UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549











FORM
10-K





(Mark One)


ý
            ANNUAL
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the Fiscal Year Ended December 31, 2008 ̈
            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.
      Employerincorporation
      or organization)
            Identification
      No.)





22619
      Pacific Coast HighwayMalibu,
      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 registeredCommon
      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 ý





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 ý





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 ýNo  ̈





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):




ý   Large
      Accelerated Filer
                 ̈   Accelerated
      Filer
                 ̈   Non-Accelerated
      Filer
                 ̈   Small
      Reporting Company(Do
      not check if a smaller Reporting Company)





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





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 February 27, 2009 of $12.67) is
$345,211,090.





The
number of shares outstanding of the registrant’s Common Stock, $.001 par value
(being the only class of its common stock), is 27,934,231 (as of February 27,
2009).




Documents
Incorporated by Reference





None.











JAKKS
PACIFIC, INC.





INDEX
TO ANNUAL REPORT ON FORM 10-K





For
the Fiscal Year ended December 31, 2008





Items
in Form 10-K





PagePART
      IItem
      1.
            Business
            2Item
      1A.
            Risk
      Factors
            11Item
      1B.
            Unresolved
      Staff Comments
            NoneItem
      2.
            Properties
            18Item
      3.
            Legal
      Proceedings
            18Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            NonePART
      IIItem
      5.
            Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
            22Item
      6.
            Selected
      Financial Data
            25Item
      7.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            26Item
      7A.
            Quantitative
      and Qualitative Disclosures About Market Risk
            36Item
      8.
            Financial
      Statements and Supplementary Data
            37Item
      9.
            Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
            NoneItem
      9A.
            Controls
      and Procedures
            62Item
      9B.
            Other
      Information
            NonePART
      IIIItem
      10.
            Directors,
      Executive Officers and Corporate Governance
            64Item
      11.
            Executive
      Compensation
            66Item
      12.
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
            77Item
      13.
            Certain
      Relationships and Related Transactions, and Director
      Independence
            79Item
      14.
            Principal
      Accountant Fees and Services
            79PART
      IVItem
      15.
            Exhibits
      and Financial Statement Schedules
            81Signatures
            
            83Certifications
            
            87





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.





1


PART
I





Item 1.Business





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





Company
Overview





We are a
leading multi-line, multi-brand toy company that designs, produces, markets and
distributes toys and related products, writing instruments and related products,
pet toys, consumables and related products, electronics and related products,
and other consumer products. We focus our business on acquiring or licensing
well-recognized trademarks and brand names, most with long product histories
(“evergreen brands”). We seek to acquire these evergreen brands because we
believe they are less subject to market fads or trends. We also develop
proprietary products marketed under our own trademarks and brand
names.  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”), The Chronicles of Narnia: Prince CaspianTM
      and Pokemon®
      franchises;




•
            Toy
      vehicles, including Road
      Champs®, RC
      Racers TM  and MXS®  toy
      vehicles and accessories, as well as those based on
    Nascar®;





•
            Electronics
      products, including Plug
      It In & Play TV GamesTM, EyeClopsTM Bionic Eye
      products, and Laser
      Challenge®, as well as others based on Disney® and Discovery Kids®
      brands;





•
            Role-play,
      dress-up and novelty products featuring entertainment and consumer
      products properties such as Dirt Devil®, Subway®, Pizza Hut® and McDonalds® pretend play
      products, Disney
      Princess® , Hannah MontanaTM, Barbie® and Dora the Explorer®
      playsets for girls and Black & Decker® and
      Pirates of the
      CaribbeanTM playsets for
boys;





•
            Infant
      and pre-school toys and plush toys featuring Care Bears®, Barney®, The Wiggles®, and
      slumber bags;





•
            Dolls
      including large, fashion and mini dolls and related accessories based on
      Cabbage Patch
      Kids®, Hannah
      Montana, Puppy in
      My Pocket and FriendsTM and Disney Princess® dolls
      and private label fashion dolls for other
  retailers;





•
            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 FlightTM vehicles;
      and





•
            Junior
      sports and toy paintball products, including Gaksplat® and The
    Storm;





•
            Baby
      dolls and baby doll pretend play accessories based on well-known licensed
      brands including Graco®,
      Fischer Price® and Disney
Princess®;





•
            Licensed
      and non-licensed indoor and outdoor kids’ furniture, accessories and room
      décor; and





•
            Innovative
      Halloween and everyday costumes based on licensed and non-licensed brands
      including Spiderman®, Power Rangers® and Disney
      Princesses®, and
      stylized Home Décor product lines for
Halloween.





Prior to
2007, we had accounted for seasonal and outdoor products as a separate category.
During 2007, we restructured our internal operations and have consolidated this
product group within the Traditional category. These products share key
characteristics, including common management, distribution and marketing
strategies. We have restated our prior segment reporting to reflect this
change.





Craft,
Activity and Writing Products





•
            Craft,
      activity and stationery products, including Flying Colors® activity
      sets, compounds, playsets and lunch boxes based on Nickelodeon®, Dora the Explorer, Pokémonand others, and Color Workshop® craft
      products such as Blopens®, Vivid Velvet®, and
      Pentech® writing
      instruments, stationery and activity products, and non-licensed brands
      including Girl
      GourmetTM and The
      Spa FactoryTM.





2


Pet
Products





•
            Pet
      products, including toys, consumables, beds, clothing and accessories,
      with licenses used in conjunction with these products, including American Kennel Club®,
      The Cat Fanciers’
      AssociationTM, Arm
      & Hammer® and The Humane Society of the
      United States® brands, as well as entertainment properties,
      including Disney,
      and private label brands.








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;





•
            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
      simple innovation and technology to make them more appealing to today’s
      kids.





Our
Business Strategy





In
addition to developing our proprietary brands and marks, licensing popular
brands 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 41 new
titles. We have recognized approximately $110.4 million in profit from the joint
venture through December 31, 2008. 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 30.1%, 13.2% and 13.2%,
respectively, of our net sales in 2008. No other customer accounted for more
than 10.0% of our net sales in 2008.





Our
Growth Strategy





The
execution of our growth strategy has resulted in increased levels
of revenues and earnings. In 2007 and 2008, we generated net sales of
$857.1 million and $903.4 million, respectively, and net income of $89.0 million
and $76.1 million, respectively. Approximately 1.4% and 1.2% of our increased
net sales in 2007 and 2008, respectively, were attributable to our acquisitions
since 2006. 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 to maximize
their longevity. Our marketing teams and product designers strive to develop new
products or product lines to offer added technological, aesthetic and functional
improvements to our extensive portfolio. We use multiple methods including
real-scan technology, articulated joints and a flexible rubberized coating to
enhance the life-like feel of our action toys, and expanded to classic
characters and special techniques such as vinyl figures. These innovations
appeal to collectors and/or 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 several related categories through the licensing of this category
from our current licensors, such MTV Networks which owns Nickelodeon .





•      Pursue Strategic
Acquisitions.   We intend to supplement our internal
growth with selected strategic acquisitions. Most recently, in February 2006, we
acquired the business of Creative Designs International, Ltd., a leading
manufacturer of girls’ dress-up and role-play toys, in October 2008 we acquired
the businesses of Tollytots Limited, a leading manufacturer of licensed baby
doll accessories and Kids Only, a leading manufacturer of licensed indoor and
outdoor kids’ furniture and in December 2008, we acquired the business of
Disguise, Inc. a leading Halloween costume and home décor company.  We
will continue focusing our acquisition strategy on businesses or brands that
have compatible product lines and offer valuable trademarks or
brands.





3


•      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, among others, 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 2008, our sales generated outside the
United States were approximately $161.9 million, or 17.9% of total net sales. We
intend to continue to expand our international sales by establishing a sales
office and distribution center and 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
2009.





•      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 additional qualified management personnel. We cannot assure you
that we will be able to recruit and retain qualified personnel or expand and
manage our operations effectively and profitably. To effectively manage future
growth, we must continue to expand our operational, financial and management
information systems and to train, motivate and manage our work force. 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
October 7, 2008, we acquired substantially all of the assets of Tollytots
Limited.  The total initial consideration of $25.5 million consisted
of $11.8 million in cash and the assumption of liabilities in the amount of
$13.7 million, and resulted in goodwill of $3.0 million. In addition, we agreed
to pay an earn-out of up to an aggregate amount of $5.0 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. Tollytots is a leading designer and producer of licensed baby
dolls and baby doll pretend play accessories based on well-known brands and was
included in our results of operations from the date of acquisition.





On
October 8, 2008, we acquired substantially all of the stock of Kids Only, Inc.
and a related Hong Kong company, Kids Only Limited (collectively, “Kids
Only”).  The total initial consideration of $23.2 million consisted of
$20.3 million in cash and the assumption of liabilities in the amount of $2.9
million, and resulted in goodwill of $12.5 million. In addition, we agreed to
pay an earn-out of up to an aggregate amount of $5.6 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. Kids Only is a leading designer and producer of licensed indoor
and outdoor kids’ furniture, and has an extensive portfolio which also includes
baby dolls and accessories, room décor and a myriad of other children’s toy
products  and was included in our results of operations from the date
of acquisition.





On
December 29, 2008, we acquired certain assets of Disguise, Inc. and a related
Hong Kong company, Disguise Limited (collectively, “Disguise”).  The
total initial consideration of $61.9 million consisted of $39.9 million in cash
and the assumption of liabilities in the amount of $22.0 million, and resulted
in goodwill of $51.6 million. We have not finalized our purchase price
allocation for Disguise and will engage a third party to perform studies and
valuations to the estimated fair value of assets and liabilities
assumed.  Disguise is a leading designer and producer of Halloween and
everyday costume play and was included in our results of operations from the
date of acquisition.





4


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 $21.6 billion in 2008. 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 $11.0 billion in
2008.





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,
EyeClopsTM Bionic Eye products and Laser Challenge® product
lines. Our current Plug It In
& Play TV
Games titles include licenses from Namco®, Disney, Marvel® and Nickelodeon, and feature such
games as SpongeBob
SquarePants®, Dora the
Explorer, Disney
Princess®, Ms.
Pac-Man® and Pac-Man®.





We
regularly release new Plug It
In & Play TV
Games titles for the pre-school and leisure gamer segments including
Wheel of Fortune®,
Deal or No Deal®,
Jeopardy®, Sesame
Street® and Thomas the
TankTM.





Wheels
Division Products





•
            Toy
      and activity vehicles





Our toy
vehicle line includes toy and activity vehicles and other toys. We also produce
radio controlled vehicles. Our toy vehicle line is comprised of an 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.





•
            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 and to offer many
exclusive programs to our retail partners to keep the line fresh and relevant to
WWE’s television programming, and to retain the interest of the
consumers.





5


We also
develop, manufacture and distribute other action figures and action figure
accessories including those based on the animated series Pokemon,  and the
Disney feature film The Chronicles of Narnia: Prince Caspian. In 2009, we expect
to launch a line of action figures and accessories based on Ultimate Fighting
Championship and in 2010, a product line of action figures and accessories based
on TNA (“Total Non-stop Action”) wrestling.








Role-play and Dress-up Products





Our line
of role-play and dress-up products features entertainment and consumer products
properties such as Disney
Princess, Hannah
Montana and Dora the
Explorer for girls and Black & Decker and Pirates of the Caribbean for
boys. These products generated a significant amount of sales in 2008, and we
expect that level of sales to continue in 2009.





Infant
and Pre-school Toys





Our
pre-school toys include plush and electronic toys based on Care Bears, The Wiggles,
Barney licenses and more, some branded under Child Guidance ® and others
under Play Along
®.





•
            Slumber
      bags





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





Dolls





Dolls
include large, fashion and mini dolls and related accessories based on Cabbage Patch Kids®, Hannah Montana, The Cheetah Girls, Puppy in My Pocket and
Friends, Hairspray the movie and Disney Princess dolls and
private label fashion dolls for other retailers and sold to Disney Stores and
Disney Parks and Resorts.





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 original Fly Wheels
vehicle line.





Junior
Sports Products





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





Baby
Dolls and Baby Doll Pretend Play Accessories





We have
an extensive line of licensed baby dolls and baby doll pretend play accessories
based on Graco®, Fischer-Price®, Disney Princess® and other
known brands. The high-quality realistic-looking lines feature baby doll
strollers, high chairs, bouncers, play yards, doll swings, travel seats and
travel bags, along with other accessories that emulate real baby products that
mothers today use.





Indoor
and Outdoor Kids’ Furniture





We
produce licensed indoor and outdoor kids' furniture, with an extensive portfolio
which includes baby dolls and accessories and room decor.  Our
licensed portfolio includes character licenses, including Disney Princesses® Toy
Story®, Mickey
Mouse®, High School
Musical®, SpongeBob
Squarepants®, Dora the
Explorer®, Batman® and many others, as well as
several licenses new to JAKKS' portfolio. Products include children’s puzzle
furniture, tables and chairs to activity sets, trays, stools and
more,





6


Halloween
and Everyday Costume Play





We
produce Halloween costume and décor with an expansive and innovative line which
includes non-licensed Halloween costumes based on everything from horror,
pirates, historical figures and aliens to animals, vampires, angels and more, as
well as popular licensed characters from top intellectual property owners
including Disney®,
Marvel®, Sesame
Workshop®, Mattel®, and many
others.





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.





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 JAKKS PetsTM 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 provided that there is an absence of a material breach of the license
agreement and that certain royalty minimums are met. Those minimums have been
met. We and the joint venture are named as defendants in lawsuits commenced by
WWE, pursuant to which WWE is claiming that there have been material breaches
with respect to the video game license and 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 extension
of 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. Since the parties have not reached an agreement
with respect to the preferred return for the Next Distribution Period, the
preferred return for the Next distribution Period is to 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 $52.8 million has been accrued for
the period from July 1, 2006 to December 31, 2008, pending the resolution of
this outstanding issue. JAKKS seeks to retain the same rates as set forth under
the original joint venture agreement, while THQ seeks to pay a substantially
lower rate. In the event the arbitration results in a lower rate to us, there
would be a material charge to earnings and reduction in the receivable from
THQ.





7


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
      fromConsole
                  Platforms
                
                
                Hand-
                  held
                  Platforms
                
                
                video
                  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
                
                
                
                13.22007
                
                
                4
                
                
                
                2
                
                
                
                21.22008
                
                
                4
                
                
                
                2
                
                
                
                17.1







(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 Plug It In & Play
      TV Games based on WWE
      content.





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 58.5% of our net sales in 2007
and 56.5% of our net sales in 2008. 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 The People’s Republic of China (“China”).
We sell the finished products on a letter of credit basis or on open account to
our customers, many of whom take title to the goods in Hong Kong or China. These
methods allow us to reduce certain operating costs and working capital
requirements. A portion of our sales originate in the United States, so we hold
certain inventory in our warehouse and fulfillment facilities. To date, a
significant portion of all of our sales has been to domestic customers. We
intend to continue expanding distribution of our products into foreign
territories and, accordingly, we have:





•
            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 $126.1 million, or 14.7% of our net sales, in 2007
and approximately $161.9 million, or 17.9% of our net sales, in 2008. We believe
that foreign markets present an attractive opportunity, and we plan to intensify
our marketing efforts and further expand our distribution channels
abroad.





8


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
publicize and 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, Disney large role playsets,
Plug It In & Play
TV Games, Puppy in My Pocket and Friends,
EyeClops, Hannah Montana 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.





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 2.5% of the wholesale sales price for each unit of a
product sold by us. We believe that utilizing experienced third-party inventors
gives us access to a wide range of development talent. We currently work with
numerous toy inventors and designers for the development of new products and the
enhancement of existing products.





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





Manufacturing
and Supplies





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





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





The
principal raw materials used in the production and sale of our toy products are
plastics, zinc alloy, plush, printed fabrics, paper products and electronic
components, all of which are currently available at reasonable prices from a
variety of sources. Although we do not manufacture our products, we own the
tools, dies and molds used in the manufacturing process, and these are
transferable among manufacturers if we choose to employ alternative
manufacturers. Tools, dyes and molds represent a substantial portion of our
property and equipment with a net book value of $14.4 million in 2007 and $19.6
million in 2008. Substantially all of these assets are located in
China.





9


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 Mega Brands (Rose Art®), 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 2008,
approximately 69.4% 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
February 27, 2009, we employed 998 persons, all of whom are full-time employees,
including three executive officers. We employed 503 people in the United States,
359 people in Hong Kong, 135 people in China and 1 person in the United Kingdom.
We believe that we have good relationships with our employees. None of our
employees are represented by a union.





Environmental
Issues





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





10


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 effect 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





•
            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.





11


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. Our toy license with the WWE expires on
December 31, 2009.





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;





12


•
            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 affect 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 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.





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. Since the parties have not reached an agreement
with respect to the preferred return for the Next Distribution Period, the
preferred return for the Next Distribution Period is to 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 $52.8 million has been accrued for the period from July
1, 2006 to December 31, 2008, pending the resolution of this outstanding issue.
JAKKS seeks to retain the same rates as set forth under the original joint
venture agreement, while THQ seeks to pay a substantially lower rate. In the
event the arbitration results in a lower rate to us, there would be a material
charge to earnings and reduction in the receivable from THQ.





13


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 2006 were approximately $11.8 million and $10.5 million, in 2007
and 2008, respectively, representing 1.4% and 1.2% 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 2006 represented
approximately 1.4% and 1.2% of our total revenues in 2007 and 2008,
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;





•
            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.





14


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





Our three
largest customers accounted for 56.5% of our net sales in 2008. 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 Co-Chief Executive Officer, and Stephen G. Berman,
our President and Co-Chief Executive 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 many 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.





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, 2008 sales to our international customers
comprised approximately 17.9% 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 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;





15


•
            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 CPSC, which has the authority to remove from the market products that are
found to be defective and present a substantial hazard or risk of serious injury
or death. The CPSC can require a manufacturer to recall, repair or replace these
products under certain circumstances. We cannot assure you that defects in our
products will not be alleged or found. Any such allegations or findings could
result in:





•
            product
      liability claims;





•
            loss
      of sales;





•
            diversion
      of resources;





•
            damage
      to our reputation;





•
            increased
      warranty 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.





16


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 of December 31, 2008, 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, 2008, approximately $427.7 million, or 41.6%, 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.





17


Item 2. Properties





The
following is a listing of the principal leased offices maintained by us as of
February 27, 2009:





Property
            
            Location
            
            Approximate
              Square
      Feet
            
            Lease
      Expiration
              DateDomesticCorporate
      Office
            
            Malibu,
      California
            
            
            29,500
            
            February
      28, 2015Design
      Center
            
            Malibu,
      California
            
            
            26,700
            
            August,
      31, 2015Showroom
            
            Santa
      Monica, California
            
            
            18,000
            
            August
      31, 2015Distribution
      Center
            
            City
      of Industry, California
            
            
            800,000
            
            January
      31, 2013Distribution
      Center
            
            St.
      Clair, Michigan
            
            
            69,000
            
            January
      31, 2013Distribution
      Center
            
            St.
      Clair, Michigan
            
            
            50,000
            
            December
      14, 2009Disguise
      Showroom
            
            New
      York, New York
            
            
            11,700
            
            November
      1, 2015Disguise
      Office / Warehouse
            
            Poway,
      California
            
            
            206,000
            
            January
      1, 2011Creative
      Designs Office
            
            Trevose,
      Pennsylvania
            
            
            14,700
            
            June
      30, 2009Sales
      Office / Showroom
            
            New
      York, New York
            
            
            11,500
            
            April
      30, 2012Sales
      Offices
            
            Bentonville,
      Arkansas
            
            
            4,400
            
            Month-to-MonthPalatine,
      Illinois
            
            
            2,100
            
            Month-to-MonthInternationalJAKKS
      / Play Along Hong Kong
            
            Kowloon,
      Hong Kong
            
            
            36,600
            
            June
      30, 2010Arbor
      Toys
            
            Kowloon,
      Hong Kong
            
            
            21,000
            
            May
      31, 2011Production
      Inspection Office
            
            Shanghai,
      China
            
            
            1,200
            
            April
      30, 2010Production
      Inspection and Testing Office
            
            Shenzhen,
      China
            
            
            5,400
            
            May
      14, 2010Kids
      Only Limited Office
            
            Kowloon,
      Hong Kong
            
            
            9,200
            
            May
      15, 2009Tollytots
      Limited Office
            
            Kowloon,
      Hong Kong
            
            
            3,000
            
            February
      28, 2011Tollytots  Limited
      Warehouse
            
            Tuen
      Mun, Hong Kong
            
            
            7,400
            
            October
      9, 2009Disguise
      Limited Office
            
            Kowloon,
      Hong Kong
            
            
            7,900
            
            July
      14, 2010JAKKS
      Nanijng Office
            
            Nanjing,
      China
            
            
            2,000
            
            September
      15, 2009








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 Executive Vice President and 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 the 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 jurisdiction 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”).





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 on
grounds that were not the subject of the first round of briefing, and our motion
to dismiss the action based on the release contained in a January 15, 2004
Settlement Agreement and General Release between WWE and the Company (the
“Release”). 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 remained stayed.





18


On
November 30, 2007, the Court indicated that the WWE Action would be dismissed.
On December 21, 2007 the Court dismissed the WWE Action with prejudice (the
"December 2007 Order") based on (1) the failure to plead RICO injury; (2) the
bar of the RICO statute of limitations; (3) the denial of WWE’s motion for
reconsideration of the Sherman Act claim; and (4) the lack of subject matter
jurisdiction with respect to the pendent state law claims. Thereafter, WWE filed
an appeal to the Second Circuit Court of Appeals. We filed a motion for
reconsideration of the part of the December 2007 Order that stated that the
Release did not bar the WWE Action. That motion was fully briefed and submitted
to the Court. In September 2008, the Court granted the motion and held that the
applicability of a January 2004 release executed by WWE in favor of the Company
would not be determined in connection with the motion to dismiss the action. We
also filed a cross-appeal based on the Court's earlier order denying our request
to dismiss based on the lack of a cognizable enterprise and based on the
December 2007 Order's statement with respect to the Release. WWE moved to
dismiss our cross-appeal. It has been withdrawn without prejudice to our right
to argue these issues as grounds for affirmance of the December 2007 Order. The
appeal briefing has been completed and argument will be scheduled.





