JAKKS PACIFIC INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of financial condition and results of operations should be read together with our Condensed Consolidated Financial Statements and Notes thereto, which appear elsewhere herein. Effective July 9, 2020, we completed a 1 for 10 reverse stock split of our $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, 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, we were notified by Nasdaq that we had regained compliance with the Nasdaq listing requirements. Explanatory Note As of the date of filing of this Quarterly Report on Form 10-Q (this “Report”), there are many uncertainties regarding the current Novel Coronavirus (“COVID-19”) pandemic, including the scope of health issues, the possible duration of the pandemic, and the extent of local and worldwide social, political, and economic disruption it may cause. To date, the COVID-19 pandemic has had far-reaching impacts on many aspects of the operations of JAKKS Pacific, Inc. (the “Company,” “we,” “our” or “us”), including on consumer behavior, customer store traffic, production capabilities, timing of product availability, our employees’ personal and business lives, and the market generally. The scope and nature of these impacts continue to evolve each day. The COVID-19 pandemic has resulted in, and may continue to result in, regional and local quarantines, labor stoppages and shortages, changes in consumer purchasing patterns, mandatory or elective shut-downs of retail locations, disruptions to supply chains, including the inability of our suppliers and service providers to deliver materials and services on a timely basis, or at all, severe market volatility, liquidity disruptions, and overall economic instability, which, in many cases, have had, and we expect will continue to have, adverse impacts on our business, financial condition and results of operations. This situation is changing rapidly, and additional impacts may arise that we are not aware of currently. In light of the uncertain and rapidly evolving situation relating to the COVID-19 pandemic, we have taken certain precautionary measures intended to help minimize the risk to our Company, employees and customers, including the following: • On March 23, 2020, we encouraged our staff to begin working from home. We expect that to be our operating model for an undetermined period of time, and to the extent permitted by federal, state and local instructions to reopen; • We identified expense reductions that we intend to implement throughout the remainder of fiscal 2020, as necessary; • Although our distribution center in City of Industry, California currently continues to operate, we continue to evaluate its operations, and may elect, or be required, to shut down its operations temporarily at any time in the future; • We have suspended all non-essential travel for our employees; and • We are discouraging employee attendance at industry events and in-person work-related meetings. Each of the remedial measures taken by the Company has had, and we expect will continue to have, adverse impacts on our current business, financial condition and results of operations, and may create additional risks for our Company. While we anticipate that the foregoing measures are temporary, we cannot predict the specific duration for which these precautionary measures will stay in effect, and we may elect or need to take additional measures as the information available to us continues to develop, including with respect to our employees, inventory receipts, and relationships with our licensors. We expect to continue to assess the evolving impact of the COVID-19 pandemic on our customers, consumers, employees, supply chain, and operations, and intend to make adjustments to our responses accordingly. However, the extent to which the COVID-19 pandemic and our precautionary measures in response thereto may impact our business, financial condition, and results of operations will depend on how the COVID-19 pandemic and its impact continues to develop in the United States and elsewhere in the world, which remains highly uncertain and cannot be predicted at this time. 33 In light of these uncertainties, for purposes of this report, except where otherwise indicated, the descriptions of our business, our strategies, our risk factors, and any other forward-looking statements, including regarding us, our business and the market generally, do not reflect the potential impact of the COVID-19 pandemic or our responses thereto. In addition, the disclosures contained in this report are made only as of the date hereof, and we undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law. For further information, see “Disclosure Regarding Forward-Looking Statements” and “Risk Factors.” Disclosure Regarding Forward-Looking Statements This Report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. For example, statements included in this Report regarding our financial position, business strategy and other plans and objectives for future operations, and assumptions and predictions about future product demand, supply, manufacturing, costs, marketing and pricing factors are all forward-looking statements. When we use words like “intend,” “anticipate,” “believe,” “estimate,” “plan” or “expect,” or other words of a similar import, we are making forward-looking statements. We believe that the assumptions and expectations reflected in such forward-looking statements are reasonable, based upon information available to us on the date hereof (but excluding the impact of COVID-19, as described above in “Explanatory Note”), but we cannot assure you that these assumptions and