SEC Filing | JAKKS Pacific Inc.

1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 19, 1999 REG. NO. 333- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM S-3 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ JAKKS PACIFIC, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 95-4527222 (STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 22761 PACIFIC COAST HIGHWAY, MALIBU, CALIFORNIA 90265 (310) 456-7799 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) JACK FRIEDMAN, CHAIRMAN JAKKS PACIFIC, INC. 22761 PACIFIC COAST HIGHWAY, MALIBU, CALIFORNIA 90265 (310) 456-7799 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ------------------------ COPIES TO: MURRAY L. SKALA, ESQ. CHRISTOPHER T. JENSEN, ESQ. FEDER, KASZOVITZ, ISAACSON, WEBER, SKALA & BASS MORGAN, LEWIS & BOCKIUS LLP LLP 101 PARK AVENUE, NEW YORK, NY 10178-0060 750 LEXINGTON AVENUE, NEW YORK, NY 10022-1200 (212) 309-6000 FAX: (212) 309-6273 (212) 888-8200 FAX: (212) 888-7776 ------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this registration statement If the only securities being registered on this Form are being offered pursuant to dividend or interest reinvestment plans, please check the following box. [ ] If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other than securities offered only in connection with dividend or interest reinvestment plans, check the following box. [ ] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] --------------- If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] ------------------ If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] ------------------------ CALCULATION OF REGISTRATION FEE - -------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------- TITLE OF EACH CLASS OF PROPOSED MAXIMUM PROPOSED MAXIMUM SECURITIES TO BE AMOUNT TO OFFERING PRICE PER AGGREGATE AMOUNT OF REGISTERED BE REGISTERED UNIT(1) OFFERING PRICE(1) REGISTRATION FEE - -------------------------------------------------------------------------------------------------------------------- Common Stock, par value $.001 per share........ 2,587,500 Shares(2) $18.7188 $48,434,895 $13,464.90 - -------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------- (1) Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457. (2) Includes 337,500 shares of common stock, par value $.001 per share, which the underwriters have the option to purchase to cover over-allotments, if any. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------

2 The information in this prospectus is not complete and may be changed. JAKKS has filed a registration statement with the Securities and Exchange Commission and we may not sell these securities until it becomes effective. We are not offering to sell, or soliciting any offer to buy these securities in any state where the offer or sale is not permitted. SUBJECT TO COMPLETION, DATED MARCH 19, 1999 2,250,000 SHARES JAKKS PACIFIC, INC. COMMON STOCK ------------------------- Of the 2,250,000 shares of common stock being offered, JAKKS Pacific, Inc. is offering 2,000,000 shares and two of our stockholders are offering 250,000 shares. Our common stock is traded on the Nasdaq National Market under the symbol "JAKK." On March 18, 1999, the last reported sale price of our common stock on the Nasdaq National Market was $18.875 per share. ------------------------- AN INVESTMENT IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON PAGE 8. ------------------------- PER SHARE TOTAL --------- ----- Public Offering Price.......................... $ $ Underwriting Discount.......................... $ $ Proceeds to JAKKS.............................. $ $ Proceeds to the Selling Stockholders........... $ $ THE SECURITIES AND EXCHANGE COMMISSION HAS NOT, NOR HAS ANY STATE SECURITIES REGULATOR, APPROVED OR DISAPPROVED THESE SECURITIES, OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. JAKKS and the selling stockholders have granted the underwriters a 30-day option to purchase up to 337,500 additional shares of our common stock to cover over-allotments. The underwriters expect to deliver the shares of common stock to purchasers on or about , 1999. ------------------------- ADVEST, INC. MORGAN KEEGAN & COMPANY, INC. SOUTHWEST SECURITIES THE DATE OF THIS PROSPECTUS IS , 1999.

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4 YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED OR INCORPORATED IN THIS PROSPECTUS. WE AND THE UNDERWRITERS HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THAT CONTAINED IN THIS PROSPECTUS. WE ARE OFFERING TO SELL, AND SEEKING OFFERS TO BUY, SHARES OF COMMON STOCK ONLY IN JURISDICTIONS WHERE OFFERS AND SALES ARE PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS ACCURATE ONLY AS OF THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF DELIVERY OF THIS PROSPECTUS OR ANY SALE OF OUR COMMON STOCK. IN THIS PROSPECTUS, REFERENCES TO THE "COMPANY," "JAKKS," "WE," "US" AND "OUR" REFER TO JAKKS PACIFIC, INC. AND ITS SUBSIDIARIES. TABLE OF CONTENTS PAGE ---- Disclosure Regarding Forward-Looking Statements............. 3 Summary..................................................... 5 Risk Factors................................................ 8 Use of Proceeds............................................. 17 Price Range of Common Stock and Dividend Policy............. 18 Capitalization.............................................. 19 Selected Consolidated Financial Data........................ 20 Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 21 Business.................................................... 30 Management.................................................. 41 Principal and Selling Stockholders.......................... 46 Certain Relationships and Related Transactions.............. 47 Description of Securities................................... 48 Underwriting................................................ 51 Legal Matters............................................... 53 Experts..................................................... 53 Where You Can Find More Information......................... 54 Index to Consolidated Financial Statements.................. F-1 ------------------------- DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS This prospectus 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 prospectus 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 under "Risk Factors" below and elsewhere in this prospectus. You should understand that forward-looking statements made in connection 3

5 with this offering 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. We own or have rights to various trademarks and brand or trade names that we use in conjunction with the sale of our products. These include World Wrestling Federation, Road Champs, Remco, Child Guidance, Ford, Chevrolet, Car and Driver and B.A.S.S. Masters, among others. We also refer in this prospectus to other trademarks or brand or trade names that are owned or licensed by other companies. 4

6 SUMMARY Because this is only a summary, it does not contain all the information that may be important to you. You should read the entire prospectus, especially "Risk Factors," beginning on page 8, and our consolidated financial statements and the related notes, before deciding to invest in our common stock. Unless otherwise indicated, all information contained in this prospectus assumes that the underwriters will not exercise their over-allotment option. THE COMPANY OUR BUSINESS................. We design, develop, produce and market toys and related products. We focus on "evergreen" branded products that are less subject to market fads or trends and feature well-known brand names and simpler, lower-priced toys and accessories. OUR PRODUCTS................. Our principal products are (1) action figures and accessories featuring licensed characters, principally from the World Wrestling Federation, (2) Road Champs die-cast collectible and toy vehicles and Remco toy vehicles and role-play toys and accessories, (3) Child Guidance infant and pre-school electronic toys, and (4) fashion and mini dolls and related accessories. We also participate in a joint venture with THQ, Inc. ("THQ") that will develop, produce and market video games based on World Wrestling Federation characters and themes under an exclusive license with Titan Sports, Inc. ("Titan Sports"). OUR CUSTOMERS................ We make most of our sales to major U.S. toy and discount retail store chains, such as Toys 'R Us, Wal-Mart, Kmart, Kay-Bee Toys and Target, department stores, specialty stores, wholesalers, hobby shops and corporate accounts. We also sell our products to customers outside the U.S., including foreign subsidiaries of some of our major U.S. customers and other non-U.S. retailers and distributors. OUR INDUSTRY................. According to Toy Manufacturers of America, Inc., the leading industry trade group, total manufacturers' shipments of toys, excluding video games, in the U.S. were approximately $15.2 billion in 1998, and sales by U.S. toy manufacturers to non-U.S. customers totaled approximately $5.5 billion in 1997. In the video game segment, manufacturers' shipments of video game software were approximately $3.0 billion in 1998. 5

7 OUR STRATEGY................. We plan to expand our core product lines and diversify into new product categories by growing internally, making strategic acquisitions and entering into additional character and product licenses. We also plan to intensify our international sales efforts. In addition, we will continue our focus on maintaining our low-overhead infrastructure and efficient operating methods. THE OFFERING Common stock offered by JAKKS............... 2,000,000 shares Common stock offered by the selling stockholders.............................. 250,000 shares Common stock outstanding after this offering.................................. 8,193,929 shares(1)(2) Use of proceeds to JAKKS.................... To fund capital obligations to our joint venture, to fund product development, to finance potential acquisitions and for working capital and general corporate purposes Nasdaq National Market Symbol............... JAKK - ------------------------- (1) Does not include 1,855,288 shares issuable upon the exercise of all our outstanding warrants and options or 1,602,138 shares issuable upon the conversion of all our outstanding convertible debentures and preferred stock. (2) If all the over-allotment shares are also sold, we would issue an additional 292,500 shares, so that 8,486,429 shares would be outstanding after this offering. ------------------------- RISK FACTORS You should refer to the section entitled "Risk Factors," beginning on page 8, for a discussion of certain factors you should consider before purchasing our common stock. 6

8 SUMMARY CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) APRIL 1, 1995 (INCEPTION) TO YEARS ENDED DECEMBER 31, DECEMBER 31, ----------------------------- 1995 1996 1997 1998 -------------- ------- ------- ------- CONSOLIDATED STATEMENT OF OPERATIONS DATA: Net sales......................... $6,078 $12,052 $41,945 $85,253 Gross profit...................... 1,947 4,821 16,070 33,253 Income from operations............ 547 1,209 4,175 9,246 Net income........................ $ 436 $ 1,180 $ 2,786 $ 6,375 ====== ======= ======= ======= Basic earnings per share.......... $ 0.22 $ 0.36 $ 0.60 $ 1.12 ====== ======= ======= ======= Weighted average shares outstanding..................... 2,000 3,284 4,621 5,693 ====== ======= ======= ======= Diluted earnings per share........ $ 0.20 $ 0.34 $ 0.52 $ 0.89 ====== ======= ======= ======= Weighted average shares and equivalents outstanding......... 2,191 3,504 6,008 7,602 ====== ======= ======= ======= AS OF DECEMBER 31, 1998 ------------------------- ACTUAL AS ADJUSTED(1) ------- -------------- CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents............................. $12,452 $47,487 Working capital....................................... 13,736 48,801 Total assets.......................................... 58,736 93,584 Total stockholders' equity............................ 37,754 75,602 - ------------------------- (1) As adjusted to reflect (a) the sale by JAKKS of 2,000,000 shares of our common stock at an assumed public offering price of $18.875 per share and our application of the net proceeds we receive from that sale and (b) the conversion of $3.0 million principal amount of our convertible debentures into 521,740 shares of our common stock on May 25, 1999. You should refer to the section entitled "Use of Proceeds" for a discussion of how we intend to use these net proceeds and the section entitled "Description of Securities -- Convertible Debentures" for a description of these securities and the terms of conversion. 7

9 RISK FACTORS The purchase of our common stock involves substantial investment risks. You should carefully consider the following risk factors, in addition to the remainder of this prospectus, before purchasing our common stock. WE ARE SUBJECT TO CHANGING CONSUMER PREFERENCES AND NEW PRODUCT INTRODUCTIONS Consumer preferences in the toy industry are continuously changing and difficult to predict. Relatively few products become popular with consumers and they often have short life cycles. We cannot assure you that: - our current products will continue to be popular with consumers; - our product lines or products we introduce will achieve any significant degree of market acceptance; and - 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. Accordingly, our success will depend on our ability to enhance existing product lines and to develop new products and product lines. The failure of new product lines to achieve or sustain market acceptance could adversely affect our business, financial condition and results of operations. In addition, the success of many of our character- and theme-related products depends on the popularity of characters in movies, television programs, live wrestling exhibitions and other media. We cannot assure you that: - if the media related to our existing character- and theme-related product lines are successful, this success will result in substantial promotional value to our products; - we will be successful in obtaining licenses to produce new character- and theme-related products in the future; and - media related to our character- and theme-related product lines will be released at the times we expect or will be successful. A LIMITED NUMBER OF OUR PRODUCT LINES ACCOUNT FOR A SUBSTANTIAL PORTION OF OUR NET SALES We derive a substantial portion of our net sales from a limited number of product lines. Sales of the World Wrestling Federation, Road Champs and Remco product lines represented approximately 82.7% of our net sales in 1997 and 78.5% in 1998. We cannot assure you that any of the products in these branded product lines will retain their current popularity. A decrease in the popularity of any one of these branded product lines may adversely affect our business, financial condition and results of operations. THERE ARE RISKS ASSOCIATED WITH OUR LICENSE AGREEMENTS 1. OUR CURRENT LICENSES REQUIRE US TO PAY MINIMUM ROYALTIES Sales of products under trademarks or trade or brand names licensed from others accounted for substantially all of our net sales in 1997 and 1998. Product licenses allow us to capitalize on characters, designs, concepts and inventions owned by others or developed 8

10 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. Our payments for royalties earned under our license agreements were approximately $2,858,000 in 1997 and approximately $6,322,000 in 1998. As of December 31, 1998, our aggregate minimum royalty payments for 1999 under our current license agreements were approximately $1,753,000. 2. THE USE OF OUR LICENSES IS RESTRICTED Under some of our license agreements, the licensors have the right to review and approve our use of licensed products, designs or materials before we are permitted to make any sales. The refusal to permit our use of any licensed property in the way we propose, or any delay resulting from their review process, could prohibit or impede our development or sale of new products. 3. NEW LICENSES ARE DIFFICULT TO OBTAIN Our success will depend in part on our ability to obtain additional licenses. Competition for desirable licenses is intense. 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. OUR NEW JOINT VENTURE IS SUBJECT TO NUMEROUS RISKS AND UNCERTAINTIES In addition to the risks relating to us and the toy industry, our joint venture faces the following risks: - Our joint venture depends entirely on a single license, which gives it the exclusive right to produce and market video games based on World Wrestling Federation characters and themes. The popularity of wrestling, in general, and the World Wrestling Federation, in particular, is subject to changing consumer tastes and demands. A decline in the popularity of the World Wrestling Federation could adversely affect the joint venture's and our business, financial condition and results of operations. - The joint venture will rely 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 licenses were to terminate and the joint venture could not otherwise obtain these licenses from the manufacturers, it would be unable to publish additional titles for these manufacturers' platforms, which would materially adversely affect its and our business, financial condition and results of operations. - The software industry has experienced periods of significant growth in consumer interest, followed by periods in which growth has substantially declined. The joint venture's sales of software titles will be dependent, among other factors, on the popularity and unit sales of platforms generally, as well as on the relative popularity and unit sales of various platforms. The relative popularity of platforms has fluctuated significantly in recent years. An unexpected decline in the popularity of a 9

11 particular platform can be expected to have a material adverse effect on consumer demand for titles released or to be released by the joint venture for these platforms. - 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 our PC 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. - We are required to make capital contributions to the joint venture to enable it to pay guaranteed minimum royalty advances to Titan Sports, as well as other royalties to developers of World Wrestling Federation titles. These significant costs are capitalized and then amortized or otherwise expensed as units of the titles are sold. If future sales of particular titles are not sufficient to recover these costs, the resulting write-off could materially adversely affect the joint venture's and our business, financial condition and results of operations. THE TOY INDUSTRY IS HIGHLY COMPETITIVE The toy industry is highly competitive. Many of our competitors have certain competitive advantages over us due to: - greater financial resources; - longer operating histories; - stronger name recognition; - larger sales and marketing and product development departments; 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. WE MAY NOT BE ABLE TO SUSTAIN OR MANAGE OUR RAPID GROWTH We experienced rapid growth in net sales and net income in 1996, 1997 and 1998. 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 or net income. Our growth strategy calls for us to continuously develop and diversify our toy business by acquiring other companies, entering into additional license agreements and expanding into international markets, which will place additional demands on our management, operational capacity and financial resources and systems. The increased demand on 10

12 management may necessitate the recruitment and retention by JAKKS of additional qualified management personnel. We cannot assure you that we will successfully recruit and retain qualified personnel or expand and manage our operations effectively and profitably. In addition, implementation of our growth strategy is subject to risks beyond our control, including competition, market acceptance of new products, changes in economic conditions, our ability to obtain or renew licenses on commercially reasonable terms and our ability to finance increased levels of accounts receivable and inventory necessary to support our sales growth, if any. Accordingly, we cannot assure you that our growth strategy will be implemented successfully. WE NEED TO BE ABLE TO ACQUIRE AND INTEGRATE COMPANIES AND NEW PRODUCT LINES SUCCESSFULLY Our growth strategy depends in part upon our ability to acquire companies or new product lines. Future acquisitions will only succeed if we can effectively assess characteristics of potential target companies or product lines, such as: - financial condition and results of operations; - attractiveness of products; - suitability of distribution channels; - management ability; and - the degree to which acquired operations can be integrated with our operations. We cannot assure you that we can identify attractive acquisition candidates or negotiate acceptable acquisition terms, and our failure to do so may adversely affect our results of operations and our ability to sustain growth. Our acquisition strategy involves a number of risks, each of which could adversely affect our operating results, including: - difficulties in integrating acquired businesses or product lines, assimilating new facilities and personnel and harmonizing diverse business strategies and methods of operation; - diversion of management attention from operation of our existing business; - loss of key personnel from acquired companies; and - failure of an acquired business to achieve targeted financial results. A FEW CUSTOMERS ACCOUNT FOR A LARGE PORTION OF OUR NET SALES In 1998, 69.6% of our net sales came from sales of our products to five customers. In 1997, that figure was 61.7%. 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 a reduction in prices, financial incentives, a change in other terms of sale or for JAKKS to bear the risks and the cost of carrying inventory could also adversely affect our business, financial condition and results of operations. 11

13 WE DEPEND ON OUR KEY PERSONNEL Our success is largely dependent upon the experience and continued services of Jack Friedman, our Chairman and Chief Executive Officer, and Stephen G. Berman, our President and Chief Operating Officer. We cannot assure you that we would be able to find an appropriate replacement for Mr. Friedman or Mr. Berman if the need should arise, and any loss or interruption of Mr. Friedman's or Mr. Berman's services could adversely affect our business, financial condition and results of operations. In addition, the holders of our 9% Convertible Debentures may require us to redeem these debentures if Mr. Friedman dies, in which case our financial condition could be materially and adversely affected. We maintain key-man life insurance on Mr. Friedman in the amount of $4 million, which may be insufficient to fund the redemption of the debentures, if required, or the cost of employing his successor. OUR BUSINESS MAY BE ADVERSELY AFFECTED BY POLITICAL OR ECONOMIC DEVELOPMENTS IN CHINA Substantially all of our products are produced by unaffiliated manufacturers in the People's Republic of China. As a result, our operations may be affected by many factors, including: - economic, political, governmental and labor conditions in China; - the possibility of expropriation, supply disruption, currency controls and exchange fluctuations; - China's relationship with the United States; and - fluctuations in the exchange rate of the U.S. dollar against foreign currencies. 1. LOSS OF CHINA'S "MOST FAVORED NATION" STATUS China currently enjoys "Most Favored Nation" status under United States tariff laws. China's Most Favored Nation status is reviewed annually by Congress, and the renewal of this status is subject to significant political uncertainties. The loss of China's Most Favored Nation status or the imposition of retaliatory or protectionist trade policies, such as a substantial increase in the duty on products we import into the United States from China, would adversely affect our business, financial condition and results of operation. 2. IMPOSITION OF TRADE RESTRICTIONS China may be subject to retaliatory trade restrictions imposed by the United States under various provisions of the Trade Act of 1974. In the past, the United States has threatened the imposition of punitive 100% tariffs on selected goods and has withdrawn this threat very shortly before sanctions were to take effect. The imposition by the United States of trade sanctions and subsequent actions by China would result in manufacturing and distribution disruptions or higher costs to us which, in turn, would adversely affect our business, financial condition and results of operations. 12

