UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark one)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2020

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to ______

 

 

 

Commission file number: 0-28104

 

JAKKS Pacific, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware

95-4527222

(State or Other Jurisdiction of Incorporation or Organization)

(I.R.S. Employer Identification No.)

 

 

2951 28th Street

Santa MonicaCalifornia

(Address of Principal Executive Offices)

90405

(Zip Code)

 

Registrant’s Telephone Number, Including Area Code: (424) 268-9444

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes   ☒       No   ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes   ☒       No   ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “non-accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  ☐

Accelerated filer  ☐

Non-accelerated filer  ☒

Smaller reporting company  

Emerging growth company  

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐ 

 

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

 

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

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock $.001 Par Value

JAKK

The NASDAQ Global Select Market

 

The number of shares outstanding of the issuer’s common stock is 4,947,918 as of November 10, 2020.

 

 

 

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

TABLE OF CONTENTS  TO QUARTERLY REPORT ON FORM 10-Q

QUARTER ENDED SEPTEMBER 30, 2020

ITEMS IN FORM 10-Q

 

Part I

FINANCIAL INFORMATION

 

Item 1.

Financial Statements

 

 

Condensed Consolidated Balance Sheets - September 30, 2020 and December 31, 2019 (Unaudited)

3

 

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2020 and 2019 (Unaudited)

4

 

Condensed Consolidated Statements of Stockholders' Equity for the Three and Nine Months Ended September 30, 2020 and 2019 (Unaudited)

5

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2020 and 2019 (Unaudited)

6

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

7

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

33

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

47

Item 4.

Controls and Procedures

47

 

 

 

Part II

OTHER INFORMATION

 

Item 1.

Legal Proceedings

48

Item 1A.

Risk Factors

48

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3.

Defaults Upon Senior Securities

None

Item 4.

Mine Safety Disclosures

None

Item 5.

Other Information

None

Item 6.

Exhibits

48

 

 

 

Signatures

49

Exhibit 31.1

 

Exhibit 31.2

 

Exhibit 32.1

 

Exhibit 32.2

 

 

 

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

 

Assets  

September 30,
2020

   

December 31,
2019

 
    (Unaudited)  

Current assets

               

Cash and cash equivalents

  $ 75,189     $ 61,613  

Restricted cash

    4,631       4,673  

Accounts receivable, net of allowance for doubtful accounts of $4,709 and $3,394 at September 30, 2020 and December 31, 2019, respectively

    166,789       117,942  

Inventory

    54,583       54,259  

Prepaid expenses and other assets

    22,125       21,898  

Total current assets

    323,317       260,385  

Property and equipment

               

Office furniture and equipment

    11,803       11,678  

Molds and tooling

    95,810       103,335  

Leasehold improvements

    6,844       6,808  

Total

    114,457       121,821  

Less accumulated depreciation and amortization

    100,238       106,562  

Property and equipment, net

    14,219       15,259  

Operating lease right-of-use assets, net

    25,473       32,081  

Other long term assets

    6,915       18,926  

Intangible assets, net

    2,284       3,188  

Goodwill

    35,083       35,083  

Trademarks

    300       300  

Total assets

  $ 407,591     $ 365,222  

Liabilities, Preferred Stock and Stockholders' Equity

               

Current liabilities

               

Accounts payable

  $ 95,529     $ 61,196  

Accrued expenses

    43,885       39,515  

Reserve for sales returns and allowances

    44,217       38,365  

Income taxes payable

    1,625       2,492  

Short term operating lease liabilities

    9,661       9,451  

Short term debt, net

    22,544       1,905  

Total current liabilities

    217,461       152,924  

Long term operating lease liabilities

    18,392       25,632  

Debt, non-current portion, net of issuance costs and debt discounts

    151,379       174,962  

Other liabilities

    5,871       5,409  

Income taxes payable

    947       1,565  

Deferred income taxes, net

    226       226  

Total liabilities

    394,276       360,718  
                 

Preferred stock, $0.001 par value; 5,000,000 shares authorized; 200,000 shares issued and outstanding at September 30, 2020 and December 31, 2019

    1,418       483  
                 

Stockholders' Equity*

               

Common stock, $0.001 par value; 100,000,000 shares authorized; 4,416,663 and 3,521,037 shares issued and outstanding at September 30, 2020 and December 31, 2019, respectively*

    5       4  

Additional paid-in capital *

    211,636       200,507  

Accumulated deficit

    (186,081 )     (183,149 )

Accumulated other comprehensive loss

    (14,841 )     (14,422 )

Total JAKKS Pacific, Inc. stockholders' equity*

    10,719       2,940  

Non-controlling interests

    1,178       1,081  

Total stockholders' equity*

    11,897       4,021  

Total liabilities, preferred stock and stockholders' equity

  $ 407,591     $ 365,222  

 

* After giving effect to a 1 for 10 reverse stock split effective July 9, 2020.

 

See accompanying notes to condensed consolidated financial statements.

 

3

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(In thousands, except per share data)

 

   

Three Months Ended September 30, (Unaudited)

   

Nine Months Ended September 30, (Unaudited)

 
   

2020

   

2019

   

2020

   

2019

 

Net sales

  $ 242,290     $ 280,130     $ 387,605     $ 446,138  

Cost of sales

    167,674       199,271       279,869       333,193  

Gross profit

    74,616       80,859       107,736       112,945  

Selling, general and administrative expenses

    36,958       44,586       93,958       113,722  

Restructuring charge

          24       1,631       294  

Pandemic related charges

    145             366        

Acquisition related and other

          587             5,957  

Income (loss) from operations

    37,513       35,662       11,781       (7,028 )

Income from joint ventures

                2        

Other income (expense), net

    112       36       166       (123 )

Loss on extinguishment of debt

          (13,205 )           (13,205 )

Change in fair value of preferred stock derivative liability

    (2,707 )           (624 )      

Change in fair value of convertible senior notes

    2,809       (463 )     2,757       (2,992 )

Interest income

    3       17       20       64  

Interest expense

    (5,566 )     (4,617 )     (16,656 )     (10,554 )

Income (loss) before provision for (benefit from) income taxes

    32,164       17,430       (2,554 )     (33,838 )

Provision for (benefit from) income taxes

    (267 )     1,016       281       1,360  

Net income (loss)

    32,431       16,414       (2,835 )     (35,198 )

Net income (loss) attributable to non-controlling interests

    49       (31 )     97       57  

Net income (loss) attributable to JAKKS Pacific, Inc.

  $ 32,382     $ 16,445     $ (2,932 )   $ (35,255 )

Net income (loss) attributable to common stockholders

  $ 32,066     $ 16,265     $ (3,867 )   $ (35,435 )

Income (loss) per share – basic*

  $ 8.39     $ 6.00     $ (1.17 )   $ (14.32 )

Shares used in income (loss) per share – basic*

    3,824       2,709       3,307       2,475  

Income (loss) per share – diluted*

  $ 3.19     $ 5.08     $ (1.17 )   $ (14.32 )

Shares used in income (loss) per share – diluted*

    9,307       6,035       3,307       2,475  

Comprehensive income (loss)

  $ 33,565     $ 15,516     $ (3,254 )   $ (35,243 )

Comprehensive income (loss) attributable to JAKKS Pacific, Inc.

  $ 33,516     $ 15,547     $ (3,351 )   $ (35,300 )

 

* After giving effect to a 1 for 10 reverse stock split effective July 9, 2020.

 

See accompanying notes to condensed consolidated financial statements.

 

4

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(In thousands)

 

Three and Nine Months Ended September 30, 2020

 

(Unaudited)

 
   

Common

Stock*

   

Treasury
Stock

   

Additional
Paid-in
Capital*

   

Accumulated
Deficit

   

Accumulated
Other
Comprehensive
Loss

   

JAKKS
Pacific, Inc.
Stockholders’
Equity*

   

Non-
Controlling
Interests

   

Total Stockholders'
Equity*

 
                                                                 

Balance, December 31, 2019

  $ 4     $     $ 200,507     $ (183,149 )   $ (14,422 )   $ 2,940     $ 1,081     $ 4,021  

Stock-based compensation expense

   
            252                   252             252  

Repurchase of common stock for employee tax withholding

   
            (172 )                 (172 )           (172 )

Preferred stock accrued dividends

   
            (307 )                 (307 )           (307 )

Net income (loss)

   
           
      (12,038 )           (12,038 )     40       (11,998 )

Foreign currency translation adjustment

   
           
            (1,634 )     (1,634 )           (1,634 )

Balance, March 31, 2020

    4             200,280       (195,187 )     (16,056 )     (10,959 )     1,121       (9,838 )

Conversion of convertible senior notes

    1             9,472                   9,473             9,473  

Stock-based compensation expense

   
            714                   714             714  

Repurchase of common stock for employee tax withholding

   
            (2 )                 (2 )           (2 )

Preferred stock accrued dividends

   
            (312 )                 (312 )           (312 )

Net income (loss)

   
           
      (23,276 )           (23,276 )     8       (23,268 )

Foreign currency translation adjustment

   
           
            81       81             81  

Balance, June 30, 2020

    5             210,152       (218,463 )     (15,975 )     (24,281 )     1,129       (23,152 )

Conversion of convertible senior notes

                1,260                   1,260             1,260  

Stock-based compensation expense

                540                   540             540  

Repurchase of common stock for employee tax withholding

                                               

Preferred stock accrued dividends

                (316 )                 (316 )           (316 )

Net income

                      32,382             32,382       49       32,431  

Foreign currency translation adjustment

                            1,134       1,134             1,134  

Balance, September 30, 2020

  $ 5     $     $ 211,636     $ (186,081 )   $ (14,841 )   $ 10,719     $ 1,178     $ 11,897  

 

Three and Nine Months Ended September 30, 2019

 

(Unaudited)

 
   

Common

Stock*

   

Treasury
Stock

   

Additional
Paid-in
Capital*

   

Accumulated
Deficit

   

Accumulated
Other
Comprehensive
Loss

   

JAKKS
Pacific, Inc.
Stockholders’
Equity*

   

Non-
Controlling
Interests

   

Total Stockholders'
Equity*

 
                                                                 

Balance, December 31, 2018

  $ 3     $ (24,000 )   $ 218,182     $ (127,601 )   $ (15,847 )   $ 50,737     $ 912     $ 51,649  

Stock-based compensation expense

   
            618                   618             618  

Repurchase of common stock for employee tax withholding

   
            (249 )                 (249 )           (249 )

Net income (loss)

   
           
      (29,158 )           (29,158 )     31       (29,127 )

Foreign currency translation adjustment

   
           
            1,303       1,303             1,303  

Balance, March 31, 2019

    3       (24,000 )     218,551       (156,759 )     (14,544 )     23,251       943       24,194  

Stock-based compensation expense

   
            397                   397             397  

Repurchase of common stock for employee tax withholding

   
            (24 )                 (24 )           (24 )

Net income (loss)

   
           
      (22,542 )           (22,542 )     57       (22,485 )

Foreign currency translation adjustment

   
           
            (450 )     (450 )           (450 )

Balance, June 30, 2019

    3       (24,000 )     218,924       (179,301 )     (14,994 )     632       1,000       1,632  

Stock-based compensation expense

                857                   857             857  

Adjustment to additional paid-in capital

                2                   2             2  

Common stock issuance

    1             4,208                   4,209             4,209  

Treasury shares retirement

          24,000       (23,997 )                 3             3  

Preferred stock accrued dividends

                (180 )                 (180 )           (180 )

Net income (loss)

                      16,445             16,445       (31 )     16,414  

Foreign currency translation adjustment

                            (898 )     (898 )           (898 )

Balance, September 30, 2019

  $ 4     $     $ 199,814     $ (162,856 )   $ (15,892 )   $ 21,070     $ 969     $ 22,039  

 

* After giving effect to a 1 for 10 reverse stock split effective July 9, 2020.