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 alleged 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 alleged 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 were 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 sought 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
was fully briefed and argument occurred on November 30, 2006. The motion was
granted in January 2008 to the extent that the Class Actions were dismissed
without prejudice to plaintiffs’ right to seek leave to file an amended
complaint based on statements that the WWE licenses were obtained from the WWE
as a result of the long-term relationship with WWE. A motion seeking leave to
file an amended complaint was granted and an amended complaint filed. Briefing
was completed with respect to a motion to dismiss that was scheduled for
argument in October 2008. The Court adjourned the argument date.  The
parties have notified the Court that an agreement in principle to resolve this
action has been reached.  The agreement, which is subject to
documentation and Court approval, will settle the matter for $3.9 million,
without any admission of liability on the part of the Company, or its officers
and directors.





We
believe that the claims in the WWE Action are without merit and we intend to
continue to defend vigorously against the WWE Action. However, because the WWE
Action is on appeal, we cannot assure you as to the outcome of it, 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.





19


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 “Connecticut Action”). The lawsuit seeks, among other
things, a declaration that WWE is entitled to terminate the video game license
and monetary damages and raised Connecticut Unfair Trade Practices Act (“CUTPA”)
and contract claims against THQ and the LLC. A motion to strike the CUTPA claim
was denied in May 2007.





In March
2007, WWE filed a motion seeking leave to amend its complaint in the Connecticut
Action to add the principal part of the state law claims present in the WWE
Action to the Connecticut Action. That motion further sought, inter alia, to add
our Company and Messrs. Friedman, Berman and Bennett (the “Individual
Defendants”) as defendants in the Connecticut Action. The motion was argued on
May 8, 2007 and was granted from the bench, subject to a decision that the
schedule was suspended and no discovery matters would be addressed until
pleading motions were resolved. In June 2007, our Company and the Individual
Defendants moved for a stay of the Connecticut Action, inter alia , based on the
pendency of the WWE Action. On July 30, 2007, in light of the pending motion to
dismiss in the WWE Action, the Court ordered a 120-day stay of the Connecticut
Action (the "Stay"). In November 2007 we moved for a continuation of the Stay.
WWE served discovery and sought leave to file an amended complaint alleging the
state law claims from the WWE Action. Thereafter we moved for a conference and a
stay of discovery. A conference was held on January 14, 2008 at which WWE was
allowed to amend its complaint to assert the state law claims set forth in the
WWE Action and a briefing schedule was established with respect to a combined
motion to strike and a motion for summary judgment (the "Dispositive Motion").
This motion was briefed and argument was held on May 19, 2008. WWE cross-moved
for partial summary judgment striking our Release defense. In August 2008, the
Dispositive Motion was granted. WWE filed a motion for reargument which was
denied. THQ filed a cross-complaint which asserts claims by THQ and Mr. Farrell
for indemnification from the Company in the event that WWE prevails on any of
its claims against THQ and Farrell and also asserts claims by THQ that the
Company breached its fiduciary duties to THQ in connection with the videogame
license between WWE and THQ/JAKKS Pacific LLC and seeks equitable and legal
relief, including substantial monetary and exemplary damages against the Company
in connection with this claim. The Company has requested that THQ revise its
claims and THQ objected to this request.  This matter has not yet been
resolved. Discovery is currently proceeding in this matter. The Company intends
to contest all of these claims vigorously.





We
believe that the claims in the Connecticut Action are without merit and we
intend to defend vigorously against them. However, because this action is
subject to appeal, we cannot assure you as to the outcome of the action, nor can
we estimate the range of our potential losses. THQ and the LLC have stated that
they believe the claims in the Connecticut Action prior to the additional claims
in the amended complaint are without merit and have filed an opposition to WWE’s
motion for partial summary judgment and filed a motion for summary judgment
dismissing the remaining claims in the Connecticut Action as a matter of law on
multiple grounds and they intend to continue 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. 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 the preferred return is to be determined
through arbitration. On April 30, 2007, THQ filed an action in the Superior
Court, Los Angeles County, to compel arbitration and to appoint an arbitrator
pursuant to the relevant provisions of the agreement. An order was issued that
identified five potential arbitrators. The parties did not agree on an
arbitrator. The Company served notices of disqualification on four of the
potential arbitrators; THQ objected; the Court struck the disqualification
notices and appointed an arbitrator, who was then stricken by JAKKS. The Company
appealed the Court’s order with respect to the disclosure and disqualification
process and the appellate court took the appeal and stayed the proceedings. The
Court rendered a decision on the matter on February 28, 2008 which affirmed the
lower court's decision ruling that disclosure was not required until after the
arbitrator was nominated to serve by the Court. The matter was remanded for
further proceedings and the parties agreed on an arbitrator and the
baseball-style arbitration is scheduled to be concluded by April
2009.  JAKKS seeks to retain the same rates as set forth under the
original joint venture agreement while THQ seeks to pay a substantially lower
rate.





20


All
matters in connection with the application by Jax, Ltd. for registration of the
trademark JAX with respect to "board games" in class 28 with the United States
Patent and Trademark Office ("PTO"), and the Jax, Ltd. counterclaim seeking
cancellation of the Company's registration for the mark JAKKS PACIFIC have been
dismissed with prejudice.





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
      StockHigh
            
            
            Low2007:First
      quarter
            
            $
            25.96
            
            
            
            19.31Second
      quarter
            
            
            28.93
            
            
            
            23.58Third
      quarter
            
            
            31.42
            
            
            
            18.19Fourth
      quarter
            
            
            28.48
            
            
            
            23.122008:First
      quarter
            
            
            29.70
            
            
            
            20.18Second
      quarter
            
            
            30.55
            
            
            
            21.65Third
      quarter
            
            
            27.12
            
            
            
            20.10Fourth
      quarter
            
            
            25.99
            
            
            
            15.46





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, 2004 to
December 31, 2008.





In
accordance with recently enacted regulations implemented by the Securities and
Exchange Commission, we retained the services of an expert compensation
consultant.  In the performance of its services, such consultant used
a peer group index for its analysis of our compensation
policies.   We believe that these companies represent a
cross-section of publicly-traded companies with product lines and businesses
similar to our own throughout the comparison period and, accordingly, we are
using the same peer group for purposes of the performance graph. Our peer group
index 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.





22





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










Annual
Return Percentage
  December
      31,
                  2004
                
                
                December
      31,
                  2005
                
                
                December
      31,
                  2006
                
                
                December
      31,
                  2007
                
                
                December
      31,
                  2008JAKKS
      Pacific
                
                
                68.2
                %
                
                
                (5.3
                )
      %
                
                
                4.3
                %
                
                
                8.1
                %
                
                
                (12.6
                )
      %Peer
      Group
                
                
                14.7
                
                
                
                (10.1
                )
                
                
                18.2
                
                
                
                8.9
                
                
                
                (45.2
                )Russell
      2000
                
                
                18.3
                
                
                
                4.6
                
                
                
                18.4
                
                
                
                (1.6
                )
                
                
                (33.8
                )
  Indexed
Returns
 
 January
      1,
                  2004
                
                
                December
      31,
                  2004
                
                
                December
      31,
                  2005
                
                
                December
      31,
                  2006
                
                
                December
31,
                  2007
                
                
                December
      31,
                  2008JAKKS
      Pacific
                
                $
                100.00
                
                
                $
                168.2
                
                
                $
                159.3
                
                
                $
                166.1
                
                
                $
                179.6
                
                
                $
                156.9Peer
      Group
                
                
                100.00
                
                
                
                114.7
                
                
                
                103.1
                
                
                
                121.9
                
                
                
                132.7
                
                
                
                72.7Russell
      2000
                
                
                100.00
                
                
                
                118.3
                
                
                
                123.7
                
                
                
                146.4
                
                
                
                144.2
                
                
                
                95.4





Security
Holders





To the
best of our knowledge, as of February 27, 2009,there were 151 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 and/or buy back in the market some of our outstanding common stock, 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,
2008 for (i) all compensation plans previously approved by our stockholders and
(ii) all compensation plans not previously approved by our stockholders, if
any:





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





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





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





Plan
      Category
            
            Number
      of
              Securities
      to
              be
      Issued
              upon
              Exercise
      of
              Outstanding
              Options,
              Warrants
              and
      Rights
              (a)
            
            
            Weighted-
              Average
      Exercise
              Price
      of
              Outstanding
              Options,
              Warrants
      and
              Rights
              (b)
            
            
            Number
      of Securities
              Remaining
      Available for
              Future
      Issuance Under
              Equity
      Compensation
              Plans
      (Excluding
              Securities
      Reflected in
              Column
      (a))(c)Equity
      compensation plans approved by security holders
            
            
            477,511
            
            
            $
            19.55
            
            
            
            513,459Equity
      compensation plans not approved by security holders
            
            
            100,000
            
            
            
            11.35
            
            
            
            —Total
            
            
            577,511
            
            
            $
            18.13
            
            
            
            513,459





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.





24


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 31,2004
            
            
            2005
            
            
            2006
            
            
            2007
            
            
            2008(In
      thousands, except per share data)Consolidated
      Statement of Income Data:Net
      sales
            
            $
            574,266
            
            
            $
            661,536
            
            
            $
            765,386
            
            
            $
            857,085
            
            
            $
            903,397Cost
      of sales
            
            
            348,259
            
            
            
            394,829
            
            
            
            470,592
            
            
            
            533,435
            
            
            
            582,184Gross
      profit
            
            
            226,007
            
            
            
            266,707
            
            
            
            294,794
            
            
            
            323,650
            
            
            
            321,213Selling,
      general and administrative expenses
            
            
            172,282
            
            
            
            178,722
            
            
            
            202,482
            
            
            
            216,652
            
            
            
            241,301Write-down
      of intangible assets
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            9,076Income
      from operations
            
            
            53,725
            
            
            
            87,985
            
            
            
            92,312
            
            
            
            106,998
            
            
            
            70,836Profit
      from video game joint venture
            
            
            7,865
            
            
            
            9,414
            
            
            
            13,226
            
            
            
            21,180
            
            
            
            17,092Other
      expense
            
            
            —
            
            
            
            (1,401
            )
            
            
            —
            
            
            
            —
            
            
            
            -Interest
      income
            
            
            2,052
            
            
            
            5,183
            
            
            
            4,930
            
            
            
            6,819
            
            
            
            3,396Interest
      expense
            
            
            (4,550
            )
            
            
            (4,544
            )
            
            
            (4,533
            )
            
            
            (5,456
            )
            
            
            (2,425
            )Income
      before provision for income taxes
            
            
            59,092
            
            
            
            96,637
            
            
            
            105,935
            
            
            
            129,541
            
            
            
            88,899Provision
      for income taxes
            
            
            15,533
            
            
            
            33,144
            
            
            
            33,560
            
            
            
            40,550
            
            
            
            12,842Net
      income
            
            $
            43,559
            
            
            $
            63,493
            
            
            $
            72,375
            
            
            $
            88,991
            
            
            $
            76,057Basic
      earnings per share
            
            $
            1.69
            
            
            $
            2.37
            
            
            $
            2.66
            
            
            $
            3.22
            
            
            $
            2.78Basic
      weighted average shares outstanding
            
            
            25,797
            
            
            
            26,738
            
            
            
            27,227
            
            
            
            27,665
            
            
            
            27,379Diluted
      earnings per share
            
            $
            1.49
            
            
            $
            2.06
            
            
            $
            2.30
            
            
            $
            2.77
            
            
            $
            2.42Diluted
      weighted average shares and equivalents outstanding
            
            
            31,406
            
            
            
            32,193
            
            
            
            32,714
            
            
            
            33,149
            
            
            
            32,637





During
the fourth quarter of 2008, we acquired Tollytots, Kids Only and
Disguise.





During
the third quarter of 2008, we decided to discontinue the use of the “Toymax” and
“Trendmaster” tradenames on products and market these products under the JAKKS
Pacific trademark . Consequently, the intangible assets associated with these
tradenames were written off to write-down of intangible assets, resulting in a
charge of $3.5 million. Also, we adjusted the value of the Child Guidance
trademark to reflect lower sales expectations for this tradename, resulting in a
charge to Write-down of Intangible Assets of $5.6 million.





In
February 2006, we acquired Creative Designs.  Also, effective January
1, 2006, we implemented SFAS 123R, which requires the expensing of share-based
compensation.





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





In June
2004, we acquired Play Along.





At
      December 31,2004
            
            
            2005
            
            
            2006
            
            
            2007
            
            
            2008(In
      thousands)Consolidated
      Balance Sheet Data:Cash
      and cash equivalents
            
            $
            176,544
            
            
            $
            240,238
            
            
            $
            184,489
            
            
            $
            241,250
            
            
            $
            169,520Working
      capital
            
            
            229,543
            
            
            
            301,454
            
            
            
            280,363
            
            
            
            352,452
            
            
            
            325,061Total
      assets
            
            
            696,762
            
            
            
            753,955
            
            
            
            881,894
            
            
            
            983,664
            
            
            
            1,028,124Long-term
      debt, net of current portion
            
            
            98,000
            
            
            
            98,000
            
            
            
            98,000
            
            
            
            98,000
            
            
            
            98,000Total
      stockholders’ equity
            
            
            451,485
            
            
            
            524,651
            
            
            
            609,288
            
            
            
            690,997
            
            
            
            746,953





25


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





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





Critical
Accounting Policies





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





Allowance for
Doubtful Accounts.   Our allowance for doubtful accounts
is based on management’s assessment of the business environment, customers’
financial condition, historical collection experience, accounts receivable
aging, customer disputes and the collectability of specific customer accounts.
If there were a deterioration of a major customer’s creditworthiness, or actual
defaults were higher than our historical experience, our estimates of the
recoverability of amounts due to us could be overstated, which could have an
adverse impact on our operating results. The allowance for doubtful accounts is
also affected by the time at which uncollectible accounts receivable balances
are actually written off.





Major
customers’ accounts are monitored on an ongoing basis; more in depth reviews are
performed based on changes in customer’s financial condition and/or the level of
credit being extended. When a significant event occurs, such as a bankruptcy
filing by a specific customer, and on a quarterly basis, the allowance is
reviewed for adequacy and the balance or accrual rate is adjusted to reflect
current risk prospects.





Revenue
Recognition.Our revenue recognition policy is to recognize revenue when
persuasive evidence of an arrangement exists, title transfer has occurred
(product shipment), the price is fixed or readily determinable, and
collectability is probable. We recognize revenue in accordance with Staff
Accounting Bulletin No. 104, “Revenue Recognition.” Sales are recorded net of
sales returns and discounts, which are estimated at the time of shipment based
upon historical data. JAKKS routinely enters into arrangements with its
customers to provide sales incentives, support customer promotions, and provide
allowances for returns and defective merchandise. Such programs are based
primarily on customer purchases, customer performance of specified promotional
activities, and other specified factors such as sales to consumers. Accruals for
these programs are recorded as sales adjustments that reduce gross revenue in
the period the related revenue is recognized. Accruals for these programs are
recorded as sales adjustments that reduce gross revenue in the period the
related revenue is recognized.





Goodwill and
other indefinite-lived intangible assets. In accordance with
Statement of Financial Accounting Standards 142 (“FAS 142”), Goodwill and Other Intangible
Assets, goodwill and indefinite-lived intangible assets are not
amortized, but are tested for impairment at least annually at the reporting unit
level.





Factors
we consider important 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.





Due to the subjective nature of
the impairment analysis significant changes in the assumptions used to develop
the estimate could materially affect the conclusion regarding the future cash
flows necessary to support the valuation of long-lived assets, including
goodwill. The valuation of goodwill involves a high degree of judgment and
consists of a comparison of the fair value of a reporting unit with its book
value. Based on the assumptions underlying the valuation, impairment is
determined by estimating the fair value of a reporting unit and comparing that
value to the reporting unit’s book value. If the implied fair value is more than
the book value of the reporting unit, an impairment loss is not indicated. If
impairment exists, the fair value of the reporting unit is allocated to all of
its assets and liabilities excluding goodwill, with the excess amount
representing the fair value of goodwill. An impairment loss is measured as the
amount by which the book value of the reporting unit’s goodwill exceeds the
estimated fair value of that goodwill.





FAS 142
requires that goodwill be allocated to various reporting units, which are either
at the operating segment level or one reporting level below the operating
segment, for purposes of evaluating whether goodwill is impaired. For 2008,
JAKKS' reporting units are: Traditional Toys, Craft and Writing, and Pet
products. Goodwill is allocated within JAKKS' reporting units based on an
allocation of brand-specific goodwill to the reporting units selling those
brands. As of October 1, 2008, JAKKS performed the annual impairment test
required by FAS 142 and determined that its goodwill was not impaired. There
were no events or circumstances that indicated the impairment test should be
performed again at December 31, 2008.





26


During
the third quarter of 2008, we decided to discontinue the use of the “Toymax” and
“Trendmaster” tradenames on products and market these products under the JAKKS
Pacific trademark . Consequently, the intangible assets associated with these
tradenames were written off to Write-down of Intangible Assets, resulting in a
charge of $3.5 million. Also, we adjusted the value of the Child Guidance
trademark to reflect lower sales expectations for this tradename, resulting in a
charge to Write-down of Intangible Assets of $5.6 million.





To
determine the fair value of our reporting units, we generally use a present
value technique (discounted cash flow) corroborated by market multiples when
available and as appropriate. The factor most sensitive to change with respect
to our discounted cash flow analyses is the estimated future cash flows of each
reporting unit which is, in turn, sensitive to our estimates of future revenue
growth and margins for these businesses. If actual revenue growth and/or margins
are lower than our expectations, the impairment test results could differ. We
applied what we believe to be the most appropriate and consistent valuation
methodology for each of the reporting units. If we had established different
reporting units or utilized different valuation methodologies, the impairment
test results could differ.





Goodwill
and intangible assets amounted to $463.4 million as of December 31,
2008.





Reserve for
Inventory Obsolescence.  We value our inventory at the lower of
cost or market. Based upon a consideration of quantities on hand, actual and
projected sales volume, anticipated product selling prices and product lines
planned to be discontinued, slow-moving and obsolete inventory is written down
to its net realizable value.





Failure
to accurately predict and respond to consumer demand could result in the Company
under producing popular items or overproducing less popular items. Furthermore,
significant changes in demand for our products would impact management’s
estimates in establishing our inventory provision.





Management
estimates are monitored on a quarterly basis and a further adjustment to reduce
inventory to its net realizable value is recorded, as an increase to cost of
sales, when deemed necessary under the lower of cost or market
standard.





Income Allocation
for Income Taxes. Our quarterly income tax provision and
related income tax assets and liabilities are based on forecasted 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 materially from
those judgments, and changes from such judgments could materially affect our
consolidated financial statements.





Income taxes and
interest and penalties related to income tax payable. We do
not file a consolidated return with our foreign subsidiaries.  We file
federal and state returns and our 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.





As of
January 1, 2007, we adopted the provisions of FASB Interpretation No. 48 (“FIN
48”), Accounting for
Uncertainty in Income Taxes , which prescribes a recognition threshold
and measurement process for recording in the financial statements uncertain tax
positions taken or expected to be taken in a tax return.  As of the
date of adoption, tax benefits that are subject to challenge by tax authorities
are analyzed and accounted for in the income tax provision.  The
cumulative effect of the potential liability for unrecognized tax benefits prior
to the adoption of FIN 48, along with the associated interest and penalties, are
recognized as a reduction in the January 1, 2007 balance of retained
earnings.





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 is periodically reviewed and adjusted as circumstances
warrant.  As of December 31, 2008, our income tax reserves are
approximately $11.9 million and relate to the potential income tax audit
adjustments, primarily in the areas of income allocation, foreign depreciation
allowances and transfer pricing.





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




Share-Based
Compensation. We grant restricted stock and options to purchase our
common stock to our employees (including officers) and non-employee directors
under our 2002 Stock Award and Incentive Plan (the “Plan”), which incorporated
the shares remaining under our Third Amended and Restated 1995 Stock Option
Plan. The benefits provided under the Plan are share-based payments subject to
the provisions of revised Statement of Financial Accounting Standards No. 123
(Revised) (FAS 123R), Share-Based Payment .
Effective January 1, 2006, we began to use the fair value method to apply the
provisions of FAS 123R. We estimate the value of share-based awards on the date
of grant using the Black-Scholes option-pricing model. The determination of the
fair value of share-based payment awards on the date of grant using an
option-pricing model is affected by our stock price, as well as assumptions
regarding a number of complex and subjective variables. These variables include
our expected stock price volatility over the term of the awards, actual and
projected employee stock option exercise behaviors, cancellations, terminations,
risk-free interest rates and expected dividends.





27


Recent
Developments




On
October 7, 2008, we acquired substantially all of the assets of Tollytots
Limited.  The total initial consideration of $25.5 million consisted
of $11.8 million in cash and the assumption of liabilities in the amount of
$13.7 million, and resulted in goodwill of $3.0 million. In addition, we agreed
to pay an earn-out of up to an aggregate amount of $5.0 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. Tollytots  is a leading designer and producer
of  licensed baby dolls and baby doll pretend play accessories based
on well-known brands and was included in our results of operations from the date
of acquisition.





On
October 8, 2008, we acquired substantially all of the stock of Kids Only, Inc.
and a related Hong Kong company, Kids Only Limited (collectively, “Kids
Only”).  The total initial consideration of $23.2 million consisted of
$20.3 million in cash and the assumption of liabilities in the amount of $2.9
million, and resulted in goodwill of $12.5 million. In addition, we agreed to
pay an earn-out of up to an aggregate amount of $5.6 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. Kids Only is a leading designer and producer of licensed indoor
and outdoor kids’ furniture, and has an extensive portfolio which also includes
baby dolls and accessories, room décor and a myriad of other children’s toy
products  and was included in our results of operations from the date
of acquisition.





