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JAKKS PACIFIC INC - Quarter Report: 2003 June (Form 10-Q)

10-Q DATED 6-30-2003 JAKKS PACIFIC, INC
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 JUNE 30, 2003

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 24,588,747 (as of August 13, 2003).



 


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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
EXHIBIT 4.1
EXHIBIT 4.2
EXHIBIT 4.3
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2


Table of Contents

JAKKS PACIFIC, INC. AND SUBSIDIARIES
INDEX TO QUARTERLY REPORT ON FORM 10-Q
QUARTER ENDED JUNE 30, 2003

ITEMS IN FORM 10-Q

                 
            PAGE
           
Facing page                
Part I   FINANCIAL INFORMATION        
Item 1   Financial Statements.        
    Condensed consolidated balance sheets —        
    December 31, 2002 and June 30, 2003 (unaudited)     3  
    Condensed consolidated statements of operations for the three and six months        
    ended June 30, 2002 and 2003 (unaudited)     4  
    Condensed consolidated statements of cash flows for the six months ended        
    June 30, 2002 and 2003 (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     12  
Item 4   Controls and Procedures     12  
Part II   OTHER INFORMATION        
Item 1   Legal Proceedings   None
Item 2   Changes in Securities and Use of Proceeds     13
Item 3   Defaults Upon Senior Securities   None
Item 4   Submission of Matters to a Vote of Security Holders   None
Item 5   Other Information   None
Item 6   Exhibits and Reports on Form 8-K     13  
Signatures             14  

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, 2002   June 30, 2003
         
 
          (*)   (unaudited)
Current assets
               
 
Cash and cash equivalents
  $ 68,412,826     $ 144,414,492   
 
Marketable Securities
          219,733   
 
Accounts receivable, net of allowances for uncollectible accounts of $6,781,324 and $6,669,503, respectively
    56,195,578       72,814,416   
 
Inventory, net of reserves for potential product obsolescence of $4,782,021 and $5,166,497, respectively
    38,009,747       37,986,869   
 
Prepaid expenses and other current assets
    6,410,278       10,575,298   
 
Notes Receivable—Officers
    1,113,000       —   
 
Income taxes receivable
    2,205,882       —   
 
Deferred income taxes
    4,445,658       4,445,658   
 
   
     
 
   
Total current assets
    176,792,969       270,456,466   
 
   
     
 
Office furniture and equipment
    5,932,385       6,383,228   
Molds and tooling
    31,068,888       32,835,325   
Leasehold improvements
    2,463,875       2,655,470   
 
   
     
 
   
Total
    39,465,148       41,874,023   
Less accumulated depreciation and amortization
    24,639,593       28,897,810   
 
   
     
 
 
Property and equipment, net
    14,825,555       12,976,213   
Investment in joint venture
    8,118,645       2,738,281   
Goodwill, net
    189,335,933       205,046,519   
Trademarks, net
    11,567,679       11,567,679   
Intangibles and other, net
    8,169,168       11,664,306   
 
   
     
 
   
Total assets
$ 408,809,949     $ 514,449,464   
 
   
     
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
               
 
Accounts payable and accrued expenses
  $ 41,967,851     $ 43,378,532   
 
Income taxes payable
    5,624,532       6,138,185  
 
Current portion of long term debt
    17,805       18,410  
 
   
     
 
   
Total current liabilities
    47,610,188       49,535,127  
Long term debt, net of current portion
    59,683       98,050,324  
Deferred income taxes
    562,948       562,948   
 
   
     
 
   
Total liabilities
    48,232,819       148,148,399   
 
   
     
 
Stockholders’ equity
               
 
Preferred shares, $.001 par value; 5,000,000 shares authorized; nil outstanding
           
 
Common stock, $.001 par value; 100,000,000 shares authorized; 24,472,884 and 24,587,327 shares issued, respectively
    24,473       24,587   
 
Additional paid-in capital
    240,101,458       240,878,034   
 
Treasury stock, at cost; nil and 412,000 shares, respectively
          (4,220,773 )
 
Retained earnings
    120,451,199       129,619,217   
 
   
     
 
   
Total stockholders’ equity
    360,577,130       366,301,065   
 
   
     
 
     
Total liabilities and stockholders’ equity
  $ 408,809,949     $ 514,449,464   
 
   
     
 

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 Six Months Ended June 30, 2002 and 2003 (Unaudited)
                                 
    Three Months Ended June 30,   Six Months Ended June 30,
   
 
    2002   2003   2002   2003
   
 
 
 
Net sales
  $ 78,991,479     $ 73,290,206     $ 138,886,969     $ 141,049,651  
Cost of sales
    43,799,876       45,384,347       77,225,515       85,701,328  
 
   
     
     
     
 
Gross profit
    35,191,603       27,905,859       61,661,454       55,348,323  
Selling, general and administrative expenses
    23,779,195       21,141,070       42,208,116       41,079,961
Acquisition shut-down and recall costs
    1,500,000       2,700,000       8,121,497       2,700,000  
 
   
     
     
     
 
Income from operations
    9,912,408       4,064,789       11,331,841       11,568,362
Profit from joint venture
    (672,170 )     (190,825 )     (1,968,865 )     (366,481
Interest, net
    (264,346 )   34,023     (532,941 )     (128,340
 
   
     
     
     
 
Income before provision for income taxes and minority interest
    10,848,924       4,221,591       13,833,647     12,063,183  
Provision for income taxes
    2,929,210       1,013,183       3,735,085       2,895,165  
 