 

See accompanying notes to condensed consolidated financial statements.

 

5

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

   

Nine Months Ended September 30,
(Unaudited)

 
   

2020

   

2019

 

Cash flows from operating activities

               

Net loss

  $ (2,835 )   $ (35,198 )

Adjustments to reconcile net loss to net cash provided by operating activities:

               

Provision for doubtful accounts

    1,793       601  

Depreciation and amortization

    8,992       14,471  

Payment-in-kind interest

    3,370       624  

Amortization of debt discount

    2,093       393  

Write-off and amortization of debt issuance costs

    1,053       1,103  

Share-based compensation expense

    1,506       1,872  

Gain on disposal of property and equipment

    (101 )     (72 )

Loss on extinguishment of debt

          13,205  

Change in fair value of convertible senior notes

    (2,757 )     2,992  

Change in fair value of preferred stock derivative liability

    624        

Changes in operating assets and liabilities:

               

Accounts receivable

    (50,640 )     (79,111 )

Inventory

    (324 )     (11,418 )

Prepaid expenses and other assets

    11,514       (2,731 )

Accounts payable

    33,505       79,360  

Accrued expenses

    4,370       30,343  

Reserve for sales returns and allowances

    5,852       8,706  

Income taxes payable

    (1,485 )     7  

Other liabilities

    (584 )     962  

Total adjustments

    18,781       61,307  

Net cash provided by operating activities

    15,946       26,109  

Cash flows from investing activities

               

Purchases of property and equipment

    (6,171 )     (7,624 )

Proceeds from sale of property and equipment

    51       12  

Net cash used in investing activities

    (6,120 )     (7,612 )

Cash flows from financing activities

               

Retirement of convertible senior notes

    (1,905 )      

Repayment of credit facility borrowings

          (7,500 )

Debt issuance costs

          (4,957 )

Term loan prepayment penalty

          (393 )

Proceeds from loan under the Paycheck Protection Program

    6,206        

Net proceeds from credit facility borrowings

          5,000  

Net proceeds from issuance of long term debt

          27,356  

Repayment of term loan facility

          (20,000 )

Repurchase of common stock for employee tax withholding

    (174 )     (273 )

Net cash provided by (used in) financing activities

    4,127       (767 )

Net increase in cash, cash equivalents and restricted cash

    13,953       17,730  

Effect of foreign currency translation

    (419 )     (45 )

Cash, cash equivalents and restricted cash, beginning of period

    66,286       58,205  

Cash, cash equivalents and restricted cash, end of period

  $ 79,820     $ 75,890  

Cash paid during the period for:

               

Income taxes

  $ 2,846     $ 152  

Interest

  $ 12,344     $ 5,956  

 

As of September 30, 2020, there was $2.9 million of property and equipment purchases included in accounts payable. As of September 30, 2019, there was $2.6 million of property and equipment purchases included in accounts payable.

 

See Notes 1, 5, 6 and 9 for additional supplemental information to the condensed consolidated statements of cash flows.

 

See accompanying notes to condensed consolidated financial statements.

 

6

 

 JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020 

 

Note 1 — Basis of Presentation

 

The accompanying unaudited interim condensed consolidated financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to prevent the information presented from being misleading. These financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K, which contains audited financial information for the three years in the period ended December 31, 2019.

 

The information provided in this report reflects all adjustments (consisting solely of normal recurring items) that are, in the opinion of management, necessary to present fairly the financial position and the results of operations for the periods presented. Interim results are not necessarily, especially given seasonality, indicative of results to be expected for a full year.

 

The condensed consolidated financial statements include the accounts of JAKKS Pacific, Inc. and its wholly-owned subsidiaries (collectively, “the Company”). The condensed consolidated financial statements also include the accounts of DreamPlay Toys, LLC, a joint venture with NantWorks LLC, JAKKS Meisheng Trading (Shanghai) Limited, a joint venture with Meisheng Cultural & Creative Corp., Ltd., and JAKKS Meisheng Animation (HK) Limited, a joint venture with Hong Kong Meisheng Cultural Company Limited.

 

Effective July 9, 2020, the Company completed a 1 for 10 reverse stock split of its $0.001 par value common stock reducing the issued and outstanding shares of common stock from 42,395,782 to 4,239,578 (“Reverse Stock Split”). The Reverse Stock Split did not cause an adjustment to the par value or the authorized shares of the common stock. All share and per share amounts in the financial statements and notes thereto have been retroactively adjusted for all periods presented to give effect to the Reverse Stock Split, including reclassifying an amount equal to the reduction in par value of common stock to additional paid-in capital. The primary reason for implementing the Reverse Stock Split was to regain compliance with the minimum bid price requirement of The NASDAQ Stock Market LLC (“Nasdaq”). On July 31, 2020, the Company was notified by Nasdaq that it had regained compliance with the Nasdaq listing requirements. On September 11, 2020, the Company received notice from Nasdaq that during the prior 30 day period the Company had not met a listing requirement to maintain a minimum Market Value of Publicly Held Shares of $15,000,000. The Company has until March 10, 2021 to cure this deficiency and/or meet any of Nasdaq’s other alternative continuing qualification criteria. 

 

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The new standard was initially effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. In November 2019, the FASB issued ASU 2019-10 which deferred the effective date of ASU 2016-13 by three years for Smaller Reporting Companies. As a result, the effective date for the standard is fiscal years beginning after December 15, 2022, and interim periods therein, and early adoption is permitted. The Company is currently evaluating the impact of the adoption of ASU 2016-13 on its condensed consolidated financial statements.

 

In August 2018, the FASB issued ASU 2018-13, “Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement,” which improves the effectiveness of the disclosures required under ASC 820 and modifies the disclosure requirements on fair value measurements, including the consideration of costs and benefits. The new standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, and early adoption is permitted. The adoption of this standard did not have an impact on the Company’s condensed consolidated financial statements.

 

In October 2018, the FASB issued ASU 2018-17, "Consolidation: Targeted Improvements to Related Party Guidance for Variable Interest Entities," which improves the accounting for variable interest entities by considering indirect interests held through related parties under common control for determining whether fees paid to decision makers and service providers are variable interests. This new standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The amendments are required to be applied retrospectively with a cumulative-effect adjustment to retained earnings at the beginning of the earliest period presented. Early adoption is permitted. The adoption of this standard did not have an impact on the Company's condensed consolidated financial statements.

 

7

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

In December 2019, the FASB issued ASU 2019-12, “Simplifying the Accounting for Income Taxes,” which simplifies the accounting for income taxes related to the approach for intra-period tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax assets for investments. The guidance also reduces complexity in certain areas, including the accounting for transactions that result in a step-up in the tax basis of goodwill and allocating taxes to members of a consolidated group. This new standard is effective for the Company for fiscal years beginning January 1, 2021, with early adoption permitted. The Company is currently evaluating the impact that the adoption of this new guidance will have on its condensed consolidated financial statements.

 

In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” The new standard provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions, for a limited period of time, to ease the potential burden of recognizing the effects of reference rate reform on financial reporting. The amendments in ASU 2020-04 apply to contracts, hedging relationships and other transactions that reference the London Inter-Bank Offered Rate ("LIBOR") or another reference rate expected to be discontinued due to the global transition away from LIBOR and certain other interbank offered rates. An entity may elect to apply ASU 2020-04 beginning March 12, 2020 through December 31, 2022. The Company is currently evaluating this option as it relates to its contracts that reference LIBOR, as well as the impact of the standard to the Company's condensed consolidated financial statements.

 

In August 2020, the FASB issued ASU 2020-06, “Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.” The new guidance eliminates two of the three models in ASC 470-20, which required entities to account for beneficial conversion features and cash conversion features in equity, separately from the host convertible debt or preferred stock. As a result, only conversion features accounted for under the substantial premium model in ASC 470-20 and those that require bifurcation in accordance with ASC 815-15 will be accounted for separately. In addition, the amendments in ASU 2020-06 eliminates some of the requirements in ASC 815-40 related to equity classification. The amendments in ASU 2020-06 further revised the guidance in ASC 260, Earnings Per Share (“EPS”), to address how convertible instruments are accounted for in calculating diluted EPS, and requires enhanced disclosures about the terms of convertible instruments and contracts in an entity’s own equity. The new standard is effective for the Company for fiscal years beginning after December 15, 2023, including interim periods within these fiscal years, with early adaption permitted. The Company is currently evaluating the impact of the adoption of ASU 2020-06 on its condensed consolidated financial statements.

 

Liquidity

 

On January 30, 2020, the World Health Organization (“WHO”) announced a global health emergency because of a new strain of coronavirus originating in Wuhan, China (the “COVID-19 outbreak”) and the risks to the international community as the virus spreads globally beyond its point of origin. In March 2020, the WHO classified the COVID-19 outbreak as a pandemic, based on the rapid increase in exposure globally.