On
December 29, 2008, we acquired certain assets of Disguise, Inc. and a related
Hong Kong company, Disguise Limited (collectively, “Disguise”).  The
total initial consideration of $61.9 million consisted of $39.9 million in cash
and the assumption of liabilities in the amount of $22.0 million, and resulted
in goodwill of $51.6 million. We have not finalized our purchase price
allocation for Disguise and will engage a third party to perform studies and
valuations to the estimated fair value of assets and liabilities
assumed.  Disguise is a leading designer and producer of Halloween and
everyday costume play and was included in our results of operations from the
date of acquisition





28


Results
of Operations





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





Years
      Ended December 31,2004
            
            
            2005
            
            
            2006
            
            
            2007
            
            
            2008Net
      Sales
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %Cost
      of Sales
            
            
            60.6
            
            
            
            59.7
            
            
            
            61.5
            
            
            
            62.2
            
            
            
            64.4Gross
      profit
            
            
            39.4
            
            
            
            40.3
            
            
            
            38.5
            
            
            
            37.8
            
            
            
            35.6Selling,
      general and administrative expenses
            
            
            30.0
            
            
            
            27.0
            
            
            
            26.5
            
            
            
            25.3
            
            
            
            26.7Write-down
      of intangible assets
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1.0Income
      from operations
            
            
            9.4
            
            
            
            13.3
            
            
            
            12.0
            
            
            
            12.5
            
            
            
            7.9Profit
      from video game joint venture
            
            
            1.4
            
            
            
            1.4
            
            
            
            1.7
            
            
            
            2.5
            
            
            
            1.9Other
      expense
            
            
            —
            
            
            
            (0.2
            )
            
            
            —
            
            
            
            —
            
            
            
            —Interest
      income
            
            
            0.4
            
            
            
            0.8
            
            
            
            0.6
            
            
            
            0.7
            
            
            
            0.4Interest
      expense
            
            
            (0.8
            )
            
            
            (0.7
            )
            
            
            (0.6
            )
            
            
            (0.6
            )
            
            
            (0.3
            )Income
      before income taxes
            
            
            10.4
            
            
            
            14.6
            
            
            
            13.7
            
            
            
            15.1
            
            
            
            9.9Provision
      for income taxes
            
            
            2.7
            
            
            
            5.0
            
            
            
            4.4
            
            
            
            4.7
            
            
            
            1.4Net
      income
            
            
            7.7
            %
            
            
            9.6
            %
            
            
            9.3
            %
            
            
            10.4
            %
            
            
            8.5
            %





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




Years
      Ended December 31,2006
            
            
            2007
            
            
            2008Net
      SalesTraditional
      Toys
            
            $
            692,498
            
            
            $
            792,998
            
            
            $
            816,852Craft/Activity/Writing
      Products
            
            
            52,834
            
            
            
            39,632
            
            
            
            65,888Pet
      Products
            
            
            20,054
            
            
            
            24,455
            
            
            
            20,657765,386
            
            
            
            857,085
            
            
            
            903,397Cost
      of SalesTraditional
      Toys
            
            
            429,411
            
            
            
            490,279
            
            
            
            526,989Craft/Activity/Writing
      Products
            
            
            29,044
            
            
            
            26,970
            
            
            
            38,693Pet
      Products
            
            
            12,137
            
            
            
            16,186
            
            
            
            16,502470,592
            
            
            
            533,435
            
            
            
            582,184Gross
      MarginTraditional
      Toys
            
            
            263,087
            
            
            
            302,719
            
            
            
            289,862Craft/Activity/Writing
      Products
            
            
            23,790
            
            
            
            12,662
            
            
            
            27,196Pet
      Products
            
            
            7,917
            
            
            
            8,269
            
            
            
            4,155$
            294,794
            
            
            $
            323,650
            
            
            $
            321,213





Comparison
of the Years Ended December 31, 2008 and 2007





Net
Sales





Traditional
Toys.  Net sales of our Traditional Toys segment were $816.9
million in 2008, compared to $793.0 million in 2007, representing an increase of
$23.9 million, or 3.0%.  The increase in net sales was primarily due
to the contribution to sales from our Tollytots and Kids Only acquisitions of
$10.4 million and strong sales of JAKKSTM dolls based on Hannah Montana®, Camp
RockTM, Puppy In My Pocket & FriendsTM and Narnia®, electronics based on
JAKKS’ Eye Clops®, G2 Game GirlTM and UltiMotionTM brands, role-play and dress-up
toys, including those based on Disney characters Hannah Montana® and classic
princesses, and other products including Neopets® plush, offset in part by
decreases in sales of some products, including WWE® and Pokemon® action figures
and accessories, and other JAKKS products, including Plug It In & Play TV
GamesTM, Fly Wheels® XPV products®, Doodle Bears®, Care Bears®, Cabbage Patch
Kids®, Speedstacks®, The Cheetah GirlsTM toys and junior sports
products.





29


Craft/Activity/Writing
Product.  Net sales of our Craft/Activity/Writing Products were
$65.9 million in 2008, compared to $39.6 million in 2007, representing an
increase of $26.3 million, or 66.4%.  The increase in net sales was
primarily due to increases in sales of our Girl GourmetTM and Spa FactoryTM
activity toys and our SpinzTM writing instruments, offset in part by decreases in
sales of our Flying Colors® and Vivid Velvet® activities products and our
PentechTM and Color Workshop® writing instruments and related
products.





Pet Products.  Net
Sales of our Pet Products were $20.7 million in 2008, compared to $24.5 million
in 2007, representing a decrease of $3.8 million, or 15.5%.  The
decrease is mainly attributable to the less available shelf space for pet
products at some of our major customer retail stores, and lower sales of
consumable pet products. Sales of pet products were led by our AKG licensed line
of products.





Cost of
Sales





Traditional
Toys.  Cost of sales of our Traditional Toys segment was $527.0
million, or 64.5% of related net sales, in 2008, compared to $490.3 million, or
61.8% of related net sales, in 2007, representing an increase of $36.7 million,
or 7.5%.  The increase primarily consisted of an increase in product
costs of $26.9 million, which is in line with the higher volume of
sales.  Product costs as a percentage of sales increased primarily due
to the mix of the product sold with higher product cost.  Furthermore,
royalty expense for our Traditional Toys segment increased by $3.6 million, but
remained consistent  as a percentage of net sales. Our depreciation of
molds and tools increased by $6.2 million due to the increased number of new
products being sold in this segment in 2008.





Craft/Activity/Writing
Products .  Cost of sales of our Craft/Activity/Writing
Products segment was $38.7 million, or 58.7% of related net sales, in 2008,
compared to $27.0 million, or 68.1% of related net sales, in 2007, representing
an increase of $11.7 million, or 43.3%.  Product costs increased by
$13.7 million, which is in line with the higher volume of
sales.  Product costs as a percentage of net sales decreased primarily
due to the mix of the product sold and lower sales of closeout
product.  Royalty expense decreased by $2.3 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. Our depreciation of molds and tools increased by $0.4
million due to the increased number of new products being sold in this segment
in 2008.





Pet Products
..  Cost of sales of our Pet Pal line of products was $16.5 million, or
79.9% of related net sales, in 2008, compared to $16.2 million, or 66.2% of
related net sales, in 2007, representing an increase of $0.3 million, or
1.9%.   Product costs as a percentage of net sales increased
primarily due to the mix of the product sold and sell-off of closeout
product.  Royalty expense decreased by $0.1 million and as a
percentage of sales. Additionally, our depreciation of molds and tools decreased
by $0.3 million in 2008 due to less new products requiring molds and
tools.





Selling, General and
Administrative Expenses





Selling,
general and administrative expenses were $241.3 million in 2008 and $216.7
million in 2007, constituting 26.7% and 25.3% of net sales,
respectively.  The overall increase of $24.6 million in such costs was
primarily due to the addition of overhead related to the operations of
Tollytots, Kids Only and Disguise ($3.4 million) and increases in general and
administrative expenses ($5.3 million), product development ($11.4 million), and
other selling expenses ($11.0 million), offset in part by decreases in
amortization expense related to intangible assets other than goodwill ($5.1
million) and share-based compensation expense ($1.8 million).  The
increase in general and administrative expenses is primarily due to increases in
salary and payroll taxes ($4.7 million) to support our growing business, travel
and entertainment expense ($1.1 million), legal expense ($5.7 million), net of
insurance reimbursements, bad debt expense ($1.0 million) due to refunds in 2007
of customer bankruptcies that had been previously written off and rent expense
($1.1 million), offset in part by offset in part by the reversal of FIN 48
penalty reserves ($1.4 million) related to income taxes and bonus expense ($9.1
million) due to the Company achieving a lower EPS growth. The increase in direct
selling expenses is primarily due to an increase in advertising and promotional
expenses of $7.5 million in 2008 in support of several of our product lines and
other direct selling expenses of $4.4 million to support the increase in
domestic sales, offset in part by decreases in sales commissions ($1.0
million).  From time to time, we may increase or decrease our
advertising efforts, if we deem it appropriate for particular
products.





Write-down of Intangible
Assets





Write-down
of intangible assets was $9.1 million in 2008, as compared to nil in 2007. We
decided to discontinue the use of the “Toymax” and “Trendmaster” tradenames on
products and market these products under the JAKKS Pacific trademark.
Consequently, the intangible assets associated with these tradenames were
written off to Write-down of Intangible Assets, resulting in a charge of $3.5
million. Also, we adjusted the value of the Child Guidance trademark to reflect
lower sales expectations for this tradename, resulting in a charge to write-down
of intangible assets of $5.6 million.





Profit from Video Game Joint
Venture





Profit
from our video game joint venture in 2008 decreased to $17.1 million, as
compared to $21.2 million in 2007, due to the lower sales of video
games.  In 2008, the Smackdown vs. Raw 2008 game and video games on
the new WII game platform were introduced.  The amount of the
preferred return we will receive from the joint venture after June 30, 2006
became subject to change (see “Risk Factors” and “World Wrestling Entertainments
Video Games” ).





30










Interest
Income





Interest
income in 2008 was $3.4 million, as compared to $6.8 million in
2007.  The decrease is due to lower interest rates during 2008
compared to 2007 and lower average cash balances.





Interest
Expense





Interest
expense was $2.4 million in 2008, as compared to $5.5 million in 2007. In 2008,
we booked interest expense of $4.5 million related to our convertible senior
notes payable, off set in part by a net benefit of $2.2 million related to FIN
48 pursuant to our January 1, 2007 adoption of the provisions of FIN 48. In
2007, we booked interest expense of $4.5 million related to our convertible
senior notes payable and net interest expense $0.9 million related to FIN 48
pursuant to our January 1, 2007 adoption of the provisions of FIN
48.





Provision for Income
Taxes





Provision
for income taxes includes federal, state and foreign income taxes at effective
tax rates of 31.3% in 2007, and 14.4% in 2008, benefiting from a flat tax rate
of 17.5% and 16.5% for 2007 and 2008, respectively, on the Company’s income
arising in, or derived from, Hong Kong.  The decrease in the effective
rate in 2008 is primarily due to the recognition of certain discrete income tax
adjustments recognized in the quarter ended September 30, 2008 and a change in
the federal tax code which reduced the amount of foreign income includible on
the federal income tax return. These discrete adjustments included the
reconciliation of the 2007 income tax provision to the actual income tax
liability as reflected in the Company’s income tax return in the amount of $5.0
million, and the reduction in income tax expense due to the recognition of a
previously recorded potential income tax liability for uncertain tax positions
that are no longer subject to audit due to the closure of the audit
period.  As of December 31, 2008, the Company had net deferred tax
liability of approximately $8.2 million,  inclusive of an allowance of
$0.9 million that has been provided since, in the opinion of management,
realization of the future benefit is uncertain.





Comparison of the Years Ended December 31, 2007 and
2006





Net
Sales





Traditional
Toys.  Net sales of our Traditional Toys segment were $793.0
million in 2007, compared to $692.5 million in 2006, representing an increase of
$100.5 million, or 14.5%.  The increase in net sales was primarily due
to impact of sales related to our Creative Designs line of products for the full
twelve months ended December 31, 2007, as compared to only a part of the twelve
months ended December 31, 2006 (as a result of the February 2006 acquisition of
Creative Designs), which had incremental sales of $17.4 million, and increases
in sales of WWE and Pokemon action figures and accessories, role-play and
dress-up toys, Bio Bytes TM, Eye ClopsTM Bionic Eye, Child Guidance pre-school
toys, Hannah Montana dolls and accessories, In My Pocket  toys,
Cheetah Girls toys, Sweet Secrets toys, Funnoodle pool toys and our Fly Wheels
XPV® toys, offset in part by decreases in sales of Dragonball Z® action figures,
JAKKSTM dolls, Plug It In & Play TV Games, wheels products, Telestory®,
Vmigo®, Sky Dancers®, Doodle Bears® Dragon FlyzTM, TrollsTM, Care Bears®, Cabbage
Patch Kids®, Speedstacks®, SnugglersTM, RC Flight toys and our Go Fly A Kite® and
junior sports products.





Craft/Activity/Writing
Products.  Net Sales of our Craft/Activity/Writing Products
were $39.6 million in 2007, compared to $52.8 million in 2006, representing a
decrease of $13.2 million, or 25.0%.  The decrease in net sales was
primarily due to decreases in sales of our Flying Colors and Vivid Velvet
activities products and our Pentech and Color Workshop writing instruments and
related products.





Pet Products.  Net
Sales of our Pet Pal line of products were $24.5 million in 2007, compared to
$20.1 million in 2006, representing an increase of $4.4 million, or
21.9%.  The increase is attributable to the expanding line of products
and expanding distribution.





Cost of
Sales





Traditional
Toys.  Cost of sales of our Traditional Toys segment was $490.3
million, or 61.8% of related net sales, in 2007, compared to $429.4 million, or
62.0% of related net sales, in 2006, representing an increase of $60.9 million,
or 14.2%.  The increase primarily consisted of an increase in product
costs of $41.1 million, which is in line with the higher volume of
sales.  Product costs as a percentage of sales decreased primarily due
to the mix of the product sold with lower product cost.  Furthermore,
royalty expense for our Traditional Toys segment increased by $16.9 million and
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 royalty rates.  Additionally, certain royalty
advances and guarantees were written off for licensed product whose sell-off
period had expired or was projected to not recoup the advances through future
sales or meet its contractual minimum guaranty.  Our depreciation of
molds and tools increased by $2.9 million due to the increased number of new
products being sold in this segment in 2007.





Craft/Activity/Writing
Products.  Cost of sales of our Craft/Activity/Writing Products
segment was $27.0 million, or 68.1% of related net sales, in 2007, compared to
$29.0 million, or 55.0% of related net sales, in 2006, representing a decrease
of $2.0 million, or 6.9%.  The decrease consisted of a decrease in
product costs of $2.2 million, which is in line with the lower volume of
sales.  Product costs as a percentage of net sales increased primarily
due to the mix of the product sold and sell-off of closeout
product.  Royalty expense increased by $0.3 million and 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 royalty rates. Additionally, certain royalty advances and
guarantees were written off for licensed product whose sell-off period had
expired or was projected to not recoup the advances through future sales or meet
its contractual minimum guaranty.  Our depreciation of molds and tools
decreased by $0.2 million in 2007 due to lower level of product in this segment
requiring molds and tools.





31


Pet Products.  Cost
of sales of our Pet Pal line of products was $16.2 million, or 66.2% of related
net sales, in 2007, compared to $12.1 million, or 60.5% of related net sales, in
2006, representing an increase of $4.1 million, or 33.9%.  The
increase primarily consisted of an increase in product costs of $3.5 million,
which is in line with the higher volume of sales.  Product costs as a
percentage of net sales increased primarily due to the mix of the product
sold.  Royalty expense increased by $0.4 million, which was in line
with the higher volume of sales.  Additionally, our depreciation of
molds and tools was comparable year-over-year.





Selling, General and
Administrative Expenses





Selling,
general and administrative expenses were $216.7 million in 2007 and $202.5
million in 2006, constituting 25.3% and 26.5% of net sales,
respectively.  The overall increase of $14.2 million in such costs was
primarily due to increases in general and administrative expenses ($16.8
million), the incremental overhead related to a full quarter impact of
operations of Creative Designs ($1.5 million) for the three months ended March
31, 2007 (as compared to a partial quarter of operations for the three months
ended March 31, 2006 as a result of the February 2006 acquisition thereof),
product development ($2.2 million) and stock based compensation ($2.6 million),
offset in part by decreases in other selling expenses ($7.0
million),  and amortization expense related to intangible assets other
than goodwill ($1.9 million).  The increase in general and
administrative expenses is primarily due to an increase in salary and payroll
taxes ($5.8 million) to support our growing business which includes a lower
allocation of JAKKS’ overhead to the video game joint venture ($1.2 million),
bonus expense ($10.6 million) based on a stronger EPS growth in 2007 compared to
2006, donations expense (2.1 million), rent expense ($1.1 million) and travel
and entertainment expense ($0.8 million), offset in part by decreases in other
expenses as a result of the reversal of FIN 48 penalties related to income taxes
payable ($0.6 million) and the buyout of our New York showroom lease ($1.3
million) and legal and other professional fees ($1.4
million).   The decrease in direct selling expenses is primarily
due to a decrease in advertising and promotional expenses of $10.9 million in
2007 in support of several of our product lines, offset in part by an increase
in sales commissions ($1.2 million) and other direct selling expenses ($2.7
million).  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 2007 increased to $21.1 million, as
compared to $13.2 million in 2006, due to the strong performance of the new
Smackdown vs. Raw 2007 game and stronger sales of existing titles in 2007
compared to 2006. Furthermore, we devoted and allocated $1.2 million less of
JAKKS’ overhead to the video game joint venture.  The amount of the
preferred return we will receive from the joint venture after June 30, 2006
became subject to change (see “Risk Factors”, infra, and Note 4 of the
Notes to Consolidated Financial Statements, supra ).





Interest
Income





Interest
income in 2007 was $6.8 million, as compared to $4.9 million in
2006.  The increase is due to higher average cash balances and higher
interest rates during 2007 compared to 2006.





Interest
Expense





Interest
expense was $5.5 million and $4.5 million for 2007 and 2006, respectively. The
increase is due to net interest accrued pursuant to our January 1, 2007 adoption
of the provisions of FIN 48. Interest expense of $4.5 million related to our
convertible senior notes payable were comparable in 2007 and 2006.





Provision for Income
Taxes





Provision
for income taxes includes federal, state and foreign income taxes at effective
tax rates of 31.7% in 2006, and 31.3% in 2007, benefiting from a flat 17.5% tax
rate on the Company’s income arising in, or derived from, Hong Kong for each of
2006 and 2007.  The effective rate in 2007 reflects the recognition of
certain discrete income tax adjustments recognized in the quarter ended
September 30, 2007.  These adjustments included the reconciliation of
the 2006 income tax provision to the actual income tax liability as reflected in
the Company’s income tax return, and the reduction in income tax expense due to
the recognition of a previously recorded potential income tax liability for
uncertain tax positions that are no longer subject to audit due to the closure
of the audit period.  These discrete items resulted in approximately a
2.1% reduction in the effective income tax rate for the twelve months ended
December 31, 2007.   As of December 31, 2007, the Company had net
deferred tax assets of approximately $7.3 million for which an allowance of $0.9
million has been provided since, in the opinion of management, realization of
the future benefit is uncertain.





32


Quarterly
Fluctuations and Seasonality





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





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





2007
            
            
            2008First
            
            
            Second
            
            
            Third
            
            
            Fourth
            
            
            First
            
            
            Second
            
            
            Third
            
            
            FourthQuarter
            
            
            Quarter
            
            
            Quarter
            
            
            Quarter
            
            
            Quarter
            
            
            Quarter
            
            
            Quarter
            
            
            QuarterNet
      sales
            
            $
            124,062
            
            
            $
            129,547
            
            
            $
            318,391
            
            
            $
            285,085
            
            
            $
            130,935
            
            
            
            145,291
            
            
            
            357,824
            
            
            
            269,347As
      a % of full year
            
            
            14.5
            %
            
            
            15.1
            %
            
            
            37.1
            %
            
            
            33.3
            %
            
            
            14.5
            %
            
            
            16.1
            %
            
            
            39.6
            %
            
            
            29.8
            %Gross
      Profit
            
            
            45,508
            
            
            
            45,295
            
            
            
            124,050
            
            
            
            108,797
            
            
            
            47,441
            
            
            
            52,058
            
            
            
            129,065
            
            
            
            92,649As
      a % of full year
            
            
            14.1
            %
            
            
            14.0
            %
            
            
            38.3
            %
            
            
            33.6
            %
            
            
            14.8
            %
            
            
            16.2
            %
            
            
            40.2
            %
            
            
            28.8
            %As
      a % of net sales
            
            
            36.7
            %
            
            
            35.0
            %
            
            
            39.0
            %
            
            
            38.2
            %
            
            
            36.2
            %
            
            
            35.8
            %
            
            
            36.1
            %
            
            
            34.4
            %Income
      (loss) from operations
            
            
            3,324
            
            
            
            6,488
            
            
            
            65,057
            
            
            
            32,129
            
            
            
            (894
            )
            
            
            5,568
            
            
            
            57,338
            
            
            
            8,824As
      a % of full year
            
            
            3.1
            %
            
            
            6.1
            %
            
            
            60.8
            %
            
            
            30.0
            %
            
            
            -1.3
            %
            
            
            7.9
            %
            
            
            80.9
            %
            
            
            12.5
            %As
      a % of net sales
            
            
            2.7
            %
            
            
            5.0
            %
            
            
            20.4
            %
            
            
            11.3
            %
            
            
            -0.7
            %
            
            
            3.8
            %
            
            
            16.0
            %
            
            
            3.3
            %Income
      before income taxes
            
            
            4,762
            
            
            
            7,403
            
            
            
            67,087
            
            
            
            50,289
            
            
            
            1,300
            
            
            
            5,994
            
            
            
            60,803
            
            
            
            20,802As
      a % of net sales
            
            
            3.8
            %
            
            
            5.7
            %
            
            
            21.1
            %
            
            
            17.6
            %
            
            
            1.0
            %
            
            
            4.1
            %
            
            
            17.0
            %
            
            
            7.7
            %Net
      income
            
            
            3,238
            
            
            
            5,034
            
            
            
            47,318
            
            
            
            33,401
            
            
            
            877
            
            
            
            4,156
            
            
            
            54,145
            
            
            
            16,879As
      a % of net sales
            
            
            2.6
            %
            
            
            3.9
            %
            
            
            14.9
            %
            
            
            11.7
            %
            
            
            0.7
            %
            
            
            2.9
            %
            
            
            15.1
            %
            
            
            6.3
            %Diluted
      earnings per share
            
            $
            0.12
            
            
            $
            0.17
            
            
            $
            1.45
            
            
            $
            1.03
            
            
            $
            0.03
            
            
            
            0.15
            
            
            
            1.70
            
            
            
            0.55Weighted
      average shares and equivalents outstanding
            
            
            27,985
            
            
            
            33,133
            
            
            
            33,145
            
            
            
            33,251
            
            
            
            28,453
            
            
            
            32,594
            
            
            
            32,257
            
            
            
            32,312





During
2007, we recorded net interest expense of $0.9 million related to FIN
48





During
the third quarter of 2008, we decided to discontinue the use of the “Toymax” and
“Trendmaster” tradenames on products and market these products under the JAKKS
Pacific trademark . Consequently, the intangible assets associated with these
tradenames were written off to Write-down of Intangible Assets, resulting in a
charge of $3.5 million. Also, we adjusted the value of the Child Guidance
trademark to reflect lower sales expectations for this tradename, resulting in a
charge to Write-down of Intangible Assets of $5.6 million.