   
     
     
     
 
Income before minority interest
    7,919,714       3,208,408       10,098,562       9,168,018  
Minority interest
    87,915             110,662        
 
   
     
     
     
 
Net income
  $ 7,831,799     $ 3,208,408     $ 9,987,900     $ 9,168,018  
 
   
     
     
     
 
Earnings per share — basic
  $ 0.37     $ 0.13     $ 0.50     $ 0.38  
 
   
     
     
     
 
Earnings per share — diluted
  $ 0.36     $ 0.l3     $ 0.47     $ 0.37  
 
   
     
     
     
 

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 Six Months Ended June 30, 2002 and 2003 (Unaudited)

                         
            Six Months Ended June 30,
           
            2002   2003
           
 
CASH FLOWS FROM OPERATING ACTIVITIES
               
 
Net income
  $ 9,987,900                 $ 9,168,018               
 
   
     
 
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
   
Depreciation and amortization
    4,892,679       4,668,207   
   
Earned Compensation from stock option grants
    (174,787 )     59,172   
   
Investment in joint venture
    4,061,995       5,380,364   
   
Forgiveness of officer note receivable
    285,000        
   
Minority interest
    110,662        
   
Change in operating assets and liabilities
               
     
Sale of marketable securities
    37,119,071        
     
Accounts receivable
    (17,623,320 )     (14,918,838)   
     
Inventory
    (12,513,181 )     3,759,194   
     
Prepaid expenses and other current assets
    1,264,439       (3,978,155)   
     
Accounts payable and accrued expenses
    6,758,756       962,317   
     
Income taxes payable
    4,022,855       2,719,535   
     
Deferred income taxes
    (463,304 )     —   
 
   
     
 
       
Total adjustments
    27,740,865       (1,348,204)   
 
   
     
 
       
Net cash provided by operating activities
    37,728,765       7,819,814   
 
   
     
 
CASH FLOWS FROM INVESTING ACTIVITIES
               
 
Cash paid for net assets acquired
    (37,262,017 )     (21,037,358)   
 
Purchase of property and equipment
    (1,582,148 )     (2,450,245)   
 
Other assets
     1,237,679       (77,461)   
 
Purchase of marketable securities
    (5,813,342 )     (219,733)  
 
Repayment of Notes receivable from officers
          1,113,000   
 
   
     
 
       
Net cash used by investing activities
    (43,419,828 )     (22,671,797 )
 
   
     
 
CASH FLOWS FROM FINANCING ACTIVITIES
               
 
Net proceeds from sale of common stock
    59,307,347        
 
Proceeds from stock options and warrants exercised
    2,631,975       717,519  
 
Repurchase of common shares
          (4,220,773)  
 
Repayment of long term debt
    (7,685 )     (8,754)  
 
Net proceeds from issuance of convertible notes payable
          94,365,657  
 
   
     
 
       
Net cash provided by financing activities
    61,931,637       90,853,649   
 
   
     
 
Net increase in cash and cash equivalents
    56,240,574       76,001,666   
Cash and cash equivalents, beginning of period
    25,036,203       68,412,826   
 
   
     
 
Cash and cash equivalents, end of period
  $ 81,276,777     $ 144,414,492   
 
   
     
 
Supplemental disclosure of cash flow information:
               
Cash paid during the period for:
               
 
Income taxes
  $ 181,450     $ 2,811,689   
 
   
     
 
 
Interest
  $ 81,743     $ 17,439   
 
   
     
 
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)
June 30, 2003

Note 1 — Basis of presentation

The accompanying 2002 and 2003 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, which contains financial information for the three years in the period ended December 31, 2002.

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 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, options, and convertible debt 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 all assets, 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 six months ended June 30, 2002 and 2003 are as follows:

                                 
    Three Months Ended June 30,   Six Months Ended June 30,
   
 
    2002   2003   2002   2003
   
 
 
 
Net Sales
                               
North America Toys
  $70,182,964     $63,983,884       $121,903,112       $124,778,954  
International
    8,630,149       9,273,332       16,665,788       16,211,840  
Other
    178,366       32,990       318,069       58,857  
 
   
     
     
     
 
 
    $78,991,479     $73,290,206       $138,886,969       $141,049,651  
 
   
     
     
     
 
                                 
    Three Months Ended June 30,   Six Months Ended June 30,
   
 
    2002   2003   2002   2003
   
 
 
 
Operating Income
                               
North America Toys
    $8,807,053       $3,548,646       $10,032,743       $10,136,914  
International
    1,082,972       514,313       1,273,405       1,426,754  
Other
    22,383       1,830       25,693       4,694  
 
   
     
     
     
 
 
    $9,912,408       $4,064,789       $11,331,841       $11,568,362  
 
   
     
     
     
 

 
 
 
 
 

                 
    June 30,
   
    2002   2003
   
 
Assets
               
North America Toys
  $360,978,990       $449,125,154    
International
  44,388,300       65,092,744    
Other
  917,406       231,566    
 
 
     
   
 
  $406,284,696       $514,449,464    
 
 
     
   

     The following tables present information about the Company by geographic area as of and for the three and six months ended June 30, 2002 and 2003:

                 
    June 30,
   
    2002   2003
   
 
Long-lived Assets
               
United States
  $139,855,550       $177,601,157    
Hong Kong
  23,321,690       58,318,842    
Europe
  581,077       3,305,833    
 