expectations will prove to have been correct or that we will take any action that we may presently be planning. We have disclosed certain important factors (e.g., see “Explanatory Note” and “Risk Factors”) that could cause our actual results to differ materially from our current expectations elsewhere in this Report. You should understand that forward-looking statements made in this Report are necessarily qualified by these factors. We are not undertaking to publicly update or revise any forward-looking statement if we obtain new information or upon the occurrence of future events or otherwise. Critical Accounting Policies and Estimates The accompanying condensed consolidated financial statements and supplementary information were prepared in accordance with accounting principles generally accepted in the United States of America. Significant accounting policies are discussed in Note 2 to the Consolidated Financial Statements set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019. Inherent in the application of many of these accounting policies is the need for management to make estimates and judgments in the determination of certain revenues, expenses, assets and liabilities. As such, materially different financial results can occur as circumstances change and additional information becomes known. The policies with the greatest potential effect on our results of operations and financial position include: Allowance for Doubtful Accounts. Our allowance for doubtful accounts is based upon management’s assessment of the business environment, customers’ financial condition, historical collection experience, accounts receivable aging, customer disputes and the collectability of specific customer accounts. If there were a deterioration of a major customer’s creditworthiness, or actual defaults were higher than our historical experience, our estimates of the recoverability of amounts due to us could be overstated, which could have an adverse impact on our operating results. Our allowance for doubtful accounts is also affected by the time at which uncollectible accounts receivable balances are actually written off. Major customers’ accounts are monitored on an ongoing basis; more in-depth reviews are performed based upon changes in a customer’s financial condition and/or the level of credit being extended. When a significant event occurs, such as a bankruptcy filing by a specific customer, and on a quarterly basis, the allowance is reviewed for adequacy and the balance or accrual rate is adjusted to reflect current risk prospects. When certain shocks to the market occur, customers are unilaterally reviewed to assess the potential impact of that shock on their financial stability. Many retailers have been operating under financial duress for several years. Ultimately, we assess the risk of liquidation and/or bankruptcy by a customer and the associated risk that we will not be paid for product shipped. To that end, it is not only outstanding accounts receivable balances but decisions to design and develop account-specific product and ultimately ship product that plays into our goal to maximize profitability while minimizing uncollectable accounts receivable. Revenue Recognition. Our contracts with customers only include one performance obligation (i.e., sale of our 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 we expect to be entitled to in exchange for those goods. Our 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. We disaggregate our revenues from contracts with customers by reporting segment: Toys/Customer Products and Halloween. We further disaggregate revenues by major geographic region. See Note 2 to the Condensed Consolidated Financial Statements for further information. 34 Table of Contents We offer 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, we occasionally grant discretionary credits to facilitate markdowns and sales of slow moving merchandise, and consequently accrue an allowance based on historic credits and management estimates. Further, while we generally do not allow product returns, we do make occasional exceptions to this policy, and consequently record 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. We adjust our 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 we have sufficient history on the related estimates and do not believe there is a risk of significant revenue reversal. We also participate in cooperative advertising arrangements with some customers, whereby we allow a discount from invoiced product amounts in exchange for customer purchased advertising that features our 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. Shipping and handling activities are considered part of our obligation to transfer the products and therefore are recorded as direct selling expenses, as incurred. Our reserve for sales returns and allowances amounted to $32.3 million as of June 30, 2020 and $38.4 million as of December 31, 2019. Fair value measurements. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, we use various methods including market, income and cost approaches. Based upon these approaches, we often utilize certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market-corroborated, or unobservable inputs. We utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based upon observable inputs used in the valuation techniques, we are required to provide information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values into three broad levels as follows: Level 1: Valuations for assets and liabilities traded in active markets from readily available pricing sources for market transactions involving identical assets or liabilities. Level 2: Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third-party pricing services for identical or similar assets or liabilities. Level 3: Valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities. In instances where the determination of the fair value measurement is based upon inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based upon the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. See Note 16 to the Condensed Consolidated Financial Statements included within for further information. Goodwill and other indefinite-lived intangible assets. Goodwill and indefinite-lived intangible assets are not amortized, but are tested for impairment at least annually at the reporting unit level. Factors we consider important that could trigger an impairment review include the following: • significant underperformance relative to expected historical or projected future operating results; • significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and • significant negative industry or economic trends. 35 Table of Contents Due to the subjective nature of the impairment analysis, significant changes in the assumptions used to develop the estimate could materially affect the conclusion regarding the future cash flows necessary to support the valuation of long-lived assets, including goodwill. The valuation of goodwill involves a high degree of judgment and uncertainty related to our key assumptions. Any changes in our key projections or estimates could result in a reporting unit either passing or failing the first step of the impairment model, which could significantly change the amount of any impairment ultimately recorded. Based upon the assumptions underlying the valuation, impairment is determined by estimating the fair value of a reporting unit and comparing that value to the reporting unit’s book value. Goodwill is tested for impairment annually, and on an interim basis if certain events or circumstances indicate that an impairment loss may have been incurred. If the fair value is more than the carrying value of the reporting unit, an impairment loss is not indicated. If a reporting unit's carrying value exceeds its fair value, an impairment charge would be recognized for the excess amount, not to exceed the carrying amount of goodwill. Based on our April 1 annual assessment, we determined the fair values of our reporting units were not less than the carrying amounts. No goodwill impairment was determined to have occurred for the six months ended June 30, 2020. Impairment of Long-Lived Assets. When facts and circumstances indicate that the carrying values of long-lived assets, including buildings, equipment and amortizable intangible assets, may be impaired, we perform an evaluation of recoverability by comparing the carrying values of the net assets to their related projected undiscounted future cash flows, in addition to other quantitative and qualitative analysis. Our estimates are subject to uncertainties and may be impacted by various external factors such as economic conditions and market competition. While we believe the inputs and assumptions utilized in our analysis of future cash flows are reasonable, events or circumstances may change, which could cause us to revise these estimates. Reserve for Inventory Obsolescence . We value our inventory at the lower of cost or net realizable value. Based upon a consideration of quantities on hand, actual and projected sales volume, anticipated product selling prices and product lines planned to be discontinued, slow-moving and obsolete inventory is written down to its net realizable value. Failure to accurately predict and respond to consumer demand could result in us under-producing popular items or over-producing less popular items. Furthermore, significant changes in demand for our products would impact management’s estimates in establishing our inventory provision. Management’s estimates are monitored on a quarterly basis, and a further adjustment to reduce inventory to its net realizable value is recorded as an increase to cost of sales when deemed necessary under the lower of cost or net realizable value standard. When unexpected shocks to market demand occur (such as the COVID-19 pandemic market shock), we review whether that shock might materially impact the value of our owned inventory. In some cases, where customers have cancelled orders, accommodation can be reached that the product will be reordered when the customer has restarted operations (in the event of store closures) or the customer agrees to minimize/eliminate requests for product line refreshment (such as in the event of Halloween order cancellations) which allows the inventory and in some cases raw materials to be held through to the following calendar year without incurring any additional obsolescence. Discrete Items for Income Taxes. The discrete expense recorded in the six months ended June 30, 2020 is $29,000 which is primarily related to excess tax deficiencies fully offset by valuation allowance, state income taxes, foreign return-to-provision adjustment, and change in uncertain tax positions. For the comparable period in 2019, a discrete tax expense of $0.1 million was recorded related to excess tax deficiencies fully offset by valuation allowance, return-to-provision adjustments for foreign jurisdictions, state income taxes, and change in uncertain tax positions. Income taxes and interest and penalties related to income tax payable. We do not file a consolidated return for our foreign subsidiaries. We file federal and state returns and our foreign subsidiaries each file returns as required. Deferred taxes are provided on an asset and liability method, whereby deferred tax assets are recognized as deductible temporary differences and operating loss and tax credit carry-forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Management employs a threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Tax benefits that are subject to challenge by tax authorities are analyzed and accounted for in the income tax provision. 