Recent
Accounting Standards





In
December 2007, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 141 (Revised) (“FAS 141(R)”), Business
Combinations.  This statement contains specific guidance
regarding the accounting for costs of business acquisitions and for estimating
contingent consideration provisions at the time of acquisition. This new
guidance replaces the previous guidance in FAS 141. We will adopt FAS 141(R) in
calendar year 2009.





In
September 2006, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 157 (“FAS 157”) Fair Value Measurements .
This standard provides new definitions for fair value and establishes a
framework for measuring fair value in financial statements. FAS 157 became
effective for us as of January 1, 2008 and the effect of the adoption of FAS 157
has been immaterial to our financial statements.





In June 2006, the Financial Accounting Standards
Board issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income
Taxes, which prescribes a recognition threshold and measurement process
for recording in the financial statements uncertain tax positions taken or
expected to be taken in a tax return.  Under FIN 48, the tax benefit
of uncertain tax positions may be recognized only if it is more likely than not
that the tax position will be sustained, based solely on its technical merits
presuming the tax authority has full knowledge of all relevant
information.  Additionally, FIN 48 provides guidance on the
de-recognition, classification, and accounting in interim periods and disclosure
requirements for uncertain tax positions.  In the first quarter of
2007, we adopted FIN 48 which resulted in the recognition of an increased
current and non-current income tax payable for unrecognized tax benefits of
$15.6 million.  We have also recognized an additional liability of
$2.5 million for penalties and $2.8 million for interest on the income tax
liability.  These increases to the liabilities resulted in a reduction
of $19.1 million to the January 1, 2007 balance of retained earnings, net of
related tax benefits.  Current interest on income tax liabilities is
recognized as interest expense and penalties on income tax liabilities are
recognized as other expense in the consolidated statement of
income.  During the year ended December 31, 2008, we reduced our net
interest expense accrual by $2.2 million.





33


Liquidity
and Capital Resources





As of
December 31, 2008, we had working capital of $325.1 million, compared to $352.5
million as of December 31, 2007. This decrease was primarily attributable to
acquisitions of Tollytots, Kids Only and Disguise, the repurchase of common
stock, offset in part by net cash provided by our operating
activities.





Operating
activities provided net cash of $60.8 million in 2008, as compared to $91.9
million in 2007. Net cash was provided primarily by net income and non-cash
charges, offset in part by changes in working capital. Our accounts receivable
turnover as measured by days sales for the quarter outstanding in accounts
receivable for the three months ended December 31, 2008 decreased from
approximately 55 days as of December 31, 2007 to approximately 49 days as of
December 31, 2008. 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, 2008, we had cash and cash equivalents of
$169.5 million.





Our
investing activities used net cash of $104.9 million in 2008, as compared to
$37.9 million in 2007, consisting primarily of cash paid for the Creative
Designs earn-out of $6.7 million, the Play Along earn-out of $6.7 million, the
Pet Pal earn-out of $1.7 million, and goodwill and other intangibles assets
purchased in the acquisition of  Tollytots for $10.1million, Kids Only
for $17.0 million, and Disguise for $37.9 million;  and the purchase
of office furniture and equipment and molds and tooling of $22.3 million used in
the manufacture of our products and other assets. In 2007, our investing
activities consisted primarily of cash paid for the Creative Designs earn-out of
$6.7 million, the Play Along earn-out of $6.7 million, the Pet Pal earn-out of
$2.0 million and the purchase of office furniture and equipment and molds and
tooling of $18.1 million used in the manufacture of our products and other
assets. 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,
2008, these agreements required future aggregate minimum guarantees of $57.9
million, exclusive of $38.6 million in advances already paid. Of this $57.9
million future minimum guarantee, $22.2 million is due over the next twelve
months.





Our
financing activities used net cash of $27.6 million in 2008, consisting of cash
paid for the repurchase of our common stock and restricted shares, partially
offset by proceeds from the exercise of stock options and the tax benefit from
the stock options exercised. In 2007, financing activities provided net cash of
$2.8 million, consisting of proceeds from the exercise of stock options and the
tax benefit from the stock options exercised.


.


The following is a summary of our significant contractual cash
obligations for the periods indicated that existed as of December 31, 2008 and
is based on information appearing in the notes to the consolidated financial
statements (in thousands):





2009
            
            
            2010
            
            
            2011
            
            
            2012
            
            
            2013
            
            
            Thereafter
            
            
            TotalLong-term
      debt
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            98,000
            
            
            $
            98,000Interest
      on long-term debt
            
            
            4,533
            
            
            
            4,533
            
            
            
            4,533
            
            
            
            4,533
            
            
            
            4,533
            
            
            
            42,870
            
            
            
            65,535Operating
      leases
            
            
            13,661
            
            
            
            11,986
            
            
            
            8,271
            
            
            
            7,217
            
            
            
            3,783
            
            
            
            5,419
            
            
            
            50,337Minimum
      guaranteed license/royaltypayments
            
            
            22,170
            
            
            
            22,019
            
            
            
            9,119
            
            
            
            2,863
            
            
            
            206
            
            
            
            1,500
            
            
            
            57,877Employment
      contracts
            
            
            3,989
            
            
            
            2,755
            
            
            
            475
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            7,219Total
      contractual cash obligations
            
            $
            44,353
            
            
            $
            41,293
            
            
            $
            22,398
            
            
            $
            14,613
            
            
            $
            8,522
            
            
            $
            147,789
            
            
            $
            278,968





The above
table excludes any potential uncertain income tax liabilities that may become
payable upon examination of the Company’s income tax returns by taxing
authorities. Such amounts and periods of payment cannot be reliably estimated.
See Note 12 to the financial statements for further explanation of the Company’s
uncertain tax positions. The above table also excludes our contractual
obligation with one of our executives regarding his retirement plan. Such
amounts and periods of payment cannot be reliably estimated. See Note 15 to the
financial statements for further explanation of the Company’s retirement plan
commitment.





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. The complaint was dismissed and an appeal has been filed
with respect to the Judgment dismissing the WWE Action. 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. In January 2008, the complaint was
dismissed without prejudice to seeking leave to file an amended complaint. Such
leave was sought in February 2008. 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
(the “Connecticut Action”). In spring 2007, WWE amended the complaint in the
Connecticut Action to allege the matters set forth in the WWE Action.
Thereafter, WWE amended the complaint in the Connecticut Action to allege state
claim laws that had been alleged in the WWE Action. WWE submitted a proposed
case management order in February 2008 and it provided for a trial on or after
October 2009. On February 22, 2008, we submitted a response in which we
requested that no case management order be adopted prior to the determination of
the motion to strike and for summary judgment (the
“Dispositive Motion”)because it would moot such a case management order
but that if a case management order is to be adopted it should provide for a
trial, if the matter is not fully dismissed, not before June 2010. The
Dispositive Motion was made and granted and WWE is now appealing the dismissal
with respect to the state law causes of action from the WWE Action. See “Legal
Proceedings.”





34


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 years ended December 31, 2006 and 2007, $1.5
million and $2.0 million, respectively, 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.





In
February 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 years ended December 31, 2006,
2007 and 2008, $6.9 million, $6.7 million and $5.7 million, respectively, 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.





In
February 2008, our Board of Directors authorized us to repurchase up to $30.0
million of our common stock. In April and May 2008, we repurchased a total of
1,259,300 shares of our common stock at an average price of $23.82 per share for
a total cost of $30.0 million. The stock repurchased represents approximately
4.4% of our outstanding shares of common stock.





InFebruary 2009,parties to our class action lawsuit  notified
the Court that an agreement in principle to settle this matter has been
reached.  The agreement, which is subject to documentation and Court
approval, will settle the matter for $3.9 million, without any admission of
liability on the part of the Company, or its officers and directors. The
Company expects for a significant portion of this settlement to be covered by
insurance.See “Legal Proceedings.”





On October 7, 2008, we acquired substantially all of the assets
of Tollytots Limited.  The total initial consideration of $25.5
million consisted of $11.8 million in cash and the assumption of liabilities in
the amount of $13.7 million, and resulted in goodwill of $3.0 million. In
addition, we agreed to pay an earn-out of up to an aggregate amount of $5.0
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. Tollytots is a leading designer and
producer of licensed baby dolls and baby doll pretend play accessories based on
well-known brands and was included in our results of operations from the date of
acquisition.





On
October 8, 2008, we acquired substantially all of the stock of Kids Only, Inc.
and a related Hong Kong company, Kids Only Limited (collectively, “Kids
Only”).  The total initial consideration of $23.2 million consisted of
$20.3 million in cash and the assumption of liabilities in the amount of $2.9
million, and resulted in goodwill of $12.5 million. In addition, we agreed to
pay an earn-out of up to an aggregate amount of $5.6 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. Kids Only is a leading designer and producer of licensed indoor
and outdoor kids’ furniture, and has an extensive portfolio which also includes
baby dolls and accessories, room décor and a myriad of other children’s toy
products  and was included in our results of operations from the date
of acquisition.




On
December 29, 2008, we acquired certain assets of Disguise, Inc. and a related
Hong Kong company, Disguise Limited (collectively, “Disguise”).  The
total initial consideration of $61.9 million consisted of $39.9 million in cash
and the assumption of liabilities in the amount of $22.0 million, and resulted
in goodwill of $51.6 million. We have not finalized our purchase price
allocation for Disguise and will engage a third party to perform studies and
valuations to the estimated fair value of assets and liabilities
assumed.  Disguise is a leading designer and producer of Halloween and
everyday costume play and was included in our results of operations from the
date of acquisition





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, 2008, and
are not convertible in the first quarter of 2009.





35


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 net cash and cash
equivalents.  As of December 31, 2008, 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/U.S. dollar exchange rate may positively or negatively
affect our operating results. The exchange rate of the Hong Kong dollar to the
U.S. dollar has been fixed by the Hong Kong government since 1983 at HK$7.80 to
US$1.00 and, accordingly, has not represented a currency exchange risk to the
U.S. dollar. We cannot assure you that the exchange rate between the United
States and Hong Kong currencies will continue to be fixed or that exchange rate
fluctuations between the United States and Hong Kong currencies will not have a
material adverse effect on our business, financial condition or results of
operations.





Item 7A.Quantitative and
Qualitative Disclosures About Market Risk





Market
risk represents the risk of loss that may impact our financial position, results
of operations or cash flows due to adverse changes in financial and commodity
market prices and rates. We are exposed to market risk in the areas of changes
in United States and international borrowing rates and changes in foreign
currency exchange rates. In addition, we are exposed to market risk in certain
geographic areas that have experienced or remain vulnerable to an economic
downturn, such as China. We purchase substantially all of our inventory from
companies in China, and, therefore, we are subject to the risk that such
suppliers will be unable to provide inventory at competitive prices. While we
believe that, 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. To date, 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,
2008. Accordingly, we are not generally subject to any direct risk of loss
arising from changes in interest rates.





Foreign Currency Risk





We have
wholly-owned subsidiaries in Hong Kong and 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, 2007. 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.





36




Item 8. Consolidated
Financial Statements and Supplementary Data





Report
of Independent Registered Public Accounting Firm








The Board
of Directors and Stockholders


JAKKS
Pacific, Inc.


Malibu,
California





We have
audited the accompanying consolidated balance sheets of JAKKS Pacific, Inc. (the
“Company”) as of December 31, 2008 and 2007 and the related consolidated
statements of income, other comprehensive income, stockholders’ equity and cash
flows for each of the three years in the period ended December 31, 2008. 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 audits 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 financial statements referred to above present fairly, in all
material respects, the financial position of JAKKS Pacific, Inc. as of December
31, 2008 and 2007, and the results of its operations and its cash flows for each
of the three years in the period ended December 31, 2008, 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, 2007, the Company changed the manner in which it accounts for
uncertain tax positions, due to the adoption of FASB Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement
No. 109.”





We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), JAKKS Pacific, Inc.’s internal control over
financial reporting as of December 31, 2008, based on criteria established in
Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) and our report dated February 28, 2009 expressed an
unqualified opinion thereon.








/s/
      BDO Seidman, LLPBDO
      Seidman, LLPLos
      Angeles, CaliforniaFebruary
      28, 2009





37





JAKKS
PACIFIC, INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS





December
      31,2007
            
            
            2008(In
      thousands, exceptshare
      data)AssetsCurrent
      assetsCash
      and cash equivalents
            
            $
            241,250
            
            
            $
            169,520Marketable
      securities
            
            
            218
            
            
            
            195Accounts
      receivable, net of allowance for uncollectible accounts of $1,354 and
      $2,005, respectively
            
            
            174,451
            
            
            
            147,587Inventory
            
            
            75,486
            
            
            
            87,944Income
      tax receivable
            
            
            —
            
            
            
            22,288Deferred
      income taxes
            
            
            13,921
            
            
            
            17,993Prepaid
      expenses and other
            
            
            17,531
            
            
            
            29,670Total
      current assets
            
            
            522,857
            
            
            
            475,197Property
      and equipmentOffice
      furniture and equipment
            
            
            9,961
            
            
            
            12,390Molds
      and tooling
            
            
            44,333
            
            
            
            63,075Leasehold
      improvements
            
            
            5,186
            
            
            
            5,947Total
            
            
            59,480
            
            
            
            81,412Less
      accumulated depreciation and amortization
            
            
            38,073
            
            
            
            52,914Property
      and equipment, net
            
            
            21,407
            
            
            
            28,498Intangibles
      and other, net
            
            
            30,402
            
            
            
            33,061Investment
      in video game joint venture
            
            
            36,090
            
            
            
            53,184Goodwill,
      net
            
            
            353,340
            
            
            
            427,693Trademarks,
      net
            
            
            19,568
            
            
            
            10,491Total
      assets
            
            $
            983,664
            
            
            $
            1,028,124Liabilities
      and Stockholders’ EquityCurrent
      liabilitiesAccounts
      payable
            
            $
            52,287
            
            
            $
            57,432Accrued
      expenses
            
            
            70,085
            
            
            
            61,780Reserve
      for sales returns and allowances
            
            
            26,036
            
            
            
            23,317Short-term
      debt
            
            
            —
            
            
            
            417Income
      taxes payable
            
            
            21,997
            
            
            
            7,190Total
      current liabilities
            
            
            170,405
            
            
            
            150,136Convertible
      senior notes
            
            
            98,000
            
            
            
            98,000Other
      liabilities
            
            
            6,432
            
            
            
            2,112Income
      taxes payable
            
            
            11,294
            
            
            
            4,686Deferred
      income taxes
            
            
            6,536
            
            
            
            26,237Total
      liabilities
            
            
            292,667
            
            
            
            281,171Commitments
      and contingenciesStockholders’
      equityPreferred
      shares, $.001 par value; 5,000,000 shares authorized; nil
      outstanding
            
            
            —
            
            
            
            —Common
      stock, $.001 par value; 100,000,000 shares authorized 28,275,116 and
      27,521,278 shares issued and outstanding, respectively
            
            
            28
            
            
            
            28Additional
      paid-in capital
            
            
            312,127
            
            
            
            292,809Retained
      earnings
            
            
            382,288
            
            
            
            458,345Accumulated
      other comprehensive loss
            
            
            (3,446
            )
            
            
            (4,229
            )Total
      stockholders’ equity
            
            
            690,997
            
            
            
            746,953Total
      liabilities and stockholders’ equity
            
            $
            983,664
            
            
            $
            1,028,124





See
notes to consolidated financial statements.





38





JAKKS
PACIFIC, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF INCOME





Years
      Ended December 31,2006
            
            
            2007
            
            
            2008(In
      thousands, except per share amounts)Net
      sales
            
            $
            765,386
            
            
            $
            857,085
            
            
            $
            903,397Cost
      of sales
            
            
            470,592
            
            
            
            533,435
            
            
            
            582,184Gross
      profit
            
            
            294,794
            
            
            
            323,650
            
            
            
            321,213Selling,
      general and administrative expenses
            
            
            202,482
            
            
            
            216,652
            
            
            
            241,301Write-down
      of intangible assets
            
            
            —
            
            
            
            —
            
            
            
            9,076Income
      from operations
            
            
            92,312
            
            
            
            106,998
            
            
            
            70,836Profit
      from video game joint venture
            
            
            13,226
            
            
            
            21,180
            
            
            
            17,092Interest
      income
            
            
            4,930
            
            
            
            6,819
            
            
            
            3,396Interest
      expense
            
            
            (4,533
            )
            
            
            (5,456
            )
            
            
            (2,425
            )Income
      before provision for income taxes
            
            
            105,935
            
            
            
            129,541
            
            
            
            88,899Provision
      for income taxes
            
            
            33,560
            
            
            
            40,550
            
            
            
            12,842Net
      income
            
            $
            72,375
            
            
            $
            88,991
            
            
            $
            76,057Basic
      earnings per share
            
            $
            2.66
            
            
            $
            3.22
            
            
            $
            2.78Basic
      weighted number of shares
            
            
            27,227
            
            
            
            27,665
            
            
            
            27,379Diluted
      earnings per share
            
            $
            2.30
            
            
            $
            2.77
            
            
            $
            2.42Diluted
      weighted number of shares
            
            
            32,714
            
            
            
            33,149
            
            
            
            32,637





See
notes to consolidated financial statements.





39





JAKKS
PACIFIC, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OTHER COMPREHENSIVE INCOME





Years
      Ended December 31,2006
            
            2007
            
            2008(In
      thousands)Other
      comprehensive income:Net
      income
            
            $
            72,375
            
            
            $
            88,991
            
            
            $
            76,057Foreign
      currency translation adjustment
            
            
            (638
            )
            
            
            (19
            )
            
            
            (783
            )Other
      comprehensive income
            
            $
            71,737
            
            
            $
            88,972
            
            
            $
            75,274





See
notes to consolidated financial statements.





40





JAKKS
PACIFIC, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY


YEARS
ENDED DECEMBER 31, 2006, 2007 AND 2008


(In
thousands)





Common
      Stock
            
            
            
            
            
            
            
            
            AccumulatedAdditional
            
            
            
            
            
            Other
            
            
            TotalNumber
            
            
            
            
            
            Paid-in
            
            
            Retained
            
            
            Comprehensive
            
            
            Stockholders’of
      Shares
            
            
            Amount
            
            
            Capital
            
            
            Earnings
            
            
            Loss
            
            
            EquityBalance,
      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 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
            )
            
            
            609,288Adoption
      of FIN 48
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (19,135
            )
            
            
            —
            
            
            
            (19,135
            )Exercise
      of options
            
            
            391
            
            
            
            —
            
            
            
            6,470
            
            
            
            —
            
            
            
            —
            
            
            
            6,470Stock
      option income tax benefit
            
            
            —
            
            
            
            —
            
            
            
            1,053
            
            
            
            —
            
            
            
            —
            
            
            
            1,053Restricted
      stock grants
            
            
            323
            
            
            
            —
            
            
            
            8,082
            
            
            
            —
            
            
            
            —
            
            
            
            8,082Compensation
      for vested stock options
            
            
            —
            
            
            
            —
            
            
            
            972
            
            
            
            —
            
            
            
            —
            
            
            
            972Retirement
      of common stock
            
            
            (191
            )
            
            
            —
            
            
            
            (4,675
            )
            
            
            —
            
            
            
            —
            
            
            
            (4,675
            )Retirement
      of Restricted Stock
            
            
            (25
            )
            
            
            —
            
            
            
            (30
            )
            
            
            —
            
            
            
            —
            
            
            
            (30
            )Net
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            88,991
            
            
            
            —
            
            
            
            88,991Foreign
      currency translation adjustment
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (19
            )
            
            
            (19
            )Balance,
      December 31, 2007
            
            
            28,275
            
            
            
            28
            
            
            
            312,127
            
            
            
            382,288
            
            
            
            (3,446
            )
            
            
            690,997Exercise
      of  options
            
            
            315
            
            
            
            —
            
            
            
            4,171
            
            
            
            —
            
            
            
            —
            
            
            
            4,171Stock
      option income tax benefit
            
            
            —
            
            
            
            —
            
            
            
            1,338
            
            
            
            —
            
            
            
            —
            
            
            
            1,338Restricted
      stock grants
            
            
            318
            
            
            
            1
            
            
            
            7,764
            
            
            
            —
            
            
            
            —
            
            
            
            7,765Compensation
      for vested stock options
            
            
            —
            
            
            
            —
            
            
            
            537
            
            
            
            —
            
            
            
            —
            
            
            
            537Retirement
      of common stock
            
            
            (1,259
            )
            
            
            (1
            )
            
            
            (30,000
            )
            
            
            —
            
            
            
            —
            
            
            
            (30,001
            )Retirement
      of Restricted Stock
            
            
            (128
            )
            
            
            —
            
            
            
            (3,128
            )
            
            
            —
            
            
            
            —
            
            
            
            (3,128
            )Net
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            76,057
            
            
            
            —
            
            
            
            76,057Foreign
      currency translation adjustment
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (783
            )
            
            
            (783
            )Balance,
      December 31, 2008
            
            
            27,521
            
            
            $
            28
            
            
            $
            292,809
            
            
            $
            458,345
            
            
            $
            (4,229
            )
            
            $
            746,953





See
notes to consolidated financial statements.