 
     
   
 
  $163,758,317       $239,225,832    
 
 
     
   
                                 
    Three Months ended June 30,   Six Months Ended June 30,
   
 
    2002   2003   2002   2003
   
 
 
 
Net Sales by Geographic Area
                               
United States
    $69,243,868       $64,016,874       $119,844,766       $123,536,714  
Europe
    7,147,105       7,144,965       14,861,922       13,489,363  
Canada
    1,117,462       1,099,013       2,376,416       2,400,110  
Hong Kong
    71,057       58,916       71,057       181,818  
Other
    1,411,987       970,438       1,732,808       1,441,646  
 
   
     
     
     
 
 
    $78,991,479       $73,290,206       $138,886,969       $141,049,651  
 
   
     
     
     
 

Note 3 — Inventories

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

                 
    December 31,   June 30,
    2002   2003
   
 
Deposits and raw materials
  $ 606,429     $ 1,176,238  
Finished goods
    37,403,318       36,810,631  
 
   
     
 
 
  $ 38,009,747     $ 37,986,869  
 
   
     
 

Note 4 — Convertible Senior Notes

     Pursuant to the terms of a Purchase Agreement, dated June 9, 2003, we sold an aggregate of $98 million of 4.625% Convertible Senior Notes due June 15, 2023. The holders of the notes may convert the notes into shares of our common stock at any time at an initial conversion price of $20.00 per share, subject to certain circumstances described in the notes. This is equivalent to a conversion rate of 50.0 shares per $1,000 principal amount of notes. We will pay cash interest on the notes at an annual rate of 4.625% of the principal amount at issuance, from the issue date to June 15, 2010, payable on June 15 and December 15 of each year, commencing on December 15, 2003. After June 15, 2010, we will not pay cash interest on the notes. At maturity, on June 15, 2023, we will redeem the notes at their accreted principal amount, which will be equal to $1,811.95 (181.195%) per $1,000 principal amount at issuance. The “accreted principal amount” of a note will be equal to the principal amount of the note at issuance plus accretion, beginning June 15, 2010, on the principal amount at issuance so that the yield to maturity of the note will remain at 4.625% per year (equal to the cash interest prior to June 15, 2010), calculated on a semi-annual bond equivalent basis using a 360-day year comprised of twelve 30-day months. The notes will mature on June 15, 2023.

     We may redeem the notes at our option in whole or in part beginning on June 15, 2010, at 100% of their accreted principal amount plus accrued and unpaid interest (including contingent interest and additional amounts), if any, payable in cash. Holders of the notes may also require us to repurchase all or part of their notes on June 15, 2010, for cash, at a repurchase price of 100% of the principal amount per note plus accrued and unpaid interest (including contingent interest and additional amounts), if any. Holders of the notes may also require us to repurchase all or part of their notes on June 15, 2013 and June 15, 2018 at a repurchase price of 100% of the accreted principal amount per note plus accrued and unpaid interest (including contingent interest and additional amounts), if any. Any repurchases at June 15, 2013 and June 15, 2018 may be paid in cash, in shares of common stock or a combination of cash and shares of common stock. If a fundamental change of the Company occurs (as defined in the notes), holders of the notes may require us to purchase all or part of their notes, for cash, at a repurchase price of 100% of the accreted principal amount per note plus accrued and unpaid interest (including contingent interest and additional amounts), if any.

     Net proceeds received from the issuance of these convertible notes payable were approximately $94.4 million.

Note 5 — Credit Facility

     In October 2001, we and all of our subsidiaries jointly and severally 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”). On June 3, 2003, we and the banks amended the loan agreements governing the Line of Credit (the “Loan Agreements”), pursuant to which amendment (i) the banks suspended certain of our covenants under the Loan Agreements, including those that prohibited us from consummating the Convertible Senior Notes offering (See Note 4) without the banks’ consent, and (ii) the banks’ obligations to extend credit under the Line of Credit were simultaneously suspended. The amendment contemplates that we and the banks will attempt to negotiate revised terms for the Line of Credit, to be reflected in a further amendment to the Loan Agreements, while waiving the requirement for obtaining consent for this offering. Neither we nor the banks, however, have any obligation to enter into such further amendment to the Loan Agreements. The amendment did not otherwise effect our right under the Loan Agreements to voluntarily reduce or terminate the Line of Credit. There have never been any outstanding borrowings under the Line of Credit since its inception.

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Note 6 — 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 JUNE 30,
   
    2002   2003
   
 
            WEIGHTED                   WEIGHTED        
            AVERAGE                   AVERAGE        
    INCOME   SHARES   PER-SHARE   INCOME   SHARES   PER-SHARE
   
 
 
 
 
 
Earnings per share — basic
Income available to common stockholders
  $ 7,831,799       20,984,929     $ 0.37     $ 3,208,408       24,174,875     $ 0.13  
 
   
     
     
     
     
     
 
Effect of dilutive securities
Options, warrants and convertible debt
          968,239                     508,537          
 
   
     
             
     
         
Earnings per share — diluted
Income available to common stockholders plus assumed exercises
  $ 7,831,799       21,953,168     $ 0.36     $ 3,208,408       24,683,412     $ 0.13  
 
   
     
     
     
     
     
 
                                                 
