Jakks Pacific Valuation Projection - Mark Moore

Jakks Pacific Valuation Projection
Lily Pad Analysis Group
Guyanka Chandrasena
Jonathan Haralson
Ben Tollerene
Joshua Yueng
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Table of Contents
Executive Summary ................................................................................................ 6
Industry Analysis ................................................................................................. 7
Accounting Analysis ............................................................................................. 8
Financial Analysis ................................................................................................ 9
Valuation Analysis .............................................................................................. 10
Business and Industry Analysis .............................................................................. 11
Company Overview ............................................................................................ 11
Industry Overview ............................................................................................. 14
Five Forces Model ................................................................................................. 17
Rivalry Among Existing Firms .............................................................................. 18
Industry Growth ............................................................................................. 18
Concentration ................................................................................................ 18
Degree of Differentiation ................................................................................ 19
Switching Costs .............................................................................................. 20
Scale Economies ............................................................................................ 21
Learning Economies ....................................................................................... 22
Fixed to Variable Costs ................................................................................... 22
Excess Capacity ............................................................................................. 23
Exit Barriers ................................................................................................... 23
Threat of New Entrants ...................................................................................... 24
Economies of Scale ........................................................................................ 25
First Mover Advantage .................................................................................... 26
Channels of Distribution .................................................................................. 26
Legal Barriers ................................................................................................ 27
Threat of Substitute Products ............................................................................. 27
Relative Price and Performance ....................................................................... 27
Buyers Willingness to Switch ........................................................................... 28
Bargaining Power of Customers .......................................................................... 29
Bargaining Power of Suppliers ............................................................................ 31
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Value Creation ...................................................................................................... 32
Economies of Scale ............................................................................................ 32
Input Costs and Production ................................................................................ 33
Quality and Variety ............................................................................................ 34
Brands and Marketing ........................................................................................ 35
Creativity and Development ................................................................................ 36
Firm Competitive Advantage Analysis ..................................................................... 37
Economics of Scale ............................................................................................ 38
Input Costs and Production ................................................................................ 39
Quality and Variety ............................................................................................ 40
Brand and Marketing ......................................................................................... 41
Creativity and Development ................................................................................ 42
Flexible Delivery ................................................................................................ 43
Customer Service .............................................................................................. 44
Formal Accounting Analysis ................................................................................... 45
Key Accounting Policies ......................................................................................... 46
Goodwill ........................................................................................................... 48
Advertising Expense .......................................................................................... 52
Research and Development ................................................................................ 54
Capital and Operating Leases ............................................................................. 56
Currency Risk .................................................................................................... 57
Quantitative Analysis ............................................................................................. 60
Sales Manipulation Diagnostics ........................................................................... 61
Net Sales/Cash from Sales .............................................................................. 62
Net Sales/Account Receivables ........................................................................ 63
Net Sales/Inventory ........................................................................................ 65
Net Sales/Unearned Revenue .......................................................................... 67
Net Sales/Warranty Liabilities .......................................................................... 67
Expense Manipulation Diagnostics ....................................................................... 69
Asset Turnover .............................................................................................. 69
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Cash Flow from Operations / Income from Operations ...................................... 70
Cash Flow from Operations / Net Operating Assets ........................................... 72
Total Accruals / Net Sales ............................................................................... 74
Pension Expense / SG&A ................................................................................. 76
Other Employment Expenses / SG&A ............................................................... 76
Potential Red Flags ............................................................................................... 78
Undo Accounting Distortions .................................................................................. 87
Financial Analysis .................................................................................................. 91
Liquidity Ratio Analysis .......................................................................................... 91
Current Ratio .................................................................................................... 91
Acid Test .......................................................................................................... 93