14 3. POLITICAL UNCERTAINTY IN HONG KONG We maintain an office in Hong Kong to supervise and monitor manufacturing and product promotion in China. On July 1, 1997, sovereignty over Hong Kong was transferred from the United Kingdom to China. If Hong Kong's business climate were to become less favorable as a result of the transfer of sovereignty, our business, financial condition and results of operations would be materially and adversely affected. OUR PRODUCT SALES ARE SUBJECT TO SEASONAL AND QUARTERLY FLUCTUATIONS Our product sales are highly seasonal, with a majority of our sales occurring between September and December, the traditional holiday season. As a result, approximately 68.1% of our 1998 shipments occurred in the third and fourth quarters. This seasonality causes our quarterly operating results and working capital needs to fluctuate significantly. OUR BUSINESS IS SUBJECT TO EXTENSIVE GOVERNMENT REGULATION AND TO POTENTIAL PRODUCT LIABILITY CLAIMS Our business is subject to various laws, including the Federal Hazardous Substances Act, the Consumer Product Safety Act, the Flammable Fabrics Act and the rules and regulations promulgated under these acts. These statutes are administered by the Consumer Product Safety Commission, which has the authority to exclude from the market products that are found to be hazardous and which can require a manufacturer to repurchase 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; and - increased warranty costs; any of which 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 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, we cannot assure you that third parties will not assert intellectual property claims against us in the future. These claims could divert management 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. 13

15 WE DEPEND ON THIRD-PARTY MANUFACTURERS We depend on third parties to manufacture all our products. Although we own the tools, dies and molds used to manufacture our products, 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 have a material adverse effect on our business, financial condition and results of operations. We do not have long-term contracts with our third-party manufacturers. Although we believe we would be able to secure other third-party manufacturers to produce our products as a result of our ownership of the tools, dies and molds used in the manufacturing process, 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 China-based 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. Accordingly, significant damage to these facilities could result in the loss of or damage to a material portion of our tools, dies and molds, in addition to production delays while new facilities were being arranged and replacement tools, dies and molds were being produced. We do not maintain an inventory of sufficient size to provide protection for any significant period against an interruption of supply, particularly if we were required to utilize alternative sources of supply. 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. THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE Market prices of the securities of toy companies are often volatile. The market price of our common stock may be affected by many factors, including: - fluctuations in our financial results; - the actions of our customers and competitors (including new product line announcements and introductions); - new regulations affecting foreign manufacturing; - other factors affecting the toy industry in general; and - sales of our common stock into the public market. In addition, the stock market periodically has experienced significant price and volume fluctuations which may have been unrelated to the operating performance of particular companies. FUTURE SALES OF OUR SHARES COULD ADVERSELY AFFECT OUR STOCK PRICE As of March 18, 1999, there were 6,193,929 shares of our common stock outstanding. An additional 2,535,720 shares of our common stock are issuable upon the conversion of our convertible debentures and our preferred stock and upon the exercise of currently exercisable warrants and options. If all these shares were issued, we would have 8,729,649 shares of our common stock outstanding. In addition, 921,706 shares of our common stock 14

16 are issuable upon the exercise of outstanding options that are not currently exercisable. Any sale of a substantial number of shares of our common stock in the public market after this offering, or the perception that such sales could occur, may adversely affect the market price of our common stock. OUR MANAGEMENT EXERCISES SUBSTANTIAL CONTROL OVER OUR BUSINESS As of March 18, 1999, our directors and executive officers beneficially owned, in the aggregate, 1,354,944 shares of our common stock, representing approximately 21.0% of the common stock outstanding. Immediately after this offering, they will beneficially own, in the aggregate, 1,104,944 shares, representing approximately 13.1% of the common stock then to be outstanding. Accordingly, if these persons act together, they could exercise considerable influence over matters requiring approval of our stockholders, including the election of our Board of Directors. THE COMPUTER SYSTEMS WE RELY ON MAY NOT ACHIEVE YEAR 2000 READINESS Many currently installed computer systems and software products are dependent upon internal calendars coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, our computer systems and software may need to be upgraded to comply with Year 2000 requirements. Otherwise, system failures or miscalculations leading to disruptions in our operations could occur. We also depend on third parties, including suppliers and customers, for the operation of our day-to-day business. We cannot assure you that our efforts or those being taken by these third parties, if any, will be sufficient to eliminate any Year 2000 problem from the computer systems used by us or these third parties. In the event that any modifications or conversions to computer systems required to be Year 2000 compliant are not completed on a timely basis, non-compliant systems or programs may fail or malfunction which could disrupt our operations, create additional costs and divert management's attention, which, in turn, would adversely affect our business, financial condition and results of operations. For a more detailed discussion of our efforts to address the Year 2000 problem, see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Impact of the Year 2000." OUR ABILITY TO ISSUE "BLANK CHECK" PREFERRED STOCK AND OUR OBLIGATION TO MAKE SEVERANCE PAYMENTS COULD PREVENT OR DELAY TAKEOVERS Our certificate of incorporation authorizes the issuance of "blank check" preferred stock (that is, preferred stock which our Board of Directors can create and issue without prior stockholder approval) with rights senior to those of our common stock. In addition, our employment agreements with two of our executive officers require us, under certain conditions, to make substantial severance payments to them if they resign after a change of control. These provisions could delay or impede a merger, tender offer or other transaction resulting in a change in control of JAKKS, even if such a transaction would have significant benefits for our stockholders. As a result, these provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock. 15

17 OUR MANAGEMENT HAS BROAD DISCRETION AS TO THE USE OF THE NET PROCEEDS OF THIS OFFERING We are allocating a substantial portion of the net proceeds of this offering to potential acquisitions, working capital and other general corporate purposes. We do not currently have any binding agreement with respect to any acquisition of any company or product line that would require the application of any significant portion of these net proceeds. In addition, our management may apply our net proceeds to purposes different from those currently contemplated or change the allocation of our net proceeds among these purposes. Thus, our management will have substantial discretion with regard to the ultimate use of the net proceeds of this offering. 16

18 USE OF PROCEEDS If we sell the common stock offered hereby at a public offering price of $18.875 per share, after we deduct the underwriting discount and pay the offering expenses, JAKKS will receive net proceeds of approximately $35.0 million and the selling stockholders will receive net proceeds of approximately $4.4 million. If the underwriters' over-allotment option is exercised in full, JAKKS will receive additional net proceeds of approximately $5.2 million and the selling stockholders will receive additional net proceeds of approximately $798,000. We will not receive or benefit from any proceeds from the sale of shares by the selling stockholders. We currently intend to use the net proceeds of this offering received by us, as follows: - approximately $13 million to fund the operation of our joint venture, including our share of its minimum royalty advance payments and its video game development and production costs; - approximately $4 million to enhance existing products and to develop new products for introduction under our current product lines in or after 2000; - approximately $1.5 million to develop and expand our interactive wrestling figures product line; - approximately $1 million to design and implement our e-commerce web site; and - the balance for the acquisition of new character or product licenses, new products or product lines or other toy companies or businesses, working capital and general corporate purposes. Depending on future events, we may determine at a later time to use our net proceeds for different purposes or to allocate our net proceeds differently among the uses described above. Pending these uses, we expect to invest these funds in short-term, interest-bearing, investment grade securities. 17

19 PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY Our common stock is traded on the Nasdaq National Market under the symbol "JAKK." The following table sets forth, for the periods indicated, the range of high and low closing sale prices for our common stock on the Nasdaq National Market. PRICE RANGE OF COMMON STOCK --------------- HIGH LOW ---- --- 1997: First quarter........................................... 8 3/4 7 1/8 Second quarter.......................................... 8 1/4 4 1/2 Third quarter........................................... 10 13/16 5 3/4 Fourth quarter.......................................... 11 1/8 7 5/8 1998: First quarter........................................... 9 3/8 7 3/16 Second quarter.......................................... 12 1/4 7 15/16 Third quarter........................................... 10 15/16 7 Fourth quarter.......................................... 17 5/8 10 11/16 1999: First quarter (through March 18)........................ 18 7/8 10 11/16 As of March 18, 1999, there were approximately 62 holders of record of our common stock. On March 18, 1999, the last sale price of our common stock reported on the Nasdaq National Market was $18.875 per share. We intend to retain our future earnings, if any, to finance the growth and development of our business, and, accordingly, we do not plan to pay any cash dividends on our common stock in the foreseeable future. The payment of dividends on our common stock (other than dividends payable in shares of our common stock) is prohibited (1) under the loan agreement relating to our convertible debentures and (2) until all accumulated dividends on our preferred stock are paid in full and sufficient funds to pay the current dividends thereon are set aside. Moreover, the loan agreements relating to our revolving credit lines prohibit some of our subsidiaries from distributing funds to us without the lender's consent. 18

20 CAPITALIZATION The following table reflects our actual short-term debt and capitalization as of December 31, 1998 and as adjusted to reflect the receipt and application of the estimated net proceeds from the sale of our common stock offered by us hereby at an assumed public offering price of $18.875 per share, after deducting the underwriting discount and estimated offering expenses, and the conversion of $3 million principal amount of our convertible debentures into 521,740 shares of our common stock. AS OF DECEMBER 31, 1998 ------------------------ ACTUAL AS ADJUSTED -------- ------------ (IN THOUSANDS, EXCEPT SHARE DATA) Current portion of long-term debt........................ $ 60 $ 30 ======= ======= Long-term debt, net of current portion................... $ 5,940 $ 2,970 ------- ------- Stockholders' equity: Preferred stock, $.001 par value, 5,000 shares authorized; 1,000 shares issued and outstanding..... -- -- Common stock, $.001 par value, 25,000,000 shares authorized; 6,026,042 shares issued and outstanding, actual; 8,547,782 shares issued and outstanding, as adjusted............................................ 6 9 Additional paid-in capital............................. 27,044 64,889 Retained earnings...................................... 10,778 10,778 Unearned compensation from grant of options............ (74) (74) ------- ------- Total stockholders' equity..................... 37,754 75,602 ------- ------- Total capitalization..................................... $43,694 $78,572 ======= ======= 19

21 SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated statement of operations data for each of the three years in the period ended December 31, 1998 and selected consolidated balance sheet data as of December 31, 1997 and 1998 have been derived from our audited consolidated financial statements, which begin on page F-1 of this prospectus. The following selected consolidated statement of operations data for the nine-month period ended December 31, 1995 and selected consolidated balance sheet data as of December 31, 1995 and 1996 have been derived from our audited consolidated financial statements, which are not included in this prospectus. 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 this prospectus, beginning on page F-1. SELECTED CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) APRIL 1, 1995 (INCEPTION) TO YEARS ENDED DECEMBER 31, DECEMBER 31, --------------------------- 1995 1996 1997 1998 -------------- ------- ------- ------- CONSOLIDATED STATEMENT OF OPERATIONS DATA: Net sales............................... $6,078 $12,052 $41,945 $85,253 Cost of sales........................... 4,131 7,231 25,875 52,000 ------ ------- ------- ------- Gross profit............................ 1,947 4,821 16,070 33,253 Selling, general and administrative expenses.............................. 1,400 3,612 11,895 24,007 ------ ------- ------- ------- Income from operations.................. 547 1,209 4,175 9,246 Interest, net........................... 8 (134) 418 423 Other (income) expense.................. (12) -- 328 591 ------ ------- ------- ------- Income before provision for income taxes................................. 551 1,343 3,429 8,232 Provision for income taxes.............. 115 163 643 1,857 ------ ------- ------- ------- Net income.............................. $ 436 $ 1,180 $ 2,786 $ 6,375 ====== ======= ======= ======= Basic earnings per share................ $ 0.22 $ 0.36 $ 0.60 $ 1.12 ====== ======= ======= ======= Weighted average shares outstanding..... 2,000 3,284 4,621 5,693 ====== ======= ======= ======= Diluted earnings per share.............. $ .20 $ 0.34 $ 0.52 $ 0.89 ====== ======= ======= ======= Weighted average shares and equivalents outstanding........................... 2,191 3,504 6,008 7,602 ====== ======= ======= ======= AS OF DECEMBER 31, ------------------------------------ 1995 1996 1997 1998 ------ ------- ------- ------- CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents.................... $ 82 $ 6,355 $ 2,536 $12,452 Working capital (deficit).................... (621) 7,824 3,368 13,736 Total assets................................. 4,128 14,200 43,605 58,736 Long-term debt, net of current portion....... 613 -- 6,000 5,940 Total stockholders' equity................... 1,850 11,746 25,959 37,754 20

22 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, including those set forth under "Risk Factors" and elsewhere in this prospectus. You should read this section in conjunction with our consolidated financial statements and the related notes, which begin on page F-1. OVERVIEW JAKKS was founded to develop, produce and market children's toys and related products. We commenced business operations when we assumed operating control over the toy business of Justin Products Limited ("Justin"), and have included the results of Justin's operations in our consolidated financial statements from July 1, 1995, the effective date of that acquisition. The Justin product lines, which consisted primarily of fashion dolls and accessories and electronic products for children, accounted for substantially all of our net sales for the period from April 1, 1995 (inception) to December 31, 1995. One of our key strategies has been to grow through the acquisition or licensing of product lines, concepts and characters. In 1996, we expanded our product lines to include products based on licensed characters and properties, such as World Wrestling Federation action figures. We acquired Road Champs in February 1997, and have included the results of operations of Road Champs from February 1, 1997, the effective date of the acquisition. We acquired the Child Guidance and Remco trademarks in October 1997, both of which contributed to operations nominally in 1997, but contributed more significantly to operations commencing in 1998. Our products currently include (1) toys and action figures featuring licensed characters, including popular wrestling characters under our World Wrestling Federation license, (2) die-cast collectible and toy vehicles marketed under our Road Champs and Remco brand names, (3) pre-school electronic toys marketed under our Child Guidance brand name, and (4) fashion dolls and related accessories. In general, we acquire products or product concepts from others or we engage unaffiliated third parties to develop our own products, thus minimizing operating costs. Royalties payable to our developers generally range from 1% to 6% of the wholesale sale price for each unit of a product sold by us. We expect that outside inventors will continue to be a source of new products in the future. We also generate internally new product concepts, for which we pay no royalties. In June 1998, we formed our joint venture with THQ, a developer, publisher and distributor of interactive entertainment software, and the joint venture licensed the rights from Titan Sports to publish World Wrestling Federation electronic video games on all platforms. The license agreement permits the joint venture to release these games after November 16, 1999. We expect that the first game produced under this license will be released in late 1999. JAKKS and THQ will share equally any profits generated by the joint venture. 21

23 We contract the manufacture of most of our products to unaffiliated manufacturers located in China. We sell the finished products on a letter of credit basis or on open account to our customers, who take title to the goods in Hong Kong. These methods allow us to reduce certain operating costs and working capital requirements. A portion of our sales, primarily sales of our Road Champs products, originate in the United States, so we hold certain inventory in a warehouse and fulfillment facility operated by an unaffiliated third party. In addition, we hold inventory of other products from time to time in support of promotions or other domestic programs with retailers. To date, substantially all of our sales have been to domestic customers. We intend to expand distribution of our products into foreign territories and, accordingly, we have (1) engaged a representative to oversee sales in certain territories, (2) engaged distributors in certain territories, and (3) established direct relations with retailers in certain territories. We establish reserves for sales allowances, including promotional allowances and allowances for anticipated defective product returns, at the time of shipment. The reserves are determined as a percentage of net sales based upon either historical experience or on estimates or programs agreed upon by our customers. Our cost of sales consists primarily of the cost of goods produced for us by unaffiliated third-party manufacturers, royalties earned by licensors on the sale of these goods and amortization of the tools, dies and molds owned by us that are used in the manufacturing process. Other costs include inbound freight and provisions for obsolescence. Significant factors affecting our cost of sales as a percentage of net sales include (1) the proportion of net sales generated by various products with disparate gross margins, (2) the proportion of net sales made domestically, which typically carry higher gross margins than sales made in Hong Kong, and (3) the effect of amortizing the fixed cost components of cost of sales, primarily amortization of tools, dies and molds, over varying levels of net sales. Selling, general and administrative expenses include costs directly associated with the selling process, such as sales commissions, advertising and travel expenses, as well as general corporate expenses, goodwill and trademark amortization and product development. We have recorded goodwill of approximately $11 million and trademarks of approximately $14.4 million in connection with acquisitions made to date. Goodwill is being amortized over a 30-year period, while trademark acquisition costs are being amortized over periods ranging from 10 to 30 years. 22

24 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain statement of operations data as a percentage of net sales. APRIL 1, 1995 (INCEPTION) TO YEARS ENDED DECEMBER 31, DECEMBER 31, -------------------------- 1995 1996 1997 1998 -------------- ------ ------ ------ Net sales............................... 100.0% 100.0% 100.0% 100.0% Cost of sales........................... 68.0 60.0 61.7 61.0 ----- ----- ----- ----- Gross profit............................ 32.0 40.0 38.3 39.0 Selling, general and administrative expenses.............................. 23.0 30.0 28.4 28.2 ----- ----- ----- ----- Income from operations.................. 9.0 10.0 9.9 10.8 Interest, net........................... 0.1 (1.1) 1.0 0.4 Other (income) expense.................. (0.2) -- 0.7 0.7 ----- ----- ----- ----- Income before income taxes.............. 9.1 11.1 8.2 9.7 Provision for income taxes.............. 1.9 1.3 1.6 2.2 ----- ----- ----- ----- Net income.............................. 7.2% 9.8% 6.6% 7.5% ===== ===== ===== ===== YEARS ENDED DECEMBER 31, 1998 AND 1997 Net Sales. Net sales increased $43.4 million, or 103%, to $85.3 million in 1998 from $41.9 million in 1997. The significant growth in net sales was due primarily to the continuing growth of the World Wrestling Federation action figure product line with its expanded product offerings and frequent character releases, as well as to the full year impact on sales of the Remco toy vehicles and Child Guidance pre-school toys which contributed only nominally in 1997 from their acquisition date in late October 1997. Contributions made by sales of Road Champs die-cast toy and collectible vehicles and our holiday doll line were comparable with the prior year, while our line of radio-controlled vehicles made only nominal contributions to net sales in 1998. Gross Profit. Gross profit increased $17.2 million, or 107%, to $33.3 million in 1998, or 39.0% of net sales, from $16.1 million, or 38.3% of net sales, in 1997. The overall increase in gross profit was attributable to the significant increase in net sales. The increase in the gross profit margin of 0.7% of net sales was due in part to the changing product mix, which included products, such as World Wrestling Federation action figures, with higher margins than some of our other products. The higher margin resulting from lower product costs was offset in part by higher royalties, and the amortization expense of molds and tools used in the manufacture of our products was comparable on a percentage basis. Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $12.1 million, or 102%, to $24.0 million, or 28.2% of net sales, in 1998, from $11.9 million, or 28.4% of net sales, in 1997. The overall significant increase of $12.1 million in these costs was due in large part to the full year impact of costs associated with our addition of infrastructure in the United States and Hong Kong in connection with the Road Champs acquisition, as well as to development and marketing costs of products under our recently-acquired Child Guidance and Remco trademarks and under existing products lines, such as the World Wrestling Federation action figures. Selling, general and administrative expenses decreased modestly as a percentage of net sales due in part to the fixed nature of certain of these expenses, which were offset in part by increases in 23