 

The full impact of the COVID-19 outbreak continues to evolve as of the date of this report. As such, it is uncertain as to the full magnitude that the pandemic will have on the Company’s financial condition, liquidity, and future results of operations. Management is actively monitoring the global situation and the resulting impact on its financial condition, liquidity, operations, suppliers, industry, and workforce. Given the daily evolution of the COVID-19 outbreak and the global responses to curb its spread, the Company is unable to estimate the effects of the COVID-19 outbreak on its results of operations, financial condition, and liquidity for fiscal years 2020 and 2021. Beginning in China and moving throughout the world, 2020 has seen the full spectrum of stay-at-home orders and retail closures to reduced retailer hours and focus on “essential” items to some markets trying to take a business-as-usual approach. In addition, published data has indicated a similar wide range in some toy categories significantly outperforming last year’s comparable period sales while others lag behind, which is at least partly due to drastic changes in purchase occasions (e.g., staying at home with family in the backyard vs. attending a school acquaintance’s birthday party).

 

8

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

In mid-March 2020, the Company began migrating to a work-from-home model in compliance with local guidance. In early April 2020, the Company began to reassess its revenue and expense projections for the year in an attempt to anticipate decreases in customer and consumer demand based on the uncertainty associated with the economic impact of the pandemic. In parallel, the Company began a review of its worldwide spending to identify both short-term and long-term cost savings opportunities to preserve both profitability and liquidity. By late April 2020, the Company had identified new revenue and spending objectives for the full-year 2020 and synchronized those expectations across the senior leadership team. It is the Company’s intention to continue monitoring the pandemic’s impact across markets, channels and customers and strike the right balance of pursuing opportunity while minimizing risk to the Company’s long-term health.

 

On March 27, 2020, President Trump signed into law the “Coronavirus Aid, Relief and Economic Security Act (“CARES Act”). The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer-side social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. The Company continues to monitor and explore any relevant government assistance programs that could support either cash liquidity or operating results in the short-medium term. As of the filing of this document, the Company continues to have no draw down on its credit facility with Wells Fargo Bank, National Association (“Wells Fargo”).

 

On June 12, 2020, the Company received a $6.2 million loan under the Paycheck Protection Program (the “PPP Loan”) within the Coronavirus Aid Relief and Economic Security Act (the “CARES Act”). The PPP Loan matures on June 2, 2022 and is subject to the CARES Act terms which include, among other terms, an interest rate of 1.00% per annum and monthly installment payments of $261,275 commencing on December 1, 2020. The PPP Loan may be prepaid at any time prior to maturity with no prepayment penalties. The PPP Loan is subject to events of default and other provisions customary for a loan of this type. The application for the loan required the Company to, in good faith, certify that the current economic uncertainty made the loan request necessary to support the ongoing operations of the Company. This certification further required the Company to take into account its current business activity and its ability to access other sources of liquidity sufficient to support ongoing operations in a manner that is not significantly detrimental to the business. The PPP Loan may be forgiven, partially or in full, if certain conditions are met, principally based on having been disbursed for permissible purposes and maintaining certain average levels of employment and payroll as required by the CARES Act. The forgiveness of the loan is also dependent on the Company having initially qualified for the loan.

 

By the end of the third quarter, the Company had exhausted the $6.2 million in funds received under the Paycheck Protection Program. The Company spent $8.3 million in eligible forgivable expenses through September 17, 2020. It remains the Company’s intention to file for forgiveness of this loan. In the absence of knowing whether any funds will be forgiven and how the program may change as the year continues, the Company accounts for the note as debt under ASC 470 and has reflected $2.5 million as short term debt and $3.7 million as long term debt on its balance sheet related to this loan.

 

On April 23, 2020, the Small Business Administration issued new guidance that questioned whether a public company with substantial market value and access to capital markets would qualify to participate in the Paycheck Protection Program. Subsequently, on April 28, 2020 the Secretary of the Treasury and Small Business Administrator announced that the government will review all PPP loans of more than $2.0 million for which the borrower applies for forgiveness. If the Company were to be audited and receive an adverse finding in such audit, the Company could be required to return the full amount of the PPP Loan, which could reduce its liquidity, and potentially subject it to fines and penalties.

 

As of September 30, 2020 and December 31, 2019, the Company held cash and cash equivalents, including restricted cash, of $79.8 million and $66.3 million, respectively. Cash, and cash equivalents, including restricted cash held outside of the United States in various foreign subsidiaries totaled $56.9 million and $27.0 million as of September 30, 2020 and December 31, 2019, respectively. The cash and cash equivalents, including restricted cash balances in the Company's foreign subsidiaries have either been fully taxed in the U.S. or tax has been accounted for in connection with the Tax Cuts and Jobs Act, or may be eligible for a full foreign dividends received deduction under such Act, and thus would not be subject to additional U.S. tax should such amounts be repatriated in the form of dividends or deemed distributions. Any such repatriation may result in foreign withholding taxes, which the Company expects would not be significant as of September 30, 2020.

 

9

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

The Company’s primary sources of working capital are cash flows from operations and borrowings under its credit facility (see Note 6 - Credit Facilities).

 

Typically, cash flows from operations are impacted by the effect on sales of (1) the appeal of the Company’s products, (2) the success of its licensed brands, (3) the highly competitive conditions existing in the toy industry and in securing commercially-attractive licenses, (4) dependency on a limited set of large customers, and (5) general economic conditions. A downturn in any single factor or a combination of factors could have a material adverse impact upon the Company’s ability to generate sufficient cash flows to operate the business. In addition, the Company’s business and liquidity are dependent to a significant degree on its vendors and their financial health, as well as the ability to accurately forecast the demand for products. The loss of a key vendor, or material changes in support by them, or a significant variance in actual demand compared to the forecast, can have a material adverse impact on the Company’s cash flows and business.

 

As of September 30, 2020, the Company had $138.8 million (including $4.0 million in payment-in-kind interest) of outstanding indebtedness under a First Lien Term Loan Facility Credit Agreement (the “New Term Loan Agreement”), and no outstanding indebtedness under its amended and extended Credit Agreement (the “Amended ABL Credit Agreement” or “Amended Wells Fargo Credit Agreement”) with Wells Fargo. The Company also had the aforementioned PPP Loan of $6.2 million secured under the CARES Act program.

 

The New Term Loan Agreement and Amended ABL Credit Agreement each contain negative covenants that, subject to certain exceptions, limit the ability of the Company and its subsidiaries to, among other things, incur additional indebtedness, make restricted payments, pledge their assets as security, make investments, loans, advances, guarantees and acquisitions, undergo fundamental changes and enter into transactions with affiliates, as well as cross-default provisions. The Company secured the appropriate waivers from both parties before receiving the proceeds of the PPP Loan. The original terms of the New Term Loan Agreement required the Company to maintain a trailing 12-month Earnings Before Interest Tax Depreciation and Amortization (“EBITDA”) (as defined and adjusted therein) of not less than $34.0 million and a minimum liquidity of not less than $10.0 million commencing with the fiscal quarter ending September 30, 2020.

 

On October 16, 2020, the Company reached an agreement (the “Amendment”) with holders of its term loan and Wells Fargo, holder of its revolving credit facility, to amend the New Term Loan Agreement and defer its EBITDA covenant calculation until March 31, 2022. Under the Amendment, the trailing 12-month EBITDA requirement has been reduced to $25.0 million, which will not be calculated earlier than March 31, 2022. The Amendment also requires the Company to pre-pay $15.0 million of the New Term Loan immediately and, under certain conditions, pre-pay up to an additional $5.0 million no later than the third quarter of fiscal year 2021. As a result, the Company reclassified $20.0 million from long term debt to short term debt as of September 30, 2020.

 

The New Term Loan Agreement contains events of default that are customary for a facility of this nature, including nonpayment of principal, nonpayment of interest, fees or other amounts, material inaccuracy of representations and warranties, violation of covenants, cross-default to other material indebtedness, bankruptcy or insolvency events, material judgment defaults and a change of control as specified in the New Term Loan Agreement, and cross-default provisions with the Amended Wells Fargo Credit Agreement. If an event of default occurs under either Agreement, the maturity of the amounts owed under the New Term Loan Agreement and the Amended Wells Fargo Credit Agreement may be accelerated.

 

The Company’s unaudited interim condensed consolidated financial statements for the three and nine months ended September 30, 2020 have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. Cash and cash equivalents, including restricted cash, projected cash flow from operations, and borrowings under the Company’s credit facility are sufficient to meet the Company’s working capital and capital expenditure requirements for the next 12 months.

 

10

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

Note 2 — Business Segments, Geographic Data, and Sales by Major Customers

 

The Company is a worldwide producer and marketer of children’s toys and other consumer products, principally engaged in the design, development, production, marketing and distribution of its diverse portfolio of products. The Company recently re-aligned its products into two reporting segments to better reflect the management and operation of the business. The Company’s segments are (i) Toys/Consumer Products and (ii) Halloween. Prior year’s segment reporting has been restated to reflect this change.

 

The Toys/Consumer Products segment includes action figures, vehicles, play sets, plush products, dolls, electronic products, construction toys, infant and pre-school toys, child-sized and hand-held role play toys and everyday costume play, foot- to-floor ride-on vehicles, wagons, novelty toys, seasonal and outdoor products, kids’ indoor and outdoor furniture, and related products, and makeup and skincare products under the C'est Moi brand.

 

Within the Halloween segment, the Company markets and sells Halloween costumes and accessories and everyday costume play products, primarily in the U.S. and Canada.

 

Segment performance is measured at the operating income (loss) level. All sales are made to external customers and general corporate expenses have been attributed to the segments based upon relative sales volumes. Segment assets are primarily comprised of accounts receivable and inventories, net of applicable reserves and allowances, goodwill and other assets.

