**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**











**FORM
      10-K**





**(Mark
                One)**T
            **ANNUAL
                REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
                1934****For
                the Fiscal Year Ended December 31, 2006**£
            **TRANSITION
                REPORT UNDER SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF
                1934**





**For
      the transition period from ____________ to ____________**





**Commission
      File Number 0-28104**





**JAKKS
      PACIFIC, INC.**


**(Exact
      name of registrant as specified in its charter)**





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





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





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





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





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





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





**Title
      of Class**


**Common
      Stock, $.001 par value per share**





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.


Yes £ No T





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15 of the Act.


Yes £ No T





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 T No £





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





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





£ Large
      Accelerated Filer  T Accelerated
      Filer  £ Non-Accelerated Filer





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





The
      aggregate market value of the voting and non-voting common equity (the only
      such
      common equity being Common Stock, $.001 par value per share) held by
      non-affiliates of the registrant (computed by reference to the closing sale
      price of the Common Stock on March 14, 2007 of $23.27) is
      $629,213,540.





The
      number of shares outstanding of the registrant’s Common Stock, $.001 par value
      (being the only class of its common stock), is 28,063,307 (as of March 14,
      2007).





**Documents
      Incorporated by Reference**


None.












**JAKKS
      PACIFIC, INC.**





**INDEX
      TO ANNUAL REPORT ON FORM 10-K**





**For
      the Fiscal Year ended December 31, 2006**





**Items
      in Form 10-K**





**Page****PART
                I**Item
                1.
            
            Business
            
            3Item
                1A.
            
            Risk
                Factors
            
            12Item
                1B.
            
            Unresolved
                Staff Comments
            
            NoneItem
                2.
            
            Properties
            
            19Item
                3.
            
            Legal
                Proceedings
            
            19Item
                4.
            
            Submission
                of Matters to a Vote of Security Holders
            
            None**PART
                II**Item
                5.
            
            Market
                for Registrant’s Common Equity, Related Stockholder Matters and Issuer
                Purchases of Equity Securities
            
            22Item
                6.
            
            Selected
                Financial Data
            
            24Item
                7.
            
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            
            25Item
                7A.
            
            Quantitative
                and Qualitative Disclosures About Market Risk
            
            34Item
                8.
            
            Financial
                Statements and Supplementary Data
            
            36Item
                9.
            
            Changes
                in and Disagreements with Accountants on Accounting and Financial
                Disclosure
            
            NoneItem
                9A.
            
            Controls
                and Procedures
            
            62Item
                9B.
            
            Other
                Information
            
            None**PART
                III**Item
                10.
            
            Directors,
                Executive Officers and Corporate Governance
            
            66Item
                11.
            
            Executive
                Compensation
            
            68Item
                12.
            
            Security
                Ownership of Certain Beneficial Owners and Management and Related
                Stockholder Matters
            
            79Item
                13.
            
            Certain
                Relationships and Related Transactions, and Director
                Independence
            
            81Item
                14.
            
            Principal
                Accountant Fees and Services
            
            81**PART
                IV**Item
                15.
            
            Exhibits
                and Financial Statement Schedules
            
            83Signatures
            
            85Certifications





**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 have disclosed certain important factors that could cause our
      actual results to differ materially from our current expectations elsewhere
      in
      this report. You should understand that forward-looking statements made in
      this
      report are necessarily qualified by these factors. We are not undertaking to
      publicly update or revise any forward-looking statement if we obtain new
      information or upon the occurrence of future events or otherwise.





2


**PART
      I**





**Item
      1.**  ***Business***





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





**Company
      Overview**





We
      are a
      leading multi-line, multi-brand toy company that designs, produces and markets
      toys and related products, writing instruments and related products, pet toys,
      treats and related products and other consumer products. We focus our business
      on acquiring or licensing well-recognized trademarks and brand names with long
      product histories (“evergreen brands”). We seek to acquire these evergreen
      brands because we believe they are less subject to market fads or trends. Our
      products are typically lower-priced toys and accessories and
      include:





**Traditional
      Toys**





·
            Action
                figures and accessories, including licensed characters, principally
                based
                on*World
                Wrestling Entertainment*®
                (“WWE”) and the*Dragon
                Ball*®
                and*Pokemon*®
                franchises, and toy vehicles, including*Road
                Champs*®
                die-cast collectibles,*Fly
                Wheels*TM
                and*RC
                Racers & MXS*TM
                toy vehicles and accessories;





·
            Electronics
                products, including*Plug
                It In & Play TV Games*TM,*Vmigo*®
                virtual pet gaming system and*Laser
                Challenge*®;





·
            Role-play
                and dress-up products featuring entertainment and consumer products
                properties such as*Disney
                Princesse®s*and*Dora
                the Explorer*for girls and*Black
                & Decker®*and*Pirates
                of the Caribbean*®
                for boys;





·
            Infant
                and pre-school toys, TV activities and plush toys featuring*Care
                Bears*®,*Barney*®
                and*Doodle
                Bears*®and
                slumber bags; and





·
            Dolls
                including fashion and mini dolls and related accessories, includes*Disney
                Princess*dolls sold to Disney Stores and Disney Parks and Resorts and private
                label
                fashion dolls for other retailers, and soft body dolls featuring*Cabbage
                Patch Kids*®.





**Craft,
      Activity and Writing Products**





·
            Craft,
                activity and stationery products, including*Flying
                Colors*®
                activity sets, compounds, playsets and lunch boxes, and*Colorworkshop*®
                craft products such as*Blopens*®,*Vivid
                Velvet*®,
                and*Pentech*®
                writing instruments, stationery and activity
                products.





**Seasonal/Outdoor
      Products**





·
            Seasonal
                and outdoor toys and leisure products, including*Go
                Fly A Kite*®,*Air
                Creations*®,
                and other kites,*Funnoodle*®
                pool toys,*The
                Storm*®
                water guns and*Fly
                Wheels XPV*and*Flight*TM
                vehicles; and





·
            Junior
                sports, including*Gaksplat*TM
                and*The
                Storm*®.





**Pet
      Products**





·
            Pet
                products, including toys, treats, beds, clothing and accessories,
                with
                licenses used in conjunction with these products, including*American
                Kennel Club*®
                and*The
                Cat Fanciers’ Association*TM
                brands, as well as entertainment properties, among
                others.





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





·
            creating
                innovative products under established brand names;





·
            focusing
                our marketing efforts to enhance consumer recognition and retailer
                interest;




3




·
            linking
                them with our evergreen portfolio of brands;





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





·
            adding
                new features and improving the functionality of products in the
                lines.





In
      addition to developing our proprietary brands and marks, we license brands
      such
      as *WWE* , *Nickelodeon* (R), *Dora
      the Explorer* , *Disney
      Princesses* , *Care
      Bears* and *Pokemon* .
      Licensing enables us to use these high-profile marks at a lower cost than we
      would incur if we purchased these marks or developed comparable marks on our
      own. By licensing marks, we have access to a far greater range of marks than
      would be available for purchase. We also license technology produced by
      unaffiliated inventors and product developers to improve the design and
      functionality of our products.





We
      have
      obtained an exclusive worldwide license for our joint venture with THQ Inc.
      (“THQ”), which develops, publishes and distributes video games based on WWE
      characters and themes. Since the joint venture’s first title release in 1999, it
      has released 29 new titles. We have recognized approximately $72.1 million
      in
      profit from the joint venture through December 31, 2006. We and the joint
      venture are named as defendants in lawsuits commenced by WWE, pursuant to which
      WWE is seeking treble, punitive and other damages (including disgorgement of
      profits) in an undisclosed amount and a declaration that the video game license
      with the joint venture and an amendment to our toy licenses with WWE are void
      and unenforceable (see “Legal Proceedings”).





We
      sell
      our products through our in-house sales staff and independent sales
      representatives to toy and mass-market retail chain stores, department stores,
      office supply stores, drug and grocery store chains, club stores, toy specialty
      stores and wholesalers. Our three largest customers are Wal-Mart, Target and
      Toys ‘R’ Us, which account for approximately 27.5%, 17.6% and 13.6%,
      respectively, of our net sales in 2006. No other customer accounted for more
      than 10.0% of our net sales in 2006.





**Our
      Growth Strategy**





The
      execution of our growth strategy has resulted in increased revenues and
      earnings. In 2005 and 2006, we generated net sales of $661.5 million and $765.4
      million, respectively, and net income of $63.5 million and $72.4 million,
      respectively. Approximately 10.1% and 24.3% of our increased net sales in 2005
      and 2006, respectively, were attributable to our acquisitions since 2004. Key
      elements of our growth strategy include:





·  ***Expand
      Core Products.*** We
      manage our existing and new brands through strong product development
      initiatives, including introducing new products, modifying existing products
      and
      extending existing product lines. Our product designers strive to develop new
      products or product lines to offer added technological, aesthetic and functional
      improvements to our product lines. We use real-scan technology in our action
      toys, and we incorporate articulated joints and a flexible rubberized coating
      to
      enhance the life-like feel of these action toys. These innovations produce
      higher quality and better likenesses of the representative
      characters.





·  ***Enter
      New Product Categories.*** We use
      our extensive experience in the toy and other consumer product industries to
      evaluate products and licenses in new product categories and to develop
      additional product lines. We began marketing licensed classic video games for
      simple plug-in use with television sets and expanded into slumber bags through
      the licensing of this category from our current licensors, such as
      Nickelodeon.





·  ***Pursue
      Strategic Acquisitions.*** We
      intend to supplement our internal growth with selected strategic acquisitions.
      Most recently, in June 2005, we acquired the assets of Pet Pal Corp. which
      expanded our offerings and distribution into pet toy, treats and related
      products, and in February 2006, we acquired the business of Creative Designs
      International, Ltd., a leading manufacturer of girls’ dress-up and role-play
      toys.. We will continue focusing our acquisition strategy on businesses or
      brands that have compatible product lines and offer valuable trademarks or
      brands.





·  ***Acquire
      Additional Character and Product Licenses.*** We have
      acquired the rights to use many familiar corporate, trade and brand names and
      logos from third parties that we use with our primary trademarks and brands.
      Currently, we have license agreements with WWE, Nickelodeon, Disney, and Warner
      Bros®, as well as with the licensors of the many popular licensed children’s
      characters previously mentioned, among others. We intend to continue to pursue
      new licenses from these entertainment and media companies and other licensors.
      We also intend to continue to purchase additional inventions and product
      concepts through our existing network of product developers.





·  ***Expand
      International Sales.*** We
      believe that foreign markets, especially Europe, Australia, Canada, Latin
      America and Asia, offer us significant growth opportunities. In 2006, our sales
      generated outside the United States were approximately $99.1 million, or 12.9%
      of total net sales. We intend to continue to expand our international sales
      by
      capitalizing on our experience and our relationships with foreign distributors
      and retailers. We expect these initiatives to continue to contribute to our
      international growth in 2007.




4




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





The
      execution of our growth strategy, however, is subject to several risks and
      uncertainties and we cannot assure you that we will continue to experience
      growth in, or maintain our present level of, net sales (see “— Risk Factors,”
beginning on page 12). For example, our growth strategy will place additional
      demands on our management, operational capacity and financial resources and
      systems. The increased demand on management may necessitate our recruitment
      and
      retention of qualified management personnel. We cannot assure you that we will
      be able to recruit and retain qualified personnel or expand and manage our
      operations effectively and profitably. To effectively manage future growth,
      we
      must continue to expand our operational, financial and management information
      systems and to train, motivate and manage our work force. There can be no
      assurance that our operational, financial and management information systems
      will be adequate to support our future operations. Failure to expand our
      operational, financial and management information systems or to train, motivate
      or manage employees could have a material adverse effect on our business,
      financial condition and results of operations.





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





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





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





**Recent
      Acquisitions**




On
      February 9, 2006, we acquired substantially all of the assets of Creative
      Designs International, Ltd. and a related Hong Kong company, Arbor Toys Company
      Limited (collectively, “Creative Designs”). The total initial consideration of
      $111.1 million consisted of cash paid at closing in the amount of $101.7
      million, the issuance of 150,000 shares of our common stock valued at
      approximately $3.3 million and the assumption of liabilities in the amount
      of
      $6.1 million, and resulted in the recording of goodwill in the amount of $53.6
      million. Goodwill represents anticipated synergies to be gained via the
      combination of Creative Designs with us. In addition, we agreed to pay an
      earn-out of up to an aggregate of $20.0 million in cash over the three calendar
      years following the acquisition based on the achievement of certain financial
      performance criteria, which will be recorded as goodwill when and if earned.
      For
      the year ended December 31, 2006, $6.9 million of the earn-out was earned and
      recorded as goodwill. Creative Designs is a leading designer and producer of
      dress-up and role-play toys. This acquisition expands our product offerings
      in
      the girls role-play and dress-up area and brings new product development and
      marketing talent to us. Our results of operations have included Creative Designs
      from the date of acquisition.





In
      June
      2005, we purchased substantially all of the operating assets and assumed certain
      liabilities relating to the Pet Pal line of pet products, including toys, treats
      and related pet products. The total initial purchase price of $10.6 million
      was
      paid in cash. In addition, we agreed to pay an earn-out of up to an aggregate
      amount of $25.0 million in cash over the three years ending June 30, 2008
      following the acquisition based on the achievement of certain financial
      performance criteria, which will be recorded as goodwill when and if earned.
      During the year-ended December 31, 2006, $1.5 million of the earn-out was earned
      and recorded as goodwill. Goodwill of $4.6 million arose from this transaction,
      which represents the excess of the purchase price over the fair value of assets
      acquired less the liabilities assumed. This acquisition expands our product
      offerings and distribution channels. Our results of operation have included
      Pet
      Pal from the date of acquisition.





In
      June
      2004, we purchased substantially all of the assets and assumed certain
      liabilities of Play Along, Inc. and related companies (collectively, “Play
      Along”). The total initial purchase price of $85.7 million consisted of cash
      paid in the amount of $70.8 million and the issuance of 749,005 shares of our
      common stock valued at $14.9 million and resulted in goodwill of $67.8 million.
      In addition, we agreed to pay an earn-out of up to $10.0 million per year for
      the three calendar years following the acquisition up to an aggregate amount
      of
      $30.0 million based on the achievement of certain financial performance criteria
      which will be recorded as goodwill when and if earned. For the three years
      in
      the period ended December 31, 2006, $10.0 million, $6.7 million and $6.7
      million, respectively, of the earn-out was earned and recorded as goodwill.
      Accordingly, the maximum earn-out for the remaining year ending December 31,
      2007 is approximately $6.6 million. Play Along designs and produces traditional
      toys, which it distributes domestically and internationally. This acquisition
      expands our product offerings in the pre-school area and brings new product
      development and marketing talent to us. Our results of operations have included
      Play Along from the date of acquisition




5




**Industry
      Overview**





According
      to Toy Industry Association, Inc., the leading toy industry trade group, the
      United States is the world’s largest toy market, followed by Japan and Western
      Europe. Total retail sales of toys, excluding video games, in the United States,
      were approximately $22.3 billion in 2006. We believe the two largest United
      States toy companies, Mattel and Hasbro, collectively hold a dominant share
      of
      the domestic non-video toy market. In addition, hundreds of smaller companies
      compete in the design and development of new toys, the procurement of character
      and product licenses, and the improvement and expansion of previously introduced
      products and product lines. In the United States video game segment, total
      retail sales of video game software were approximately $12.5 billion in
      2006.





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





**Products**





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





**Traditional
      Toys**





***Electronics
      Products***





Our
      electronic products category includes our *Plug
      it in & Play TV Games, Vmigo* virtual
      pet gaming system and *Laser
      Challenge* product
      line. Our current *TV
      Games* TM
titles
      include licenses from Namco®, Disney, Marvel® and Nickelodeon, and feature such
      games as Dora the Explorer, Disney Princesses, Ms. Pac-Man® and
      Pac-Man®.





We
      regularly release new *TV
      Games* titles
      for the pre-school and leisure gamer segments including *Wheel
      of Fortune* ®, *Deal
      or No Deal* ®, *Sesame
      Street* ®
and *Thomas
      the Tank* ®;
      and in
      2006 we introduced *TeleStory* TM
      interactive electronic books featuring classic and other well-known stories
      including *Dora
      the Explorer* , *Lion
      King* ®, *Cinderella* ®,
      and *Winnie
      the Pooh* ®,
      and *Vmigo* virtual
      pet gaming system, both of which use our plug-and-play TV
      technology.





***Wheels
      Division Products***





·  *Toy
      and activity vehicles*





We
      internally developed a line of toy wheels and play sets called *Fly
      Wheels* that
      feature scale replicas of popular automobile tires and wheels and skateboard
      wheels. The wheels are launched from a handle with the pull of a zip cord.
      We
      continue to expand on the brand with new introductions.





Our *Remco* ®
toy
      line includes toy and activity vehicles and other toys. We also produce infrared
      radio controlled vehicles and *Mighty
      Mo’s* ®
toy
      vehicles. Our toy vehicle line is comprised of a large assortment of rugged
      die-cast and plastic vehicles that range in size from four- and three- quarter
      inch to big-wheeled seventeen inch vehicles. The breadth of the line is
      extensive, with themes ranging from emergency, fire, farm and construction,
      to
      racing and jungle adventure.





·  *Road
      Champs die-cast collectible and toy vehicles*





The *Road
      Champs* product
      line consists of highly detailed, die-cast replicas of new and classic cars,
      trucks, motorcycles, emergency vehicles and service vehicles, primarily in
      1/43
      scale (including police cars, fire trucks and ambulances), buses and aircraft.
      Through licenses, we produce replicas of well-known vehicles including those
      from *Ford* ®, *Chevrolet* ®
and *Porsche* ®.
      We
      believe that these licenses, increase the perceived value of the products and
      enhance their marketability.


6


·  *Extreme
      sports die-cast collectibles and toy vehicles and action
      figures*





Our
      extreme sports offerings include our *MXS* line of
      motorcycles with riders, off-road vehicles, personal watercraft, surfboards
      and
      skateboards, which are sold individually and with playsets and
      accessories.




***Action
      Figures and Accessories***





We
      have
      an extensive toy license with the WWE pursuant to which we have the right,
      until
      December 31, 2009, to develop and market a full line of toy products based
      on
      the popular *WWE* professional wrestlers. These wrestlers perform throughout the year at live
      events that attract large crowds, many of which are broadcast on free and cable
      television, including pay-per-view specials. We launched this product line
      in
      1996 with various series of 6 inch articulated action figures that have movable
      body parts. We continually expand and enhance this product line by using
      technology in the development and in the products themselves. The 6 inch figures
      currently make up a substantial portion of our overall *WWE* line,
      which has since grown to include many other new products including playsets.
      Our
      strategy has been to release new figures and accessories frequently to keep
      the
      line fresh and relevant to WWE’s television programming, and to retain the
      interest of the consumers.





We
      also
      develop, manufacture and distribute other action figures and action figure
      accessories including those based on the animated series *Dragon
      Ball Z* ®
and *Pokemon* ®.





***Infant
      and pre-school toys***





Our
      pre-school toys include *Care
      Bears* plush
      and electronic toys, *Doodle
      Bear* plush
      and *Cabbage
      Patch Kids* soft
      body dolls. These products generated a significant amount of net sales in 2006,
      and we expect that level of sales to continue in 2007.





·  *Child
      Guidance*





Our
      line
      of pre-school *Child
      Guidance* ®
      electronic toys features the character *Barney* .
      We also
      produce a line of licensed TV activity products featuring *HIT* , *Disney* and *Nickelodeon* characters, as well as non-licensed versions *.* In
      2007,
      we expect to introduce new pre-school foam play products called *Gorilla
      Blocks* TM.





·  *Slumber
      bags*





Our
      line
      of children’s indoor slumber bags features *Dora
      the Explorer* , *SpongeBob
      SquarePants* and *Blue’s
      Clues* ,
      in
      addition to our own proprietary designs.





***Fashion
      Dolls*** **





Fashion
      and mini dolls and related accessories, includes *Disney
      Princess* dolls
      sold to Disney Stores and Disney Parks and Resorts, and private label fashion
      dolls for our other retailers. We also expect to market fashion dolls for Disney
      characters *Hannah
      Montana* ®
and *The
      Cheetah Girls* ®
in
      2007.





**Craft,
      Activity and Writing Products**





We
      market
      products into the toy activity category which contain a broad range of
      activities, such as make and paint your own characters, jewelry making, art
      studios, posters, puzzles and other projects. These activities, which feature
      popular characters, such as Nickelodeon’s *Dora
      the Explorer* ,
      among
      others, have immediate visual appeal and brand recognition. Our product lines
      also include stationery, back-to-school and office pens, pencils, markers,
      notebooks and craft products such as *Blopens* and *Vivid
      Velvet* ®
      activities. These products are primarily marketed under our *Flying
      Colors* and *Pentech* brands,
      in addition to various private label and other brands.





**Seasonal/
      Outdoor Products**





***Seasonal/
      Outdoor Products***





We
      have a
      wide range of seasonal toys and outdoor and leisure products. Our *Go
      Fly A Kite* product
      line includes youth and adult kites and a wide array of decorative flags,
      windsocks, and windwheels. Our *Funnoodle* pool
      toys include the basic funnoodle, pool floats and a variety of other pool toys.
      Our *The
      Storm* product
      line includes water guns, gliders and sport balls. Another outdoor product
      is
      our *Fly
      Wheels XPV* and *Flight* ,
      extensions of our popular *Fly
      Wheels* vehicle
      line, incorporating our rip-cord design and patented connector with flying
      discs
      and flight-powered foam planes.




7




***Junior
      Sports Products***





Our
      junior sports products include *Gaksplat* and *Storm,* which
      include a variety of mini sport balls and activity products.





**Pet
      Products**





We
      entered the Pet Products category with our acquisition of Pet Pal, whose
      products include pet toys, treats, beds, clothes and related pet products.
      These
      products are marketed under JPI and licenses include *American
      Kennel Club* , *The
      Cat Fanciers’ Association* , *Bratz* ®, *Disney* and *Marvel* ®,
      as
      well as numerous other entertainment and consumer product
      properties.





**World
      Wrestling Entertainment Video Games**





In
      June
      1998, we formed a joint venture with THQ, a developer, publisher and distributor
      of interactive entertainment software for the leading hardware game platforms
      in
      the home video game market. The joint venture entered into a license agreement
      with the WWE under which it acquired the exclusive worldwide right to publish *WWE* video
      games on all hardware platforms. The term of the license agreement expires
      on
      December 31, 2009, and the joint venture has a right to renew the license for
      an
      additional five years under various conditions. We and the joint venture are
      named as defendants in lawsuits commenced by WWE, pursuant to which WWE is
      seeking treble, punitive and other damages (including disgorgement of profits)
      in an undisclosed amount and a declaration that the video game license with
      the
      joint venture and an amendment to our toy licenses with WWE are void and
      unenforceable (see “Legal Proceedings”).





The
      games
      are designed, developed, manufactured and distributed by or through THQ. THQ
      arranges for the manufacture of the CD-ROMs and game cartridges used in the
      various video game platforms under non-exclusive licenses with Sony, Nintendo
      and Microsoft. No other licenses are required for the manufacture of the
      personal computer titles.




The
      joint
      venture agreement provides for us to have received guaranteed preferred returns
      through June 30, 2006 at varying rates of the joint venture’s net sales
      depending on the cumulative unit sales and platform of each particular game. The
      preferred return was subject to change after June 30, 2006 and was to be
      set for the distribution period beginning July 1, 2006 and ending
      December 31, 2009 (the “Next Distribution Period”). The agreement provides
      that the parties will negotiate in good faith and agree to the preferred return
      not less than 180 days prior to the start of the Next Distribution Period.
      It further provides that if the parties are unable to agree on a preferred
      return, the preferred return will be determined by arbitration. The parties
      have
      not reached an agreement with respect to the preferred return for the Next
      Distribution Period and we anticipate that the reset, if any, of the preferred
      return will be determined through arbitration. The
      preferred return is accrued in the quarter in which the licensed games are
      sold
      and the preferred return is earned. Based on the same rates as set forth under
      the original joint venture agreement, an estimated receivable of $13.5 million
      has been accrued for the six months ended December 31, 2006, pending the
      resolution of this outstanding issue.





The
      joint
      venture currently publishes titles for the Sony, Nintendo and Microsoft
      consoles, Sony and Nintendo hand-held platforms, mobile/wireless and personal
      computers. It will also publish titles for new hardware platforms when, and
      as
      they are introduced to the market and have established a sufficient installed
      base to support new software. These titles are marketed to our existing
      customers as well as to game, electronics and other specialty stores, such
      as
      Electronics Boutique and Best Buy.





The
      following table presents our results with the joint venture since its
      inception:





**New
                Game Titles**
            
            **Profit
                from video****Console
                Platforms**
            
            **Hand-held
                Platforms**
            
            **game
                joint venture(1)****(In
                millions)**1999
            
            
            1
            
            
            1
            
            $
            3.62000
            
            
            4
            
            
            1
            
            
            15.92001
            
            
            1
            
            
            2
            
            
            6.72002
            
            
            3
            
            
            1
            
            
            8.02003
            
            
            5
            
            
            —
            
            
            7.42004
            
            
            2
            
            
            1
            
            
            7.92005
            
            
            3
            
            
            1
            
            
            9.42006
            
            
            2
            
            
            1
            
            
            13.2








(1)
            Profit
                from the video game joint venture reflects our preferred return on
                joint
                venture revenue less certain costs incurred directly by us and payments
                made by us to THQ for their share of the profit on TV Games based
                on
                *WWE* content.




8




Wrestling
      video games have demonstrated consistent popularity. We believe that the success
      of *WWE* titles
      is
      dependent on the graphic look and feel of the software, the depth and variation
      of game play and the popularity of *WWE.* We
      believe that as a franchise property, *WWE* titles
      have brand recognition and sustainable consumer appeal, which may allow the
      joint venture to use titles over an extended period of time through the release
      of sequels and extensions and to re-release such products at different price
      points in the future.





**Sales,
      Marketing and Distribution**





We
      sell
      all of our products through our own in-house sales staff and independent sales
      representatives to toy and mass-market retail chain stores, department stores,
      office supply stores, drug and grocery store chains, club stores, toy specialty
      stores and wholesalers. Our three largest customers are Wal-Mart, Target and
      Toys ‘R’ Us, which accounted for approximately 59.1% of our net sales in 2005
      and 58.7% of our net sales in 2006. With the addition of the Pet Pal product
      line, we began to distribute pet products to key pet supply retailers Petco
      and
      Petsmart in addition to many other pet retailers and our existing customers.
      Except for purchase orders relating to products on order, we do not have written
      agreements with our customers. Instead, we generally sell products to our
      customers pursuant to letters of credit or, in some cases, on open account
      with
      payment terms typically varying from 30 to 90 days. From time to time, we allow
      our customers credits against future purchases from us in order to facilitate
      their retail markdown and sales of slow-moving inventory. We also sell our
      products through e-commerce sites, including Toysrus.com and
      Amazon.com.





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





·
            engaged
                representatives to oversee sales in certain
                territories,





·
            engaged
                distributors in certain territories,





·
            established
                direct relationships with retailers in certain territories,
                and





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





Outside
      of the United States, we currently sell our products primarily in Europe,
      Australia, Canada, Latin America and Asia. Sales of our products abroad
      accounted for approximately $99.1 million, or 12.9% of our net sales, in 2006
      and approximately $99.1 million, or 15.0% of our net sales, in 2005. We believe
      that foreign markets present an attractive opportunity, and we plan to intensify
      our marketing efforts and further expand our distribution channels
      abroad.





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





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





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





We
      advertise our products in trade and consumer magazines and other publications,
      market our products at international, national and regional toy, stationery
      and
      other specialty trade shows, conventions and exhibitions and carry on
      cooperative advertising programs with toy and mass market retailers and other
      customers which include the use of print and television ads and in-store
      displays. We also produce and broadcast television commercials for several
      of
      our product lines, including our *WWE* action
      figure line, *Fly
      Wheels* , *Disney* large
      role playsets, *TV
      Games* , *Doodle
      Bears* and *Cabbage
      Patch Kids* .
      We may
      also advertise some of our other products on television, if we expect that
      the
      resulting increase in our net sales will justify the relatively high cost of
      television advertising.




9




**Product
      Development**





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





We
      employ
      a staff of designers for all of our product lines. We occasionally acquire
      our
      other product concepts from unaffiliated third parties. If we accept and develop
      a third party’s concept for new toys, we generally pay a royalty on the toys
      developed from this concept that are sold, and may, on an individual basis,
      guarantee a minimum royalty. In addition, we engage third party developers
      to
      program our line of *Plug
      it in & Play TV Games* .
      Royalties payable to inventors and developers generally range from 1% to 2%
      of
      the wholesale sales price for each unit of a product sold by us. We believe
      that
      utilizing experienced third-party inventors gives us access to a wide range
      of
      development talent. We currently work with numerous toy inventors and designers
      for the development of new products and the enhancement of existing
      products.





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





**Manufacturing
      and Supplies**





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





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





The
      principal raw materials used in the production and sale of our toy products
      are
      plastics, zinc alloy, plush, printed fabrics, paper products and electronic
      components, all of which are currently available at reasonable prices from
      a
      variety of sources. Although we do not manufacture our products, we own the
      tools, dies and molds used in the manufacturing process, and these are
      transferable among manufacturers if we choose to employ alternative
      manufacturers. Tools, dies and molds represent a substantial portion of our
      property and equipment with a net book value of $7.5 million in 2005 and $12.6
      million in 2006. Substantially all of these assets are located in
      China.





10


**Trademarks
      and Copyrights**





Most
      of
      our products are produced and sold under trademarks owned by or licensed to
      us.
      We typically register our properties, and seek protection under the trademark,
      copyright and patent laws of the United States and other countries where our
      products are produced or sold. These intellectual property rights can be
      significant assets. Accordingly, while we believe we are sufficiently protected,
      the loss of some of these rights could have an adverse effect on our business,
      financial condition and results of operations.





**Competition**





Competition
      in the toy industry is intense. Globally, certain of our competitors have
      greater financial resources, larger sales and marketing and product development
      departments, stronger name recognition, longer operating histories and benefit
      from greater economies of scale. These factors, among others, may enable our
      competitors to market their products at lower prices or on terms more
      advantageous to customers than those we could offer for our competitive
      products. Competition often extends to the procurement of entertainment and
      product licenses, as well as to the marketing and distribution of products
      and
      the obtaining of adequate shelf space. Competition may result in price
      reductions, reduced gross margins and loss of market share, any of which could
      have a material adverse effect on our business, financial condition and results
      of operations. In each of our product lines we compete against one or both
      of
      the toy industry’s two dominant companies, Mattel and Hasbro. In addition, we
      compete in our *Flying
      Colors* and *Pentech* product
      categories, with Rose Art (Mega Brands), Hasbro (Play-doh®) and Binney &
Smith (Crayola®), and in our toy vehicle lines, with RC2. We also compete with
      numerous smaller domestic and foreign toy manufacturers, importers and marketers
      in each of our product categories. Our joint venture’s principal competitors in
      the video game market are Electronic Arts and Activision.





**Seasonality
      and Backlog**





In
      2006,
      approximately 70% of our net sales were made in the third and fourth quarters.
      Generally, the first quarter is the period of lowest shipments and sales in
      our
      business and the toy industry generally and therefore the least profitable
      due
      to various fixed costs. Seasonality factors may cause our operating results
      to
      fluctuate significantly from quarter to quarter. However, our writing instrument
      and activity products generally are counter-seasonal to the traditional toy
      industry seasonality due to the higher volume generally shipped for
      back-to-school beginning in the second quarter. In addition, our seasonal
      products are primarily sold in the spring and summer seasons. Our results of
      operations may also fluctuate as a result of factors such as the timing of
      new
      products (and related expenses) introduced by us or our competitors, the
      advertising activities of our competitors, delivery schedules set by our
      customers and the emergence of new market entrants. We believe, however, that
      the low retail price of most of our products may be less subject to seasonal
      fluctuations than higher priced toy products.





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





**Government
      and Industry Regulation**





Our
      products are subject to the provisions of the Consumer Product Safety Act
      (“CPSA”), the Federal Hazardous Substances Act (“FHSA”), the Flammable Fabrics
      Act (“FFA”) and the regulations promulgated thereunder. The CPSA and the FHSA
      enable the Consumer Products Safety Commission (“CPSC”) to exclude from the
      market consumer products that fail to comply with applicable product safety
      regulations or otherwise create a substantial risk of injury, and articles
      that
      contain excessive amounts of a banned hazardous substance. The FFA enables
      the
      CPSC to regulate and enforce flammability standards for fabrics used in consumer
      products. The CPSC may also require the repurchase by the manufacturer of
      articles. Similar laws exist in some states and cities and in various
      international markets. We maintain a quality control program designed to ensure
      compliance with all applicable laws.





**Employees**





As
      of
      March 14, 2007, we employed 702 persons, all of whom are full-time employees,
      including three executive officers. We employed 393 people in the United States,
      241 people in Hong Kong and 68 people in China. We believe that we have good
      relationships with our employees. None of our employees are represented by
      a
      union.





11


**Environmental
      Issues**





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





**Available
      Information**





We
      make
      available free of charge on or through our Internet website,
      www.jakkspacific.com, our annual report on Form 10-K, quarterly reports on
      Form
      10-Q, current reports on Form 8-K, and amendments to these reports filed or
      furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act
      of
      1934 as soon as reasonably practicable after we electronically file such
      material with, or furnish it to, the SEC.





**Our
      Corporate Information**





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





**Item
      1A.**  ***Risk
      Factors***





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





***The
      outcome of litigation in which we have been named as a defendant is
      unpredictable and a materially adverse decision in any such matter could have
      a
      material adverse affect on our financial position and results of
      operations.***





We
      are
      defendants in litigation matters, as described under “Legal Proceedings” in our
      periodic reports filed pursuant to the Securities Exchange Act of 1934,
      including the lawsuit commenced by WWE and the purported securities class action
      and derivative action claims stemming from the WWE lawsuit (see “Legal
      Proceedings”). These claims may divert financial and management resources that
      would otherwise be used to benefit our operations. Although we believe that
      we
      have meritorious defenses to the claims made in each and all of the litigation
      matters to which we have been named a party, and intend to contest each lawsuit
      vigorously, no assurances can be given that the results of these matters will
      be
      favorable to us. A materially adverse resolution of any of these lawsuits could
      have a material adverse affect on our financial position and results of
      operations.





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





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





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





·
            *Increasing
                use of technology;*





·
            *Shorter
                life cycles for individual products; and*




12




·
            *Higher
                consumer expectations for product quality, functionality and
                value.*





We
                cannot assure you that:





·
            *our
                current products will continue to be popular with
                consumers;*





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





·
            *the
                life cycles of our products will be sufficient to permit us to recover
                licensing, design, manufacturing, marketing and other costs associated
                with those products.*





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





***The
      failure of our character-related and theme-related products to become and/or
      remain popular with children may materially and adversely impact our business,
      financial condition and results of operations.***





The
      success of many of our character-related and theme-related products depends
      on
      the popularity of characters in movies, television programs, live wrestling
      exhibitions, auto racing events and other media. We cannot assure you
      that:





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





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





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





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





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





***There
      are risks associated with our license agreements.***


·
            *Our
                current licenses require us to pay minimum royalties*




Sales
      of
      products under trademarks or trade or brand names licensed from others account
      for substantially all of our net sales. Product licenses allow us to capitalize
      on characters, designs, concepts and inventions owned by others or developed
      by
      toy inventors and designers. Our license agreements generally require us to
      make
      specified minimum royalty payments, even if we fail to sell a sufficient number
      of units to cover these amounts. In addition, under certain of our license
      agreements, if we fail to achieve certain prescribed sales targets, we may
      be
      unable to retain or renew these licenses.