    SIX MONTHS ENDED JUNE 30,
   
    2002   2003
   
 
            WEIGHTED                   WEIGHTED        
            AVERAGE                   AVERAGE        
    INCOME   SHARES   PER-SHARE   INCOME   SHARES   PER-SHARE
   
 
 
 
 
 
Earnings per share — basic
Income available to common stockholders
  $ 9,987,900       20,004,500     $ 0.50     $ 9,168,018       24,285,649     $ 0.38  
 
   
     
     
     
     
     
 
Effect of dilutive securities
Options, warrants and convertible debt
          1,076,370                     502,865                     
 
   
     
             
     
         
Earnings per share — diluted
Income available to common stockholders plus assumed exercises
  $ 9,987,900       21,080,870     $ 0.47     $ 9,168,018       24,788,514     $ 0.37  
 
   
     
     
     
     
     
 


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JAKKS PACIFIC, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
June 30, 2003

Note 7 — 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. In September 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 in May 2002 and 525,000 shares of our common stock in June 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.

      In March 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 October 2002, the merger was completed and an additional 520,000 shares of common stock were issued.

      In February 2003, our Board of Directors approved a buyback of up to $20 million of our Common Stock. As of June 30, 2003, we repurchased 412,000 shares of our Common Stock for a total of approximately $4.2 million.

Note 8 — Acquisitions

     We acquired the following entities to further enhance our existing product lines and to continue diversification into other seasonal business.

     In March 2002, we purchased a controlling interest in Toymax International, Inc. In October 2002, we completed that acquisition by acquiring the remaining outstanding common shares in a merger transaction. The total purchase price of approximately $62.2 million consisted of 1,166,360 shares of the Company’s common stock, 598,697 options and approximately $41.0 million in cash.

     In November 2002, we purchased certain product lines, assets and assumed certain specific liabilities from Trendmasters, Inc. (“Trendmasters”). The total purchase price of approximately $27.7 million consisted of cash paid in the amount of $19.0 million and assumed liabilities of $8.7 million. Our results of operations have included Trendmasters from the date of acquisition.

     On May 31, 2003, we purchased the product lines, related assets and assumed certain liabilities from P&M Products Inc. (“P&M”). The total purchase price of approximately $20.9 million consisted of cash paid in the amount of $20.3 million and liabilities of $0.6 million and resulted in goodwill of $14.5 million. Our results of operations have included P&M from the date of acquisition.

The following unaudited pro forma information represents our consolidated results of operations as if the acquisitions of Toymax, Trendmasters and P&M had occurred on January 1, 2002 and after giving effect to certain adjustments including the elimination of certain general and administrative expenses and other income and expense items not attributable to on-going operations, interest 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 Toymax, Trendmasters and P&M occurred on January 1, 2002 or future operating results.

                                     
    Three Months Ended June 30,   Six Months Ended June 30,
   
 
    2002   2003   2002   2003
   
 
 
 
Net Sales   $ 97,549,095     $ 77,295,206     $ 187,955,535     $ 151,378,651  


   
   
   
Net income (loss)   $ 6,141,556     $ 2,170,375     $ 5,718,561     $ 7,342,469  


   
   
   
Earnings (loss) per share — basic   $ 0.29     $ 0.09     $ 0.27     $ 0.30  


   
   
   
Weighted average shares outstanding — basic   21,504,929     24,174,875     21,094,634     24,285,649  


   
   
   
Earnings (loss) per share — diluted     0.27       0.09       0.25       0.30  


   
   
   
Weighted average shares and equivalents outstanding — diluted     23,071,865       24,683,412       22,787,170       24,788,514  


   
   
   

Note 9 — Notes Receivable From Officers

     On March 27, 2003, the balance of the notes receivable from two of our officers totaling $1,113,000 plus accrued interest at interest rates of 6.5% per annum each, were paid in full.

Note 10 — Stock Option Plans

     In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148 “ Accounting for Stock-Based Compensation —Transition and Disclosure an Amendment of FASB Statement No. 123” (SFAS 148). SFAS 148 Statement amends Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of that Statement to require prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based employee compensation. Finally, SFAS 148 amends APB Opinion No. 28, Interim Financial Reporting, to require disclosure about those effects in interim financial information.

At June 30, 2003 we have stock-based employee compensation plans and account for those plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. However, certain options had been repriced resulting in compensation adjustments, which have been reflected in net income. The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS 123, to stock-based employee compensation.

In 2002 and 2003, the fair value of each employee option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used: risk-free rate of interest of 4%; dividend yield of 0%, with volatility of 87%; and expected lives of five years.

                                      
                   
    Three Months Ended June 30,   Six Months Ended June 30,
   
 
    2002   2003   2002   2003
   
 
 
 
Net income, as reported
  $ 7,831,799     $ 3,208,408     $ 9,987,900     $ 9,168,018
Add (Deduct): Stock-based employee compensation expense (income) included in reported net income
    (983,951 )     1,093,228       (174,787 )     59,172
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards net of related tax effects
              (45,831 )    
 
   
     
     
     
Pro forma net income
  $ 6,847,848     $ 4,301,636     $ 9,767,282     $ 9,227,190
 
   
     
     
     
Earnings per share:
                             
Basic — as reported
  $ 0.37     $ 0.13     $ 0.50     $ 0.38
 
   
     
     
     
Basic — pro forma
  $ 0.33     $ 0.18     $ 0.49     $ 0.38
 
   
     
     
     
Diluted — as reported
  $ 0.36     $ 0.13     $ 0.47     $ 0.37
 
   
     
     
     
Diluted — pro forma
  $ 0.31     $ 0.17     $ 0.46     $ 0.37
 
   
     
     
     

Note 11 — Recent Accounting Pronouncements

     In June 2001, the FASB issued Statement No. 143, “Accounting for Asset Retirement Obligations” (SFAS No. 143). The objective of SFAS No. 143 is to establish an accounting standard for the recognition and measurement of an asset retirement obligation on certain long-lived assets. The retirement obligation must be one that results from the acquisition, construction or normal operation of a long-lived asset. SFAS 143 was adopted effective January 1, 2003. The adoption of this statement did not have a material effect on the consolidated financial statements.