 

Results are not necessarily those which would be achieved if each segment was an unaffiliated business enterprise. Information by segment and a reconciliation to reported amounts for the three and nine months ended September 30, 2020 and 2019 and as of September 30, 2020 and December 31, 2019 are as follows (in thousands):

 

 

   

Three Months Ended
September 30,

   

Nine Months Ended
September 30,

 
   

2020

   

2019

   

2020

   

2019

 

Net Sales

                               

Toys/Consumer Products

  $ 187,309     $ 204,338     $ 306,088     $ 330,319  

Halloween

    54,981       75,792       81,517       115,819  
    $ 242,290     $ 280,130     $ 387,605     $ 446,138  

 

   

Three Months Ended
September 30,

   

Nine Months Ended
September 30,

 
   

2020

   

2019

   

2020

   

2019

 

Income (Loss) from Operations

                               

Toys/Consumer Products

  $ 33,843     $ 32,515     $ 15,493     $ (966 )

Halloween

    3,670       3,147       (3,712 )     (6,062 )
    $ 37,513     $ 35,662     $ 11,781     $ (7,028 )

 

   

Three Months Ended
September 30,

   

Nine Months Ended
September 30,

 
   

2020

   

2019

   

2020

   

2019

 

Depreciation and Amortization Expense

                               

Toys/Consumer Products

  $ 4,280     $ 5,499     $ 8,396     $ 11,827  

Halloween

    251       1,499       596       2,644  
    $ 4,531     $ 6,998     $ 8,992     $ 14,471  

 

11

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

   

September 30,
2020

   

December 31,
2019

 

Assets

               

Toys/Consumer Products

  $ 353,172     $ 356,584  

Halloween

    54,419       8,638  
    $ 407,591     $ 365,222  

 

The following tables present information about the Company by geographic area as of September 30, 2020 and December 31, 2019 and for the three and nine months ended September 30, 2020 and 2019 (in thousands):

 

   

September 30,
2020

   

December 31,
2019

 

Long-lived Assets

               

United States

  $ 24,467     $ 31,175  

China

    11,454       11,461  

Hong Kong

    2,149       2,937  

United Kingdom

    1,431       1,633  

Canada

    102       134  

Mexico

    89        
    $ 39,692     $ 47,340  

 

   

Three Months Ended
September 30,

   

Nine Months Ended

September 30,

 
   

2020

   

2019

   

2020

   

2019

 

Net Sales by Customer Area

                               

United States

  $ 202,303     $ 229,975     $ 320,998     $ 369,942  

Europe

    21,045       25,740       34,424       39,477  

Canada

    9,523       10,218       14,555       14,960  

Asia

    2,744       3,820       5,976       7,287  

Australia & New Zealand

    1,936       2,582       4,269       4,270  

Latin America

    4,504       6,853       6,586       8,789  

Middle East & Africa

    235       942       797       1,413  
    $ 242,290     $ 280,130     $ 387,605     $ 446,138  

 

Major Customers

 

Net sales to major customers for the three and nine months ended September 30, 2020 and 2019 were as follows (in thousands, except for percentages):

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2020

   

2019

   

2020

   

2019

 
   

Amount

   

Percentage
of Net Sales

   

Amount

   

Percentage
of Net Sales

   

Amount

   

Percentage
of Net Sales

   

Amount

   

Percentage
of Net Sales

 

Wal-Mart

  $ 75,018       31.0

%

  $ 78,347       28.0

%

  $ 115,736       29.9

%

  $ 130,165       29.2 %

Target

    60,683       25.0       64,172       22.9       94,227       24.3       90,367       20.2  
    $ 135,701       56.0

%

  $ 142,519       50.9

%

  $ 209,963       54.2

%

  $ 220,532       49.4 %

 

No other customer accounted for more than 10% of the Company's total net sales.

 

12

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

The concentration of the Company’s business with a relatively small number of customers may expose the Company to material adverse effects if one or more of its large customers were to experience financial difficulty. The Company performs ongoing credit evaluations of its top customers and maintains an allowance for potential credit losses.

 

Note 3 — Inventory

 

Inventory, which includes the ex-factory cost of goods, in-bound freight, duty and capitalized warehouse costs, is valued at the lower of cost (first-in, first-out) or net realizable value, net of inventory obsolescence reserve, and consists of the following (in thousands):

 

   

September 30,
2020

   

December 31,
2019

 

Raw materials

  $ 3     $ 144  

Finished goods

    54,580       54,115  
    $ 54,583     $ 54,259  

 

Note 4 — Revenue Recognition and Reserve for Sales Returns and Allowances

 

The Company’s contracts with customers only include one performance obligation (i.e., sale of the Company’s products). Revenue is recognized in the gross amount at a point in time when delivery is completed and control of the promised goods is transferred to the customers. Revenue is measured as the amount of consideration the Company expects to be entitled to in exchange for those goods. The Company’s contracts do not involve financing elements as payment terms with customers are less than one year. Further, because revenue is recognized at the point in time goods are sold to customers, there are no contract assets or contract liability balances.

 

The Company disaggregates its revenues from contracts with customers by reporting segment: Toys/Consumer Products and Halloween. The Company further disaggregates revenues by major geographic region. See Note 2 - Business Segments, Geographic Data, and Sales by Major Customers, for further information.

 

The Company offers various discounts, pricing concessions, and other allowances to customers, all of which are considered in determining the transaction price. Certain discounts and allowances are fixed and determinable at the time of sale and are recorded at the time of sale as a reduction to revenue. Other discounts and allowances can vary and are determined at management’s discretion (variable consideration). Specifically, the Company occasionally grants discretionary credits to facilitate markdowns and sales of slow moving merchandise, and consequently accrues an allowance based on historic credits and management estimates. Further, while the Company generally does not allow product returns, the Company does make occasional exceptions to this policy, and consequently records a sales return allowance based upon historic return amounts and management estimates. These allowances (variable consideration) are estimated using the expected value method and are recorded at the time of sale as a reduction to revenue. The Company adjusts its estimate of variable consideration at least quarterly or when facts and circumstances used in the estimation process may change. The variable consideration is not constrained as the Company has sufficient history on the related estimates and does not believe there is a risk of significant revenue reversal.

 

The Company also participates in cooperative advertising arrangements with some customers, whereby it allows a discount from invoiced product amounts in exchange for customer purchased advertising that features the Company’s products. Generally, these allowances range from 1% to 20% of gross sales, and are generally based upon product purchases or specific advertising campaigns. Such allowances are accrued when the related revenue is recognized. These cooperative advertising arrangements provide a distinct benefit at fair value, and are accounted for as direct selling expenses.

 

Sales commissions are expensed when incurred as the related revenue is recognized at a point in time and therefore the amortization period is less than one year. As a result, these costs are recorded as direct selling expenses, as incurred.

 

13

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

Shipping and handling activities are considered part of the Company’s obligation to transfer the products and therefore are recorded as direct selling expenses, as incurred.

 

The Company’s reserve for sales returns and allowances amounted to $44.2 million as of September 30, 2020, compared to $38.4 million as of December 31, 2019.

 

Note 5 — Debt

 

Convertible senior notes

 

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

 

   

September 30, 2020

   

December 31, 2019

 

4.875% convertible senior notes due 2020

  $     $ 1,905  

3.25% convertible senior notes due 2023*

    38,401       50,753  

Total convertible senior notes

  $ 38,401     $ 52,658  

 

* The amounts presented for the 3.25% convertible senior notes due 2023 within the table represent the fair value as of September 30, 2020 and December 31, 2019 (see Note 16 - Fair Value Measurements). The principal amount of these notes totaled $29.6 million and $37.6 million as of September 30, 2020 and December 31, 2019, respectively. The accrued, but unpaid, payment-in-kind interest is $1.0 million and $0.4 million as of September 30, 2020 and December 31, 2019, respectively.

 

Effective July 9, 2020, the Company completed a 1 for 10 reverse stock split of its $0.001 par value common stock reducing the issued and outstanding shares of common stock from 42,395,782 to 4,239,578 (“Reverse Stock Split”). The Reverse Stock Split did not cause an adjustment to the par value or the authorized shares of the common stock. All share and per share amounts in the financial statements and notes thereto have been retroactively adjusted for all periods presented to give effect to this Reverse Stock Split. The primary reason for implementing the Reverse Stock Split was to regain compliance with the minimum bid price requirement of The NASDAQ Stock Market LLC (“Nasdaq”). On July 31, 2020, the Company was notified by Nasdaq that it had regained compliance with the Nasdaq listing requirements.

 

In July 2013, the Company sold an aggregate of $100.0 million principal amount of 4.25% convertible senior notes due 2018 (the “2018 Notes”). The 2018 Notes, which were senior unsecured obligations of the Company, paid interest semi-annually in arrears on August 1 and February 1 of each year at a rate of 4.25% per annum and matured on August 1, 2018. Excluding the impact of the 1 for 10 reverse stock split, the initial conversion rate for the 2018 Notes was 114.3674 shares of the Company’s common stock per $1,000 principal amount of notes, equivalent to an initial conversion price of approximately $8.74 per share of common stock, subject to adjustment in certain events. In 2016, the Company repurchased and retired an aggregate of approximately $6.1 million principal amount of the 2018 Notes. In addition, approximately $0.1 million of the unamortized debt issuance costs were written off and a nominal gain was recognized in conjunction with the retirement of the 2018 Notes. During the first quarter of 2017, the Company exchanged and retired $39.1 million principal amount of the 2018 Notes at par for $24.1 million in cash and approximately 290,000 shares of its common stock. During the second quarter of 2017, the Company exchanged and retired $12.0 million principal amount of the 2018 Notes at par for $11.6 million in cash and 11,240 shares of its common stock, and approximately $0.1 million of the unamortized debt issuance costs were written off and a $0.1 million gain was recognized in conjunction with the exchange and retirement of the 2018 Notes.

 

14

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

In August 2017, the Company agreed with Oasis Management and Oasis Investments II Master Fund Ltd., (collectively, “Oasis”) the holder of approximately $21.6 million face amount of its 2018 Notes, to extend the maturity date of these notes to November 1, 2020. In addition, the interest rate was reduced to 3.25% per annum and, excluding the impact of the 1 for 10 reverse stock split, the conversion rate was increased to 328.0302 shares of the Company’s common stock per $1,000 principal amount of notes, among other things. After execution of a definitive agreement for the modification and final approval by the other members of the Company’s Board of Directors and Oasis’ Investment Committee, the transaction closed on November 7, 2017. In connection with this transaction, the Company recognized a loss on extinguishment of the debt of approximately $0.6 million. On July 26, 2018, the Company closed a transaction with Oasis to exchange $8.0 million face amount of the 2018 Notes with convertible senior notes similar to those issued to Oasis in November 2017. The July 26, 2018 $8.0 million Oasis notes mature on November 1, 2020, accrue interest at an annual rate of 3.25% and, excluding the impact of the 1 for 10 reverse stock split, are convertible into shares of the Company’s common stock at an initial rate of 322.2688 shares per $1,000 principal amount of the new notes. In connection with this transaction, the Company recognized a loss on extinguishment of the debt of approximately $0.5 million. The conversion price for the 3.25% convertible senior notes due 2020 was reset on November 1, 2018 and November 1, 2019 (each, a “reset date”) to a price equal to 105% above the 5-day Volume Weighted Average Price ("VWAP") preceding the reset date; provided, however, among other reset restrictions, that if the conversion price resulting from such reset is lower than 90 percent of the average VWAP during the 90 calendar days preceding the reset date, then the reset price shall be the 30-day VWAP preceding the reset date. Excluding the impact of the 1 for 10 reverse stock split, the conversion price of the 3.25% convertible senior notes due 2020 reset on November 1, 2018 to $2.54 per share and the conversion rate was increased to 393.7008 shares of the Company's common stock per $1,000 principal amount of notes.