·
            *Some
                of our licenses are restricted as to use*





Under
      the
      majority of our license agreements the licensors have the right to review and
      approve our use of their licensed products, designs or materials before we
      may
      make any sales. If a licensor refuses to permit our use of any licensed property
      in the way we propose, or if their review process is delayed, our development
      or
      sale of new products could be impeded.





·
            *New
                licenses are difficult and expensive to obtain*





Our
      continued success will depend substantially on our ability to obtain additional
      licenses. Intensive competition exists for desirable licenses in our industry.
      We cannot assure you that we will be able to secure or renew significant
      licenses on terms acceptable to us. In addition, as we add licenses, the need
      to
      fund additional royalty advances and guaranteed minimum royalty payments may
      strain our cash resources.





·
            *A
                limited number of licensors account for a large portion of our net
                sales*





We
      derive
      a significant portion of our net sales from a limited number of licensors.
      If
      one or more of these licensors were to terminate or fail to renew our license
      or
      not grant us new licenses, our business, financial condition and results of
      operations could be adversely affected.




13




***The
      toy industry is highly competitive and our inability to compete effectively
      may
      materially and adversely impact our business, financial condition and results
      of
      operations.***





The
      toy
      industry is highly competitive. Globally, certain of our competitors have
      financial and strategic advantages over us, including:





·
            *greater
                financial resources;*





·
            *larger
                sales, marketing and product development
                departments;*





·
            *stronger
                name recognition;*





·
            *longer
                operating histories; and*





·
            *greater
                economies of scale.*





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




***An
      adverse outcome in the litigation commenced against us and against our video
      game joint venture with THQ by WWE, or a decline in the popularity of WWE,
      could
      adversely impact our interest in that joint venture.***




The
      joint
      venture with THQ depends entirely on a single license, which gives the venture
      exclusive worldwide rights to produce and market video games based on World
      Wrestling Entertainment characters and themes. An adverse outcome against us,
      THQ or the joint venture in the lawsuit commenced by WWE, or an adverse outcome
      against THQ or the joint venture in the lawsuit commenced by WWE against THQ
      and
      the joint venture (see the first Risk Factor, above, and “Legal Proceedings”),
      would adversely impact our rights under the joint venture’s single license,
      which would adversely effect the joint venture’s and our business, financial
      condition and results of operation.




Furthermore,
      the popularity of professional wrestling, in general, and World Wrestling
      Entertainment, in particular, is subject to changing consumer tastes and
      demands. The relative popularity of professional wrestling has fluctuated
      significantly in recent years. A decline in the popularity of World Wrestling
      Entertainment could adversely affect the joint venture’s and our business,
      financial condition and results of operations.





***The
      termination of THQ’s manufacturing licenses and the inability of the joint
      venture to otherwise obtain these licenses from other manufacturers would
      materially adversely affect the joint venture’s and our business, financial
      condition and results of operations.***





The
      joint
      venture relies on hardware manufacturers and THQ’s non-exclusive licenses with
      them for the right to publish titles for their platforms and for the manufacture
      of the joint venture’s titles. If THQ’s manufacturing licenses were to terminate
      and the joint venture could not otherwise obtain these licenses from other
      manufacturers, the joint venture would be unable to publish additional titles
      for these manufacturers’ platforms, which would materially adversely affect the
      joint venture’s and our business, financial condition and results of
      operations.





***The
      failure of the joint venture or THQ to perform as anticipated could have a
      material adverse affect on our financial position and results of
      operations.***





The
      joint
      venture’s failure to timely develop titles for new platforms that achieve
      significant market acceptance, to maintain net sales that are commensurate
      with
      product development costs or to maintain compatibility between its personal
      computer CD-ROM titles and the related hardware and operating systems would
      adversely affect the joint venture’s and our business, financial condition and
      results of operations.





Furthermore,
      THQ controls the day-to-day operations of the joint venture and all of its
      product development and production operations. Accordingly, the joint venture
      relies exclusively on THQ to manage these operations effectively. THQ’s failure
      to effectively manage the joint venture would have a material adverse effect
      on
      the joint venture’s and our business and results of operations. We are also
      dependent upon THQ’s ability to manage cash flows of the joint venture. If THQ
      is required to retain cash for operations, or because of statutory or
      contractual restrictions, we may not receive cash payments for our share of
      profits, on a timely basis, or at all.




14




***The
      amount of preferred return that we now receive from the joint venture is subject
      to change, which could adversely affect our results of
      operations.***




The
      joint
      venture agreement provides for us to have received guaranteed preferred returns
      through June 30, 2006 at varying rates of the joint venture’s net sales
      depending on the cumulative unit sales and platform of each particular game. The
      preferred return was subject to change after June 30, 2006 and was to be
      set for the distribution period beginning July 1, 2006 and ending
      December 31, 2009 (the “Next Distribution Period”). The agreement provides
      that the parties will negotiate in good faith and agree to the preferred return
      not less than 180 days prior to the start of the Next Distribution Period.
      It further provides that if the parties are unable to agree on a preferred
      return, the preferred return will be determined by arbitration. The parties
      have
      not reached an agreement with respect to the preferred return for the Next
      Distribution Period and we anticipate that the reset, if any, of the preferred
      return will be determined through arbitration. The
      preferred return is accrued in the quarter in which the licensed games are
      sold
      and the preferred return is earned. Based on the same rates as set forth under
      the original joint venture agreement, an estimated receivable of $13.5 million
      has been accrued for the six months December 31, 2006, pending the resolution
      of
      this outstanding issue.




Any
      adverse change to the preferred return for the next distribution period as
      well
      as the ongoing performance of the joint venture may result in our experiencing
      reduced net income, which would adversely affect our results of
      operations.





***We
      may not be able to sustain or manage our rapid growth, which may prevent us
      from
      continuing to increase our net revenues.***





We
      have
      experienced rapid growth in our product lines resulting in higher net sales
      over
      the last six years, which was achieved through acquisitions of businesses,
      products and licenses. For example, revenues associated with companies we
      acquired since 2004 were approximately $185.6 million and $67.1 million, in
      2006
      and 2005, respectively, representing 24.3% and 10.1% of our total revenues
      for
      those periods. As a result, comparing our period-to-period operating results
      may
      not be meaningful and results of operations from prior periods may not be
      indicative of future results. We cannot assure you that we will continue to
      experience growth in, or maintain our present level of, net sales.





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





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





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





Our
      growth strategy depends in part upon our ability to acquire companies and new
      product lines. Revenues associated with our acquisitions since 2004 represented
      approximately 24.3% and 10.1% of our total revenues in 2006 and 2005,
      respectively. Future acquisitions will succeed only if we can effectively assess
      characteristics of potential target companies and product lines, such
      as:


·
            *attractiveness
                of products;*




·
            *suitability
                of distribution channels;*


·
            *management
                ability;*  15


·
            *financial
                  condition and results of operations; and*




·
            *the
                degree to which acquired operations can be integrated with our
                operations.*




We
      cannot
      assure you that we can identify attractive acquisition candidates or negotiate
      acceptable acquisition terms, and our failure to do so may adversely affect
      our
      results of operations and our ability to sustain growth. Our acquisition
      strategy involves a number of risks, each of which could adversely affect our
      operating results, including:




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




·
            *diversion
                of management attention from operation of our existing
                business;*


·
            *loss
                of key personnel from acquired companies; and*




·
            *failure
                of an acquired business to achieve targeted financial
                results.*




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





Our
      three
      largest customers accounted for 58.7% of our net sales in 2006. Except for
      outstanding purchase orders for specific products, we do not have written
      contracts with or commitments from any of our customers. A substantial reduction
      in or termination of orders from any of our largest customers could adversely
      affect our business, financial condition and results of operations. In addition,
      pressure by large customers seeking price reductions, financial incentives,
      changes in other terms of sale or for us to bear the risks and the cost of
      carrying inventory also could adversely affect our business, financial condition
      and results of operations. If one or more of our major customers were to
      experience difficulties in fulfilling their obligations to us, cease doing
      business with us, significantly reduce the amount of their purchases from us
      or
      return substantial amounts of our products, it could have a material adverse
      effect on our business, financial condition and results of operations. In
      addition, the bankruptcy or other lack of success of one or more of our
      significant retailers could negatively impact our revenues and bad debt
      expense.





***We
      depend on our key personnel and any loss or interruption of either of their
      services could adversely affect our business, financial condition and results
      of
      operations.***





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





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





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





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




16




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





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





We
      sell
      products and operate facilities in numerous countries outside the United States.
      For the year ended December 31, 2006, sales to our international customers
      comprised approximately 12.9% of our net sales. We expect our sales to
      international customers to account for a greater portion of our revenues in
      future fiscal periods. Additionally, we utilize third-party manufacturers
      located principally in The People’s Republic of China (“China”) which are
      subject to the risks normally associated with international operations,
      including:





·
            *currency
                conversion risks and currency fluctuations;*




·
            *limitations,
                including taxes, on the repatriation of
                earnings;*




·
            *political
                instability, civil unrest and economic
                instability;* ·
              *greater
                  difficulty enforcing intellectual property rights and weaker laws
                  protecting such rights;* ·
                *complications
                    in complying with laws in varying jurisdictions and changes in
                    governmental policies;* ·
                  *greater
                      difficulty and expenses associated with recovering from natural
                      disasters;* ·
                    *transportation
                        delays and interruptions;* ·
                      *the
                          potential imposition of tariffs; and* ·
                        *the
                            pricing of intercompany transactions may be challenged
                            by taxing
                            authorities in both Hong Kong and the United States,
                            with potential
                            increases in income taxes.*


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





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





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





·
            *product
                liability claims;* ·
              *loss
                  of sales;* ·
                *diversion
                    of resources;* 17
  ·
                  *damage
                      to our reputation;* ·
                    *increased
                        warranty costs; and* ·
                      *removal
                          of our products from the market.*


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





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





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





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





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





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





On
      June
      15, 2010, June 15, 2013 and June 15, 2018, holders of our convertible senior
      notes may require us to purchase their notes, which repurchase may be made
      for
      cash. In addition, holders may also require us to purchase their notes for
      cash
      upon the occurrence of certain fundamental changes in our board composition
      or
      ownership structure, if we liquidate or dissolve under certain circumstances
      or
      if our common stock ceases being quoted on an established over-the-counter
      trading market in the United States. If we do not have, or have access to,
      sufficient funds to repurchase the notes, then we could be forced into
      bankruptcy. In fact, we expect that we would require third-party financing,
      but
      we cannot assure you that we would be able to obtain that financing on favorable
      terms or at all.





***We
      have a material amount of goodwill which, if it becomes impaired, would result
      in a reduction in our net income.***





Goodwill
      is the amount by which the cost of an acquisition accounted for using the
      purchase method exceeds the fair value of the net assets we acquire. Current
      accounting standards require that goodwill no longer be amortized but instead
      be
      periodically evaluated for impairment based on the fair value of the reporting
      unit. As at December 31, 2006, we have not had any impairment of Goodwill,
      which
      is reviewed on a quarterly basis and formally evaluated on an annual
      basis.





At
      December 31, 2006, approximately $338.0 million, or 38.2%, of our total assets
      represented goodwill. Declines in our profitability may impact the fair value
      of
      our reporting units, which could result in a write-down of our goodwill.
      Reductions in our net income caused by the write-down of goodwill would
      adversely affect our results of operations.





18


**Item
      2.**  ***Properties***





The
      following is a listing of the principal leased offices maintained by us as
      of
      March 14, 2007:





**Property**
            
            **Location**
            
            **Approximate**
              **Square
                Feet**
            
            **Lease
                Expiration Date***Domestic*Corporate
                Office
            
            
            Malibu,
                California
            
            
            29,500
            
            
            February
                28, 2015Design
                Center
            
            
            Malibu,
                California
            
            
            16,800
            
            
            August,
                31, 2008Distribution
                Center
            
            
            City
                of Industry, California
            
            
            800,000
            
            
            January
                31, 2013Go
                Fly A Kite
            
            
            Clinton,
                Connecticut
            
            
            10,300
            
            
            September
                30, 2007Play
                Along U.S.
            
            
            Deerfield
                Beach, Florida
            
            
            24,600
            
            
            December
                31, 2007Creative
                Designs
            
            
            Trevose,
                Pennsylvania
            
            
            14,700
            
            
            June
                30, 2009Sales
                Office / Showroom
            
            
            New
                York, New York
            
            
            14,500
            
            
            April
                30, 2007 (1)Sales
                Office / Showroom
            
            
            New
                York, New York
            
            
            11,500
            
            
            December
                30, 2009Sales
                Offices
            
            
            Bentonville,
                Arkansas
            
            
            4,400
            
            
            November
                30, 2008Palatine,
                Illinois
            
            
            
            
            
            1,200
            
            
            Month-to
                Month*International*JAKKS
                Hong Kong
            
            
            Kowloon,
                Hong Kong
            
            
            22,900
            
            
            October
                31, 2007 (2)Play
                Along Hong Kong
            
            
            Kowloon,
                Hong Kong
            
            
            18,300
            
            
            May
                23, 2007 (2)JAKKS
                / Play Along Hong Kong
            
            
            Kowloon,
                Hong Kong
            
            
            36,600
            
            
            March
                31, 2009Arbor
                Toys Hong Kong
            
            
            Kowloon,
                Hong Kong
            
            
            19,500
            
            
            May
                31, 2007 (3)Production
                Inspection Office
            
            
            Shanghai,
                China
            
            
            1,700
            
            
            March
                31, 2007 (3)Shenzhen
                Office
            
            
            Shenzhen,
                China
            
            
            2,900
            
            
            June
                30, 2008







(1)
            These
                premises will be vacated and all personnel and operations are expected
                to
                be relocated in April 2007 to new office space in New York which
                is
                currently under lease.





(2)
            These
                premises will be vacated and all personnel and operations will be
                relocated in April 2007 to new office space in Hong Kong which is
                currently under lease.





(3)
            These
                leases are expected to be renewed on terms comparable to those of
                the
                expiring leases.





**Item
      3.**  ***Legal
      Proceedings***





On
      October 19, 2004, we were named as defendants in a lawsuit commenced by WWE
      in the U.S. District Court for the Southern District of New York concerning
      our
      toy licenses with WWE and the video game license between WWE and the joint
      venture company operated by THQ and us, encaptioned World Wrestling
      Entertainment, Inc. v. JAKKS Pacific, Inc., et al., 1:04-CV-08223-KMK (the
“WWE
      Action”). The complaint also named as defendants THQ, the joint venture, certain
      of our foreign subsidiaries, Jack Friedman (our Chairman and Chief Executive
      Officer), Stephen Berman (our Chief Operating Officer, President and Secretary
      and a member of our Board of Directors), Joel Bennett (our Chief Financial
      Officer), Stanley Shenker and Associates, Inc., Bell Licensing, LLC, Stanley
      Shenker and James Bell.




WWE
      sought treble, punitive and other damages (including disgorgement of profits)
      in
      an undisclosed amount and a declaration that the video game license with the
      joint venture, which is scheduled to expire in 2009 (subject to joint venture’s
      right to extend that license for an additional five years), and an amendment
      to
      our toy licenses with WWE, which are scheduled to expire in 2009, are void
      and
      unenforceable. This action alleged violations by the defendants of the Racketeer
      Influenced and Corrupt Organization Act (“RICO”) and the anti-bribery provisions
      of the Robinson-Patman Act, and various claims under state law.




On
      February 16, 2005, we filed a motion to dismiss the WWE Action. On
      March 30, 2005, the day before WWE’s opposition to our motion was due, WWE
      filed an Amended Complaint seeking, among other things, to add the Chief
      Executive Officer of THQ as a defendant and to add a claim under the Sherman
      Act. The Court allowed the filing of the Amended Complaint and ordered a
      two-stage resolution of the viability of the Complaint, with motions to dismiss
      the federal claims based on certain threshold issues to proceed and all other
      matters to be deferred for consideration if the Complaint survived scrutiny
      with
      respect to the threshold issues. The Court also stayed discovery pending the
      determination of the motions to dismiss.




The
      motions to dismiss the Amended Complaint based on these threshold issues were
      fully briefed and argued and, on March 31, 2006, the Court granted the part
      of our motion seeking dismissal of the Robinson-Patman Act and Sherman Act
      claims and denied the part of our motion seeking to dismiss the RICO claims
      on
      the basis of the threshold issue that was briefed (the “March 31
      Order”).




19




On
      April 7, 2006, we sought certification to appeal from the portion of the
      March 31 Order denying our motion to dismiss the RICO claim on the one
      ground that was briefed. Shortly thereafter, WWE filed a motion for reargument
      with respect to the portion of the March 31 Order that dismissed the
      Sherman Act claim and, alternatively, sought judgment with respect to the
      Sherman Act claim so that it could pursue an immediate appeal. At a court
      conference on April 26, 2006 the Court deferred the requests for judgment
      and for certification and set up briefing schedules with respect to our motion
      to dismiss the RICO claim, which claim is presently the sole remaining basis
      for
      federal jurisdiction, on grounds that were not the subject of the first round
      of
      briefing, and our motion to dismiss the action based on the Release that WWE
      executed. The Court also established a briefing schedule for WWE’s motion for
      reargument of the dismissal of the Sherman Act claim. These motions were argued
      and submitted in September 2006. Discovery remains stayed.




In
      November 2004, several purported class action lawsuits were filed in the
      United States District Court for the Southern District of New York: (1) Garcia
      v. Jakks Pacific, Inc. et al., Civil Action No. 04-8807 (filed on
      November 5, 2004), (2) Jonco Investors, LLC v. Jakks Pacific, Inc. et al.,
      Civil Action No. 04-9021 (filed on November 16, 2004), (3) Kahn v. Jakks
      Pacific, Inc. et al., Civil Action No. 04-8910 (filed on November 10,
      2004), (4) Quantum Equities L.L.C. v. Jakks Pacific, Inc. et al., Civil Action
      No. 04-8877 (filed on November 9, 2004), and (5) Irvine v. Jakks Pacific,
      Inc. et al., Civil Action No. 04-9078 (filed on November 16, 2004) (the
“Class Actions”). The complaints in the Class Actions allege that defendants
      issued positive statements concerning increasing sales of our WWE licensed
      products which were false and misleading because the WWE licenses had allegedly
      been obtained through a pattern of commercial bribery, our relationship with
      the
      WWE was being negatively impacted by the WWE’s contentions and there was an
      increased risk that the WWE would either seek modification or nullification
      of
      the licensing agreements with us. Plaintiffs also allege that we misleadingly
      failed to disclose the alleged fact that the WWE licenses were obtained through
      an unlawful bribery scheme. The plaintiffs in the Class Actions are described
      as
      purchasers of our common stock, who purchased from as early as October 26,
      1999 to as late as October 19, 2004. The Class Actions seek compensatory
      and other damages in an undisclosed amount, alleging violations of Section
      10(b)
      of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5
      promulgated thereunder by each of the defendants (namely the Company and
      Messrs. Friedman, Berman and Bennett), and violations of Section 20(a) of
      the Exchange Act by Messrs. Friedman, Berman and Bennett. On
      January 25, 2005, the Court consolidated the Class Actions under the
      caption In re JAKKS Pacific, Inc. Shareholders Class Action Litigation, Civil
      Action No. 04-8807. On May 11, 2005, the Court appointed co-lead counsels
      and provided until July 11, 2005 for an amended complaint to be filed; and
      a briefing schedule thereafter with respect to a motion to dismiss. The motion
      to dismiss has been fully briefed and argument occurred on November 30,
      2006. The motion is still pending.




We
      believe that the claims in the WWE Action and the Class Actions are without
      merit and we intend to defend vigorously against them. However, because these
      Actions are in their preliminary stages, we cannot assure you as to the outcome
      of the Actions, nor can we estimate the range of our potential
      losses.




On
      December 2, 2004, a shareholder derivative action was filed in the Southern
      District of New York by Freeport Partner, LLC against us, nominally, and against
      Messrs. Friedman, Berman and Bennett, Freeport Partners v. Friedman, et
      al., Civil Action No. 04-9441 (the “Derivative Action”). The Derivative Action
      seeks to hold the individual defendants liable for damages allegedly caused
      to
      us by their actions and in particular to hold them liable on a contribution
      theory with respect to any liability we incur in connection with the Class
      Actions. On or about February 10, 2005, a second shareholder derivative
      action was filed in the Southern District of New York by David Oppenheim against
      us, nominally, and against Messrs. Friedman, Berman, Bennett, Blatte,
      Glick, Miller and Skala, Civil Action 05-2046 (the “Second Derivative Action”).
      The Second Derivative Action seeks to hold the individual defendants liable
      for
      damages allegedly caused to us by their actions as a result of alleged breaches
      of their fiduciary duties. On or about March 16, 2005, a third shareholder
      derivative action was filed. It is captioned Warr v. Friedman, Berman, Bennett,
      Blatte, Glick, Miller, Skala, and JAKKS (as a nominal defendant), and it was
      filed in the Superior Court of California, Los Angeles County (the “Third
      Derivative Action”). The Third Derivative Action seeks to hold the individual
      defendants liable for (1) damages allegedly caused to us by their alleged
      breaches of fiduciary duty, abuse of control, gross mismanagement, waste of
      corporate assets and unjust enrichment; and (2) restitution to us of profits,
      benefits and other compensation obtained by them. Stays/and or extensions of
      time to answer are in place with respect to the derivative actions.




On
      March 1, 2005, we delivered a Notice of Breach of Settlement Agreement and
      Demand for Indemnification to WWE (the “Notification”). The Notification
      asserted that WWE’s filing of the WWE Action violated A Covenant Not to Sue
      contained in a January 15, 2004 Settlement Agreement and General Release
      (“General Release”) entered into between WWE and us and, therefore, that we were
      demanding indemnification, pursuant to the Indemnification provision contained
      in the General Release, for all losses that the WWE’s actions have caused or
      will cause to us and our officers, including but not limited to any losses
      sustained by us in connection with the Class Actions. On March 4, 2005, in
      a letter from its outside counsel, WWE asserted that the General Release does
      not cover the claims in the WWE Action.




20




On
      March 30, 2006, WWE’s counsel wrote a letter alleging breaches by the joint
      venture of the video game agreement relating to the manner of distribution
      and
      the payment of royalties to WWE with respect to sales of the WWE video games
      in
      Japan. WWE has demanded that the alleged breaches be cured within the time
      periods provided in the video game license, while reserving all of its rights,
      including its alleged right of termination of the video game license.




On
      April 28, 2006 the joint venture responded, asserting, among other things,
      that WWE had acquiesced in the manner of distribution in Japan and the payment
      of royalties with respect to such sales and, in addition, had separately
      released the joint venture from any claims with respect to such matter,
      including the payment of royalties with respect to such sales, and that there
      is
      therefore no basis for an allegation of a breach of the license
      agreement.




While
      the
      joint venture does not believe that WWE has a valid claim, it tendered a
      protective “cure” of the alleged breaches with a full reservation of rights. WWE
“rejected” that cure and reserved its rights. On October 12, 2006, WWE
      commenced a lawsuit in Connecticut state court against THQ and THQ/JAKKS Pacific
      LLC (the “LLC”), involving a claim set forth above concerning allegedly improper
      sales of WWE video games in Japan and other countries in Asia. The lawsuit
      seeks, among other things, a declaration that WWE is entitled to terminate
      the
      video game license and monetary damages. A motion to strike one claim was argued
      on March 12, 2007 and submitted to the Court. Additionally, a schedule has
      been
      set, with trial no earlier than October 2008. THQ and the LLC have stated that
      they believe the lawsuit is without merit and intend to defend themselves
      vigorously. However, because this action is in its preliminary stage, we cannot
      assure you as to the outcome, nor can we estimate the range of our potential
      losses, if any.




Our
      agreement with THQ provides for payment of a preferred return to us in
      connection with our joint venture (see Note 10, Joint Ventures). The preferred
      return is subject to change after June 30, 2006 and is to be set for the
      distribution period beginning July 1, 2006 and ending December 31,
      2009 (the “Next Distribution Period”). The agreement provides that the parties
      will negotiate in good faith and agree to the preferred return not less than
      180
      days prior to the start of the Next Distribution Period. It further provides
      that if the parties are unable to agree on a preferred return, the preferred
      return will be determined by arbitration. The parties have not reached an
      agreement with respect to the preferred return for the Next Distribution Period
      and we anticipate that the reset, if any, of the preferred return will be
      determined through arbitration. With respect to the matter of the change in
      the
      preferred return, we cannot assure you of the outcome.




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





21


**PART
      II**





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





**Market
      Information**





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





**Price
                Range of****Common Stock****High**
            
            **Low****2005:**First
                quarter
            
            $
            23.96
            
            $
            17.25Second
                quarter
            
            
            21.97
            
            
            18.38Third
                quarter
            
            
            20.20
            
            
            15.54Fourth
                quarter
            
            
            23.35
            
            
            14.80**2006:**First
                quarter
            
            
            27.10
            
            
            19.23Second
                quarter
            
            
            28.50
            
            
            17.06Third
                quarter
            
            
            20.24
            
            
            15.26Fourth
                quarter
            
            
            23.38
            
            
            17.17





**Performance
      Graph**





The
      graph
      and tables below display the relative performance of our common stock, the
      Russell 2000 Price Index (the “Russell 2000”) and a peer group index, by
      comparing the cumulative total stockholder return (which assumes reinvestment
      of
      dividends, if any) on an assumed $100 investment in our common stock, the
      Russell 2000 and the peer group index over the period from January 1, 2002
      to December 31, 2006.





In
      accordance with recently enacted regulations implemented by the Securities
      and
      Exchange Commission, we retained the services of an expert compensation
      consultant. In the performance of its services, such consultant used a peer
      group index for its analysis of our compensation policies. Certain of the
      companies included in such peer group index were different from the companies
      included in the peer group index we used in our proxy statement for 2006. For
      the sake of consistency, we elected to utilize the new peer group index when
      preparing the below graph and tables. Our new peer group index (referred to
      below as “Peer Group II”) includes the following companies: *Activision,
      Inc., Electronic Arts, Inc., EMak Worldwide, Inc., Hasbro, Inc., Leapfrog
      Enterprises, Inc., Marvel Enterprises, Inc., Mattel, Inc., Russ Berrie and
      Company, Inc., RC2 Corp., Take-Two Interactive, Inc. and THQ
      Inc.* We
      believe that these companies represent a cross-section of publicly-traded
      companies with product lines and businesses similar to our own throughout the
      comparison period.





The
      peer
      group index used by us in last year’s proxy statement (referred to below as
“Peer Group”) includes the following companies: *Acclaim
      Entertainment, Inc., EMAK Worldwide, Inc., Mega Brands, Inc., Hasbro, Inc.,
      Mattel, Inc., Russ Berrie and Company, Inc. and RC2 Corp.*





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





22





comparison





**Annual
      Return Percentage**





**December
                31,****2002**
            
            **December
                31,****2003**
            
            **December
                31,****2004**
            
            **December
                31,****2005**
            
            **December
                31,****2006**JAKKS
                Pacific
            
            
            (28.92
            )%
            
            (2.37
            )%
            
            68.15
            %
            
            (5.29
            )%
            
            4.30
            %Peer
                Group
            
            
            1.30
            
            
            16.81
            
            
            1.98
            
            
            (10.71
            )
            
            42.28Peer
                Group II
            
            
            (19.83
            )
            
            77.75
            
            
            24.09
            
            
            (10.15
            )
            
            7.35Russell
                2000
            
            
            (20.48
            )
            
            47.25
            
            
            18.33
            
            
            4.56
            
            
            18.35





**Indexed
      Returns**





**January
                1, 2002**
            
            **December
                31, 2002**
            
            **December
                31, 2003**
            
            **December
                31, 2004**
            
            **December
                31, 2005**
            
            **December
                31, 2006**JAKKS
                Pacific
            
            $
            100.00
            
            
            71.08
            
            
            69.40
            
            
            116.69
            
            
            110.52
            
            
            115.28Peer
                Group
            
            $
            100.00
            
            
            101.30
            
            
            118.33
            
            
            120.68
            
            
            107.76
            
            
            153.32Peer
                Group II
            
            $
            100.00
            
            
            80.17
            
            
            142.51
            
            
            176.84
            
            
            158.89
            
            
            170.57Russell
                2000
            
            $
            100.00
            
            
            79.52
            
            
            117.09
            
            
            138.55
            
            
            144.87
            
            
            171.45





**Security
      Holders**





To
      the
      best of our knowledge, as of March 14, 2007, there were 194 holders of record
      of
      our common stock. We believe there are numerous beneficial owners of our common
      stock whose shares are held in “street name.”





**Dividends**





We
      have
      never paid any cash dividends on our common stock. We currently intend to retain
      our future earnings, if any, to finance the growth and development of our
      business, but may consider implementing a plan to pay cash dividends on our
      common stock in the future.




23




**Equity
      Compensation Plan Information**





The
      table
      below sets forth the following information as of the year ended December 31,
      2006 for (i) all compensation plans previously approved by our stockholders
      and
      (ii) all compensation plans not previously approved by our stockholders, if
      any:





(a)
      the
      number of securities to be issued upon the exercise of outstanding options,
      warrants and rights;





(b)
      the
      weighted-average exercise price of such outstanding options, warrants and
      rights;





(c)
      other
      than securities to be issued upon the exercise of such outstanding options,
      warrants and rights, the number of securities remaining available for future
      issuance under the plans.





**Plan
                Category**
            
            **Number
                of**
              **Securities
                to be**
              **Issued
                upon Exercise**
              **of
                Outstanding**
              **Options,**
              **Warrants
                and Rights**
              **(a)**
            
            **Weighted-Average**
              **Exercise
                Price of**
              **Outstanding**
              **Options,**
              **Warrants
                and**
              **Rights**
              **(b)**
            
            **Number
                of Securities**
              **Remaining
                Available**
              **for**
              **Future
                Issuance Under**
              **Equity
                Compensation**
              **Plans
                (Excluding**
              **Securities
                Reflected in**
              **Column
                (a))**
              **(c)**Equity
                compensation plans approved by security holders
            
            
            1,462,378
            
            $
            17.05
            
            
            1,224,876Equity
                compensation plans not approved by security holders
            
            
            100,000
            
            
            11.35
            
            
            —Total
            
            
            1,562,378
            
            $
            16.69
            
            
            1,224,876





Equity
      compensation plans approved by our stockholders consists of the 2002 Stock
      Award
      and Incentive Plan. Equity compensation plans not approved by our security
      holders consist of a fully-vested warrant issued by us in 2003 (and expiring
      in
      2013) in connection with license costs relating to our video game joint
      venture.





**Item
      6.**  ***Selected
      Financial Data***





You
      should read the financial data set forth below in conjunction with “Management’s
      Discussion and Analysis of Financial Condition and Results of Operations” and
      our consolidated financial statements and the related notes (included in Item
      8).





**Years
                Ended December 31,****2002**
            
            **2003**
            
            **2004**
            
            **2005**
            
            **2006****(In
                thousands, except per share data)****Consolidated
                Statement of Income Data:**Net
                sales
            
            $
            310,016
            
            $
            315,776
            
            $
            574,266
            
            $
            661,536
            
            $
            765,386Cost
                of sales
            
            
            180,173
            
            
            189,334
            
            
            348,259
            
            
            394,829
            
            
            470,592Gross
                profit
            
            
            129,843
            
            
            126,442
            
            
            226,007
            
            
            266,707
            
            
            294,794Selling,
                general and administrative expenses
            
            
            98,111
            
            
            113,053
            
            
            172,282
            
            
            178,722
            
            
            202,482Acquisition
                shut-down and product recall costs
            
            
            6,718
            
            
            2,000
            
            
            —
            
            
            —
            
            
            —Income
                from operations
            
            
            25,014
            
            
            11,389
            
            
            53,725
            
            
            87,985
            
            
            92,312Profit
                from video game joint venture
            
            
            8,004
            
            
            7,351
            
            
            7,865
            
            
            9,414
            
            
            13,226Other
                expense
            
            
            —
            
            
            —
            
            
            —
            
            
            (1,401
            )
            
            —Interest
                income
            
            
            1,258
            
            
            1,131
            
            
            2,052
            
            
            5,183
            
            
            4,930Interest
                expense
            
            
            (117)1
            
            
            (2,536
            )
            
            (4,550
            )
            
            (4,544
            )
            
            (4,533
            )Income
                before provision for income taxes and minority interest
            
            
            34,159
            
            
            17,335
            
            
            59,092
            
            
            96,637
            
            
            105,935Provision
                for income taxes
            
            
            6,466
            
            
            1,440
            
            
            15,533
            
            
            33,144
            
            
            33,560Income
                before minority interest
            
            
            27,693
            
            
            15,895
            
            
            43,559
            
            
            63,493
            
            
            72,375Minority
                interest
            
            
            (237
            )
            
            —
            
            
            —
            
            
            —
            
            
            —Net
                income
            
            $
            27,930
            
            $
            15,895
            
            $
            43,559
            
            $
            63,493
            
            $
            72,375Basic
                earnings per share
            
            $
            1.27
            
            $
            0.66
            
            $
            1.69
            
            $
            2.37
            
            $
            2.66Basic
                weighted average shares outstanding
            
            
            21,963
            
            
            24,262
            
            
            25,797
            
            
            26,738
            
            
            27,227Diluted
                earnings per share
            
            $
            1.23
            
            $
            0.66
            
            $
            1.49
            
            $
            2.06
            
            $
            2.30Diluted
                weighted average shares and equivalents outstanding
            
            
            22,747
            
            
            27,426
            
            
            31,406
            
            
            32,193
            
            
            32,714





In
      February 2006, we acquired Creative Designs. Also, effective January 1, 2006,
      we
      implemented SFAS 123R, which added required share-based compensation expense
      to
      be recorded.




24




In
      June
      2005, we acquired the Pet Pal line of products.





In
      June
      2004, we acquired Play Along.




