M. Bennett
 
  Executive Vice President and
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)

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CERTIFICATIONS

I, Jack Friedman, certify that:

     1. I have reviewed this quarterly report on Form 10-Q of JAKKS Pacific, Inc.;

     2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

     3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

     4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

        a)    designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
        b)    evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
        c)    presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

     5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

        a)    all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
        b)    any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

     6. The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

     Date: November 14, 2002

     
  By:  /s/ JACK FRIEDMAN
   
    JACK FRIEDMAN
Chairman and Chief Executive Officer

 


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I, Joel M. Bennett, certify that:

     1. I have reviewed this quarterly report on Form 10-Q of JAKKS Pacific, Inc.;

     2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

     3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

     4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

        a)    designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
        b)    evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
        c)    presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

     5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

        a)    all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
        b)    any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

     6. The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

     Date: November 14, 2002

     
  By:  /s/ JOEL M. BENNETT
   
    JOEL M. BENNETT
Chief Financial Officer