25 advertising expenses and product development costs in 1998. The overall dollar increase was also due to the significant increase in net sales with their proportionate impact on variable selling costs, such as freight and shipping related expenses, sales commissions, cooperative advertising and travel expenses. We produced television commercials in support of several of our products, including World Wrestling Federation action figures, in 1998 and 1997, as well as radio-controlled vehicles, in 1997. From time to time, we may increase our advertising efforts, including the use of more expensive advertising media, such as television, if we deem it appropriate for particular products. Interest, Net. We had comparable interest-bearing obligations in 1998 and in 1997 with our convertible debentures and seller notes issued in connection with the Child Guidance/Remco and Road Champs acquisitions. In addition, we had comparable average cash balances during 1998 and 1997. Provision for Income Taxes. Provision for income taxes included Federal, state and foreign income taxes in 1998 and also included a tax benefit generated by operating losses for Federal and state purposes in 1997. Our earnings were subject to effective tax rates of 22.6% and 18.8% in 1998 and 1997, respectively, benefiting from a flat 16.5% Hong Kong Corporation Tax on our income arising in, or derived from, Hong Kong. As of December 31, 1997, we had federal and state net operating loss carry-forwards of $727,000 and $306,000, respectively, available to offset future taxable income. The carry-forwards were fully utilized in 1998. As of December 31, 1998, we had deferred tax assets of approximately $493,000 for which no allowance has been provided for since, in the opinion of management, realization of the future benefit is probable. In making this determination, management considered all available evidence, both positive and negative, as well as the weight and importance given to such evidence. YEARS ENDED DECEMBER 31, 1997 AND 1996 Net Sales. Net sales increased $29.8 million, or 248%, to $41.9 million in 1997 from $12.1 million in 1996. The significant growth in net sales was due primarily to the continuing growth of the World Wrestling Federation action figure product line with its expanded product offerings and frequent character releases, as well as to the contribution made by sales of Road Champs die-cast toy and collectible vehicles, which have been included from the effective date of the acquisition, February 1, 1997. Our holiday doll line performed comparably with the prior year and our new line of radio-controlled vehicles made modest contributions to net sales in 1997. Gross Profit. Gross profit increased $11.3 million, or 233%, to $16.1 million, or 38.3% of net sales, in 1997 from $4.8 million, or 40.0% of net sales, in 1996. The overall increase in gross profit was attributable to the significant increase in net sales. The decline in the gross profit margin of 1.7% of net sales was due in part to the changing product mix, which included products, such as Road Champs and radio-controlled vehicles, with lower margins than some of our other products. Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $8.3 million, or 229%, to $11.9 million, or 28.4% of net sales, in 1997 from $3.6 million, or 30.0% of net sales, in 1996. The significant overall increase of $8.3 million in such costs was due in large part to the costs associated with our addition of infrastructure in the United States and Hong Kong in connection with the Road Champs acquisition. We have since combined the acquired operations in Hong Kong with those of our existing operations and may achieve other efficiencies in our operations. As expected, 24

26 selling, general and administrative expenses decreased as a percentage of net sales due in part to the fixed nature of certain of these expenses. The overall dollar increase was also due to the significant increase in net sales with their proportionate impact on variable selling costs, such as freight and shipping related expenses, sales commissions and travel expenses. Additionally, we produced television commercials in support of several of our products, including World Wrestling Federation action figures and radio-controlled vehicles. Interest, Net. We had significantly higher interest-bearing obligations in 1997 than in 1996 resulting from the issuance of our convertible debentures and seller notes in connection with the Road Champs acquisition. In addition, we had lower average cash balances during 1997 than in 1996 due to significant cash payments made and working capital employed in connection with the Road Champs acquisition. Provision for Income Taxes. Provision for income taxes included state and foreign income taxes in 1997 and also included a tax benefit generated by operating losses for Federal and state purposes in 1996. Our earnings were subject to effective tax rates of 18.8% and 12.2% in 1997 and 1996, respectively, benefiting from a flat 16.5% Hong Kong Corporation Tax on our income arising in, or derived from, Hong Kong. As of December 31, 1997, we had federal and state net operating loss carry-forwards of $727,000 and $306,000, respectively, available to offset future taxable income. 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 tables present our unaudited quarterly results for the years indicated. The seasonality of our business is reflected in this quarterly presentation. 1997 1998 ----------------------------------- ------------------------------------- 1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH ------ ------ ------- ------- ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net sales............ $5,235 $8,059 $15,919 $12,732 $11,030 $16,131 $34,218 $23,873 Gross profit......... 1,911 3,203 6,620 4,336 4,350 6,118 13,242 9,542 Income from operations......... 173 721 2,021 1,260 768 1,427 5,069 1,983 Income before income taxes.............. 124 604 1,908 793 610 1,316 4,648 1,658 Net income........... 203 457 1,455 671 462 958 3,434 1,521 Diluted earnings per share.............. $ 0.05 $ 0.10 $ 0.29 $ 0.11 $ 0.08 $ 0.14 $ 0.45 $ 0.21 Weighted average shares and equivalents outstanding........ 4,332 4,752 5,092 6,953 7,160 7,786 7,872 7,837 25

27 1997 1998 -------------------------------- -------------------------------- 1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH ----- ----- ----- ----- ----- ----- ----- ----- (IN PERCENTAGES OF NET SALES) Net sales............ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Gross profit......... 36.5 39.7 41.6 34.1 39.4 37.9 38.7 40.0 Income from operations......... 3.3 8.9 12.7 9.9 7.0 8.8 14.8 8.3 Income before income taxes.............. 2.4 7.5 12.0 6.2 5.5 8.2 13.6 6.9 Net income........... 3.9 5.7 9.1 5.3 4.2 5.9 10.0 6.4 LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1998, we had working capital of $13.7 million, as compared to $3.4 million as of December 31, 1997. This increase was primarily attributable to operating activities and the placement of our preferred stock in April 1998. Operating activities provided net cash of $12.0 million in 1998 as compared to $3.2 million in 1997. Net cash was provided primarily by net income, non-cash charges, such as depreciation, amortization and recognition of compensation expense for options, and increases in operating liabilities, which were offset in part by increases in accounts receivable and inventory. As of December 31, 1998, we had cash and cash equivalents of $12.5 million. Our investing activities used net cash of $5.1 million in 1998, as compared to $24.4 million in 1997, consisting primarily of the purchase of molds and tooling used in the manufacture of our products, the initial funding of the World Wrestling Federation joint venture in 1998, trademarks purchased in connection with the acquisitions of Road Champs and the Child Guidance and Remco brands, and goodwill acquired in connection with the acquisition of Road Champs in 1997. As part of our strategy to develop and market new products, we have entered into various character and product licenses with royalties ranging from 1% to 10% payable on net sales of such products. As of January 1, 1999, these agreements required future aggregate minimum guarantees of $17.2 million, exclusive of $1.3 million in advances already paid. Our financing activities provided net cash of $3.0 million in 1998, consisting primarily of the issuance of 1,000 shares of our preferred stock at a price of $5,000 per share in a private placement to two investors, partially offset by the repayment of various debt issued in connection with the Road Champs and Child Guidance/Remco trademark acquisitions. In 1997, financing activities provided net cash of $17.4 million, consisting of the issuance of our 4% Redeemable Convertible Preferred Stock in October 1997, which provided $6.8 million, net of offering costs, the placement of our convertible debentures in January 1997, which provided $5.5 million, net of offering costs, and various notes and other debt issued in connection with our acquisitions in 1997, less approximately $5.2 million in debt repaid. In January 1997, we received proceeds, net of issuance costs, of approximately $5.5 million from the issuance of $6.0 million in convertible debentures which are currently convertible into 1,043,480 shares of our common stock at a conversion price of $5.75 per share, subject to various anti-dilution adjustments. These debentures bear interest at 9% per annum, payable monthly, and are due in December 2003. Pursuant to the debenture agreements, the debenture holders notified us of their intention to convert an 26

28 aggregate principal amount of $3.0 million of the convertible debentures into 521,740 shares of our common stock on May 25, 1999. The unpaid principal balance is subject to mandatory repayment at the rate of 1% per month of the then outstanding balance beginning on December 31, 1999. In February 1997, we acquired Road Champs for approximately $12.5 million. Consideration paid at closing was approximately $4.7 million in cash plus the issuance of 198,020 shares of our common stock (valued at approximately $1.5 million) and the assumption of $0.8 million of liabilities. The balance of the cash consideration ($5.5 million) was paid during the twelve-month period ended in February 1998. Assets included in the purchase were molds and tooling, office and warehouse equipment and other operating assets, as well as license agreements, trade name and goodwill. In October 1997, we acquired the Child Guidance and Remco trademarks for approximately $13.4 million. Consideration paid at closing was $10.6 million in cash plus the issuance of a 10% note payable in the amount of $1.2 million, which was paid in five quarterly installments ended December 31, 1998. In addition, we incurred legal and accounting fees of approximately $0.3 million and assumed liabilities of $1.3 million. The acquisition was funded in part by the issuance of shares of our 4% Redeemable Convertible Preferred Stock, which were converted into 939,998 shares of our common stock on March 30, 1998. Also in connection with this acquisition, we entered into a manufacturing and supply agreement whereby the seller of the trademarks will provide the tools and other manufacturing resources for the production of products under the trademarks. That agreement provides for four quarterly payments to the seller of $110,000, followed by six quarterly payments of $160,000, which commenced on December 31, 1997. In October 1997, we entered into a credit facility agreement with Norwest Bank Minnesota, N.A. which provides our Hong Kong subsidiaries with a working capital line of credit and letters of credit for the purchase of products and the operation of those subsidiaries. The facility has an overall limit of $5.0 million, but is subject to other limitations based on advance rates on letters of credit and open accounts receivable. As of December 31, 1998, there were no advances outstanding under the facility. In April 1998, we received $4.7 million in net proceeds from the issuance of shares of our Series A Cumulative Convertible Preferred Stock to two investors in a private placement, which are currently convertible into 558,658 shares of our common stock at a conversion price of $8.95 per share. The use of proceeds was for working capital and general corporate purposes. We believe that our cash flow from operations, cash on hand and cash from the net proceeds of this offering, together with the availability under the Norwest facility, will be sufficient to meet our working capital and capital expenditure requirements and provide to 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. 27

29 EXCHANGE RATES We sell all of our products in U.S. dollars and pay for all of our manufacturing costs in either U.S. or Hong Kong dollars. Operating expenses of the Hong Kong office are paid in Hong Kong dollars. 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 will not have a material adverse effect on our business, financial condition or results of operations. RECENT ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board ("FASB") recently issued Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income," which is effective for financial statements issued for fiscal years beginning after December 15, 1997. This statement establishes standards for reporting and displaying comprehensive income and its components in financial statements. Comprehensive income, as defined, includes all changes to equity (net assets) during a period from non-owner sources. To date, we have not had any transactions that are required to be reported in other comprehensive income. The FASB recently issued SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information," which is effective for financial statements issued for fiscal years beginning after December 15, 1997. This statement establishes standards for the way public business enterprises are to report information about operating segments in annual financial statements and requires those enterprises to report selected information about operating segments in interim financial reports. We operate in one reportable segment: the development, production and marketing of toy and related products. IMPACT OF THE YEAR 2000 Many currently installed computer systems and software products are dependent upon internal calendars coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, our computer systems and software may need to be upgraded to comply with Year 2000 requirements. Otherwise, system failures or miscalculations leading to disruptions in our operations could occur. JAKKS has taken actions to address this potential problem, including the identification of any non-compliant processes or systems and the implementation of corrective measures. We expect to replace internal software with non-compliant codes with software that is compliant by July 1999. We believe the financial reporting systems of our Hong Kong subsidiaries are Year 2000 compliant. Their systems were upgraded in 1998 in the normal course of business with software and hardware which the manufacturer has represented as being Year 2000 compliant. We are currently in the process of selecting a new software package in our corporate office which the manufacturer has represented as being Year 2000 compliant, and we believe it will be implemented by July 1999. We estimate the cost of the new software, including implementation and data conversion costs, to be approximately $60,000. Our other software is generally certified as Year 2000 compliant or is not considered critical to our operations. 28

30 Other than the cost of the new software to be implemented in our corporate office, we have spent only nominal amounts on the Year 2000 issue, and we do not expect any significant future expenditures. Although we believe our cost estimates to be accurate, we cannot assure you that these costs will not increase or that the proposed solutions will be installed on schedule by the date estimated. We have addressed the Year 2000 preparedness of our critical suppliers and major customers and related electronic data interfaces with these third parties. We began in 1998, and are continuing our efforts, to contact critical suppliers and larger customers to determine whether they are, or will be, compliant by the Year 2000. Based on our evaluation and testing, these third parties are, or are expected to be, compliant by the Year 2000. However, we will continue to monitor the situation and we will formulate contingency plans to resolve customer-related issues that may arise. At this time we cannot estimate the impact that noncompliant suppliers and customers may have on us or our level of operations in the Year 2000. At present, we have not developed contingency plans, but we will determine whether to develop such plans when our assessment is completed. 29

31 BUSINESS COMPANY OVERVIEW We design, develop, produce and market toys and related products. Our principal products are (1) action figures and accessories featuring licensed characters, principally from the World Wrestling Federation, (2) Road Champs die-cast collectible and toy vehicles and Remco toy vehicles and role-play toys and accessories, (3) Child Guidance infant and pre-school electronic toys, and (4) fashion and mini dolls and related accessories. We focus on "evergreen" branded products that are less subject to market fads or trends and feature well-known brand names and simpler, lower-priced toys and accessories. We have been successful at acquiring and capitalizing on "evergreen" brands, which are well-recognized trademarks or corporate, trade or brand names with long product histories. We continually review the marketplace to identify and evaluate evergreen brands that, for various reasons, we believe are underperforming. We seek to acquire or license these brands and revitalize them by intensifying the marketing effort to restore and enhance consumer recognition and retailer interest. We reinforce brands by linking them with other evergreen brands on our products, adding to the branded product lines new items that we expect to enjoy greater popularity, eliminating products with fading popularity, adding new features and improving the functionality of products in the line. We also try to improve point-of-sale brand visibility through better shelf positioning and more eye-catching product packaging. We license much of the intellectual property we use in our business. We license the World Wrestling Federation trademark, as well as numerous other trademarks, corporate, trade and brand names and logos from third parties, including Car and Driver, Caterpillar, Peterson Publishing Co. and B.A.S.S. Masters. This enables us to use high-profile marks at a lower cost than that which 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 those that would be available for purchase, and we maintain the flexibility to acquire newly-popular marks and to discontinue our use of marks whose popularity or value has faded. We also license technology produced by unaffiliated inventors and product developers to improve the design and functionality of our products. We believe that our experience in the toy industry, our flexibility and our recent success in developing and marketing products make us more attractive to toy inventors and developers. Most of our current products are relatively simple and inexpensive toys. We believe that these products have proven to have enduring appeal and are less subject to general economic conditions, toy product fads and trends, changes in retail distribution channels and other factors. In addition, the simplicity of these products enables us to choose among a wider range of manufacturers and affords us greater flexibility in product design, pricing and marketing. We formed our joint venture with THQ in June 1998 to develop, manufacture and market, under an exclusive license with Titan Sports, video games based on World Wrestling Federation characters and themes. The joint venture's first product is expected to be released at the end of 1999. We sell our products through our in-house sales staff and independent sales representatives. Purchasers of our products include toy and discount retail chain stores, 30

32 department stores, toy specialty stores and wholesalers. The Road Champs products are also sold to smaller hobby shops, specialty retailers and corporate accounts, among others. Our five largest customers are Toys 'R Us, Wal-Mart, Kay-Bee Toys, Kmart and Target. 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 not to 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 with a smaller staff. INDUSTRY OVERVIEW According to Toy Manufacturers of America, Inc. ("TMA"), the leading industry trade group, total manufacturers' shipments of toys, excluding video games, in the U.S., were approximately $15.2 billion in 1998. According to the TMA, the United States is the world's largest toy market, followed by Japan and Western Europe. Sales by U.S. toy manufacturers to non-U.S. customers totaled approximately $5.5 billion in 1997 (the last year for which TMA published this data). We believe the two largest U.S. 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 video game segment, manufacturers' shipments of video game software were approximately $3.0 billion in 1998. BUSINESS STRATEGY Our business strategy consists of the following elements: - Expand core products. In 1999, we plan to introduce hundreds of new items within our core product lines, including World Wrestling Federation action figures and accessories, Road Champs and Remco vehicles, Child Guidance toys and our fashion dolls, and to continue to add technological and functional innovations to our product lines. - Enter new product categories. Through our participation in the joint venture, we expect to enter the video game market with its line of World Wrestling Federation licensed video games. Also, we will continue to use our extensive experience in the toy industry to evaluate toys and licenses in new product categories which we believe will enable us to develop additional product lines in 1999 and beyond. - Pursue strategic acquisitions. Since our inception, we have acquired and developed evergreen brands through the acquisition of other toy companies or their assets. These include our Road Champs, Remco and Child Guidance product lines. We intend to continue our efforts to acquire and develop evergreen brands through the opportunistic acquisition of other toy businesses with valuable trademarks or brands and compatible product lines. - Acquire 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 in conjunction with our primary trademarks and brands. Currently, we have license 31

33 agreements with Titan Sports, Car and Driver, Caterpillar, Petersen Publishing Co. and B.A.S.S. Masters, among others. We intend to continue to pursue new licenses from these companies and from other entertainment and media companies. 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 in Europe and Canada, offer us the opportunity for growth. We intend to expand our international sales by capitalizing on our experience and our relationships with foreign distributors and retailers. - Exploit our operating efficiencies. We believe that our current infrastructure and low-overhead operating methods can accommodate significant growth without a proportionate increase in our operating and administrative expenses, thereby increasing our operating margins. - Leverage core product cash flows. Allowing for the natural seasonal fluctuations in the toy industry, sales of our core products have historically generated a reliable revenue stream. We expect this trend to continue and plan to use a portion of these cash flows to fund our entry into new product lines and consumer markets. PRODUCTS - - World Wrestling Federation Action Figures and Accessories We have a master toy license with Titan Sports pursuant to which we have the exclusive right, until December 31, 2009, to develop and market a full line of toy products based on the popular World Wrestling Federation professional wrestlers in the United States, Canada, Europe (excluding Great Britain), Australia and Africa. 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 six-inch articulated action figures that have movable body parts and feature real-life action sounds from our patented bone-crunching mechanism that allows the figures' "bones" to crack when they are bent. The six-inch figures currently make up a substantial portion of the overall World Wrestling Federation line, which has since grown to include many other new products. Our strategy has been to release new figures and accessories frequently to keep the line fresh and to retain the interest of the consumers. Following the launch of the action figures, we marketed wrestling ring play sets and microphones with action background sounds to enhance the play value of the action figures. Since then, we have continually added new products, including action figures of varying sizes, such as three-inch sets with wrestling rings, amplifying microphones, seven-inch collector's editions, large soft body figures and small bean-bag figures with electronic sound chips of the popular wrestlers' catch phrases and in-ring banter. Building on the popularity of World Wrestling Federation and its wrestlers, we have continued to develop the line with exciting and innovative technological and functional concepts to enhance the value of the line. In 1999, we will be introducing a line of 12-inch interactive figures that has created a new category of toys in the industry. The line will be launched with a figure based on the World Wrestling Federation World Champion, "Stone Cold Steve Austin." The figures will be capable of accepting daily downloads of sound bites from a World 32