**At
                December 31,****2002**
            
            **2003**
            
            **2004**
            
            **2005**
            
            **2006****(In
                thousands)****Consolidated
                Balance Sheet Data:**Cash
                and cash equivalents
            
            $
            68,413
            
            $
            118,182
            
            $
            176,544
            
            $
            240,238
            
            $
            184,489Working
                capital
            
            
            129,183
            
            
            232,601
            
            
            229,543
            
            
            301,454
            
            
            280,363Total
                assets
            
            
            408,916
            
            
            529,997
            
            
            696,762
            
            
            753,955
            
            
            881,894Long-term
                debt, net of current portion
            
            
            60
            
            
            98,042
            
            
            98,000
            
            
            98,000
            
            
            98,000Total
                stockholders’ equity
            
            
            357,236
            
            
            377,900
            
            
            451,485
            
            
            524,651
            
            
            609,288





**Item
      7.**  ***Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations***





*The
      following Management’s Discussion and Analysis of Financial Condition and
      Results of Operations contains forward-looking statements that involve risks
      and
      uncertainties. Our actual results could differ materially from those anticipated
      in these forward-looking statements as a result of various factors. You should
      read this section in conjunction with our consolidated financial statements
      and
      the related notes (included in Item 8).*





**Critical
      Accounting Policies**





The
      accompanying consolidated financial statements and supplementary information
      were prepared in accordance with accounting principles generally accepted in
      the
      United States of America. Significant accounting policies are discussed in
      Note
      2 to the Consolidated Financial Statements, Item 8. Inherent in the application
      of many of these accounting policies is the need for management to make
      estimates and judgments in the determination of certain revenues, expenses,
      assets and liabilities. As such, materially different financial results can
      occur as circumstances change and additional information becomes known. The
      policies with the greatest potential effect on our results of operations and
      financial position include:





***Allowance
      for Doubtful Accounts.*** The
      allowance for doubtful accounts is based on our assessment of the collectibility
      of specific customer accounts and the aging of the accounts receivable. If
      there
      were a deterioration of a major customer’s creditworthiness, or actual defaults
      were higher than our historical experience, our estimates of the recoverability
      of amounts due to us could be overstated, which could have an adverse impact
      on
      our operating results.





***Revenue
      Recognition.*** Our
      revenue recognition policy is significant because our revenue is a key component
      of our results of operations. In addition, our revenue recognition determines
      the timing of certain expenses, such as commissions and royalties. We follow
      very specific and detailed guidelines in measuring revenues; however, certain
      judgments affect the application of our revenue policy. Revenue results are
      difficult to predict, and any shortfall in revenue or delay in recognizing
      revenue could cause our operating results to vary significantly from quarter
      to
      quarter.





***Long-Lived
      Assets.*** We
      assess the impairment of long-lived assets and goodwill at least annually or
      whenever events or changes in circumstances indicate that the carrying value
      may
      not be recoverable. Factors we consider important which could trigger an
      impairment review include the following:


·
            significant
                underperformance relative to expected historical or projected future
                operating results; ·
                significant
                    changes in the manner of our use of the acquired assets or the
                    strategy
                    for our overall business; and ·
                    significant
                        negative industry or economic trends.


When
      we
      determine that the carrying value of long-lived assets and goodwill may not
      be
      recoverable based upon the existence of one or more of the above indicators
      of
      impairment, we measure any impairment based on a projected discounted cash
      flow
      method using a discount rate determined by our management to be commensurate
      with the risk inherent in our current business model. Net long-lived assets,
      including goodwill, amounted to $413.8 million as of December 31,
      2006.




25




***Reserve
      Inventory Obsolescence*** .
      We
      value our inventory at the lower of cost or market. We accrue a reserve for
      obsolete, slow-moving inventory which is based on management’s assessment of all
      relevant information. We periodically review and adjust our assumptions as
      circumstances warrant.





***Income
      Allocation for Income Taxes.*** Our
      income tax provision and related income tax assets and liabilities are based
      on
      actual income as allocated to the various tax jurisdictions based upon our
      transfer pricing study, US and foreign statutory income tax rates, and tax
      regulations and planning opportunities in the various jurisdictions in which
      the
      Company operates. Significant judgment is required in interpreting tax
      regulations in the US and foreign jurisdictions, and in evaluating worldwide
      uncertain tax positions. Actual results could differ materiality from those
      judgments, and changes in judgments could materially affect our consolidated
      financial statements.





We
      accrue
      a tax reserve for additional income taxes and interest, which may become payable
      in future years as a result of audit adjustments by tax authorities. The reserve
      is based on management’s assessment of all relevant information, and are
      periodically reviewed and adjusted as circumstances warrant. As of December
      31,
      2006, our income tax reserves are approximately $10.3 million and relate to
      the
      potential income tax audit adjustments, primarily in the areas of income
      allocation and transfer pricing.





***Share-Based
      Payments*** .
      We
      grant restricted stock and options to purchase our common stock to our employees
      (including officers) and non-employee directors under our 2002 Stock Award
      and
      Incentive Plan (“the Plan”), which incorporated our Third Amended and Restated
      1995 Stock Option Plan. The benefits provided under the Plan are share-based
      payments subject to the provisions of revised Statement of Financial Accounting
      Standards No. 123 (Revised) (SFAS 123R), *Share-Based
      Payment* .
      Effective January 1, 2006, we began to use the fair value method to apply the
      provisions of SFAS 123R with a modified prospective application. The valuation
      provisions of SFAS 123R apply to new awards and to awards that were outstanding
      on the effective date and subsequently modified, cancelled or became vested.
      Under the modified prospective application, prior periods are not restated
      for
      comparative purposes. Share-based compensation expense recognized on a
      straight-line basis over the requisite service period under SFAS 123R for the
      year ended December 31, 2006 was $1.9 million, relating to stock options, and
      $4.6 million relating to restricted stock. At December 31, 2006, total
      unrecognized estimated compensation expense related to non-vested stock options
      granted prior to that date was $2.5 million, which is expected to be recognized
      over a weighted average period of 3.51 years, and $4.5 million related to
      non-vested restricted stock, which is expected to be recognized over a weighted
      average period of 2.7 years. Net stock options, after forfeitures and
      cancellations, granted during the year ended December 31, 2005 represented
      1.13%
      of outstanding shares as of December 31, 2005. There were no stock options
      granted in 2006.




We
      estimate the value of share-based awards on the date of grant using the
      Black-Scholes option-pricing model. Prior to the adoption of SFAS 123R, the
      estimated value of each share-based award was used for the pro forma information
      required to be disclosed under SFAS 123. The determination of the fair value
      of
      share-based payment awards on the date of grant using an option-pricing model
      is
      affected by our stock price as well as assumptions regarding a number of complex
      and subjective variables. These variables include our expected stock price
      volatility over the term of the awards, actual and projected employee stock
      option exercise behaviors, cancellations, terminations, risk-free interest
      rate
      and expected dividends.




If
      factors change and we employ different assumptions in the application of SFAS
      123R in future periods, the compensation expense that we record under SFAS
      123R
      may differ from what we have recorded in the current period. Option-pricing
      models were developed for use in estimating the value of traded options that
      have no vesting or hedging restrictions, are fully transferable and do not
      cause
      dilution. Because our share-based payments have characteristics significantly
      different from those of freely traded options, and because changes in the
      subjective input assumptions can materially affect our estimates of fair values,
      in our opinion, existing valuation models, including the Black-Scholes and
      lattice binomial models, may not provide reliable measures of the fair values
      of
      our share-based compensation. Consequently, there is a risk that our estimates
      of the fair values of our share-based compensation awards on the grant dates
      may
      differ from the actual values realized upon the exercise, expiration, early
      termination or forfeiture of those share-based payments in the future. Certain
      share-based payments, such as employee stock options, may expire worthless
      or
      otherwise result in zero intrinsic value as compared to the fair values
      originally estimated on the grant date and reported in our financial statements.
      Alternatively, value may be realized from these instruments that is
      significantly in excess of the fair values originally estimated on the grant
      date and reported in our financial statements. There is currently no
      market-based mechanism or other practical application to verify the reliability
      and accuracy of the estimates stemming from these valuation models, nor is
      there
      a means to compare and adjust the estimates to actual values. Although the
      fair
      value of employee share-based awards is determined in accordance with SFAS
      123R
      and the Securities and Exchange Commission's Staff Accounting Bulletin No.
      107
      (SAB 107) using an option-pricing model, that value may not be indicative of
      the
      fair value observed in a willing buyer/willing seller market
      transaction.




Estimates
      of share-based compensation expenses do have an impact on our financial
      statements, but these expenses are based on the aforementioned option valuation
      model and will never result in the payment of cash by us. For this reason,
      and
      because we do not view share-based compensation as related to our operational
      performance, we exclude estimated share-based compensation expense when
      evaluating the business performance of our operating segments.




26




The
      guidance in SFAS 123R and SAB 107 is relatively new, and best practices are
      not
      well established. The application of these principles may be subject to further
      interpretation and refinement over time. There are significant differences
      among
      valuation models, and there is a possibility that we will adopt different
      valuation models in the future. This may result in a lack of consistency in
      future periods and materially affect the fair value estimate of share-based
      payments. It may also result in a lack of comparability with other companies
      that use different models, methods and assumptions.




Furthermore,
      theoretical valuation models and market-based methods are evolving and may
      result in lower or higher fair value estimates for share-based compensation.
      The
      timing, readiness, adoption, general acceptance, reliability and testing of
      these methods is uncertain. Sophisticated mathematical models may require
      voluminous historical information, modeling expertise, financial analyses,
      correlation analyses, integrated software and databases, consulting fees,
      customization and testing for adequacy of internal controls. Market-based
      methods are emerging that, if employed by us, may dilute our earnings per share
      and involve significant transaction fees and ongoing administrative expenses.
      The uncertainties and costs of these extensive valuation efforts may outweigh
      the benefits to investors.





**Recent
      Developments**





On
      February 9, 2006, we acquired substantially all of the assets of Creative
      Designs International, Ltd. and a related Hong Kong company, Arbor Toys Company
      Limited (collectively, “Creative Designs”). The total initial purchase price of
      $111.1 million consisted of $101.7 million in cash, 150,000 shares of our common
      stock at a value of approximately $3.3 million and the assumption of liabilities
      in the amount of $6.1 million. In addition, we agreed to pay an earn-out of
      up
      to an aggregate amount of $20.0 million in cash over the three calendar years
      following the acquisition based on the achievement of certain financial
      performance criteria, which will be recorded as goodwill when and if earned.
      For
      the year ended December 31, 2006, $6.9 million of the earn-out was earned and
      recorded as goodwill. Creative Designs is a leading designer and producer of
      dress-up and role-play toys and was included in our results of operations from
      the date of acquisition.





**Results
      of Operations**





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





**Years
                Ended December 31,****2002**
            
            **2003**
            
            **2004**
            
            **2005**
            
            **2006**Net
                sales
            
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %Cost
                of sales
            
            
            58.1
            
            
            60.0
            
            
            60.6
            
            
            59.7
            
            
            61.5Gross
                profit
            
            
            41.9
            
            
            40.0
            
            
            39.4
            
            
            40.3
            
            
            38.5Selling,
                general and administrative expenses
            
            
            31.6
            
            
            35.8
            
            
            30.0
            
            
            27.0
            
            
            26.5Acquisition
                shut-down and product recall costs
            
            
            2.2
            
            
            0.6
            
            
            —
            
            
            —
            
            
            —Income
                from operations
            
            
            8.1
            
            
            3.6
            
            
            9.4
            
            
            13.3
            
            
            12.0Profit
                from video game joint venture
            
            
            2.6
            
            
            2.3
            
            
            1.4
            
            
            1.4
            
            
            1.7Other
                expense
            
            
            —
            
            
            —
            
            
            —
            
            
            (0.2
            )
            
            —Interest
                income
            
            
            0.4
            
            
            0.4
            
            
            0.4
            
            
            0.8
            
            
            0.6Interest
                expense
            
            
            —
            
            
            (0.8
            )
            
            (0.8
            )
            
            (0.7
            )
            
            (0.6
            )Income
                before income taxes
            
            
            11.1
            
            
            5.5
            
            
            10.4
            
            
            14.6
            
            
            13.7Provision
                for income taxes
            
            
            2.1
            
            
            0.5
            
            
            2.7
            
            
            5.0
            
            
            4.4Net
                income
            
            
            9.0
            %
            
            5.0
            %
            
            7.7
            %
            
            9.6
            %
            
            9.3
            %





27




During
      2006, we reorganized our business segments to conform to product groups that
      have become the focus of management review. The following unaudited table
      summarizes, for the periods indicated, certain income statement data by segment
      (in thousands).





**Years
                Ended**
              **December
                31,****2005**
            
            **2006****Net
                Sales**Traditional
                Toys
            
            $
            568,737
            
            $
            658,804Craft/Activity/Writing
                Products
            
            
            62,058
            
            
            52,834Seasonal/Outdoor
                Products
            
            
            20,978
            
            
            33,694Pet
                Products
            
            
            9,763
            
            
            20,054661,536
            
            
            765,386**Cost
                of Sales**Traditional
                Toys
            
            
            334,669
            
            
            410,339Craft/Activity/Writing
                Products
            
            
            39,928
            
            
            29,044Seasonal/Outdoor
                Products
            
            
            13,957
            
            
            19,072Pet
                Products
            
            
            6,275
            
            
            12,137394,829
            
            
            470,592**Gross
                Margin**Traditional
                Toys
            
            
            234,068
            
            
            248,465Craft/Activity/Writing
                Products
            
            
            22,130
            
            
            23,790Seasonal/Outdoor
                Products
            
            
            7,021
            
            
            14,622Pet
                Products
            
            
            3,488
            
            
            7,917$
            266,707
            
            $
            294,794





***Comparison
      of the Years Ended December 31, 2006 and 2005***




Net
      Sales




*Traditional
      Toys* .
      Net
      sales of our Traditional Toys segment were $658.8 million in 2006, compared
      to
      $568.7 million in 2005, representing an increase of $90.1 million or 15.8%.
      The
      increase in net sales was primarily due to the addition of the Creative Designs
      line of products, which we acquired in February 2006, with sales of $181.1
      million and increases in sales of WWE actions figures and accessories, Doodle
      Bear, Speed Stacks, Snugglers, Dragonflyz and Trolls, offset in part by
      decreases in sales of TV Games, wheels products, dolls, Sky Dancers, Care Bears
      and Cabbage Patch Kids.




*Craft/Activity/Writing
      Products* .
      Net
      Sales of our Craft/Activity/Writing Products were $52.8 million in 2006,
      compared to $62.0 million in 2005, representing a decrease of $9.2 million
      or
      14.8%. The decrease in net sales was primarily due to decreases in sales of
      our
      Flying Colors activities and our Pentech and Color Workshop writing instruments
      and related products, offset in part by an increase in sales of our Creepy
      Crawlers activity sets.




*Seasonal/Outdoor
      Products* .
      Net
      sales of our Seasonal/Outdoor Products were $33.7 million in 2006, compared
      to
      $21.0 million in 2005, representing an increase of $12.7 million or 60.5%.
      The
      increase in net sales was primarily due to increases in sales of our Fly Wheels
      XPV and Flight toys and our Funnoodle pool toys, offset in part by decreases
      in
      sales of our Go Fly A Kite and junior sports products.




*Pet
      Products* .
      Net
      Sales of our Pet Pal line of products, which we acquired in June 2005, were
      $20.1 million in 2006, compared to $9.8 million in 2005, representing an
      increase of $10.3 million or 105.1%. The increase is attributable to the growth
      in sales of this new line of products through our existing distribution channels
      and having sales for the entire year in 2006.




Cost
      of Sales




*Traditional
      Toys* .
      Cost of
      sales of our Traditional Toys segment was $410.3 million in 2006, compared
      to
      $334.7 million in 2005, representing an increase of $75.6 million or 22.6%.
      The
      increase primarily consisted of an increase in product costs of $68.8 million,
      which is in line with the higher volume of sales. Furthermore, royalty expense
      for our Traditional Toys segment decreased by $1.2 million and as a percentage
      of net sales due to changes in the product mix to more products with lower
      royalty rates or proprietary products with no royalty rates, from products
      with
      higher royalty rates. Product costs as a percentage of sales increased due
      to
      the mix of the product sold and sell-through of closeout product. Our
      depreciation of molds and tools increased by $8.1 million due to new products
      being sold in this segment.




28




*Craft/Activity/Writing
      Products* .
      Cost of
      sales of our Craft/Activity/Writing Products was $29.0 million in 2006, compared
      to $39.9 million in 2005, representing a decrease of $10.9 million or 27.3%.
      The
      decrease primarily consisted of decreases in product costs of $8.6 million
      and
      royalty expense of $2.2 million, which were in line with the lower volume of
      sales. Additionally, our depreciation of molds and tools was comparable
      year-over-year.




*Seasonal/Outdoor
      Products* .
      Cost of
      sales of our Seasonal/Outdoor Products segment was $19.1 million in 2006,
      compared to $14.0 million in 2005, representing an increase of $5.1 million
      or
      36.4%. The increase primarily consisted of increases in product costs of $5.6
      million which were in line with the higher volume of sales, partially offset
      by
      a decrease in royalty expense of $0.3 million. Furthermore, royalty expense
      for
      the Seasonal/Outdoor segment decreased as a percentage of net sales due to
      changes in the product mix to more products with lower royalty rates or
      proprietary products with no royalty rates, from products with higher royalty
      rates. Product costs as a percentage of sales also decreased due to the mix
      of
      the product sold. Our depreciation of molds and tools decreased by $0.2 million,
      which was comparable year-over-year.




*Pet
      Products* .
      Cost of
      sales of our Pet Pal line of products, which we acquired in June 2005, was
      $12.1
      million in 2006, compared to $6.3 million in 2005, representing an increase
      of
      $5.8 million or 92.1%. The increase primarily consisted of increases in product
      costs of $4.8 million and royalty expense of $0.8 million, which were in line
      with the higher volume of sales. Additionally, our depreciation of molds and
      tools increased by $0.3 million.




Selling,
      General and Administrative Expenses




Selling,
      general and administrative expenses were $202.5 million in 2006 and $178.7
      million in 2005, constituting 26.5% and 27.0% of net sales, respectively. The
      overall increase of $23.8 million in such costs was primarily due to the
      addition of overhead related to the operations of Creative Designs ($20.3
      million), increases in product development ($2.7 million), amortization expense
      related to intangible assets other than goodwill ($7.4 million) and stock-based
      compensation ($3.1 million), offset in part by a decrease in other selling
      expenses ($12.0 million). Increased grants of restricted stock awards to our
      non-employee directors and the increase in the price of our common stock in
      2006
      compared to 2005 resulted in stock-based compensation expense of $6.5 million
      in
      2006, compared to $3.4 million in 2005. The decrease in direct selling expenses
      is primarily due to efficiencies gained by closing two third-party warehouses,
      and decreases in sales commission expense of $1.9 million and advertising and
      promotional expenses of $6.4 million in 2006 in support of several of our
      product lines. From time to time, we may increase or decrease our advertising
      efforts, if we deem it appropriate for particular products.




Profit
      from Video Game Joint Venture





Profit
      from our video game joint venture in 2006 increased to $13.2 million, as
      compared to $9.4 million in 2005, due to the strong performance of the three
      new
      games released and stronger sales of existing titles in 2006, offset by the
      reduction of $0.1 million to THQ for their share of profit on our sales of
      WWE
      themed TV Games compared to 2005, in which period four new games were released
      and $0.8 million was earned by THQ for the WWE themed TV Games. The amount
      of
      the preferred return we will receive from the joint venture after June 30,
      2006
      is subject to change (see “Risk Factors” and “World Wrestling Entertainment
      Video Games”).





Other
      Expense





Other
      expense in 2005 of $1.4 million related to the write-off of an investment in
      a
      Chinese joint venture. There was no such expense in 2006.




Interest
      Income





Interest
      income in 2006 was $4.9 million, as compared to $5.2 million in 2005. This
      decrease is due to lower average cash balances in 2006 as a result of our
      acquisition of Creative Designs, offset in part by higher interest rates during
      2006 compared to 2005.




Interest
      Expense





Interest
      expense in 2006 of $4.5 million related to the convertible senior notes payable
      was comparable to 2005.




29




Provision
      for Income Taxes





Provision
      for income taxes included Federal, state and foreign income taxes at effective
      tax rates of 34.3% in 2005 and 31.7% in 2006, benefiting from a flat 17.5%
      Hong
      Kong Corporation Tax on our income arising in, or derived from, Hong Kong for
      each of 2005 and 2006. The decrease in the effective tax rate in 2006 is due
      to
      the effect, in 2005, of a one-time repatriation of undistributed earnings from
      our international subsidiaries, which created additional taxes in 2005 on 15%
      of
      the dividends received. As of December 31, 2006, we had net deferred tax assets
      of approximately $8.2 million for which an allowance of $0.9 million has been
      provided since, in the opinion of management, realization of this portion of
      the
      future benefit is uncertain.





***Comparison
      of the Years Ended December 31, 2005 and 2004***





*Net
      Sales.* Net
      sales were $661.5 million in 2005 compared to $574.3 million in 2004,
      representing an increase of $87.2 million or 15.2%. The increase in net sales
      was primarily due to an increase in sales of our Traditional Toy products of
      $71.9 million, which includes the addition of $54.8 million in sales from
      product lines acquired in our acquisition of Play Along, Inc. and related
      companies (collectively, “Play Along”), and increases in WWE action figures and
      accessories, wheels products, *Cabbage
      Patch Kids* , *Doodle
      Bear* ®
and *Sky
      Dancers* ®,
      offset
      in part by decreases in *TV
      Games* ,
      dolls,
      other action figures and *Care
      Bears* and *Teletubbies* products; and an increase in International sales of $30.7 million, including
      increases in sales of *TV
      Games* ,
      action
      figures and wheels product. The net increase in net sales was partially offset
      by decreases in sales of our Crafts and Activities and Writing instruments
      of
      $19.1 million and our Seasonal products of $5.5 million. Our *Funnoodle* line
      was
      adversely impacted by competition at retail in 2005. We have secured alternate
      sources of manufacturing for the *Funnoodle* products
      resulting in lower costs which we expect will enable us to expand distribution
      of this product line in 2006. Additionally, net sales in 2005 included
      approximately $9.8 million of Pet Pal products.





With
      the
      addition of Creative Designs in 2006 and our other on-going initiatives in
      product development and marketing, we believe that the increased level of net
      sales of Traditional Toys should continue throughout 2006. (See “Forward Looking
      Information”).





*Gross
      Profit.* Gross
      profit increased $40.7 million, or 18.0%, to $266.7 million, or 40.3% of net
      sales, in 2005 from $226.0 million, or 39.4% of net sales, in 2004. The overall
      increase in gross profit was attributable to the increase in net sales. The
      increase in gross profit margin of 0.9% of net sales was primarily due to lower
      product costs and tool and mold amortization, offset in part by an increase
      in
      royalty expense as a percentage of net sales due to changes in the product
      mix
      to more products with higher royalty rates from products with lower royalty
      rates or proprietary products with no royalties and the write-off of advances
      and guarantees related to expired or discontinued licenses in 2005.





*Selling,
      General and Administrative Expenses.* Selling,
      general and administrative expenses were $178.7 million in 2005 and $172.3
      million in 2004, constituting 27.0% and 30.0% of net sales, respectively. The
      overall increase of $6.4 million in such costs was primarily due to increases
      in
      direct selling expenses ($17.3 million), product development costs ($4.0
      million) and general and administrative expenses ($1.0 million), partially
      offset by a decrease in amortization expense related to intangible assets other
      than goodwill and trademarks ($5.0 million) and stock-based compensation expense
      ($10.2 million). Comparable grants of restricted stock awards and the increase
      in the price of our common stock in 2004 compared to a decrease in the price
      of
      our common stock in 2005 resulted in a stock-based compensation expense of
      $3.4
      million in 2005 compared to an expense of $13.6 million in 2004. The increase
      in
      general and administrative expenses is primarily due to additional overhead
      related to the operations of Play Along and increases in bonus expense ($3.6
      million) and donation expense ($5.6 million), offset in part by decreases in
      legal costs ($5.0 million), bad debt expense ($2.0 million) and rent expense
      ($1.3 million). The increase in direct selling expenses is primarily due to
      an
      increase in advertising and promotional expenses of $12.1 million in 2005 in
      support of the sell-through of our various products at retail. We produce and
      air television commercials in support of several of our product lines. From
      time
      to time, we may increase or decrease our advertising efforts, if we deem it
      appropriate for particular products.





*Profit
      from Video Game Joint Venture.* Profit
      from our video game joint venture in 2005 was $9.4 million, as compared to
      $7.9
      million in 2004, due to the release of four new games and stronger sales of
      existing titles in 2005, offset by the payment of $0.8 million to THQ for their
      share of profit on our sales of WWE themed TV Games compared to 2004, in which
      period three new games were released and no payments were made by us to THQ.
      The
      amount of the preferred return we will receive after June 30, 2006 is subject
      to
      change (see “Risk Factors”).





*Other
      Expense.* Other
      expense in 2005 of $1.4 million relates to the write-off of an investment in
      a
      Chinese joint venture. There were no such expenses in 2004.




30




*Interest,
      Income.* Interest
      income increased due to higher average cash balances and higher interest rates
      during 2005 compared to 2004.




*Interest
      Expense.* Interest
      expense in 2005 of $4.5 million related to the convertible senior notes payable
      was comparable to 2004.





*Provision
      for Income Taxes.* Provision for income taxes included Federal, state and foreign income taxes
      at
      effective tax rates of 26.3% in 2004 and 34.3% in 2005, benefiting from a flat
      17.5% Hong Kong Corporation Tax on our income arising in, or derived from,
      Hong
      Kong for each of 2004 and 2005. The increase in the effective tax rate in 2005
      is due to a greater proportion of taxable income generated in the United States.
      As of December 31, 2005, we had net deferred tax assets of approximately $7.2
      million for which no allowance has been provided since, in the opinion of
      management, realization of the future benefit is probable. In October 2004,
      the
      American Jobs Creation Act of 2004 (the “Act”) was signed into law. The Act
      created a one-time incentive for U.S. corporations to repatriate undistributed
      earnings from their international subsidiaries by providing an 85%
      dividends-received deduction for certain international earnings. The deduction
      was available to corporations during the tax year that included October 2004,
      or
      in the immediately subsequent tax year. In the fourth quarter of 2005, our
      Board
      of Directors approved a plan to repatriate $105.5 million in foreign earnings,
      which was completed in December 2005. The Federal and state income tax expense
      related to this repatriation was approximately $5.4 million.





**Quarterly
      Fluctuations and Seasonality**





We
      have
      experienced significant quarterly fluctuations in operating results and
      anticipate these fluctuations in the future. The operating results for any
      quarter are not necessarily indicative of results for any future period. Our
      first quarter is typically expected to be the least profitable as a result
      of
      lower net sales but substantially similar fixed operating expenses. This is
      consistent with the performance of many companies in the toy
      industry.





The
      following table presents our unaudited quarterly results for the years
      indicated. The seasonality of our business is reflected in this quarterly
      presentation.


**2004**
            
            **2005**
            
            **2006****First**
            
            **Second**
            
            **Third**
            
            **Fourth**
            
            **First**
            
            **Second**
            
            **Third**
            
            **Fourth**
            
            **First**
            
            **Second**
            
            **Third**
            
            **Fourth****Quarter**
            
            **Quarter**
            
            **Quarter**
            
            **Quarter**
            
            **Quarter**
            
            **Quarter**
            
            **Quarter**
            
            **Quarter**
            
            **Quarter**
            
            **Quarter**
            
            **Quarter**
            
            **Quarter****(In
                thousands, except per share data)**Net
                sales
            
            
            73,986
            
            
            109,395
            
            
            206,083
            
            
            184,802
            
            
            134,676
            
            
            127,091
            
            
            233,500
            
            
            166,269
            
            
            107,244
            
            
            124,041
            
            
            295,789
            
            
            238,312As
                a
                % of full year
            
            
            12.9
            %
            
            19.0
            %
            
            35.9
            %
            
            32.2
            %
            
            20.4
            %
            
            19.2
            %
            
            35.3
            %
            
            25.1
            %
            
            14.0
            %
            
            16.2
            %
            
            38.6
            %
            
            31.1
            %Gross
                profit
            
            
            30,466
            
            
            41,281
            
            
            81,801
            
            
            72,459
            
            
            54,212
            
            
            48,073
            
            
            93,452
            
            
            70,970
            
            
            44,163
            
            
            49,280
            
            
            112,883
            
            
            88,468As
                a
                % of full year
            
            
            13.5
            %
            
            18.3
            %
            
            36.2
            %
            
            32.1
            %
            
            20.3
            %
            
            18.0
            %
            
            35.0
            %
            
            26.6
            %
            
            15.0
            %
            
            16.7
            %
            
            38.3
            %
            
            30.0
            %As
                a
                % of net sales
            
            
            41.2
            %
            
            37.7
            %
            
            39.7
            %
            
            39.2
            %
            
            40.3
            %
            
            37.8
            %
            
            40.0
            %
            
            42.7
            %
            
            41.2
            %
            
            39.7
            %
            
            38.2
            %
            
            37.1
            %Income
                (loss) from operations
            
            
            4,885
            
            
            8,321
            
            
            29,915
            
            
            10,604
            
            
            13,675
            
            
            14,614
            
            
            47,218
            
            
            12,478
            
            
            2,244
            
            
            8,963
            
            
            58,204
            
            
            22,901As
                a
                % of full year
            
            
            9.1
            %
            
            15.5
            %
            
            55.7
            %
            
            19.7
            %
            
            15.5
            %
            
            16.6
            %
            
            53.7
            %
            
            14.2
            %
            
            2.4
            %
            
            9.7
            %
            
            63.1
            %
            
            24.8
            %As
                a
                % of net sales
            
            
            6.6
            %
            
            7.6
            %
            
            14.5
            %
            
            5.7
            %
            
            10.2
            %
            
            11.5
            %
            
            20.2
            %
            
            7.5
            %
            
            2.1
            %
            
            7.2
            %
            
            19.7
            %
            
            9.6
            %Income
                before income taxes
              and
                minority interest
            
            
            4,764
            
            
            7,637
            
            
            30,042
            
            
            16,649
            
            
            13,627
            
            
            15,732
            
            
            46,306
            
            
            20,972
            
            
            3,283
            
            
            9,135
            
            
            57,855
            
            
            35,662As
                a
                % of net sales
            
            
            6.4
            %
            
            7.0
            %
            
            14.6
            %
            
            9.0
            %
            
            10.1
            %
            
            12.4
            %
            
            19.8
            %
            
            12.6
            %
            
            3.1
            %
            
            7.4
            %
            
            19.6
            %
            
            15.0
            %Net
                income
            
            
            3,791
            
            
            6,004
            
            
            23,255
            
            
            10,508
            
            
            10,084
            
            
            11,642
            
            
            32,753
            
            
            9,014
            
            
            2,331
            
            
            6,361
            
            
            40,499
            
            
            23,184As
                a
                % of net sales
            
            
            5.1
            %
            
            5.5
            %
            
            11.3
            %
            
            5.7
            %
            
            7.5
            %
            
            9.2
            %
            
            14.0
            %
            
            5.4
            %
            
            2.2
            %
            
            5.1
            %
            
            13.7
            %
            
            9.7
            %Diluted
                earnings per share
            
            $
            0.15
            
            $
            0.22
            
            $
            0.76
            
            $
            0.36
            
            $
            0.34
            
            $
            0.39
            
            $
            1.05
            
            $
            0.29
            
            $
            0.09
            
            $
            0.22
            
            $
            1.26
            
            $
            0.73Weighted
                average shares and
              equivalents
                outstanding
            
            
            30,676
            
            
            31,123
            
            
            31,919
            
            
            31,855
            
            
            32,256
            
            
            32,229
            
            
            32,088
            
            
            32,197
            
            
            32,617
            
            
            32,790
            
            
            32,736
            
            
            32,803





During
      the fourth quarter of 2004, we recorded non-cash charges, which impacted
      operating income, of $5.6 million relating to the grant of restricted stock
      and
      $8.6 million relating to the amortization of short-lived intangible assets
      acquired in connection with the Play Along acquisition.





During
      the second quarter of 2005, we wrote-off our $1.4 million investment in a
      Chinese joint venture to Other Expense on our determination that none of the
      value would be realized.





During
      the fourth quarter of 2005, we recorded a non-cash charge, which impacted net
      income, of $3.6 million for restricted stock, and we repatriated $105.5 million
      from our Hong Kong subsidiaries which resulted in incremental income tax expense
      of $5.4 million and reduced net income.





***Recent
      Accounting Standards***





In
      July
      2006, the FASB issued Final Interpretation No. (“FIN”) 48, *Accounting
      for Uncertainly in Income Taxes* ,
      an
      Interpretation of SFAS 109, which clarifies the accounting for income taxes
      by
      prescribing the minimum recognition threshold an uncertain tax position is
      required to meet before tax benefits associated with such uncertain tax position
      are recognized in the financial statements. FIN 48 also provides guidance on
      derecognition, measurement, classification, interest and penalties, accounting
      in interim periods, disclosure and transition. In addition, FIN 48 excludes
      income taxes from the scope of SFAS 5, *Accounting
      for Contingencies* .
      FIN 48
      is effective for fiscal years beginning after December 15, 2006. Differences
      between the amounts recognized in the consolidated balance sheets prior to
      the
      adoption of FIN 48 and the amounts reported after adoption are accounted for
      as
      a cumulative-effect adjustment to the beginning balance of retained earnings
      upon adoption of FIN 48. FIN 48 also requires that amounts recognized in the
      balance sheet related to uncertain tax positions be classified as a current
      or
      non-current liability, based upon the timing of the ultimate payment to a taxing
      authority. We will adopt FIN 48 as of January 1, 2007 and are in the process
      of
      finalizing the effect FIN 48 will have on our financial statements. Under the
      guidance of FIN 48, management estimates that our income tax reserve may
      increase by approximately $15.0 million to $25.0 million, which is subject
      to
      revision when management completes an analysis of the impact of FIN 48. As
      required by FIN 48, upon adoption on January 1, 2007, this difference will
      be
      recorded in retained earnings as a cumulative effect adjustment.




31




In
      September 2006, the FASB issued SFAS 157, *Fair
      Value Measurements* ,
      which
      provides guidance for using fair value to measure assets and liabilities. Under
      SFAS 157, fair value refers to the price that would be received to sell an
      asset
      or paid to transfer a liability in an orderly transaction that fair value should
      be based on the assumptions market participants would use when pricing the
      asset
      or liability and establishes a fair value hierarchy that prioritizes the
      information used to develop those assumptions. The fair value hierarchy gives
      the highest priority to quoted prices in active markets and the lowest priority
      to unobservable data, for example, the reporting entity’s own data. Fair value
      measurements would be separately disclosed by level within the fair value
      hierarchy. SFAS 157 is effective for financial statements issued for fiscal
      years beginning after November 15, 2007, and interim periods within those fiscal
      years. We do not expect the adoption of SFAS 157 to have a material impact
      on
      our results of operations and financial position.





In
      February 2007, the FASB issued SFAS 159, *The
      Fair Value Option for Financial Assets and Financial
      Liabilities* ,
      which
      provides companies with an option to report selected financial assets and
      liabilities at fair value. The objective of SFAS 159 is to reduce both the
      complexity in accounting for financial instruments and the volatility in
      earnings caused by measuring related assets and liabilities differently. SFAS
      159 is effective for us as of January 1, 2008 and we do not expect the adoption
      of SFAS 159 to have a material effect on our operating results or financial
      position.





**Liquidity
      and Capital Resources**





As
      of
      December 31, 2006, we had working capital of $280.4 million, as compared to
      $301.5 million as of December 31, 2005. This decrease was primarily attributable
      to cash used in connection with the acquisition of Creative Designs, partially
      offset by cash provided by our operating results.