     In April 2002, the FASB issued Statement No. 145, “Rescission of Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Correction” (SFAS 145). SFAS 145 eliminates extraordinary accounting treatment for reporting gains or losses on debt extinguishments, and amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The provisions of this SFAS was adopted effective January 1, 2003. The adoption of SFAS 145 did not have a material effect on its consolidated results of operations in accordance with APB 30, “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions”.

In June 2002, the FASB issued Statement No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS No. 146), which changes the accounting for costs such as lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity initiated after December 31, 2002. The standard requires companies to recognize the fair value of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS 146 was adopted effective January 1, 2003 and did not have a material effect on the Company’s financial position or results of operations.

In May 2003, the FASB issued Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS No. 150), which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The provisions of this SFAS were adopted effective June 9, 2003. The adoption of SFAS 150 did not have a material effect on the Company’s financial position or results of operations.

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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.

RECENT DEVELOPMENTS

     On March 11, 2002, we purchased a controlling interest in Toymax. On October 25, 2002, we completed that acquisition by acquiring the remaining outstanding common shares. The total purchase price of approximately $62.2 million consisted of 1,166,360 shares of our common stock, 598,697 stock options and approximately $41.0 million in cash and resulted in additional goodwill of $64.9 million. Our results of operations have included Toymax from March 12, 2002, however for the period March 12, 2002 through October 25, 2002 the minority interest’s share of Toymax’s earnings were excluded.

     On November 27, 2002, we purchased certain product lines, assets and assumed certain liabilities from Trendmasters. The total purchase price of approximately $27.7 million consisted of cash paid in the amount of $19.0 million and assumed liabilities of $8.7 million and resulted in goodwill of $26.2 million. Our results of operations have included Trendmasters from the date of acquisition.

     On May 31, 2003, we purchased the product lines, related assets and assumed certain liabilities from P&M Products Inc. (“P&M”). The total purchase price of approximately $20.9 million consisted of cash paid in the amount of $20.3 million and liabilities of $0.6 million and resulted in goodwill of $14.5 million. Our results of operations have included P&M from the date of acquisition.

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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   SIX MONTHS ENDED
    JUNE 30,   JUNE 30,
   
 
    2002   2003   2002   2003
   
 
 
 
Net sales
    100.0 %     100.0 %   100.0 %     100.0 %
Cost of sales
    55.5 %     61.9     55.6       60.8  
 
   
     
   
     
 
Gross profit
    44.5       38.1     44.4       39.2  
Selling, general and administrative expenses
    30.1       28.9     30.4       29.1  
Acquisition shut-down and recall costs
    1.9       3.7     5.8     1.9  
 
   
     
   
     
 
Income from operations
    12.5       5.5     8.2       8.2  
Profit from joint venture
    (0.9 )     (.3 )   (1.4 )     (0.3 )
Interest, net
    (0.3 )       (0.4 )     (0.1 )
 
   
     
   
     
 
Income before income taxes and minority interest
    13.7       5.8     10.0       8.6  
Provision for income taxes
    3.7       1.4     2.7       2.1  
 
   
     
   
     
 
Income before minority interest
    10.0       4.4     7.3       6.5  
Minority interest
    0.1           0.1        
 
   
     
   
     
 
Net income
    9.9 %     4.4 %   7.2 %     6.5 %
 
   
     
   
     
 

THREE MONTHS ENDED JUNE 30, 2003 AND 2002

     Net Sales. Net sales were $73.3 million in 2003 compared to $79.0 million in 2002, representing a decrease of 7.2%. The contribution to net sales by our traditional products, including action figures, dolls and vehicles, and writing instruments, was offset by a decrease in sales of our crafts and activities and our seasonal products, including Go Fly a Kite, Funnoodle and sports toys.

     Gross Profit. Gross profit decreased $7.3 million, or 20.7%, to $27.9 million, or 38.1% of net sales, in 2003 from $35.2 million, or 44.5% of net sales, in 2002. The overall decrease in gross profit was attributable to the decrease in net sales and a decrease in gross profit margin. The decrease in gross profit margin of 6.5% of net sales was due to an increase in net sales of lower margin traditional products and a decrease in net sales of higher margin crafts and activities 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 $21.1 million in 2003 and $23.8 million in 2002, constituting 28.9% and 30.1% of net sales, respectively. The overall decrease of $2.6 million in such costs was primarily due to the decrease in overhead costs resulting from efficiencies with the integration of our Toymax acquisition and a decrease in direct selling expenses, partially offset by an increase in product development costs. The decrease as a percentage of net sales is primarily attributable to gained cost efficiencies. We produced and aired television commercials in support of several of our products, including World Wrestling Entertainment action figures and Flying Colors products, in 2002 and 2003. 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. There were no such costs in 2003. Operations impacted by these shut-downs were sales, design, distribution and administration. The integrations of Toymax and Kidz Biz were completed in 2002. In June 2003, we accrued $2.7 million for the recall of one of our products, compared to having accrued $1.5 million in June 2002 for the recall of the same product.