34 Wrestling Federation web site, to which we expect to contribute content compatible with our toy products. We expect this product to create awareness of our pending presence on the internet in support of our current e-commerce efforts. Another technological innovation that will be added in 1999 is the "Titan Tron," featuring proximity-based technology that enables this play set to recognize the character of specially-equipped wrestling figures in order to play the wrestler's unique video and theme music with flashing lights. Other enhancements to the World Wrestling Federation product line include a sweating functionality in the "Maximum Sweat" line of action figures where the figures, when filled with water, "sweat" from the brow and chest, adding more realism and play value to the line. The various World Wrestling Federation products retail from $5.99 to $49.99. - - World Wrestling Federation 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 Titan Sports under which it acquired the exclusive worldwide right to publish World Wrestling Federation video games on all hardware platforms. The games will be designed, developed, manufactured and marketed by the joint venture. JAKKS and THQ will share equally any profits generated by the joint venture. The license agreement with Titan Sports permits the joint venture to release its first World Wrestling Federation game after November 16, 1999, and we expect that the first game produced under this license will be released in late 1999. The term of the license agreement expires on December 31, 2009, subject to a right of the joint venture to renew the license for an additional five years under various conditions. The joint venture will publish titles for the Sony PlayStation and Nintendo 64 consoles, hand-held Game Boy and personal computers ("PCs"). We expect the joint venture will launch its first product, a video game for the Nintendo 64 platform, and, if possible, a product for Game Boy, in late November or December 1999. It will also publish titles for new hardware platforms when and as they are introduced to the market and have established a sufficiently installed base to support new software. These titles will be marketed to our existing customers as well as to game, electronics and other specialty stores, such as Electronics Boutique and Best Buy. The home video game software market consists both of (1) cartridge-based and CD-ROM-based software for use solely on dedicated hardware systems, such as Sony PlayStation and Nintendo 64, and (2) software distributed on CD-ROMs for use on PCs. According to NPD Group, a leading independent toy industry research firm, Nintendo 64 and Sony PlayStation accounted for a substantial portion of the installed base of all hardware platforms and software sales in 1998. Under non-exclusive licenses with Sony, Nintendo and Sega, the joint venture will arrange for the manufacture of the CD-ROMs and cartridges. No other licenses are required for the manufacture of the PC titles. Profit margins for cartridge products can vary based on the cost of the memory chip used for a particular title. As software has grown more complex, the trend in the software industry has been to utilize chips with greater capacity and thus greater cost. CD-ROMs have significantly lower per unit manufacturing costs than cartridge-based products. However, these savings may be offset by typically higher development costs for titles published on CD-ROMs; these higher 33

35 costs result from increasing and enhancing content to take advantage of the greater storage capacity of CD-ROMs. Wrestling video games have demonstrated consistent popularity, with two wrestling-theme video games among the top 10, in terms of unit sales volumes in 1998. Approximately 2.3 million units of these two games were sold in 1998, at retail prices ranging from approximately $42 to $60. We believe that the success of the World Wrestling Federation titles is dependent on the graphic look and feel of the software, the depth and variation of game play and the popularity of the World Wrestling Federation. We believe that as a franchise property, the World Wrestling Federation titles will have brand recognition and sustainable consumer appeal which may allow the joint venture to exploit 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. Also, as new hardware platforms are introduced, software for these platforms requires new standards of design and technology to fully exploit these platforms' capabilities and requires that software developers devote substantial resources to product design and development. The joint venture will use external software developers to conceptualize and develop titles. Typically, these developers receive advances based on specific development milestones. Royalties in excess of the advances are based on a fixed amount per unit sold and range from $0.30 to $10.00 per unit. Upon completion of development, each title is extensively "play-tested" by us and THQ and sent to the manufacturer for its review and approval. - - 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 (including propeller planes, jets and helicopters). As a part of the Road Champs acquisition in February 1997, we acquired the right to produce the Road Champs line of die-cast and collectible vehicle replicas, including various well-known vehicles from Ford, Chevrolet, Jeep, Kawasaki and Yamaha, as well as the right to use familiar corporate names on the die-cast vehicles, such as Pepsi, Goodyear and Hershey. Recently, we licensed the right to reproduce vehicles featured on the covers of automotive magazines, such as Rod & Custom and Car and Driver, and to market vehicles with the B.A.S.S. Masters logo and replicas of the World Wrestling Federation Attitude Racing NHRA Team. We believe that these licenses increase the perceived value of the products and enhance their marketability. Under the terms of these licenses, which expire on various dates through May 10, 2001 (many of which include automatic annual extensions without affirmative action taken by either party), we pay the licensor a royalty based on our sales of each product bearing such licensed name. While we are not required to pay any royalty on some of the products, the royalties on a majority of the products range from 1% to 9% of sales. The Road Champs products are produced by unaffiliated foreign manufacturers. These products are sold individually, retailing from $2.99 to $7.99 each, and in play sets which retail from $9.99 to $24.99 each. We have divided the markets of this product line into adult collectible and children's toy segments, recognizing the specific needs of these different consumers. Each collector product features a collector case in which to store and display the vehicle and a certificate of authenticity. We produce a limited number, generally not more than 34

36 10,000, of each distinctive product to enhance its collectibility. This line presently has numerous themes, including Anniversary Collection, Police, Then & Now, World War II Fighter Planes and Classics Scenes with die-cast scenic accessories, such as 1950's soda machines or gas pumps. The toy segment is marketed by focusing on size and value with its slogan "Bigger is Better." Our die-cast vehicles are 1/43 scale, which are larger than most other competing die-cast vehicles. The size appeals to collectors, since it enables us to show greater detail on the vehicles, and to children and their parents, who perceive a greater value in the larger size. The toys are packaged on two-pack blister cards, further highlighting the value. In addition, series were created to encourage children to collect our vehicles. - - Remco Toy Vehicles and Role Play Our Remco toy line includes toy vehicles, role play and other toys. Our toy vehicle line is comprised of a large assortment of rugged die-cast and plastic vehicles. Marketed under a sub-brand called "Tuff Ones," our toy vehicles range in size from 4 3/4" to big-wheeled 17" vehicles. We have revitalized them considerably by creating new packaging, redecorating the vehicles and adding highly-recognized licensed names, such as NASA, Pennzoil, U-Haul and Castrol, among others. The breadth of the line is extensive, with themes ranging from emergency, fire, farm and construction, to racing and jungle adventure. In 1999, we expanded our Remco vehicle line by adding an innovative line of trucks, called "Real Ones," which enhances the traditional play pattern by allowing children to drain an oil tanker, dump a dump truck full of dirt, or dispose of an entire load of garbage without making a mess. We accomplished this by enclosing real materials inside the trucks in a way that makes vehicle play more fun without the mess. We offer a variety of branded and non-branded role play sets in this new category under the Remco name. Themes include Caterpillar construction, B.A.S.S. Masters fishing, police, fire and NASA. Additionally, capitalizing on the popularity of World Wrestling Federation, we will be introducing a World Wrestling Federation role play product which will give children the opportunity to dress like and imagine being their favorite wrestling superstars. We market Remco "Fight Back Action Fishing Poles" under the B.A.S.S. Masters license for fun with simulated fishing action. - - Child Guidance Infant and Pre-school Toys We acquired the Child Guidance trade name in 1997 to accelerate our entry into the infant/pre-school toy category. This category has been recently dominated by higher-priced licensed products, which creates an opportunity for us to sell our lower price, high value line of pre-school toys. Our line of pre-school electronic toys features products that enhance sensory stimulation and learning through play, while offering value to the trade as well as to the consumer. Our products are designed for children ages two and under. We have combined the fun of music, lights, motion and sound with the early introduction of numbers, letters, shape and color recognition, all at a value price. The line consists of more than 50 products that are marketed in continually updated "try me" interactive packaging that allows the consumers to sample the product prior to purchase. We support the products with extensive advertising in popular magazines and other publications, focusing on parenting, women's and family publications, including Good Housekeeping. These products carry the Good Housekeeping Seal of Approval(R). Our current products include the Wiggle Waggle Caterpillar and Musical Pony pull- 35

37 along toys, which were introduced in 1998. Other 1998 noteworthy products include Musical Magnets, which were recognized as one of the top toys of the year by Sesame Street Parent Magazine. In 1999, we have extended the Wiggle Waggle line to include the Wiggle Waggle Duck which features spinning action. We have added approximately 30 other new products to the line in 1999. We have recently expanded the distribution of the Child Guidance products to include more upscale and specialty retailers. Child Guidance products are priced at retail from $2.99 to $14.99. In addition to creating products internally, we often acquire products and concepts from numerous toy inventors with whom we have ongoing relationships. License agreements for products and concepts call for royalties ranging from 1% to 6% of net sales, and some may require minimum guarantees and advances. Both development of internally-created items and acquiring items are ongoing efforts. In either case, it may take as long as nine months for an item to reach the market. As part of an effort to keep the product line fresh and to extend the life of the item, we create new packaging, change sound chips and change product colors from time to time. - - Fashion/Mini Dolls We produce various propriety fashion dolls and accessories for children between the ages of three and 10. The product lines include: (1) 11 1/2" fashion dolls customized with high-fashion designs that correspond with particular holidays, events or themes such as Christmas, birthdays, Fairytale, Victorian Romance and Gibson Girl Romance; and (2) 6 1/2" fashion dolls based on children's classic fairy tales and holidays. In 1999, we intend to add to our doll line by producing additional dolls based on other theme-based play sets. We have introduced two new line extensions for sale in 1999: (1) a 15 1/2" fashion doll that has movable body parts and intricate hairstyles and that has themes such as Era of Elegance, Renaissance and Ballet; and (2) our American Sisters baby dolls in paired 12" and 8" sizes with themes like Off to School, Ballet Recital, Birthday Surprise and Tea Party Fun. These dolls will be priced at retail from $9.99 to $24.99. Our in-house product developers originate the design and functionality of most of our fashion dolls. In many cases, they work with retailers and incorporate their input on doll characteristics, packaging and other design elements to create exclusive product lines for them. SALES, MARKETING AND DISTRIBUTION We sell all of our products through our own in-house sales staff and independent sales representatives. Purchasers of our products include toy and discount retail chain stores, department stores, toy specialty stores and wholesalers. The Road Champs product line is also sold to smaller hobby shops, specialty retailers and corporate accounts, among others. Our five largest customers are Toys 'R Us, Wal-Mart, Kay-Bee Toys, Kmart and Target, which accounted for approximately 61.7% of our net sales in 1997 and 69.6% in 1998. 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. 36

38 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 are generally made in writing, and we take appropriate steps to notify our manufacturers of such cancellations. Based upon the sales of the Road Champs products in the past, we expect approximately half of the Road Champs products to be sold domestically through a third-party warehouse and fulfillment center in Seattle, Washington, where we store inventory for sale. We maintain a full-time sales and marketing staff, many of whom make on-site visits to customers for the purpose of 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 sometimes test the consumer acceptance of new products in selected markets before committing resources to large-scale production. We generally budget approximately 5% of our net sales for advertising and promotion of our products. We produce and broadcast television commercials for our World Wrestling Federation action figure line. 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. We advertise our products in trade and consumer magazines and other publications, market our products at major and regional toy trade shows, conventions and exhibitions and carry on cooperative advertising with toy retailers and other customers. Outside of the United States, we currently sell our products primarily in Canada, Great Britain, Latin America, Australia and Japan. Sales of our products abroad accounted for approximately 8.9% of our net sales in 1997 and 7.4% in 1998. We believe that foreign markets present an attractive opportunity, and we plan to intensify our marketing efforts and expand our distribution channels abroad. PRODUCT DEVELOPMENT Each of our product lines has an in-house manager responsible for product development, including identifying and evaluating 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, the principal source of products for our fashion doll line, and products to more fully exploit our concept and character licenses. While we do have the capability to create and develop products from inception to production, we use third parties to provide a substantial 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 to culminate in production of the products for shipment to our customers. We generally acquire our 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. Royalties payable to developers generally range from 1% to 6% 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. We believe that toy inventors and designers have come to appreciate our practice of acting quickly and decisively to acquire 37

39 and market licensed products. In addition, we believe that our experience in the toy industry, our flexibility and our recent success in developing and marketing products make us more attractive to toy inventors and developers than some of our competitors. Safety testing of our products is done at the manufacturers' facilities by an engineer employed by us or independent third-party contractors engaged by us, and is designed to meet safety regulations imposed by federal and state governmental authorities. We also monitor quality assurance procedures for our products for safety purposes. MANUFACTURING AND SUPPLIES Our products are currently produced by 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. All of the manufacturing services performed overseas for us are paid for either by letter of credit or 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 approximately 15 manufacturers. We believe that alternative sources of supply are available, although we cannot assure you that adequate supplies of manufactured products can be obtained. Although we do not conduct the day-to-day manufacturing of our products, we participate in the design of the product prototype and production tooling and molds for the products we develop or acquire, 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 production. The principal raw materials used in the production and sale of our toy products are zinc alloy, plastics, 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 molds and tooling used in the manufacturing process, and these are transferable among manufacturers if we choose to employ alternative manufacturers. 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 and results of operations. COMPETITION Competition in the toy industry is intense. Many of our competitors have greater financial resources, stronger name recognition and larger sales, marketing and product development departments 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 38

40 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, Inc. and Hasbro, Inc. In addition, we compete, in our action figures line, with the Toy-Biz division of Marvel Enterprises, Inc. and, in our toy vehicle lines, with Racing Champions, Inc. We also compete with numerous smaller domestic and foreign toy manufacturers, importers and marketers in each of our product categories. We expect that the joint venture's principal competition in the video game market will be Electronic Arts, which will produce video games based on World Championship Wrestling characters, and Acclaim Entertainment, Inc. SEASONALITY AND BACKLOG Sales of toy products are seasonal. In 1998, approximately 68.1% our 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. Due to these fluctuations, our results of operations for any quarter may vary significantly. Our results of operations may also fluctuate as a result of factors such as the timing of new products (and expenses incurred in connection therewith) 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 product lines that we sell 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. 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 Product Safety Commission 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 Consumer Products Safety Commission to regulate and enforce flammability standards for fabrics used in consumer products. The Consumer Products Safety Commission may also require the repurchase by the manufacturer of articles which are banned. 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. In addition, many of our Child Guidance products are sold under the Good Housekeeping Seal of Approval(R). To qualify for this designation, our products are tested by Good Housekeeping to ensure compliance with its product safety and quality standards. 39

41 EMPLOYEES As of March 18, 1999, we employed 66 persons, all of whom are full-time employees, including three executive officers. Thirty-six of our employees were located in the United States, while the remaining 30 were located in Hong Kong. We believe that we have good relationships with our employees. None of our employees is represented by a union. PROPERTIES Our principal executive offices occupy approximately 9,000 square feet of space in Malibu, California under a lease expiring on August 31, 2002. We lease showroom and office space of approximately 4,100 square feet at the International Toy Center in New York City. We also have a leased office and showroom space of approximately 5,000 square feet in Hong Kong from which we oversee our China-based third-party manufacturing operations, and we have smaller leased sites in Dallas, Texas and Union, New Jersey. We believe that our facilities in the United States and Hong Kong are adequate for our reasonably foreseeable future needs. 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. We do not believe that any environmental obligations will have a material adverse effect on our business, financial condition or results of operations. LEGAL PROCEEDINGS; INSURANCE We are not a party to, nor is our property the subject of, any pending legal proceeding, other than routine litigation that is incidental to our business. We maintain comprehensive liability insurance with total coverage of $12,000,000 to reduce our exposure from product liability, consumer protection and other claims or legal proceedings. 40

42 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS Our directors and executive officers are as follows: NAME AGE POSITIONS WITH THE COMPANY ---- --- -------------------------- Jack Friedman 59 Chairman and Chief Executive Officer Stephen G. Berman 34 Chief Operating Officer, President, Secretary and Director Joel M. Bennett 37 Chief Financial Officer Robert E. Glick 53 Director Michael G. Miller 51 Director Murray L. Skala 52 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. 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. Robert E. Glick has been one of our directors since October 1996. For more than 20 years, Mr. Glick has been an officer, director and principal stockholder in a number of privately-held companies which manufacture and market women's apparel. Michael G. Miller has been one of our directors since February 1996. From 1979 until May 1998, Mr. Miller was President and a director of several privately-held affiliated companies, including a list brokerage and list management consulting firm, a database management consulting firm, and a direct mail graphic and creative design firm. Mr. Miller's interests in such companies were sold in May 1998. Since 1991, he has been President of an advertising company. 41

43 Murray L. Skala has been one of our directors since October 1995. Since 1976, Mr. Skala has been a partner of the law firm Feder, Kaszovitz, Isaacson, Weber, Skala & Bass LLP, our general counsel. Mr. Skala is a director of Quintel Entertainment, Inc., a publicly-held company in the business of telecommunications services and entertainment. Mr. Skala has also served as a director of other public companies, including THQ from January 1991 to January 1997, Katz Digital Technologies, Inc., a digital prepress and printing company, from December 1995 to December 1998, and Grand Toys International, Inc., from 1993 to 1994. All directors hold office until the next annual meeting of stockholders and until their successors are elected and qualified. Directors currently receive no cash compensation for serving on the Board, but are reimbursed for reasonable expenses incurred in attending meetings. Directors who are not employees are entitled to receive options to purchase shares of our common stock upon their initial election as a director and annually while they serve as directors. See the section entitled "Third Amended and Restated 1995 Stock Option Plan" below. Officers are elected annually by the Board and serve at the discretion of the Board. The holders of our convertible debentures have the right to designate one person for nomination by management to serve as one of our directors or as an advisor to the Board. Upon certain events of default under the loan agreement for our convertible debentures, the holders may designate an additional person as a director. The holders of our preferred stock also have the right, if we miss two quarterly dividends, to designate two persons to be added to our Board of Directors. COMMITTEES OF THE BOARD OF DIRECTORS We have an Audit Committee, a Compensation Committee and a Stock Option Committee. The Board does not have a Nominating Committee and performs the functions of a Nominating Committee itself. Audit Committee. The primary functions of the Audit Committee are to recommend the appointment of our independent certified public accountants and to review the scope and effect of such audits. Messrs. Glick, Miller and Skala are the current members of the Audit Committee. 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 and compensation, other than our Third Amended and Restated 1995 Stock Option Plan (the "Option Plan"). Messrs. Friedman, Miller and Skala are the current members of the Compensation Committee. Stock Option Committee. The function of the Stock Option Committee is to determine the recipients of and the size of awards granted under the Option Plan. Messrs. Glick and Miller, both of whom are non-employee directors, are the current members of the Stock Option Committee. 42