Operating
      activities provided net cash of $63.7 million in the year ended December 31,
      2006, as compared to $71.1 million in 2005. Net cash was provided primarily
      by
      net income of 72.4 million, non-cash charges and changes in working capital.
      Accounts receivable turnover as measured by days sales outstanding in accounts
      receivable increased from approximately 52 days as of December 31, 2005 to
      approximately 57 days as of December 31, 2006 primarily due to a shift in sales
      from FOB China to domestic sales origin, which carry longer payment terms,
      and
      the timing of sales where a greater percentage of the last quarter sales
      occurred at the end of the quarter. Other than open purchase orders, issued
      in
      the normal course of business, we have no obligations to purchase finished
      goods
      from our manufacturers. As of December 31, 2006, we had cash and cash
      equivalents of $184.5 million.





Our
      investing activities used cash of $121.9 million in the year ended December
      31,
      2006, as compared to $9.5 million in 2005, consisting primarily of the purchase
      of office furniture and equipment and molds and tooling used in the manufacture
      of our products, and the goodwill and other intangible assets acquired in the
      acquisition of Creative Designs, plus the $6.7 million in goodwill relating
      to
      the earn-out of Play Along, $1.5 million in goodwill relating to the earn-out
      of
      Pet Pal and the purchase of marketable securities. In 2005, our investing
      activities consisted primarily of the purchase of molds and tooling used in
      the
      manufacture of our products and the goodwill and other intangible assets
      acquired in the acquisition of Pet Pal, plus the $10.0 million in goodwill
      relating to the earn-out of Play Along, partially offset by the sale of
      marketable securities of $19.0 million. As part of our strategy to develop
      and
      market new products, we have entered into various character and product licenses
      with royalties generally ranging from 1% to 14% payable on net sales of such
      products. As of December 31, 2006, these agreements required future aggregate
      minimum guarantees of $47.4 million, exclusive of $20.4 million in advances
      already paid. We do not have any significant capital expenditure commitments
      as
      of December 31, 2006.




32




Our
      financing activities provided net cash of $3.1 million in the year ended
      December 31, 2006, as compared to $3.2 million in 2005. In 2006, cash was
      primarily provided from the exercise of stock options and the tax benefit from
      stock options exercised. In 2005, cash was primarily provided from the exercise
      of stock options.





The
      following is a summary of our significant contractual cash obligations for
      the
      periods indicated that existed as of December 31, 2006 and is based on
      information appearing in the notes to the consolidated financial statements
      (in
      thousands):





**2007**
            
            **2008**
            
            **2009**
            
            **2010**
            
            **2011**
            
            **Thereafter**
            
            **Total**Long-term
                debt
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            98,000
            
            $
            98,000Operating
                leases
            
            
            8,146
            
            
            6,964
            
            
            5,383
            
            
            4,633
            
            
            4,548
            
            
            7,729
            
            
            37,403Minimum
                guaranteed license/royaltypayments
            
            
            20,722
            
            
            15,760
            
            
            6,366
            
            
            3,358
            
            
            —
            
            
            1,145
            
            
            47,351Employment
                contracts
            
            
            6,585
            
            
            3,986
            
            
            2,734
            
            
            2,280
            
            
            —
            
            
            —
            
            
            15,585Total
                contractual cash obligations
            
            $
            35,453
            
            $
            26,710
            
            $
            14,483
            
            $
            10,271
            
            $
            4,548
            
            $
            106,874
            
            $
            198,339





In
      October 2004, the American Jobs Creation Act of 2004 (the “Act”) was signed into
      law. The Act created a one-time incentive for U.S. corporations to repatriate
      undistributed earnings from their international subsidiaries by providing an
      85%
      dividends-received deduction for certain international earnings. The deduction
      was available to corporations during the tax year that included October 2004,
      or
      in the immediately subsequent tax year. In the fourth quarter of 2005, our
      Board
      of Directors approved a plan to repatriate $105.5 million in foreign earnings,
      which was completed in December 2005. The Federal and state income tax expense
      related to this repatriation was approximately $5.4 million.





In
      June
      2004, we purchased substantially all of the assets and assumed certain
      liabilities of Play Along. The total initial purchase price of $85.7 million
      consisted of cash paid in the amount of $70.8 million and the issuance of
      749,005 shares of our common stock valued at $14.9 million. In addition, we
      agreed to pay an earn-out of up to $10.0 million per year for the four calendar
      years following the acquisition up to an aggregate amount of $30.0 million
      based
      on the achievement of certain financial performance criteria which will be
      recorded as goodwill when and if earned. For the three years in the period
      ended
      December 31, 2006, $10.0 million, $6.7 million and $6.7 million, respectively,
      of the earn-out was earned and recorded as goodwill. Accordingly, the maximum
      earn-out remaining for the year ending December 31, 2007 is approximately $6.6
      million. Our results of operations have included Play Along from the date of
      acquisition.





In
      October 2004, we were named as a defendant in a lawsuit commenced by WWE (the
      “WWE Action”). The complaint also named as defendants, among others, the joint
      venture with THQ Inc., certain of our foreign subsidiaries and our three
      executive officers. In November 2004, several purported class action lawsuits
      were filed in the United States District Court for the Southern District of
      New
      York, alleging damages associated with the facts alleged in the WWE Action.
      Three shareholder derivative actions have also been filed against us, nominally,
      and against certain of our Board members (the “Derivative Actions”). The
      Derivative Actions seek to hold the individual defendants liable for damages
      allegedly caused to our Company by their actions, and, in one of the Derivative
      Actions, seeks restitution to our Company of profits, benefits and other
      compensation obtained by them. In October 2006, WWE commenced a lawsuit against
      THQ and the joint venture concerning allegedly improper sales of WWE video
      games
      in Japan and other countries in Asia, seeking among other things, a declaration
      that WWE is entitled to terminate its video games license with the joint venture
      and monetary damages. See “Legal Proceedings.”





In
      June
      2005, we purchased substantially all of the operating assets and assumed certain
      liabilities relating to the Pet Pal line of pet products, including toys, treats
      and related pet products. The total initial purchase price of $10.6 million
      was
      paid in cash. In addition, we agreed to pay an earn-out of up to an aggregate
      amount of $25.0 million in cash over the three years ending June 30, 2008
      following the acquisition based on the achievement of certain financial
      performance criteria, which will be recorded as goodwill when and if earned.
      During the year ended December 31, 2006, $1.5 million of the earn-out was earned
      and recorded as goodwill. Goodwill of $4.6 million arose from this transaction,
      which represents the excess of the purchase price over the fair value of assets
      acquired less liabilities assumed. This acquisition expands our product
      offerings and distribution channels. Our results of operations have included
      Pet
      Pal from the date of acquisition.





On
      February 9, 2006, we acquired substantially all of the assets of Creative
      Designs. The total initial purchase price of $111.1 million consisted of $101.7
      million in cash, 150,000 shares of our common stock at a value of approximately
      $3.3 million and the assumption of liabilities in the amount of $6.1 million.
      In
      addition, we agreed to pay an earn-out of up to an aggregate amount of $20.0
      million in cash over the three calendar years following the acquisition based
      on
      the achievement of certain financial performance criteria, which will be
      recorded as goodwill when and if earned. For the year ended December 31, 2006,
      $6.9 million of the earn-out was earned and recorded as goodwill. Creative
      Designs is a leading designer and producer of dress-up and role-play toys and
      is
      included in our results of operations from the date of acquisition.




33




In
      June
      2003, we sold an aggregate of $98.0 million of 4.625% Convertible Senior Notes
      due June 15, 2023. The notes may be converted into shares of our common stock
      at
      an initial conversion price of $20.00 per share, or 50 shares per note, subject
      to certain circumstances. The notes may be converted in each quarter subsequent
      to any quarter in which the closing price of our common stock is at or above
      a
      prescribed price for at least 20 trading days in the last 30 trading day period
      of the quarter. The prescribed price for the conversion trigger is $24.00
      through June 30, 2010, and increases nominally each quarter thereafter. Cash
      interest is payable 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, interest
      will accrue at the same rate on the outstanding notes until maturity. At
      maturity, 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,
      unless redeemed or converted earlier. The notes were not convertible as of
      December 31, 2006.





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,
      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, 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, 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.





We
      believe that our cash flows from operations and cash and cash equivalents will
      be sufficient to meet our working capital and capital expenditure requirements
      and provide us with adequate liquidity to meet our anticipated operating needs
      for at least the next 12 months. 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. We intend to finance our long-term liquidity
      requirements out of net cash provided by operations and cash and cash
      equivalents. As of December 31, 2006, we do not have any off-balance sheet
      arrangements.





**Exchange
      Rates**





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





**Item
      7A.**  ***Quantitative
      and Qualitative Disclosures About Market Risk***





Market
      risk represents the risk of loss that may impact our financial position, results
      of operations or cash flows due to adverse changes in financial and commodity
      market prices and rates. We are exposed to market risk in the areas of changes
      in United States and international borrowing rates and changes in foreign
      currency exchange rates. In addition, we are exposed to market risk in certain
      geographic areas that have experienced or remain vulnerable to an economic
      downturn, such as China. We purchase substantially all of our inventory from
      companies in China, and, therefore, we are subject to the risk that such
      suppliers will be unable to provide inventory at competitive prices. While
      we
      believe that, 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 December 31,
      2006, we have not used derivative instruments or engaged in hedging activities
      to minimize our market risk.





**Interest
      Rate Risk**





In
      June
      2003, we issued convertible senior notes payable of $98.0 million with a fixed
      interest rate of 4.625% per annum, which remain outstanding as of December
      31,
      2006. Accordingly, we are not generally subject to any direct risk of loss
      arising from changes in interest rates.




34




**Foreign
      Currency Risk**





We
      have
      wholly-owned subsidiaries in Hong Kong and China. Sales are made by these
      operations on FOB China or Hong Kong terms and are denominated in U.S. dollars.
      However, purchases of inventory and Hong Kong operating expenses are typically
      denominated in Hong Kong dollars and local operating expenses in China are
      denominated in local currency, thereby creating exposure to changes in exchange
      rates. Changes in the Chinese Yuan or Hong Kong dollar/U.S. dollar exchange
      rates may positively or negatively affect our gross margins, operating income
      and retained earnings. A gain in Hong Kong dollars gave rise to the other
      comprehensive loss in the balance sheet at December 31, 2006. 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 Chinese
      Yuan.





35


**Item
      8.**  ***Consolidated
      Financial Statements and Supplementary Data***





**Report
      of Independent Registered Public Accounting Firm**





The
      Board
      of Directors and Stockholders


JAKKS
      Pacific, Inc.


Malibu,
      California





We
      have
      audited the accompanying consolidated balance sheet of JAKKS Pacific, Inc.
      (the
“Company”) as of December 31, 2006 and the related consolidated statements of
      income, other comprehensive income, stockholders’ equity and cash flows for the
      year then ended. These financial statements are the responsibility of the
      Company’s management. Our responsibility is to express an opinion on these
      financial statements based on our audit.





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





In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the financial position of JAKKS Pacific, Inc. as of December
      31, 2006, and the results of its operations and its cash flows for the year
      then
      ended, in conformity with accounting principles generally accepted in the United
      States of America.





As
      more
      fully described in Note 2 to the consolidated financial statements, effective
      January 1, 2006, the Company adopted the provisions of Statement of Financial
      Accounting Standards No. 123(R), “Share-Based Payment.”





We
      have
      also audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the effectiveness of the Company’s internal
      control over financial reporting as of December 31, 2006, based on the criteria
      established in *Internal Control - Integrated Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission and
      our
      report dated March 15, 2007 expressed an unqualified opinion thereon.


/s/
              BDO Seidman,
              LLPBDO
                Seidman, LLP




Los
      Angeles, California


March
      15,
      2007





36




REPORT
      OF
      INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





The
      Board
      of Directors and Stockholders


JAKKS
      Pacific, Inc. and Subsidiaries





We
      have
      audited the accompanying consolidated balance sheets of JAKKS Pacific, Inc.
      and
      Subsidiaries (Company) as of December 31, 2005, and the related consolidated
      statements of operations, other comprehensive income, stockholders’ equity, and
      cash flows and the financial statement schedule for each of the two years in
      the
      period ended December 31, 2005. These financial statements are the
      responsibility of the Company’s management. Our responsibility is to express an
      opinion on these financial statements based on our audits.





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





In
      our
      opinion, the consolidated financial statements and schedule referred to above
      present fairly, in all material respects, the financial position of JAKKS
      Pacific, Inc. and Subsidiaries as of December 31, 2005, and the results of
      their
      operations and their cash flows for each of the two years in the period ended
      December 31, 2005 in conformity with accounting principles generally accepted
      in
      the United States of America.


/s/
                PKFPKF
                  Certified
                    Public Accountants
                  A
                    Professional Corporation


Los
      Angeles, California


February
      13, 2006





37


**JAKKS
        PACIFIC, INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        BALANCE SHEETS**
 
 **December
                  31,****2005**
              
              **2006****(In
                  thousands, except****share
                  data)****Assets****Current
                  assets**Cash
                  and cash equivalents
              
              $
              240,238
              
              $
              184,489Marketable
                  securities
              
              
              —
              
              
              210Accounts
                  receivable, net of allowance for uncollectible accounts of $2,336
                  and
                  $1,206, respectively
              
              
              87,199
              
              
              153,116Inventory
              
              
              66,729
              
              
              76,788Deferred
                  income taxes
              
              
              13,618
              
              
              10,592Prepaid
                  expenses and other
              
              
              17,533
              
              
              26,543Total
                  current assets
              
              
              425,317
              
              
              451,738**Property
                  and equipment**Office
                  furniture and equipment
              
              
              7,619
              
              
              8,299Molds
                  and tooling
              
              
              26,948
              
              
              36,600Leasehold
                  improvements
              
              
              3,522
              
              
              4,882Total
              
              
              38,089
              
              
              49,781Less
                  accumulated depreciation and amortization
              
              
              25,394
              
              
              32,898Property
                  and equipment, net
              
              
              12,695
              
              
              16,883Intangibles
                  and other, net
              
              
              18,512
              
              
              40,833Investment
                  in video game joint venture
              
              
              10,365
              
              
              14,873Goodwill,
                  net
              
              
              269,298
              
              
              337,999Trademarks,
                  net
              
              
              17,768
              
              
              19,568Total
                  assets
              
              $
              753,955
              
              $
              881,894**Liabilities
                  and Stockholders’ Equity****Current
                  liabilities**Accounts
                  payable
              
              $
              50,533
              
              $
              65,574Accrued
                  expenses
              
              
              44,415
              
              
              54,664Reserve
                  for sales returns and allowances
              
              
              25,123
              
              
              32,589Income
                  taxes payable
              
              
              3,792
              
              
              18,548Total
                  current liabilities
              
              
              123,863
              
              
              171,375Convertible
                  senior notes
              
              
              98,000
              
              
              98,000Deferred
                  rent liability
              
              
              995
              
              
              854Deferred
                  income taxes
              
              
              6,446
              
              
              2,377Total
                  liabilities
              
              
              229,304
              
              
              272,606Commitments
                  and contingencies**Stockholders’
                  equity**Preferred
                  shares, $.001 par value; 5,000,000 shares authorized; nil
                  outstanding
              
              
              —
              
              
              —Common
                  stock, $.001 par value; 100,000,000 shares authorized; 26,944,559
                  and
                  27,776,947 shares issued and outstanding, respectively
              
              
              27
              
              
              28Additional
                  paid-in capital
              
              
              287,356
              
              
              300,255Retained
                  earnings
              
              
              240,057
              
              
              312,432Accumulated
                  other comprehensive loss
              
              
              (2,789
              )
              
              (3,427
              )Total
                  stockholders’ equity
              
              
              524,651
              
              
              609,288Total
                  liabilities and stockholders’ equity
              
              $
              753,955
              
              $
              881,894
 
 *See
        notes to consolidated financial statements.*
  38
 
 **JAKKS
        PACIFIC, INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OF INCOME**
 
 **Years
                  Ended December 31,****2004**
              
              **2005**
              
              **2006****(In
                  thousands, except per share amounts)**Net
                  sales
              
              $
              574,266
              
              $
              661,536
              
              $
              765,386Cost
                  of sales
              
              
              348,259
              
              
              394,829
              
              
              470,592Gross
                  profit
              
              
              226,007
              
              
              266,707
              
              
              294,794Selling,
                  general and administrative expenses
              
              
              172,282
              
              
              178,722
              
              
              202,482Income
                  from operations
              
              
              53,725
              
              
              87,985
              
              
              92,312Profit
                  from video game joint venture
              
              
              7,865
              
              
              9,414
              
              
              13,226Other
                  expense
              
              
              —
              
              
              (1,401
              )
              
              —Interest
                  income
              
              
              2,052
              
              
              5,183
              
              
              4,930Interest
                  expense
              
              
              (4,550
              )
              
              (4,544
              )
              
              (4,533
              )Income
                  before provision for income taxes
              
              
              59,092
              
              
              96,637
              
              
              105,935Provision
                  for income taxes
              
              
              15,533
              
              
              33,144
              
              
              33,560Net
                  income
              
              $
              43,559
              
              $
              63,493
              
              $
              72,375Basic
                  earnings per share
              
              $
              1.69
              
              $
              2.37
              
              $
              2.66Basic
                  weighted number of shares
              
              
              25,797
              
              
              26,738
              
              
              27,227Diluted
                  earnings per share
              
              $
              1.49
              
              $
              2.06
              
              $
              2.30Diluted
                  weighted number of shares
              
              
              31,406
              
              
              32,193
              
              
              32,714
 
 *See
        notes to consolidated financial statements.*
  39
  **JAKKS
        PACIFIC, INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OF OTHER COMPREHENSIVE INCOME**
 
 **Years
                  Ended December 31,****2004**
              
              **2005**
              
              **2006****(In
                  thousands)**Other
                  comprehensive income:Net
                  income
              
              $
              43,559
              
              $
              63,493
              
              $
              72,375Foreign
                  currency translation adjustment
              
              
              (1,398
              )
              
              (1,042
              )
              
              (638
              )Other
                  comprehensive income
              
              $
              42,161
              
              $
              62,451
              
              $
              71,737
 
 *See
        notes to consolidated financial statements.*
 
 40
  **JAKKS
        PACIFIC, INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OF STOCKHOLDERS’ EQUITY**
 **YEARS
        ENDED DECEMBER 31, 2004, 2005 AND 2006**
 **(In
        thousands)**
 
 **Deferred****Compensation**
              
              **Accumulated****Common
                  Stock**
              
              **Additional**
              
              
              
              **From**
              
              **Other**
              
              **Total****Number**
              
              
              
              **Paid-in**
              
              **Retained**
              
              **Restricted**
              
              **Comprehensive**
              
              **Stockholders’****of
                  Shares**
              
              **Amount**
              
              **Capital**
              
              **Earnings**
              
              **Stock
                  Grants**
              
              **Loss**
              
              **Equity**Balance,
                  December 31, 2003
              
              
              24,927
              
              $
              25
              
              $
              246,008
              
              $
              133,005
              
              $
              (789
              )
              $
              (349
              )
              $
              377,900Exercise
                  of options
              
              
              192
              
              
              —
              
              
              1,699
              
              
              —
              
              
              —
              
              
              —
              
              
              1,699Stock
                  option income tax benefit
              
              
              —
              
              
              —
              
              
              739
              
              
              —
              
              
              —
              
              
              —
              
              
              739Restricted
                  stock grants
              
              
              340
              
              
              —
              
              
              7,487
              
              
              —
              
              
              789
              
              
              —
              
              
              8,276Compensation
                  for fully vested stock options
              
              
              —
              
              
              —
              
              
              5,365
              
              
              —
              
              
              —
              
              
              —
              
              
              5,365Issuance
                  of common stock for Play Along
              
              
              749
              
              
              1
              
              
              14,850
              
              
              —
              
              
              —
              
              
              —
              
              
              14,851Issuance
                  of common stock for Kidz Biz earn-out
              
              
              26
              
              
              —
              
              
              494
              
              
              —
              
              
              —
              
              
              —
              
              
              494Net
                  income
              
              
              —
              
              
              —
              
              
              —
              
              
              43,559
              
              
              —
              
              
              —
              
              
              43,559Foreign
                  currency translation adjustment
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (1,398
              )
              
              (1,398
              )Balance,
                  December 31, 2004
              
              
              26,234
              
              
              26
              
              
              276,642
              
              
              176,564
              
              
              —
              
              
              (1,747
              )
              
              451,485Exercise
                  of options
              
              
              567
              
              
              1
              
              
              4,872
              
              
              —
              
              
              —
              
              
              —
              
              
              4,873Stock
                  option income tax benefit
              
              
              —
              
              
              —
              
              
              4,119
              
              
              —
              
              
              —
              
              
              —
              
              
              4,119Restricted
                  stock grants
              
              
              245
              
              
              —
              
              
              5,130
              
              
              —
              
              
              —
              
              
              —
              
              
              5,130Compensation
                  for fully vested stock options
              
              
              —
              
              
              —
              
              
              (1,706
              )
              
              —
              
              
              —
              
              
              —
              
              
              (1,706
              )Retirement
                  of common stock
              
              
              (101
              )
              
              —
              
              
              (1,701
              )
              
              —
              
              
              —
              
              
              —
              
              
              (1,701
              )Net
                  income
              
              
              —
              
              
              —
              
              
              —
              
              
              63,493
              
              
              —
              
              
              —
              
              
              63,493Foreign
                  currency translation adjustment
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (1,042
              )
              
              (1,042
              )Balance,
                  December 31, 2005
              
              
              26,945
              
              
              27
              
              
              287,356
              
              
              240,057
              
              
              —
              
              
              (2,789
              )
              
              524,651Exercise
                  of options
              
              
              333
              
              
              —
              
              
              4,382
              
              
              —
              
              
              —
              
              
              —
              
              
              4,382Stock
                  option income tax benefit
              
              
              —
              
              
              —
              
              
              1,509
              
              
              —
              
              
              —
              
              
              —
              
              
              1,509Restricted
                  stock grants
              
              
              473
              
              
              1
              
              
              4,579
              
              
              —
              
              
              —
              
              
              —
              
              
              4,580Compensation
                  for fully vested stock options
              
              
              —
              
              
              —
              
              
              1,902
              
              
              —
              
              
              —
              
              
              —
              
              
              1,902Retirement
                  of common stock
              
              
              (124
              )
              
              —
              
              
              (2,798
              )
              
              —
              
              
              —
              
              
              —
              
              
              (2,798
              )Issuance
                  of common stock for Creative Designs
              
              
              150
              
              
              —
              
              
              3,325
              
              
              —
              
              
              —
              
              
              —
              
              
              3,325Net
                  income
              
              
              —
              
              
              —
              
              
              —
              
              
              72,375
              
              
              —
              
              
              —
              
              
              72,375Foreign
                  currency translation adjustment
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (638
              )
              
              (638
              )Balance,
                  December 31, 2006
              
              
              27,777
              
              $
              28
              
              $
              300,255
              
              $
              312,432
              
              $
              —
              
              $
              (3,427
              )
              $
              609,288
 
 *See
        notes to consolidated financial statements.*
 
 41
  **JAKKS
        PACIFIC, INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OF CASH FLOWS**
 
 **Years
                  Ended December 31,****2004**
              
              **2005**
              
              **2006****(In
                  thousands)****Cash
                  flows from operating activities**Net
                  income
              
              $
              43,559
              
              $
              63,493
              
              $
              72,375Adjustments
                  to reconcile net income to net cash provided by operating activities
                  Depreciation and amortization
              
              
              21,518
              
              
              15,527
              
              
              26,166Share-based
                  compensation expense
              
              
              13,641
              
              
              3,424
              
              
              6,482Acquisition
                  earn-out
              
              
              494
              
              
              —
              
              
              —Investment
                  in video game joint venture
              
              
              (719
              )
              
              (548
              )
              
              (5,147
              )Loss
                  on disposal of property and equipment
              
              
              1,096
              
              
              104
              
              
              48Write-off
                  of investment in Chinese Joint Venture
              
              
              —
              
              
              1,401
              
              
              —Changes
                  in operating assets and liabilities
                Accounts
                  receivable
              
              
              (4,333
              )
              
              16,697
              
              
              (52,885
              )Inventory
              
              
              784
              
              
              (13,272
              )
              
              (8,352
              )Prepaid
                  expenses and other
              
              
              (3,613
              )
              
              1,088
              
              
              (8,293
              )Accounts
                  payable
              
              
              19,192
              
              
              (9,437
              )
              
              12,608Accrued
                  expenses
              
              
              19,742
              
              
              (1,915
              )
              
              1,882Income
                  taxes payable
              
              
              5,945
              
              
              (2,936
              )
              
              14,756Reserve
                  for sales returns and allowances
              
              
              13,289
              
              
              1,732
              
              
              5,253Deferred
                  rent liability
              
              
              —
              
              
              995
              
              
              (140
              )Deferred
                  income taxes
              
              
              795
              
              
              (5,292
              )
              
              (1,043
              )Total
                  adjustments
              
              
              87,831
              
              
              7,568
              
              
              (8,665
              )Net
                  cash provided by operating activities
              
              
              131,390
              
              
              71,061
              
              
              63,710**Cash
                  flows from investing activities**Purchases
                  of property and equipment
              
              
              (5,917
              )
              
              (8,270
              )
              
              (11,204
              )Purchases
                  of other assets
              
              
              (26,863
              )
              
              118
              
              
              (655
              )Cash
                  paid for net assets
              
              
              (41,438
              )
              
              (20,362
              )
              
              (109,845
              )Net
                  (purchases) sales of marketable securities
              
              
              967
              
              
              19,047
              
              
              (210
              )Net
                  cash used by investing activities
              
              
              (73,251
              )
              
              (9,467
              )
              
              (121,914
              )**Cash
                  flows from financing activities**Proceeds
                  from stock options exercised (net of cash-less exercises of $1.7
                  million
                  and $2.8 million in 2005 and 2006, respectively)
              
              
              1,682
              
              
              3,173
              
              
              1,584Tax
                  benefit from stock options exercised
              
              
              —
              
              
              —
              
              
              1,509Repayments
                  of debt
              
              
              (61
              )
              
              —
              
              
              —Net
                  cash provided by financing activities
              
              
              1,621
              
              
              3,173
              
              
              3,093Foreign
                  currency translation adjustment
              
              
              (1,398
              )
              
              (1,073
              )
              
              (638
              )Net
                  increase (decrease) in cash and cash equivalents
              
              
              58,362
              
              
              63,694
              
              
              (55,749
              )Cash
                  and cash equivalents, beginning of year
              
              
              118,182
              
              
              176,544
              
              
              240,238Cash
                  and cash equivalents, end of year
              
              $
              176,544
              
              $
              240,238
              
              $
              184,489Cash
                  paid during the period for:Interest
              
              $
              4,534
              
              $
              4,533
              
              $
              4,533Income
                  taxes
              
              $
              2,688
              
              $
              41,284
              
              $
              19,496
 
 See
        Notes
        5 and 18 for additional supplemental information to consolidated statements
        of
        cash flows.
 
 *See
        notes to consolidated financial statements.*
 
 42
  **JAKKS
        PACIFIC, INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
        31, 2006**
 
 **Note
        1—Principal Industry**
 
 JAKKS
        Pacific, Inc. (the “Company”) is engaged in the development, production and
        marketing of consumer products, including toys and related products, stationery
        and writing instruments and pet toys and related products, some of which
        are
        based on highly-recognized entertainment properties and character licenses.
        The
        Company commenced its primary business operations in July 1995 through the
        purchase of substantially all of the assets of a Hong Kong toy company. The
        Company markets its product lines domestically and internationally.
 
 The
        Company was incorporated under the laws of the State of Delaware in January
        1995.
 
 **Note
        2—Summary of Significant Accounting Policies**
 
 ***Principles
        of consolidation***
 
 The
        consolidated financial statements include accounts of the Company and its
        wholly-owned subsidiaries. In consolidation, all significant inter-company
        balances and transactions are eliminated.
 
 ***Cash
        and cash equivalents***
 
 The
        Company considers all highly liquid assets, having an original maturity of
        less
        than three months, to be cash equivalents. The Company maintains its cash
        in
        bank deposits which, at times, may exceed federally insured limits. The Company
        has not experienced any losses in such accounts. The Company believes it
        is not
        exposed to any significant credit risk on cash and cash
        equivalents.
 
 ***Use
        of estimates***
 
 The
        preparation of financial statements in conformity with accounting principles
        generally accepted in the United States of America requires management to
        make
        estimates and assumptions that affect the reported amounts of assets and
        liabilities, disclosure of contingent assets and liabilities at the dates
        of the
        financial statements, and the reported amounts of revenue and expenses during
        the reporting periods. Actual future results could differ from those
        estimates.
 
 ***Revenue
        recognition***
 
 Revenue
        is recognized upon the shipment of goods to customers or their agents, depending
        on terms, provided that there are no uncertainties regarding customer
        acceptance, the sales price is fixed or determinable, and collectibility
        is
        reasonably assured and not contingent upon resale.
 
 Generally,
        the Company does not allow for product returns. The Company provides a
        negotiated allowance for breakage or defects to its customers, which is recorded
        when the related revenue is recognized. However, the Company does make
        occasional exceptions to this policy and consequently accrues a return allowance
        in gross sales based on historic return amounts and management
        estimates.
 
 The
        Company also will occasionally grant credits to facilitate markdowns and
        sales
        of slow moving merchandise. These credits are recorded as a reduction of
        gross
        sales at the time of occurrence. The Company’s reserve for sales returns and
        allowances increased by $7.5 million from $25.1 million as of December 31,
        2005
        to $32.6 million as of December 31, 2006.
 
 ***Inventory***
 
 Inventory,
        which includes the ex-factory cost of goods, capitalized warehouse costs
        and
        in-bound freight and duty, is valued at the lower of cost (first-in, first-out)
        or market, net of inventory obsolescence reserve, and consists of the following
        (in thousands):
 
 **December
                  31,****2005**
              
              **2006**Raw
                  materials
              
              $
              2,679
              
              $
              3,845Finished
                  goods
              
              
              64,050
              
              
              72,943$
              66,729
              
              $
              76,788
  43
  ***Fair
        value of financial instruments***
 
 The
        Company’s cash and cash equivalents, marketable securities and accounts
        receivable represent financial instruments. The carrying value of these
        financial instruments is a reasonable approximation of fair value. The fair
        value of the $98.0 million of convertible senior notes payable at December
        31,
        2006 was approximately $127.4 million based on the quoted market
        price.
 
 ***Property
        and equipment***
 
 Property
        and equipment are stated at cost and are being depreciated using the
        straight-line method over their estimated useful lives as follows:
 
 Office
                  equipment
              
              5
                  yearsAutomobiles
              
              5
                  yearsFurniture
                  and fixtures
              
              5
                  -
                  7 yearsMolds
                  and tooling
              
              2
                  -
                  4 yearsLeasehold
                  improvements
              
              Shorter
                  of length of lease or 10 years
 
 ***Advertising***
 
 Production
        costs of commercials and programming are charged to operations in the year
        during which the production is first aired. The costs of other advertising,
        promotion and marketing programs are charged to operations in the year incurred.
        Advertising expense for the three years in the period ended December 31,
        2006,
        was approximately $26.4 million, $38.8 million and $36.7 million,
        respectively.
 
 The
        Company also participates in cooperative advertising arrangements with some
        customers, whereby it allows a discount from invoiced product amounts in
        exchange for customer purchased advertising that features the Company’s
        products. Typically, these discounts range from 1% to 6% of gross sales,
        and are
        generally based on product purchases or on specific advertising campaigns.
        Such
        amounts are accrued when the related revenue is recognized or when the
        advertising campaign is initiated. These cooperative advertising arrangements
        are accounted for as direct selling expenses.
 
 ***Income
        taxes***
 
 The
        Company does not file a consolidated return with its foreign subsidiaries.
        The
        Company files Federal and state returns and its foreign subsidiaries each
        file
        Hong Kong returns, as applicable. Deferred taxes are provided on a liability
        method whereby deferred tax assets are recognized as deductible temporary
        differences and operating loss and tax credit carry-forwards and deferred
        tax
        liabilities are recognized for taxable temporary differences. Temporary
        differences are the differences between the reported amounts of assets and
        liabilities and their tax basis. Deferred tax assets are reduced by a valuation
        allowance when, in the opinion of management, it is more likely than not
        that
        some portion or all of the deferred tax assets will not be realized. Deferred
        tax assets and liabilities are adjusted for the effects of changes in tax
        laws
        and rates on the date of enactment.
 
 ***Translation
        of foreign currencies***
 
 Assets
        and liabilities denominated in Hong Kong dollars are translated into United
        States dollars at the rate of exchange ruling at the balance sheet date.
        Transactions during the period are translated at the rates ruling at the
        dates
        of the transactions.
 
 Profits
        and losses resulting from the above translation policy are recognized in
        the
        statements of other comprehensive income.
 
 ***Accounting
        for the impairment of long-lived assets***
 
 Long-lived
        assets with finite lives, which include property and equipment, intangible
        assets other than goodwill, are evaluated at least annually for impairment
        when
        events or changes in circumstances indicate that the carrying amount of the
        assets may not be recoverable through the estimated undiscounted future cash
        flows from the use of these assets. When any such impairment exists, the
        related
        assets will be written down to fair value. Finite-lived intangible assets
        consist primarily of product technology rights, acquired backlog, customer
        relationships, product lines and license agreements. These intangible assets
        are
        amortized over the estimated economic lives of the related assets. Accumulated
        amortization as of December 31, 2005 and 2006 was $32.0 million and $48.5
        million, respectively.
 
 44
  ***Goodwill
        and other indefinite-lived intangible assets***
 
 In
        accordance with the adoption of Statement of Financial Accounting Standards
        (“SFAS”) 142, *Goodwill
        and Other Intangible Assets,* on
        January 1, 2002, goodwill and indefinite-lived intangible assets are not
        amortized, but are tested for impairment at least annually at the reporting
        unit
        level. Losses in value are recorded when and as material impairment has occurred
        in the underlying assets or when the benefits of the identified intangible
        assets are realized. As of December 31, 2006, there was no impairment to
        the
        underlying value of goodwill or indefinite-lived intangible assets other
        than
        goodwill. Indefinite-lived intangible assets other than goodwill consists
        of
        trademarks.
 
 The
        carrying value of goodwill and trademarks are based on cost which is subject
        to
        management’s current assessment of fair value. Management evaluates fair value
        recoverability using both objective and subjective factors. Objective factors
        include management’s best estimates of projected future earnings and cash flows
        and analysis of recent sales and earnings trends. Subjective factors include
        competitive analysis and the Company’s strategic focus.
 
 ***Share-based
        Payments***
 
 In
        December 2004, the FASB issued SFAS 123 (Revised), *Share-Based
        Payment* ,
        (SFAS
        123R) which amends SFAS 123, *Accounting
        for Stock Based Compensation,* and
        SFAS
        95, *Statement
        of Cash Flows* .
        SFAS
        123R requires companies to measure all employee stock-based compensation
        awards
        using a fair value method and record such expense in its consolidated financial
        statements, and requires additional accounting and disclosure related to
        the
        income tax and cash flow effects resulting from share-based payment
        arrangements. SFAS 123R was effective for the Company beginning as of January
        1,
        2006, and it recorded $1.9 million of share-based compensation expense in
        2006
        as further detailed in Note 16.
 