36 Table of Contents We accrue a tax reserve for additional income taxes, which may become payable in future years as a result of audit adjustments by tax authorities. The reserve is based upon management’s assessment of all relevant information and is periodically reviewed and adjusted as circumstances warrant. As of June 30, 2020 and December 31, 2019, our income tax reserves were approximately $1.5 million and $1.6 million, respectively. The $1.5 million balance primarily relates to the potential tax settlements in Hong Kong and adjustments in the area of withholding taxes. Our income tax reserves are included in income tax payable on the Condensed Consolidated Balance Sheets and within provision for (benefit from) income taxes on the Condensed Consolidated Statements of Operations and Comprehensive Loss. Share-Based Compensation . We grant restricted stock units and awards to our employees (including officers) and to non-employee directors under our 2002 Stock Award and Incentive Plan (the “Plan”), as amended. The benefits provided under the Plan are share-based payments. We amortize over a requisite service period, the net total deferred restricted stock expense based upon the fair value of the underlying common stock on the date of the grants. In certain instances, the service period may differ from the period in which each award will vest. Additionally, certain groups of grants are subject to performance criteria and/or an expected forfeiture rate calculation. 37 Table of Contents New Accounting Pronouncements See Note 1 to the Condensed Consolidated Financial Statements. 38 Table of Contents Results of Operations The following unaudited table sets forth, for the periods indicated, certain statement of income data as a percentage of net sales. Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales 78.7 81.4 77.2 80.7 Gross profit 21.3 18.6 22.8 19.3 Selling, general and administrative expenses 31.3 35.6 39.2 41.6 Restructuring charge 2.1 — 1.1 0.2 Pandemic related charges 0.3 — 0.2 — Acquisition related and other — 2.6 — 3.2 Loss from operations (12.4) (19.6) (17.7) (25.7) Income from joint ventures — — — — Other income (expense), net — (0.3) — (0.1) Change in fair value of preferred stock derivative liability — — — — Change in fair value of convertible senior notes (9.8) (0.1) 1.4 (1.5) Interest income — — — — Interest expense (7.0) (3.0) (7.6) (3.6) Loss before provision for income taxes (29.2) (23.0) (23.9) (30.9) Provision for income taxes 0.3 0.6 0.4 0.2 Net loss (29.5) (23.6) (24.3) (31.1) Net income attributable to non-controlling interests — 0.1 — — Net loss attributable to JAKKS Pacific, Inc. (29.5) % (23.7) % (24.3) % (31.1) % The following unaudited table summarizes, for the periods indicated, certain statements of operations data by segment (in thousands): Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 Net Sales Toys/Consumer Products $ 56,214 $ 58,795 $ 118,779 $ 125,981 Halloween 22,544 36,387 26,536 40,027 78,758 95,182 145,315 166,008 Cost of Sales Toys/Consumer Products 42,942 48,818 90,378 102,117 Halloween 19,046 28,618 21,817 31,805 61,988 77,436 112,195 133,922 Gross Profit Toys/Consumer Products 13,272 9,977 28,401 23,864 Halloween 3,498 7,769 4,719 8,222 $ 16,770 $ 17,746 $ 33,120 $ 32,086 39 Table of Contents Comparison of the Three Months Ended June 30, 2020 and 2019 Net Sales Toys/Consumer Products. Net sales of our Toys/Consumer Products segment were $56.2 million for the three months ended June 30, 2020 compared to $58.8 million for the prior year period, representing a decrease of $2.6 million, or 4.4%. Sales were negatively impacted by the closure of many of the stores operated by the Company’s retail customers during the stay-at-home mandates, both in the U.S. and Europe. Increases in Boys’ and Girls’ toys were more than offset by declines in Seasonal products. The Seasonal downside was primarily driven by the discontinuation of our Funnoodle business at the end of calendar year 2019. Hallow een. Net sales of our Halloween segment were $22.5 million for the three months ended June 2020 compared to $36.4 million for the prior year period, representing a decrease of $13.9 million, or 38.2%. Sales for the quarter were lower due to retailers reducing orders due to concerns about the impact of the COVID-19 pandemic on traditional Halloween celebrations. Last year also saw unusually strong sales in the second quarter powered by a stronger entertainment calendar, including the releases of Toy Story 4 and Frozen 2. Cost of Sales Toys/Consumer Products. Cost of sales of our Toys/Consumer Products segment was $42.9 million, or 76.3% of related net sales for the three months ended June 30, 2020 compared to $48.8 million, or 83.0% of related net sales for the prior year period, representing a decrease of $5.9 million, or 12.1%. The decrease in dollars is due to lower overall sales in 2020. The decrease as a percentage of net sales, year over year, is due to lower average manufacturing costs resulting from a focused effort to design and develop our product lines for greater product margins. This decrease is partially offset by a higher average royalty rate, in part driven by the mix of products sold in the quarter. Halloween . Cost of sales of our Halloween segment was $19.0 million, or 84.4% of related