44 EXECUTIVE COMPENSATION The following table sets forth the compensation we paid for our fiscal years ended December 31, 1996, 1997 and 1998 to our Chief Executive Officer and to each of our other executive officers whose compensation exceeded $100,000 on an annual basis (collectively, the "Named Officers"). SUMMARY COMPENSATION TABLE LONG-TERM AWARDS ANNUAL COMPENSATION -------------------- ---------------------------------------- RESTRICTED OTHER ANNUAL STOCK NAME AND SALARY BONUS COMPENSATION AWARDS OPTIONS PRINCIPAL POSITION YEAR ($) ($) ($) ($) (#) ------------------ ---- ------- ------- ------------- ---------- ------- Jack Friedman................ 1998 446,000 550,000 -- -- 125,000 Chairman and Chief 1997 296,000 130,224 -- -- 125,000 Executive Officer 1996 226,000 53,722 -- -- -- Stephen G. Berman............ 1998 421,000 550,000 -- -- 125,000 Chief Operating Officer, 1997 271,000 130,224 -- -- 125,000 President and Secretary 1996 201,000 53,722 -- -- -- Joel M. Bennett.............. 1998 135,000 45,000 -- -- -- Chief Financial Officer 1997 110,000 40,000 -- -- 30,000 1996 85,000 10,200 -- -- -- - - Employment Agreements We have entered into employment agreements with Mr. Friedman and Mr. Berman, pursuant to which Mr. Friedman serves as our Chairman and Chief Executive Officer and Mr. Berman serves as our President and Chief Operating Officer. Mr. Friedman's annual base salary in 1999 is $521,000 and Mr. Berman's is $496,000. Their annual base salaries are subject to annual increases in an amount, not less than $25,000, determined by our Board of Directors. Each of them is also entitled to receive an annual bonus equal to 4% of our pre-tax earnings, if our pre-tax earnings are at least $2,000,000. We are required to pay them certain severance payments in the event of the termination of their employment upon a "Change in Control" (as defined in the employment agreement) or certain other specified events. 43

45 The following table sets forth certain information regarding options granted to the Named Officers in 1998. OPTION/SAR GRANTS IN LAST FISCAL YEAR INDIVIDUAL GRANTS NUMBER OF % OF TOTAL SECURITIES OPTIONS/SARS EXERCISE UNDERLYING GRANTED TO OR BASE OPTIONS/SARS EMPLOYEES IN PRICE EXPIRATION NAME GRANTED (#) FISCAL YEAR(1) ($/SHARE) DATE ---- ------------ -------------- ------------- --------------- Jack Friedman............. 125,000 33.7 8.6625 10/9/03 Stephen G. Berman......... 125,000 33.7 7.875 10/9/03 - ------------------------- (1) Options to purchase a total of 371,500 shares of our common stock were granted to our employees, including the Named Officers, during 1998. The following table sets forth certain information regarding options exercised and exercisable during 1998, and the value of options held as of December 31, 1998 by the Named Officers: AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS/SARS OPTIONS/SARS SHARES AT FISCAL YEAR END AT FISCAL YEAR END(2) ACQUIRED ON VALUE --------------------------- --------------------------- NAME EXERCISE (#) REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ---- ------------ ------------ ----------- ------------- ----------- ------------- Jack Friedman........ -- -- 41,667 83,333 1,042 2,083 -- 125,000 -- 260,938 Stephen G. Berman.... -- -- 41,667 83,333 41,667 83,333 -- 125,000 -- 359,375 Joel M. Bennett...... 20,000 165,070(1) 13,250 16,625 115,938 145,469 10,000 20,000 10,000 20,000 - ------------------------- (1) The difference between (x) the product of the number of exercised options and $10.2535 (the average sale price per share of the common stock sold on the exercise dates) and (y) the aggregate exercise price of such options. (2) The difference between (x) the product of the number of unexercised options and $10.75 (the closing sale price of the common stock on December 31, 1998) and (y) the aggregate exercise price of such options. - - Third Amended and Restated 1995 Stock Option Plan In its current form, our Option Plan was adopted and approved by the stockholders and directors in July 1998. Options to purchase, in the aggregate, up to 1,250,000 shares of our common stock may be granted under the Option Plan. The Option Plan allows us to grant options that are intended to qualify as incentive stock options ("Incentive Stock Options") within the meaning of Section 422 of the Internal Revenue Code or as options that are not intended to meet the requirements of such section ("Nonstatutory Stock Options"). Under the Option Plan, Incentive Stock Options may only be granted to our 44

46 employees (including officers), while Nonstatutory Stock Options may be granted to employees (including officers), non-employee directors, consultants or advisors. The Option Plan is administered by the Stock Option Committee, whose members are non-employee directors chosen by our Board. Subject to the restrictions prescribed in the Option Plan, this committee has discretionary authority to select the persons to whom, the number of shares for which, the times and the exercise price at which options will be granted. Options granted to an employee expire immediately upon the termination of employment voluntarily by such employee or for cause. Employee options may be exercised up to one year after the termination of employment due to death or disability, or up to three months after termination for any other reason. Incentive Stock Options must have an exercise price greater than or equal to the fair market value of the shares underlying the option on the date of grant (or, if granted to a holder of 10% or more of our common stock, an exercise price of at least 110% of the underlying shares' fair market value on the date of grant). The maximum exercise period of Incentive Stock Options is 10 years from the date of grant (or five years in the case of a holder of 10% or more of our common stock). The aggregate fair market value (determined at the date the option is granted) of shares with respect to which Incentive Stock Options are exercisable for the first time by the holder of the option during any calendar year may not exceed $100,000. If that amount exceeds $100,000, our Board or the Stock Option Committee may designate those shares that will be treated as Nonstatutory Stock Options. The Option Plan provides for certain grants to non-employee directors. Each non-employee director serving on the Board when the Option Plan was adopted received options to purchase an aggregate of 10,850 shares of common stock at the fair market value of our common stock on such date. Since then, the Option Plan provides for any newly appointed non-employee director to receive an option to purchase 25,000 shares at their then current fair market value on the date of appointment. In addition, every calendar quarter, each non-employee director receives an option to purchase 6,250 shares at their then current fair market value. Options granted to a non-employee director expire upon the termination of the director's services for cause, but may be exercised at any time during a one-year period after such person ceases to serve as a director for any other reason. The Option Plan provides for the inclusion in any grant of options to one of our employees of a provision requiring the optionee, for a period of one year after the optionee's employment is terminated, not to disclose certain of our confidential information and, under certain circumstances, not to compete with us or be employed by an individual or entity that competes with us. As of the date of this prospectus, we have granted options to purchase an aggregate of 1,212,250 shares of our common stock under the Option Plan. All the shares issuable upon exercise of outstanding options granted under the Option Plan are currently registered under the Securities Act. 45

47 PRINCIPAL AND SELLING STOCKHOLDERS The following table sets forth certain information as of March 18, 1999 with respect to the beneficial ownership of our common stock by (1) each of our directors, (2) each Named Officer, (3) all our directors and executive officers as a group and (4) each person known by us to own beneficially more than 5% of the outstanding shares of our common stock. SHARES BENEFICIALLY NUMBER OF SHARES BENEFICIALLY OWNED PRIOR TO THIS SHARES OWNED AFTER OFFERING OFFERED THIS OFFERING NAME AND ADDRESS OF -------------------- --------- -------------------- BENEFICIAL OWNER NUMBER PERCENT NUMBER PERCENT ------------------- --------- ------- --------- ------- Jack Friedman(1)(2).......... 959,655(4) 15.4 192,000 767,655(4) 9.3 Stephen G. Berman(1)(2)...... 171,165(5) 2.7 58,000 113,165(5) 1.4 Joel M. Bennett(1)........... 24,250(6) * 0 24,250(6) * Robert E. Glick(1)........... 60,775(7) * 0 60,775(7) * Michael G. Miller(1)......... 53,775(8) * 0 53,775(8) * Murray L. Skala(1)........... 152,196(9) 2.4 0 152,196(9) 1.8 Renaissance Capital Growth & Income Fund III, Inc.(3)... 856,935(10) 12.2 0 856,935(10) 9.5 Renaissance US Growth & Income Trust PLC(3)........ 521,740(11) 7.8 0 521,740(11) 6.0 Kern Capital Management, LLC(12).................... 310,000 5.0 0 310,000 3.8 All directors and executive officers as a group (6 persons)................... 1,354,944(13) 21.0 250,000 1,104,944(13) 13.1 - ------------------------- * Less than 1% of our outstanding shares. (1) The address of Messrs. Friedman, Berman, Bennett, Glick, Miller and Skala is 22761 Pacific Coast Highway, Malibu, California 90265. (2) If the underwriters' over-allotment option is exercised in full, Mr. Friedman will sell 227,000 shares and will beneficially own 732,655 shares (8.9% of the outstanding shares) after this offering, and Mr. Berman will sell 68,000 shares and will beneficially own 103,165 shares (1.3% of the outstanding shares) after this offering. (3) The address of this beneficial owner is 8080 N. Central Parkway, Dallas, TX 75026. (4) Includes 66,872 shares held in trusts for the benefit of children of Mr. Friedman. Also includes 41,667 shares which Mr. Friedman may purchase upon the exercise of certain stock options. (5) Includes 41,667 shares which Mr. Berman may purchase upon the exercise of certain stock options. (6) Includes 23,250 shares which Mr. Bennett may purchase upon the exercise of certain stock options. (7) Includes 53,775 shares which Mr. Glick may purchase upon the exercise of certain stock options. (8) Represents shares which Mr. Miller may purchase upon the exercise of certain stock options. 46

48 (9) Includes 59,200 shares which Mr. Skala may purchase upon the exercise of certain stock options and 66,872 shares held by Mr. Skala as trustee under trusts for the benefit of children of Mr. Friedman. (10) Consists of 521,740 shares which Renaissance Capital Growth & Income Fund III, Inc. has the right to acquire upon the conversion of $3,000,000 principal amount of our convertible debentures held by it (at a conversion price of $5.75 per share), and 335,195 shares which it has the right to acquire upon the conversion of 600 shares of our preferred stock held by it (at a conversion price of $8.95 per share). (11) Represents shares which Renaissance US Growth & Income Trust PLC has the right to acquire upon the conversion of $3,000,000 principal amount of our convertible debentures owned by it (at a conversion price of $5.75 per share). (12) Reflects shares owned as of December 31, 1998. Robert E. Kern Jr. and David G. Kern are principal and controlling members of Kern Capital Management, LLC and, as such, may be deemed beneficial owners of the shares, although they have expressly denied such beneficial ownership. Kern Capital Management, LLC is an investment advisor that holds these shares for the benefit of certain institutional accounts. The address of these beneficial owners is 114 West 47th Street, Suite 1926, New York, New York 10036. We have relied solely on a statement on Schedule 13G jointly filed by these beneficial owners on February 12, 1999. (13) Includes 66,872 shares held in trusts for the benefit of children of Mr. Friedman and an aggregate of 273,334 shares which the directors and executive officers may purchase upon the exercise of certain stock options. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS One of our directors, Murray L. Skala, is a partner in the law firm of Feder, Kaszovitz, Isaacson, Weber, Skala & Bass LLP, which has performed, and is expected to continue to perform, legal services for us. In 1998, we paid his firm legal fees of approximately $510,000. 47

49 DESCRIPTION OF SECURITIES GENERAL We are currently authorized to issue 25,000,000 shares of common stock, par value $.001 per share, and 1,000,000 shares of preferred stock, par value $.001 per share. As of March 18, 1999, 6,193,929 shares of our common stock were outstanding and owned of record by approximately 62 persons, and 1,000 shares of our preferred stock, consisting of Series A Cumulative Convertible Preferred Stock, were outstanding. After we issue 521,740 shares of our common stock upon conversion of $3.0 million principal amount of our convertible debentures and an additional 2,000,000 shares in this offering, 8,715,669 shares will be outstanding. COMMON STOCK Holders of our common stock are entitled to one vote for each share on all matters submitted to a vote of our stockholders, including the election of directors. Our certificate of incorporation does not provide for cumulative voting. Accordingly, holders of a majority of the shares of common stock entitled to vote in any election of directors may elect all of the directors standing for election if they choose to do so. Holders of common stock will be entitled to receive ratably dividends, if any, declared from time to time by our Board of Directors, and will be entitled to receive ratably all of our assets available for distribution to them upon liquidation. Holders of common stock have no preemptive, subscription or redemption rights. All the currently outstanding shares of our common stock are, and all shares of our common stock offered by us hereby, upon issuance and sale, will be, fully paid and nonassessable. PREFERRED STOCK Our certificate of incorporation currently provides that we are authorized to issue up to 1,000,000 shares of "blank check" preferred stock. Without any further approval by our stockholders, our Board of Directors may designate and authorize the issuance, upon the terms and conditions it may determine, of one or more classes or series of preferred stock with prescribed preferential dividend and liquidation rights, voting, conversion, redemption and other rights. The issuance of preferred stock, while providing flexibility in connection with possible acquisitions and other corporate purposes, could, among other things, adversely affect the voting power of the holders of the common stock. Under certain circumstances, the issuance of preferred stock could also make it more difficult for a third party to gain control of JAKKS, discourage bids for the common stock at a premium or otherwise adversely affect the market price of our common stock. On April 1, 1998, we issued and sold 1,000 shares of our Series A Cumulative Convertible Preferred Stock in a private placement to two investment funds at a price of $5,000 per share. The holders of our preferred stock are entitled to receive quarterly payments of preferential dividends at an annual rate of $350 per share and to convert their shares into our common stock based on a current conversion price of $8.95 (subject to adjustment for certain dilutive events and specified transactions). The preferred stock is redeemable, in whole, but not in part, at its liquidation value (together with all accrued and unpaid dividends) at our option if (1) our common stock is then traded on the Nasdaq National Market or the New York Stock Exchange; (2) the average "Current Market Price" (as defined) of our common stock over a period of 20 trading days equals 48

50 or exceeds $20.00; and (3) the shares of our common stock issuable upon conversion of the preferred stock are subject to a registration statement under the Securities Act that has become effective and permits the sale of such shares on a continuous or delayed basis. The preferred stock is also redeemable at its liquidation value (together with accrued and unpaid dividends) at the option of any holder upon the occurrence of specified "Events of Redemption," including an amendment to our certificate of incorporation or our by-laws affecting our Board of Directors, our merger or consolidation with another company, or a sale of all or substantially all of our assets. The holders of the preferred stock have no voting rights, other than as required by the Delaware General Corporation Law, class voting with respect to certain amendments of our certificate of incorporation or by-laws or the authorization or issuance of certain shares of our capital stock. In addition, if at any time dividends on our preferred stock for two quarters are not paid in full, they may, subject to certain limitations, designate or elect two additional directors. CONVERTIBLE DEBENTURES On December 31, 1996, we issued and sold at par $6 million principal amount of our 9.0% Convertible Debentures due December 31, 2003 in a private placement to two investment funds. We are required to repay the outstanding principal amount of the convertible debentures in monthly installments, beginning on December 31, 1999, in an amount equal to 1% of the outstanding principal amount, with the entire principal balance due at maturity on December 31, 2003. The convertible debentures bear interest, payable monthly, at a rate of 9% per annum on the outstanding principal amount. Any holder of a convertible debenture may convert it at any time into our common stock based on a current conversion price of $5.75 per share (subject to adjustment for certain dilutive events and specified transactions). If the entire principal amount of the convertible debentures were converted at this price, we would issue 1,043,480 shares of our common stock. A holder of our convertible debentures may require us to redeem the debentures, prior to maturity, at par, if Mr. Friedman dies or, at the greater of the market value thereof or an amount representing a 20% annual return, if our common stock is not listed on the Nasdaq National Market, the New York Stock Exchange or the American Stock Exchange or if any person acquires a majority of our common stock. We can redeem a portion or all of the convertible debentures, at 120% of par, if our common stock trades above certain specified levels and certain other conditions are met. We recently attained one of these levels, entitling us to redeem $3 million principal amount of the convertible debentures, and we notified the holders of our intention to redeem these debentures. In turn, the holders of the convertible debentures have notified us that, on May 25, 1999, they will convert $3 million principal amount of their convertible debentures into 521,740 shares of our common stock. Under the loan agreement governing the convertible debentures, we are prohibited from, among other things, borrowing money or incurring other indebtedness, pledging our assets as security for an obligation, selling our assets, except in the ordinary course of business, amending our certificate of incorporation or by-laws or paying dividends on our common stock, except as specifically permitted. The holders of the convertible debentures may designate a nominee for election to our Board of Directors or a non-director observer to participate at meetings of directors. If we default under the convertible debentures, the holders may similarly designate a second nominee to serve as a director. 49

51 Substantially all of our assets have been pledged to secure our obligations under the convertible debentures. We also pay each of the holders of the convertible debentures a financial advisory fee of $500 per month. WARRANTS In connection with our initial public offering in May 1996, we issued to the representatives of the underwriters warrants to purchase, until May 1, 2001, an aggregate of 150,000 shares of our common stock, of which warrants to purchase 82,200 shares at a current exercise price of $8.4375 per share remain outstanding as of March 18, 1999. For its assistance in connection with our sale of the convertible debentures in January 1997, we issued to an investment banking firm a warrant to purchase, until January 8, 2002, an aggregate of 150,000 shares of our common stock, of which warrants to purchase 97,928 shares at a current exercise price of $6.75 per share remain outstanding as of March 18, 1999. In connection with a public offering of our common stock in May 1997, we issued to the underwriter warrants to purchase, until May 1, 2002, up to 60,000 shares of our common stock at an exercise price of $7.475. In connection with the formation of our joint venture, we agreed to issue to THQ a warrant to purchase, at any time during a five year period, up to 150,000 shares of our common stock and to issue to Titan Sports and a related party warrants to purchase, at any time during a 10 year period, up to 125,000 shares of our common stock. These warrants will have an exercise price of $10.00 per share. We also agreed to grant the holders of these warrants certain registration rights under the Securities Act. To date, we have not issued and delivered these warrants, although we remain obligated to do so. SECURITIES ACT REGISTRATION All of the shares of our common stock issued or issuable upon the conversion of our convertible debentures or our preferred stock and upon the exercise of our outstanding warrants and options have been registered under the Securities Act. TRANSFER AGENT The transfer agent for our common stock is U.S. Stock Transfer Corporation, Glendale, California. 50

52 UNDERWRITING The underwriters named below, acting through their representatives, Advest, Inc., Morgan Keegan & Company, Inc. and Southwest Securities, Inc. (the "Representatives"), have severally agreed with us and the selling stockholders, subject to the terms and conditions of the Underwriting Agreement, to purchase from us and the selling stockholders the number of shares of our common stock set forth opposite their names below. The underwriters are committed to purchase and pay for all such shares, if any are purchased. NUMBER OF UNDERWRITERS SHARES ------------ --------- Advest, Inc................................................. Morgan Keegan & Company, Inc................................ Southwest Securities, Inc................................... ------- Total ======= The Representatives have advised us that the underwriters propose to offer these shares of common stock to the public at the public offering price set forth on the cover page of this prospectus and to certain dealers at this price less a concession of not more than $ per share, of which $ may be reallowed to other dealers. After the public offering, the public offering price, concession and reallowance to dealers may be reduced by the underwriters. No such reduction will change the amount of proceeds to be received by us or the selling stockholders as set forth on the cover page of this prospectus. We and the selling stockholders have granted to the underwriters an option, exercisable during the 30-day period after the date of this prospectus, to purchase up to 337,500 additional shares of common stock at the same price per share as is being paid for the 2,250,000 shares that the underwriters have committed to purchase. To the extent that the underwriters exercise this option, each of the underwriters will have a firm commitment to purchase approximately the same percentage of such additional shares that the number of shares of common stock to be purchased by it shown in the above table represents as a percentage of the first 2,250,000 shares offered hereby. If any of these additional shares are purchased, they will be sold by the underwriters on the same terms as those on which the first 2,250,000 shares are sold. The following table presents certain information about compensation that the underwriters will receive in connection with this offering: TOTAL ------------------- PER SHARE MINIMUM* MAXIMUM* --------- -------- -------- JAKKS................................... $ $ $ Selling Stockholders.................... $ $ $ *Minimum amounts assume that the over-allotment option is not exercised; maximum amounts assume that the over-allotment option is exercised in full. 51