41





JAKKS PACIFIC, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS





Years
      Ended December 31,2006
                
                
                2007
                
                
                2008(In
      thousands)Cash
      flows from operating activitiesNet
      income
                
                $
                72,375
                
                
                $
                88,991
                
                
                $
                76,057Adjustments
      to reconcile net income to net cash provided by operating
      activitiesDepreciation
      and amortization
                
                
                26,166
                
                
                
                26,663
                
                
                
                27,566Share-based
      compensation expense
                
                
                6,482
                
                
                
                9,054
                
                
                
                7,302Profit
      from video game joint venture
                
                
                (5,147
                )
                
                
                (21,856
                )
                
                
                (17,507
                )Loss
      on disposal of property and equipment
                
                
                48
                
                
                
                1,781
                
                
                
                99Write-down
      of intangible assets
                
                
                —
                
                
                
                —
                
                
                
                9,076Deferred
      income taxes
                
                
                (1,043
                )
                
                
                2,644
                
                
                
                14,367Changes
      in operating assets and liabilities, net of acquisitionsAccounts
      receivable
                
                
                (52,885
                )
                
                
                (21,334
                )
                
                
                46,204Inventory
                
                
                (8,352
                )
                
                
                1,329
                
                
                
                (6,553
                )Prepaid
      expenses and other
                
                
                (8,293
                )
                
                
                9,019
                
                
                
                (6,329
                )Income
      tax receivable
                
                
                —
                
                
                
                —
                
                
                
                (22,288
                )Accounts
      payable
                
                
                12,608
                
                
                
                (13,061
                )
                
                
                (31,324
                )Accrued
      expenses
                
                
                1,882
                
                
                
                14,493
                
                
                
                (6,573
                )Income
      taxes payable
                
                
                14,756
                
                
                
                (891
                )
                
                
                (21,415
                )Reserve
      for sales returns and allowances
                
                
                5,253
                
                
                
                (6,489
                )
                
                
                (2,718
                )Other
      liabilities
                
                
                (140
                )
                
                
                1,519
                
                
                
                (5,169
                )Total
      adjustments
                
                
                (8,665
                )
                
                
                2,871
                
                
                
                (15,262
                )Net
      cash provided by operating activities
                
                
                63,710
                
                
                
                91,862
                
                
                
                60,795Cash
      flows from investing activitiesPurchases
      of property and equipment
                
                
                (11,204
                )
                
                
                (18,116
                )
                
                
                (22,274
                )Change
      in other assets
                
                
                46
                
                
                
                (4,208
                )
                
                
                (2,155
                )Change
      in deposits
                
                
                (701
                )
                
                
                17
                
                
                
                (901
                )Cash
      paid for net assets of businesses acquired
                
                
                (109,845
                )
                
                
                (15,605
                )
                
                
                (79,598
                )Net
      (purchases) sales of marketable securities
                
                
                (210
                )
                
                
                (7
                )
                
                
                23Net
      cash used by investing activities
                
                
                (121,914
                )
                
                
                (37,919
                )
                
                
                (104,905
                )Cash
      flows from financing activitiesProceeds
      from stock options exercised (net of cashless exercises of $ 2.8 million,
      $4.7 million and $3.1 million in 2006, 2007 and 2008,
      respectively)
                
                
                1,584
                
                
                
                1,765
                
                
                
                1,043Common
      stock repurchased
                
                
                —
                
                
                
                —
                
                
                
                (30,001
                )Tax
      benefit from stock options exercised
                
                
                1,509
                
                
                
                1,053
                
                
                
                1,338Net
      cash provided by (used in) financing activities
                
                
                3,093
                
                
                
                2,818
                
                
                
                (27,620
                )Impact
      of foreign currency translation
                
                
                (638
                )
                
                
                —
                
                
                
                —Net
      increase (decrease) in cash and cash equivalents
                
                
                (55,749
                )
                
                
                56,761
                
                
                
                (71,730
                )Cash
      and cash equivalents, beginning of year
                
                
                240,238
                
                
                
                184,489
                
                
                
                241,250Cash
      and cash equivalents, end of year
                
                $
                184,489
                
                
                $
                241,250
                
                
                $
                169,520Cash
      paid during the period for:Interest
                
                $
                4,533
                
                
                $
                4,533
                
                
                $
                4,610Income
      taxes
                
                $
                19,496
                
                
                $
                32,198
                
                
                $
                43,408





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, 2008





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 of 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 collectability 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 decreased by $2.7 million from $26.0 million as of December 31, 2007
to $23.3 million as of December 31, 2008.  This decrease is primarily
due to certain customers taking their year-end allowances related to 2007 and
2008 during 2008 and lower sales in the fourth quarter of 2008 compared to the
fourth quarter of 2007.





43





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
      31,2007
            
            2008Raw
      materials
            
            $
            1,694
            
            
            $
            3,778Finished
      goods
            
            
            73,792
            
            
            
            84,166$
            75,486
            
            
            $
            87,944





Fair
value of financial instruments





The
Company’s cash and cash equivalents, marketable securities, accounts receivable,
accounts payable and accrued expenses 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, 2007 and 2008 was approximately $137.7 million and
$103.8 million, respectively, based on the most recent 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





For the
years ended December 31, 2006, 2007, and 2008, the Company’s aggregate
depreciation expense related to property and equipment was $8.5 million, $11.4
million and $17.7 million, respectively.





Advertising





Production
costs of commercials and programming are charged to operations in the period
during which the production is first aired. The costs of other advertising,
promotion and marketing programs are charged to operations in the period
incurred. Advertising expense for the three years in the period ended December
31, 2008, was approximately $36.7 million, $22.3 million and $28.0 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 an asset and
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.





44





Profits
and losses resulting from the above translation policy are recognized in the
statements of other comprehensive income.





Accounting
for the impairment of finite-lived intangible assets





Long-lived
assets with finite lives, which include property and equipment and 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, 2007 and 2008 was $63.1 million and
$72.5 million, respectively.





Goodwill
and other indefinite-lived intangible assets





In
accordance with Statement of Financial Accounting Standards (“SFAS”) 142, Goodwill and Other Intangible
Assets, 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.  Indefinite-lived intangible assets other than
goodwill consist of trademarks.





During
the third quarter of 2008, the Company decided to discontinue the use of the
“Toymax” and “Trendmaster” tradenames on products and market these products
under the JAKKS Pacific trademark. Consequently, the intangible assets
associated with these tradenames were written off to Write-down of Intangible
Assets, resulting in a charge of $3.5 million. Also, the Company adjusted the
value of the Child Guidance trademark to reflect lower sales expectations for
this tradename, resulting in a charge to Write-down of Intangible Assets of $5.6
million.  As of December 31, 2008, there was no impairment to the
underlying value of goodwill.





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
Compensation





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 the Company
recorded $1.9 million, $1.0 million and $0.5 million of stock option
expense in 2006, 2007 and 2008, respectively, and $4.6 million, $8.1
million and $6.8 million of restricted stock expense, respectively, in 2006,
2007 and 2008. See Note 16 for further details relating to share based
compensation.





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):





2006WeightedAverageIncome
            
            
            Shares
            
            
            Per
      ShareBasic
      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
            
            
            —
            
            
            
            362Diluted
      EPS
            
            
            —
            
            
            
            225Income
      available to common stockholders plus assumed exercises and
      conversion
            
            $
            75,321
            
            
            
            32,714
            
            
            $
            2.30





45








2007WeightedAverageIncome
            
            
            Shares
            
            
            Per
      ShareBasic
      EPSIncome
      available to common stockholders
            
            $
            88,991
            
            
            
            27,665
            
            
            $
            3.22Effect
      of dilutive securitiesAssumed
      conversion of convertible senior notes
            
            
            2,946
            
            
            
            4,900Options
      and warrants
            
            
            —
            
            
            
            328Unvested
      restricted stock grants
            
            
            —
            
            
            
            256Diluted
      EPSIncome
      available to common stockholders plus assumed exercises and
      conversion
            
            $
            91,937
            
            
            
            33,149
            
            
            $
            2.77





2008WeightedAverageIncome
            
            
            Shares
            
            
            Per
      ShareBasic
      EPSIncome
      available to common stockholders
            
            $
            76,057
            
            
            
            27,379
            
            
            $
            2.78Effect
      of dilutive securitiesAssumed
      conversion of convertible senior notes
            
            
            2,946
            
            
            
            4,900Options
      and warrants
            
            
            —
            
            
            
            134Unvested
      restricted stock grants
            
            
            —
            
            
            
            224Diluted
      EPSIncome
      available to common stockholders plus assumed exercises and
      conversion
            
            $
            79,003
            
            
            
            32,637
            
            
            $
            2.42





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, restricted stock and
convertible debt to the extent they are dilutive).  Potentially
dilutive stock options of 406,612, nil and 14,892 for the years ended December
31, 2006, 2007 and 2008, respectively, were not included in the computation of
diluted earnings 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. Potentially dilutive
restricted stock of nil, 13,907 and nil for the years ended December 31,
2006, 2007 and 2008, respectively, were not included in the computation of
diluted earnings per share as the average market price of the Company’s common
stock did not exceed the weighted average exercise price of such restricted
stock and to have included them would have been anti-dilutive.





Recent
Accounting Standards





In
December 2007, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 141 (Revised) (“FAS 141(R)”), Business
Combinations.  This statement contains specific guidance
regarding the accounting for costs of business acquisitions and for estimating
contingent consideration provisions at the time of acquisition. This new
guidance replaces the previous guidance in FAS 141. The Company will adopt FAS
141(R) in calendar year 2009.





In June
2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48
(“FIN 48”), Accounting for
Uncertainty in Income Taxes, which prescribes a recognition threshold and
measurement process for recording in the financial statements uncertain tax
positions taken or expected to be taken in a tax return.  Under FIN
48, the tax benefit of uncertain tax positions may be recognized only if it is
more likely than not that the tax position will be sustained, based solely on
its technical merits presuming the tax authority has full knowledge of all
relevant information.  Additionally, FIN 48 provides guidance on the
de-recognition, classification, and accounting in interim periods and disclosure
requirements for uncertain tax positions.  In the first quarter of
2007, the Company adopted FIN 48 which resulted in the recognition of an
increased current and non-current income tax payable for unrecognized tax
benefits of $15.6 million.  The Company has also recognized an
additional liability of $2.5 million for penalties and $2.8 million for interest
on the income tax liability.  These increases to the liabilities
resulted in a reduction of $19.1 million to the January 1, 2007 balance of
retained earnings, net of related tax benefits.  Current interest on
income tax liabilities is recognized as interest expense and penalties on income
tax liabilities are recognized as other expense in the consolidated statement of
income.





46


In
September 2006, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 157 (“FAS 157”) Fair Value Measurements. This
standard provides new definitions for fair value and establishes a framework for
measuring fair value in financial statements. FAS 157 became effective for the
Company as of January 1, 2008 and the effect of the adoption of FAS 157 has been
immaterial to its financial statements.





Reclassifications





Certain
reclassifications have been made to prior year balances in order to conform to
the current year presentation.





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 other
consumer products, principally engaged in the design, development, production,
marketing and distribution of its diverse portfolio. The Company’s reportable
segments are Traditional Toys, Craft/Activity/Writing Products, and Pet
Products, each of which includes worldwide sales.





The
Traditional Toys segment includes action figures, vehicles, playsets, plush
products, dolls, accessories, pretend play products, electronic products,
novelty toys, construction toys, compounds, infant and pre-school toys, water
toys, kites, squirt guns, and related products.





Craft/Activity/Writing
Products include pens, pencils, stationery products and drawing, crayons,
markers, paints, and other do-it-yourself related products.





Pet
Products include pet toys, treats, apparel and related pet
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, 2008 are
as follows (in thousands):





Years
      Ended December 31,2006
            
            
            2007
            
            
            2008Net
      SalesTraditional
      Toys
            
            $
            692,498
            
            
            $
            792,998
            
            
            $
            816,852Craft/Activity/Writing
      Products
            
            
            52,834
            
            
            
            39,632
            
            
            
            65,888Pet
      Products
            
            
            20,054
            
            
            
            24,455
            
            
            
            20,657$
            765,386
            
            
            $
            857,085
            
            
            $
            903,397





Years
      Ended December 31,2006
            
            
            2007
            
            
            2008Operating
      IncomeTraditional
      Toys
            
            $
            83,521
            
            
            $
            100,227
            
            
            $
            65,133Craft/Activity/Writing
      Products
            
            
            6,372
            
            
            
            4,079
            
            
            
            4,604Pet
      Products
            
            
            2,419
            
            
            
            2,692
            
            
            
            1,099$
            92,312
            
            
            $
            106,998
            
            
            $
            70,836





Years
      Ended December 31,2006
            
            
            2007
            
            
            2008Depreciation
      and Amortization ExpenseTraditional
      Toys
            
            $
            24,780
            
            
            $
            25,339
            
            
            $
            25,332Craft/Activity/Writing
      Products
            
            
            995
            
            
            
            829
            
            
            
            1,182Pet
      Products
            
            
            391
            
            
            
            495
            
            
            
            185$
            26,166
            
            
            $
            26,663
            
            
            $
            26,699





47










December
      31,2007
            
            
            2008AssetsTraditional
      Toys
            
            $
            840,232
            
            
            $
            877,606Craft/Activity/Writing
      Products
            
            
            115,893
            
            
            
            128,036Pet
      Products
            
            
            27,539
            
            
            
            22,482$
            983,664
            
            
            $
            1,028,124





The
following tables present information about the Company by geographic area as of
and for the three years ended December 31, 2008 (in thousands):





December
      31,2007
            
            
            2008Long-lived
      AssetsUnited
      States
            
            $
            19,372
            
            
            $
            26,179Hong
      Kong
            
            
            2,035
            
            
            
            2,319$
            21,407
            
            
            $
            28,498





Years
      Ended December 31,2006
            
            
            2007
            
            
            2008Net
      Sales by Geographic AreaUnited
      States
            
            $
            666,294
            
            
            $
            730,971
            
            
            $
            741,486Europe
            
            
            30,169
            
            
            
            37,585
            
            
            
            46,832Canada
            
            
            27,067
            
            
            
            29,155
            
            
            
            36,929Hong
      Kong
            
            
            17,500
            
            
            
            30,175
            
            
            
            38,318Other
            
            
            24,356
            
            
            
            29,199
            
            
            
            39,832$
            765,386
            
            
            $
            857,085
            
            
            $
            903,397





Major
Customers





Net sales
to major customers were as follows (in thousands, except for
percentages):





2006
            
            
            2007
            
            
            2008Percentage
      of
            
            
            
            
            
            Percentage
      of
            
            
            
            
            
            Percentage
      ofAmount
            
            
            Net
      Sales
            
            
            Amount
            
            
            Net
      Sales
            
            
            Amount
            
            
            Net
      SalesWal-Mart
            
            $
            210,758
            
            
            
            27.5
            %
            
            $
            219,145
            
            
            
            25.5
            %
            
            $
            272,211
            
            
            
            30.1
            %Target
            
            
            134,347
            
            
            
            17.6
            
            
            
            142,026
            
            
            
            16.6
            
            
            
            118,850
            
            
            
            13.2Toys
      ‘R’ Us
            
            
            104,392
            
            
            
            13.6
            
            
            
            140,387
            
            
            
            16.4
            
            
            
            119,125
            
            
            
            13.2$
            449,497
            
            
            
            58.7
            %
            
            $
            501,558
            
            
            
            58.5
            %
            
            $
            510,186
            
            
            
            56.5
            %





No other
customer accounted for more than 10% of our total net sales.





At
December 31, 2007 and 2008, the Company’s three largest customers accounted for
approximately 82.2% and 74.0%, 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.





48


Note
4—Joint Venture





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 based on the WWE franchise 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
preferred return for the Next Distribution Period is to 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 $52.8 million has been accrued for the period from July
1, 2006 to December 31, 2008, pending the resolution of this outstanding
issue.  JAKKS seeks to retain the same rates as set forth under the
original joint venture agreement, while THQ seeks to pay a substansially
lower rate. In the event the arbitration results in a lower rate to the Company,
there would be a material charge to earnings and reduction in the
receivable from THQ. As of December 31, 2007 and 2008, the balance of the
investment in the video game joint venture includes the following components (in
thousands):




December
      31,2007
            
            
            2008Preferred
      return receivable
            
            $
            35,338
            
            
            $
            52,845Investment
      costs, net
            
            
            752
            
            
            
            339$
            36,090
            
            
            $
            53,184





The
Company’s joint venture partner retains the financial risk of the joint venture
and is responsible for 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 2006, 2007 and 2008, the Company earned $13.2
million, $21.2 million and $17.1 million, respectively, in net profit from the
joint venture.





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
October 7, 2008, the Company acquired substantially all of the assets of
Tollytots Limited.  The total initial consideration of $25.5 million
consisted of $11.8 million in cash and the assumption of liabilities in the
amount of $13.7 million, and resulted in goodwill of $3.0 million. In addition,
the Company agreed to pay an earn-out of up to an aggregate amount of $5.0
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.  Tollytots is a leading
designer and producer of licensed baby dolls and baby doll pretend play
accessories based on well-known brands and was included in our results of
operations from the date of acquisition.  Pro forma results of
operations are not provided since the amounts are not material to the
consolidated results of operations.





On
October 8, 2008, the Company acquired substantially all of the stock of Kids
Only, Inc, and a related Hong Kong company, Kids Only Limited (collectively,
“Kids Only”).  The total initial consideration of $23.2 million
consisted of $20.3 million in cash and the assumption of liabilities in the
amount of $2.9 million, and resulted in goodwill of $12.5 million. In addition,
the Company agreed to pay an earn-out of up to an aggregate amount of $5.6
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.  Kids Only is a leading
designer and producer of licensed indoor and outdoor kids’ furniture, and has an
extensive portfolio which also includes baby dolls and accessories, room décor
and a myriad of other children’s toy products  and was included in our
results of operations from the date of acquisition.  Pro forma results
of operations are not provided since the amounts are not material to the
consolidated results of operations.





On
December 29, 2008, the Company acquired certain assets of Disguise, Inc. and a
related Hong Kong company, Disguise Limited (collectively,
“Disguise”).  The total initial consideration of $61.9 million
consisted of $39.9 million in cash and the assumption of liabilities in the
amount of $22.0 million, and resulted in goodwill of $51.6 million. The Company
has not finalized its purchase price allocation for Disguise and will engage a
third party to perform studies and valuations to the estimated fair value of
assets and liabilities assumed.  Disguise is a leading designer and
producer of Halloween and everyday costume play and was included in our results
of operations from the date of acquisition.  Pro forma results of
operations are not provided since the amounts are not material to the
consolidated results of operations.





In
February 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 years ended December 31, 2006, 2007 and 2008, $6.9
million, $6.7 and $5.7 million, respectively, 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.





49


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 aggregate
earn-out amount of $19.3 million earned through December 31, 2008 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
            
            
            72,853$
            124,253





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, 2006 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, 2006 or on
future operating results (in thousands, except per share data).





Year
      Ended
              December
      31,
              2006Net
      sales
            
            $
            778,269Net
      income
            
            $
            75,221Basic
      earnings per share
            
            $
            2.73Weighted
      average shares outstanding
            
            
            27,512Diluted
      earnings per share
            
            $
            2.38Weighted
      average shares and equivalents outstanding
            
            
            32,777





Note 6—Goodwill





The
changes in the carrying amount of goodwill for the years ended December 31, 2007
and 2008 are as follows (in thousands):





Traditional
              Toys
            
            
            Craft/Activity
              /Writing
              Products
            
            
            Pet
              Products
            
            
            TotalBalance,
      December 31, 2006
            
            $
            249,049
            
            
            $
            82,826
            
            
            $
            6,124
            
            
            $
            337,999Adjustments
      to goodwill during the year
            
            
            13,341
            
            
            
            —
            
            
            
            2,000
            
            
            
            15,341Balance,
      December 31, 2007
            
            
            262,390
            
            
            
            82,826
            
            
            
            8,124
            
            
            
            353,340Adjustments
      to goodwill during the year
            
            
            72,693
            
            
            
            —
            
            
            
            1,660
            
            
            
            74,353Balance
      December 31, 2008
            
            $
            335,083
            
            
            $
            82,826
            
            
            $
            9,784
            
            
            $
            427,693





During
2007, adjustments to goodwill include earn-outs of $6.7 million, $6.6 million
and $2.0 million earned during 2007 related to the Company’s Play Along,
Creative Designs, an Pet Pal acquisitions, respectively.