net sales for the three months ended June 30, 2020 compared to $28.6 million, or 78.6% of related net sales for the prior year period, representing a decrease in dollars of $9.6 million, or 33.6%. The decrease in dollars is due to lower overall sales in 2020. The increase as a percentage of net sales, year over year, is due to a higher average royalty rate, in part driven by the mix of products sold in the quarter. Selling, General and Administrative Expenses Selling, general and administrative expenses were $24.7 million for the three months ended June 30, 2020 compared to $33.9 million for the prior year period constituting 31.3% and 35.6% of net sales, respectively. Selling, general and administrative expenses decreased by $9.2 million from the prior year period primarily driven by company-wide cost savings initiatives begun in 2019 as well as other pandemic-driven cost mitigation programs. Restructuring Charge During the three months ended June 30, 2020, we recognized $1.6 million of restructuring charges as a result of a company-wide restructuring initiative. The restructuring charges primarily related to employee severance costs. Pandemic Related Charges During the three months ended June 30, 2020, we recognized $0.2 million spending directly attributable to making necessary accommodations related to the COVID-19 pandemic. Acquisition Related and Other During the three months ended June 30, 2019, we recognized $2.5 million in acquisition related and other charges as a result of our ongoing evaluation and negotiation of a strategic and/or re-financing transaction, including Hong Kong Meisheng Cultural Company Limited's expression of interest in acquiring additional shares of our common stock and the refinancing of our convertible senior notes due in 2020. 40 Table of Contents Interest Expense Interest expense was $5.5 million for the three months ended June 30, 2020, as compared to $2.9 million in the prior year period. During the three months ended June 30, 2020, we booked interest expense of $0.6 million related to our convertible senior notes due in 2020 and 2023, $4.6 million related to our Term Loan, and $0.3 million related to our revolving credit facility. During the three months ended June 30, 2019, we booked interest expense of $1.6 million related to our convertible senior notes due in 2020, and $1.1 million related to our revolving credit and term loan facilities. Provision for (Benefit from) Income Taxes Our income tax expense, which includes federal, state and foreign income taxes and discrete items, was $0.3 million, or an effective tax rate of (1.2)%, for the three months ended June 30, 2020. During the comparable period in 2019, our income tax expense was $0.6 million, or an effective tax rate of (2.7)%. Comparison of the Six Months Ended June 30, 2020 and 2019 Net Sales Toys/Consumer Products. Net sales of our Toys/Consumer Products segment were $118.8 million for the six months ended June 30, 2020 compared to $126.0 million for the prior year period, representing a decrease of $7.2 million, or 5.7%. The decrease in net sales is primarily driven by the discontinuation of our low-growth, low-margin Funnoodle business within our Seasonal division at the end of calendar year 2019. Halloween. Net sales of our Halloween segment were $26.5 million for the six months ended June 30, 2020 compared to $40.0 million for the prior year period, representing a decrease of $13.5 million, or 33.8%. Sales were lower due to retailers reducing orders due to concerns about the impact of the COVID-19 pandemic on traditional Halloween celebrations. Last year also saw unusually strong sales powered by a stronger entertainment calendar, including the releases of Toy Story 4 and Frozen 2. Cost of Sales Toys/Consumer Products. Cost of sales of our Toys/Consumer Products segment was $90.4 million, or 76.1% of related net sales for the six months ended June 30, 2020 compared to $102.1 million, or 81.0% of related net sales for the prior year period, representing a decrease of $11.7 million, or 11.5%. The decrease in dollars is due to lower overall sales in 2020. The decrease as a percentage of net sales, year over year, is due to lower average manufacturing costs resulting from a focused effort to design and develop our product lines for greater product margins. This decrease is partially offset by a higher average royalty rate, in part driven by the mix of products sold during the six-month period. Halloween . Cost of sales of our Halloween segment was $21.8 million, or 82.2% of related net sales for the six months ended June 30, 2020 compared to $31.8 million, or 79.5% of related net sales for the prior year period, representing a decrease in dollars of $10.0 million, or 31.4%. The decrease in dollars is due to lower overall sales in 2020. The increase as a percentage of net sales is due primarily to higher average royalty rate compared to prior period. Selling, General and Administrative Expenses Selling, general and administrative expenses were $57.0 million for the six months ended June 30, 2020 compared to $69.1 million for the prior year period constituting 39.2% and 41.6% of net sales, respectively. Selling, general and administrative expenses decreased by $12.1 million from the prior year period primarily driven by company-wide cost savings initiatives begun in 2019 as well as other COVID-19 pandemic-driven cost mitigation programs. In addition, the write-down of the Maui intangible asset during the fourth quarter of 2019 results in a year-over-year reduction of amortization expense of $1.7 million in the first half of 2020. Restructuring Charges During the six months ended June 30, 2020, we recognized $1.6 million of restructuring charges as a result of a company-wide restructuring initiative. The restructuring charges primarily related to employee severance costs. 