53 In addition, JAKKS will pay to Advest, Inc., upon completion of this offering, a financial advisory fee in the amount of $50,000. We have also agreed that upon the completion of this offering and for a nine month period thereafter, Advest, Inc. will have the right of first offer to provide us with investment banking services in connection with subsequent public offerings of our equity securities and merger and acquisition advisory services relating to a sale or other disposition of all our securities or a material portion of our assets. In connection with such investment banking or advisory services, prior to contacting any other investment banking or financial advisory firms, we will first provide Advest, Inc. with a description of the contemplated services and invite Advest, Inc. to submit to us a proposal for providing such services. If its fees are no less favorable than those submitted by another nationally recognized investment banking or advisory firm, we will engage Advest, Inc. exclusively to provide such services. We expect the total expenses incurred in connection with this offering (excluding the underwriting discount discussed above) to be $450,000. JAKKS is obligated to pay all these expenses; the selling stockholders will not pay any of these expenses. The Underwriting Agreement contains covenants of indemnity among us, the selling stockholders and the underwriters against certain civil liabilities, including liabilities arising under the Securities Act. All of our directors and officers have agreed that until 180 days after the date of this prospectus (the "Lock-up Period") they will not, without the prior written consent of Advest, Inc., offer, contract to sell, sell, encumber, grant any option for the sale of, distribute, transfer or dispose of any of our common stock or any options, warrants or securities convertible into or exercisable or exchangeable for shares of our common stock now owned or hereafter acquired by them or with respect to which they have or acquire the power of disposition (other than shares of common stock being sold hereby by selling stockholders or shares disposed of by bona fide gifts). They have also agreed to waive their registration rights with respect to our common stock during the Lock-up Period. Similarly, we have agreed that, during the Lock-up Period, we will not, subject to some exceptions, issue, sell, contract to sell or otherwise dispose of any shares of our common stock other than the issuance of our common stock upon the exercise of outstanding options, warrants or convertible securities. The Representatives have advised us that, pursuant to Regulation M under the Exchange Act, certain persons participating in this offering may engage in transactions, including stabilizing bids, syndicate covering transactions or the imposition of penalty bids which may have the effect of stabilizing or maintaining the market price of the common stock at a level about that which might otherwise prevail in the open market. A "stabilizing bid" is a bid for or the purchase of our common stock on behalf of the underwriters for the purpose of fixing or maintaining the price of our common stock. A "syndicate covering transaction" is the bid for or the purchase of our common stock on behalf of the underwriters to reduce a short position incurred by the underwriters in connection with this offering. A "penalty bid" is an arrangement permitting the underwriters to reclaim the selling concession otherwise accruing to an underwriter or syndicate member in connection with this offering if the common stock originally sold by such underwriter or syndicate member is purchased by underwriters in a syndicate covering transaction and has therefore not been effectively placed by such underwriter or syndicate member. The underwriters have advised us that such transactions may be effected on the 52

54 Nasdaq National Market or otherwise and, if commenced, may be discontinued at any time. In connection with this offering, certain underwriters and selling group members (if any) who are qualified market makers on the Nasdaq National Market may engage in passive market making transactions in our common stock on the Nasdaq National Market in accordance with Rule 103 of Regulation M under the Exchange Act. Passive market makers must comply with applicable volume and price limitations and must be identified as such. In general, a passive market maker must display its bid at a price not in excess of the highest independent bid for such security; if all independent bids are lowered below the passive market maker's bid, however, its bid must then be lowered when certain purchase limits are exceeded. LEGAL MATTERS The legality of the common stock offered hereby will be passed upon for us by Feder, Kaszovitz, Isaacson, Weber, Skala & Bass LLP, New York, New York. Murray L. Skala, a partner of that firm, is one of our directors and holds of record 92,996 shares (of which 66,872 shares are held in trust for the benefit of Mr. Friedman's children) and options to purchase 59,200 shares of our common stock, all of which are currently exercisable. Morgan, Lewis & Bockius LLP, New York, New York will pass upon certain legal matters for the underwriters in connection with this offering. EXPERTS Our consolidated financial statements as of December 31, 1997 and 1998 and for each of the three years in the period ended December 31, 1998 included in this prospectus were audited by Pannell Kerr Forster, Certified Public Accountants, A Professional Corporation, Los Angeles, California, independent auditors, as stated in their report appearing herein and are included in reliance upon the report of that firm given upon their authority as experts in accounting and auditing. 53

55 WHERE YOU CAN FIND MORE INFORMATION This prospectus is part of a registration statement we filed with the SEC. We also file annual, quarterly and current reports, proxy statements and other information with the SEC. You may read and copy any document we file at the SEC's public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. Our SEC filings are also available to the public from the SEC's Website at "http://www.sec.gov." The SEC allows us, under certain circumstances, to "incorporate by reference" the information we file with them, which means that we can disclose important information to you by referring you to those documents. The information incorporated by reference is considered to be part of this prospectus, and information that we file later with the SEC will automatically update and supersede this information. We incorporate by reference the documents listed below and any future filings we will make with the SEC under Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act (File No. 0-28104). 1. Our Annual Report on Form 10-KSB for our fiscal year ended December 31, 1997; 2. Our Quarterly Reports on Form 10-QSB for the quarters ended March 31, 1998, June 30, 1998 and September 30, 1998; 3. Our Current Report on Form 8-K filed April 7, 1998; and 4. The "Description of Registrant's Securities to be Registered" contained in our Registration Statement on Form 8-A (File No. 0-28104), filed March 29, 1996, and the "Description of Securities -- Common Stock" incorporated therein by reference to our Registration Statement on Form SB-2 (Reg. No. 333-2048-LA). You may request a copy of these filings, at no cost, by writing or telephoning our Chief Financial Officer at the following address: JAKKS Pacific, Inc. 22761 Pacific Coast Highway Suite 226 Malibu, California 90265 (310) 456-7799 54

56 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE Independent Auditors' Report................................ F-2 Consolidated Balance Sheets as of December 31, 1997 and 1998...................................................... F-3 Consolidated Statements of Operations for the years ended December 31, 1996, 1997 and 1998.......................... F-4 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1996, 1997 and 1998.............. F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1997 and 1998.......................... F-6 Notes to Consolidated Financial Statements.................. F-7 Financial Statement Schedule: Schedule II -- Valuation and Qualifying Accounts....................................... F-23 F-1

57 INDEPENDENT AUDITORS' REPORT The Stockholders JAKKS Pacific, Inc. and Subsidiaries We have audited the accompanying consolidated balance sheets of JAKKS Pacific, Inc. and Subsidiaries as of December 31, 1997 and 1998, and the related consolidated statements of operations, stockholders' equity, cash flows and the financial statement schedule listed in the accompanying index on page F-1 for each of the three years in the period ended December 31, 1998. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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 consolidated financial statements and schedule referred to above present fairly, in all material respects, the financial position of JAKKS Pacific, Inc. and Subsidiaries as of December 31, 1997 and 1998, and the results of their operations and cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. PANNELL KERR FORSTER Certified Public Accountants A Professional Corporation February 22, 1999 except for note 18, for which the date is March 1, 1999 F-2

58 JAKKS PACIFIC, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS DECEMBER 31, -------------------------- 1997 1998 ----------- ----------- Current assets Cash and cash equivalents............................... $ 2,535,925 $12,452,201 Accounts receivable, net of allowance for uncollectible accounts of $51,153 and $133,986 for 1997 and 1998, respectively.......................................... 8,735,528 11,926,725 Inventory, net of reserves of $129,695 and $464,133 for 1997 and 1998, respectively........................... 1,948,250 2,918,941 Deferred product development costs...................... 807,603 237,914 Prepaid expenses and other.............................. 632,315 789,691 Advanced royalty payments............................... 252,603 307,542 Due from officers....................................... 15,112 -- ----------- ----------- Total current assets............................. 14,927,336 28,633,014 Property and equipment Office furniture and equipment.......................... 217,786 440,162 Molds and tooling....................................... 3,647,638 5,826,643 Leasehold improvements.................................. 90,432 195,909 ----------- ----------- Total............................................ 3,955,856 6,462,714 Less accumulated depreciation and amortization.......... 1,099,207 2,173,708 ----------- ----------- Net property and equipment....................... 2,856,649 4,289,006 Deferred offering and acquisition costs................... 626,713 408,151 Intangibles and deposits, net............................. 318,511 489,936 Investment in joint venture............................... -- 1,044,708 Goodwill, net............................................. 10,695,488 10,322,896 Trademarks, net........................................... 14,180,118 13,548,054 ----------- ----------- Total assets..................................... $43,604,815 $58,735,765 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Accounts payable........................................ $ 4,266,456 $ 3,705,116 Accrued expenses........................................ 2,467,246 4,371,711 Reserve for sales returns and allowances................ 1,860,821 5,341,517 Current portion of long-term debt....................... 2,361,076 60,000 Income taxes payable.................................... 603,614 1,418,763 ----------- ----------- Total current liabilities........................ 11,559,213 14,897,107 Long-term debt, net of current portion.................... 6,000,000 5,940,000 Deferred income taxes..................................... 86,896 144,705 ----------- ----------- Total liabilities................................ 17,646,109 20,981,812 ----------- ----------- Commitments and contingencies Stockholders' equity Common stock, $.001 par value; 25,000,000 shares authorized; issued and outstanding 4,942,094 and 6,026,042 shares, respectively........................ 4,942 6,026 Convertible preferred stock, $.001 par value; 5,000 shares authorized; issued and outstanding 3,525 and 1,000, respectively................................... 4 1 Additional paid-in capital.............................. 21,693,061 27,044,536 Retained earnings....................................... 4,402,636 10,777,662 ----------- ----------- 26,100,643 37,828,225 Unearned compensation from grant of options............. 141,937 74,272 ----------- ----------- Total stockholders' equity....................... 25,958,706 37,753,953 ----------- ----------- Total liabilities and stockholders' equity....... $43,604,815 $58,735,765 =========== =========== See notes to consolidated financial statements. F-3

59 JAKKS PACIFIC, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, ----------------------------------------- 1996 1997 1998 ----------- ----------- ----------- Net sales............................. $12,052,016 $41,944,921 $85,252,563 Cost of sales......................... 7,231,296 25,874,784 52,000,135 ----------- ----------- ----------- Gross profit.......................... 4,820,720 16,070,137 33,252,428 Selling, general and administrative expenses............................ 3,611,471 11,895,260 24,006,497 ----------- ----------- ----------- Income from operations................ 1,209,249 4,174,877 9,245,931 Interest, net......................... (133,795) 417,293 422,553 Other (income) expense................ -- 328,139 590,948 ----------- ----------- ----------- Income before provision for income taxes............................... 1,343,044 3,429,445 8,232,430 Provision for income taxes............ 163,275 642,949 1,857,404 ----------- ----------- ----------- Net income............................ $ 1,179,769 $ 2,786,496 $ 6,375,026 =========== =========== =========== Basic earnings per share.............. $ 0.36 $ 0.60 $ 1.12 =========== =========== =========== Diluted earnings per share............ $ 0.34 $ 0.52 $ 0.89 =========== =========== =========== See notes to consolidated financial statements. F-4

60 JAKKS PACIFIC, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY DECEMBER 31, 1996, 1997 AND 1998 CONVERTIBLE PAR UNEARNED COMMON PREFERRED VALUE ADDITIONAL COMPENSATION TOTAL SHARES SHARES PER STOCK PAID-IN RETAINED FROM GRANT STOCKHOLDERS' OUTSTANDING OUTSTANDING SHARE AMOUNT CAPITAL EARNINGS OF OPTIONS EQUITY ----------- ----------- ----- ------ ----------- ----------- ------------ ------------- Balance, December 31, 1995.................... 2,000,000 -- $.001 $2,000 $ 1,624,238 $ 436,371 $(212,905) $ 1,849,704 Issuance of common stock for cash................ 1,502,000 -- .001 1,502 7,652,761 -- -- 7,654,263 Issuance of common stock from bridge financing conversion.............. 469,300 -- .001 469 1,044,310 -- -- 1,044,779 Issuance of common stock in partial consideration for purchase of toy business assets......... 13,649 -- .001 14 (14) -- -- -- Earned compensation from grant of options........ -- -- -- -- -- -- 17,742 17,742 Net income................ -- -- -- -- -- 1,179,769 -- 1,179,769 --------- ------ ----- ------ ----------- ----------- --------- ----------- Balance, December 31, 1996.................... 3,984,949 -- .001 3,985 10,321,295 1,616,140 (195,163) 11,746,257 Issuance of common stock for cash................ 690,000 -- .001 690 2,921,063 -- -- 2,921,753 Exercise of options....... 69,125 -- .001 69 132,555 -- -- 132,624 Issuance of common stock in partial consideration for purchase of toy business................ 198,020 -- .001 198 1,499,802 -- -- 1,500,000 Issuance of convertible preferred stock for cash.................... -- 3,525 .001 4 6,818,346 -- -- 6,818,350 Earned compensation from grant of options........ -- -- -- -- -- -- 53,226 53,226 Net income................ -- -- -- -- -- 2,786,496 -- 2,786,496 --------- ------ ----- ------ ----------- ----------- --------- ----------- Balance, December 31, 1997.................... 4,942,094 3,525 .001 4,946 21,693,061 4,402,636 (141,937) 25,958,706 Conversion of preferred stock................... -- (3,525) .001 (4) 4 -- -- -- Issuance of common stock from conversion of preferred stock......... 939,998 -- .001 940 (940) -- -- -- Issuance of 7% convertible preferred stock for cash.................... -- 1,000 .001 1 4,731,151 -- -- 4,731,152 Exercise of options....... 143,950 -- .001 144 647,248 -- -- 647,392 Earned compensation from grant of options........ -- -- -- -- -- -- 41,677 41,677 Cancellation of options, unearned compensation... -- -- -- -- (25,988) -- 25,988 -- Net income................ -- -- -- -- -- 6,375,026 -- 6,375,026 --------- ------ ----- ------ ----------- ----------- --------- ----------- Balance, December 31, 1998.................... 6,026,042 1,000 $.001 $6,027 $27,044,536 $10,777,662 $ (74,272) $37,753,953 ========= ====== ===== ====== =========== =========== ========= =========== See notes to consolidated financial statements. F-5

61 JAKKS PACIFIC, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, ------------------------------------------ 1996 1997 1998 ----------- ------------ ----------- Cash flows from operating activities Net income........................................... $ 1,179,769 $ 2,786,496 $ 6,375,026 ----------- ------------ ----------- Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization..................... 338,032 1,605,226 2,986,137 Earned compensation from stock option grants...... 17,742 53,226 41,677 Loss on disposal of property and equipment........ -- 328,139 719,331 Changes in operating assets and liabilities Accounts receivable............................. (1,844,981) (6,315,058) (3,191,197) Inventory....................................... (53,977) (1,808,145) (970,691) Prepaid expenses and other...................... (973,076) (450,545) 357,374 Accounts payable................................ 899,929 2,655,469 (561,340) Accrued expenses................................ 27,049 2,262,159 1,904,465 Income taxes payable............................ 191,622 331,009 815,149 Reserve for sales returns and allowances........ (285,513) 1,685,621 3,480,696 Deferred income taxes........................... (40,186) 94,427 57,809 ----------- ------------ ----------- Total adjustments............................ (1,723,359) 441,528 5,639,410 ----------- ------------ ----------- Net cash provided by (used for) operating activities................................. (543,590) 3,228,024 12,014,436 ----------- ------------ ----------- Cash flows from investing activities Deferred costs....................................... (85,300) -- -- Property and equipment............................... (1,058,654) (2,934,935) (3,875,852) Due from officers.................................... (120,030) 104,918 15,112 Other assets......................................... (49,129) (241,572) (197,928) Trademarks........................................... -- (14,352,556) (12,252) Investment in joint venture.......................... -- -- (1,044,708) Cash paid in excess of cost over toy business assets acquired (goodwill)............................... -- (7,006,753) -- ----------- ------------ ----------- Net cash used by investing activities........ (1,313,113) (24,430,898) (5,115,628) ----------- ------------ ----------- Cash flows from financing activities Proceeds from sale of common stock................... 7,669,263 2,946,603 -- Proceeds from convertible preferred stock............ -- 6,818,350 4,731,152 Proceeds from debt................................... 1,104,694 13,413,659 -- Repayments of note payable to officer................ (382,816) -- -- Proceeds from stock options exercised................ -- 132,624 647,392 Repayments of debt................................... (260,930) (5,245,665) (2,361,076) Deferred financing costs............................. -- (682,032) -- ----------- ------------ ----------- Net cash provided by financing activities.... 8,130,211 17,383,539 3,017,468 ----------- ------------ ----------- Net increase (decrease) in cash and cash equivalents... 6,273,508 (3,819,335) 9,916,276 Cash and cash equivalents, beginning of year........... 81,752 6,355,260 2,535,925 ----------- ------------ ----------- Cash and cash equivalents, end of year................. $ 6,355,260 $ 2,535,925 12,452,201 ----------- ------------ ----------- Cash paid during the period for: Interest............................................. $ 49,638 $ 648,187 $ 647,404 ----------- ------------ ----------- Income taxes......................................... $ 11,839 $ 217,213 $ 1,042,255 ----------- ------------ ----------- See note 16 for additional supplemental information to consolidated statements of cash flows. See notes to consolidated financial statements. F-6

62 JAKKS PACIFIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 NOTE 1 -- PRINCIPAL INDUSTRY JAKKS Pacific, Inc. (the "Company"), a Delaware corporation, is engaged in the development, production and marketing of toys and children's electronics products, some of which are based on highly-recognized entertainment properties and character licenses. The Company commenced operations in July 1995 through the purchase of substantially all of the assets of a Hong Kong toy company. The Company is marketing its product lines domestically and internationally. The Company was incorporated under the laws of the State of Delaware in January 1995. NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include accounts of the Company and its wholly-owned subsidiaries. In consolidation, all significant inter-company balances and transactions are eliminated. CASH AND CASH EQUIVALENTS The Company considers all highly liquid assets, having an original maturity of less than three months, to be cash equivalents. The Company maintains its cash in bank deposits which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant credit risk on cash and cash equivalents. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles 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. Provisions for estimated defective products and markdowns are made at the time of sale. DEFERRED PRODUCT DEVELOPMENT COSTS The Company defers certain costs related to the preliminary activities associated with the manufacture of its products, which the Company has determined have future economic benefit. These costs are then expensed in the period in which the initial shipment of the related product is made. Management periodically reviews and revises, when necessary, its F-7