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, 2007
            
            
            December
      31, 2008Weighted
              Useful
              Lives
            
            
            Gross
              Carrying
              Amount
            
            
            Accumulated
              Amortization
            
            
            Net
              Amount
            
            
            Gross
              Carrying
              Amount
            
            
            Accumulated
              Amortization
            
            
            Net
              Amount(Years)Amortized
      Intangible Assets:Acquired
      order backlog
            
            
            0.50
            
            
            $
            1,298
            
            
            $
            (1,298
            )
            
            $
            —
            
            
            $
            2,393
            
            
            $
            (2,165
            )
            
            $
            228Licenses
            
            
            4.41
            
            
            
            58,699
            
            
            
            (39,091
            )
            
            
            19,608
            
            
            
            67,088
            
            
            
            (46,638
            )
            
            
            20,450Product
      lines
            
            
            3.45
            
            
            
            17,700
            
            
            
            (17,700
            )
            
            
            —
            
            
            
            17,700
            
            
            
            (17,700
            )
            
            
            —Customer
      relationships
            
            
            5.57
            
            
            
            3,646
            
            
            
            (1,805
            )
            
            
            1,841
            
            
            
            4,096
            
            
            
            (2,301
            )
            
            
            1,795Non-compete/Employment
      contracts
            
            
            4.00
            
            
            
            2,748
            
            
            
            (2,348
            )
            
            
            400
            
            
            
            2,748
            
            
            
            (2,703
            )
            
            
            45Debt
      offering costs
            
            
            20.00
            
            
            
            3,705
            
            
            
            (847
            )
            
            
            2,858
            
            
            
            3,705
            
            
            
            (1,033
            )
            
            
            2,672Total
      amortized intangible assets
            
            
            
            
            
            
            87,796
            
            
            
            (63,089
            )
            
            
            24,707
            
            
            
            97,730
            
            
            
            (72,540
            )
            
            
            25,190Unamortized
      Intangible Assets:Trademarks
            
            indefinite
            
            
            
            19,568
            
            
            
            N/A
            
            
            
            19,568
            
            
            
            10,491
            
            
            
            —
            
            
            
            10,491$
            107,364
            
            
            $
            (63,089
            )
            
            $
            44,275
            
            
            $
            108,221
            
            
            $
            (72,540
            )
            
            $
            35,681





During
the third quarter of 2008, the Company decided to discontinue the use of the
“Toymax” and “Trendmaster” tradenames on products and market these products
under the JAKKS Pacific trademark. Consequently, the intangible assets
associated with these tradenames were written off to write-down of intangible
assets, resulting in a charge of $3.5 million. Also, the Company adjusted the
value of the Child Guidance trademark to reflect lower sales expectations for
this tradename, resulting in a charge to write-down of intangible assets of $5.6
million.





For the
years ended December 31, 2006, 2007, and 2008, the Company’s aggregate
amortization expense related to intangible assets was $16.5 million, $14.6
million and $9.5 million, respectively. The Company currently estimates
continuing amortization expense for the next five years to be approximately (in
thousands):





2009
            
            $
            8,4102010
            
            
            6,3592011
            
            
            4,5582012
            
            
            2,0432013
            
            
            2,075





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
conditions, 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, 2007 and 2008, the Company’s three largest customers accounted for
approximately 82.2% and 74.0%, 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):





2007
            
            
            2008Royalties
            
            $
            25,318
            
            
            $
            24,691Bonuses
            
            
            17,223
            
            
            
            8,352Acquisition
      earn-out
            
            
            13,333
            
            
            
            5,667Employee
      salaries and benefits
            
            
            1,273
            
            
            
            1,832Unearned
      revenue
            
            
            172
            
            
            
            554Sales
      commissions
            
            
            2,225
            
            
            
            2,502Accrued
      interest expense
            
            
            198
            
            
            
            526Molds
      and tools
            
            
            1,952
            
            
            
            3,024Acquisition
      license transfer fees
            
            
            —
            
            
            
            1,640Acquisition
      working capital adjustment
            
            
            —
            
            
            
            4,983Deposits
            
            
            650
            
            
            
            259Other
            
            
            7,741
            
            
            
            7,750$
            70,085
            
            
            $
            61,780





Note
10—Related Party Transactions





A
director of the Company is a partner in a 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 $2.7 million in 2006, $1.9 million in 2007 and $2.5
million in 2008. As of December 31, 2007 and 2008, legal fees and reimbusable
expenses of $0.9 million and $1.5 million, respectively, were payable to this
law firm.





Note
11—Convertible Senior Notes





Convertible
senior notes consist of the following (in thousands):





2007
            
            
            20084.625%
      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, 2008, and
are not convertible in the first quarter of 2009.





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.





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 returns.





Provision
for income taxes includes Federal, state and foreign income taxes at effective
tax rates of 31.7%, 31.3% and 14.4%, respectively for the years ended 2006, 2007
and 2008. The effective tax rate benefits from a tax rate of 17.5%, 17.5% and
16.5% for 2006, 2007 and 2008, respectively, on the Company’s income arising in,
or derived from, Hong Kong. The decrease in the effective rate in 2008 is
primarily due to the recognition of certain discrete income tax adjustments
recognized in the quarter ended September 30, 2008 and a change in the federal
tax code which reduced the amount of foreign income includible on the federal
income tax return. These discrete adjustments included the reconciliation of the
2007 income tax provision to the actual income tax liability as reflected in the
Company’s income tax return, and the reduction in income tax expense due to the
de-recognition of a previously recorded potential income tax liability for
uncertain tax positions that are no longer subject to audit due to the closure
of the audit period. Absent these discrete items, the effective tax rate would
be 32.2% in 2006, 33.2% in 2007, and 30.5% in 2008. As of December 31, 2008, the
Company had net deferred tax liabilities of approximately $8.2 million,
inclusive of an allowance of $0.9 million that has been provided since, in the
opinion of management, realization of the future benefit is
uncertain.





Income
taxes reflected in the accompanying consolidated statements of income are
comprised of the following (in thousands):





2006
            
            
            2007
            
            
            2008Federal
            
            $
            22,031
            
            
            $
            23,931
            
            
            $
            (6,978
            )State
      and local
            
            
            4,310
            
            
            
            6,016
            
            
            
            (435
            )Foreign
            
            
            8,204
            
            
            
            8,719
            
            
            
            5,230Total
      Current
            
            
            34,545
            
            
            
            38,666
            
            
            
            (2,183
            )APIC
            
            
            58
            
            
            
            1,053
            
            
            
            1,338Deferred
            
            
            (1,043
            )
            
            
            831
            
            
            
            13,687Total
            
            $
            33,560
            
            
            $
            40,550
            
            
            $
            12,842





The
components of deferred tax assets/(liabilities) are as follows (in
thousands):





2007
            
            
            2008Net
      deferred tax assets/(liabilities):Current:Reserve
      for sales allowances and possible losses
            
            $
            115
            
            
            $
            2,752Accrued
      expenses
            
            
            4,915
            
            
            
            8,339Restricted
      stock grant
            
            
            3,076
            
            
            
            2,974Federal
      and state net operating loss carryforwards
            
            
            2,993
            
            
            
            920Uncertain
      tax positions
            
            
            624
            
            
            
            715Foreign
      tax and other credits
            
            
            —
            
            
            
            1,709State
      income taxes
            
            
            2,272
            
            
            
            1,712Other
            
            
            (130
            )
            
            
            (931
            )Total
      current
            
            
            13,865
            
            
            
            18,190Long
      Term:Property
      and equipment
            
            
            1,064
            )
            
            
            4,555Original
      issue discount interest
            
            
            (12,249
            )
            
            
            (16,623
            )Deductible
      goodwill and intangibles
            
            
            1,678
            
            
            
            1,506Foreign
      net operating loss carryforward
            
            
            2,718
            
            
            
            2,718Stock
      options
            
            
            802
            
            
            
            818Section
      481(a) adjustments
            
            
            (2,312
            
            
            
            (1,266
            )Income
      from joint venture
            
            
            1,763
            
            
            
            (17,945
            )Uncertain
      tax positions
            
            
            976
            
            
            
            723Total
      long-term
            
            
            (5,560
            )
            
            
            (25,514
            )Valuation
      allowance related to state net operating loss
carryforwards
            
            
            (920
            )
            
            
            (920
            )Total
      net deferred tax assets/(liabilities)
            
            $
            7,385
            
            
            $
            (8,244
            )





53


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:





2006
            
            
            2007
            
            
            2008Federal
      income tax expense
            
            
            35.0
            %
            
            
            35.0
            %
            
            
            35.0
            %State
      income tax expense, net of federal tax effect
            
            
            2.6
            
            
            
            3.3
            
            
            
            2.6Effect
      of differences in U.S. and Foreign statutory rates
            
            
            (5.4
            )
            
            
            (5.1
            )
            
            
            (6.5
            )Uncertain
      tax positions
            
            
            —
            
            
            
            —
            
            
            
            (10.4
            )Filed
      return to provision
            
            
            —
            
            
            
            —
            
            
            
            (5.6
            )Other,
      including adjustments to previously accrued taxes for statute
      expirations
            
            
            (0.5
            )
            
            
            (1.9
            )
            
            
            (0.7
            )31.7
            %
            
            
            31.3
            %
            
            
            14.4
            %





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, 2008, the Company has state net operating loss carryforwards of
$12.5 million expiring through 2023 and 2024. These carryforwards resulted from
the acquisitions of Toymax. As of December 31, 2008, 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 uncertainty about
the ability to utilize these losses prior to expiration.





The
components of income before provision for income taxes are as follows (in
thousands):





2006
            
            
            2007
            
            
            2008Domestic
            
            $
            58,227
            
            
            $
            73,115
            
            
            $
            57,787Foreign
            
            
            47,708
            
            
            
            56,426
            
            
            
            31,112$
            105,935
            
            
            $
            129,541
            
            
            $
            88,899





As of
January 1, 2007, the Company adopted the provisions of FIN 48 “Accounting for
Uncertainty in Income Taxes” which prescribes a recognition threshold and
measurement process for recording in the financial statements uncertain tax
positions (“UTP”) taken or expected to be taken in a tax return. As a result of
FIN 48, the Company recognized a liability for UTP of $22.8 million, which was
accounted for as a reduction to the January 1, 2007 balance of retained
earnings. These UTPs are primarily due to income allocation issues between the
United States and Hong Kong, and fixed asset depreciation in Hong Kong. The
Company has also recognized an additional liability of $2.5 million for
penalties and $2.8 for interest on the potential tax liability. These amounts
were also accounted for as a reduction in the January 1, 2007 balance of
retained earnings. Current interest on potential tax liabilities is recognized
as interest expense.





Approximately
$1.5 million of the liability for UTP relating to Hong Kong fixed asset
depreciation was recognized during 2008.  The following table provides
further information of UTPs that would affect the effective tax rate, if
recognized, as of 12/31/08 (in millions):





Balance,
      January 1, 2007
            
            $
            22.8Current
      year additions
            
            
            0.3Current
      year reduction due to lapse of applicable statute of
      limitations
            
            
            (2.8
            )Balance,
      January 1, 2008
            
            
            20.3Current
      year additions
            
            
            1.5Current
      year reduction due to lapse of applicable statute of
      limitations
            
            
            (9.9
            )Balance,
      December 31, 2008
            
            $
            11.9





Current
year interest and penalty liability reversals related to UTPs are $2.2 million
and $2.0 million, respectively. The interest and penalty liabilities related to
UTPs is $1.5 million and nil on the December 31, 2008 statement of financial
position.





Approximately
$9.9 million of United States based UTPs became recognized during 2008 as they
related to income tax years for which the audit period had expired. These items
are included in the 2008 income tax provision. The tax years 2000 through 2008
are subject to examination in Hong Kong, the tax years 2005 through 2008 are
subject to examination in the United States, and the tax year 2004 through 2008
are subject to examination in California.  In the normal course of
business, the Company is audited by federal, state, and foreign tax
authorities.  The U.S. Internal Revenue Service is performing a
limited examination related to the 2005 and 2006 U.S. federal income tax
returns. The Company will be under examination for various state jurisdictions
during 2009.  The ultimate resolution of the U.S. and state
examinations, including matters that may be resolved within the next twelve
months, is not yet determinable.





54


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, 2006, 2007
and 2008 totaled $9.1 million, $10.4 million and $11.5 million, respectively.
The following is a schedule of minimum annual lease payments (in
thousands).





2009
            
            $
            13,6612010
            
            
            11,9862011
            
            
            8,2712012
            
            
            7,2172013
            
            
            3,783Thereafter
            
            
            5,419$
            50,337





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.





In
January 2008, the Company issued an aggregate of 240,000 shares of restricted
stock at an aggregate value of $5.7 million to two of its executive officers,
which vest 50% in each of January 2009 and 2010 subject to acceleration based on
the Company achieving certain financial performance criteria, and an aggregate
of 25,340 shares of restricted stock to its five non-employee directors, which
vest in January 2009, at an aggregate value of approximately $0.6 million. In
February 2008, the Company issued an aggregate of 41,134 shares of restricted
stock as 2007 bonus compensation to two of its executive officers, which vested
immediately, at an aggregate value of approximately $1.0 million. In February
2008, the Company issued 3,593 shares of restricted stock as 2007 bonus
compensation at a value of $0.1 million to an executive officer, which vests 50%
on each of March 1, 2009 and 2010. During the twelve months
ended December 31, 2008, the Company also issued 315,517 shares of
common stock on the exercise of options at a value of $4.2 million, and 122,202
shares of restricted stock previously received by two executive officers were
surrendered at a value of $3.0 million to cover their income taxes due on the
2008 vesting of the restricted shares granted to them in 2006, 2007 and 2008.
This surrendered restricted stock was subsequently retired by the
Company.





In
February 2008, the Company’s Board of Directors authorized it to repurchase up
to $30.0 million of its common stock. In April and May 2008, the Company
repurchased an aggregate of 1,259,300 shares of its common stock at an average
price of $23.82 per share for a total cost of $30.0 million. The repurchased
stock represented approximately 4.4% of the Company’s outstanding shares of
common stock at the time of the repurchase and was subsequently retired by the
Company.





In
July 2008, the Company issued 7,500 shares of restricted stock at a value of
$0.2 million to an employee, which vests 15% on July 1, 2008, 15% on each of
December 2008 and 2009, 25% on December 31, 2010, and 30% on December 2011. This
employee surrendered 489 shares at a value of $10,484 to cover his income taxes
due on the July 1, 2008 vested shares. During 2008, certain employees
surrendered an aggregate of 5,151 shares of restricted stock at a value of
$112,593 to cover their income taxes due on the 2008 vesting of the restricted
shares granted to them in 2006.





During
2007, the Company issued an aggregate of 240,000 shares of restricted stock to
two of its executive officers, which vest 50% in each of January 2008 and 2009
subject to acceleration based on the Company achieving certain financial
performance criteria, and an aggregate of 27,340 shares of restricted stock to
its five non-employee directors, which vest in January 2008, at an aggregate
value of approximately $5.8 million. In July 2007, the Company issued 15,000
shares of restricted stock at a value of $0.5 million to an executive officer,
which vests one-third on each of December 31, 2007, 2008 and
2009.  During 2007, the Company also issued 216,200 shares of common
stock on the exercise of options at a value of $3.6 million, and 83,644 shares
of restricted stock previously received by two executive officers were
surrendered at a value of $1.8 million to cover their income taxes due on the
2007 vesting of the restricted shares granted them in 2006. This surrendered
restricted stock was subsequently retired by the
Company.   Additionally, one executive officer surrendered
107,637 shares of common stock of the Company at a value of $2.8 million to
cover his exercise of options to purchase 175,000 shares of common stock of the
Company.   During 2007, certain employees surrendered an
aggregate of 1,340 shares of restricted stock at a value of $29,931 to cover
their income taxes on the 2007 vesting of the restricted shares granted them in
2006. The Company granted and issued an aggregate of 41,000 shares of restricted
stock to its employees at an aggregate value of approximately $1.1
million.  As of December 31, 2007, 536,977 shares of the restricted
stock remained unvested, of which $2.9 million remained
unamortized.





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.





55


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:





WeightedAverageNumber
            
            
            Exerciseof
      Shares
            
            
            PriceOutstanding,
      December 31, 2008
            
            
            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.





Future
annual minimum royalty guarantees as of December 31, 2008 are as follows (in
thousands):





2009
            
            $
            22,1702010
            
            
            22,0192011
            
            
            9,1192012
            
            
            2,8632013
            
            
            206Thereafter
            
            
            1,500$
            57,877





The
Company has entered into employment and consulting agreements with certain
executives expiring through December 31, 2011. The aggregate future annual
minimum guaranteed amounts due under those agreements as of December 31, 2008
are as follows (in thousands):





2009
            
            $
            3,9892010
            
            
            2,7552011
            
            
            475$
            7,219




The
Company has entered into a retirement plan agreement with one of its executives.
Upon meeting the eligibility criteria for retirement, the executive can elect to
retire and receive a single-life annuity retirement payment of approximately
$1.0 million per year for a period of ten years following his
retirement.  Furthermore, in the event of his death during such
period, his estate will receive a death benefit equal to the difference between
approximately $2.9 million and retirement benefits previously paid to
him.  This retirement benefit is conditioned upon the executive
agreeing to accept the position of Chairman Emeritus of our Board of Directors,
if so requested by the Board.





56


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 6,525,000
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 in the same manner, with the exception of
certain awards vesting over one to two years.  Share-based
compensation expense is recognized on a straight-line basis over the requisite
service period.





Restricted Stock





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 2008, 5,068 shares
per director) which vest after one year.   In January 2006 and
2007, respectively, the Company issued 268,660 shares of restricted stock at a
value of $5.6 million and 267,340 shares of restricted stock at a value of $5.8
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.  In July 2007, the Company
issued 15,000 shares of restricted stock at a value of $0.5 million to an
executive officer, which vests one-third on each of December 31, 2007, 2008 and
2009.  During 2007, the Company granted and issued an aggregate of
41,000 shares of restricted stock to its employees at an aggregate value of
approximately $1.1 million.  During 2008, the Company issued 310,067
shares of restricted stock at a value of $7.4 million to three executive
officers and five non-employee directors of the Company.  During 2008, the
Company granted and issued an aggregate of 27,500 shares of restricted stock to
its employees at an aggregate value of approximately $0.6 million; of which,
20,000 shares were cancelled prior to vest at an aggregate value of $0.5 million
and all expense related was reversed as of December 31, 2008 based on the
one-year vest schedule associated with said restricted award.  As of
December 31, 2008, 465,533 shares of the restricted stock remained unreleased,
of which $3.4 million remained unamortized, including estimated
forfeitures.





The table
below summarizes the grant activity for the year ended December 31, 2008 and is
broken down in the following three distinct groups because each group has unique
characteristics: executives, board of directors, and employees:





Group
      Type
              
              #
      Shares
                Granted
              
              
              Grant
      Price Range
              
              Vest
      Schedule RangeExecutives
              
              
              284,727
              
              
              $
              23.61
      - 27.83
              
              1 –
      3 yearsBoard
      of directors
              
              
              25,340
              
              
              $
              23.61
              
              1
      yearEmployees
              
              
              27,500
              
              
              $
              22.36
      – 23.61
              
              Immediate
      - 5 yearsTotal
              
              
              337,567
              
              
              $
              22.36
      – 27.83
              
              Immediate
      – 5 years





Stock
Options





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.





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 years ended
December 31, 2006, 2007 and 2008 is based on options granted prior to January 1,
2006 and restricted stock issued during the years ended December 31, 2006, 2007
and 2008, 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.





57


The
following table summarizes the total share-based compensation expense and
related tax benefits recognized (in thousands):





Year
      Ended December 31,2006
            
            
            2007
            
            
            2008Stock
      option compensation expense
            
            $
            1,093
            
            
            $
            972
            
            
            $
            537Tax
      benefit related to stock option compensation
            
            $
            623
            
            
            $
            314
            
            
            $
            180Restricted
      stock compensation expense
            
            $
            4,580
            
            
            $
            8,082
            
            
            $
            6,765Tax
      benefit related to restricted stock compensation
            
            $
            1,404
            
            
            $
            2,859
            
            
            $
            2,522





As of December 31, 2008, 513,459 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:




WeightedAverageNumber
                      
                      
                      Exerciseof
      Shares
                      
                      
                      PriceOutstanding,
      December 31, 2005
                      
                      
                      1,804,106
                      
                      
                      $
                      16.33Granted
                      
                      
                      —
                      
                      
                      
                      —Exercised
                      
                      
                      (333,228
                      )
                      
                      
                      13.15Canceled
                      
                      
                      (8,500
                      )
                      
                      
                      17.23Outstanding,
      December 31, 2006
                      
                      
                      1,462,378
                      
                      
                      $
                      17.05Granted
                      
                      
                      —
                      
                      
                      
                      —Exercised
                      
                      
                      (391,200
                      )
                      
                      
                      16.54Canceled
                      
                      
                      (235,000
                      )
                      
                      
                      17.10Outstanding,
      December 31, 2007
                      
                      
                      836,178
                      
                      
                      $
                      17.27Granted
                      
                      
                      —
                      
                      
                      
                      —Exercised
                      
                      
                      (315,513
                      )
                      
                      
                      13.22Canceled
                      
                      
                      (43,150
                      )
                      
                      
                      21.60Outstanding,
      December 31, 2008
                      
                      
                      477,515
                      
                      
                      $
                      19.55





The
following characteristics apply to the Plan stock options that are fully vested,
or expected to vest, as of December 31, 2008:





Aggregate
      intrinsic value of options outstanding
            
            $
            794,278Weighted-average
      contractual term of options outstanding
            
            
            3.30Number
      of options currently exercisable
            
            
            328,015Weighted-average
      exercise price of options currently exercisable
            
            $
            18.66Aggregate
      intrinsic value of options currently exercisable
            
            $
            772,819Weighted-average
      contractual term of currently exercisable
            
            
            3.84





The
following table summarizes information about stock options outstanding and
exercisable at December 31, 2008:





Outstanding
            
            
            ExercisableWeighted
            
            
            Weighted
            
            
            
            
            
            WeightedAverage
            
            
            Average
            
            
            
            
            
            AverageNumber
            
            
            Life
            
            
            Exercise
            
            
            Number
            
            
            ExerciseOption
      Price Range
            
            
            of
      Shares
            
            
            in
      Years
            
            
            Price
            
            
            of
      Shares
            
            
            Price$
            11.56
      – $19.27
            
            
            
            160,396
            
            
            
            3.88
            
            
            $
            15.92
            
            
            
            157,396
            
            
            $
            15.86$
            19.85
      – $20.94
            
            
            
            119,694
            
            
            
            3.07
            
            
            $
            20.31
            
            
            
            82,644
            
            
            $
            20.38$
            22.01
      – $22.11
            
            
            
            197,425
            
            
            
            2.97
            
            
            $
            22.03
            
            
            
            87,975
            
            
            $
            22.05





58





Note
17—Employee Benefits 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
$0.7 million, $0.9 million and $1.2 million for 2006, 2007 and 2008,
respectively.