41 Table of Contents Pandemic Related Charges During the six months ended June 30, 2020, we recognized $0.2 million spending directly attributable to making necessary accommodations related to the COVID-19 pandemic. Acquisition Related and Other During the six months ended June 30, 2019, we recognized $5.4 million in acquisition related and other charges as a result of our ongoing evaluation and negotiation of a strategic and/or refinancing transaction, including Hong Kong Meisheng Cultural Company Limited's expression of interest in acquiring additional shares of our common stock and the refinancing of our convertible senior notes due in 2020. Interest Expense Interest expense was $11.1 million for the six months ended June 30, 2020, as compared to $5.9 million in the prior year period. During the six months ended June 30, 2020, we booked interest expense of $1.2 million related to our convertible senior notes due in 2020 and 2023, $9.3 million related to our Term Loan, and $0.6 million related to our revolving credit facility. During the six months ended June 30, 2019, we booked interest expense of $3.2 million related to our convertible senior notes due in 2020, and $1.8 million related to our revolving credit and term loan facilities. Provision for (Benefit from) Income Taxes Our income tax expense, which includes federal, state and foreign income taxes and discrete items, was $0.5 million, or an effective tax rate of (1.6)%, for the six months ended June 30, 2020. During the comparable period in 2019, our income tax expense was $0.3 million, or an effective tax rate of (0.7)%. 42 Table of Contents Seasonality and Backlog The retail toy industry is inherently seasonal. Generally, our sales have been highest during the third and fourth quarters, and collections for those sales have been highest during the succeeding fourth and first quarters. Our working capital needs have been highest during the second and third quarters. While we have taken steps to level sales over the entire year, sales are expected to remain heavily influenced by the seasonality of our toy and Halloween products. The result of these seasonal patterns is that operating results and the demand for working capital may vary significantly by quarter. Orders placed with us are generally cancelable until the date of shipment. The combination of seasonal demand and the potential for order cancellation makes accurate forecasting of future sales difficult and causes us to believe that backlog may not be an accurate indicator of our future sales. Similarly, financial results for a particular quarter may not be indicative of results for the entire year. 43 Table of Contents Liquidity and Capital Resources As of June 30, 2020, we had working capital of $85.3 million, compared to $107.5 million as of December 31, 2019. The decrease was primarily attributable to the net loss and a lower accounts receivable balance, partially offset by lower accounts payable and accrued expense balances. Operating activities used net cash of $11.9 million in the six months ended June 30, 2020, as compared to $8.9 million in the prior year period. Net cash during the six months ended June 30, 2020 was primarily impacted by a decrease in accounts payable, accrued expenses and reserve for sales returns and allowances, partially offset by a decrease in accounts receivable. Net cash during the six months ended June 30, 2019 was primarily impacted by a decrease in accounts receivable and an increase in accounts payable and accrued expenses, partially offset by an increase in prepaid and other assets and a decrease in the reserve for sales returns and allowances. Other than open purchase orders issued in the normal course of business related to shipped product, we have no obligations to purchase inventory from our manufacturers. However, we may incur costs or other losses as a result of not placing orders consistent with our forecasts for product manufactured by our suppliers or manufacturers for a variety of reasons including customer order cancellations or a decline in demand. As part of our strategy to develop and market new products, we have entered into various character and product licenses with royalties generally ranging from 1% to 23% payable on net sales of such products. As of June 30, 2020, these agreements required future aggregate minimum royalty guarantees of $45.0 million, exclusive of $30.9 million in advances already paid. Of this $45.0 million future minimum royalty guarantee, $35.1 million is due over the next twelve months. Our investing activities used net cash of $4.3 million in the six months ended June 30, 2020, as compared to using net cash of $5.2 million in the prior year period, and consisted primarily of cash paid for the purchase of molds and tooling used in the manufacture of our products. Our financing activities provided net cash of $4.1 million for the six months ended June 30, 2020, primarily consisting of proceeds from the loan under the Paycheck Protection Program, partially offset by the retirement of convertible senior notes. Our financing activities used net cash of $7.9 million for the six months ended June 30, 2019, primarily consisting of the repayment of credit facility borrowings. As of June 30, 2020, we have substantial indebtedness including $134.8 million of outstanding indebtedness under a First Lien Term Loan Facility Credit Agreement (the “New Term Loan Agreement). As of June 30, 2020, we have no outstanding indebtedness under an amended and extended Credit Agreement (the “Amended ABL Credit Agreement” or “Amended Wells Fargo Credit Agreement”) with Wells Fargo Bank, National Association (“Wells Fargo”). 