 

The remaining $13.2 million of 2018 Notes were redeemed at par at maturity on August 1, 2018.

 

In August 2019, the Company entered into and consummated multiple, binding definitive agreements (collectively, the “Recapitalization Transaction”) among Wells Fargo, Oasis Investments II Master Fund Ltd. and an ad hoc group of holders of the 4.875% convertible senior notes due 2020 ( the "Investor Parties") to recapitalize the Company’s balance sheet, including the extension to the Company of incremental liquidity and at least three-year extensions of substantially all of the Company’s outstanding convertible debt obligations and revolving credit facility. The Company’s term loan agreement entered into with Great American Capital Partners (see Note 6 – Credit Facilities) was paid in full and terminated in connection with the Recapitalization Transaction.

 

In connection with the Recapitalization Transaction, the Company issued (i) amended and restated notes with respect to the $21.6 million Oasis Note issued on November 7, 2017, and the $8.0 million Oasis Note issued on July 26, 2018 (together, the “Existing Oasis Notes”), and (ii) a new $8.0 million convertible senior note having the same terms as such amended and restated notes (the "New $8.0 million Oasis Note" and collectively, the “New Oasis Notes” or the "3.25% convertible senior notes due 2023"). Interest on the New Oasis Notes is payable on each May 1 and November 1 until maturity and accrues at an annual rate of (i) 3.25% if paid in cash or 5.00% if paid in stock plus (ii) 2.75% payable in kind. The New Oasis Notes mature 91 days after the amounts outstanding under the New Term Loan are paid in full, and in no event later than July 3, 2023. 

 

Excluding the impact of the 1 for 10 reverse stock split, the New Oasis Notes provide, among other things, that the initial conversion price is $1.00. The conversion price will be reset on each February 9 and August 9, starting on February 9, 2020 (each, a “reset date”) to a price equal to 105% of the 5-day VWAP preceding the applicable reset date. Under no circumstances shall the reset result in a conversion price be below the greater of (i) the closing price on the trading day immediately preceding the applicable reset date and (ii) 30% of the stock price as of the Transaction Agreement Date, or August 7, 2019, and will not be greater than the conversion price in effect immediately before such reset. The Company may trigger a mandatory conversion of the New Oasis Notes if the market price exceeds 150% of the conversion price under certain circumstances. The Company may redeem the New Oasis Notes in cash if a person, entity or group acquires shares of the Company’s Common Stock, par value $0.001 per share (the “Common Stock”), and as a result owns at least 49% of the Company’s issued and outstanding Common Stock. In connection with the issuance of the New Oasis Notes, the Company recognized a loss on extinguishment of the Existing Oasis Notes of approximately $10.4 million. On February 9, 2020, excluding the impact of the 1 for 10 reverse stock split, the conversion price of the New Oasis Notes reset to $1.00 per share ($10.00 per share after reverse stock split). On August 9, 2020, the conversion price of the New Oasis Notes reset to $5.647.

 

15

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

In June 2020, $7.1 million of the New Oasis Notes (including $0.2 million in payment-in-kind interest) were converted for 710,100 shares of common stock. As a result, the Company recorded an increase to additional paid-in capital of $9.5 million. In August 2020, $1.0 million of the New Oasis Notes (including $27,288 in payment-in-kind interest) were converted for 177,085 shares of common stock. As a result, the Company recorded an increase to additional paid-in capital of $1.3 million.

 

A director of the Company is a portfolio manager at Oasis Management. 

 

The Company has elected to measure and present the debt held by Oasis at fair value using Level 3 inputs and as a result, recognized a gain of $2.8 million (net of payment-in-kind interest of $0.2 million) and a gain of $2.8 million (net of payment-in-kind interest of $0.7 million) for the three and nine months ended September 30, 2020, respectively, related to changes in the fair value of the New Oasis Notes. At September 30, 2020 and December 31, 2019, the debt held by Oasis had a fair value of approximately $38.4 million and $50.8 million, respectively (see Note 16 - Fair Value Measurements). The Company evaluated its credit risk as of September 30, 2020, and determined that there was no change from December 31, 2019.

 

In June 2014, the Company sold an aggregate of $115.0 million principal amount of 4.875% convertible senior notes due 2020 (the “2020 Notes”). The 2020 Notes are senior unsecured obligations of the Company paying interest semi-annually in arrears on June 1 and December 1 of each year at a rate of 4.875% per annum and will mature on June 1, 2020. Excluding the impact of the 1 for 10 reverse stock split, the initial and still current conversion rate for the 2020 Notes is 103.7613 shares of the Company’s common stock per $1,000 principal amount of notes, equivalent to an initial conversion price of approximately $9.64 per share of common stock, subject to adjustment in certain events. Upon conversion, the 2020 Notes will be settled in shares of the Company’s common stock. Holders of the 2020 Notes may require that the Company repurchase for cash all or some of their notes upon the occurrence of a fundamental change (as defined in the 2020 Notes). In January 2016, the Company repurchased and retired an aggregate of $2.0 million principal amount of the 2020 Notes. In addition, approximately $0.1 million of the unamortized debt issuance costs were written off and a $0.1 million gain was recognized in conjunction with the retirement of the 2020 Notes.

 

In connection with the Recapitalization Transaction, the 2020 Notes with a face amount of $111.1 million of the total $113.0 million that were outstanding at the time of the Recapitalization Transaction were refinanced and the maturity dates were extended. Of the refinanced amount, $103.8 million was refinanced with the Investor Parties through the issuance of the New Common Equity (as defined below), the New Preferred Equity (as defined below) (see Note 9 - Common Stock and Preferred Stock) and new secured term debt that matures in February 2023 (see Term Loan section below). Additionally, $1.0 million of accrued interest was refinanced with the Investor Parties. The remaining refinanced amount of $7.3 million was exchanged into the new $8.0 million Oasis Note discussed above. In connection with the issuance of the new secured term loan, as well as the New Common Equity and the New Preferred Equity, the Company recognized a loss on extinguishment of the 2020 Notes refinanced with the Investor Parties of approximately $2.4 million, and wrote off $0.7 million of unamortized debt issuance costs related to the 2020 Notes.

 

The Company classified the remaining $1.9 million of the 2020 Notes as current liabilities on the condensed consolidated balance sheet. The $1.9 million of the 2020 Notes were redeemed at par at maturity on June 1, 2020.

 

The fair value of the 4.875% convertible senior notes due 2020 as of December 31, 2019 was $1.7 million based upon the most recent quoted market prices. The fair value of the convertible senior notes is considered to be Level 3 measurements on the fair value hierarchy.

 

Amortization expense classified as interest expense related to debt issuance costs of the Company's convertible senior notes was nil and $0.1 million for the three months ended September 30, 2020 and 2019, respectively. Amortization expense classified as interest expense related to debt issuance costs of the Company's convertible senior notes was nil and $0.5 million for the nine months ended September 30, 2020 and 2019, respectively.

 

16

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

Term Loan

 

Term loan consists of the following (in thousands):

 

   

September 30, 2020

   

December 31, 2019

 
   

Principal Amount**

   

Debt Discount/
Issuance
Costs*

   

Net
Amount

   

Principal Amount**

   

Debt Discount/
Issuance
Costs*

   

Net
Amount

 

Term Loan

  $ 134,801     $ (9,441 )   $ 125,360     $ 134,801     $ (12,319 )   $ 122,482  

 

* The term loan was valued using the discounted cash flow method to determine the implied debt discount. The debt discount and issuance costs are being amortized over the life of the term loan.

 

** The amount presented excludes accrued, but unpaid, payment-in-kind interest of $4.0 million and $1.3 million as of September 30, 2020 and December 31, 2019, respectively.

 

In August 2019, in connection with the Recapitalization Transaction, the Company entered into a First Lien Term Loan Facility Credit Agreement (the “New Term Loan Agreement”), with certain of the Investor Parties, and Cortland Capital Market Services LLC, as agent, for a $134.8 million first-lien secured term loan (the “New Term Loan”). The Company also issued common stock and preferred stock (see Note 9 - Common Stock and Preferred Stock) to the Investor Parties.

 

Amounts outstanding under the New Term Loan accrue interest at 10.50% per annum, payable semi-annually (with 8% per annum payable in cash and 2.5% per annum payable in kind). The New Term Loan matures on February 9, 2023.

 

The New Term Loan Agreement contains negative covenants that, subject to certain exceptions, limit the ability of the Company and its subsidiaries to, among other things, incur additional indebtedness, make restricted payments, pledge their assets as security, make investments, loans, advances, guarantees and acquisitions, undergo fundamental changes and enter into transactions with affiliates. The original terms of the New Term Loan Agreement required the Company to maintain a trailing 12-month EBITDA (as defined and adjusted therein) of not less than $34.0 million and a minimum liquidity of not less than $10.0 million commencing with the fiscal quarter ending September 30, 2020.

 

On October 16, 2020, the Company reached an agreement (the “Amendment”) with holders of its term loan and Wells Fargo, holder of its revolving credit facility, to amend its New Term Loan Agreement and defer its EBITDA covenant calculation until March 31, 2022. Under the Amendment, the trailing 12-month EBITDA requirement has been reduced to $25.0 million, which will not be calculated earlier than March 31, 2022. The Amendment also requires the Company to pre-pay $15.0 million of the term loan immediately and, under certain conditions, pre-pay up to an additional $5.0 million no later than the third quarter of fiscal year 2021. As a result, the Company reclassified $20.0 million from long term debt to short term debt as of September 30, 2020. As of September 30, 2020, the Company had $138.8 million (including $4.0 million in payment-in-kind interest) outstanding under the New Term Loan Agreement.

 

The New Term Loan Agreement contains events of default that are customary for a facility of this nature, including nonpayment of principal, nonpayment of interest, fees or other amounts, material inaccuracy of representations and warranties, violation of covenants, cross-default to other material indebtedness, bankruptcy or insolvency events, material judgment defaults and a change of control as specified in the New Term Loan Agreement. If an event of default occurs, the maturity of the amounts owed under the New Term Loan Agreement may be accelerated.