Note
18—Supplemental Information to Consolidated Statements of Cash
Flows





In 2008,
two executive officers surrendered an aggregate of 122,202 shares of restricted
stock at a value of $3.0 million to cover their income taxes due on the 2008
vesting of the restricted shares granted them in 2007. During 2008, certain
employees surrendered an aggregate of 5,640 shares of restricted stock at a
value of $0.1 million to cover their incomes taxes on the 2008 vesting of the
restricted shares granted them in 2006.  Additionally, the Company
recognized a $1.3 million tax benefit from the exercise of stock
options.





In 2007,
two executive officers surrendered an aggregate of 83,644 shares of restricted
at a value of $1.8 million to cover their income taxes due on the 2007 vesting
of the restricted shares granted them in 2006. This surrendered restricted stock
was subsequently retired by the Company.   Additionally, one
executive officer surrendered 107,637 shares of common stock of the Company at a
value of $2.8 million to cover his exercise of options to purchase 175,000
shares of common stock of the Company.   During 2007, certain
employees surrendered an aggregate of 1,340 shares of restricted stock at a
value of $29,931 to cover their incomes taxes on the 2007 vesting of the
restricted shares granted them in 2006.  Additionally, the Company
recognized a $1.1 million tax benefit from the exercise of stock
options.





Note 19—Selected Quarterly
Financial Data (Unaudited)





Selected
unaudited quarterly financial data for the years 2007 and 2008 are summarized
below:





2007
            
            
            2008First
            
            
            Second
            
            
            Third
            
            
            Fourth
            
            
            First
            
            
            Second
            
            
            Third
            
            
            FourthQuarter
            
            
            Quarter
            
            
            Quarter
            
            
            Quarter
            
            
            Quarter
            
            
            Quarter
            
            
            Quarter
            
            
            Quarter(in
      thousands, except per share data)Net
      sales
            
            $
            124,062
            
            
            $
            129,547
            
            
            $
            318,391
            
            
            $
            285,085
            
            
            $
            130,935
            
            
            $
            145,291
            
            
            $
            357,824
            
            
            $
            269,347Gross
      profit
            
            $
            45,508
            
            
            $
            45,295
            
            
            $
            124,050
            
            
            $
            108,797
            
            
            $
            47,441
            
            
            $
            52,058
            
            
            $
            129,065
            
            
            $
            92,649Income
      from operations
            
            $
            3,324
            
            
            $
            6,488
            
            
            $
            65,057
            
            
            $
            32,129
            
            
            $
            (894
            )
            
            $
            5,568
            
            
            $
            57,338
            
            
            $
            8,824Income
      before income taxes
            
            $
            4,762
            
            
            $
            7,403
            
            
            $
            67,087
            
            
            $
            50,289
            
            
            $
            1,300
            
            
            $
            5,994
            
            
            $
            60,803
            
            
            $
            20,802Net
      income
            
            $
            3,238
            
            
            $
            5,034
            
            
            $
            47,318
            
            
            $
            33,401
            
            
            $
            877
            
            
            $
            4,156
            
            
            $
            54,145
            
            
            $
            16,879Basic
      earnings per share
            
            $
            0.12
            
            
            $
            0.18
            
            
            $
            1.71
            
            
            $
            1.20
            
            
            $
            0.03
            
            
            $
            0.15
            
            
            $
            2.01
            
            
            $
            0.62Weighted
      average shares outstanding
            
            
            27,498
            
            
            
            27,631
            
            
            
            27,733
            
            
            
            27,738
            
            
            
            28,060
            
            
            
            27,288
            
            
            
            26,981
            
            
            
            27,065Diluted
      earnings per share
            
            $
            0.12
            
            
            $
            0.17
            
            
            $
            1.45
            
            
            $
            1.03
            
            
            $
            0.03
            
            
            $
            0.15
            
            
            $
            1.70
            
            
            $
            0.55Weighted
      average shares and equivalents outstanding
            
            
            27,985
            
            
            
            33,133
            
            
            
            33,145
            
            
            
            33,251
            
            
            
            28,453
            
            
            
            32,594
            
            
            
            32,257
            
            
            
            32,312





59


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 remained stayed. In December 2007 the Court
dismissed the WWE Action and WWE appealed. The Company sought reconsideration of
and filed a cross-appeal with respect to certain parts of the Court’s Orders.
The appeal and cross-appeal were in abeyance pending the determination of the
reconsideration motion. The reconsideration motion was granted in September 2008
and the Court held that the issue of the applicability of a January 2004 release
executed by WWE in favor of the Company would not be determined in connection
with the motion to dismiss. The cross-appeal was withdrawn without prejudice and
the briefing of the appeal has been completed.




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”). A
motion to dismiss was filed, was fully briefed and argument occurred on November
30, 2006. The motion was granted without prejudice to seeking leave to amend;
such leave was granted to plaintiffs, an amended complaint was filed and
briefing has been completed with respect to a motion to dismiss, which was
scheduled for argument in October 2008. That date was adjourned by the Court.
The parties have notified the Court that an agreement in principle to settle
this matter has been reached.  The agreement, which is subject to
documentation and Court approval, will settle the matter for $3.9 million,
without any admission of liability on the part of the Company, or its officers
and directors.  The Company expects for a significant portion of this
settlement to be covered by insurance. 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.   Thereafter, WWE
amended the complaint to import state law claims from the WWE Action. A motion
to strike and for summary judgment (the “Dispositive Motion”) was briefed and
argument took place on May 19, 2008. The Judge ordered the parties to file
supplemental briefing on May 23, 2008, upon which filing the motion was
submitted to the Court for decision. WWE filed a cross-motion for partial
summary judgment with respect to the Company’s Release defense. At the end of
August, the Court granted the Dispositive Motion. WWE moved to reargue that
decision and that motion was denied. WWE has filed an appeal and it is
anticipated that briefing of that appeal will be scheduled. THQ filed a
cross-complaint which asserts claims by THQ and Mr. Farrell for indemnification
from the Company in the event that WWE prevails on any of its claims against THQ
and Farrell and also asserts claims by THQ that the Company breached its
fiduciary duties to THQ in connection with the videogame license between WWE and
THQ/JAKKS Pacific LLC and seeks equitable and legal relief, including
substantial monetary and exemplary damages against the Company in connection
with this claim. The Company requested that the THQ claims be revised and
objection thereto was filed but this issue has not been resolved. Discovery is
currently proceeding in this matter. The Company intends to contest all of these
claims vigorously.





WWE filed
a motion for partial summary judgment with respect to the claims remaining in
the Joint Venture Action which seeks a declaration that WWE may terminate the
joint venture’s videogame license.  The joint venture has opposed this
motion and has filed a motion for summary judgment dismissing the JV Action as a
matter of law on multiple grounds.





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 for the period through December 31,
2009 (the “Next Distribution Period”). 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
preferred return for the Next Distribution Period is to 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 $52.8 million for the cumulative preferred return for
the period from July 1, 2006 to December 31, 2008 has been accrued as of
December 31, 2008 pending the resolution of this outstanding
issue.   JAKKS seeks to retain the same rates as set forth under
the original joint venture agreement while THQ seeks to pay a substantially
lower rate.  In the event the arbitration results in a lower rate to
the Company, there would be a material charge to earnings and reduction in the
receivable from THQ.





The
claims and counterclaims involving Jax, Ltd. have been dismissed with
prejudice.





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 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
audits referred to in our report dated February 28, 2009 relating to the
consolidated financial statements of JAKKS Pacific, Inc., which is contained in
Item 8 of this Form 10-K also included the audit of 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 audits.





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








/s/
      BDO Seidman, LLPBDO
      Seidman, LLPLos
      Angeles, CaliforniaFebruary
      28, 2009





61





JAKKS
PACIFIC, INC. AND SUBSIDIARIES


SCHEDULE
II—VALUATION AND QUALIFYING ACCOUNTS


YEARS
ENDED DECEMBER 31, 2006, 2007 and 2008





Allowances
are deducted from the assets to which they apply, except for sales returns and
allowances.





Balance
      at
            
            
            Charged
      to
            
            
            Charged
      to
            
            
            
            
            
            BalanceBeginning
            
            
            Costs
      and
            
            
            Other
            
            
            
            
            
            at
      Endof
      Period
            
            
            Expenses
            
            
            Accounts
            
            
            Deductions
            
            
            of
      Period(In
      thousands)Year
      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
            (a)
            
            
            (44,698
            )
            
            
            32,589$
            34,906
            
            
            $
            53,400
            
            
            $
            2,213
            
            
            $
            (49,369
            )
            
            $
            41,150Year
      ended December 31, 2007:Allowance
      for:Uncollectible
      accounts
            
            $
            1,206
            
            
            $
            (269
            )
            
            $
            —
            
            
            $
            417
            
            
            $
            1,354Reserve
      for potential product obsolescence
            
            
            7,355
            
            
            
            2,788
            
            
            
            —
            
            
            
            (5,072
            )
            
            
            5,071Reserve
      for sales returns and allowances
            
            
            32,589
            
            
            
            40,193
            
            
            
            —
            
            
            
            (46,746
            )
            
            
            26,036$
            41,150
            
            
            $
            42,712
            
            
            $
            —
            
            
            $
            (51,401
            )
            
            $
            32,461Year
      ended December 31, 2008:Allowance
      for:Uncollectible
      accounts
            
            $
            1,354
            
            
            $
            812
            
            
            $
            —
            
            
            $
            (161
            )
            
            $
            2,005Reserve
      for potential product obsolescence
            
            
            5,071
            
            
            
            3,943
            
            
            
            —
            
            
            
            (3,906
            )
            
            
            5,108Reserve
      for sales returns and allowances
            
            
            26,036
            
            
            
            60,274
            
            
            
            —
            
            
            
            (62,993
            )
            
            
            23,317$
            32,461
            
            
            $
            65,029
            
            
            $
            —
            
            
            $
            (67,060
            )
            
            $
            30,430


___________





(a)
            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.





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.





62


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, 2008. 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, 2008,
our internal control over financial reporting is effective based on those
criteria.





Management’s
assessment did not include the internal controls of Tollytots, Kids Only or
Disguise, due to the limited time between the respective purchase dates and
management’s assessment.





Our
independent auditors have issued a report on our internal controls over
financial reporting. This report appears below.





Report of the Independent Registered
Public Accounting Firm.





Report
of Independent Registered Public Accounting Firm








The Board
of Directors and Stockholders


JAKKS
Pacific, Inc.


Malibu,
California





We have
audited JAKKS Pacific, Inc.’s internal control over financial reporting as of
December 31, 2008, 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, included in the accompanying Item 9A, “Management’s Annual Report on
Internal Control over Financial Reporting.” Our responsibility is to express an
opinion on 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, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audit also included 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
being 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.





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 Kids Only Inc. and Kids Only Limited, which were
acquired on October 7, 2008, Tollytots Limited, which was acquired on October 8,
2008, and Disguise, Inc. and Disguise Limited, which were acquired on December
29, 2008 (collectively, the “Acquired Entities”), and which are included in the
consolidated balance sheets of JAKKS Pacific, Inc. as of December 31, 2008, and
the related consolidated statements of income, other comprehensive income,
stockholders’ equity, and cash flows for the year then ended. The Acquired
Entities constituted 10.1% and 9.5% of total assets and net assets,
respectively, as of December 31, 2008, and 1.2% and 3.4% of revenues and net
income, respectively, for the year then ended. Management did not assess the
effectiveness of internal control over financial reporting of the Acquired
Entities because of the timing of the acquisitions which were completed during
the year ended December 31, 2008. 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 the Acquired Entities.





In our
opinion, JAKKS Pacific, Inc. maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2008, based on the
COSO criteria.





We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of JAKKS
Pacific, Inc. as of December 31, 2008 and 2007 and the related consolidated
statements of income, other comprehensive income, stockholders’ equity and cash
flows for each of the three years in the period ended December 31, 2008 and our
report dated February 28, 2009 expressed an unqualified opinion
thereon.








/s/ BDO Seidman,
    LLPBDO
      Seidman, LLPLos Angeles, California


February
28, 2009





63





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 CompanyJack
      Friedman
            69
            Chairman
      and Chief Executive OfficerStephen
      G. Berman
            44
            Chief
      Operating Officer, President, Secretary and DirectorJoel
      M. Bennett
            47
            Executive
      Vice President and Chief Financial OfficerDan
      Almagor
            55
            DirectorDavid
      C. Blatte
            44
            DirectorRobert
      E. Glick
            63
            DirectorMichael
      G. Miller
            61
            DirectorMurray
      L. Skala
            62
            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. 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 until May, 2007, Mr.
Glick was an officer, director and principal stockholder in a number of
privately-held companies which manufacture and market women’s apparel and he is
currently employed as President of a division by a publicly-held company engaged
in the apparel industry.





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. Mr. Miller is
currently retired.





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 LLP (f/k/a Feder, Kaszovitz, Isaacson, Weber,
Skala, Bass & Rhine LLP), our general counsel.





64


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 audit committee 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 2008 and Forms 5 and amendments thereto furnished to us with respect to
2008, during 2008, Jack Friedman and Stephen Berman, executive officers of our
Company and members of our Board of Directors, each untimely filed one report on
Form 4 reporting  one  late transaction and Michael Miller,
one of our directors, also 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 2008 and Forms 5 and amendments
thereto furnished to us with respect to 2008, all other Forms 3, 4 and 5
required to be filed during 2008 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.





65


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”).  With respect to our chief
executive officer and president (now our co-chief executive officers), 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.  Pursuant to the terms of their employment agreements, this bonus
is capped at a maximum of 200% of base salary, although the Compensation
Committee has the authority, in its discretion, to increase the
maximum.  The Compensation Committee also 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, Berman and Bennett 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.





While the
Compensation Committee does not establish target performance levels for our
chief financial officer, it does consider similar factors when determining such
officer’s bonus. The employment agreement for Mr. Bennett authorizes our
Compensation Committee and Board of Directors to award an annual bonus to Mr.
Bennett in an amount up to 50% of his salary as the Committee or Board
determines in its discretion and also gives the Compensation Committee and the
Board the discretionary authority to pay Mr. Bennett additional incentive
compensation as it determines.





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 2008, 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.





66


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.·
            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 2008 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 expires on December
31, 2009.  Pursuant to the terms of their employment agreements,
Messrs. Friedman and Berman each receive a base salary which, pursuant to his
employment agreement, is increased automatically each year by $25,000. Mr.
Bennett’s employment agreement does not provide for automatic annual increases
in base salary.  Any increase or additional increase in base salary,
as the case may be, 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 base
salaries of Messrs. Friedman and Berman above the contractually required minimum
increase in 2009 as unnecessary to maintain our competitive total compensation
position in the marketplace, but did determine to raise Mr. Bennett’s base
salary for 2008 by $20,000.





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, although the Compensation Committee has the
ability to increase the maximum in its discretion.  During the first
quarter of each year, the Compensation Committee meets to establish the target
thresholds for that year.  During 2008, the Company’s EPS declined
so  Messrs. Friedman and Berman were not entitled to a mandated cash
bonus. Mr. Bennett’s employment agreement provides for an annual bonus of up to
50% of his base salary to be awarded in the discretion of the Compensation
Committee or the Board of Directors, upon consideration of such factors as
economic and business conditions affecting us and his personal performance.
Following such consideration, the Compensation Committee determined to award Mr.
Bennett a cash bonus of $125,000 for 2008.





67


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.  The Compensation Committee also gave particular consideration
to the factthat we successfully completed three acquisitions, including
the Disguise Halloween business, during 2008; the fact that we maintained our
gross revenue levels in 2008 compared to 2007 despite the onset of a serious
world-wide economic downturn during the latter part of 2008; and that management
quickly identified successors within the company to assume responsibility for
its CDI division with the departure of Geoffrey Greenberg at the end of 2008
following months of discussions with Mr. Greenberg regarding renewal of his
employment agreement. In
addition, in the case of Mr. Bennett, the Compensation Committee and the Board
of Directors considered the continued 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.
Following consideration of all of the above as well as input from FWC, the
Compensation Committee approved discretionary bonuses in the amount of
$250,000 to each of Messrs. Friedman and Berman (representing less than 23% of
their respective 2008 base salary).  As a condition to this award, the
Compensation Committee required that Messrs. Friedman and Berman agree that,
with respect to the 120,000 shares of our restricted stock each received on
January 1, 2009 pursuant to the terms of their employment agreements, sale or
transfer of 7,250 of the first 60,000 shares scheduled to vest on January 1,
2010 be restricted for two years from the date of vesting and sale or transfer
of 7,250 of the balance of such 120,000 shares initially scheduled to vest on
January 1, 2011 (subject to acceleration as provided in their respective
employment agreements) be restricted for two years from the vesting date of the
balance of such 120,000 shares.





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, all
or part of 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 2008, 50% of the 2008 restricted stock awards to Messrs.
Friedman and Berman vested on January 1, 2009  The remaining 50% of
the 2008 award will vest on January 1, 2010.  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.





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 no additional restricted stock (or stock option) awards
should be granted to our named executives for fiscal 2008.





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 2008, 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.





68


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 69 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.





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, 2008 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, 2008.







By
      the Compensation Committee of the Board of Directors:
              
              Robert
      E. Glick, Chairman
              Dan
      Almagor, Member
              Michael
      G. Miller, Member




69




The
following table sets forth the compensation we paid for our fiscal years ended
December 31, 2006, 2007 and 2008 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
                ($)
              
              
              Option
                Awards
                ($)
              
              
              Non-Equity
                Incentive
      Plan
                Compensation
                ($)
              
              
              Change
      in
                Pension
                Value
      and
                Nonqualified
                Deferred
                Compensation
                Earnings
      ($)
              
              
              All
      Other
                Compensation
                ($)
      (5)
              
              
              Total
                ($)Jack
      Friedman
              
              2008
              
              
              1,090,000
              
              
              
              250,000
              
              
              
              2,833,200
              (1)
              
              
              
              
              
              
              
              
              
              
              
              33,500
              
              
              
              4,206,700Chairman
      and
              
              2007
              
              
              1,065,000
              
              
              
              2,662,500
              
              
              
              3,421,400
              (2)
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              28,000
              
              
              
              7,176,900Chief
      Executive Officer
              
              2006
              
              
              1,040,000
              
              
              
              250,000
              
              
              
              1,884,600
              (3)
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              28,000
              
              
              
              3,202,000Stephen
      G. Berman
              
              2008
              
              
              1,090,000
              
              
              
              250,000
              
              
              
              2,833,200
              (1)
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              29,200
              
              
              
              4,202,400Chief
      Operating
              
              2007
              
              
              1,065,000
              
              
              
              2,662,500
              
              
              
              3,421,400
              (2)
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              25,500
              
              
              
              7,176,900Officer,
      President and Secretary
              
              2006
              
              
              1,040,000
              
              
              
              250,000
              
              
              
              1,884,600
              (3)
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              25,500
              
              
              
              3,199,500Joel
      M. Bennett
              
              2008
              
              
              420,000
              
              
              
              125,000
              
              
              
              99,993
              (4)
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              23,500
              
              
              
              668,493Executive
      Vice
              
              2007
              
              
              400,000
              
              
              
              300,000
              
              
              
              155,200
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              19,500
              
              
              
              874,700President
      and Chief Financial Officer
              
              2006
              
              
              360,000
              
              
              
              300,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              14,700
              
              
              
              674,700








(1)
            Pursuant
      to the 2002 Plan, on January 1, 2008, 120,000 shares of restricted stock
      were granted to the Named Officer, of which 50% vest on January 1, 2009
      and 50% vest on January 1, 2010, subject to acceleration.  The
      amount in this column was calculated as the product of (a) 120,000 shares
      of restricted stock multiplied by (b) $23.61, the last sales price of our
      common stock, as reported by Nasdaq on January 1, 2008, the date the
      shares were granted. See “— Critical Accounting
  Policies.”(2)
            Pursuant
      to the 2002 Plan, on January 1, 2007, 120,000 shares of restricted stock
      were granted to the Named Officer, of which 50% vest on January 1, 2008
      and 50% vest on January 1, 2009, subject to acceleration. Based on the
      Company’s 2007 financial performance, the vesting of 45,000 of the January
      1, 2009 vesting shares were accelerated. The amount in this column
      reflects the expense recorded in the Company’s 2007 financial statements
      and was calculated as the product of (a) 105,000 shares of restricted
      stock multiplied by (b) $21.84, the last sales price of our common stock,
      as reported by Nasdaq on January 1, 2007, the date the shares were
      granted, reflecting the 60,000 shares vested on January 1, 2008 and 45,000
      of the remaining 60,000 shares whose vesting accelerated based on the
      Company’s 2007 financial performance. See “— Critical Accounting
      Policies.” Also reflects the expense recorded in the Company’s 2007
      financial statements and was calculated as the product of (a) 30,000
      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 30,000 shares vested on January 1,
      2007. Also includes stock award of $500,000 of restricted stock as
      additional bonus compensation granted on February 14,
  2008.