Accounts Receivable Turnover ............................................................................ 94
Days Sales Outstanding ..................................................................................... 95
Inventory Turnover ............................................................................................ 95
Days Supply of Inventory ................................................................................... 96
Working Capital Turnover ................................................................................... 97
Profitability Analysis .............................................................................................. 99
Gross Profit Margin ............................................................................................ 99
Operating Profit Margin ..................................................................................... 100
Net Profit Margin .............................................................................................. 101
Asset Turnover ................................................................................................. 102
Return on Assets .............................................................................................. 103
Return on Equity .............................................................................................. 104
Capital Structure Analysis ..................................................................................... 106
Debt to Equity Ratio ......................................................................................... 106
Times Interest Earned ...................................................................................... 108
Debt Service Margin ......................................................................................... 111
Altman Z Scores ............................................................................................... 112
Sustainable Growth Rate ................................................................................... 114
Financial Statement Forecast ................................................................................ 117
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Goodwill Adjustment ......................................................................................... 117
Income Statement ............................................................................................ 118
Balance Sheet .................................................................................................. 125
Statement of Cash Flows ................................................................................... 134
Cost of Capital ..................................................................................................... 140
Cost of Equity .................................................................................................. 140
Cost of Debt ..................................................................................................... 141
Weighted Average Cost of Capital ...................................................................... 142
Valuation Analysis ................................................................................................ 144
Method of Comparables .................................................................................... 145
Price to Earnings (Trailing)............................................................................. 146
Price to Earnings (Forward)............................................................................ 147
Price to Book ................................................................................................ 148
Price Earnings Growth ................................................................................... 149
Price to EBITDA ............................................................................................ 150
Price to Free Cash Flows ................................................................................ 151
Price to Free Cash Flows ................................................................................ 152
Intrinsic Valuation Models ................................................................................. 153
Free Cash Flows Model .................................................................................. 153
Residual Income Model .................................................................................. 155
Long-Run Residual Income Model ................................................................... 157
Abnormal Earnings Growth Model ................................................................... 159
Analyst Opinion ................................................................................................ 161
Appendix............................................................................................................. 162
References .......................................................................................................... 185
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Executive Summary
Investment Recommendation: Fairly Valued – Hold (6/1/2008)
JAKK - NYSE (6/1/2008) $22.79 Altman Z-Scores
52 Week Range $18.19 - $31.42 2003 2004 2005 2006 2007
Revenue $857.09 M Initial 2.53 2.52 3.25 2.75 3.06
Market Capitalization $652.35 M Adjusted 2.25 2.23 3.00 2.47 2.81
Shares Outstanding
28.62 M
Market Price (6/1/2008) $22.79
Initial Adjusted
Book Value per Share $24.14 $21.67
ROE 14.61% 7.47% Method of Comparables Initial Adjusted
ROA 10.09% 4.97% P/E (Trailing) $49.12 $22.27
P/E (Forward) $55.13 $28.96
Cost of Capital P/B $66.63 $59.81
Estimated R-Squared Beta Ke P.E.G. $65.40 $29.65
3-Month 0.1360 1.33 0.1648 P/EBITDA $35.77 $35.77
6-Month 0.1361 1.33 0.1647 P/FCF $21.14 $29.82
1-Year 0.1361 1.33 0.1641 EV/EBITDA $35.28 $35.28
5-Year 0.1363 1.33 0.1620
10-Year 0.1364 1.33 0.1580
Intrinsic Valuations Initial Adjusted
Alt. Cost of Equity Estimate 14.38% Free Cash Flows Model $44.53 $61.73
Published Beta 0.28 Residual Income Model $24.67 $14.23
Long Run Residual Income Model $25.17 N/A
Initial Adjusted Abnormal Earnings Growth Model $22.39 $25.15
Cost of Debt 7.04% 7.04%
WACC (BT) 13.20% 13.00%
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Industry Analysis
Industry Analysis
Rivalry Among Existing Firms
Threat of New Entrants
Threat of Substitute Products
Bargaining Power of Customers
Bargaining Power of Suppliers
High
Average
High
High
Average
In this analysis, the industry was deemed to be highly competitive due to the
array of companies that design, develop, and market consumer goods. These goods
include traditional toys for children of all ages, pet toys, writing utensils, and related
items for each category. However, in the case of some leaders in this industry, game
consoles and game software have been added to the business activities in an effort to
diversify product lines. In the toy and game industry, there is a high amount of rivalry
among the existing firms with very low industry growth. Overall, the degree of
differentiation in the toy and game industry is very low. Since many products are very
similar, firms have to find other means of gaining competitive advantages. Companies
in this industry are not able to change the type of products they produce without
incurring high costs. Manufacturing companies, like the toy industry, that invest heavily
in capital equipment can run the risk of not being able to exit easily. But, they can
become profitable by keeping variable costs down and managing the overhead
expenses associated with manufacturing facilities. The potential for abnormal profits in
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this industry are low due to the large number of companies meaning there are few
entry barriers. But, these companies enter at a disadvantage due to smaller economics
of scale. A first mover advantage is difficult to obtain and can only be achieved by
designing a new or innovative toy that either dramatically changes the way toys are
made or sets a new standard in the market trend of toys.