 ***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 (“EPS”) for the periods
        presented (in thousands, except per share data):
 
 **2004****Weighted****Average****Income**
              
              **Shares**
              
              **Per
                  Share**Basic
                  EPSIncome
                  available to common stockholders
              
              $
              43,559
              
              
              25,797
              
              $
              1.69Effect
                  of dilutive securitiesAssumed
                  conversion of convertible senior notes
              
              
              3,354
              
              
              4,900Options
                  and warrants
              
              
              —
              
              
              709Diluted
                  EPSIncome
                  available to common stockholders plus assumed exercises
              
              $
              46,913
              
              
              31,406
              
              $
              1.49
 
 **2005****Weighted****Average****Income**
              
              **Shares**
              
              **Per
                  Share**Basic
                  EPSIncome
                  available to common stockholders
              
              $
              63,493
              
              
              26,738
              
              $
              2.37Effect
                  of dilutive securitiesAssumed
                  conversion of convertible senior notes
              
              
              2,978
              
              
              4,900Options
                  and warrants
              
              
              —
              
              
              555Diluted
                  EPSIncome
                  available to common stockholders plus assumed exercises
              
              $
              66,471
              
              
              32,193
              
              $
              2.06
 
 45
 
 **2006****Weighted****Average****Income**
              
              **Shares**
              
              **Per
                  Share**Basic
                  EPSIncome
                  available to common stockholders
              
              $
              72,375
              
              
              27,227
              
              $
              2.66Effect
                  of dilutive securitiesAssumed
                  conversion of convertible senior notes
              
              
              2,946
              
              
              4,900Options
                  and warrants
              
              
              —
              
              
              362Unvested
                  restricted stock grants
              
              
              —
              
              
              225Diluted
                  EPSIncome
                  available to common stockholders plus assumed exercises
              
              $
              75,321
              
              
              32,714
              
              $
              2.30
  Basic
        earnings per share has been computed using the weighted average number of
        common
        shares outstanding. Diluted earnings per share has been computed using the
        weighted average number of common shares and common share equivalents
        outstanding (which consist of warrants, options and convertible debt to the
        extent they are dilutive). Potentially dilutive stock options of 279,275,
        487,506 and 406,612 for the years ended December 31, 2004, 2005 and 2006,
        respectively, were not included in the computation of diluted earning per
        share
        as the average market price of the Company’s common stock did not exceed the
        weighted average exercise price of such options and to have included them
        would
        have been anti-dilutive.
 
 ***Recent
        Accounting Standards***
 
 In
        July
        2006, the FASB issued Interpretation No. (“FIN”) 48, *Accounting
        for Uncertainly in Income Taxes, an Interpretation of SFAS 109* ,
        which
        clarifies the accounting for income taxes by prescribing the minimum recognition
        threshold an uncertain tax position is required to meet before tax benefits
        associated with such uncertain tax position are recognized in the financial
        statements. FIN 48 also provides guidance on derecognition, measurement,
        classification, interest and penalties, accounting in interim periods,
        disclosure and transition. In addition, FIN 48 excludes income taxes from
        the
        scope of SFAS 5, Accounting for Contingencies. FIN 48 is effective for fiscal
        years beginning after December 15, 2006. Differences between the amounts
        recognized in the consolidated balance sheets prior to the adoption of FIN
        48
        and the amounts reported after adoption are accounted for as a cumulative-effect
        adjustment to the beginning balance of retained earnings upon adoption of
        FIN
        48. FIN 48 also requires that amounts recognized in the balance sheet related
        to
        uncertain tax positions be classified as a current or noncurrent liability,
        based upon the timing of the ultimate payment to a taxing authority. The
        Company
        will adopt FIN 48 as of January 1, 2007 and is in the process of finalizing
        the
        effect FIN 48 will have on its financial statements. Under the guidance of
        FIN
        48, management estimates that its income tax reserve may increase by
        approximately $15.0 million to $25.0 million, which is subject to revision
        when
        management completes an analysis of the impact of FIN 48. As required by
        FIN 48,
        upon adoption on January 1, 2007, this difference will be recorded in retained
        earnings as a cumulative effect adjustment.
 
 In
        September 2006, the FASB issued SFAS 157, *Fair
        Value Measurements* ,
        which
        provides guidance for using fair value to measure assets and liabilities.
        Under
        SFAS 157, fair value refers to the price that would be received to sell an
        asset
        or paid to transfer a liability in an orderly transaction that fair value
        should
        be based on the assumptions market participants would use when pricing the
        asset
        or liability and establishes a fair value hierarchy that prioritizes the
        information used to develop those assumptions. The fair value hierarchy gives
        the highest priority to quoted prices in active markets and the lowest priority
        to unobservable data, for example, the reporting entity’s own data. Fair value
        measurements would be separately disclosed by level within the fair value
        hierarchy. SFAS 157 is effective for financial statements issued for fiscal
        years beginning after November 15, 2007, and interim periods within those
        fiscal
        years. The Company does not expect the adoption of SFAS 157 to have a material
        impact on its results of operations and financial position.
 
 In
        February 2007, the FASB issued SFAS 159, *Fair
        Value Option for Financial Assets and Financial Liabilities* ,
        which
        provides companies with an option to report selected financial assets and
        liabilities at fair value. The objective of SFAS 159 is to reduce both the
        complexity in accounting for financial instruments and the volatility in
        earnings caused by measuring related assets and liabilities differently.
        SFAS
        159 is effective for the Company as of January 1, 2008 and it does not expect
        the adoption of SFAS 159 to have a material effect on its operating results
        or
        financial position.
 
 ***Reclassifications***
 
 Certain
        reclassifications have been made to prior year balances in order to conform
        to
        the current year presentation.
 
 46
  **Note
        3—Business Segments, Geographic Data, Sales by Product Group, and Major
        Customers**
 
 The
        Company 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, plush, construction toys, and infant and preschool toys, as well as
        pet
        treats, toys and related pet products. Prior to 2006, the Company’s reportable
        segments were North America Toys, Pet Products and International. During
        2006,
        the Company reorganized its business segments to conform to product groups
        that
        have become the focus of management review. The Company’s reportable segments
        are Traditional Toys, Craft/Activity/Writing Products, Seasonal/Outdoor
        Products, and Pet Products.
 
 All
        segments included worldwide sales. Traditional Toys include boys’ action
        figures, vehicles and playsets, plush products, role-play and electronic
        toys.
        Craft/Activity/Writing Products include pens, pencils, stationery and drawing,
        painting and other craft related products. Seasonal/Outdoor Products include
        swimming pool toys, kites, remote control flying vehicles, squirt guns, and
        related products. Pet Products include pet treats, toys and related
        products.
 
 Segment
        performance is measured at the operating income level. All sales are made
        to
        external customers, and general corporate expenses have been attributed to
        the
        various segments based on sales volumes. Segment assets are comprised of
        accounts receivable and inventories, net of applicable reserves and allowances,
        goodwill and other assets.
 
 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 years in the period ended December 31, 2006
        are
        as follows (in thousands):
 
 **Years
                  Ended December 31,****2004**
              
              **2005**
              
              **2006****Net
                  Sales**Traditional
                  Toys
              
              $
              463,299
              
              $
              568,737
              
              $
              658,804Craft/Activity/Writing
                  Products
              
              
              84,197
              
              
              62,058
              
              
              52,834Seasonal/Outdoor
                  Products
              
              
              26,770
              
              
              20,978
              
              
              33,694Pet
                  Products
              
              
              —
              
              
              9,763
              
              
              20,054$
              574,266
              
              $
              661,536
              
              $
              765,386
 
 **Years
                  Ended December 31,****2004**
              
              **2005**
              
              **2006****Operating
                  Income**Traditional
                  Toys
              
              $
              43,344
              
              $
              75,643
              
              $
              79,457Craft/Activity/Writing
                  Products
              
              
              7,877
              
              
              8,254
              
              
              6,372Seasonal/Outdoor
                  Products
              
              
              2,504
              
              
              2,790
              
              
              4,064Pet
                  Products
              
              
              —
              
              
              1,298
              
              
              2,419$
              53,725
              
              $
              87,985
              
              $
              92,312
 
 **December
                  31,****2005**
              
              **2006****Assets**Traditional
                  Toys
              
              $
              526,984
              
              $
              687,162Craft/Activity/Writing
                  Products
              
              
              153,646
              
              
              119,883Seasonal/Outdoor
                  Products
              
              
              56,241
              
              
              56,784Pet
                  Products
              
              
              17,084
              
              
              18,065$
              753,955
              
              $
              881,894
 
 The
        following tables present information about the Company by geographic area
        as of
        and for the three years ended December 31, 2006 (in thousands):
  **December
                  31,****2005**
              
              **2006****Long-lived
                  Assets**United
                  States
              
              $
              283,350
              
              $
              352,959Hong
                  Kong
              
              
              34,038
              
              
              60,814$
              317,388
              
              $
              413,773
  47
 **Years
                    Ended December 31,****2004**
                
                **2005**
                
                **2006****Net
                    Sales by Geographic Area**United
                    States
                
                $
                505,803
                
                $
                562,396
                
                $
                666,294Europe
                
                
                37,700
                
                
                38,620
                
                
                30,169Canada
                
                
                15,658
                
                
                20,589
                
                
                27,067Hong
                    Kong
                
                
                4,410
                
                
                24,388
                
                
                17,500Other
                
                
                10,695
                
                
                15,543
                
                
                24,356$
                574,266
                
                $
                661,536
                
                $
                765,386
 
 **Major
          Customers**
 
 Net
          sales
          to major customers were approximately as follows (in thousands, except
          for
          percentages):
 
 **2004**
                
                **2005**
                
                **2006****Percentage**
                
                
                
                **Percentage**
                
                
                
                **Percentage****Amount**
                
                **of
                    Net Sales**
                
                **Amount**
                
                **of
                    Net Sales**
                
                **Amount**
                
                **of
                    Net Sales**Wal-Mart
                
                $
                193,776
                
                
                33.7
                %
                $
                212,620
                
                
                32.1
                %
                $
                210,758
                
                
                27.5
                %Target
                
                
                74,429
                
                
                13.0
                
                
                95,716
                
                
                14.5
                
                
                134,347
                
                
                17.6Toys
                    ‘R’ Us
                
                
                68,279
                
                
                11.9
                
                
                82,732
                
                
                12.5
                
                
                104,392
                
                
                13.6$
                336,484
                
                
                58.6
                %
                $
                391,068
                
                
                59.1
                %
                $
                449,497
                
                
                58.7
                %
 
 No
          other
          customer accounted for more than 10% of our total net sales.
 
 At
          December 31, 2005 and 2006, the Company’s three largest customers accounted for
          approximately 73.0% and 78.1%, respectively, of net accounts receivable.
          The
          concentration of the Company’s business with a relatively small number of
          customers may expose the Company to material adverse effects if one or
          more of
          its large customers were to experience financial difficulty. The Company
          performs ongoing credit evaluations of its top customers and maintains
          an
          allowance for potential credit losses.
 
 **Note
          4—Joint Ventures**
  The
          Company owns a fifty percent interest in a joint venture with THQ Inc.
          (“THQ”)
          which develops, publishes and distributes interactive entertainment software
          for
          the leading hardware game platforms in the home video game market. The
          joint
          venture has entered into a license agreement with an initial license period
          expiring December 31, 2009 and a renewal period at the option of the joint
          venture expiring December 31, 2014 under which it acquired the exclusive
          worldwide right to publish video games on all hardware platforms. The Company’s
          investment is accounted for using the cost method due to the financial
          and
          operating structure of the venture and its lack of significant influence
          over
          the joint venture. The Company’s basis consists primarily of organizational
          costs, license costs and recoupable advances and is being amortized over
          the
          term of the initial license period. The joint venture agreement provides
          for the
          Company to receive guaranteed preferred returns through June 30, 2006 at
          varying
          rates of the joint venture’s net sales depending on the cumulative unit sales
          and platform of each particular game. The
          preferred return was subject to change after June 30, 2006 and was to be
          set for the distribution period beginning July 1, 2006 and ending
          December 31, 2009 (the “Next Distribution Period”). The agreement provides
          that the parties will negotiate in good faith and agree to the preferred
          return
          not less than 180 days prior to the start of the Next Distribution Period.
          It further provides that if the parties are unable to agree on a preferred
          return, the preferred return will be determined by arbitration. The parties
          have
          not reached an agreement with respect to the preferred return for the Next
          Distribution Period and the Company anticipates that the reset, if any,
          of the
          preferred return will be determined through arbitration. The
          preferred return is accrued in the quarter in which the licensed games
          are sold
          and the preferred return is earned. Based on the same rates as set forth
          under
          the original joint venture agreement, an estimated receivable of $13.5
          million
          has been accrued for the six months ended December 31, 2006, pending the
          resolution of this outstanding issue. As of December 31, 2005 and 2006,
          the
          balance of the investment in the video game joint venture includes the
          following
          components (in thousands):
  
 **December
                    31,****2005**
                
                **2006**Preferred
                    return receivable
                
                $
                8,334
                
                $
                13,482Investment
                    costs, net
                
                
                2,031
                
                
                1,391$
                10,365
                
                $
                14,873
 
 48
  The
          Company’s joint venture partner retains the financial risk of the joint venture
          and is responsible for the day-to-day operations, including development,
          sales
          and distribution, for which they are entitled to any remaining profits.
          In
          addition, THQ is entitled to receive a preferred return based on the sale
          by the
          Company of its WWE-themed TV Games. During 2005 and 2006, the Company incurred
          a
          liability of approximately $0.8 million and $0.1 million, respectively,
          which is
          recorded as a reduction of profit from the joint venture. During 2004,
          2005 and
          2006, the Company earned $7.9 million, $9.4 million and $13.2 million,
          respectively, in net profit from the joint venture.
 
 During
          2005, the Company wrote-off its $1.4 million investment in a Chinese joint
          venture to Other Expense on its determination that none of the value would
          be
          realized.
 
 **Note
          5—Business Combinations**
 
 The
          Company acquired the following entities to further enhance its existing
          product
          lines and to continue diversification into other toy categories and seasonal
          businesses:
  On
          February 9, 2006, the Company acquired substantially all of the assets
          of
          Creative Designs International, Ltd. and a related Hong Kong company, Arbor
          Toys
          Company Limited (collectively, “Creative Designs”). The total initial
          consideration of $111.1 million consisted of cash paid at closing in the
          amount
          of $101.7 million, the issuance of 150,000 shares of the Company’s common stock
          valued at approximately $3.3 million and the assumption of liabilities
          in the
          amount of $6.1 million, and resulted in the recording of goodwill in the
          amount
          of $53.6 million. Goodwill represents anticipated synergies to be gained
          via the
          combination of Creative Designs with the Company. In addition, the Company
          agreed to pay an earn-out of up to an aggregate of $20.0 million in cash
          over
          the three calendar years following the acquisition based on the achievement
          of
          certain financial performance criteria, which will be recorded as goodwill
          when
          and if earned. For the year ended December 31, 2006, $6.9 million of the
          earn-out was earned and recorded as goodwill. Creative Designs is a leading
          designer and producer of dress-up and role-play toys. This acquisition
          expands
          the Company’s product offerings in the girls role-play and dress-up area and
          brings it new product development and marketing talent . The Company’s results
          of operations have included Creative Designs from the date of
          acquisition.
  The
          amount of goodwill from the Creative Designs acquisition that is expected
          to be
          deductible for Federal and state income tax purposes is approximately $51.4
          million. The total purchase price was allocated based on studies and valuations
          performed to the estimated fair value of assets acquired and liabilities
          assumed. The purchase price allocation including an earn-out of $6.9 million
          earned through December 31, 2006 is set forth in the following table (in
          thousands):
  Estimated
                    fair value of net assets:Current
                    assets acquired
                
                $
                15,655Property
                    and equipment, net
                
                
                1,235Other
                    assets
                
                
                103Liabilities
                    assumed
                
                
                (6,081
                )Intangible
                    assets other than
                    goodwill
                
                
                40,488Goodwill
                
                
                60,519$
                111,919
 
 The
          following unaudited pro forma information represents the Company’s consolidated
          results of operations as if the acquisition of Creative Designs had occurred
          on
          January 1, 2005 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 ongoing 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
          acquisition of Creative Designs actually occurred on January 1, 2005 or
          on
          future operating results.
 
 **Year
                    Ended December 31,****2005**
                
                **2006****(In
                    thousands,****Except
                    per share data)**Net
                    sales
                
                $
                829,622
                
                $
                778,269Net
                    income
                
                $
                81,702
                
                $
                75,221Basic
                    earnings per share
                
                $
                3.02
                
                $
                2.73Weighted
                    average shares outstanding
                
                
                27,049
                
                
                27,512Diluted
                    earnings per share
                
                $
                2.62
                
                $
                2.38Weighted
                    average shares and equivalents outstanding
                
                
                32,342
                
                
                32,777
 
 49
  In
          June
          2005, the Company purchased substantially all of the operating assets and
          assumed certain liabilities relating to the Pet Pal line of pet products,
          including toys, treats and related pet products. The total initial purchase
          price of $10.6 million was paid in cash. In addition, the Company agreed
          to pay
          an earn-out of up to an aggregate amount of $25.0 million in cash over
          the three
          years ending June 30, 2008 following the acquisition based on the achievement
          of
          certain financial performance criteria, which will be recorded as goodwill
          when
          and if earned. During the year-ended December 31, 2006, $1.5 million of
          the
          earn-out was earned and recorded as goodwill. Goodwill of $4.6 million
          arose
          from this transaction, which represents the excess of the purchase price
          over
          the fair value of assets acquired less the liabilities assumed. This acquisition
          expands the Company’s product offerings and distribution channels. The Company’s
          results of operation have included Pet Pal from the date of acquisition.
          Proforma results of operations are not provided since the amounts are not
          material to the consolidated results of operations.
 
 In
          June
          2004, the Company purchased substantially all of the assets and assumed
          certain
          liabilities of Play Along, Inc. and related companies (collectively, “Play
          Along”). The total initial purchase price of $85.7 million consisted of cash
          paid in the amount of $70.8 million and the issuance of 749,005 shares
          of the
          Company common stock valued at $14.9 million and resulted in goodwill of
          $67.8
          million. In addition, the Company agreed to pay an earn-out of up to $10.0
          million per year for the three calendar years following the acquisition
          up to an
          aggregate amount of $30.0 million based on the achievement of certain financial
          performance criteria which will be recorded as goodwill when and if earned.
          For
          the three years ended December 31, 2006, $10.0 million, $6.7 million and
          $6.7
          million, respectively, of the earn-out was earned and recorded as goodwill.
          Accordingly, the maximum earn-out remaining for the year ending December
          31,
          2007 is approximately $6.6 million. Play Along designs and produces traditional
          toys, which it distributes domestically and internationally. This acquisition
          expands the Company’s product offerings in the pre-school area and brings new
          product development and marketing talent to the Company. This transaction
          has
          been accounted for by the Company under the purchase method of accounting,
          and
          the Company’s results of operations have included Play Along from the date of
          acquisition.
 
 In
          determining the allocation of the purchase price of Play Along, the Company
          considered the acquired intangible assets that arise from contractual or
          other
          legal rights, including trademarks, copyrights, patents and license agreements,
          potential noncontractual intangible assets, including customer lists and
          customer-related relationships, as well as the value of synergies that
          will
          result from combining the operations of Play Along into the operations
          of the
          Company.
 
 The
          total
          purchase price of Play Along, including the earn-outs earned through December
          31, 2006 in the aggregate amount of $23.4 million, which was allocated
          to
          goodwill, was allocated to the estimated fair value of assets acquired
          and
          liabilities assumed as set forth in the following table (in
          thousands):
 
 Estimated
                    fair value:Current
                    assets
                
                $
                24,063Property
                    and equipment, net
                
                
                546Other
                    assets
                
                
                3,184Liabilities
                    assumed
                
                
                (22,263
                )Intangible
                    assets other than goodwill
                
                
                22,100Goodwill
                
                
                81,390$
                109,020
 
 Approximately
          $46.4 million of the Play Along goodwill is expected to be deductible for
          Federal and state income tax purposes.
 
 **Note
          6—Goodwill**
 
 The
          changes in the carrying amount of goodwill for the year ended December
          31, 2006
          are as follows (in thousands):
 
 **Traditional
                    Toys**
                
                **Craft/Activity/**
                  **Writing
                    Products**
                
                **Seasonal/
                    Outdoor Products**
                
                **Pet**
                  **Products**
                
                **Total**Balance
                    at beginning of the year
                
                $
                142,962
                
                $
                82,826
                
                $
                38,906
                
                $
                4,604
                
                $
                269,298Goodwill
                    acquired during the year (See Note 5)
                
                
                60,519
                
                
                —
                
                
                —
                
                
                —
                
                
                60,519Adjustments
                    to goodwill during the year
                
                
                6,662
                
                
                —
                
                
                —
                
                
                1,520
                
                
                8,182Balance
                    at end of the year
                
                $
                210,143
                
                $
                82,826
                
                $
                38,906
                
                $
                6,124
                
                $
                337,999
 
 Adjustments
          to goodwill during the year represents earn-outs earned during the year
          on
          acquisitions made in prior years (see Note 5).
  50
  **Note
          7—Intangible Assets Other Than Goodwill**
 
 Intangible
          assets other than goodwill consist primarily of licenses, product lines,
          debt
          offering costs from the Company’s convertible senior notes and trademarks.
          Amortized intangible assets are included in the Intangibles and other,
          net, in
          the accompanying balance sheets. Trademarks are disclosed separately in
          the
          accompanying balance sheets. Intangible assets are as follows (in
          thousands):
 
 **December
                    31, 2005**
                
                **December
                    31, 2006****Weighted**
                  **Useful
                    Lives**
                
                **Gross
                    Carrying**
                  **Amount**
                
                **Accumulated**
                  **Amortization**
                
                **Net**
                  **Amount**
                
                **Gross
                    Carrying**
                  **Amount**
                
                **Accumulated**
                  **Amortization**
                
                **Net**
                  **Amount**Amortized
                    Intangible
                  Assets:Acquired
                    order backlog
                
                
                0.50
                
                $
                —
                
                $
                —
                
                $
                —
                
                $
                1,298
                
                $
                (1,298
                )
                $
                —Licenses
                
                
                4.75
                
                
                23,635
                
                
                (12,082
                )
                
                11,553
                
                
                58,699
                
                
                (25,821
                )
                
                32,878Product
                    lines
                
                
                3.50
                
                
                17,700
                
                
                (17,700
                )
                
                —
                
                
                17,700
                
                
                (17,700
                )
                
                —Customer
                    relationships
                
                
                6.25
                
                
                1,846
                
                
                (700
                )
                
                1,146
                
                
                3,646
                
                
                (1,239
                )
                
                2,407Non-compete/
                    Employment contracts
                
                
                4.00
                
                
                2,748
                
                
                (1,049
                )
                
                1,699
                
                
                2,748
                
                
                (1,753
                )
                
                995Debt
                    offering costs
                
                
                20
                    Years
                
                
                3,705
                
                
                (477
                )
                
                3,228
                
                
                3,705
                
                
                (662
                )
                
                3,043Total
                    amortized intangible assets
                
                
                
                
                
                49,634
                
                
                (32,008
                )
                
                17,626
                
                
                87,796
                
                
                (48,473
                )
                
                39,323Unamortized
                    Intangible
                  Assets:Trademarks
                
                
                indefinite
                
                
                17,768
                
                
                N/A
                
                
                17,768
                
                
                19,568
                
                
                N/A
                
                
                19,568$
                67,402
                
                $
                (32,008
                )
                $
                35,394
                
                $
                107,364
                
                $
                (48,473
                )
                $
                58,891
  For
          the
          years ended December 31, 2004, 2005, and 2006, the Company’s aggregate
          amortization expense related to intangible assets was $14.0 million, $9.1
          million and $16.5 million, respectively. The Company currently estimates
          continuing amortization expense for the next five years to be approximately
          (in
          thousands):
 
 2007
                
                $
                14,0432008
                
                
                9,1082009
                
                
                5,2492010
                
                
                3,0482011
                
                
                2,011
  **Note
          8—Concentration of Credit Risk**
 
 Financial
          instruments that subject the Company to concentration of credit risk are
          cash
          and cash equivalents and accounts receivable. Cash equivalents consist
          principally of short-term money market funds. These instruments are short-term
          in nature and bear minimal risk. To date, the Company has not experienced
          losses
          on these instruments.
 
 The
          Company performs ongoing credit evaluations of its customers’ financial
          condition, but does not require collateral to support domestic customer
          accounts
          receivable. Most goods shipped FOB Hong Kong or China are secured with
          irrevocable letters of credit.
 
 At
          December 31, 2005 and 2006, the Company’s three largest customers accounted for
          approximately 73.0% and 78.1%, respectively, of net accounts receivable.
          The
          concentration of the Company’s business with a relatively small number of
          customers may expose the Company to material adverse effects if one or
          more of
          its large customers were to experience financial difficulty. The Company
          performs ongoing credit evaluations of its top customers and maintains
          an
          allowance for potential credit losses.
 
 51
  **Note
          9—Accrued Expenses**
 
 Accrued
          expenses consist of the following (in thousands):
 
 **2005**
                
                **2006**Royalties
                
                $
                15,918
                
                $
                17,829Bonuses
                
                
                11,554
                
                
                7,172Acquisition
                    earn-out
                
                
                6,667
                
                
                13,598Employee
                    salaries and benefits
                
                
                1,781
                
                
                1,616Promotional
                    commitment
                
                
                1,066
                
                
                1,341Sales
                    commissions
                
                
                682
                
                
                1,764Molds
                    and tools
                
                
                868
                
                
                1,489Other
                
                
                5,879
                
                
                9,855$
                44,415
                
                $
                54,664
 
 **Note
          10—Related Party Transactions**
 
 A
          director of the Company is a partner in the law firm that acts as counsel
          to the
          Company. The Company incurred legal fees and expenses to the law firm in
          the
          amount of approximately $3.3 million in 2004, $3.2 million in 2005 and
          $2.7 in
          2006.
 
 **Note
          11—Convertible Senior Notes**
 
 Convertible
          senior notes consist of the following (in thousands):
 
 **2005**
                
                **2006**4.625%
                    Convertible senior notes
                
                $
                98,000
                
                $
                98,000
 
 In
          June
          2003, the Company sold an aggregate of $98.0 million of 4.625% Convertible
          Senior Notes due June 15, 2023. The notes may be converted into shares
          of the
          Company’s common stock at an initial conversion price of $20.00 per share, or 50
          shares per note, subject to certain circumstances. The notes may be converted
          in
          each quarter subsequent to any quarter in which the closing price of the
          Company’s common stock is at or above a prescribed price for at least 20 trading
          days in the last 30 trading day period of the quarter. The prescribed price
          for
          the conversion trigger is $24.00 through June 30, 2010, and increases nominally
          each quarter thereafter. Cash interest is payable 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, interest will accrue at the same rate on the outstanding
          notes.
          At maturity, the Company 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, unless redeemed or converted earlier. The notes were not
          convertible as of December 31, 2006.
 
 The
          Company may redeem the notes at its option in whole or in part beginning
          on June
          15, 2010, at 100% of their accreted principal amount plus accrued and unpaid
          interest, if any, payable in cash. Holders of the notes may also require
          the
          Company 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, if any. Holders of the notes may also require the Company
          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, 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.
 
 The
          following is a schedule of payments for the convertible senior notes (in
          thousands):
 
 2007
                
                $
                —2008
                
                
                —2009
                
                
                —2010
                
                
                —2011
                
                
                —Thereafter
                
                
                98,000$
                98,000
 
 52
  **Note
          12—Income Taxes**
 
 The
          Company does not file a consolidated return with its foreign subsidiaries.
          The
          Company files Federal and state returns and its foreign subsidiaries file
          Hong
          Kong and United Kingdom returns. Income taxes reflected in the accompanying
          consolidated statements of operations are comprised of the following (in
          thousands):
 
 **2004**
                
                **2005**
                
                **2006**Federal
                
                $
                696
                
                $
                20,821
                
                $
                22,031State
                    and local
                
                
                1,088
                
                
                4,326
                
                
                4,310Foreign
                
                
                12,954
                
                
                13,290
                
                
                8,20414,738
                
                
                38,437
                
                
                34,545APIC
                
                
                —
                
                
                —
                
                
                58Deferred
                
                
                795
                
                
                (5,293
                )
                
                (1,043
                )$
                15,533
                
                $
                33,144
                
                $
                33,560
 
 The
          components of deferred tax assets/(liabilities) are as follows (in
          thousands):
 
 **2005**
                
                **2006**Net
                    deferred tax assets/(liabilities):Current:Reserve
                    for sales allowances and possible losses
                
                $
                3,305
                
                $
                881Accrued
                    expenses
                
                
                1,895
                
                
                2,404Restricted
                    stock grant
                
                
                31
                
                
                1,882Foreign
                    tax credit
                
                
                (127
                )
                
                —Federal
                    and state net operating loss carryforwards
                
                
                4,117
                
                
                2,993Deductible
                    intangible assets
                
                
                2,240
                
                
                2,079State
                    income taxes
                
                
                2,309
                
                
                1,302Other
                
                
                (152
                )
                
                (29
                )13,618
                
                
                11,512Long
                    Term:Undistributed
                    earnings
                
                
                (3,802
                )
                
                —Property
                    and equipment
                
                
                (2,419
                )
                
                (608
                )Original
                    issue discount interest
                
                
                (4,355
                )
                
                (8,816
                )Deductible
                    goodwill and intangibles
                
                
                1,103
                
                
                1,873Foreign
                    tax credit
                
                
                2,718
                
                
                2,718Stock
                    options
                
                
                —
                
                
                686Income
                    from joint venture
                
                
                —
                
                
                1,770Other
                
                
                309
                
                
                —(6,446
                )
                
                (2,377
                )Valuation
                    allowance related to federal and state net operating loss
                    carryforwards
                
                
                —
                
                
                (920
                )Total
                    net deferred tax assets/(liabilities)
                
                $
                7,172
                
                $
                8,215
 
 In
          October 2004, the American Jobs Creation Act of 2004 (the “Act”) was signed into
          law. The Act created a one-time incentive for U.S. corporations to repatriate
          undistributed earnings from their international subsidiaries by providing
          an 85%
          dividends-received deduction for certain international earnings. The deduction
          was available to corporations during the tax year that included October
          2004, or
          in the immediately subsequent tax year. In the fourth quarter of 2005,
          the
          Company’s Board of Directors approved a plan to repatriate $105.5 million in
          foreign earnings, which was completed in December 2005. The Federal and
          State
          income tax expense related to this repatriation was approximately $5.4
          million.
 
 Income
          tax expense varies from the U.S. Federal statutory rate. The following
          reconciliation shows the significant differences in the tax at statutory
          and
          effective rates:
 
 **2004**
                
                **2005**
                
                **2006**Federal
                    income tax expense
                
                
                35.0
                %
                
                35.0
                %
                
                35.0
                %State
                    income tax expense, net of federal tax effect
                
                
                1.3
                
                
                2.1
                
                
                2.6One
                    time dividend from foreign subsidiaries
                
                
                —
                
                
                8.3
                
                
                —Effect
                    of differences in U.S. and Foreign statutory rates
                
                
                (12.1
                )
                
                (9.0
                )
                
                (5.4
                )Other
                
                
                1.8
                
                
                (2.1
                )
                
                (0.5
                )26.0
                %
                
                34.3
                %
                
                31.7
                %
  53
  Deferred
          taxes result from temporary differences between tax bases of assets and
          liabilities and their reported amounts in the consolidated financial statements.
          The temporary differences result from costs required to be capitalized
          for tax
          purposes by the U.S. Internal Revenue Code (“IRC”), and certain items accrued
          for financial reporting purposes in the year incurred but not deductible
          for tax
          purposes until paid.
 
 As
          of
          December 31, 2006, the Company has federal and state net operating loss
          carryforwards of $5.9 million and $12.5 million, respectively, expiring
          through
          2023 and 2024. These carryforwards resulted from the acquisitions of Pentech
          and
          Toymax. The utilization of these losses to offset future income is limited
          under
          IRC§382. As of December 31, 2006, the Company’s management concluded that a
          deferred tax asset valuation allowance was necessary for $0.9 million of
          the
          state net operating loss carryforwards due to uncertainly about the ability
          to
          utilize these losses prior to expiration.
 
 The
          components of income before provision for income taxes are as follows (in
          thousands):
 
 **2004**
                
                **2005**
                
                **2006**Domestic
                
                $
                (22,669
                )
                $
                24,953
                
                $
                58,227Foreign
                
                
                81,761
                
                
                71,684
                
                
                47,708$
                59,092
                
                $
                96,637
                
                $
                105,935
 
 **Note
          13—Leases**
 
 The
          Company leases office, warehouse and showroom facilities and certain equipment
          under operating leases. Rent expense for the years ended December 31, 2004,
          2005
          and 2006 totaled $5.8 million, $7.1 million and $9.1 million, respectively.
          The
          following is a schedule of minimum annual lease payments (in
          thousands).
 
 2007
                
                $
                8,1462008
                
                
                6,9642009
                
                
                5,3832010
                
                
                4,6332011
                
                
                4,548Thereafter
                
                
                7,729$
                37,403
 
 **Note
          14—Common Stock, Preferred Stock and Warrants**
 
 The
          Company has 105,000,000 authorized shares of stock consisting of 100,000,000
          shares of $.001 par value common stock and 5,000,000 shares of $.001 par
          value
          preferred stock.
 
 During
          2006, the Company issued 150,000 shares of common stock at a value of $3.3
          million in connection with the Creative Designs acquisition. The Company
          issued
          473,160 shares of restricted stock to two executive officers, five non-employee
          directors of the Company and certain of the Company’s management at a value of
          approximately $9.0 million. The Company also issued 333,228 shares of common
          stock on the exercise of options for a total value of $4.4 million, including
          37,910 shares of common stock acquired by two executive officers in a cashless
          exercise of options through the surrender of an aggregate of 13,264 shares
          of
          restricted stock as payment of the exercise prices therefor at a value
          of $0.3
          million. In addition, the two executive officers surrendered an aggregate
          of
          110,736 shares of restricted stock at a value of $2.5 million as payment
          for
          income taxes due on the vesting of such stock. This restricted stock was
          subsequently retired by the Company.
 
 During
          2005, the Company issued 245,000 shares of restricted stock to two executive
          officers and five non-employee directors of the Company at a value of
          approximately $5.1 million. The Company also issued 566,546 shares of common
          stock on the exercise of options for a total of $4.9 million, including
          215,982
          shares of common stock acquired by two executive officers in a cashless
          exercise
          of options through the surrender of an aggregate of 101,002 shares of restricted
          stock as payment of the exercise prices therefor at a value of $1.7 million.
          This restricted stock was subsequently retired by the Company.
 
 During
          2004, the Company issued 749,005 shares of common stock at a value of $14.9
          million in connection with the Play Along acquisition and 25,749 shares
          of
          common stock at a value of $0.5 million in connection with the 2001 Kidz
          Biz
          acquisition. In addition, the Company issued 340,310 shares of restricted
          stock
          to three executive officers and five non-employee directors of the Company
          at a
          value of approximately $4.5 million. The Company also issued 192,129 shares
          of
          common stock on the exercise of options for a total of $1.7
          million.
 