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. Commencing with the fiscal quarter ending September 30, 2020, we are also required under the New Term Loan Agreement to maintain a minimum EBITDA of not less than $34.0 million over the previous twelve months and a minimum liquidity of not less than $10.0 million. 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. We were in compliance with the financial covenants under the New Term Loan Agreement as of June 30, 2020. However, given the current uncertainties created by the COVID-19 pandemic, as discussed further in Note 1 "Basis of Presentation," it is probable that we will not achieve the minimum EBITDA threshold required under the New Term Loan Agreement at September 30, 2020. Failure to satisfy such requirement would constitute an event of default under the New Term Loan Agreement and Amended ABL Credit Agreement unless the lenders agreed to waive compliance with such requirement. 44 Table of Contents Debt and Credit Facilities Convertible Senior Notes In July 2013, we 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, 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 our 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, we repurchased and retired an aggregate of approximately $6.1 million principal amount of the 2018 Notes. During the first quarter of 2017, we 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 our common stock. During the second quarter of 2017, we 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 our common stock. In August 2017, we agreed with Oasis Management and Oasis Investments II Master Fund Ltd., (collectively, “Oasis”) the holder of approximately $21.6 million face amount of our 4.25% convertible senior notes due in 2018, 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 our 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 our Board of Directors and Oasis’ Investment Committee, the transaction closed on November 7, 2017. On July 26, 2018, we 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 our common stock at an initial rate of 322.2688 shares per $1,000 principal amount of the new notes. 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 our 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, we 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 our balance sheet, including the extension to us of incremental liquidity and at least three-year extensions of substantially all of our outstanding convertible debt obligations and revolving credit facility. Our term loan agreement entered into with Great American Capital Partners was paid in full and terminated in connection with the Recapitalization Transaction. In connection with the Recapitalization Transaction, we 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. We may trigger a mandatory conversion of the New Oasis Notes if the market price exceeds 150% of the conversion price under certain circumstances. We may redeem the New Oasis Notes in cash if a person, entity or group acquires shares of our Common Stock, par value $0.001 per share (the “Common Stock”), and as a result owns at least 49% of our issued and outstanding Common Stock. Excluding the impact of the 1 for 10 reverse stock split the conversion price of the new Oasis Notes reset on February 9, 2020 to $1.00 per share. 45 Table of Contents 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 our common stock. In June 2014, we 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 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 our 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 our common stock. Holders of the 2020 Notes may require that we 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, we repurchased and retired an aggregate of $2.0 million principal amount 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, the New Preferred Equity (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. The remaining $1.9 million principal amount of 2020 Notes were redeemed at par at maturity on June 1, 2020. Term Loan On August 9, 2019, in connection with the Recapitalization Transaction, we entered into a First Lien Term Loan Facility Credit Agreement, (the “New Term Loan Agreement”), with certain holders of the 2020 Notes, or 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”). We 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 our ability and the ability of our 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. Commencing with the fiscal quarter ending September 30, 2020, we are also required to maintain a minimum EBITDA of not less than $34.0 million and a minimum liquidity of not less than $10.0 million. 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 us, the subsidiary borrowers thereunder and certain of the other existing and future direct and indirect subsidiaries and are secured by substantially all of our assets, the subsidiary borrowers thereunder and such other subsidiary guarantors, in each case, subject to certain exceptions and permitted liens. 