The toy and games industry is highly competitive. The largest firms are battling
for market share and to win customers they must implement strategies that create
value and competitive advantages. In this, differentiation is offering something
superior, be it unique products, customer service, variety, or brand image, at a cost less
than what the customers is willing to pay for it. In addition, cost leadership revolves
around minimizing costs and maximizing efficiency to allow them to sell the product for
the same price as their competitors and make a greater profit. In the toy industry a
mixture of differentiation and cost leadership strategies is effective.
Accounting Analysis
Accounting Analysis Flexibility Disclosure
Goodwill Low High
Advertising Expense Low Low
Research and Development Low None
Capital and Operating Leases High Low
Currency Risk Low Average
The accounting analysis will look into how well the firms in the industry are
managing their accounting policies. In addition, the accounting policies are items within
the financial statements that directly relate to success factors identified in the five
forces model. In comparing the disclosure of the company with the guidelines provided
by GAAP, we can make an assessment as to whether or not the firm misused the
flexibility in GAAP. Each accounting policy will be assessed based on disclosure
requirements as defined by GAAP, based upon the level of disclosure, they will be
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indentified as conservative or aggressive. In conservative accounting, managers do not
want to overstate income. In aggressive accounting, managers are reporting items in
such a way that they might lead to higher reported earnings. In this analysis, we can
determine from the information presented if the company is disclosing the information
that is useful to making proper investment decisions. Jakk has a high level of disclosure
with an aggressive accounting policy in regards to goodwill. Jakks Pacific, Inc. is a
company of low disclosure when it comes to advertising expenses and in regards to
GAAP there is low flexibility in what they can do. In terms of Research and
Development, Jakks Pacific did not provide any information on the cost involved in the
R&D of their products but Hasbro and Leapfrog treated it like an operating expense.
In the quantitative analysis, we will use sales manipulation diagnostics and
expense manipulation diagnostics to determine if the numbers reported in the financial
statements are accurate (reflects true value of the firm) or distorted (more profitable
than it actually is). In general, we found several red flags but in terms of accounting the
only real issue was goodwill which accounted for about 36% of total assets, this was
addressed in the undo accounting distortions section, and was included in our
forecasting.
Financial Analysis
In the financial analysis, we look into ratios such as liquidity, profitability, and
capital structure. Liquidity deals with how fast the company can convert assets into
Cash. In analyzing the Profitability of the toy and games industry, we looked at how
efficient each company is at generating sales. Capital Structure determines how the
firms are financing their activities. Altman Z Score is treated as part of the capital
structure ratios and is a method of calculating a company’s risk of bankruptcy.
We will use these ratios along with patterns from previous years, industry
knowledge, and knowledge of the firm itself to forecast items on the balance sheet,
income statement, and statement of cash flows. In this, we are using our knowledge
and understanding of what the company is and does to reasonably predict what might
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happen in the future. In doing so, we are able to determine if the company is fairly
valued through the use of valuation models which are discussed later. In forecasting,
we will focus on the raw statements (what the company provided) and then on
adjusted statements (if we accounted for goodwill). Goodwill was deemed a red flag in
the accounting section, not only have we accounted for it impairment in the ratios
mentioned earlier, but we have included it in the forecasting, and valuations models
discussed later. In addition to this, we will estimate the cost of capital to gain insight on
how operations are funded and to increase our knowledge of the value of the firm. The
cost of equity is defined as the minimum rate of return that shareholders require to be
compensated for the time waiting for returns and the risk involved.