63 JAKKS PACIFIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) estimate of the future benefit of these costs, and expenses them if it is deemed there no longer is a future benefit. DEFERRED OFFERING, FINANCING AND ACQUISITION COSTS During 1997, financing costs were incurred in obtaining a line of credit facility. The financing deferred costs are being amortized over the term of the credit facility. During 1996, costs incurred for a follow-on offering, debenture offering and certain acquisition costs were deferred. The deferred acquisition costs were reclassified to investment costs upon completion of the acquisition of Road Champs, Inc. The deferred offering costs related to the debentures are being amortized over the term of the debentures, or will be written-off upon conversion (note 8). INVENTORY Inventory is valued at the lower of cost (first-in, first-out) or market. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's cash and cash equivalents, accounts receivable and notes payable represent financial instruments. The carrying value of these financial instruments is a reasonable approximation of fair value. 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: Personal computers................... 5 years Office equipment..................... 5 years Furniture and fixtures............... 5 years Molds and tooling.................... 2 - 4 years Leasehold improvements............... Shorter of length of lease or 10 years ADVERTISING Production costs of commercials and programming are charged to operations in the year during which the production is first aired. The costs of other advertising, promotion and marketing programs are charged to operations in the year incurred. Advertising expense for the years ended December 31, 1996, 1997 and 1998 was approximately $22,000, $1,304,000 and $3,903,000, respectively. F-8

64 JAKKS PACIFIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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. Deferred taxes are provided on a liability method whereby deferred tax assets are recognized as deductible temporary differences and operating loss and tax credit carry-forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. TRANSLATION OF FOREIGN CURRENCIES Monetary assets and liabilities denominated in Hong Kong dollars are translated into United States dollars at the rates of exchange ruling at the balance sheet date. Transactions during the period are translated at the rates ruling at the dates of the transactions. Profits and losses resulting from the above translation policy are recognized in the consolidated statement of operations. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill represents the excess purchase price paid over the fair market value of the assets of acquired toy companies. Goodwill is being amortized over 30 years on a straight-line basis. Accumulated amortization at December 31, 1997 and 1998 totaled $482,263 and $632,519, respectively. The carrying value of goodwill is based on management's current assessment of recoverability. Management evaluates 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. Intangible assets other than goodwill consist of product technology rights and trademarks. Intangible assets are amortized on a straight-line basis, over five to thirty years, the estimated economic lives of the related assets. Accumulated amortization as of December 31, 1997 and 1998 was $192,606 and $1,177,306, respectively. EARNINGS PER SHARE (EPS) In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings per Share." This statement establishes simplified standards for computing and presenting earnings per share (EPS). It requires dual presentation of basic and diluted F-9

65 JAKKS PACIFIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) EARNINGS PER SHARE (EPS) (CONTINUED) EPS on the face of the income statement for entities with complex capital structures and disclosures of the calculation of each EPS amount. 1996 ------------------------------------ WEIGHTED AVERAGE INCOME SHARES PER SHARE ---------- --------- --------- Basic EPS Income available to common stockholders..... $1,179,769 3,284,432 $0.36 ----- Effect of dilutive securities Options and warrants........................ -- 219,335 ---------- --------- Diluted EPS Income available to common stockholders plus assumed exercises......................... $1,179,769 3,503,767 $0.34 ---------- --------- ----- 1997 ------------------------------------ WEIGHTED AVERAGE INCOME SHARES PER SHARE ---------- --------- --------- Basic EPS Income available to common stockholders..... $2,786,496 4,621,369 $0.60 ----- Effect of dilutive securities Options and warrants........................ -- 187,761 9% convertible debentures................... 363,286 1,023,411 4% convertible preferred stock.............. -- 175,904 ---------- --------- Diluted EPS Income available to common stockholders plus assumed exercises and conversions......... $3,149,782 6,008,445 $0.52 ---------- --------- ----- F-10

66 JAKKS PACIFIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) EARNINGS PER SHARE (EPS) (CONTINUED) 1998 ------------------------------------ WEIGHTED AVERAGE PER- INCOME SHARES SHARE ---------- --------- --------- Basic EPS Income available to common stockholders..... $6,375,026 5,692,601 $1.12 ----- Effect of dilutive securities Options and warrants........................ -- 217,898 9% convertible debentures................... 372,732 1,043,480 4% convertible preferred stock.............. -- 227,252 7% convertible preferred stock.............. -- 420,528 ---------- --------- Diluted EPS Income available to common stockholders plus assumed exercises and conversions......... $6,747,758 7,601,759 $0.89 ---------- --------- ----- NOTE 3 -- ACQUISITIONS AND JOINT VENTURE In February 1997, the Company acquired all of the stock of Road Champs, Inc. (RCI) and all of the operating assets of an affiliated company for $11,723,924. Consideration paid at closing was $4,719,413 in cash plus the issuance of $1,500,000 (198,020 shares) of the Company's common stock. The balance of the adjusted purchase price of $3,079,026 was paid in three equal installments bearing interest at a rate of 7.0% per annum. As of December 31, 1998, all such payments were made in full. In addition, the payment for inventory of $2,188,778, without interest, was made in 1997. Professional fees totaling $236,707 were incurred as part of the acquisition costs. Outstanding balances were secured by all acquired shares and assets, however, they were subordinated to the convertible debentures due December 31, 2003 (note 8). The assets acquired and liabilities assumed from Road Champs, Inc. were as follows: Inventory, net of reserve of $200,000............. $ 1,956,358 Prepaid expenses.................................. 226,881 Property and equipment............................ 694,788 Deposits.......................................... 105,461 Trademarks........................................ 1,000,000 Goodwill.......................................... 8,506,753 Liabilities assumed............................... (766,317) ----------- Net assets acquired $11,723,924 =========== F-11

67 JAKKS PACIFIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 NOTE 3 -- ACQUISITIONS AND JOINT VENTURE (CONTINUED) In October 1997, the Company acquired the right, title and interest in and to the Remco and Child Guidance (R&CG) trademarks, and all registrations and applications for registration thereof, throughout the world. Total costs of the trademarks included: Cash.............................................. $10,600,000 Promissory note................................... 1,200,000 Liabilities assumed............................... 1,350,000 Professional service fees......................... 202,556 ----------- Total acquisition costs $13,352,556 =========== The total purchase price paid to the seller consisted of cash and a promissory note totaling $11,800,000. The liabilities assumed included a reserve for returns and allowances of $750,000 and a reserve of $600,000 that represents the Company's contributions to the seller's settlement with its Hong Kong representative agent for early termination of its service contract due to sale of the trademarks. Costs incurred in professional service fees of $202,556 are attributed to executing the acquisition of the trademarks. The Company also entered into a firm commitment, manufacturing and supply agreement with seller (note 12). In June 1998, the Company formed a joint venture with a company that 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 under which it acquired the exclusive worldwide right to publish video games on all hardware platforms. As of December 31, 1998, the Company has made initial contributions to the joint venture of $1,044,708 (note 12). NOTE 4 -- CONCENTRATION OF CREDIT RISK Financial instruments that subject the Company to concentration of credit risk are cash equivalents and trade receivables. Cash equivalents consist principally of short-term money market funds. These instruments are short-term in nature and bear minimal risk. To date, the Company has not experienced losses on these instruments. The Company performs ongoing credit evaluations of its customers' financial condition, but does not require collateral to support customer receivables. Most goods are sold on irrevocable letter of credit basis. Included in the Company's consolidated balance sheets at December 31, 1997 and 1998 are its operating net assets, most of which are located in facilities in Hong Kong and China and which totaled $8,948,131 and $8,627,240 for 1997 and 1998, respectively. NOTE 5 -- DUE FROM OFFICERS Due from officer represented a balance of $15,112, at December 31, 1997, due from a Company officer. The $15,112, due on demand, was non-interest bearing and was repaid in 1998. F-12

68 JAKKS PACIFIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 NOTE 6 -- ACCRUED EXPENSES Accrued expenses consist of the following: 1997 1998 ---------- ---------- Bonuses............................... $ 254,737 $ 841,000 Trademarks acquisition reserve........ 600,000 177,245 Interest expense...................... 37,607 -- Royalties and sales commissions....... 1,130,512 2,681,973 Hong Kong subsidiaries accruals....... 384,747 529,722 Other................................. 59,643 141,771 ---------- ---------- $2,467,246 $4,371,711 ========== ========== NOTE 7 -- RELATED PARTY TRANSACTIONS A director of the Company is a partner in the law firm that acts as counsel to the Company. The Company paid legal fees and expenses to the law firm in the amount of approximately $270,000 in 1996, $151,000 in 1997 and $510,000 in 1998. Also see note 5 for other related party transactions. F-13

69 JAKKS PACIFIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 NOTE 8 -- LONG-TERM DEBT Long-term debt consists of the following: 1997 1998 ---------- ---------- Convertible debentures, bearing interest on the principal amounts outstanding at 9% per annum with the first monthly installment payable on February 1, 1997. If not sooner redeemed or converted into common stock, the debenture shall mature on December 31, 2003. Commencing on December 31, 1999, mandatory monthly principal redemption installments are to be made in the amount of $10 per $1,000 of the then remaining principal amount of the debenture. Such debentures are convertible into 1,043,480 shares of the Company's common stock at $5.75 per share. The debentures are secured by all outstanding shares of the Company's wholly-owned subsidiaries, and substantially all operating assets of the Company (note 2)............................................ $6,000,000 $6,000,000 Note payable, due in five quarterly principal installments of $240,000 starting December 31, 1997, with interest at 10% per annum. The note is secured by the Remco and Child Guidance trademarks.......... 1,200,000 -- Note payable, due in three principal payments with the final installment due February 6, 1998, with interest at 7% per annum. The note is secured by the RCI assets.......................................... 1,046,376 -- Line of credit facility (note 12)..................... 114,700 -- ---------- ---------- 8,361,076 6,000,000 Less current portion of long-term debt................ 2,361,076 60,000 ---------- ---------- Long-term debt, net of current portion................ $6,000,000 $5,940,000 ========== ========== NOTE 9 -- INCOME TAXES The provision differs from the expense that would result from applying Federal statutory rates to income before taxes because of the inclusion of a provision for state income taxes and the income of the Company's foreign subsidiaries is taxed at a rate of 16.5% applicable in Hong Kong. In addition, the provision includes deferred income taxes resulting from adjustments in the amount of temporary differences. Temporary differences arise primarily from differences in timing in the deduction of state income taxes and the use of the straight-line method of depreciation for financial reporting purposes and accelerated methods of depreciation for tax purposes. F-14

70 JAKKS PACIFIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 NOTE 9 -- INCOME TAXES (CONTINUED) 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. Income taxes reflected in the accompanying consolidated statements of operations are comprised of the following: 1996 1997 1998 --------- -------- ---------- Federal.................... $ -- $ -- $ 715,000 State and local............ 1,350 26,000 210,000 Hong Kong.................. 277,994 522,522 874,595 --------- -------- ---------- 279,344 548,522 1,799,595 Deferred................... (116,069) 94,427 57,809 --------- -------- ---------- $ 163,275 $642,949 $1,857,404 ========= ======== ========== As of December 31, 1998, the Company has utilized all net operating loss carry-forwards. 1997 1998 --------- --------- Deferred tax assets resulting from deductible temporary differences from loss carry-forwards, noncurrent................... $ 258,239 $ 493,134 Deferred tax liabilities resulting from taxable temporary differences, noncurrent............ (345,135) (637,839) --------- --------- $ (86,896) $(144,705) ========= ========= The Company's management concluded that a deferred tax asset valuation allowance as of December 31, 1997 and 1998 was not necessary. A reconciliation of the statutory United States Federal income tax rate to the Company's effective income tax rate is as follows: 1996 1997 1998 ---- ---- ---- Statutory income tax rate......................... 35% 35% 35% State and local income taxes, net of Federal income tax effect............................... 1 1 1 Effect of temporary differences and Hong Kong's lower tax rate.................................. -- -- (22) Effect of net operating loss carry-forwards....... (40) (35) (11) Income taxes on foreign earnings at rates other than the United States Statutory rate not subject to United States income taxes........... 16 18 19 --- --- --- 12% 19% 22% === === === F-15

71 JAKKS PACIFIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 NOTE 9 -- INCOME TAXES (CONTINUED) The components of earnings before income taxes are as follows: 1996 1997 1998 ---------- ---------- ---------- Domestic................. $ (360,040) $ 16,216 $3,681,456 Foreign.................. 1,703,084 3,413,229 4,550,974 ---------- ---------- ---------- $1,343,044 $3,429,445 $8,232,430 ========== ========== ========== NOTE 10 -- LEASES The Company leases office and showroom facilities and certain equipment under operating leases. The following is a schedule of minimum annual lease payments. Rent expense for the years ended December 31, 1996, 1997 and 1998 totaled $182,690, $582,766 and $550,360, respectively. 1999............................... $ 549,360 2000............................... 423,940 2001............................... 324,852 2002............................... 223,632 2003............................... 23,032 ---------- $1,544,816 ========== NOTE 11 -- COMMON STOCK AND PREFERRED STOCK The Company has 25,005,000 authorized shares of stock consisting of 25,000,000 shares of $.001 par value common stock and 5,000 shares of $.001 par value of preferred stock. On April 1, 1998, the Company sold 1,000 shares of its Series A 7% cumulative convertible preferred stock to two investors for $4,731,152, net of costs. The holders of the shares have the right, at their option, to convert such shares into common stock of the Company at any time. The price at which shares of common stock shall be delivered upon conversion shall initially be $8.95 per share of common stock. The conversion price may be adjusted in certain instances. Preferred stockholders are entitled to receive cumulative cash dividends at an annual rate of $350 per share payable as and when declared by the Company's Board of Directors. During 1998, 143,950 shares of the Company's common stock were issued on exercise of options for a total of $647,392. During 1997, the Company issued 690,000 shares of its common stock in a public offering and 198,020 shares as partial payment for the RCI acquisition (note 3). During 1997, in a private placement, the Company issued 3,525 shares of its 4% redeemable convertible preferred stock at a purchase price of $2,000 per share. On March 12, 1998, all of the 3,525 shares of such issue were converted into an aggregate of F-16

72 JAKKS PACIFIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 NOTE 11 -- COMMON STOCK AND PREFERRED STOCK (CONTINUED) 939,998 shares of the Company's common stock based on a conversion price of $7.50 per share. NOTE 12 -- COMMITMENTS The Company has entered into various license agreements whereby the Company may use certain characters and properties in conjunction with its products. Such license agreements call for royalties to be paid at 5 to 10% of net sales with minimum guarantees and advance payments. Additionally, under one such license, the Company has committed to spend 12.5% of related net sales, not to exceed $1,000,000, on advertising per year. Future annual minimum royalty guarantees are as follows: 1999.............................. $ 1,752,833 2000.............................. 1,653,583 2001.............................. 1,551,750 2002.............................. 1,475,000 2003.............................. 1,380,000 Thereafter........................ 9,387,500 ----------- Total $17,200,666 =========== The Company entered into a joint venture agreement (note 3) creating a new limited liability company (LLC) in which the Company holds a 50% ownership interest. On June 10, 1998, the LLC entered into a license agreement through December 31, 2009, with an option for a five year automatic extension if the LLC pays the licensor $27,000,000 in royalties during the initial ten year period of the agreement. The license agreement includes a total of $18,000,000 in guaranteed royalty payments, payable over the ten year initial term and $7,500,000 guaranteed payments over the five year renewal period, if applicable. The Company is responsible for $7,500,000 of the $18,000,000 guarantee royalty payments. The guarantee payments include a $3,000,000 advance, paid within 15 days after the agreements were executed, and ten minimum guaranteed installments of $1,500,000, due each January 30, starting in 2000 and ending 2009. The Company was responsible for funding $1,000,000 of the initial advance and is responsible for $500,000 of the first four and $750,000 of the next six of ten yearly installments. All unpaid guaranteed amounts as of December 31, 1998 are included in the totals of the "future annual minimum royalty guarantees" table noted above. The $7,500,000 renewal guaranteed will be payable in five yearly installments, of which the Company will be responsible for 50% of each yearly payment. The Company entered into a firm price commitment, manufacturing and supply agreement in connection with the acquisition of the R&CG trademarks purchased in 1997 (note 3). The agreement was entered into with the seller of the trademarks to obtain from the seller tools and other manufacturing resources of the seller for the manufacture of products, upon request by the Company. The manufacturing and supply agreement has created a firm commitment by the Company for a minimum of $1,400,000. A minimum F-17

73 JAKKS PACIFIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 NOTE 12 -- COMMITMENTS (CONTINUED) payment of $110,000 on the agreement was due on December 31, 1997, with three additional payments of $110,000 and six of $160,000 payments to follow thereafter, through March 31, 2000, which is also the date on which the agreement terminates. The Company and its subsidiaries are acting as joint and several guarantors of a $5,000,000 conditional, secured, revolving, short-term trade facility available to the Company's Hong Kong wholly-owned subsidiaries. Proceeds on the credit facility are to finance working capital needs and operations, in the normal course of business. At December 31, 1997 and 1998, there was an unused amount available on the line of credit of $4,885,300 and $5,000,000 and an outstanding balance of $114,700 and $0, respectively. Outstanding balances accrue interest at rates equal to the bank's base rate of interest plus 1% per annum for advances of open accounts receivable, and the bank's base rate of interest plus 1/2% for advances received under negotiation of export letters of credit. At December 31, 1998, the credit facility carried interest at rates of 9.5% and 9%, respectively. Outstanding balances are collateralized by all assets of the borrower and accounts receivable and inventory of the guarantors. The credit facility expires May 31, 1999, unless terminated sooner (note 8). NOTE 13 -- STOCK OPTION PLAN Under its Third Amended and Restated 1995 Stock Option Plan (the Plan), the Company has reserved 1,250,000 shares of its common stock for issuance under the Plan. In 1998, stockholders approved an increase of 500,000 shares in the number of shares available for grant. Under the Plan, employees (including officers), non-employee directors and independent consultants may be granted options to purchase shares of common stock. Prior to the adoption of the Plan in 1995, options for 276,500 shares were granted at an exercise price of $2.00 per share. The Company recorded deferred compensation costs and a related increase in paid-in capital of $212,905 for the difference between the grant price and the deemed fair market value of the common stock of $2.77 per share at the date of grant. Such compensation costs are recognized on a straight-line basis over the vesting period of the options, which is 25% per year commencing twelve months after the grant date of such options. In 1996, 1997 and 1998, the fair value of each employee option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used: risk-free rate of interest of 6%; dividend yield of 0%; and expected lives of five years. As of December 31, 1998, 308,000 shares were available for future grant. Additional shares may become available to the extent that options presently outstanding under the Plan terminate or expire unexercised. F-18