 

The obligations under the New Term Loan Agreement are guaranteed by the Company, the subsidiary borrowers thereunder and certain of the other existing and future direct and indirect subsidiaries of the Company and are secured by substantially all of the assets of the Company, the subsidiary borrowers thereunder and such other subsidiary guarantors, in each case, subject to certain exceptions and permitted liens.

 

17

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

Amortization expense classified as interest expense related to the $3.8 million of debt issuance costs associated with the issuance of the New Term Loan was $0.3 million and $0.8 million for the three and nine months ended September 30, 2020, respectively.

 

Amortization expense classified as interest expense related to the $10.1 million debt discount associated with the issuance of the New Term Loan was $0.7 million and $2.1 million for the three and nine months ended September 30, 2020, respectively.

 

The fair value of the New Term Loan as of September 30, 2020 and December 31, 2019 was $131.0 million and $123.4 million, respectively. The estimated fair value was calculated using a discounted cash flow method and is classified as Level 3 within the fair value hierarchy.

 

Loan under Paycheck Protection Program

 

On June 12, 2020, the Company received a $6.2 million PPP Loan under the PPP within the CARES Act. The PPP Loan matures on June 2, 2022, and is subject to the CARES Act terms which include, among other terms, an interest rate of 1.00% per annum and monthly installment payments of $261,275 commencing on December 1, 2020. The PPP Loan may be prepaid at any time prior to maturity with no prepayment penalties. The PPP Loan is subject to events of default and other provisions customary for a loan of this type. The PPP Loan may be forgiven, partially or in full, if certain conditions are met, principally based on having been disbursed for permissible purposes and maintaining certain average levels of employment and payroll as required by the CARES Act. As of September 30, 2020, the Company has recorded the PPP Loan as a liability and classified $2.5 million as a current liability and $3.7 million as a non-current liability on the condensed consolidated balance sheet. The Company intends to apply for forgiveness of amounts received under the PPP in accordance with the requirements of the CARES Act, as amended. Any loan amounts forgiven will be removed from liabilities recorded. While the Company used the proceeds of the PPP Loan only for permissible purposes, there can be no assurance that it will be eligible for forgiveness of the PPP Loan, in full or in part.

 

The carrying value of the PPP Loan is a reasonable approximation of fair value.

 

Note 6 — Credit Facilities

 

Wells Fargo

 

In March 2014, the Company and its domestic subsidiaries entered into a secured credit facility with General Electric Capital Corporation (“GECC”). The credit facility, as amended and subsequently assigned to Wells Fargo Bank pursuant to its acquisition of GECC, provides for a $75.0 million revolving credit facility subject to availability based on prescribed advance rates on certain domestic accounts receivable and inventory amounts used to compute the borrowing base (the “Credit Facility”). The Credit Facility includes a sub-limit of up to $35.0 million for the issuance of letters of credit. The amounts outstanding under the Credit Facility, as amended, were payable in full upon maturity of the facility on September 27, 2019, except that the Credit Facility would mature on June 15, 2018 if the Company did not refinance or extend the maturity of the convertible senior notes that mature in 2018, provided that any such refinancing or extension shall have a maturity date that is no sooner than six months after the stated maturity of the Credit Facility (i.e., on or about September 27, 2019). On June 14, 2018, the Company entered into a Term Loan Agreement with Great American Capital Partners to provide the necessary capital to refinance the 2018 convertible senior notes (see additional details regarding the Term Loan Agreement below). In addition, on June 14, 2018, the Company revised certain of the Credit Facility documents (and entered into new ones) so that certain of its Hong Kong based subsidiaries became additional parties to the Credit Facility. As a result, the receivables of these subsidiaries can now be included in the borrowing base computation, subject to certain limitations, thereby effectively increasing the amount of funds the Company can borrow under the Credit Facility. Any additional borrowings under the Credit Facility will be used for general working capital purposes. In August 2019, in connection with the Recapitalization Transaction (see Note 5 - Debt), the Company entered into an amended and extended revolving credit facility with Wells Fargo (the “Amended ABL Credit Agreement” or “Amended ABL Facility”). The Amended ABL Credit Agreement amends and restates the Company’s existing Credit Facility, dated as of March 27, 2014, as amended, with GECC and subsequently assigned to Wells Fargo, to, among other things, decrease the borrowing capacity from $75.0 million to $60.0 million and extend the maturity to August 9, 2022.

 

18

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

The obligations under the Amended ABL Credit Agreement are guaranteed by the Company, the subsidiary borrowers thereunder and certain of the other existing and future direct and indirect subsidiaries of the Company and are secured by substantially all of the assets of the Company, the subsidiary borrowers thereunder and such other subsidiary guarantors, in each case, subject to certain exceptions and permitted liens. As of September 30, 2020, the amount of outstanding borrowings was nil, the amount of outstanding stand-by letters of credit totaled $10.4 million and the total excess borrowing capacity was $36.6 million. As of December 31, 2019, the amount of outstanding borrowings was nil, the amount of outstanding stand-by letters of credit totaled $9.2 million and the total excess borrowing capacity was $41.8 million.

 

The Amended ABL Credit Agreement contains negative covenants that, subject to certain exceptions, limit the ability of the Company and its subsidiaries to, among other things, incur additional indebtedness, make restricted payments, pledge their assets as security, make investments, loans, advances, guarantees and acquisitions, undergo fundamental changes and enter into transactions with affiliates. The Company is also required to maintain a fixed charge coverage ratio of not less than 1.1 to 1.0 under certain circumstances, and a minimum liquidity of $25.0 million and a minimum availability of at least $9.0 million. As of September 30, 2020 and December 31, 2019, the Company was in compliance with the financial covenants under the Amended ABL Facility and the previous Credit Facility, as applicable.

 

Any amounts borrowed under the Amended ABL Facility accrue interest, at either (i) LIBOR plus 1.50%-2.00% (determined by reference to a fixed charge coverage ratio-based pricing grid) or (ii) base rate plus 0.50%-1.00% (determined by reference to a fixed charge coverage ratio-based pricing grid). As of September 30, 2020, the weighted average interest rate on the credit facility with Wells Fargo was 0%. As of December 31, 2019, the weighted average interest rate on the credit facility with Wells Fargo was 4.53%.

 

The Amended ABL Facility also contains customary events of default, including a cross default provision and a change of control provision. In the event of a default, all of the obligations of the Company and its subsidiaries under the Amended ABL Facility may be declared immediately due and payable.

 

As described in Note 5 – Debt, on October 16, 2020, the Company amended its New Term Loan to reduce the amount and defer the calculation of its EBITDA covenant, with Wells Fargo as party to the agreement.

 

As of September 30, 2020, off-balance sheet arrangements include letters of credit issued by Wells Fargo of $10.4 million.

 

Great American Capital Partners

 

On June 14, 2018, the Company entered into a Term Loan Agreement, Term Note, Guaranty and Security Agreement and other ancillary documents and agreements (the “Term Loan”) with Great American Capital Partners Finance Co., LLC (“GACP”), for itself as a Lender (as defined below) and as the Agent (in such capacity, “Agent”) for the Lenders from time to time party to the Term Loan (collectively, “Lenders”) and the other “Secured Parties” under and as defined therein, with respect to the issuance to the Company by Lenders of a $20.0 million term loan. To secure the Company’s obligations under the Term Loan, the Company granted to Agent, for the benefit of the Secured Parties, a security interest in a substantial amount of the Company’s consolidated assets and a pledge of the majority of the capital stock of various of its subsidiaries. The Term Loan was a secured obligation, second only to the Credit Facility with Wells Fargo, except with respect to certain of the Company’s inventory in which GACP has a priority secured position.

 

The Term Loan required the repayment of principal in the amount of 10% of the outstanding Term Loan per year (payable monthly) beginning after the first anniversary. All then-outstanding borrowings under the Term Loan would be due, and the Term Loan would terminate, no later than June 14, 2021, unless sooner terminated in accordance with its terms, which included the date of termination of the Wells Fargo Credit Facility and the date that is 91 days prior to the maturity of the Company’s various convertible senior notes due in 2020 (see Note 5 - Debt). The Company was permitted to prepay the Term Loan, which would have required a prepayment fee (i) in year one of up to any unearned and unpaid interest that would have become due and payable in year one had the prepayment not occurred plus 2% of the initial amount of the Term Loan (i.e., $20.0 million), (ii) in year two of 2% of the initial amount of the Term Loan and (iii) in year three of 1% of the initial amount of the Term Loan.

 

19

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

In August 2019, in connection with the Recapitalization Transaction (see Note 5 - Debt), the Company repaid in full and terminated the Term Loan Agreement.

 

Amortization expense classified as interest expense related to the $1.3 million of debt issuance costs associated with the transactions that closed on June 14, 2018 (i.e., the amendment of the Wells Fargo Credit Facility and the GACP Term Loan) and $1.1 million of debt issuance costs associated with the transaction that closed on August 9, 2019 (i.e., Amended ABL Facility) was $0.1 million and $0.3 million for the three and nine months ended September 30, 2020, respectively, and $0.1 million and $0.5 million for the three and nine months ended September 30, 2019, respectively.

 

Note 7 — Income Taxes

 

The Company’s income tax benefit of $0.3 million for the three months ended September 30, 2020 reflects an effective tax rate of (0.8%). The Company’s income tax expense of $1.0 million for the three months ended September 30, 2019 reflects an effective tax rate of 5.8%. The tax benefit for the three months ended September 30, 2020 relates to foreign income taxes and discrete items. The majority of the tax expense for the three months ended September 30, 2019 relates to foreign income taxes and discrete items.

 

The Company’s income tax expense of $0.3 million for the nine months ended September 30, 2020 reflects an effective tax rate of (11.0%). The Company’s income tax expense of $1.4 million for the nine months ended September 30, 2019 reflects an effective tax rate of (4.0%). The majority of the tax expense for the nine months ended September 30, 2020 and 2019 relates to foreign income taxes and discrete items.

 

The CARES Act was signed into federal law on March 27, 2020. The CARES Act is an emergency economic stimulus package in response to the Coronavirus outbreak, which among other things contains numerous income tax provisions. Some of these tax provisions are expected to be effective retroactively for years ending before the date of enactment. However, the Company does not anticipate these benefits will have a material financial impact.