46 Table of Contents Loan under Paycheck Protection Program On June 12, 2020, we received a $6.2 million loan (the “PPP Loan”) under the Paycheck Protection Program (the “PPP”) 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 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 loan received has been recorded as a liability by the Company as of the date received. We intend 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 we intend to use the proceeds of the PPP Loan only for permissible purposes, there can be no assurance that we will be eligible for forgiveness of the PPP Loan, in full or in part. Wells Fargo In March 2014, we and our 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 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 we 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, we 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, we revised certain of the Credit Facility documents (and entered into new ones) so that certain of our 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 we 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), we entered into the Amended ABL Credit Agreement with Wells Fargo). The Amended ABL Credit Agreement, amends, extends and restates our 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. The obligations under the Amended ABL Credit Agreement are guaranteed by us, the subsidiary borrowers thereunder and certain of the other existing and future direct and indirect subsidiaries and are secured by substantially all of our assets, the subsidiary borrowers thereunder and such other subsidiary guarantors, in each case, subject to certain exceptions and permitted liens. As of June 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 $23.6 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 our ability to, among other things, incur additional indebtedness, make restricted payments, pledge our assets as security, make investments, loans, advances, guarantees and acquisitions, undergo fundamental changes and enter into transactions with affiliates. We are 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 June 30, 2020 and December 31, 2019, we are in compliance with the financial covenants under the Amended ABL Credit Agreement and the previous Credit Facility, as applicable. Any amounts borrowed under the Amended ABL Credit Agreement 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 June 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%. 47 Table of Contents The Amended ABL Agreement 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 our obligations and our subsidiaries obligations under the Amended ABL Agreement may be declared immediately due and payable. For certain events of default relating to insolvency, all outstanding obligations become due and payable. Great American Capital Partners On June 14, 2018, we 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 us by Lenders of a $20.0 million term loan. To secure our obligations under the Term Loan, we granted to Agent, for the benefit of the Secured Parties, a security interest in a substantial amount of our consolidated assets and a pledge of the majority of the capital stock of various of our subsidiaries. The Term Loan was a secured obligation, second only to the Credit Facility with Wells Fargo, except with respect to certain of our 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 our various convertible senior notes due in 2020 (see Note 5 — Debt). We were 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. In August 2019, in connection with the Recapitalization Transaction (see Note 5 — Debt), we repaid in full and terminated the Term Loan Agreement. We are subject to negative covenants which, during the life of the Amended Wells Fargo Credit Agreement and New Term Loan Agreement, prohibit and/or limit us from, among other things, incurring certain types of other debt, acquiring other companies, making certain expenditures or investments, and changing the character of our business. An outbreak of infectious disease, a pandemic or a similar public health threat, such as the 2019 Novel Coronavirus outbreak, or a fear of any of the foregoing, could adversely impact our ability to comply with such covenants. Our failure to comply with such covenants or any other breach of the Amended Wells Fargo Credit Agreement or New Term Loan Agreement could cause a default and we may then be required to repay borrowings under our Amended Wells Fargo Credit Agreement or New Term Loan Agreement with capital from other sources, or reach some other accommodation with those parties. As of June 30, 2020 and December 31, 2019, we held cash and cash equivalents, including restricted cash, of $52.7 million and $66.3 million, respectively. Cash, and cash equivalents, including restricted cash held outside of the United States in various foreign subsidiaries totaled $24.7 million and $27.0 million as of June 30, 2020 and December 31, 2019, respectively. The cash and cash equivalents, including restricted cash balances in our 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 we expect would not be significant as of June 30, 2020. Our primary sources of working capital are cash flows from operations and borrowings under our Amended Wells Fargo Credit Agreement (see Note 6 — Credit Facilities). 48 Table of Contents Typically, cash flows from operations are impacted by the effect on sales of (1) the appeal of our products, (2) the success of our 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 our ability to generate sufficient cash flows to operate the business. In addition, our business and liquidity are dependent to a significant degree on our 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 our cash flows and business. Given the conditions in the toy industry environment in general, vendors, including licensors, may seek further assurances or take actions to protect against non-payment of amounts due to them. Changes in this area could have a material adverse impact on our liquidity. Off-Balance Sheet Arrangements As of June 30, 2020, off-balance sheet arrangements include letters of credit issued by Wells Fargo of $10.4 million. 49 Table of Contents