     The remaining component of the acquisition shut-down and recall costs is as follows:

                                 
    Accrued Balance           Accrued Balance
    March 31, 2003   Accrual   Actual   June 30, 2003
   
 
 
 
Lease abandonment costs   $ 1,410,780     $     $ 620,825     $ 789,955  
Recall costs           2,700,000       350,376       2,349,624  
 
   
     
     
     
 
Total   $ 1,410,780     $ 2,700,000     $ 971,201     $ 3,139,579  
 
   
     
     
     
 

     Profit from Joint Venture. Profit from joint venture decreased by $0.5 million in 2003 due to lower unit sales of both new titles at lower price points and existing titles, whereas in 2002 the joint venture released a new Xbox titled “RAW” and a new GameCube titled “Wrestlemania X8” with higher unit sales at a higher price point.

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     Interest, Net. Interest income resulting from higher average cash balances during 2003 than in 2002 was offset by lower interest rates and accrued interest of $0.3 million for the convertible notes sold in June 2003.

     Provision for Income Taxes. Provision for income taxes included Federal, state and foreign income taxes in 2002 and 2003, at effective tax rates of 27.0% in 2002 and 24.0% in 2003, benefiting from a flat 16.5% and 17.0% Hong Kong Corporation Tax on our income arising in, or derived from, Hong Kong for 2002 and 2003, respectively. As of June 30, 2003, we had deferred tax assets of approximately $4.4 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.

SIX MONTHS ENDED JUNE 30, 2003 AND 2002

     Net Sales. Net sales were $141.0 million in 2003 compared to $138.9 million in 2002, representing an increase of 1.6%. The contribution to net sales by our seasonal products, including Go Fly a Kite, Funnoodle and sports toys, were offset in part by a decrease in sales in our traditional products, including action figures, dolls and vehicles, our crafts and activities, our writing instruments and international sales.

     Gross Profit. Gross profit decreased $6.3 million, or 10.2%, to $55.3 million, or 39.2% of net sales, in 2003 from $61.7 million, or 44.4% of net sales, in 2002. The overall decrease in gross profit was attributable to the increase in net sales of lower margin seasonal products and a decrease in gross profit margin. The decrease in gross profit margin of 5.2% of net sales was due to lower margins for seasonal 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 $41.1 million in 2003 and $42.2 million in 2002, constituting 29.1% and 30.4% of net sales, respectively. The overall decrease of $1.1 million in such costs was primarily due to the decrease in direct selling expenses, partially offset by an increase in product development costs. The decrease as a percentage of net sales is primarily attributable to the fixed nature of certain expenses with a concurrent increase in net sales. We produced and aired television commercials in support of several of our products, including World Wrestling Entertainment action figures and Flying Colors products in 2002 and 2003. 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. There were no such costs in 2003. Operations impacted by these shut-downs were sales, design, distribution, and administration. The integrations of Toymax and Kidz Biz were completed in 2002. In June 2003, we accrued $2.7 million for the recall of one of our products, compared to having accrued $1.5 million in June 2002 for the recall of the same product.

     The remaining component of the acquisition shut-down and recall costs is as follows:

                                 
    Accrued Balance                   Accrued Balance
    December 31, 2002   Accrual   Actual   June 30, 2003
   
 
 
 
Lease abandonment costs
  $ 2,309,800     $     $ 1,519,845     $ 789,955  
Recall costs
          2,700,000       350,376       2,349,624  
 
   
     
     
     
 
Total
  $ 2,309,800     $ 2,700,000     $ 1,870,221     $ 3,139,579  
 
   
     
     
     
 

     Profit from Joint Venture. Profit from joint venture decreased by $1.6 million in 2003 due to lower unit sales of both new titles at lower price points and existing titles, whereas in 2002 the joint venture released a new Xbox titled “RAW” and a new GameCube titled “Wrestlemania X8” with higher unit sales at a higher price point.

     Interest, Net. Interest income resulting from higher average cash balances during 2003 than in 2002 was offset by lower interest rates and accrued interest of $0.3 million for the convertible notes sold in June 2003.

     Provision for Income Taxes. Provision for income taxes included Federal, state and foreign income taxes in 2002 and 2003, at effective tax rates of 27.0% in 2002 and 24.0% in 2003, benefiting from a flat 16.5% and 17.0%. Hong Kong Corporation Tax on our income arising in, or derived from, Hong Kong for 2002 and 2003, respectively. As of June 30, 2003, we had deferred tax assets of approximately $4.4 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, Funnoodle and Storm 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.

RECENT ACCOUNTING PRONOUNCEMENTS

     In June 2001, the FASB issued Statement No. 143, “Accounting for Asset Retirement Obligations” (SFAS No. 143). The objective of SFAS No. 143 is to establish an accounting standard for the recognition and measurement of an asset retirement obligation on certain long-lived assets. The retirement obligation must be one that results from the acquisition, construction or normal operation of a long-lived asset. SFAS 143 was adopted effective January 1, 2003. The adoption of this statement did not have a material effect on the consolidated financial statements.