 54
  During
          2003, the Company awarded 2,760,000 shares of restricted stock to four
          executive
          officers of the Company pursuant to its 2002 Stock Award and Incentive
          Plan
          (“the Award’), of which 636,000 were earned during 2003, 396,000 were earned
          during 2004, 288,000 were canceled upon the termination of employment of
          one of
          our executive officers in October 2004, and the balance may be earned through
          2010 based upon the achievement of certain financial criteria and continuing
          employment (see Note 16.)
 
 During
          2003, the Company issued 100,000 fully vested warrants, expiring in 2013,
          in
          connection with license costs relating to its video game joint venture.
          The fair
          value of these warrants was approximately $1.1 million and has been included
          in
          the basis of the joint venture (Note 4). The Company also issued $98.0
          million
          of convertible senior notes payable that may be converted (at their initial
          conversion rate of $20.00 per share) into an aggregate of 4.9 million shares
          of
          the Company’s common stock (Note 11).
 
 Warrant
          activity is summarized as follows:
 
 **Weighted****Average****Number**
                
                **Exercise****of
                    Shares**
                
                **Price**Outstanding,
                    December 31, 2006
                
                
                100,000
                
                $
                11.35
 
 There
          has
          been no other warrant activity since the issuance in 2003.
 
 **Note
          15—Commitments**
 
 The
          Company has entered into various license agreements whereby the Company
          may use
          certain characters and intellectual properties in conjunction with its
          products.
          Generally, such license agreements provide for royalties to be paid at
          1% to 14%
          of net sales with minimum guarantees and advance payments. Additionally,
          under
          three separate licenses, the Company has committed to spend 2% to 10% of
          related
          net sales on advertising per year on such licenses. The Company estimates
          that
          its minimum commitment for advertising in fiscal 2007 will be approximately
          $4.4
          million.
 
 Future
          annual minimum royalty guarantees as of December 31, 2006 are as follows
          (in
          thousands):
 
 2007
                
                $
                20,7222008
                
                
                15,7602009
                
                
                6,3662010
                
                
                3,3582011
                
                
                —Thereafter
                
                
                1,145$
                47,351
 
 The
          Company has entered into employment and consulting agreements with certain
          executives expiring through December 31, 2010. The aggregate future annual
          minimum guaranteed amounts due under those agreements as of December 31,
          2006
          are as follows (in thousands):
 
 2007
                
                $
                6,5852008
                
                
                3,9862009
                
                
                2,7342010
                
                
                2,280$
                15,585
 
 **Note
          16—Share-Base Payments**
 
 Under
          its
          2002 Stock Award and Incentive Plan (“the Plan”), which incorporated its Third
          Amended and Restated 1995 Stock Option Plan, the Company has reserved 6,025,000
          shares of its common stock for issuance upon the exercise of options granted
          under the Plan, as well as for the awarding of other securities. Under
          the Plan,
          employees (including officers), non-employee directors and independent
          consultants may be granted options to purchase shares of common stock and
          other
          securities (Note 14). The vesting of these options and other securities
          may
          vary, but typically vest on a step-up basis over a maximum period of 5
          years and
          restricted shares typically vest over one to two years. Share-based compensation
          expense is recognized on a straight-line basis over the requisite service
          period.
 
 55
 
 Under
          the
          Plan, share-based compensation payments may include the issuance of shares
          of
          restricted stock. Two executive officers are each entitled to be awarded
          120,000
          shares of restricted stock annually on each January 1 (through and including
          January 1, 2010). Such awards vest 50% each on the first and second
          anniversaries of issuance, subject to acceleration. Beginning in January
          2006,
          the Company's five non-employee directors each receive annual grants of
          restricted stock at a value of $120,000 (or, for 2006, 5,732 shares per
          director) which vest after one year. In March 2003, two executive officers
          of
          the Company were each granted 240,000 shares of restricted stock which,
          based on
          the achievement of certain financial performance criteria, vested on January
          1,
          2004. In January 2004, the Company issued 240,000 shares of restricted
          stock
          which, based on the achievement of certain financial performance criteria,
          vested on January 1, 2005. In January 2005 and 2006, respectively, the
          Company
          issued 245,000 shares of restricted stock at a value of $5.1 million and
          268,660
          shares of restricted stock at a value of $5.6 million to two executive
          officers
          and five non-employee directors of the Company. During 2006, the Company
          granted
          and issued an aggregate of 204,500 shares of restricted stock to its employees,
          which vest over a five-year period, at an aggregate value of approximately
          $3.4
          million, which represents the fair market value at the grant date. No shares
          of
          restricted stock were forfeited in 2006.
 
 Under
          SFAS 123R, share-based compensation cost is measured at the grant date,
          based on
          the estimated fair value of the award, and is recognized as expense over
          the
          employee's requisite service period. The Company adopted the provisions
          of SFAS
          123R using a modified prospective application. The valuation provisions
          of SFAS
          123R apply to new awards and to awards that are outstanding on the effective
          date and subsequently vest or are modified or cancelled. Estimated compensation
          expense for awards outstanding at the effective date will be recognized
          over the
          remaining service period using the compensation cost calculated for pro
          forma
          disclosure purposes under SFAS 123, *Accounting
          for Stock-Based Compensation* .
  In
          November 2005, the FASB issued FASB Staff Position No. SFAS 123(R)-3, *Transition
          Election Related to Accounting for Tax Effects of Share-Based Payment
          Awards* .
          The
          Company has elected to adopt the alternative transition method provided
          in this
          FASB Staff Position for calculating the tax effects of share-based compensation
          pursuant to SFAS 123R. The alternative transition method includes a simplified
          method to establish the beginning balance of the additional paid-in capital
          pool
          (APIC pool) related to the tax effects of employee share-based compensation,
          which is available to absorb tax deficiencies recognized subsequent to
          the
          adoption of SFAS 123R.
  The
          Company uses the Black-Scholes method of valuation for share-based option
          awards. In valuing the stock options, the Black-Scholes model incorporates
          assumptions about stock volatility, expected term of stock options, and
          risk
          free interest rate. The valuation is reduced by an estimate of stock option
          forfeitures.
  The
          amount of share-based compensation expense recognized in the year ended
          December
          31, 2006 is based on options granted prior to January 1, 2006 and restricted
          stock issued during the year ended December 31, 2006, and ultimately expected
          to
          vest, and it has been reduced for estimated forfeitures. SFAS 123R requires
          forfeitures to be estimated at the time of grant and revised, if necessary,
          in
          subsequent periods if actual forfeitures differ from those
          estimates.
  56
  Total
          share-based compensation expense and related tax benefits recognized for
          the
          year ended December 31, 2006 was $1.9 million and $0.6 million, respectively,
          relating to options and $4.6 million and $1.4 million, respectively, relating
          to
          restricted stock. As
          of
          December 31, 2006, 1,224,876 shares were available for future grant. Additional
          shares may become available to the extent that options or shares of restricted
          stock presently outstanding under the Plan terminate or expire. Stock option
          activity pursuant to the Plan is summarized as follows:
  **Weighted****Average****Number**
                
                **Exercise****of
                    Shares**
                
                **Price**Outstanding,
                    December 31, 2003
                
                
                2,265,266
                
                $
                12.15Granted
                
                
                302,644
                
                
                9.48Exercised
                
                
                (192,129
                )
                
                8.91Canceled
                
                
                (287,775
                )
                
                13.76Outstanding,
                    December 31, 2004
                
                
                2,088,006
                
                
                13.28Granted
                
                
                360,000
                
                
                21.74Exercised
                
                
                (566,546
                )
                
                8.60Canceled
                
                
                (77,354
                )
                
                15.74Outstanding,
                    December 31, 2005
                
                
                1,804,106
                
                
                16.33Granted
                
                
                —
                
                
                —Exercised
                
                
                (333,228
                )
                
                13.15Canceled
                
                
                (8,500
                )
                
                17.23Outstanding,
                    December 31, 2006
                
                
                1,462,378
                
                $
                17.05
 
 The
          weighted average fair value of options granted to employees in 2004 and
          2005 was
          $19.48 and $21.74 per share, respectively.
 
 In
          2004
          and 2005, 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 2.25% and 4.25%, respectively;
          dividend yield of 0%; with volatility of 136.9% and 130.2%, respectively;
          and
          expected lives of five years. There were no option grants in 2006.
 
 The
          following table summarizes information about stock options outstanding
          and
          exercisable at December 31, 2006:
 
 **Outstanding**
                
                **Exercisable****Weighted**
                
                **Weighted**
                
                
                
                **Weighted****Average**
                
                **Average**
                
                
                
                **Average****Number**
                
                **Life**
                
                **Exercise**
                
                **Number**
                
                **Exercise****Option
                    Price Range**
                
                **of
                    Shares**
                
                **in
                    Years**
                
                **Price**
                
                **of
                    Shares**
                
                **Price**$7.875
                    — $13.48
                
                
                411,338
                
                
                4.77
                
                $
                11.87
                
                
                304.038
                
                $
                11.39$13.49
                    — $19.27
                
                
                540,825
                
                
                1.80
                
                $
                16.92
                
                
                506,925
                
                $
                16.81$19.28
                    — $22.11
                
                
                510,219
                
                
                4.64
                
                $
                21.35
                
                
                156,094
                
                $
                21.25
 
 As
          of December 31, 2005, the Company had 245,000 shares of restricted stock
          outstanding, all of which vested during the first quarter of 2006. In January
          2006, the Company issued 268,660 shares of restricted stock, 240,000 of
          which
          vest over a two-year period subject to acceleration and 28,660 of which
          vest
          over a one-year period. In August and October 2006, the Company issued
          200,000
          shares and 4,500 shares of restricted stock, respectively, to certain of
          its
          employees, which vest over a five-year period. All restricted shares granted
          during 2006 remain unvested as of December 31, 2006. Restricted stock issued
          is
          valued at the fair market value of the traded common stock at the date
          of
          issuance.
  The
          following characteristics apply to the Plan stock options that are fully
          vested,
          or expected to vest, as of December 31, 2006:
  Number
                    of options outstanding
                
                
                1,462,378Weighted-average
                    exercise price
                
                $
                17.05Aggregate
                    intrinsic value of options outstanding
                
                $
                7,068,762Weighted-average
                    contractual term of options
                    outstanding
                
                
                3.6
                    yearsNumber
                    of options currently exercisable
                
                
                967,057Weighted-average
                    exercise price of options currently exercisable
                
                $
                15.82Aggregate
                    intrinsic value of options currently exercisable
                
                $
                5,838,931Weighted-average
                    contractual term of currently exercisable
                
                
                3.36
                    years
  57
  At
          and
          for the two years in the period ended December 31, 2005, the Company accounted
          for options granted under the Plan using the recognition and measurement
          principles of APB Opinion No. 25, *Accounting
          for Stock Issued to Employees* ,
          and
          related Interpretations. Prior to the implementation of SFAS 123R, stock-based
          employee compensation expense was not generally reflected in net income,
          as all
          options granted under the Plan had an exercise price equal to the market
          value
          of the underlying common stock on the date of grant. The following table
          illustrates the effect on net income and earnings per share if the Company
          had
          applied the fair value recognition provisions of SFAS 123R to stock-based
          employee compensation for the years ended December 31, 2004 and 2005 (in
          thousands, except per share data):
 
 **Years
                    Ended December 31,****2004**
                
                **2005****(In
                    thousands,****except
                    per share data)**Net
                    income, as reported
                
                $
                43,559
                
                $
                63,493Add
                    (Deduct): Stock-based employee compensation expense (income)
                    included in
                    reported net income net of related tax effects
                
                
                3,970
                
                
                (1,121
                )Deduct:
                    Total stock-based employee compensation expense determined under
                    fair
                    value method for all awards net of related tax effects
                
                
                (1,694
                )
                
                (2,343
                )Pro
                    forma net income
                
                $
                45,819
                
                $
                60,029Earnings
                    per share:Basic
                    — as reported
                
                $
                1.69
                
                $
                2.37Basic
                    — pro forma
                
                $
                1.78
                
                $
                2.25Diluted
                    — as reported
                
                $
                1.49
                
                $
                2.06Diluted
                    — pro forma
                
                $
                1.57
                
                $
                1.96
 
 **Note
          17—Employee Pension Plan**
 
 The
          Company sponsors for its U.S. employees, a defined contribution plan under
          Section 401(k) of the Internal Revenue Code. The plan provides that employees
          may defer up to 50% of their annual compensation subject to annual dollar
          limitations, and that the Company will make a matching contribution equal
          to
          100% of each employee’s deferral, up to 5% of the employee’s annual
          compensation. Company matching contributions, which vest immediately, totaled
          $0.4 million, $0.5 million and $0.7 million for 2004, 2005 and 2006,
          respectively.
 
 **Note
          18—Supplemental Information to Consolidated Statements of Cash
          Flows**
 
 In
          2006,
          two executive officers acquired 37,910 shares of common stock in a cashless
          exercise of options through the surrender of an aggregate of 13,264 shares
          of
          restricted stock as payment of the exercise prices therefor at a value
          of $0.3
          million. In addition, the two executive officers surrendered an aggregate
          of
          110,736 shares of restricted stock at a value of $2.5 million as payment
          for
          income taxes due on the vesting of such stock. This restricted stock was
          subsequently retired by the Company. Additionally, the Company recognized
          a $1.5
          million tax benefit from the exercise of stock options. During 2006, the
          Company
          issued 150,000 shares of common stock at a value of $3.3 million in connection
          with the Creative Designs acquisition.
 
 In
          2005,
          two executive officers acquired 215,982 shares of common stock in a cashless
          exercise of options through the surrender of an aggregate of 101,002 shares
          of
          restricted stock as payment of the exercise prices therefor at a value
          of $1.7
          million. This restricted stock was subsequently retired by the Company.
          Additionally, the Company recognized a $4.1 million tax benefit from the
          exercise of stock options.
 
 In
          2004,
          749,005 shares of common stock valued at approximately $14.9 million were
          issued
          in connection with the acquisition of Play Along and 25,749 shares of common
          stock valued at approximately $0.5 million were issued in connection with
          the
          2001 Kidz Biz acquisition. Additionally, the Company recognized a $0.7
          million
          tax benefit from the exercise of stock options.
 
 58
  **Note
          19—Selected Quarterly Financial Data (Unaudited)**
 
 Selected
          unaudited quarterly financial data for the years 2005 and 2006 are summarized
          below:
 
 **2005**
                
                **2006****First**
                
                **Second**
                
                **Third**
                
                **Fourth**
                
                **First**
                
                **Second**
                
                **Third**
                
                **Fourth****Quarter**
                
                **Quarter**
                
                **Quarter**
                
                **Quarter**
                
                **Quarter**
                
                **Quarter**
                
                **Quarter**
                
                **Quarter****(in
                    thousands, except per share data)**Net
                    sales
                
                $
                134,676
                
                $
                127,091
                
                $
                233,500
                
                $
                166,269
                
                $
                107,244
                
                $
                124,041
                
                $
                295,789
                
                $
                238,312Gross
                    profit
                
                $
                54,212
                
                $
                48,073
                
                $
                93,452
                
                $
                70,970
                
                $
                44,163
                
                $
                49,280
                
                $
                112,883
                
                $
                88,468Income
                    from operations
                
                $
                13,675
                
                $
                14,614
                
                $
                47,218
                
                $
                12,478
                
                $
                2,244
                
                $
                8,963
                
                $
                58,204
                
                $
                22,901Income
                    before income taxes
                
                $
                13,627
                
                $
                15,732
                
                $
                46,306
                
                $
                20,972
                
                $
                3,283
                
                $
                9,135
                
                $
                57,855
                
                $
                35,662Net
                    income
                
                $
                10,084
                
                $
                11,642
                
                $
                32,753
                
                $
                9,014
                
                $
                2,331
                
                $
                6,361
                
                $
                40,499
                
                $
                23,184Basic
                    earnings per share
                
                $
                0.38
                
                $
                0.44
                
                $
                1.22
                
                $
                0.33
                
                $
                0.09
                
                $
                0.23
                
                $
                1.46
                
                $
                0.85Weighted
                    average shares outstanding
                
                
                26,560
                
                
                26,678
                
                
                26,778
                
                
                26,930
                
                
                27,310
                
                
                27,536
                
                
                27,694
                
                
                27,298Diluted
                    earnings per share
                
                $
                0.34
                
                $
                0.39
                
                $
                1.05
                
                $
                0.29
                
                $
                0.09
                
                $
                0.22
                
                $
                1.26
                
                $
                0.73Weighted
                    average shares and equivalents outstanding
                
                
                32,256
                
                
                32,229
                
                
                32,088
                
                
                32,197
                
                
                32,617
                
                
                32,790
                
                
                32,736
                
                
                32,803
 
 During
          the second quarter of 2005, the Company wrote-off its $1.4 investment in
          a
          Chinese joint venture to Other Expense on its determination that none of
          the
          value would be realized.
 
 During
          the fourth quarter of 2005, the Company recorded a non-cash charge, which
          impacted operating income, of $3.6 million for restricted stock, and it
          repatriated $105.5 million from its Hong Kong subsidiaries which resulted
          in
          incremental income for tax expense of $5.4 million and reduced net
          income.
 
 **Note
          20—Litigation**
  In
          October 2004, the Company was named as a defendant in a lawsuit commenced
          by
          World Wrestling Entertainment, Inc. (“WWE”) (the “WWE Action”). The complaint
          also named as defendants, among others, the joint venture with THQ Inc.,
          certain
          of the Company’s foreign subsidiaries and the Company’s three executive
          officers. The Complaint was amended, the antitrust claims were dismissed
          and, on
          grounds not previously considered by the Court, a motion to dismiss the
          RICO
          claim, the only remaining basis for jurisdiction, was argued and submitted
          in
          September 2006. Discovery remains stayed. In November 2004, several purported
          class action lawsuits were filed in the United States District Court for
          the
          Southern District of New York, alleging damages associated with the facts
          alleged in the WWE Action (the “Class Action”). They are the subject of a motion
          to dismiss that has been fully briefed and argument occurred on November
          30,
          2006. The motion is still pending. Three shareholder derivative actions
          have
          also been filed against the Company, nominally, and against certain of
          the
          Company’s Board members (the “Derivative Actions”). The Derivative Actions seek
          to hold the individual defendants liable for damages allegedly caused to
          the
          Company by their actions, and, in one of the Derivative Actions, seeks
          restitution to the Company of profits, benefits and other compensation
          obtained
          by them. These actions are currently stayed or the time to answer has been
          extended.
  The
          Company received notice from WWE alleging breaches of the video game license
          in
          connection with sales of WWE video games in Japan and other countries in
          Asia.
          The joint venture responded that WWE acquiesced in the arrangements, and
          separately released any claim against the joint venture in connection therewith
          and accordingly there is no breach of the joint venture’s video game license.
          While the joint venture does not believe that WWE has a valid claim, it
          tendered
          a protective “cure” of the alleged breaches with a full reservation of rights.
          WWE “rejected” that cure and reserved its rights. On October 12, 2006, WWE
          commenced a lawsuit in Connecticut state court against THQ and the joint
          venture, involving the claim set forth above concerning allegedly improper
          sales
          of WWE video games in Japan and other countries in Asia (the “JV Action”). The
          lawsuit seeks, among other things, a declaration that WWE is entitled to
          terminate the video game license and monetary damages. A motion to strike
          one
          claim was argued on March 12, 2007 and submitted to the Court. Additionally,
          a
          schedule has been set, with trial no earlier than October 2008.
  In
          connection with the joint venture with THQ (see Note 4), the Company receives
          its profit through a preferred return based on net sales of the joint venture,
          which was to be reset as of July 1, 2006. The agreement with THQ provides
          for
          the parties to agree on the reset of the preferred return or, if no agreement
          is
          reached, for arbitration of the issue. No agreement has been reached and
          the
          Company anticipates that the reset, if any, of the preferred return will
          be
          determined through arbitration. The preferred return is accrued in the
          quarter
          in which the licensed games are sold and the preferred return is earned.
          Based
          on the same rates as set forth under the original joint venture agreement,
          an
          estimated receivable of $13.5 million has been accrued for the six months
          ended
          December 31, 2006, pending the resolution of this outstanding
          issue.
  59
  The
          Company is a party to, and certain of its property is the subject of, various
          other pending claims and legal proceedings that routinely arise in the
          ordinary
          course of its business. Other than with respect to the claims in the WWE
          Action,
          the Class Action, the JV Action and the matter of the reset of the preferred
          return from THQ in connection with the joint venture, with respect to which
          the
          Company cannot give assurance as to the outcome, the Company does not believe
          that any of these claims or proceedings will have a material effect on
          its
          business, financial condition or results of operations.
 
 60
  **Report
          of Independent Registered Public Accounting Firm**
  The
          Board
          of Directors and Stockholders
 JAKKS Pacific,
          Inc.
 Malibu,
          California
  The
          audit
          referred to in our report dated March 15, 2007 relating to the 2006 consolidated
          financial statements of JAKKS Pacific, Inc., which is contained in Item
          8 of
          this Form 10-K  included
          the audit of the 2006 amounts in the accompanying financial statement schedule.
          This financial statement schedule is the responsibility of the Company's
          management. Our responsibility is to express an opinion on this financial
          statement schedule based upon our audit.
  In
          our
          opinion such financial statement schedule presents fairly, in all material
          respects, the information for 2006 set forth therein.
 /s/
                    BDO Seidman, LLPBDO
                    Seidman, LLPLos
                    Angeles, California
                  March
                    15, 2007
 61
 
 **JAKKS
          PACIFIC, INC. AND SUBSIDIARIES**
 **SCHEDULE
          II—VALUATION AND QUALIFYING ACCOUNTS**
 **YEARS
          ENDED DECEMBER 31, 2004, 2005 and 2006**
 
 Allowances
          are deducted from the assets to which they apply, except for sales returns
          and
          allowances.
 
 **Balance
                    at**
                
                **Charged
                    to**
                
                **Charged
                    to**
                
                
                
                **Balance****Beginning**
                
                **Costs
                    and**
                
                **Other**
                
                
                
                **at
                    End****of
                    Period**
                
                **Expenses**
                
                **Accounts**
                
                **Deductions**
                
                **of
                    Period****(In
                    thousands)**Year
                    ended December 31, 2004:Allowance
                    for:Uncollectible
                    accounts
                
                $
                7,877
                
                $
                2,903
                
                $
                —
                
                $
                (3,722
                )
                $
                7,058Reserve
                    for potential product obsolescence
                
                
                5,025
                
                
                5,342
                
                
                —
                
                
                (2,325
                )
                
                8,042Reserve
                    for sales returns and allowances
                
                
                7,753
                
                
                49,956
                
                
                2,131(a
                )
                
                (36,667
                )
                
                23,173$
                20,655
                
                $
                58,201
                
                $
                2,131
                
                $
                (42,714
                )
                $
                38,273Year
                    ended December 31, 2005:Allowance
                    for:Uncollectible
                    accounts
                
                $
                7,058
                
                $
                902
                
                $
                (1,291)(b
                )
                $
                (4,333
                )
                $
                2,336Reserve
                    for potential product obsolescence
                
                
                8,042
                
                
                6,981
                
                
                —
                
                
                (7,576
                )
                
                7,447Reserve
                    for sales returns and allowances
                
                
                23,173
                
                
                54,767
                
                
                218(c
                )
                
                (53,035
                )
                
                25,123$
                38,273
                
                $
                62,650
                
                $
                (1,073
                )
                $
                (64,944
                )
                $
                34,906Year
                    ended December 31, 2006:Allowance
                    for:Uncollectible
                    accounts
                
                $
                2,336
                
                $
                37
                
                $
                —
                
                $
                (1,167
                )
                $
                1,206Reserve
                    for potential product obsolescence
                
                
                7,447
                
                
                3,412
                
                
                —
                
                
                (3,504
                )
                
                7,355Reserve
                    for sales returns and allowances
                
                
                25,123
                
                
                49,951
                
                
                2,213(d
                )
                
                (44,698
                )
                
                32,589$
                34,906
                
                $
                53,400
                
                $
                2,213
                
                $
                (49,369
                )
                $
                41,150
 
 (a)  Play
          Along acquired reserve.
 
 (b)
          Pet
          Pal acquired reserve, $0.1 million; customer preference payments booked
          to
          Accrued Expenses, ($1.4 million).
 
 (c)  Pet
          Pal
          acquired reserve.
 
 (d)  Creative
          Designs acquired reserve.
 
 **Item
          9A.**  ***Controls
          and Procedures***
 
 *Evaluation
          of Disclosure Controls and Procedures.*
 
 Our
          Chief
          Executive Officer and Chief Financial Officer, after evaluating the
          effectiveness of our disclosure controls and procedures (as defined in
          Exchange
          Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered
          by this
          Annual Report, have concluded that as of that date, our disclosure controls
          and
          procedures were adequate and effective to ensure that information required
          to be
          disclosed by us in the reports we file or submit with the Securities and
          Exchange Commission is recorded, processed, summarized and reported within
          the
          time periods specified in the Securities and Exchange Commission’s rules and
          forms.
 
 *Changes
          in Internal Control over Financial Reporting.*
 
 There
          were no changes in our internal control over financial reporting identified
          in
          connection with the evaluation required by Exchange Act Rules 13a-15(d)
          and
          15d-15 that occurred during the fourth quarter period covered by this Annual
          Report that has materially affected, or is reasonably likely to materially
          affect, our internal control over financial reporting.
 
 *Management’s
          Annual Report on Internal Control over Financial Reporting.*
 
 We,
          as
          management, are responsible for establishing and maintaining adequate “internal
          control over financial reporting” (as defined in Exchange Act Rule 13a-15(f)).
          Our internal control system was designed by or is under the supervision
          of
          management and our board of directors to provide reasonable assurance regarding
          the reliability of financial reporting and the preparation of published
          financial statements.
 
 62
  All
          internal control systems, no matter how well designed, have inherent
          limitations. Therefore, even those systems determined to be effective can
          provide only reasonable assurance with respect to financial statement
          preparation and presentation.
 
 Our
          management, including our Chief Executive Officer and Chief Financial Officer,
          evaluated the effectiveness of our internal control over financial reporting
          as
          of December 31, 2006. In making this assessment, management used the criteria
          set forth by the Committee of Sponsoring Organizations of the Treadway
          Commission (COSO) in *Internal
          Control — Integrated Framework* .
          We
          believe that, as of December 31, 2006, our internal control over financial
          reporting is effective based on those criteria.
 
 On
          February 9, 2006, the Company acquired substantially all of the assets
          of
          Creative Designs International, Ltd. and a related Hong Kong company, Arbor
          Toys
          Limited (collectively, “Creative Designs”). Management’s assessments did not
          include the internal controls of Creative Designs for the year of acquisition.
          Creative Designs contributed $181.1 million in net sales and $34.9 million
          in
          operating income to our consolidated operations during 2006.
 
 Our
          independent auditors have issued an attestation report on management’s
          assessment of our internal control over financial reporting. This report
          appears
          below.
 
 *Attestation
          Report of the Independent Registered Public Accounting Firm* .
  63
 
 **Report
          of Independent Registered Public Accounting Firm**
  Board
          of
          Directors and Stockholders
 JAKKS
          Pacific, Inc.
 Malibu,
          California
  We
          have
          audited management’s assessment, included in the accompanying *Item
          9A, Management’s Annual Report on Internal Control over Financial
          Reporting* ,
          that
          JAKKS Pacific, Inc. (the “Company”) maintained effective internal control over
          financial reporting as of December 31, 2006, based on criteria established
          in *Internal
          Control - Integrated Framework* issued
          by the Committee of Sponsoring Organizations of the Treadway Commission
          (the
          COSO criteria). JAKKS Pacific Inc.’s management is responsible for maintaining
          effective internal control over financial reporting and for its assessment
          of
          the effectiveness of internal control over financial reporting. Our
          responsibility is to express an opinion on management’s assessment and an
          opinion on the effectiveness of the Company’s internal control over financial
          reporting based on our audit.
  We
          conducted our audit in accordance with the standards of the Public Company
          Accounting Oversight Board (United States). Those standards require that
          we plan
          and perform the audit to obtain reasonable assurance about whether effective
          internal control over financial reporting was maintained in all material
          respects. Our audit included obtaining an understanding of internal control
          over
          financial reporting, evaluating management’s assessment, testing and evaluating
          the design and operating effectiveness of internal control, and performing
          such
          other procedures as we considered necessary in the circumstances. We believe
          that our audit provides a reasonable basis for our opinion.
  A
          company’s internal control over financial reporting is a process designed to
          provide reasonable assurance regarding the reliability of financial reporting
          and the preparation of financial statements for external purposes in accordance
          with generally accepted accounting principles. A company’s internal control over
          financial reporting includes those policies and procedures that (1) pertain
          to
          the maintenance of records that, in reasonable detail, accurately and fairly
          reflect the transactions and dispositions of the assets of the company;
          (2)
          provide reasonable assurance that transactions are recorded as necessary
          to
          permit preparation of financial statements in accordance with generally
          accepted
          accounting principles, and that receipts and expenditures of the company
          are
          made only in accordance with authorizations of management and directors
          of the
          company; and (3) provide reasonable assurance regarding prevention or timely
          detection of unauthorized acquisition, use, or disposition of the Company’s
          assets that could have a material effect on the financial
          statements.
  Because
          of its inherent limitations, internal control over financial reporting
          may not
          prevent or detect misstatements. Also, projections of any evaluation of
          effectiveness to future periods are subject to the risk that controls may
          become
          inadequate because of changes in conditions, or that the degree of compliance
          with the policies or procedures may deteriorate.
  64
  As
          indicated in the accompanying *Item
          9A,*  *Management’s
          Annual Report on Internal Control over Financial Reporting* ,
          management’s assessment of and conclusion on the effectiveness of internal
          control over financial reporting did not include the internal controls
          of
          Creative Designs International, Ltd. and Arbor Toys Limited (Collectively
          “Creative Designs), which were acquired on February 9, 2006, and which are
          included in the consolidated balance sheet of JAKKS Pacific, Inc. as of
          December
          31, 2006, and the related consolidated statements of income, other comprehensive
          income, stockholders’ equity, and cash flows for the year then ended. Creative
          Designs constituted 6.6% and 6.7% of total assets and net assets, respectively,
          as of December 31, 2006, and 23.7% and 45.8% of revenues and net income,
          respectively, for the year then ended. Management did not assess the
          effectiveness of internal control over financial reporting of Creative
          Designs
          because of the timing of the acquisition which was completed on February
          9,
          2006. Our audit of internal control over financial reporting of JAKKS Pacific,
          Inc. also did not include an evaluation of the internal control over financial
          reporting of Creative Designs.
  In
          our
          opinion, management’s assessment that JAKKS Pacific, Inc. maintained effective
          internal control over financial reporting as of December 31, 2006, is fairly
          stated, in all material respects, based on the COSO criteria. Also in our
          opinion, JAKKS Pacific, Inc. maintained, in all material respects, effective
          internal control over financial reporting as of December 31, 2006, based
          on the
          COSO criteria.
  We
          have
          also audited, in accordance with the standards of the Public Company Accounting
          Oversight Board (United States), the consolidated balance sheet of JAKKS
          Pacific, Inc. as of December 31, 2006, and the related consolidated statements
          of income, other comprehensive income, stockholders’ equity, and cash flows for
          the year then ended and our report dated March 15, 2007 expressed an unqualified
          opinion thereon.
 /s/
                    BDOSeidman,
                    LLPBDO
                    Seidman, LLPLos
                    Angeles, California
                  March
                    15, 2007
  65


**PART
      III**





**Item
      10.**  ***Directors,
      Executive Officers, and Corporate Governance***





**Directors
      and Executive Officers**





Our
      directors and executive officers are as follows:





**Name**
            
            **Age**
            
            **Positions
                with the Company**Jack
                Friedman
            
            67
            
            Chairman
                and Chief Executive OfficerStephen
                G. Berman
            
            42
            
            Chief
                Operating Officer, President, Secretary and DirectorJoel
                M. Bennett
            
            45
            
            Executive
                Vice President and Chief Financial OfficerDan
                Almagor
            
            53
            
            DirectorDavid
                C. Blatte
            
            42
            
            DirectorRobert
                E. Glick
            
            61
            
            DirectorMichael
                G. Miller
            
            59
            
            DirectorMurray
                L. Skala
            
            60
            
            Director





*Jack
      Friedman* has
      been
      our Chairman and Chief Executive Officer since co-founding JAKKS with Mr. Berman
      in January 1995. Until December 31, 1998, he was also our President. From
      January 1989 until January 1995, Mr. Friedman was Chief Executive Officer,
      President and a director of THQ. From 1970 to 1989, Mr. Friedman was President
      and Chief Operating Officer of LJN Toys, Ltd., a toy and software company.
      After
      LJN was acquired by MCA/Universal, Inc. in 1986, Mr. Friedman continued as
      President until his departure in late 1988.





*Stephen
      G. Berman* has
      been
      our Chief Operating Officer and Secretary and one of our directors since
      co-founding JAKKS with Mr. Friedman in January 1995. Since January 1, 1999,
      he
      has also served as our President. From our inception until December 31, 1998,
      Mr. Berman was also our Executive Vice President. From October 1991 to August
      1995, Mr. Berman was a Vice President and Managing Director of THQ
      International, Inc., a subsidiary of THQ. From 1988 to 1991, he was President
      and an owner of Balanced Approach, Inc., a distributor of personal fitness
      products and services.





*Joel
      M. Bennett* joined
      us
      in September 1995 as Chief Financial Officer and was given the additional title
      of Executive Vice President in May 2000. From August 1993 to September 1995,
      he
      served in several financial management capacities at Time Warner Entertainment
      Company, L.P., including as Controller of Warner Brothers Consumer Products
      Worldwide Merchandising and Interactive Entertainment. From June 1991 to August
      1993, Mr. Bennett was Vice President and Chief Financial Officer of TTI
      Technologies, Inc., a direct-mail computer hardware and software distribution
      company. From 1986 to June 1991, Mr. Bennett held various financial management
      positions at The Walt Disney Company, including Senior Manager of Finance for
      its international television syndication and production division. Mr. Bennett
      holds a Master of Business Administration degree and is a Certified Public
      Accountant.





*Dan
      Almagor* has been
      one of our directors since September 2004. Since March 1992, Mr. Almagor has
      served as the Chairman of ACG Inc., an advisory firm affiliated with First
      Chicago Bank One Equity Capital, a global private equity organization which
      provides equity capital financing primarily to private companies.





*David
      C. Blatte* has been
      one of our directors since January 2001. From January 1993 to May 2000, Mr.
      Blatte was a Senior Vice President in the consumer/retail group of the
      investment banking division of Donaldson, Lufkin and Jenrette Securities
      Corporation. From May 2000 to January 2004, Mr. Blatte was a partner in
      Catterton Partners, a private equity fund. Since February 2004, Mr. Blatte
      has
      been a partner in Centre Partners, a private equity fund.





*Robert
      E. Glick* has
      been
      one of our directors since October 1996. For more than 20 years, Mr. Glick
      has
      been an officer, director and principal stockholder in a number of
      privately-held companies which manufacture and market women’s
      apparel.