74 JAKKS PACIFIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 NOTE 13 -- STOCK OPTION PLAN (CONTINUED) Stock option activity pursuant to the Plan is summarized as follows: WEIGHTED AVERAGE NUMBER EXERCISE OF SHARES PRICE --------- -------- Outstanding, December 31, 1995............ 10,850 $4.50 Granted................................. 114,625 6.70 Exercised............................... -- -- Canceled................................ -- -- ------- ----- Outstanding, December 31, 1996............ 125,475 6.51 Granted................................. 405,025 9.92 Exercised............................... -- -- Canceled................................ -- -- ------- ----- Outstanding, December 31, 1997............ 530,500 9.12 Granted................................. 484,500 8.38 Exercised............................... (31,800) 8.18 Canceled................................ (73,000) 8.77 ------- ----- Outstanding, December 31, 1998............ 910,200 $8.79 ======= ===== Stock option activity outside of the Plan is summarized as follows: WEIGHTED AVERAGE NUMBER EXERCISE OF SHARES PRICE --------- -------- Outstanding, December 31, 1995............ 276,500 $2.00 Granted................................. 75,000 7.54 Exercised............................... -- -- Canceled................................ -- -- -------- ----- Outstanding, December 31, 1996............ 351,500 3.18 Granted................................. 60,000 6.88 Exercised............................... (69,125) 2.00 Canceled................................ -- -- -------- ----- Outstanding, December 31, 1997............ 342,375 4.07 Granted................................. -- -- Exercised............................... (100,900) 3.93 Canceled................................ (33,750) 2.00 -------- ----- Outstanding, December 31, 1998............ 207,725 $4.47 ======== ===== The weighted average fair value of options granted to employees in 1996, 1997 and 1998 was $2.30, $5.01 and $6.15 per share, respectively. F-19

75 JAKKS PACIFIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 NOTE 13 -- STOCK OPTION PLAN (CONTINUED) The following table summarizes information about stock options outstanding and exercisable at December 31, 1998: OUTSTANDING EXERCISABLE -------------------------------- -------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE NUMBER AVERAGE EXERCISE NUMBER EXERCISE OPTION PRICE RANGE OF SHARES LIFE PRICE OF SHARES PRICE ------------------ --------- --------- -------- --------- -------- $2.00-$10.725................... 1,117,925 5.7 years $7.99 434,400 $7.53 In addition, as of December 31, 1998, 635,000 shares were reserved for issuance upon exercise of warrants granted in connection with the Company's initial public offering, follow-on public offering, private placement of convertible debentures and certain license agreements, at exercise prices ranging from $6.75 to $10.00 per share. Had the compensation cost for the Company's Plan been determined on a basis consistent with SFAS No. 123, the Company's net income and earnings per share (EPS) for 1996, 1997 and 1998 would approximate the pro forma amounts below, which are not indicative of future amounts: YEARS ENDED DECEMBER 31, -------------------------------------------------------------------------- 1996 1997 1998 ----------------------- ----------------------- ---------------------- AS AS AS REPORTED PRO FORMA REPORTED PRO FORMA REPORTED PRO FORMA ---------- ---------- ---------- ---------- --------- ---------- SFAS No. 123 charge, net of tax......... $ -- $ 18,172 $ -- $ 132,895 -- $ 551,541 Net income........... 1,179,769 1,161,597 2,786,496 2,653,601 6,375,026 5,823,485 Basic EPS............ 0.36 0.35 0.60 0.57 1.12 1.02 Diluted EPS.......... 0.34 0.33 0.52 0.50 0.89 0.82 F-20

76 JAKKS PACIFIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 NOTE 14 -- PROFIT SHARING PLAN Effective January 1, 1997, the Company adopted a 401(k) profit sharing plan and trust (Plan). The Plan is for the exclusive benefit of eligible employees and beneficiaries. Under the Plan, employees may choose to reduce their compensation and have those amounts contributed to the Plan on their behalf. Contributions made to the Plan will be held and invested by the Plan's trustee. The Company will act as the Plan's administrator. The Plan year begins on January 1st and ends on December 31st. Employees then employed were eligible to participate in the Plan as of the effective date. Otherwise, employees may be eligible to participate in the Plan after they have completed one year of service. The Company will make matching contributions equal to 50% of the amount of salary reduction deferred. However, in applying the matching percent, only salary reductions up to 10% of compensation will be considered. The Company may also make discretionary contributions to the Plan each year. Participants may elect to defer up to 15% of their compensation each year. However, deferrals in any taxable year may not exceed a dollar limit which is set by law. The limit for 1998 was $10,000. Vesting in the Plan is based on years of service, as follows: YEARS OF SERVICE CUMULATIVE PERCENT VESTED ---------------- ------------------------- 1 20% 2 40 3 60 4 80 5 100 Participants are immediately 100% vested in their salary reduction amounts contributed to the Plan. The Company has the right to amend and, terminate the Plan at any time. Upon termination, all amounts credited to participants accounts will become 100% vested. As of December 31, 1998, the Plan has not been "qualified" under the provisions of the Internal Revenue Code, and for the year then ended, the Company contributed $65,217 in matching contributions to the Plan. NOTE 15 -- MAJOR CUSTOMERS AND INTERNATIONAL SALES Net sales to major customers were as follows: 1996 1997 1998 ------------------------ ------------------------- ------------------------- AMOUNT PERCENTAGE AMOUNT PERCENTAGE AMOUNT PERCENTAGE ---------- ---------- ----------- ---------- ----------- ---------- $3,398,000.. 28.2% $14,689,000 35.0% $23,604,000 27.7% 1,679,000.. 13.9 3,422,000 8.2 11,103,000 13.0 1,008,000.. 8.4 3,199,000 7.6 10,944,000 12.8 847,000... 7.0 2,658,000 6.3 9,951,000 11.7 509,000... 4.2 1,925,000 4.6 3,717,000 4.4 ---------- ---- ----------- ---- ----------- ---- $7,441,000.. 61.7% $25,893,000 61.7% $59,319,000 69.6% ========== ==== =========== ==== =========== ==== F-21

77 JAKKS PACIFIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 NOTE 15 -- MAJOR CUSTOMERS AND INTERNATIONAL SALES (CONTINUED) Net sales to international customers totaled approximately $1,043,000, $3,733,000 and $6,309,000 in 1996, 1997 and 1998, respectively. NOTE 16 -- SUPPLEMENTAL INFORMATION TO CONSOLIDATED STATEMENTS OF CASH FLOWS On March 30, 1998, the 3,525 shares of 4% redeemable convertible preferred stock with a total stockholders' equity value of $6,818,350 were converted into an aggregate of 939,998 shares of the Company's common stock. In 1997, 198,020 shares of common stock valued at $1,500,000 were issued in connection with the acquisition of RCI (note 3). In 1996, 469,300 shares of common stock were issued pursuant to the conversion of bridge financing promissory notes which provided net proceeds of $1,044,779. NOTE 17 -- RECENT ACCOUNTING PRONOUNCEMENTS In March 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income." This statement establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. This statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. This new standard requires that an enterprise classify items of other comprehensive income by their nature in a financial statement; display the accumulated balances of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. This statement is effective for fiscal years beginning after December 15, 1997. To date, the Company has not had any transactions that are required to be reported in other comprehensive income. In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement requires public business enterprises to report financial and descriptive information about reportable segments. The statement also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement is effective for fiscal years beginning after December 15, 1997. The Company operates in one reportable segment: the development, production and marketing of toy and related products. NOTE 18 -- SUBSEQUENT EVENT On March 1, 1999, the holders of the Company's 9% convertible debentures have elected to convert an aggregate of $3,000,000 principal amount of the debentures into 521,740 shares of the Company's common stock on May 25, 1999. F-22

78 JAKKS PACIFIC, INC. AND SUBSIDIARIES SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 Allowances are deducted from the assets to which they apply, except for sales returns and allowances. BALANCE AT CHARGED TO CHARGED TO BALANCE BEGINNING OF COSTS AND OTHER AT END PERIOD EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD ------------ ---------- ---------- ---------- ---------- Year ended December 31, 1996: Allowance for: Uncollectible accounts.......... $ -- $ -- $ -- $ -- $ -- Reserve for potential product obsolescence...... -- -- -- -- -- Reserve for sales returns and allowances........ 460,513 253,568 -- 539,081 175,000 ---------- ---------- ---------- ---------- ---------- $ 460,513 $ 253,568 $ -- $ 539,081 $ 175,000 ========== ========== ========== ========== ========== Year ended December 31, 1997: Allowance for: Uncollectible accounts.......... $ -- $ -- $ 51,153 $ -- $ 51,153 Reserve for potential product obsolescence...... -- -- 200,000 70,305 129,695 Reserve for sales returns and allowances........ 175,000 3,660,775 1,050,000 3,024,954 1,860,821 ---------- ---------- ---------- ---------- ---------- $ 175,000 $3,660,775 $1,301,153 $3,095,259 $2,041,669 ========== ========== ========== ========== ========== Year ended December 31, 1998: Allowance for: Uncollectible accounts.......... $ 51,153 $ 82,833 $ -- $ -- $ 133,986 Reserve for potential product obsolescence...... 129,695 334,438 -- -- 464,133 Reserve for sales returns and allowances........ 1,860,821 6,525,867 -- 3,045,171 5,341,517 ---------- ---------- ---------- ---------- ---------- $2,041,669 $6,943,138 $ -- $3,045,171 $5,939,636 ========== ========== ========== ========== ========== F-23

79 PART II. INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth all costs and expenses in connection with the issuance and distribution of the securities being registered, other than underwriting discounts. All such expenses will be paid by the Company; none will be paid by the selling stockholders. SEC registration fee........................................ $ 13,465 NASD filing fee............................................. 5,343 *Blue sky fees and expenses (including legal fees).......... 500 Nasdaq National Market listing fee.......................... 17,500 *Printing and engraving expenses............................ 125,000 *Legal fees and expenses.................................... 200,000 *Accounting fees and expenses............................... 25,000 *Miscellaneous.............................................. 63,192 -------- *TOTAL............................................ $450,000 ======== - ------------------------- * Estimated ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS The Registrant's Certificate of Incorporation provides that the personal liability of the directors of the Registrant shall be limited to the fullest extent permitted by the provisions of Section 102(b)(7) of the General Corporation Law of the State of Delaware ("DGCL"). Section 102(b)(7) of the DGCL generally provides that no director shall be liable personally to the Registrant or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that the Certificate of Incorporation does not eliminate the liability of a director for (1) any breach of the director's duty of loyalty to the Registrant or its stockholders; (2) acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law; (3) acts or omissions in respect of certain unlawful dividend payments or stock redemptions or repurchases; or (4) any transaction from which such director derives an improper personal benefit. The effect of this provision is to eliminate the rights of the Registrant and its stockholders to recover monetary damages against a director for breach of her or his fiduciary duty of care as a director (including breaches resulting from negligent or grossly negligent behavior) except in the situations described in clauses (1) through (4) above. The limitations summarized above, however, do not affect the ability of the Registrant or its stockholders to seek nonmonetary remedies, such as an injunction or rescission, against a director for breach of her or his fiduciary duty. In addition, the Certificate of Incorporation provides that the Registrant shall, to the fullest extent permitted by Section 145 of the DGCL, indemnify all persons whom it may indemnify pursuant to Section 145 of the DGCL. In general, Section 145 of the DGCL permits the Registrant to indemnify a director, officer, employee or agent of the Registrant or, when so serving at the Registrant's request, another company who was or is a party or is threatened to be made a party to any proceeding because of his or her position, if he or she acted in good faith and in a manner reasonably believed to be in or not opposed to the best interests of the Registrant and, with respect to any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful. II-1

80 The Registrant maintains a directors' and officers' liability insurance policy covering certain liabilities that may be incurred by any director or officer in connection with the performance of his or her duties and certain liabilities that may be incurred by the Registrant, including the indemnification payable to any director or officer. This policy provides for $1 million in maximum aggregate coverage, including defense costs. The entire premium for such insurance is paid by the Registrant. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers, or persons controlling the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been informed that in the opinion of the Commission, such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. ITEM 16. EXHIBITS EXHIBIT NUMBER DESCRIPTION ------- ----------- 1.1 Form of Underwriting Agreement(1) 4.1 Restated Certificate of Incorporation of the Registrant(2) 4.1.1 Certificate of Designation and Preferences of Series A Cumulative Convertible Preferred Stock of the Registrant(3) 4.1.2 Amendment to Restated Certificate of Incorporation of the Registrant(4) 4.2 By-laws of the Registrant(2) 4.2.1 Amendment to By-laws of the Registrant(5) 5.1 Opinion of Feder, Kaszovitz, Isaacson, Weber, Skala & Bass LLP(1) 23.1 Consent of Pannell Kerr Forster, Certified Public Accountants, A Professional Corporation(4) 23.2 Consent of Feder, Kaszovitz, Isaacson, Weber, Skala & Bass LLP (included in Exhibit 5.1)(1) 24.1 Power of Attorney (included in Part II to this registration statement) 27.1 Financial Data Schedule(4) - ------------------------- (1) To be filed by amendment. (2) Filed previously as an exhibit to the Registrant's Registration Statement on Form SB-2 (Reg. No. 333-2048-LA), dated May 1, 1996, and incorporated herein by reference. (3) Filed previously as an exhibit to the Registrant's Current Report on Form 8-K, filed August 7, 1998, and incorporated herein by reference. (4) Filed herewith. (5) Filed previously as an exhibit to the Registrant's Registration Statement on Form SB-2 (Reg. No. 333-22583), effective May 1, 1997, and incorporated herein by reference. ITEM 17. UNDERTAKINGS 1. The Registrant hereby undertakes that, for purposes of determining any liability under the Securities Act of 1933, each filing of the Registrant's annual report pursuant to section 13(a) or section 15(d) of the Securities Exchange Act of 1934 (and, where II-2

81 applicable, each filing of an employee benefit plan's annual report pursuant to section 15(d) of the Securities Exchange Act of 1934) that is incorporated by reference in the registration statement shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. 2. The Registrant hereby undertakes that: (a) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. (b) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. 3. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. II-3

82 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements of filing on Form S-3 and has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Malibu, State of California, on March 19, 1999. JAKKS PACIFIC, INC. By: /s/ JACK FRIEDMAN ----------------------------------- Jack Friedman, Chairman Each of the undersigned hereby constitutes and appoints Jack Friedman, Stephen G. Berman and Joel M. Bennett, and each of them, as his attorneys-in-fact, with full power of substitution and resubstitution, to execute in his name, place and stead, individually and in each capacity stated below, one or more amendments (including without limitation post-effective amendments) to this registration statement, any related Rule 462(b) registration statement and any other document, to file the same with the Commission and to take any other action to effect the registration under the Securities Act of 1933 of the common stock of the registrant, as the attorney-in-fact acting in the premises deems appropriate as fully for all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact, or his substitute or substitutes, acting severally, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities and on the date indicated. SIGNATURE TITLE DATE --------- ----- ---- /s/ JACK FRIEDMAN Chief Executive Officer March 19, 1999 - --------------------------------------------- and Chairman (Principal Jack Friedman Executive Officer) /s/ STEPHEN G. BERMAN Director March 19, 1999 - --------------------------------------------- Stephen G. Berman /s/ JOEL M. BENNETT Chief Financial Officer March 19, 1999 - --------------------------------------------- (Principal Financial Joel M. Bennett Officer and Principal Accounting Officer) /s/ ROBERT E. GLICK Director March 19, 1999 - --------------------------------------------- Robert E. Glick /s/ MICHAEL G. MILLER Director March 19, 1999 - --------------------------------------------- Michael G. Miller /s/ MURRAY L. SKALA Director March 19, 1999 - --------------------------------------------- Murray L. Skala II-4

83 EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION - ------- ----------- 1.1 Form of Underwriting Agreement(1) 4.1 Restated Certificate of Incorporation of the Registrant(2) 4.1.1 Certificate of Designation and Preferences of Series A Cumulative Convertible Preferred Stock of the Registrant(3) 4.1.2 Amendment to Restated Certificate of Incorporation of the Registrant(4) 4.2 By-laws of the Registrant(2) 4.2.1 Amendment to By-laws of the Registrant(5) 5.1 Opinion of Feder, Kaszovitz, Isaacson, Weber, Skala & Bass LLP(1) 23.1 Consent of Pannell Kerr Forster, Certified Public Accountants, A Professional Corporation(4) 23.2 Consent of Feder, Kaszovitz, Isaacson, Weber, Skala & Bass LLP (included in Exhibit 5.1)(1) 24.1 Power of Attorney (included in Part II to this registration statement) 27.1 Financial Data Schedule(4) - ------------------------- (1) To be filed by amendment. (2) Filed previously as an exhibit to the Registrant's Registration Statement on Form SB-2 (Reg. No. 333-2048-LA), dated May 1, 1996, and incorporated herein by reference. (3) Filed previously as an exhibit to the Registrant's Current Report on Form 8-K, filed August 7, 1998, and incorporated herein by reference. (4) Filed herewith. (5) Filed previously as an exhibit to the Registrant's Registration Statement on Form SB-2 (Reg. No. 333-22583), effective May 1, 1997, and incorporated herein by reference.

1 EXHIBIT 4.1.2 CERTIFICATE OF AMENDMENT OF RESTATED CERTIFICATE OF INCORPORATION OF JAKKS PACIFIC, INC. The undersigned hereby certifies as follow: 1. The Board of Directors of JAKKS Pacific, Inc., a Delaware corporation (the "Company"), has adopted resolutions to increase the number of shares of Preferred Stock that the Company shall have authority to issue to 1,000,000 shares, and, for this purpose, authorizing that the Company's Restated Certificate of Incorporation be amended by deleting Article FOURTH thereof in its entirety and by inserting in lieu thereof the following: FOURTH: The total number of shares of stock which the Company shall have authority to issue is 26,000,000 shares, of which 25,000,000 shares shall comprise a single class of common stock, par value $.001 per share, and 1,000,000 shares shall comprise a single class of preferred stock, par value $.001 per share (the "Preferred Stock"). The shares of Preferred Stock may be issued from time to time, when and as authorized by the Company's Board of Directors in one or more series, upon such terms and conditions as the Company's Board of Directors shall approve. The Company's Board of Directors is expressly authorized to provide for the issuance of all or any shares of the Preferred Stock in one or more classes or series, and, subject to the provisions hereof, to fix by resolution or resolutions the designations, powers, preferences and relative, participating, optional or other special rights, and the qualifications, limitations and restrictions, of each such class or series. 2. The foregoing amendment was duly adopted in accordance with Section 242 of the General Corporation Law of Delaware. IN WITNESS WHEREOF, the undersigned has duly executed this Certificate on this 12th day of February, 1999. /s/ Stephen G. Berman ---------------------------------- Stephen G. Berman, President

1 EXHIBIT 23.1 CONSENT OF PANNELL KERR FORSTER We hereby consent to the inclusion in the Registration Statement on Form S-3 of JAKKS Pacific, Inc. of our report dated February 22, 1999, except for note 18, for which the date is March 1, 1999, on our audits of the consolidated financial statements of JAKKS Pacific, Inc. as of December 31, 1997 and 1998, and for each of the three years in the period ended December 31, 1998. We also hereby consent to the reference to our firm as "Experts" in the Registration Statement. /s/ PANNELL KERR FORSTER -------------------------------------- Pannell Kerr Forster Certified Public Accountants A Professional Corporation Los Angeles, California March 19, 1999

5 US DOLLARS YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 1 12,452,201 0 12,060,711 133,986 2,918,941 28,633,014 6,462,714 2,173,708 58,735,765 14,897,107 5,940,000 0 1 6,026 37,747,926 58,735,765 85,252,653 85,252,653 52,000,135 24,006,497 590,948 0 422,553 8,232,430 1,857,404 0 0 0 0 6,375,026 1.12 .89