     In April 2002, the FASB issued Statement No. 145, “Rescission of Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Correction” (SFAS 145). SFAS 145 eliminates extraordinary accounting treatment for reporting gains or losses on debt extinguishments, and amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The provisions of this SFAS was adopted effective January 1, 2003. The adoption of SFAS 145 did not have a material effect on its consolidated results of operations in accordance with APB 30, “Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions”.

     In June 2002, the FASB issued Statement No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS No. 146), which changes the accounting for costs such as lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity initiated after December 31, 2002. The standard requires companies to recognize the fair value of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS 146 was adopted effective January 1, 2003 and did not have a material effect on the Company’s financial position or results of operations.

     In May 2003, the FASB issued Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS No. 150), which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The provisions of this SFAS were adopted effective June 9, 2003. The adoption of SFAS 150 did not have a material effect on the Company’s financial position or results of operations.

LIQUIDITY AND CAPITAL RESOURCES

     As of June 30, 2003, we had working capital of $220.9 million, as compared to $129.2 million as of December 31, 2002. This increase was primarily attributable to the receipt of the net proceeds from the sale of convertible notes payable, our operating results and the receipt of the preferred return from the joint venture with THQ, though offset in part by disbursements related to the repurchase of our common shares.

     Operating activities provided net cash of $7.8 million in 2003, as compared to $37.7 million in 2002, which included $37.1 million provided from the sale of marketable securities. Net cash was provided primarily by net income and a non-cash charge consisting of depreciation and amortization, as well as an increase in the cash received from the preferred return from THQ joint venture, a decrease in inventory and increases in accounts payable and accrued expenses and income taxes payable, which were offset in part by increases in accounts receivable and prepaid expenses and other current operating assets. As of June 30, 2003, we had cash and cash equivalents of $144.4 million.

     Our investing activities used net cash of $22.7 million in 2003, as compared to $43.4 million in 2002, consisting primarily of the purchase of office furniture and equipment and molds and tooling used in the manufacture of our products, cash paid in excess of the fair value of the net assets acquired for P&M, and the purchase of marketable securities, partially offset by the repayment of notes receivable from officers. In 2002, our investing activities consisted primarily of cash paid for net assets acquired in the Toymax acquisition, the purchase of office furniture and equipment and molds and tooling used in the manufacture of our products and the purchase of marketable securities. 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 18% payable on net sales of such products. As of June 30, 2003, these agreements required future aggregate minimum guarantees of $16.2 million, exclusive of $4.2 million in advances already paid.

     Our financing activities provided net cash of $90.9 million in 2003, consisting primarily of proceeds from the exercise of stock options and warrants and net proceeds from the sale of convertible notes, partially offset by the repurchase of our common stock. In 2002, financing activities provided net cash of $61.9 million, consisting of proceeds from the sale of our common stock and the exercise of stock options and warrants, partially offset by the repayment of long term debt.

      In March 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, until the completion of the merger, 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 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 not 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 February 2003, our Board of Directors approved a buyback of up to $20 million of our common stock. As of June 30, 2003, we repurchased 412,000 shares of our common stock for a total of approximately $4.2 million.

     On May 31, 2003, we purchased the product lines, related assets and assumed certain liabilities from P&M Products Inc. (“P&M”). The total purchase price of approximately $20.9 million consisted of cash paid in the amount of $20.3 million and liabilities of $0.6 million and resulted in goodwill of $14.5 million. Results of operations have included P&M from the date of acquisition.

     Pursuant to the terms of a Purchase Agreement, dated June 9, 2003, we sold an aggregate of $98 million of 4.625% Convertible Senior Notes due June 15, 2023. The holders of the notes may convert the notes into shares of our common stock at any time at an initial conversion price of $20.00 per share, subject to certain circumstances described in the notes. This is equivalent to a conversion rate of 50.0 shares per $1,000 principal amount of notes. We will pay cash interest on the notes at an annual rate of 4.625% of the principal amount at issuance, from the issue date to June 15, 2010, payable on June 15 and December 15 of each year, commencing on December 15, 2003. After June 15, 2010, we will not pay cash interest on the notes. At maturity, on June 15, 2023, we will redeem the notes at their accreted principal amount, which will be equal to $1,811.95 (181.195%) per $1,000 principal amount at issuance. The “accreted principal amount” of a note will be equal to the principal amount of the note at issuance plus accretion, beginning June 15, 2010, on the principal amount at issuance so that the yield to maturity of the note will remain at 4.625% per year (equal to the cash interest prior to June 15, 2010), calculated on a semi-annual bond equivalent basis using a 360-day year comprised of twelve 30-day months. The notes will mature on June 15, 2023.

     We may redeem the notes at our option in whole or in part beginning on June 15, 2010, at 100% of their accreted principal amount plus accrued and unpaid interest (including contingent interest and additional amounts), if any, payable in cash. Holders of the notes may also require us to repurchase all or part of their notes on June 15, 2010, for cash, at a repurchase price of 100% of the principal amount per note plus accrued and unpaid interest (including contingent interest and additional amounts), if any. Holders of the notes may also require us to repurchase all or part of their notes on June 15, 2013 and June 15, 2018 at a repurchase price of 100% of the accreted principal amount per note plus accrued and unpaid interest (including contingent interest and additional amounts), if any. Any repurchases at June 15, 2013 and June 15, 2018 may be paid in cash, in shares of common stock or a combination of cash and shares of common stock. If a fundamental change of the Company occurs (as defined in the notes), holders of the notes may require us to purchase all or part of their notes, for cash, at a repurchase price of 100% of the accreted principal amount per note plus accrued and unpaid interest (including contingent interest and additional amounts), if any.