*Michael
      G. Miller* has
      been
      one of our directors since February 1996. From 1979 until May 1998, Mr. Miller
      was President and a director of a group of privately-held companies, including
      a
      list brokerage and list management consulting firm, a database management
      consulting firm, and a direct mail graphic and creative design firm. Mr.
      Miller’s interests in such companies were sold in May 1998. Since 1991, he has
      been President of an advertising company.




66




*Murray
      L. Skala* has
      been
      one of our directors since October 1995. Since 1976, Mr. Skala has been a
      partner of the law firm Feder, Kaszovitz, Isaacson, Weber, Skala, Bass &
Rhine LLP, our general counsel.





A
      majority of our directors are “independent,” as defined under the rules of
      Nasdaq. Such independent directors are Messrs. Blatte, Glick, Miller and
      Almagor. Our directors hold office until the next annual meeting of stockholders
      and until their successors are elected and qualified. Our officers are elected
      annually by our Board of Directors and serve at its discretion.





**Committees
      of the Board of Directors**





We
      have
      an Audit Committee, a Compensation Committee and a Nominating and Corporate
      Governance Committee.





*Audit
      Committee.* The
      primary functions of the Audit Committee are to select or to recommend to our
      Board the selection of outside auditors; to monitor our relationships with
      our
      outside auditors and their interaction with our management in order to ensure
      their independence and objectivity; to review, and to assess the scope and
      quality of, our outside auditor’s services, including the audit of our annual
      financial statements; to review our financial management and accounting
      procedures; to review our financial statements with our management and outside
      auditors; and to review the adequacy of our system of internal accounting
      controls. Messrs. Blatte, Glick and Miller are the current members of the Audit
      Committee and are each “independent” (as that term is defined in NASD Rule
      4200(a)(14)), and are each able to read and understand fundamental financial
      statements. Mr. Blatte, our financial expert, is the Chairman of the Audit
      Committee and possesses the financial expertise required under Rule 401(h)
      of
      Regulation SK of the Act and NASD Rule 4350(d)(2). He is further “independent”,
      as that term is defined under Item 7(d)(3)(iv) of Schedule 14A under the
      Exchange Act. We will, in the future, continue to have (i) an Audit Committee
      of
      at least three members comprised solely of independent directors, each of whom
      will be able to read and understand fundamental financial statements (or will
      become able to do so within a reasonable period of time after his or her
      appointment); and (ii) at least one member of the Audit Committee that will
      possess the financial expertise required under NASD Rule 4350(d)(2). Our Board
      has adopted a written charter for the Audit Committee and the Audit Committee
      reviews and reassesses the adequacy of that charter on an annual
      basis.





*Compensation
      Committee.* The
      functions of the Compensation Committee are to make recommendations to the
      Board
      regarding compensation of management employees and to administer plans and
      programs relating to employee benefits, incentives, compensation and awards
      under our 2002 Stock Award and Incentive Plan (the “2002 Plan”). Messrs. Glick
      (Chairman), Almagor and Miller are the current members of the Compensation
      Committee. The Board has determined that each of them are “independent,” as
      defined under the applicable rules of Nasdaq.





*Nominating
      and Corporate Governance Committee.* The
      functions of the Nominating and Corporate Governance Committee are to develop
      our corporate governance system and to review proposed new members of our board
      of directors, including those recommended by our stockholders. Messrs. Almagor
      (Chairman), Glick and Miller are the current members of our Nominating and
      Corporate Governance Committee. The Nominating and Corporate Governance
      Committee operates pursuant to a written charter adopted by the Board. The
      full
      text of the charter is available on our website at *www.jakkspacific.com.* The
      Board has determined that each member of this Committee is “independent,” as
      defined under the applicable rules of Nasdaq.





**Section
      16(a) Beneficial Ownership Reporting Compliance**





Based
      solely upon a review of Forms 3 and 4 and amendments thereto furnished to us
      during 2006 and Forms 5 and amendments thereto furnished to us with respect
      to
      2006, during 2006, Jack Friedman, an executive officer of our Company and a
      member of our Board of Directors, untimely filed one report on Form 4 reporting
      one late transaction. Based solely upon a review of Forms 3 and 4 and amendments
      thereto furnished to us during 2006 and Forms 5 and amendments thereto furnished
      to us with respect to 2006, all other Forms 3, 4 and 5 required to be filed
      during 2006 were done so on a timely basis.





**Code
      of Ethics**





We
      have a
      Code of Ethics that applies to all our employees, officers and directors. This
      code was filed as an exhibit to our Annual Report on Form 10-K for the fiscal
      year ended December 31, 2003. We have posted on our website,
      www.jakkspacific.com, the full text of such Code. We will disclose when there
      have been waivers of, or amendments to, such Code, as required by the rules
      and
      regulations promulgated by the Securities and Exchange Commission and/or
      Nasdaq.





67


**Item
      11.**  ***Executive
      Compensation***





COMPENSATION
      DISCUSSION AND ANALYSIS




Compensation
      Philosophy and Objectives




We
      believe that a strong management team comprised of highly talented individuals
      in key positions is critical to our ability to deliver sustained growth and
      profitability, and our executive compensation program is an important tool
      for
      attracting and retaining such individuals. We also believe that our most
      important resource is our people. While some companies may enjoy an exclusive
      or
      limited franchise or are able to exploit unique assets or proprietary
      technology, we depend fundamentally on the skills, energy and dedication of
      our
      employees to drive our business. It is only through their constant efforts
      that
      we are able to innovate through the creation of new products and the continual
      rejuvenation of our product lines, to maintain superior operating efficiencies,
      and to develop and exploit marketing channels. With this in mind, we have
      consistently sought to employ the most talented, accomplished and energetic
      people available in the industry. Therefore, we believe it is vital that our
      named executive officers receive an aggregate compensation package that is
      both
      highly competitive with the compensation received by similarly-situated
      executive officers at peer group companies, and also reflective of each
      individual named executive officer’s contributions to our success on both a
      long-term and short-term basis. As discussed in greater depth below, the
      objectives of our compensation program are designed to execute this philosophy
      by compensating our executives at the top quartile of their peers.




Our
      executive compensation program is designed with three main
      objectives:





·
            to
                offer a competitive total compensation opportunity that will allow
                us to
                continue to retain and motivate highly talented individuals to fill
                key
                positions;




·
            to
                align a significant portion of each executive’s total compensation with
                our annual performance and the interests of our stockholders;
                and




·
            reflect
                the qualifications, skills, experience and responsibilities of our
                executives




Administration
      and Process




Our
      executive compensation program is administered by the Compensation Committee.
      The Compensation Committee receives legal advice from our outside general
      counsel and has retained Frederick W. Cook & Co., Inc. (“FWC), a
      compensation consulting firm, that provided advice directly to the Compensation
      Committee. The base salary, bonus structure and the long-term equity
      compensation of our executive officers are governed by the terms of their
      individual employment agreements (see “-Employment Agreements and Termination of
      Employment Arrangements”). The Compensation Committee, with input from FWC,
      establishes target performance levels for incentive bonuses based on a number
      of
      factors that are designed to further our executive compensation objectives,
      including our performance, the compensation received by similarly-situated
      executive officers at peer group companies, the conditions of the markets in
      which we operate and the relative earnings performance of peer group companies.




Pursuant
      to the terms of their employment agreements, during the first quarter of each
      year, the Compensation Committee establishes the targeted level of our Adjusted
      EPS (as defined below) growth and corresponding bonus levels, as a percentage
      of
      base salary, Messrs. Friedman and Berman will earn if the target is met. This
      bonus is capped at a maximum of 200% of base salary. The Compensation Committee
      has wide discretion to set the target levels of Adjusted EPS and they work
      together with FWC to establish target levels that will accomplish the general
      objectives outlined above of also promoting growth and alignment with our
      shareholders’ interests. The employment agreements also give the Compensation
      Committee the authority to award additional compensation to Messrs. Friedman
      and
      Berman as it determines in its sole discretion based upon criteria it
      establishes.




Adjusted
      EPS is the net income per share of our common stock calculated on a
      fully-diluted basis in accordance with GAAP, applied on a basis consistent
      with
      past periods, as adjusted in the sole discretion of the Compensation Committee
      to take account of extraordinary or special items.




The
      Compensation Committee also annually reviews the overall compensation of our
      named executive officers for the purpose of determining whether discretionary
      bonuses should be granted. In 2006, FWC presented a report to the Compensation
      Committee comparing our performance, size and executive compensation levels
      to
      those of peer group companies. FWC also reviewed with the Compensation Committee
      the base salaries, annual bonuses, total cash compensation, long-term
      compensation and total compensation of our senior executive officers relative
      to
      those companies. The performance comparison presented to the Compensation
      Committee each year includes a comparison of our total shareholder return,
      earnings per share growth, sales, net income (and one-year growth of both
      measures) to the peer group companies. The Compensation Committee reviews this
      information along with details about the components of each named executive
      officer’s compensation.




68




Peer
      Group




One
      of
      the factors considered by the Compensation Committee is the relative performance
      and the compensation of executives of peer group companies. The peer group
      is
      comprised of a group of the companies selected in conjunction with FWC that
      we
      believe provides relevant comparative information, as these companies represent
      a cross-section of publicly-traded companies with product lines and businesses
      similar to our own throughout the comparison period. The composition of the
      peer
      group is reviewed annually and companies are added or removed from the group
      as
      circumstances warrant. For the last fiscal year, the peer group companies
      utilized for executive compensation analysis were:





·
            Activision,
                Inc.




·
            Action
                Performance Companies, Inc.




·
            Electronic
                Arts, Inc.




·
            EMak
                Worldwide, Inc.




·
            Hasbro,
                Inc.




·
            Leapfrog
                Enterprises, Inc.




·
            Marvel
                Enterprises, Inc.




·
            Mattel,
                Inc.




·
            RC2
                Corp.




·
            Russ
                Berrie and Company, Inc.




·
            Take-Two
                Interactive, Inc.




·
            THQ
                Inc.




Elements
      of Executive Compensation




The
      compensation package for the Company’s senior executives has both
      performance-based and non-performance based elements. Based on its review of
      each named executive officer’s total compensation opportunities and performance,
      and our performance, the Compensation Committee determines each year’s
      compensation in the manner that it considers to be most likely to achieve the
      objectives of our executive compensation program. The specific elements, which
      include base salary, annual cash incentive compensation and long-term equity
      compensation, are described below.




The
      Compensation Committee has negative discretion to adjust performance results
      used to determine annual incentive and the vesting schedule of long-term
      incentive payouts to the named executive officers. The Compensation Committee
      also has discretion to grant bonuses even if the performance targets were not
      met.




Base
      Salary




Each
      of
      our named executive officers received compensation in 2006 pursuant to the
      terms
      of his respective employment agreement. As discussed in greater detail below,
      the employment agreements for Messrs. Friedman and Berman expire on December
      31,
      2010 and Mr. Bennett’s employment agreement expired on December 31, 2006. Our
      Compensation Committee is currently in the process of negotiating a new
      employment agreement for Mr. Bennett that will not provide for automatic annual
      increases of base salary. Pursuant to the terms of his employment agreement,
      two
      of our named executive officers receive a base salary which, pursuant to his
      employment agreement, is increased automatically each year by $25,000 for
      Messrs. Friedman and Berman. Any additional increase in base salary is
      determined by the Compensation Committee based on a combination of two factors.
      The first factor is the Compensation Committee’s evaluation of the salaries paid
      in peer group companies to executives with similar responsibilities. The second
      factor is the Compensation Committee’s evaluation of the executive’s unique
      role, job performance and other circumstances. Evaluating both of these factors
      allows us to offer a competitive total compensation value to each individual
      named executive officer taking into account the unique attributes of, and
      circumstances relating to, each individual, as well as marketplace factors.
      This
      approach has allowed us to continue to meet our objective of offering a
      competitive total compensation value and attracting and retaining key personnel.
      Based on its review of these factors, the Compensation Committee determined
      not
      to increase any of the named executive officers’ base salaries above the
      contractually required minimum increase in 2006 as unnecessary to maintain
      our
      competitive total compensation position in the marketplace.




69




Annual
      Cash Incentive Compensation




The
      function of the annual cash bonus is to establish a direct correlation between
      the annual incentives awarded to the participants and our financial performance.
      This purpose is in keeping with our compensation program’s objective of aligning
      a significant portion of each executive’s total compensation with our annual
      performance and the interests of our shareholders.




The
      employment agreements for Messrs. Friedman and Berman provide for an incentive
      cash bonus award based on a percentage of each participant’s base salary if the
      performance goals set by the Compensation Committee are met for that year.
      The
      employment agreements mandate that the specific criteria to be used is earnings
      per share and the Compensation Committee sets the various target thresholds
      to
      be met to earn increasing amounts of the bonus up to a maximum of 200% of base
      salary. During the first quarter of each year, the Compensation Committee meets
      to establish the target thresholds for that year. During 2006, while the
      Company’s EPS grew almost 12%, we did not meet the minimum target levels
      established by the Compensation Committee. Consequently, Messrs. Friedman and
      Berman did not earn their contractually established cash bonus.




The
      employment agreement for each of our named executive officers contemplates
      that
      the Compensation Committee may grant discretionary bonuses in situations where,
      in its sole judgment, it believes they are warranted. The Compensation Committee
      approaches this aspect of the particular executive’s compensation package by
      looking at the other components of each executive’s aggregate compensation and
      then evaluating if any additional compensation is appropriate to meet our
      compensation goals. As part of this review, the Compensation Committee, with
      significant input from FWC, collects information about the total compensation
      packages in our peer group and various indicia of performance by the peer group
      such as sales, one-year sales growth, net income, one-year net income growth,
      market capitalization, size of companies, one- and three-year stockholder
      returns, etc. and then compares such data to our corresponding performance
      data.
      Following consideration of all of the above as well as input from FWC, and
      in
      particular considering the fact that we ended the year with over $184 million
      in
      cash, no long term debt and a strong balance sheet, all of which poised us
      for
      continued growth, and that our earnings per share grew by 11.65% over 2005,
      which while less than the targeted amount was nonetheless substantial, the
      Compensation Committee determined to give discretionary bonuses in the amount
      of
      $250,000 to each of Messrs. Friedman and Berman (representing approximately
      25%
      of their 2006 base salary) and a discretionary bonus in the amount of $300,000
      to Mr. Bennett (representing approximately 83% of his 2006 base salary). In
      addition, in the case of Mr. Bennett, the Compensation Committee and the Board
      of Directors considered the expansion of Mr. Bennett’s responsibilities as a
      result of our growth and Mr. Bennett’s management of the integration of the
      operations we acquired into our overall financial controls.




Long-Term
      Compensation




Long-term
      compensation is an area of particular emphasis in our executive compensation
      program, because we believe that these incentives foster the long-term
      perspective necessary for our continued success. Again, this emphasis is in
      keeping with our compensation program objective of aligning a significant
      portion of each executive’s total compensation with our long-term performance
      and the interests of our shareholders.




Historically,
      our long-term compensation program has focused on the granting of stock options
      that vested over time. However, commencing in 2006 we began shifting the
      emphasis of this element of compensation and we currently favor the issuance
      of
      restricted stock awards. The Compensation Committee believes that the award
      of
      full- value shares that vest over time is consistent with our overall
      compensation philosophy and objectives as the value of the restricted stock
      varies based upon the performance of our common stock, thereby aligning the
      interests of our executives with our shareholders. The Compensation Committee
      has also determined that awards of restricted stock are anti-dilutive as
      compared to stock options inasmuch as it feels that less restricted shares
      have
      to be granted to match the compensation value of stock options.




The
      employment agreements for Messrs. Friedman and Berman provide for annual grants
      of 120,000 shares of restricted stock subject to a two-year vesting period,
      which may be accelerated to one year if we achieve earnings per share growth
      targets. The initial vesting of the restricted stock is subject to our achieving
      pre-tax income in excess of $2 million in the fiscal year that the grant is
      made. Since we had in excess of $2 million of pre-tax income for 2006, 50%
      of
      the 2006 restricted stock awards to Messrs. Freidman and Berman vested on
      January 1, 2007. Moreover, since the 2006 earnings per share growth exceeded
      the
      targets for 2006, the vesting schedule for 25% of the 2006 award was accelerated
      and vested completely on January 1, 2007. The remaining 25% of the 2006 award
      will vest on January 1, 2008. Mr. Bennett’s employment agreement does not
      provide for any specified award of restricted shares, rather the Compensation
      Committee has discretion to determine if an award of restricted shares (or
      stock
      options) should be granted and if granted, the specific terms of the
      grant.




70




After
      a
      review of all of the factors discussed above, the Compensation Committee
      determined that, in keeping with our compensation objectives, other than the
      contractual amounts noted above, no additional restricted stock (or stock
      option) awards should be granted to our named executives for fiscal
      2006.





Other
      Benefits and Perquisites




Our
      executive officers participate in the health and dental coverage, life
      insurance, paid vacation and holidays, 401(k) retirement savings plans and
      other
      programs that are generally available to all of the Company’s employees.




The
      provision of any additional perquisites to each of the named executive officers
      is subject to review by the Compensation Committee. Historically, these
      perquisites include payment of an automobile allowance and matching
      contributions to a 401(k) defined contribution plan. In 2006, the named
      executive officers were granted the following perquisites: automobile allowance
      and matching contributions to a 401(k) defined contribution plan. We value
      perquisites at their incremental cost to us in accordance with SEC
      regulations.




We
      believe that the benefits and perquisites we provide to our named executive
      officers are within competitive practice and customary for executives in key
      positions at comparable companies. Such benefits and perquisites serve our
      objective of offering competitive compensation that allows us to continue to
      attract, retain and motivate highly talented people to these critical positions,
      ultimately providing a substantial benefit to our shareholders.




Change
      of
      Control/Termination Agreements




We
      recognize that, as with any public company, it is possible that a change of
      control may take place in the future. We also recognize that the threat or
      occurrence of a change of control can result in significant distractions of
      key
      management personnel because of the uncertainties inherent in such a situation.
      We further believe that it is essential and in our best interest and the
      interests of our shareholders to retain the services of our key management
      personnel in the event of the threat or occurrence of a change of control and
      to
      ensure their continued dedication and efforts in such event without undue
      concern for their personal financial and employment security. In keeping with
      this belief and its objective of retaining and motivating highly talented
      individuals to fill key positions, which is consistent with our general
      compensation philosophy, the employment agreements for our executive officers
      contain provisions which guarantee the named executive officers specific
      payments and benefits upon a termination of employment as a result of a change
      of control of the Company. In addition, the employment agreements also contain
      provisions providing for certain lump-sum payments in the event the executive
      is
      terminated without “cause” or if we materially breach the agreement leading the
      affected executive to terminate the agreement for good reason.




Additional
      details of the terms of the change of control agreements and termination
      provisions outlined above are provided below.




Retirement
      Plans




Mr.
      Friedman’s employment agreement provides that, commencing at age 67, he may
      retire and receive a single-life annuity retirement payment of $975,000 per
      year
      for a period of ten (10) years following his retirement. Mr. Friedman is
      currently 67 years old. In the event of his death during such period, his estate
      will receive a death benefit equal to the difference between $2,925,000 and
      retirement benefits previously paid to him. This retirement benefit is
      conditioned upon Mr. Friedman agreeing to accept the position of Chairman
      Emeritus of our Board of Directors, if so requested by the Board.




We
      believe that by limiting our retirement benefits to only our senior-most
      executive we are striking a fair and reasonable balance between achieving our
      compensation objective of retaining a highly-talented individual to fill our
      most key position and the best interests of our stockholders.




Impact
      of
      Accounting and Tax Treatments




Section 162(m)
      of the Internal Revenue Code (the “Code”) prohibits publicly held companies like
      us from deducting certain compensation to any one named executive officer in
      excess of $1,000,000 during the tax year. However, Section 162(m) provides
      that, to the extent that compensation is based on the attainment of performance
      goals set by the Compensation Committee pursuant to plans approved by the
      Company’s shareholders, the compensation is not included for purposes of
      arriving at the $1,000,000.




71




The
      Company, through the Compensation Committee, intends to attempt to qualify
      executive compensation as tax deductible to the extent feasible and where it
      believes it is in our best interests and in the best interests of our
      shareholders. However, the Compensation Committee does not intend to permit
      this
      arbitrary tax provision to distort the effective development and execution
      of
      our compensation program. Thus, the Compensation Committee is permitted to
      and
      will continue to exercise discretion in those instances in which mechanistic
      approaches necessary to satisfy tax law considerations could compromise the
      interests of our shareholders. In addition, because of the uncertainties
      associated with the application and interpretation of Section 162(m) and
      the regulations issued thereunder, there can be no assurance that compensation
      intended to satisfy the requirements for deductibility under Section 162(m)
      will in fact be deductible.





**Compensation
      Committee Report**





The
      compensation committee has reviewed and discussed the Compensation Discussion
      and Analysis (the “CD&A”) for the year ended December 31, 2006 with
      management. In reliance on the reviews and discussions referred to above, the
      compensation committee recommended to the board, and the board has approved,
      that the CD&A be furnished in the annual report on Form 10-K for the year
      ended December 31, 2006.





By
      the
      Compensation Committee of the Board of Directors:




Robert
      E.
      Glick, Chairman


Dan
      Almagor, Member


Michael
      G. Miller, Member




The
      following table sets forth the compensation we paid for our fiscal year ended
      December 31, 2006 to (i) our Chief Executive Officer; (ii) each of our other
      executive officers whose compensation exceeded $100,000 on an annual basis;
      and
      (iii) up to two additional individuals for whom disclosure would have been
      provided under the foregoing clause (ii) but for the fact that the individual
      was not serving as an executive officer of our Company at the end of the last
      completed fiscal year (collectively, the “Named Officers”).





**Summary
      Compensation Table**




**Name
                and Principal Position**
            
            **Year**
            
            **Salary**
              **($)**
            
            **Bonus**
              **($)**
            
            **Stock**
              **Awards**
              **($)
                (1)**
            
            **Option**
              **Awards**
              **($)**
            
            **Non-Equity**
              **Incentive
                Plan**
              **Compensation**
              **($)**
            
            **Change
                in**
              **Pension**
              **Value
                and**
              **Nonqualified**
              **Deferred**
              **Compensation**
              **Earnings
                ($)**
            
            **All
                Other**
              **Compensation**
              **($)
                (2)**
            
            **Total**
              **($)**Jack
                Friedman
            
            
            2006
            
            
            1,040,000
            
            
            250,000
            
            
            1,884,600
            
            
            —
            
            
            —
            
            
            —
            
            
            28,000
            
            
            3,202,000Chairman
                and Chief
              Executive
                OfficerStephen
                G. Berman
            
            
            2006
            
            
            1,040,000
            
            
            250,000
            
            
            1,884,600
            
            
            —
            
            
            —
            
            
            —
            
            
            25,500
            
            
            3,199,500Chief
                Operating
              Officer,President
                and
              SecretaryJoel
                M. Bennett
            
            
            2006
            
            
            360,000
            
            
            300,000
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            14,700
            
            
            674,700Executive
                Vice
              President
                andChief
              Financial
                Officer







(1)  Pursuant
      to the 2002 Plan, on January 1, 2006, 120,000 shares of restricted stock were
      granted to the Named Officer, of which 50% vest on January 1, 2007 and 50%
      vest
      on January 1, 2008, subject to acceleration. Based on the Company’s 2006
      financial performance, the vesting of 30,000 of the January 1, 2008 vesting
      shares were accelerated. The amount in this column reflects the expense recorded
      in the Company’s 2006 financial statements and was calculated as the product of
      (a) 90,000 shares of restricted stock multiplied by (b) $20.94, the last sales
      price of our common stock, as reported by Nasdaq on January 1, 2006, the date
      the shares were granted, reflecting the 60,000 shares vested on January 1,
      2007
      and 30,000 of the remaining 60,000 shares whose vesting accelerated based on
      the
      Company’s 2006 financial performance. See “— Critical Accounting
      Policies.”





72




(2)  Represents
      automobile allowances paid in the amount of $18,000, $18,000 and $7,200,
      respectively, to Messrs. Friedman, Berman and Bennett and matching contributions
      made by us to the Named Officer’s 401(k) defined contribution plan in the amount
      of $10,000, $7,500 and $7,500, respectively, for Messrs. Friedman, Berman and
      Bennett. See “— Employee Pension Plan.”





The
      following table sets forth certain information regarding the annual bonus
      performance structure for our fiscal year ended December 31, 2006 for the Named
      Officers:





**Grants
      of Plan-Based Awards**




**Estimated**
                  **Possible
                    Payouts**
                  **Under
                    Non-Equity**
                  **Incentive
                    Plan Awards**
                
                **Estimated**
                  **Future
                    Payouts**
                  **Under
                    Equity**
                  **Incentive
                    Plan Awards**
                
                **All**
                    **Other**
                    **Stock**
                    **Awards:**
                    **Number of**
                    **Shares**
                    **of**
                    **Stock**
                
                **All**
                    **Other**
                    **Options**
                    **Awards:**
                    **Number
                      of**
                    **Securities**
                    **Underlying**
                
                **Exercise**
                    **or
                      Base**
                    **Price**
                    **of**
                    **Option**
                
                **Closing**
                    **Price
                      of**
                    **Stock**
                    **on
                      Grant**
                
                **Grant**
                    **Date**
                    **Fair
                      Value**
                    **Of
                      Stock and Option****Name**
                
                **Grant**
                  **Date**
                
                **Threshold**
                  **($)**
                
                **Target**
                  **($)**
                
                **Maximum**
                  **($)**
                
                **Threshold**
                  **($)**
                
                **Target**
                  **($)**
                
                **Maximum**
                  **($)**
                
                **or
                    Units**
                  **(#)**
                
                **Options**
                  **(#)**
                
                **Awards**
                  **($/Sh)**
                
                **Date
                    ($)**
                
                **Awards**
                  **($)
                    (1)**Jack
                    Friedman
                
                
                1/1/06
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                120,000
                
                
                —
                
                
                —
                
                
                20.94
                
                
                2,512,800Stephen
                    G. Berman
                
                
                1/1/06
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                120,000
                
                
                —
                
                
                —
                
                
                20.94
                
                
                2,512,800Jack
                    Friedman (2)
                
                
                —
                
                
                832,000
                
                
                1,040,000
                
                
                3,120,000
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —Stephen
                    G. Berman (2)
                
                
                —
                
                
                832,000
                
                
                1,040,000
                
                
                3,120,000
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —


(1)  The
      product of (x) $20.94 (the closing sale price of the common stock on December
      30, 2005) multiplied by (y) the number of restricted shares granted on January
      1, 2006.





(2)  As
      previously discussed, the minimum threshold was not met and none of these
      payments were made.




73


The
      following table sets forth certain information regarding all equity-based
      compensation awards outstanding as of December 31, 2006 by the Named
      Officers:





**Outstanding
      Equity Awards At Fiscal Year-end**




**Option
                Awards**
            
            **Stock
                Awards****Name**
            
            **Number of**
              **Securities**
              **Underlying**
              **Unexercised**
              **Options**
              **Exercisable**
              **(#)**
            
            **Number of**
              **Securities**
              **Underlying**
              **Unexercised**
              **Options**
              **Unexercisable**
              **(#)**
            
            **Equity**
              **Incentive**
              **Plan**
              **Awards:**
              **Number
                of**
              **Securities**
              **Underlying**
              **Unexercised**
              **Unearned**
              **Options
                (#)**
            
            **Option**
              **Exercise**
              **Price**
              **($)**
            
            **Option**
              **Expiration**
              **Date**
            
            **Number
                of**
              **Shares
                or**
              **Units
                of**
              **Stock**
              **that**
              **Have**
              **Not Vested**
              **(#)**
            
            **Market**
              **Value
                of**
              **Shares
                or**
              **Units
                of**
              **Stock**
              **that**
              **Have**
              **Not Vested**
              **($)
                (1)**
            
            **Equity**
              **Incentive**
              **Plan**
              **Awards:**
              **Number of**
              **Unearned**
              **Shares,**
              **Units
                or**
              **Other**
              **Rights**
              **that**
              **Have
                Not**
              **Vested
                (#)**
            
            **Equity**
              **Incentive**
              **Plan**
              **Awards:**
              **Market**
              **or
                Payout**
              **Value
                of**
              **Unearned**
              **Shares,**
              **Units
                or**
              **Other**
              **Rights**
              **That**
              **Have
                Not**
              **Vested**
              **($)**Jack
                Friedman
            
            
            175,000
            
            
            —
            
            
            —
            
            
            16.25
            
            
            7/11/07
            
            
            120,000
            
            
            2,620,800
            
            
            —
            
            
            —Stephen
                G. Berman
            
            
            175,000
            
            
            —
            
            
            —
            
            
            16.25
            
            
            7/11/07
            
            
            120,000
            
            
            2,620,800
            
            
            —
            
            
            —Joel
                M. Bennett
            
            
            20,000
            
            
            —
            
            
            —
            
            
            16.25
            
            
            7/11/07
            
            
            —
            
            
            —
            
            
            —
            
            
            —








(1)
            The
                product of (x) $21.84 (the closing sale price of the common stock
                on
                December 29, 2006) multiplied by (y) the number of unvested restricted
                shares outstanding.





The
      following table sets forth certain information regarding amount realized upon
      the vesting and exercise of any equity-based compensation awards during 2006
      by
      the Named Officers:





**Options
      Exercises And Stock Vested**





**Option
                Awards**
            
            **Stock
                Awards****Name**
            
            **Number of**
              **Shares**
              **Acquired on**
              **Exercise
                (#)**
            
            **Value**
              **Realized
                on**
              **Exercise**
              **($)
                (1)**
            
            **Number of**
              **Shares**
              **Acquired on**
              **Vesting
                (#)**
            
            **Value**
              **Realized on**
              **Vesting
                ($) (2)**Jack
                Friedman
            
            
            18,955
            
            
            277,406
            
            
            120,000
            
            
            2,702,400Stephen
                G. Berman
            
            
            18,955
            
            
            277,406
            
            
            120,000
            
            
            2,702,400Joel
                M. Bennett
            
            
            64,870
            
            
            969,482
            
            
            —
            
            
            —


(1)
              Represents
                  the product of (x) the difference between the closing sale price
                  of the
                  common stock on the date of exercise less the exercise price, multiplied
                  by (y) the number of shares acquired on
                  exercise.


(2)
            Represents
                the product of (x) the closing sale price of the common stock on
                the date
                of vesting multiplied by (y) the number of restricted shares
                vested.





74


**Potential
      Payments upon Termination or Change in Control**





The
      following tables describe potential payments and other benefits that would
      have
      been received by each Named Officer at, following or in connection with any
      termination, including, without limitation, resignation, severance, retirement
      or a constructive termination of such Named Officer, or a change in control
      of
      our Company or a change in such Named Officer’s responsibilities. The potential
      payments listed below assume that there is no earned but unpaid base salary
      at
      December 31, 2006. Under our vacation policy, the Named Officers would not
      receive payment for 2007 vacation unless they were employed at January 1, 2007.
       Any vested stock options held by the Named Officers at December 31, 2006
      were then fully vested and exercisable. Accordingly, no value for stock options
      is included in the tables below.





***Jack
      Friedman***





Upon
                Retirement
            
            Quits
                For “Good Reason”
              (3)
            
            Upon
              Death
            
            Upon
              “Disability”
              (4)
            
            Termination
                Without “Cause”
            
            Termination
                For “Cause”
              (5)
            
            Involuntary
                Termination In Connection with Change of Control(6)Base
                Salary
            
            $
            -
            
            $
            520,000
            
            $
            -
            
            $
            731,250
            
            $
            520,000
            
            $
            -
            
            $
            3,109,600
            (7)Retirement
                Benefit (1)
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Restricted
                Stock - Performance-Based
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            2,620,800
            (8)Annual
                Cash Incentive Award (2)
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -






***Stephen
      G. Berman***





Upon
              Retirement
            
            Quits
                For “Good Reason”
              (3)
            
            Upon
              Death
            
            Upon
              “Disability”
              (4)
            
            Termination
                Without Cause
            
            Termination
                For “Cause”
              (5)
            
            Involuntary
                Termination In Connection with Change of Control(6)Base
                Salary
            
            $
            -
            
            $
            520,000
            
            $
            -
            
            $
            -
            
            $
            520,000
            
            $
            -
            
            $
            3,109,600
            (7)Restricted
                Stock - Performance-Based
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            2,620,800
            (8)Annual
                Cash Incentive Award (2)
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -





(1)  Mr.
      Friedman’s employment agreement with us (see “ - Employment Agreements”)
      provides that if he retires and is at least 67 years old, then he is entitled
      to
      be paid an annual retirement benefit of $975,000 (the “Retirement Benefit”)
      during the 10-year period following his retirement; provided, however, that
      Mr.
      Friedman must agree to serve as our non-executive Chairman Emeritus for so
      long
      as may be requested by the Board of Directors; and provided further, however,
      that if Mr. Friedman dies before the payment of his entire Retirement Benefit,
      the remaining Retirement Benefit will be reduced such that his designated
      beneficiary or estate, as the case may be, will receive in a lump sum the
      positive difference, if any, between $2,925,000 and any Retirement Benefit
      already paid to him.  Mr Friedman was not yet 67 years of age at December
      31, 2006.





(2)  Assumes
      that if the Named Officer is terminated on December 31, 2006, they were employed
      through the end of the incentive period.





75




(3)  Defined
      as (i) our violation or failure to perform or satisfy any material covenant,
      condition or obligation required to be performed or satisfied by us, or (ii)
      the
      material change in the nature or scope of the duties, obligations, rights or
      powers of the Named Officer’s employment resulting from any action or failure to
      act by us.





(4)  Defined
      as a Named Officer’s inability to perform his duties by reason of any disability
      or incapacity (due to any physical or mental injury, illness or defect) for
      an
      aggregate of 180 days in any consecutive 12-month period.





(5)  Defined
      as (i) the Named Officer’s conviction of, or entering a plea of guilty or nolo
      contendere (which plea is not withdrawn prior to its approval by the court)
      to,
      a felony offense and either the Named Officer’s failure to perfect an appeal of
      such conviction prior to the expiration of the maximum period of time within
      which, under applicable law or rules of court, such appeal may be perfected
      or,
      if he does perfect such an appeal, the sustaining of his conviction of a felony
      offense on appeal; or (ii) the determination by our Board of Directors, after
      due inquiry, based on convincing evidence, that the Named Officer
      has:




(A)  committed
      fraud against, or embezzled or misappropriated funds or other assets of, our
      Company;




(B)  violated,
      or caused us or any of our officers, employees or other agents, or any other
      individual or entity to violate, any material law, rule, regulation or
      ordinance, or any material written policy, rule or directive of our Company
      or
      our Board of Directors;




(C)  willfully,
      or because of gross or persistent inaction, failed properly to perform his
      duties or acted in a manner detrimental to, or adverse to our interests; or




(D)  violated,
      or failed to perform or satisfy any material covenant, condition or obligation
      required to be performed or satisfied by him under his employment agreement
      with
      us;





and
      that,
      in the case of any violation or failure referred to in clause (B), (C) or (D),
      above, such violation or failure has caused, or is reasonably likely to cause,
      us to suffer or incur a substantial casualty, loss, penalty, expense or other
      liability or cost.