 

Note 8 — Income (Loss) Per Share

 

The following table is a reconciliation of the weighted average shares used in the computation of income (loss) per share for the periods presented (in thousands, except per share data):

 

   

Three Months Ended September 30,

 
   

2020

   

2019

 

Income (loss) per share – basic

 

Income (Loss)

   

Weighted Average Shares

   

Per-Share

   

Income (Loss)

   

Weighted Average Shares

   

Per-Share

 

Net income (loss) attributable to common stockholders

  $ 32,066

*

    3,824     $ 8.39     $ 16,265

*

    2,709     $ 6.00  

Effect of dilutive securities:

                                               

Convertible senior notes

    (2,344 )     5,300             14,367       3,165        

Unvested performance stock grants

          166                   7        

Unvested restricted stock grants

          17                   154        

Income (loss) per share - diluted

                                               

Net income (loss) attributable to common stockholders plus assumed exercises and conversion

  $ 29,722       9,307     $ 3.19     $ 30,632       6,035     $ 5.08  

 

20

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

   

Nine Months Ended September 30,

 
   

2020

   

2019

 

Income (loss) per share – basic

 

Income (Loss)

   

Weighted Average Shares

   

Per-Share

   

Income (Loss)

   

Weighted Average Shares

   

Per-Share

 

Net income (loss) attributable to common stockholders

  $ (3,867

) *

    3,307     $ (1.17 )   $ (35,435

) *

    2,475     $ (14.32 )

Effect of dilutive securities:

                                               

Convertible senior notes

                                   

Unvested performance stock grants

                                   

Unvested restricted stock grants

                                   

Income (loss) per share - diluted

                                               

Net income (loss) attributable to common stockholders plus assumed exercises and conversion

  $ (3,867 )     3,307     $ (1.17 )   $ (35,435 )     2,475     $ (14.32 )

 

* Net income (loss) attributable to common stockholders was computed by deducting preferred dividends of $316,000 and $935,000 for the three and nine months ended September 30, 2020, respectively, and $180,000 for the three and nine months ended September 30, 2019.

 

Basic earnings per share is calculated using the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated using the weighted average number of common shares and common share equivalents outstanding during the period (which consist of restricted stock awards, restricted stock units and convertible debt to the extent they are dilutive). The convertible debt shares included in the diluted earnings per share computation are calculated using the “if-converted method” utilizing the conversion rate on the last day of the reporting period. Common share equivalents that could potentially dilute basic earnings per share in the future, which were excluded from the computation of diluted earnings per share due to being anti-dilutive, totaled 389,879 and 6,754,069 for the three and nine months ended September 30, 2020, respectively. Common share equivalents that could potentially dilute basic earnings per share in the future, which were excluded from the computation of diluted earnings per share due to being anti-dilutive, totaled 546,087 and 3,134,139 for the three and nine months ended September 30, 2019, respectively.

 

Note 9 — Common Stock and Preferred Stock

 

Common Stock

 

Effective July 9, 2020, the Company completed a 1 for 10 reverse stock split of its $0.001 par value common stock. All common stock and price per share amounts in this report have been restated to reflect the 1 for 10 reverse stock split. The Reverse Stock Split did not cause an adjustment to the par value or the authorized shares of the common stock. All share and per share amounts in the financial statements and notes thereto have been retroactively adjusted for all periods presented to give effect to this Reverse Stock Split, including reclassifying an amount equal to the reduction in par value of common stock to additional paid-in capital. The primary reason for implementing the Reverse Stock Split was to regain compliance with the minimum bid price requirement of Nasdaq. On July 31, 2020, the Company was notified by Nasdaq that it had regained compliance with the Nasdaq listing requirements. On September 11, 2020, the Company received notice from Nasdaq that during the prior 30 day period the Company had not met a listing requirement to maintain a minimum Market Value of Publicly Held Shares of $15,000,000. The Company has until March 10, 2021 to cure this deficiency and/or meet any of Nasdaq’s other alternative continuing qualification criteria.

 

21

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

In June 2014, the Company effectively repurchased 311,284 shares of its common stock at an average cost of $77.10 per share for an aggregate amount of $24.0 million pursuant to a prepaid forward share repurchase agreement entered into with Merrill Lynch International (“ML”). These repurchased shares are treated as retired for basic and diluted EPS purposes although they remain legally outstanding. The Company reflects the aggregate purchase price as a reduction to stockholders’ equity classified as Treasury Stock. The Company reflected the aggregate purchase price of its common shares repurchased as a reduction to stockholders’ equity allocated to treasury stock. On September 13, 2019, ML returned the shares to the Company. The Company subsequently retired the shares which had no impact to the Company’s stockholder’s equity.

 

In January 2019, the Company was obligated to issue an aggregate of 306,122 shares of restricted stock at a value of approximately $4.5 million to two executive officers pursuant to the applicable employment contracts. The shares were not issued at that time due to insufficient shares available in the 2002 Stock Award and Incentive Plan. Such shares were subsequently approved by the Company's shareholders and issued in July 2019. In addition, an aggregate of 32,823 shares of restricted stock at an aggregate value of approximately $0.5 million were issued to its six non-employee directors. In August 2019, the Board resolved to accelerate and immediately vest upon closing of the Recapitalization Transaction, 16,417 shares of the annual stock compensation granted to resigning members of the Board on January 1, 2019. Each resigning Board member forfeited the remaining balance of the annual stock compensation granted on January 1, 2019, or an aggregate of 5,470 shares. The remaining 10,936 shares of restricted stock vested in January 2020.

 

During the first quarter of 2019, certain employees, including two executive officers surrendered an aggregate of 16,670 shares of restricted stock for approximately $249,000 to cover income taxes due on the vesting of restricted shares.

 

During the second quarter of 2019, an executive officer surrendered an aggregate of 2,428 shares of restricted stock for approximately $25,000 to cover income taxes due on the vesting of restricted stock units.

 

On August 9, 2019, in connection with the Recapitalization Transaction (see Note 5 - Debt), the Company issued to the Investor Parties, in the aggregate, 585,300 shares of Common Stock valued at $4.2 million on the date of issuance (the "New Common Equity").

 

In January 2020, the Company issued an aggregate of 70,421 shares of restricted stock at a value of approximately $0.7 million to two executive officers, which vest, in four equal annual installments over four years.

 

During the first quarter of 2020, certain employees, including two executive officers surrendered an aggregate of 16,640 shares of restricted stock for $172,000 to cover income taxes due on the vesting of restricted shares. Additionally, an aggregate of 26,214 shares of restricted stock granted in 2017 with a value of approximately $270,000 was forfeited during the first quarter of 2020.

 

During the second quarter of 2020, certain employees surrendered an aggregate of 246 shares of restricted stock for $1,526 to cover income taxes due on the vesting of restricted shares. Additionally, an aggregate of 26,214 shares of restricted stock granted in 2017 with a value of approximately $163,000 was forfeited during the second quarter of 2020.

 

In June 2020, $7.1 million of the New Oasis Notes (including $0.2 million in payment-in-kind interest) were converted for 710,100 shares of common stock. As a result, the Company recorded an increase to additional paid-in capital of $9.5 million.

 

In August 2020, $1.0 million of the New Oasis Notes (including $27,288 in payment-in-kind interest) were converted for 177,085 shares of common stock. As a result, the Company recorded an increase to additional paid-in capital of $1.3 million.

 

All issuances of common stock, including those issued pursuant to stock option and warrant exercises, restricted stock grants and acquisitions, are issued from the Company’s authorized but not issued and outstanding shares.

 

No dividend was declared or paid in the three and nine months ended September 30, 2020 or 2019.

 

22

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

Preferred Stock

 

On August 9, 2019, in connection with the Recapitalization Transaction (see Note 5 - Debt), the Company issued 200,000 shares of Series A Senior Preferred Stock (the “Series A Preferred Stock”), $0.001 par value per share, to the Investor Parties (the “New Preferred Equity”). As of September 30, 2020 and December 31, 2019, 200,000 shares of Series A Preferred Stock were outstanding. 

 

Each share of Series A Preferred Stock has an initial value of $100 per share, which is automatically increased for any accrued and unpaid dividends (the “Accreted Value”).

 

The Series A Preferred Stock has the right to receive dividends on a quarterly basis equal to 6.0% per annum, payable in cash or, if not paid in cash, by an automatic accretion of the Series A Preferred Stock. No dividends have been declared or paid. For the three and nine months ended September 30, 2020, the Company recorded $316,000 and $935,000 of preferred stock dividends as an increase in the value of the Series A Preferred Stock, respectively. For the three and nine months ended September 30, 2019, the Company recorded $180,000 of preferred stock dividends as an increase in the value of the Series A Preferred Stock.

 

The Series A Preferred Stock has no stated maturity, however, the Company has the right to redeem all or a portion of the Series A Preferred Stock at its Liquidation Preference (as defined below) at any time after payment in full of the New Term Loan. In addition, upon the occurrence of certain change of control type events, holders of the Series A Preferred Stock are entitled to receive an amount (the “Liquidation Preference”), in preference to holders of Common Stock or other junior stock, equal to (i) 20% of the Accreted Value in the case of a certain specified transaction, or (ii) otherwise, 150% of the Accreted value, plus any accrued and unpaid dividends.

 

The Company has the right, but is not required, to repurchase all or a portion of the Series A Preferred Stock at its Liquidation Preference at any time after payment in full of the New Term Loan (see Note 5 - Debt).The Series A Preferred Stock does not have any voting rights, except to the extent required by the Delaware General Corporation Law, except for the exclusive right to elect the Series A Preferred Directors (as described below) and except for certain approval rights over certain transactions (as described below). These approval rights require the prior consent of specified percentages of holders (or in certain cases, all holders) of the Series A Preferred Stock in order for the Company to take certain actions, including the issuance of additional shares of Series A Preferred Stock or parity stock, the issuance of senior stock, certain amendments to the Amended and Restated Certificate of Incorporation, the Certificate of Designations of the Series A Preferred Stock (the “Certificate of Designations”), the Second Amended and Restated By-laws or the Amended and Restated Nominating and Corporate Governance Committee Charter, material changes in the Company’s line of business and certain change of control type transactions. In addition, the Certificate of Designations provides that the approval of at least six directors is required for any related person transaction within the meaning of Item 404 of Regulation S-K under the Securities Act of 1933, as amended, including, without limitation, the adoption of, or any amendment, modification or waiver of, any agreement or arrangement related to any such transaction. The Certificate of Designations also includes restrictions on the ability of the Company to pay dividends on or make distributions with respect to, or redeem or repurchase, shares of Common Stock or other junior stock. In addition, holders of the Series A Preferred Stock have preemptive rights regarding future issuance of Series A Preferred Stock or parity stock.