Valuation Analysis
In this report, we seek to determine the true value of the firm by using the method of
comparables and the intrinsic valuation models. In the first, we use the industry
average of ratios (price to earnings, etc) to calculate a share price for the company and
will compare that price to the stated price to determine if the company is fairly valued.
In the comparables, we found the company to be undervalued, but this methodology is
not known for its reliability, therefore, the intrinsic valuation models are more relevant
in determining the firm’s value. The intrinsic models used for our valuation were the
Free Cash Flows Model (FCFM), Residual Income Model (RIM), Long Run Residual
Income Model (LRIM) and the Abnormal Earnings Growth Model (AEGM).
In using the intrinsic valuation models we found that in the free cash flow model
that the company was undervalued both prior to the goodwill adjustment and after. In
the more reliable and less sensitive residual income model, we found that the company
was fairly valued prior to the goodwill adjustment. In the long-run residual income
model we found that the company was again fairly valued. Lastly, the abnormal
earnings growth model supported the company being fairly valued. In closing, we,
based on the intrinsic valuation models, have concluded that the company is fairly
valued.
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Business and Industry Analysis
Company Overview
Jakks Pacific, Inc. was founded in 1995 by Jack Friedman, Chairman and Chief
Executive Officer, and Stephan G. Berman, President and Chief Operating Officer. Jakks
Pacific’s Headquarters are located on the Pacific Coast Highway in Malibu, California and
their products are manufactured in Asia. Jakks Pacific’s product lines feature traditional
toys, electronic products (EyeClops Bionic Eye and Laser Challenge), wheels division
products (toy and activity vehicles), action figures and accessories (WWE, Pokemon,
Dragon Ball Z, and Hannah Montana), Dolls, Junior Sports Products (Paintball Products),
Crafts with popular kid characters, pet products, and WWE games (Jakks Pacific, Inc
2007 10-K).
Jakks Pacific is ranked in the top five in the United States based on their market
share. Their stated goal is to “engage children in creative play with products that
encourage learning, interaction, and fun” and “to be a billion dollar company through
organic growth of its core product lines, dynamic partnerships, strategic alliances as
well as through strategic acquisitions” (www.jakkspacific.com). In this statement, they
speak of creating toys that appeal to children and of seeking ways of expanding the
business. In the toy industry, companies fight to acquire licenses for popular or lasting
brands to gain the approval of their customers and to gain the edge over competitors.
In this regard, it is important to get the most out of those brands by creating products
that target a wider range of consumers. In keeping to those goals, Jakks Pacific
acquired the license for WWE and formed a joint venture with THQ Inc. (first title
release in 1999) to gain the right to publish and market video games based on the
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popular brand. In addition, they have acquired licenses from Nickelodeon, Disney ®,
and Warner Bros ® and have created products based on characters from Marvel and
Pokemon. In the global market, their foreign sales accounted for 14.7% of total sales
(2007), to expand on those sales they intend to capitalize “on their experience and
relationships with foreign distributors and retailers” (Jakks Pacific, Inc. 2007 10-K).
The major competitors for Jakks Pacific are Hasbro Inc. (HAS), Mattel Inc.
(MAT), and Leapfrog Enterprises Inc. (LP). Jakks Pacific has a Market Cap of 646.38
Million, Leapfrog, founded in 1995 (same as Jakks Pacific), has a Market Cap of 525.26
Million. Hasbro, founded in 1923, and Mattel, founded in 1945, have Market Caps of
5.02 Billion and 7.29 Billion respectively. Jakks Pacific is a small company compared to
the larger and older companies (Hasbro and Mattel) that dominated the market for a
longer period of time. In spite of this, they push forward and became a strong
competitor in the toy industry.