(6)  Section
      280G of the Code disallows a company’s tax deduction for what are defined as
“excess parachute payments” and Section 4999 of the Code imposes a 20% excise
      tax on any person who receives excess parachute payments.  As discussed
      above, Messrs. Friedman and Berman are entitled to certain payments upon
      termination of their employment, including termination following a change in
      control of our Company.  Under the terms of their respective employment
      agreements (see “ - Employment Agreements”), neither Mr. Friedman nor Mr. Berman
      are entitled to any payments that would be an excess parachute payment, and
      such
      payments are to be reduced by the least amount necessary to avoid the excise
      tax.  Accordingly, our tax deduction would not be disallowed under Section
      280G of the Code, and no excise tax would be imposed under Section 4999 of
      the
      Code.





(7)  Under
      the
      terms of Messrs. Friedman’s and Berman’s respective employment agreements (see “
- Employment Agreements”), if a change of control occurs, then they each have
      the right to terminate their employment and receive a payment equal to 2.99
      times their then current annual salary (which was $1,040,000 in
      2006).





(8)  Each
      of
      Messrs. Friedman and Berman were granted and are scheduled to be granted
      restricted stock of our Company in accordance with the terms of their respective
      employment agreements (see “ - Employment Agreements”). Pursuant to the terms of
      those employment agreements, vesting accelerates for performance-based
      restricted stock upon a change in control, whether or not the relevant
      performance targets are met. Furthermore, under our Third Amended and Restated
      1995 Stock Option Plan and 2002 Stock Award and Incentive Plan, in the event
      of
      a change in control, stock options granted under those plans become immediately
      exercisable in full and under our 2002 Stock Award and Incentive Plan, shares
      of
      restricted stock granted under that plan are immediately vested. The stock
      price
      used to calculate values in the above tables is $21.84 per share, the closing
      price on the last trading day of 2006.




*Compensation
      of Directors*





Analogous
      to our executive compensation philosophy, it is our desire to similarly
      compensate our non-employee directors for their services in a way that will
      serve to attract and retain highly qualified members. As changes in the
      securities laws require greater involvement by, and places additional burdens
      on, a company’s directors it becomes even more necessary to locate and retain
      highly qualified directors. As such, in close cooperation with FWC, the
      Compensation Committee has reconfigured the structure of the compensation
      package of our directors so that it places our directors at approximately the
      median total compensation package for directors in our peer group.





76




For
      2006,
      each of our non-employee directors received (i) a cash stipend of $30,000
      for serving on the Board, (ii) $1,000 for each board or committee meeting
      attended (whether in person or by telephone), and (iii) a grant of
      restricted shares of our common stock valued at $121,000 (using a per share
      value equal to the average closing price of our common stock for the last ten
      trading days of December in the year preceding the grant date). Directors are
      also reimbursed for reasonable expenses incurred in attending meetings. The
      Chairman of the Audit Committee receives a cash stipend of $25,000 for serving
      in such capacity and the Chairmen of the Compensation Committee and the
      Nominating and Corporate Governance Committee each receive cash stipends of
      $10,000 for serving in such capacities.





Newly-elected
      non-employee directors will receive a portion of the foregoing annual
      consideration, pro rated according to the portion of the year in which they
      serve in such capacity.





The
      following table sets forth the compensation we paid to our non-employee
      directors for our fiscal year ended December 31, 2006:




**Director
      Compensation**





**Name**
            
            **Year**
            
            **Fees Earned**
              **or
                Paid in**
              **Cash**
              **($)**
            
            **Stock Awards**
              **($)
                (1)**
            
            **Option Awards**
              **($)**
            
            **Non-Equity**
              **Incentive
                Plan**
              **Compensation**
              **($)**
            
            **Change
                in**
              **Pension
                Value**
              **and**
              **Nonqualified**
              **Deferred**
              **Compensation**
              **Earnings**
              **($)**
            
            **All
                Other**
              **Compensation**
              **($)**
            
            **Total**
              **($)**Dan
                Almagor
            
            
            2006
            
            
            66,000
            
            
            120,028
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            186,028David
                Blatte
            
            
            2006
            
            
            76,000
            
            
            120,028
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            196,028Robert
                Glick
            
            
            2006
            
            
            65,000
            
            
            120,028
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            185,028Michael
                Miller
            
            
            2006
            
            
            51,000
            
            
            120,028
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            171,028Murray
                Skala
            
            
            2006
            
            
            36,000
            
            
            120,028
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            156,028





(1)  Represents
      the product of (a) 5,732 shares of restricted stock multiplied by (b) $20.94,
      the last sales price of our common stock, as reported by Nasdaq on January
      1,
      2006, the date the shares were granted, all of which shares vested on January
      1,
      2007.





*Employment
      Agreements and Termination of Employment Arrangements*





In
      March
      2003 we amended and restated our employment agreements with each of the Named
      Officers.





Mr.
      Friedman’s amended and restated employment agreement, pursuant to which he
      serves as our Chairman and Chief Executive Officer, provides for an annual
      base
      salary in 2007 of $1,065,000. Mr. Friedman’s agreement expires December 31,
      2010. His base salary is subject to annual increases determined by our Board
      of
      Directors, but in an amount not less than $25,000 per annum. For each fiscal
      year between 2007 through 2010, Mr. Friedman’s bonus will depend on our
      achieving certain earnings per share growth targets, with such earnings per
      share growth targets to be determined annually by the Compensation Committee
      of
      our Board of Directors. Depending on the levels of earnings per share growth
      that we achieve in each fiscal year, Mr. Friedman will receive an annual bonus
      from 0% to up to 200% of his base salary. This bonus will be paid in accordance
      with the terms and conditions of our 2002 Stock Award and Incentive Plan. In
      addition, in consideration for modifying and replacing the pre-tax income
      formula provided in his prior employment agreement for determining his annual
      bonus, and for entering into the amended employment agreement, Mr. Friedman
      was
      granted the right to be issued an aggregate of 1,080,000 shares of restricted
      stock. The first tranche of restricted stock, totaling 240,000 shares, was
      granted at the time the agreement became effective, and 120,000 shares were
      granted on each of January 1, 2004, 2005, 2006 and 2007 (or 480,000 shares
      in
      the aggregate). In each subsequent year of the employment agreement term, Mr.
      Friedman will receive 120,000 shares of restricted stock. The grant of these
      shares is in accordance with our 2002 Stock Award and Incentive Plan, and the
      vesting of each tranche of restricted stock is subject to our achieving pre-tax
      income in excess of $2,000,000 in the fiscal year that the grant is made. Each
      tranche of restricted stock granted or to be granted from January 1, 2004
      through January 1, 2008 is subject to a two-year vesting period, which may
      be
      accelerated to one year if we achieve certain earnings per share growth targets.
      Each tranche of restricted stock to be granted thereafter through January 1,
      2010, is subject to a one-year vesting period. Finally, the agreement provides
      that Mr. Friedman upon his retirement at or after age 67 will receive a
      single-life annuity retirement payment equal to $975,000 a year for a period
      of
      10 years, or in the event of his death during such retirement period, his estate
      will receive a death benefit equal to the difference between $2,925,000 and
      any
      prior retirement benefits previously paid to him; provided, however, that Mr.
      Friedman must agree to serve as Chairman Emeritus of our Board of Directors,
      if
      requested to do so by such Board.





77




Mr.
      Berman’s amended and restated employment agreement, pursuant to which he serves
      as our President and Chief Operating Officer, provides for an annual base salary
      in 2007 of $1,065,000. Mr. Berman’s agreement expires December 31, 2010. His
      base salary is subject to annual increases determined by our Board of Directors,
      but in an amount not less than $25,000 per annum. For our fiscal year ended
      December 31, 2006, Mr. Berman received a bonus of $250,000. For each fiscal
      year
      between 2007 through 2010, Mr. Berman’s bonus will depend on our achieving
      certain earnings per share growth targets, with such earnings per share growth
      targets to be determined annually by the Compensation Committee of our Board
      of
      Directors. Depending on the levels of earnings per share growth that we achieve
      in each fiscal year, Mr. Berman will receive an annual bonus of from 0% to
      up to
      200% of his base salary. This bonus will be paid in accordance with the terms
      and conditions of our 2002 Stock Award and Incentive Plan. In addition, in
      consideration for modifying and replacing the pre-tax income formula provided
      in
      his prior employment agreement for determining his annual bonus, and for
      entering into the amended employment agreement, Mr. Berman was granted the
      right
      to be issued an aggregate of 1,080,000 shares of restricted stock. The first
      tranche of restricted stock, totaling 240,000 shares, was granted at the time
      the agreement became effective, and 120,000 shares were granted on each of
      January 1, 2004, 2005, 2006 and 2007 (or 480,000 shares in the aggregate).
      In
      each subsequent year of the employment agreement term, Mr. Berman will receive
      120,000 shares of restricted stock. The grant of these shares is in accordance
      with our 2002 Stock Award and Incentive Plan, and the vesting of each tranche
      of
      restricted stock is subject to our achieving pre-tax income in excess of
      $2,000,000 in the fiscal year that the grant is made. Each tranche of restricted
      stock granted or to be granted from January 1, 2004 through January 1, 2008
      is
      subject to a two-year vesting period, which may be accelerated to one year
      if we
      achieve certain earnings per share growth targets. Each tranche of restricted
      stock to be granted thereafter through January 1, 2010, is subject to a one-year
      vesting period.





Mr.
      Bennett’s amended and restated employment agreement, pursuant to which Mr.
      Bennett serves as our Executive Vice President and Chief Financial Officer,
      expired December 31, 2006. On February 12, 2007, the Board of Directors directed
      management to enter into a three year employment agreement with Mr. Bennett,
      pursuant to which he will receive (i) a base salary of $400,000 per year; (ii)
      an annual discretionary bonus of up to 50% of his annual base salary, based
      on
      performance; (iii) a $1,000 per month car allowance; and (iv) a one-time grant
      of 15,000 shares of restricted stock, vesting over four years in equal annual
      installments of 3,750 shares each commencing on the first anniversary of the
      grant provided he remains employed by us on each anniversary date. Such
      employment agreement has not yet been finalized.





If
      we
      terminate Mr. Friedman’s or Mr. Berman’s employment other than “for cause” or if
      such Named Officer resigns because of our material breach of the employment
      agreement or because we cause a material change in his employment, we are
      required to make a lump-sum severance payment in an amount equal to his base
      salary and bonus during the balance of the term of the employment agreement,
      based on his then applicable annual base salary and bonus. In the event of
      the
      termination of his employment under certain circumstances after a “Change of
      Control” (as defined in each employment agreement), we are required to make a
      one-time payment of an amount equal to 2.99 times of the “base amount” of such
      Named Officer determined in accordance with the applicable provisions of the
      Internal Revenue Code.





The
      foregoing is only a summary of the material terms of our employment agreements
      with the Named Officers. For a complete description, copies of such agreements
      are annexed herein in their entirety as exhibits or are otherwise incorporated
      herein by reference.





*Employee
      Pension Plan*





We
      sponsor for our U.S. employees (including the Named Officers), a defined
      contribution plan under Section 401(k) of the Internal Revenue Code. The plan
      provides that employees may defer up to 50% of their annual compensation subject
      to annual dollar limitations, and that we will make a matching contribution
      equal to 100% of each employee’s deferral, up to 5% of the employee’s annual
      compensation. Our matching contributions, which vest immediately, totaled $0.4
      million, $0.5 million and $0.7 million for 2004, 2005 and 2006,
      respectively.





*Compensation
      Committee Interlocks and Insider Participation*





None
      of
      our executive officers has served as a director or member of a compensation
      committee (or other board committee performing equivalent functions) of any
      other entity, one of whose executive officers served as a director or a member
      of our Compensation Committee.




78




**Item
      12.** ***Security
      Ownership of Certain Beneficial Owners and Management and Related Stockholder
      Matters***





The
      following table sets forth certain information as of March 14, 2007 with respect
      to the beneficial ownership of our common stock by (1) each person known by
      us
      to own beneficially more than 5% of the outstanding shares of our common stock,
      (2) each of our directors, (3) each Named Officer, and (4) all our directors
      and
      executive officers as a group.





**Name
                and Address of**
              **Beneficial
                Owner(1)(2)**
            
            **Amount
                and**
              **Nature
                of**
              **Beneficial**
              **Ownership(s)(3)**
            
            **Percent
                of**
              **Outstanding**
              **Shares(4)**Third
                Avenue Management LLC
            
            
            3,997,941
            (5)
            
            14.3
            %Barclays
                Global Investors, N.A.
            
            
            3,168,246
            (6)
            
            11.3Dimensional
                Fund Advisors, LP.
            
            
            2,355,969
            (7)
            
            8.4FMR
                Corp.
            
            
            2,281,263
            (8)
            
            8.1AXA
                Financial, Inc.
            
            
            1,431,508
            (9)
            
            4.9Jack
                Friedman
            
            
            793,497
            (10)
            
            2.8Stephen
                G. Berman
            
            
            580,122
            (11)
            
            2.1Joel
                M. Bennett
            
            
            72,773
            (12)
            
            *Dan
                Almagor
            
            
            42,154
            (13)
            
            *David
                C. Blatte
            
            
            95,700
            (14)
            
            *Robert
                E. Glick
            
            
            112,219
            (15)
            
            *Michael
                G. Miller
            
            
            102,844
            (16)
            
            *Murray
                L. Skala
            
            
            114,157
            (17)
            
            *All
                directors and executive officers as a group (8 persons)
            
            
            1,910,280
            (18)
            
            6.6
            %





*  Less
      than
      1% of our outstanding shares.





(1)  Unless
      otherwise indicated, such person’s address is c/o JAKKS Pacific, Inc., 22619
      Pacific Coast Highway, Malibu, California 90265.





(2) The
      number of shares of common stock beneficially owned by each person or entity
      is
      determined under the rules promulgated by the Securities and Exchange
      Commission. Under such rules, beneficial ownership includes any shares as to
      which the person or entity has sole or shared voting power or investment power.
      The percentage of our outstanding shares is calculated by including among the
      shares owned by such person any shares which such person or entity has the
      right
      to acquire within 60 days after March 13, 2007. The inclusion herein of any
      shares deemed beneficially owned does not constitute an admission of beneficial
      ownership of such shares.





(3) E xcept
      as
      otherwise indicated, exercises sole voting power and sole investment power
      with
      respect to such shares.





(4)  Does
      not
      include any shares of common stock issuable upon the conversion of $98.0 million
      of our 4.625% convertible senior notes due 2023, initially convertible at the
      rate of 50 shares of common stock per $1,000 principal amount at issuance of
      the
      notes (but subject to adjustment under certain circumstances as described in
      the
      notes).





(5)  The
      address of Third Avenue Management LLC is 622 Third Avenue, New York, NY 10017.
      Possesses sole voting power with respect to 3,946,172 of such shares and sole
      dispositive power with respect to all of such 3,997,941 shares. All the
      information presented in this Item with respect to this beneficial owner was
      extracted solely from the Schedule 13G/A filed on February 14,
      2007.





(6) The
      address of Barclays Global Investors, N.A. is 45 Fremont Street, San Francisco,
      CA 94105. Possesses sole voting power with respect to 3,036,833 of such shares
      and sole dispositive power with respect to all of such 3,168,246 shares. All
      the
      information presented in this Item with respect to this beneficial owner was
      extracted solely from the Schedule 13G/A filed on January 23, 2007.





(7)  The
      address of Dimensional Fund Advisors, LP (formerly known as Dimensional Fund
      Advisors, Inc.) is 1299 Ocean Avenue, 11th Floor, Santa Monica, CA 90401. All
      the information presented in this Item with respect to this beneficial owner
      was
      extracted solely from the Schedule 13G/A filed on February 9, 2007.





79




(8)  The
      address of FMR Corp. is 82 Devonshire Street, Boston, Massachusetts 02109.
      All
      the information with respect to this beneficial owner was extracted solely
      from
      its Schedule 13G/A filed on February 14, 2007.





(9)  The
      address of AXA Financial, Inc. is 1290 Avenue of the Americas, New York, NY
      10104. Possesses sole voting power with respect to 651,044 of such shares and
      sole dispositive power with respect to all of such 1,431,508 shares. All the
      information presented in this Item with respect to this beneficial owner was
      extracted solely from the Schedule 13G filed on February 13, 2007.





(10)  Includes
      3,186 shares held in trusts for the benefit of children of Mr. Friedman. Also
      includes 175,000 shares of common stock issuable upon the conversion of options
      held by Mr. Friedman. Also includes 120,000 shares of common stock issued on
      January 1, 2007 pursuant to the terms of Mr. Friedman’s January 1, 2003
      Employment Agreement, which shares are further subject to the terms of our
      January 1, 2007 Restricted Stock Award Agreement with Mr. Friedman (the
“Friedman Agreement”). The Friedman Agreement provides that Mr. Friedman will
      forfeit his rights to all 120,000 shares unless certain conditions precedent
      are
      met prior to January 1, 2008, including the condition that our Pre-Tax Income
      (as defined in the Friedman Agreement) for 2006 exceeds $2,000,000, whereupon
      the forfeited shares will become authorized but unissued shares of our common
      stock. The Friedman Agreement further prohibits Mr. Friedman from selling,
      assigning, transferring, pledging or otherwise encumbering (a) 60,000 of the
      120,000 shares prior to January 1, 2008 and (b) the remaining 60,000 shares
      prior to January 1, 2009; provided, however, that if our Pre-Tax Income for
      2007
      exceeds $2,000,000 and our Adjusted EPS Growth (as defined in the Friedman
      Agreement) for 2007 increases by certain percentages as set forth in the
      Friedman Agreement, the vesting of some or all of the 60,000 shares that would
      otherwise vest on January 1, 2009 will be accelerated to the date the Adjusted
      EPS Growth is determined. The Friedman Agreement further provides that Mr.
      Friedman is prohibited from selling, assigning, transferring, pledging or
      otherwise encumbering 30,000 shares issued him on January 1, 2006 until January
      1, 2008.





(11)  Includes
      175,000 shares of common stock issuable upon the conversion of options held
      by
      Mr. Berman. Also includes 120,000 shares of common stock issued on January
      1,
      2007 pursuant to the terms of Mr. Berman’s January 1, 2003 Employment Agreement,
      which shares are further subject to the terms of our January 1, 2007 Restricted
      Stock Award Agreement with Mr. Berman (the “Berman Agreement”). The Berman
      Agreement provides that Mr. Berman will forfeit his rights to all 120,000 shares
      unless certain conditions precedent are met prior to January 1, 2008, including
      the condition that our Pre-Tax Income (as defined in the Berman Agreement)
      for
      2007 exceeds $2,000,000, whereupon the forfeited shares will become authorized
      but unissued shares of our common stock. The Berman Agreement further prohibits
      Mr. Berman from selling, assigning, transferring, pledging or otherwise
      encumbering (a) 60,000 of the 120,000 shares prior to January 1, 2008 and (b)
      the remaining 60,000 shares prior to January 1, 2009; provided, however, that
      if
      our Pre-Tax Income for 2007 exceeds $2,000,000 and our Adjusted EPS Growth
      (as
      defined in the Berman Agreement) for 2007 increases by certain percentages
      as
      set forth in the Berman Agreement, the vesting of some or all of the 60,000
      shares that would otherwise vest on January 1, 2009 will be accelerated to
      the
      date the Adjusted EPS Growth is determined. The Berman Agreement further
      provides that Mr. Berman is prohibited from selling, assigning, transferring,
      pledging or otherwise encumbering 30,000 shares issued him on January 1, 2006
      until January 1, 2008.





(12)  Does
      not
      include 15,000 shares of restricted common stock authorized by our Board of
      Directors to be granted to Mr. Bennett upon the execution of his new employment
      agreement (see “Executive Compensation- Employment Agreements”), which
      restricted shares will vest over four years in equal annual installments of
      3,750 shares each.





(13)  Includes
      29,644 shares which Mr. Almagor may purchase upon the exercise of certain stock
      options and 12,510 shares of common stock issued pursuant to our 2002 Stock
      Award and Incentive Plan, pursuant to which 5,468 shares may not be sold,
      mortgaged, transferred or otherwise encumbered prior to January 1,
      2008.





(14)  Includes
      82,500 shares which Mr. Blatte may purchase upon the exercise of certain stock
      options and 13,200 shares of common stock issued pursuant to our 2002 Stock
      Award and Incentive Plan, pursuant to which 5,468 of such shares may not be
      sold, mortgaged, transferred or otherwise encumbered prior to January 1,
      2008.





(15)  Includes
      99,019 shares which Mr. Glick may purchase upon the exercise of certain stock
      options and 13,200 shares of Common Stock issued pursuant to our 2002 Stock
      Award and Incentive Plan, pursuant to which 5,468 of such shares may not be
      sold, mortgaged, transferred or otherwise encumbered prior to January 1,
      2008.





(16)  Includes
      89,644 shares which Mr. Miller may purchase upon the exercise of certain stock
      options and 13,200 shares of Common Stock issued pursuant to our 2002 Stock
      Award and Incentive Plan, pursuant to which 5,468 of such shares may not be
      sold, mortgaged, transferred or otherwise encumbered prior to January 1,
      2008.





80




(17) Includes
      97,771 shares which Mr. Skala may purchase upon the exercise of certain stock
      options, 3,186 shares held by Mr. Skala as trustee under a trust for the benefit
      of Mr. Friedman’s minor child and 13,200 shares of common stock issued pursuant
      to our 2002 Stock Award and Incentive Plan, pursuant to which 5,468 of such
      shares may not be sold, mortgaged, transferred or otherwise encumbered prior
      to
      January 1, 2008.





(18)  Includes
      3,186 shares held in a trust for the benefit of Mr. Friedman’s minor child and
      an aggregate of 748,578 shares which the directors and executive officers may
      purchase upon the exercise of certain stock options.





**Item
      13.**  ***Certain
      Relationships and Related Transactions, and Director
      Independence***





*(a)*
            *Transactions
                with Related Persons*





One
      of
      our directors, Murray L. Skala, is a partner in the law firm of Feder,
      Kaszovitz, Isaacson, Weber, Skala, Bass & Rhine LLP, which has performed,
      and is expected to continue to perform, legal services for us. In 2006, we
      incurred approximately $2,382,661 for legal fees and $312,282 for reimbursable
      expenses payable to that firm. As of December 31, 2005 and 2006, legal fees
      and
      reimbursable expenses of $975,538 and $825,749, respectively, were payable
      to
      this law firm.





*(b)*
            *Review,
                Approval or Ratification of Transactions with Related
                Persons*





Pursuant
      to our Code of Ethics (a copy of which may be found on our website,
      www.jakkspacific.com), all of our employees are required to disclose to our
      General Counsel, the Board of directors or any committee established by the
      Board of Directors to receive such information, any material transaction or
      relationship that reasonably could be expected to give rise to actual or
      apparent conflicts of interest between any of them, personally, and us. In
      addition, our Code of Ethics also directs all employees to avoid any
      self-interested transactions without full disclosure. This policy, which applies
      to all of our employees, is reiterated in our Employee Handbook which states
      that a violation of this policy could be grounds for termination. In approving
      or rejecting a proposed transaction, our General Counsel, Board of Directors
      or
      designated committee will consider the facts and circumstances available and
      deemed relevant, including but not limited to, the risks, costs, and benefits
      to
      us, the terms of the transactions, the availability of other sources for
      comparable services or products, and, if applicable, the impact on director
      independence. Upon concluding their review, they will only approve those
      agreements that, in light of known circumstances, are in or are not inconsistent
      with, our best interests, as they determine in good faith





*(c)*
            *Director
                Independence*





For
      a
      description of our Board of Directors and its compliance with the independence
      requirements therefor as promulgated by the Securities and Exchange Commission
      and Nasdaq, see “Item 10- Directors, Executive Officers and Corporate
      Governance”.





**Item
      14.**  ***Principal
      Accountant Fees and Services.***





Before
      our principal accountant is engaged by us to render audit or non-audit services,
      where required by the rules and regulations promulgated by the Securities and
      Exchange Commission and/or Nasdaq, such engagement is approved by the Audit
      Committee.




The
      following are the fees of BDO Seidman, LLP, our principal auditor since June
      28,
      2006, for services rendered in connection with the 2006 audit (all of which
      have
      been pre-approved by the Audit Committee):





**2006**Audit
                Fees
            
            $
            631,700Audit
                Related Fees
            
            $
            —Tax
                Fees
            
            $
            —All
                Other Fees
            
            $
            —





81


The
      following are the fees billed us by PKF, Certified Public Accountants, A
      Professional Corporation, our auditor from inception through and including
      March
      31, 2006, for services rendered thereby during 2006 and 2005 (all of which
      have
      been pre-approved by the Audit Committee):





**2005**
            
            
            **2006**Audit
                Fees
            
            $
            731,579
            
            $
            69,257Audit
                Related Fees
            
            $
            36,249
            
            $
            —Tax
                Fees
            
            $
            53,436
            
            $
            —All
                Other Fees
            
            $
            12,180
            
            $
            30,988





*Audit
      Fees* consist
      of the aggregate fees for professional services rendered for the audit of our
      annual financial statements and the reviews of the financial statements included
      in our Forms 10-Q and for any other services that were normally provided by
      our
      auditors in connection with our statutory and regulatory filings or
      engagements.





*Audit
      Related Fees* consist
      of the aggregate fees billed for professional services rendered for assurance
      and related services that were reasonably related to the performance of the
      audit or review of our financial statements and were not otherwise included
      in
      Audit Fees.





*Tax
      Fees* consist
      of the aggregate fees billed for professional services rendered for tax
      consulting. Included in such Tax Fees were fees for consultancy, review, and
      advice related to our income tax provision and the appropriate presentation
      on
      our financial statements of the income tax related accounts.





*All
      Other Fees* consist
      of the aggregate fees billed for products and services provided by our auditors
      and not otherwise included in Audit Fees, Audit Related Fees or Tax Fees.
      Included in such





Our
      Audit
      Committee has considered whether the provision of the non-audit services
      described above is compatible with maintaining our auditors’ independence and
      determined that such services are appropriate.





82


**PART
      IV**





**Item
      15.**  ***Exhibits
      and Financial Statement Schedules***





The
      following documents are filed as part of this Annual Report on Form
      10-K:





(1)  Financial
      Statements (included in Item 8):




· Reports
      of Independent Registered Public Accounting Firms




·Consolidated
      Balance Sheets as of December 31, 2005 and 2006




·Consolidated
      Statements of Operations for the years ended December 31, 2004, 2005 and
      2006




·Consolidated
      Statements of Other Comprehensive Income for the years ended December 31, 2004,
      2005 and 2006


· Consolidated
        Statements of Stockholders’ Equity for the years ended December 31, 2004, 2005
        and 2006
  ·Consolidated
        Statements of Cash Flows for the years ended December 31, 2004, 2005 and
        2006
  ·Notes
        to
        Consolidated Financial Statements





(2)  Financial
      Statement Schedules (included in Item 8)


·Schedule
        II — Valuation and Qualifying Accounts





(3)  Exhibits





**Exhibit**
              **Number**
            
            **Description**3.1
            
            Amended
                and Restated Certificate of Incorporation of the Company
                (1)3.2.1
            
            By-Laws
                of the Company (2)3.2.2
            
            Amendment
                to By-Laws of the Company (3)10.1.1
            
            Third
                Amended and Restated 1995 Stock Option Plan (4)10.1.2
            
            1999
                Amendment to Third Amended and Restated 1995 Stock Option Plan
                (5)10.1.3
            
            2000
                Amendment to Third Amended and Restated 1995 Stock Option Plan
                (6)10.1.4
            
            2001
                Amendment to Third Amended and Restated 1995 Stock Option Plan
                (7)10.2
            
            2002
                Stock Award and Incentive Plan (8)10.3
            
            Amended
                and Restated Employment Agreement between the Company and Jack Friedman,
                dated as of March 26, 2003 (9)10.4
            
            Amended
                and Restated Employment Agreement between the Company and Stephen
                G.
                Berman dated as of March 26, 2003 (9)10.5
            
            Office
                Lease dated November 18, 1999 between the Company and Winco Maliview
                Partners (10)10.6
            
            Form
                of Restricted Stock Agreement (9)14
            
            Code
                of Ethics (11)21
            
            Subsidiaries
                of the Company (*)31.1
            
            Rule
                13a-14(a)/15d-14(a) Certification of Jack Friedman (*)31.2
            
            Rule
                13a-14(a)/15d-14(a) Certification of Joel Bennett (*)32.1
            
            Section
                1350 Certification of Jack Friedman (*)32.2
            
            Section
                1350 Certification of Joel Bennett
                (*)




83





(1)
            Filed
                previously as Appendix 2 to the Company’s Schedule 14A Proxy Statement,
                filed August 23, 2002, and incorporated herein by
                reference.




(2)
              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.
 (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
                          previously as Appendix A to the Company’s Schedule 14A Proxy Statement,
                          filed June 23, 1998, and incorporated herein by
                          reference.
 (5)
                          Filed
                              previously as an exhibit to the Company’s Registration Statement on Form
                              S-8 (Reg. No. 333-90055), filed November 1, 1999, and
                              incorporated herein
                              by reference.
 (6)
                              Filed
                                  previously as an exhibit to the Company’s Registration Statement on Form
                                  S-8 (Reg. No. 333-40392), filed June 29, 2000,
                                  and incorporated herein by
                                  reference.
 (7)
                                  Filed
                                      previously as Appendix B to the Company’s Schedule 14A Proxy Statement,
                                      filed June 11, 2001, and incorporated herein
                                      by
                                      reference.
 (8)
                                      Filed
                                          previously as an exhibit to the Company’s Registration Statement on Form
                                          S-8 (Reg. No. 333-101665), filed December
                                          5, 2002, and incorporated herein
                                          by
                                          reference.


(9)
                Filed
                      previously as an exhibit to the Company’s Annual Report on Form 10-K for
                      its fiscal year ended December 31, 2002, filed March 31, 2003,
                      and
                      incorporated herein by
                      reference.
 (10)
                      Filed
                            previously as an exhibit to the Company’s Annual Report on Form 10-K for
                            its fiscal year ended December 31, 1999, filed March
                            30, 2000, and
                            incorporated herein by
                            reference.
 (11)
                            Filed
                                  previously as an exhibit to the Company’s Annual Report on Form 10-K for
                                  its fiscal year ended December 31, 2003, filed
                                  March 15, 2004, and
                                  incorporated herein by
                                  reference.
 (*)
                                  Filed
                                        herewith.
 84


**SIGNATURES**





Pursuant
      to the requirements of Section 13 or 15(d) 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.


Dated:
                March 15, 2007
            JAKKS
              PACIFIC, INC.By:
            /s/ JACK FRIEDMANJack
                Friedman
              *Chairman
                and**Chief
                Executive Officer*




Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of the registrant and in the
      capacities and on the dates indicated.


**Signature**
              
              **Title**
              
              **Date**/s/
                  JACK FRIEDMAN
                
                Jack
                  Friedman
              
              Chairman
                  of the Board
                of
                  Directors and
                Chief
                  Executive Officer
                (Principal
                  Executive Officer)
              
              March
                  15, 2007/s/
                  JOEL M. BENNETT
                
                Joel
                  M. Bennett
              
              Chief
                  Financial Officer
                (Principal
                  Financial Officer and
                Principal
                  Accounting Officer)
              
              March
                  15, 2007/s/
                  STEPHEN G. BERMAN
                
                Stephen
                  G. Berman
              
              Director
              
              March
                  15, 2007/s/
                  DAN ALMAGOR
                
                Dan
                  Almagor
              
              Director
              
              March
                  15, 2007/s/
                  DAVID C. BLATTE
                
                David
                  C. Blatte
              
              Director
              
              March
                  15, 2007/s/
                  ROBERT E. GLICK
                
                Robert
                  E. Glick
              
              Director
              
              March
                  15, 2007/s/
                  MICHAEL G. MILLER
                
                Michael
                  G. Miller
              
              Director
              
              March
                  15, 2007/s/
                  MURRAY L. SKALA
                
                Murray
                  L. Skala
              
              Director
              
              March
                  15, 2007




85




**EXHIBIT
      INDEX**





**Exhibit**
              **Number**
            
            **Description**3.1
            
            Amended
                and Restated Certificate of Incorporation of the Company
                (1)3.2.1
            
            By-Laws
                of the Company (2)3.2.2
            
            Amendment
                to By-Laws of the Company (3)10.1.1
            
            Third
                Amended and Restated 1995 Stock Option Plan (4)10.1.2
            
            1999
                Amendment to Third Amended and Restated 1995 Stock Option Plan
                (5)10.1.3
            
            2000
                Amendment to Third Amended and Restated 1995 Stock Option Plan
                (6)10.1.4
            
            2001
                Amendment to Third Amended and Restated 1995 Stock Option Plan
                (7)10.2
            
            2002
                Stock Award and Incentive Plan (8)10.3
            
            Amended
                and Restated Employment Agreement between the Company and Jack Friedman,
                dated as of March 26, 2003 (9)10.4
            
            Amended
                and Restated Employment Agreement between the Company and Stephen
                G.
                Berman dated as of March 26, 2003 (9)10.5
            
            Office
                Lease dated November 18, 1999 between the Company and Winco Maliview
                Partners (10)10.6
            
            Form
                of Restricted Stock Agreement (9)14
            
            Code
                of Ethics (11)21
            
            Subsidiaries
                of the Company (*)31.1
            
            Rule
                13a-14(a)/15d-14(a) Certification of Jack Friedman (*)31.2
            
            Rule
                13a-14(a)/15d-14(a) Certification of Joel Bennett (*)32.1
            
            Section
                1350 Certification of Jack Friedman (*)32.2
            
            Section
                1350 Certification of Joel Bennett
                (*)





(1)
            Filed
                previously as Appendix 2 to the Company’s Schedule 14A Proxy Statement,
                filed August 23, 2002, and incorporated herein by
                reference.





(2)
            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.





(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
                previously as Appendix A to the Company’s Schedule 14A Proxy Statement,
                filed June 23, 1998, and incorporated herein by
                reference.





(5)
            Filed
                previously as an exhibit to the Company’s Registration Statement on Form
                S-8 (Reg. No. 333-90055), filed November 1, 1999, and incorporated
                herein
                by reference.





(6)
            Filed
                previously as an exhibit to the Company’s Registration Statement on Form
                S-8 (Reg. No. 333-40392), filed June 29, 2000, and incorporated herein
                by
                reference.





(7)
            Filed
                previously as Appendix B to the Company’s Schedule 14A Proxy Statement,
                filed June 11, 2001, and incorporated herein by
                reference.





(8)
            Filed
                previously as an exhibit to the Company’s Registration Statement on Form
                S-8 (Reg. No. 333-101665), filed December 5, 2002, and incorporated
                herein
                by reference.





(9)
            Filed
                previously as an exhibit to the Company’s Annual Report on Form 10-K for
                its fiscal year ended December 31, 2002, filed March 31, 2003, and
                incorporated herein by reference.





(10)
            Filed
                previously as an exhibit to the Company’s Annual Report on Form 10-K for
                its fiscal year ended December 31, 1999, filed March 30, 2000, and
                incorporated herein by reference.





(11)
            Filed
                previously as an exhibit to the Company’s Annual Report on Form 10-K for
                its fiscal year ended December 31, 2003, filed March 15, 2004, and
                incorporated herein by reference.





(*)
            Filed
                herewith.





86