(3)
            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.”(4)
            The
      amount in this column was calculated as the product of (a) 3,593 shares of
      restricted stock multiplied by (b) $27.83, the last sales price of our
      common stock, as reported by Nasdaq on February 28, 2008, the date before
      the shares were granted,





(5)
            Represents
      automobile allowances paid in the amount of $18,000 to each of Messrs.
      Friedman and Berman and $7,200, $12,000 and $12,000 for 2006, 2007 and
      2008, respectively, to Mr. 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 2006 and 2007 and $15,500,
      $11,200 and $11,500, respectively, for 2008 for Messrs. Friedman, Berman
      and Bennett. See “— Employee Pension
Plan.”





70


The
following table sets forth certain information regarding the annual bonus
performance structure for our fiscal year ended December 31, 2007 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
                OptionName
              
              Grant
                Date
              
              Threshold
                ($)
              
              
              Target
                ($)
              
              
              Maximum
                ($)
              
              
              Threshold
                ($)
              
              
              Target
                ($)
              
              
              Maximum
                ($)
              
              
              Or
      Units
                (#)
              
              
              Options
                (#)
              
              
              Awards
                ($/Sh)
              
              
              Date
                ($)
              
              
              Awards
                ($)
      (1)Jack
      Friedman
              
              1/1/08
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              120,000
              
              
              
              —
              
              
              
              —
              
              
              
              23.61
              
              
              
              2,833,200Stephen
      G. Berman
              
              1/1/08
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              120,000
              
              
              
              —
              
              
              
              —
              
              
              
              23.61
              
              
              
              2,833,2000Joel
      M. Bennett
              
              2/28/08
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              3,593
              
              
              
              —
              
              
              
              —
              
              
              
              27.83
              
              
              
              99,993





(1) The
product of (x) $23.61 for Messrs. Friedman and Berman (the closing sale price of
the common stock on December 31, 2007) and $27.83 for Mr. Bennett (the closing
sale price of the common stock on February 28, 2008) multiplied by (y) the
number of restricted shares granted on January 1, 2008 for Messrs. Friedman and
Berman and on February 29, 2008, for Mr. Bennett.





The
following table sets forth certain information regarding all equity-based
compensation awards outstanding as of December 31, 2008 by the Named
Officers:





Outstanding
Equity Awards At Fiscal Year-end





Option
      Awards
              
              
              Stock
      AwardsName
              
              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
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              135,000
              
              
              
              2,785,050
              
              
              
              —
              
              
              
              —Stephen
      G. Berman
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              135,000
              
              
              
              2,785,050
              
              
              
              —
              
              
              
              —Joel
      M. Bennett
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              8,593
              
              
              
              177,274
              
              
              
              —
              
              
              
              —





(1)
            The
      product of (x) $20.63 (the closing sale price of the common stock on
      December 31, 2008) multiplied by (y) the number of unvested restricted
      shares outstanding.





71


The
following table sets forth certain information regarding amount realized upon
the vesting and exercise of any equity-based compensation awards during 2008 by
the Named Officers:





Options
Exercises And Stock Vested





Option
      Awards
              
              
              Stock
      AwardsName
              
              Number
      of
                Shares
                Acquired
      on
                Exercise
      (#)
              
              
              Value
                Realized
      on
                Exercise
                ($)
              
              
              Number
      of
                Shares
                Acquired
      on
                Vesting
      (#)
              
              
              Value
                Realized
      on
                Vesting
      ($)
                (1)Jack
      Friedman
              
              
              —
              
              
              
              —
              
              
              
              155,567
              
              
              
              3,882,634Stephen
      G. Berman
              
              
              —
              
              
              
              —
              
              
              
              155,567
              
              
              
              3,882,634Joel
      M. Bennett
              
              
              —
              
              
              
              —
              
              
              
              5,000
              
              
              
              103,150





(1)
            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.










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 on December 31,
2008.  The potential payments listed below assume that there is no
earned but unpaid base salary at December 31, 2008.





Jack
Friedman





Upon
              Retirement
            
            
            Quits
      For
              “Good
              Reason”
              (3)
            
            
            Upon
              Death
            
            
            Upon
              “Disability”
              (4)
            
            
            Termination
              Without
              “Cause”
            
            
            Termination
              For
      “Cause”
              (6)
            
            
            Involuntary
              Termination
              In
              Connection
              with
      Change
              of
              Control(7)Base
      Salary
            
            $
            -
            
            
            $
            931,875
            
            
            $
            -
            
            
            $
            (5
            )
            
            $
            931,875
            
            
            $
            -
            
            
            $
            3,259,100
            (8)Retirement
      Benefit (1)
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Restricted
      Stock - Performance-Based
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            2,475,600
            (9)Annual
      Cash Incentive Award (2)
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -





72





Stephen
G. Berman





Upon
              Retirement
            
            
            Quits
      For
              “Good
              Reason”
              (3)
            
            
            Upon
              Death
            
            
            Upon
              “Disability”
              (4)
            
            
            Termination
              Without
              “Cause”
            
            
            Termination
              For
      “Cause”
              (6)
            
            
            Involuntary
              Termination
              In
              Connection
              with
      Change
              of
              Control(7)Base
      Salary
            
            $
            -
            
            
            $
            931,875
            
            
            $
            -
            
            
            $
            -
            
            
            $
            931,875
            
            
            $
            -
            
            
            $
            3,259,100
            (8)Restricted
      Stock - Performance-Based
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            2,475,600
            (9)Annual
      Cash Incentive Award (2)
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -





Joel
M. Bennett





Upon
              Retirement
            
            
            Quits
      For
              “Good
              Reason”
              (3)
            
            
            Upon
              Death
            
            
            Upon
              “Disability”
              (4)
            
            
            Termination
              Without
              “Cause”
            
            
            Termination
              For
      “Cause”
              (6)
            
            
            Involuntary
              Termination
              In
              Connection
              with
      Change
              of
              Control(7)Base
      Salary
            
            $
            -
            
            
            $
            420,000
            
            
            $
            210,000
            
            
            $
            210,000
            
            
            $
            420,000
            
            
            $
            -
            
            
            $
            210,000Restricted
      Stock - Performance-Based
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -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 69 years of age as at December
31, 2008.





(2)
Assumes that if the Named Officer is terminated on December 31, 2008, they were
employed through the end of the incentive period.





(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) An
amount equal to 90% of the Retirement Benefit described in footnote (1)
above.





(6)
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;




73


(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.





(7)
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.





(8) 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 $1,090,000 in
2008).





(9) 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 $20.63 per share, the closing price on the last trading day of
2008.





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.





For 2008,
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 $120,000 (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.





74











The
following table sets forth the compensation we paid to our non-employee
directors for our fiscal year ended December 31, 2008:





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
              
              2008
              
              
              67,000
              
              
              
              119,656
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              186,656David
      Blatte
              
              2008
              
              
              55,000
              
              
              
              119,656
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              174,656Robert
      Glick
              
              2008
              
              
              67,000
              
              
              
              119,656
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              186,656Michael
      Miller
              
              2008
              
              
              50,000
              
              
              
              119,656
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              169,656Murray
      Skala
              
              2008
              
              
              30,000
              
              
              
              119,656
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              149,656





(1)
Represents the product of (a) 5,068 shares of restricted stock multiplied by (b)
$23.61, the average last sales price of our common stock over the last ten
trading days in December 2007, as reported by Nasdaq, which represents the last
ten trading days preceding January 1, 2008, the date the shares were granted,
all of which shares vested on January 1, 2009.





Employment
Agreements and Termination of Employment Arrangements





In March
2003 we amended and restated our employment agreements with each of Messrs.
Friedman and Berman and on July 17, 2007 entered into a new employment agreement
with Joel Bennett.





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 2008 of $1,090,000. 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.





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 2008 of $1,090,000. 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.





75








On July
17, 2007, we entered into a new employment agreement with Mr. Bennett that
expires on December 31, 2009, 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, determined by the Compensation Committee or the Board of
Directors; (iii) a $1,000 per month car allowance; and (iv) a one-time grant of
15,000 shares of restricted stock, vesting over three years in equal annual
installments of 5,000 shares on December 31, 2007, 2008 and 2009, provided he
remains employed by us on each vesting date.





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 the sum of
his base salary on the termination date and the performance bonus paid for the
last completed year prior to the termination date multiplied by a fraction the
numerator of which is the number of full months remaining in the balance of the
term of the employment agreement after the termination date and the denominator
of which is 96. 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.





If Mr.
Bennett’s employment is terminated by (a) him for “good reason” (as described in
his employment agreement) or due to a Change of Control (as defined in his
employment agreement), or (b) by us other than as a result of the occurrence of
a “For Cause Event” (as defined in his employment agreement), Mr. Bennett will
be entitled to receive an amount equal to the total amount of his base annual
salary in effect as of the date of termination; and if Mr. Bennett’s employment
terminates as a result of his death or disability, he or his guardian, custodian
or other legal representative or successor will be entitled to continue to
receive his base salary for a period of six months following the date of
termination.





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
Benefits 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 $0.7
million, $0.9 million and $1.2 million for 2006, 2007 and 2008,
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.





76


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





The
following table sets forth certain information as of February 27, 2009 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
              
              
              2,549,525
              (5)
              
              
              8.9
              %Barclays
      Global Investors, NA.
              
              
              2,000,117
              (6)
              
              
              7.0Dimensional
      Fund Advisors LP
              
              
              2,433,579
              (7)
              
              
              8.5AXA
      Financial, Inc.
              
              
              1,590,238
              (8)
              
              
              5.6Jack
      Friedman
              
              
              504,708
              (9)
              
              
              1.8Stephen
      G. Berman
              
              
              180,000
              (10)
              
              
              *Joel
      M. Bennett
              
              
              51,366
              (11)
              
              
              *Dan
      Almagor
              
              
              53,290
              (12)
              
              
              *David
      C. Blatte
              
              
              101,836
              (13)
              
              
              *Robert
      E. Glick
              
              
              57,357
              (14)
              
              
              *Michael
      G. Miller
              
              
              54,336
              (15)
              
              
              *Murray
      L. Skala
              
              
              61,836
              (16)
              
              
              *All
      directors and executive officers as a group (8 persons)
              
              
              1,067,915
              (17)
              
              
              3.8
              %







*
            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 February
      27, 2008. The inclusion herein of any shares deemed beneficially owned
      does not constitute an admission of beneficial ownership of such
      shares.





(3)
            Except
      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. All the information presented in this Item with respect to this
      beneficial owner was extracted solely from the Schedule 13G/A filed on
      February 11, 2008.





(6)
            The
      address of Barclays Global Investors, NA. is 45 Fremont Street, San
      Francisco, CA 94105. Possesses sole voting power with respect to 1,612,442
      of such shares and sole dispositive power with respect to all of such
      2,000,117 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 5, 2008.





(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 6, 2008.





(8)
            The
      address of AXA Financial, Inc. is 1290 Avenue of the Americas, New York,
      NY 10104. Possesses sole voting power with respect to 737,414 of such
      shares and sole dispositive power with respect to all of such 1,590,238
      shares. All the information presented in this Item with respect to this
      beneficial owner was extracted solely from the Schedule 13G filed on
      February 14, 2008.





77




(9)
            Includes
      3,186 shares held in trusts for the benefit of children of Mr. Friedman.
      Also includes 120,000 shares of common stock issued on January 1, 2009
      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,
      2009 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, 2010, including the condition that
      our Pre-Tax Income (as defined in the Friedman Agreement) for 2008 exceeds
      $2,000,000, whereupon the forfeited shares will become authorized but
      unissued shares of our common stock. The Friedman Agreement, as modified
      by a subsequent agreement with our Compensation Committee, further
      prohibits Mr. Friedman from selling or transferring 7,250 of the first 60,000 shares
      scheduled to vest on January 1, 2010 for two years from the date of
      vesting and sale or transfer of 7,250 of the balance of such 120,000
      shares initially scheduled to vest on January 1, 2011 (subject to
      acceleration as provided in the Friedman Agreement) be restricted for two
      years from the vesting date of the balance of such 120,000
      shares.  Also includes 120,000 shares granted on January 1,
      2008, one-half of which were scheduled to vest (subject to acceleration)
      on January 1, 2009 and the balance on January 1, 2010, but the vesting
      schedule was modified by our  Board of Directors as a
      condition to receiving the 20,567 restricted share grant described below,
      further prohibiting Mr. Friedman from selling, assigning, transferring,
      pledging or otherwise encumbering (a) 10,000 of such shares
      until January 1, 2011, (b) of the remaining 60,000 shares, 50,000 shares
      prior to January 1, 2010; and (c) the remaining 10,000 shares until two
      years after the vesting date of all of the 50,000 shares described in
      (b). Also includes 20,567 shares granted on February 14, 2008 which
      are subject to a three-year restriction on sale and 175,000 shares subject
      to restriction on sale until June 11, 2009 of which shares not more than
      87,500 shares may be sold prior to June 11,
  2010.





(10)
            Includes
      120,000 shares of common stock issued on January 1, 2009 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, 2009 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,
      2010, including the condition that our Pre-Tax Income (as defined in the
      Berman Agreement) for 2009 exceeds $2,000,000, whereupon the forfeited
      shares will become authorized but unissued shares of our common stock. The
      Berman Agreement, as modified by a subsequent agreement with our
      Compensation Committee, further prohibits Mr. Berman from selling or
      transferring 7,250 of the
      first 60,000 shares scheduled to vest on January 1, 2010 for two years
      from the date of vesting and sale or transfer of 7,250 of the balance of
      such 120,000 shares initially scheduled to vest on January 1, 2011
      (subject to acceleration as provided in the Berman Agreement) be
      restricted for two years from the vesting date of the balance of such
      120,000 shares.  Also includes 120,000 shares granted on January
      1, 2008, one-half of which were scheduled to vest (subject to
      acceleration) on January 1, 2009 and the balance on January 1, 2010, but
      the vesting schedule was modified by our Board of Directors as a
      condition to receiving the 20,567 restricted share grant described below,
      further prohibiting Mr. Berman from selling, assigning, transferring,
      pledging or otherwise encumbering (a) 10,000 of such shares until
      January 1, 2011, (b) of the remaining 60,000 shares, 50,000 shares prior
      to January 1, 2010; (c) the remaining 10,000 shares until two years after
      the vesting date of all of the 50,000 shares described in (b). Also
      includes 20,567 shares granted on February 14, 2008 which are subject to a
      three-year restriction on sale and 175,000 shares subject to restriction
      on sale until June 11, 2009 of which shares not more than 87,500 shares
      may be sold prior to June 11, 2010.





(11)
            Includes
      10,000 shares of restricted common stock granted by our Board of Directors
      to Mr. Bennett upon the execution of his new employment agreement (see
      “Executive Compensation- Employment Agreements”), which restricted shares
      vest in equal annual installments of 5,000 shares each on December 31,
      2008 and 2009 and includes 3,593 restricted shares granted on February 29,
      2008 and which vest 50% on March 1, 2009 and the balance on March 1,
      2010.





(12)
            Includes
      29,644 shares which Mr. Almagor may purchase upon the exercise of certain
      stock options and 23,646 shares of common stock issued pursuant to our
      2002 Stock Award and Incentive Plan, pursuant to which 6,068 shares may
      not be sold, mortgaged, transferred or otherwise encumbered prior to
      January 1, 2010.





(13)
            Includes
      82,500 shares which Mr. Blatte may purchase upon the exercise of certain
      stock options and 19,336 shares of common stock issued pursuant to our
      2002 Stock Award and Incentive Plan, pursuant to which 6,068 of such
      shares may not be sold, mortgaged, transferred or otherwise encumbered
      prior to January 1, 2010.





(14)
            Includes
      99,021 shares which Mr. Glick may purchase upon the exercise of certain
      stock options and 24,336 shares of Common Stock issued pursuant to our
      2002 Stock Award and Incentive Plan, pursuant to which 6,068 of such
      shares may not be sold, mortgaged, transferred or otherwise encumbered
      prior to January 1, 2010.





78


(15)
            Includes
      89,646 shares which Mr. Miller may purchase upon the exercise of certain
      stock options and 24,336 shares of Common Stock issued pursuant to our
      2002 Stock Award and Incentive Plan, pursuant to which 6,068 of such
      shares may not be sold, mortgaged, transferred or otherwise encumbered
      prior to January 1, 2010.





(16)
            Includes
      97,771 shares which Mr. Skala may purchase upon the exercise of certain
      stock options and 24,336 shares of common stock issued pursuant to our
      2002 Stock Award and Incentive Plan, pursuant to which 6,068 of such
      shares may not be sold, mortgaged, transferred or otherwise encumbered
      prior to January 1, 2010.






(17)
            Includes
      3,186 shares held in trust for the benefit of Mr. Friedman’s children and
      an aggregate of 212,665 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
LLP (f/k/a Feder, Kaszovitz, Isaacson, Weber, Skala, Weber, Bass & Rhine
LLP), which has performed, and is expected to continue to perform, legal
services for us. In 2008, we incurred approximately $2,534,136 for legal fees
and $300,913  for reimbursable expenses payable to that firm. As of
December 31, 2007 and 2008, legal fees and reimbursable expenses of $916,048 and
$1,530,653, 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
            
            
            2007
            
            
            2008Audit
      Fees
            
            $
            1,015,700
            
            
            $
            1,026,500
            
            
            $
            1,065,000Audit
      Related Fees
            
            $
            
            
            
            $
            —
            
            
            $
            4,400Tax
      Fees
            
            $
            
            
            
            $
            —
            
            
            $
            21,200All
      Other Fees
            
            $
            
            
            
            $
            —
            
            
            $
            25,000





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.





79


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.





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.




80


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
Firm





•
            Consolidated
      Balance Sheets as of December 31, 2007 and
2008





•
            Consolidated
      Statements of Operations for the years ended December 31, 2006, 2007 and
      2008





•
            Consolidated
      Statements of Other Comprehensive Income for the years ended December 31,
      2006, 2007 and 2008





•
            Consolidated
      Statements of Stockholders’ Equity for the years ended December 31, 2006,
      2007 and 2008





•
            Consolidated
      Statements of Cash Flows for the years ended December 31, 2006, 2007 and
      2008





•
            Notes
      to Consolidated Financial
Statements





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





•
            Schedule
      II — Valuation and Qualifying
Accounts





(3)
            Exhibits:





Exhibit
              Number
            
            Description3.1
            
            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)10.2.1
            
            2008
      Amendment to 2002 Stock Award and Incentive Plan (9)10.3
            
            Amended
      and Restated Employment Agreement between the Company and Jack Friedman,
      dated as of March 26, 2003 (10)10.4
            
            Amended
      and Restated Employment Agreement between the Company and Stephen G.
      Berman dated as of March 26, 2003 10)10.5
            
            Office
      Lease dated November 18, 1999 between the Company and Winco Maliview
      Partners (11)10.6
            
            Form
      of Restricted Stock Agreement (10)10.7
            
            Employment
      Agreement between the Company and Joel M. Bennett, dated July 17, 2007
      (12)14
            
            Code
      of Ethics (13)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.





81


(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 Schedule 14A Proxy Statement,
      filed August 20, 2008, 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, 2002, filed March 31, 2003, 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, 1999, filed March 30, 2000, and
      incorporated herein by reference.(12)
            Filed
      previously as an exhibit to the Company’s Current Report on Form 8-K filed
      July 17, 2007, and incorporated herein by
  reference.





(13)
            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.





82





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:
      February 27, 2009
                  JAKKS
      PACIFIC, INC.By:
                  /s/
      JACK FRIEDMANJack
      FriedmanChairman
      andCo-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 FRIEDMANJack
      Friedman
                                                    
                                                    Chairman
      of the Board
                                                      of
      Directors and
                                                    
                                                    February
      27, 2009Co-Chief
      Executive Officer
                                                      (Principal
      Executive Officer)/s/
      JOEL M. BENNETTJoel
      M. Bennett
                                                    
                                                    Chief
      Financial Officer
                                                      (Principal
      Financial Officer and
                                                    
                                                    February
      27, 2009Principal
      Accounting Officer)/s/
      STEPHEN G. BERMANStephen
      G. Berman
                                                    
                                                    Director
      and
                                                      Co-Chief
      Executive Officer
                                                    
                                                    February
      27, 2009/s/
      DAN ALMAGOR
                                                    
                                                    
                                                    
                                                    February
      27, 2009Dan
      Almagor
                                                    
                                                    Director/s/
      DAVID C. BLATTE
                                                    
                                                    
                                                    
                                                    February
      27, 2009David
      C. Blatte
                                                    
                                                    Director/s/
      ROBERT E. GLICK
                                                    
                                                    
                                                    
                                                    February
      27, 2009Robert
      E. Glick
                                                    
                                                    Director/s/
      MICHAEL G. MILLER
                                                    
                                                    
                                                    
                                                    February
      27, 2009Michael
      G. Miller
                                                    
                                                    Director/s/
      MURRAY L. SKALA
                                                    
                                                    
                                                    
                                                    February
      27, 2009Murray
      L. Skala
                                                    
                                                    Director








83








EXHIBIT
INDEX





Exhibit
                    Number
                  
                  Description3.1
                  
                  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)10.2.1
                  
                  2008
      Amendment to 2002 Stock Award and Incentive Plan (9)10.3
                  
                  Amended
      and Restated Employment Agreement between the Company and Jack Friedman,
      dated as of March 26, 2003 (10)10.4
                  
                  Amended
      and Restated Employment Agreement between the Company and Stephen G.
      Berman dated as of March 26, 2003 (10)10.5
                  
                  Office
      Lease dated November 18, 1999 between the Company and Winco Maliview
      Partners (11)10.6
                  
                  Form
      of Restricted Stock Agreement (10)10.7
                  
                  Employment
      Agreement between the Company and Joel M. Bennett, dated July 17, 2007
      (12)14
                  
                  Code
      of Ethics (13)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 Schedule 14A Proxy Statement,
      filed August 20, 2008 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, 2002, filed March 31, 2003, 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, 1999, filed March 30, 2000, and
      incorporated herein by reference.




84





(12)
            Filed
      previously as an exhibit to the Company’s Current Report on Form 8-K filed
      July 17, 2007, and incorporated herein by reference.(13)
            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.








85