     Net proceeds received from the issuance of these convertible notes payable were approximately $94.4 million.

     In October 2001, we and all of our subsidiaries jointly and severally 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”). On June 3, 2003, we and the banks amended the loan agreements governing the Line of Credit (the “Loan Agreements”), pursuant to which amendment (i) the banks suspended certain of our covenants under the Loan Agreements, including those that prohibited us from consummating the Convertible Senior Notes offering (see Note 4) without the banks’ consent, and (ii) the banks’ obligations to extend credit under the Line of Credit were simultaneously suspended. The amendment contemplates that we and the banks will attempt to negotiate revised terms for the Line of Credit, to be reflected in a further amendment to the Loan Agreements, while waiving the requirement for obtaining consent for this offering. Neither we nor the banks, however, have any obligation to enter into such further amendment to the Loan Agreements. The amendment did not otherwise effect our right under the Loan Agreements to voluntarily reduce or terminate the Line of Credit. There have never been any outstanding borrowings under the Line of Credit since its inception.

     We believe that our cash flow from operations, cash and cash equivalents on hand 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 June 30, 2003, we have not used derivative instruments or engaged in hedging activities to minimize our market risk.

INTEREST RATE RISK

     As of June 30, 2003, we did not have any outstanding balances on our Line of Credit. On June 9, 2003, we issued convertible notes payable of $98,000,000 with a fixed interest rate of 4.625% per annum. 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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

      Pursuant to the terms of a Purchase Agreement, dated June 9, 2003, we sold an aggregate of $98 million of 4.625% Convertible Senior Notes due June 15, 2023. The holders of the notes may convert the notes into shares of our common stock at any time at an initial conversion price of $20.00 per share, subject to certain circumstances described in the notes. This is equivalent to a conversion rate of 50.0 shares per $1,000 principal amount of notes. We will pay cash interest on the notes at an annual rate of 4.625% of the principal amount at issuance, from the issue date to June 15, 2010, payable on June 15 and December 15 of each year, commencing on December 15, 2003. After June 15, 2010, we will not pay cash interest on the notes. At maturity, on June 15, 2023, we will redeem the notes at their accreted principal amount, which will be equal to $1,811.95 (181.195%) per $1,000 principal amount at issuance. The “accreted principal amount” of a note will be equal to the principal amount of the note at issuance plus accretion, beginning June 15, 2010, on the principal amount at issuance so that the yield to maturity of the note will remain at 4.625% per year (equal to the cash interest prior to June 15, 2010), calculated on a semi-annual bond equivalent basis using a 360-day year comprised of twelve 30-day months. The notes will mature on June 15, 2023.

      We may redeem the notes at our option in whole or in part beginning on June 15, 2010, at 100% of their accreted principal amount plus accrued and unpaid interest (including contingent interest and additional amounts), if any, payable in cash. Holders of the notes may also require us to repurchase all or part of their notes on June 15, 2010, for cash, at a repurchase price of 100% of the principal amount per note plus accrued and unpaid interest (including contingent interest and additional amounts), if any. Holders of the notes may also require us to repurchase all or part of their notes on June 15, 2013 and June 15, 2018 at a repurchase price of 100% of the accreted principal amount per note plus accrued and unpaid interest (including contingent interest and additional amounts), if any. Any repurchases at June 15, 2013 and June 15, 2018 may be paid in cash, in shares of common stock or a combination of cash and shares of common stock. If a fundamental change of the Company occurs (as defined in the notes), holders of the notes may require us to purchase all or part of their notes, for cash, at a repurchase price of 100% of the accreted principal amount per note plus accrued and unpaid interest (including contingent interest and additional amounts), if any.

      The issuance and sale of the notes and the subsequent offering of the notes by the initial purchaser were exempt from the registration provisions of the Securities Act of 1933 pursuant to Section 4(2) of such Act and Rule 144A promulgated thereunder. The aggregate commission to the initial purchaser was approximately $3.8 million.

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)
4.1   Indenture, dated as of June 9, 2003, by and between the Registrant and Wells Fargo Bank, N.A.(4)
4.2   Form of 4.625% Convertible Senior Note(4)
4.3   Registration Rights Agreement, dated as of June 9, 2003, by and among the Registrant and Bear, Stearns & Co. Inc.(4)
 
31.1   Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer(4)
 
31.2   Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer(4)
 
32.1   Section 1350 Certification of Chief Executive Officer(4)
 
32.2   Section 1350 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 Current Reports on Form 8-K on (i) April 22, 2003 relating to the Company’s announcement of earnings for the first quarter of 2003; and (ii) each of June 4 and June 12, 2003 relating to the Company’s Convertible Senior Note Offering.

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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: August 14, 2003 By:  /s/ Joel M. Bennett
 
  Executive Vice President and
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)

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Exhibit Index

     
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)
4.1   Indenture, dated as of June 9, 2003, by and between the Registrant and Wells Fargo Bank, N.A.(4)
4.2   Form of 4.625% Convertible Senior Note(4)
4.3   Registration Rights Agreement, dated as of June 9, 2003, by and among the Registrant and Bear, Stearns & Co. Inc.(4)
 
31.1   Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer(4)
 
31.2   Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer(4)
 
32.1   Section 1350 Certification of Chief Executive Officer(4)
 
32.2   Section 1350 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.