 

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JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

In addition, the Certificate of Designations provides the holders of Series A Preferred Stock certain board representation rights. The Certificate of Designations provides, among other things, that, for so long as at least 50,000 shares of Series A Preferred Stock remain outstanding, (i) the holders of a majority of the outstanding shares of Series A Preferred Stock have the sole right to nominate candidates to serve as the Series A Preferred Directors and (ii) the holders of shares of Series A Preferred Stock, voting as a separate class, have the right to elect two individuals to serve as the Series A Preferred Directors. From and after (i) the first annual meeting of stockholders occurring after less than 50,000 shares of Series A Preferred Stock remain outstanding, the holders of Series A Preferred Stock will only have the right to nominate and elect one Series A Preferred Director, and (ii) the time no shares of Series A Preferred Stock remain outstanding, the holders of Series A Preferred Stock will no longer have the right to nominate or elect any Series A Preferred Directors. The Series A Preferred Directors will serve for terms ending at the annual meeting of stockholders in 2023 and for successive three-year terms thereafter (until no shares of Series A Preferred Stock remain outstanding), and as of such time as the proposal to amend the Certificate of Incorporation to classify the Board into three classes, designated Class I, Class II and Class III, with staggered three-year terms, the Series A Preferred Directors shall be deemed to serve in Class III. The number of directors elected by the holders of the Company’s Common Stock and the number of Series A Preferred Directors is fixed and cannot be amended without the approval of holders of a majority of the outstanding Common Stock and holders of at least 80% of the outstanding shares of Series A Preferred Stock, each voting as a separate class.

 

The Series A Preferred Stock redemption amount is contingent upon certain events with no stated redemption date as of the reporting date, although may become redeemable in the future. In accordance with the SEC guidance within ASC Topic 480, Distinguishing Liabilities from Equity: Classification and Measurement of Redeemable Securities, the Company classified the Series A Preferred Stock as temporary equity as the Series A Preferred Stock contains a redemption feature which is contingent upon certain deemed liquidation events, the occurrence of which may not solely be within the control of the Company.

 

Under ASC 815, Derivatives and Hedging, certain contractual terms that meet the accounting definition of a derivative must be accounted for separately from the financial instrument in which they are embedded. The Company has concluded that the redemption upon a change of control and the repurchase option by the Company constitute embedded derivatives.

 

The embedded redemption upon a change of control must be accounted for separately from the Series A Preferred Stock. The redemption provision specifies if certain events that constitute a change of control occur, the Company may be required to settle the Series A Preferred Stock at 150% of its accreted amount. Accordingly, the redemption provision meets the definition of a derivative, and its economic characteristics are not considered clearly and closely related to the economic characteristics of the Series A Preferred Stock, which is considered more akin to a debt instrument than equity.

 

Accordingly, these two embedded derivatives are required to be bundled into a single derivative instrument and accounted for separately from the Series A Preferred Stock at fair value.

 

The Company considers the repurchase option to have no value as the likelihood is remote that this event, within the Company’s control, would ever occur. On August 9, 2019 the Company determined that the fair value of the redemption provision upon a change of control was $4.9 million and recorded as a long term liability. In subsequent periods, the liability is accounted for at fair value, with changes in fair value recognized as other income (expense) on the Company's condensed consolidated statements of operations. The value of the redemption provision explicitly considered the present value of the potential premium that would be paid related to, and the probability of, an event that would trigger its payment. The probability of a triggering event was based on management’s estimates of the probability of a change of control event occurring.

 

As of September 30, 2020, the Series A Preferred Stock is recorded in temporary equity at the amount of accrued, but unpaid dividends of $1.4 million, and the redemption provision, as a bifurcated derivative, is recorded as a long term liability with an estimated value of $5.9 million. As of September 30, 2019, the Series A Preferred Stock is recorded in temporary equity at the amount of accrued but unpaid dividends of $180,000, and the redemption provision, as a bifurcated derivative, is recorded as a long term liability with an estimated value of $4.9 million.

 

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JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

The following table provides a reconciliation of the beginning and ending balances of the Series A Preferred Stock, which is recorded in temporary equity:

 

   

2020

   

2019

 

Balance, January 1,

  $ 483     $  

Preferred stock accrued dividends

    307        

Balance, March 31,

    790        

Preferred stock accrued dividends

    312        

Balance, June 30,

    1,102        

Preferred stock accrued dividends

    316       180  

Balance, September 30,

  $ 1,418     $ 180  

 

Note 10 — Joint Ventures

 

The Company owns a fifty percent interest in a joint venture (“Pacific Animation Partners”) with the U.S. entertainment subsidiary of a leading Japanese advertising and animation production company. The joint venture was created to develop and produce a boys’ animated television show, which it licensed worldwide for television broadcast as well as consumer products. The Company produced toys based upon the television program under a license from the joint venture which also licensed certain other merchandising rights to third parties. The joint venture completed and delivered 65 episodes of the show, which began airing in February 2012, and has since ceased production of the television show. For the three and nine months ended September 30, 2020, the Company recognized income from the joint venture of nil and $2,000, respectively. For the three and nine months ended September 30, 2019, the Company recognized income from the joint venture of nil.

 

As of September 30, 2020 and December 31, 2019, the balance of the investment in the Pacific Animation Partners joint venture is nil.

 

In September 2012, the Company entered into a joint venture (“DreamPlay Toys”) with NantWorks LLC (“NantWorks”) in which it owns a fifty percent interest. Pursuant to the operating agreement of DreamPlay Toys, the Company paid to NantWorks cash in the amount of $8.0 million and issued NantWorks a warrant to purchase 1.5 million shares of the Company’s common stock at a value of $7.0 million in exchange for the exclusive right to arrange for the provision of the NantWorks recognition technology platform for toy products. The Company had classified these rights as an intangible asset, which was being amortized over the anticipated revenue stream from the exploitation of these rights. However, the Company has abandoned the use of the technology in connection with its toy products and no future sales are anticipated, and the Company recorded an impairment charge to income of $2.9 million to write off the remaining unamortized technology rights during the third quarter of 2017. The Company retains the financial risk of the joint venture and is responsible for the day-to-day operations, which are expected to be nominal in future periods. The results of operations of the joint venture are consolidated with the Company’s results.

 

In addition, in 2012, the Company invested $7.0 million in cash in exchange for a five percent economic interest in a related entity, DreamPlay, LLC, that was expected to monetize the exploitation of the recognition technologies in non-toy consumer product categories. Adoption of the technology has been inadequate to establish a commercially viable market for the technology. NantWorks has the right to repurchase the Company’s interest for $7.0 million, but the Company does not anticipate that NantWorks will do so. As of September 30, 2017, the Company determined the value of this investment will not be realized and that full impairment of the value had occurred. Accordingly, the Company recorded an impairment charge of $7.0 million during the quarter ended September 30, 2017.

 

25

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

In November 2014, the Company entered into a joint venture with Meisheng Culture & Creative Corp., for the purpose of providing certain JAKKS licensed and non-licensed toys and consumer products to agreed-upon territories of the People’s Republic of China. The joint venture includes a subsidiary in the Shanghai Free Trade Zone that sells, distributes and markets these products, which include dolls, plush, role play products, action figures, costumes, seasonal items, technology and app-enhanced toys, based on entertainment licenses and JAKKS’ own proprietary brands. The Company owns fifty-one percent of the joint venture and consolidates the joint venture since control rests with the Company. The non-controlling interest’s share of the income (loss) was $49,000 and ($31,000) for the three months ended September 30, 2020 and 2019, respectively, and $97,000 and $57,000 for the nine months ended September 30, 2020 and 2019, respectively.

 

In October 2016, the Company entered into a joint venture with Hong Kong Meisheng Cultural Company Limited ("Meisheng"), a Hong Kong-based subsidiary of Meisheng Culture & Creative Corp., for the purpose of creating and developing original, multiplatform content for children including new short-form series and original shows. JAKKS and Meisheng each own fifty percent of the joint venture and will jointly own the content. JAKKS will retain merchandising rights for kids’ consumer products in all markets except China, which Meisheng Culture & Creative Corp. will oversee through the Company’s existing distribution joint venture. The results of operations of the joint venture are consolidated with the Company's results. The non-controlling interest’s share of the income from the joint venture for the three and nine months ended September 30, 2020 and 2019 was nil. As of September 30, 2020, Meisheng beneficially owns more than 10% of the Company’s outstanding common stock.

 

In March 2017, the Company entered into an equity purchase agreement with Meisheng which provided, among other things, that as long as Meisheng and its affiliates hold 10% or more of the issued and outstanding shares of common stock of the Company, Meisheng shall have the right from time to time to designate a nominee (who currently is Mr. Xiaoqiang Zhao) for election to the Company’s board of directors.

 

Meisheng also serves as a significant manufacturer of the Company. In the first quarter of 2019, Meisheng acquired New Time Group, which was a third-party manufacturer of the Company. For the three and nine months ended September 30, 2020, the Company made inventory-related payments to Meisheng of approximately $31.4 million and $54.4 million, respectively. For the three and nine months ended September 30, 2019, the Company made inventory-related payments to Meisheng of approximately $49.6 million and $74.8 million, respectively. As of September 30, 2020 and December 31, 2019, amounts due to Meisheng for inventory received by the Company, but not paid totaled $22.1 million and $18.1 million, respectively.

 

Note 11 — Goodwill

 

The Company applies a fair value-based impairment test to the carrying value of goodwill and indefinite-lived intangible assets on an annual basis and, on an interim basis, if certain events or circumstances indicate that an impairment loss may have been incurred. Goodwill impairment exists when the estimated fair value of goodwill is less than its carrying value. Based on the Company's April 1 annual assessment, it determined that the fair values of its reporting units were not less than the carrying amounts. No goodwill impairment was determined to have occurred for the nine months ended September 30, 2020.

 

As of September 30, 2020, $35.1 million of goodwill was allocated to the Toys/Consumer Products reporting unit, which had a negative carrying value.

 

26

 

JAKKS PACIFIC, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2020

 

Note 12 — Intangible Assets Other Than Goodwill

 

Intangible assets other than goodwill consist primarily of licenses, product lines, customer relationships and trademarks. Amortized intangible assets are included in intangibles in the accompanying condensed consolidated balance sheets. Trademarks are disclosed separately in the accompanying condensed consolidated balance sheets. Intangible assets as of September 30, 2020 and December 31, 2019 include the following (in thousands, except for weighted useful lives):

 

           

September 30, 2020

   

December 31, 2019

 
   

Weighted
Useful
Lives

   

Gross
Carrying
Amount

   

Accumulated
Amortization

   

Net
Amount