In 2004, Jakks Pacific found a demand for videogames that plug into the
television, created games based on the world poker tour and marketed cabbage patch
kids and care bear stuffed animals, which were popular at the time (online.wsj.com). It
is due to that popularity that sales growth was recorded at 81.86%, which was the
highest recorded in the chart below. Jakks Pacific had better sales growth between
2004 and 2006 than other firms in the industry but was beaten by Hasbro in 2007. It is
interesting to note that sales growth for the industry tends to be favorable. In truth,
this is expected for kids may never lose interest in their desire to have toys. In the
chart, two contradictions to the positive growth can be noted, one was by Hasbro in
2004 and the other was by Leapfrog.
Sales Growth
2003 2004 2005 2006 2007
Jakks 1.86% 81.86% 15.20% 15.70% 11.98%
Hasbro 11.45% ‐4.50% 3.01% 2.07% 21.77%
Mattel 1.53% 2.88% 1.49% 9.10% 5.66%
Leapfrog 27.88% ‐5.84% 1.48% ‐22.70% ‐11.94%
Total Industry 6.45% 2.42% 2.82% 5.13% 10.31%
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In actual sales, Jakks Pacific performed admirably but was outperformed by
Hasbro and Mattel. Leapfrog, on the other hand, showed a negative 34.96% decrease
in sales between 2003 and 2007. In the industry, sales have grown from 9.1 billion in
2003 to 11.1 billion in 2007.
Sales (in thousands)
2003 2004 2005 2006 2007
Jakks $315,776 $574,266 $661,537 $765,386 $857,085
Hasbro $3,138,657 $2,997,510 $3,087,627 $3,151,481 $3,837,557
Mattel $4,960,100 $5,102,786 $5,179,016 $5,650,156 $5,970,090
Leapfrog $680,012 $640,289 $649,757 $502,255 $442,271
Total Industry $9,094,545 $9,314,851 $9,577,937 $10,069,278 $11,107,003
Jakks Pacific grew steadily with respect to asset value but was beaten by Hasbro
and Mattel. In truth, they can catch up, but to do so, may take them a few years.
Leapfrog, on the other hand, shrank by negative 31.12% in asset value from 2003 to
2007. In thinking back, it seems ironic on what happened to Leapfrog, prior to 2004,
they were a promising company with signs of favorable growth, but after that year,
Jakks Pacific started to gain larger assets (from 2004) and stronger sales (from 2005).
Total Asset Value (in thousands)
2003 2004 2005 2006 2007
Jakks $529,997 $696,762 $753,955 $881,894 $982,688
Hasbro $3,163,376 $3,240,660 $3,301,143 $3,096,905 $3,237,063
Mattel $4,510,950 $4,756,492 $4,372,313 $4,955,884 $4,805,455
Leapfrog $552,659 $559,794 $605,829 $450,441 $380,153
Total Industry $8,756,982 $9,253,708 $9,033,240 $9,385,124 $9,405,359
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Industry Overview
There are about 900 companies in the toy and game industry with combined
annual revenues of $5 billion (www.MarketResearch.com). In this analysis, the industry
was highly competitive due to the array of companies that design, develop, and market
consumer goods. These goods include traditional toys for children of all ages, pet toys,
writing utensils, and related items for each category. However, in the case of some
leaders in this industry, game consoles and game software have been added to the
business activities in an effort to diversify product lines. Growth in both demand and
profitability is influenced by children of ages twelve and under. That is, the growth in
revenues is dependent upon the children that demand their products.
The chart above compares stock returns for Jakks (red line), Hasbro (green line),
and Mattel (orange line) to the S&P 500 index (blue line). As you can see, Mattel and
Hasbro have outperformed the S&P 500 index for the past eight years by a considerable
amount. Jakks Pacific has been on par with the S&P 500 index. This chart shows how
resilient the toy and game industry is to the rest of the market. Even though other
industries in the consumer goods sector might be affected by the current recession,
parents seem to sacrifice to keep their children happy by buying them toys. According
to the sales growth among Jakks, Hasbro and Mattel, the industry does not appear to
be slowing down. In defining the industry with these companies, we can conclude that
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the toy and game industry has outperformed the market on average and will continue
to do so.
In order to hold value in the toy manufacturing industry, the value drivers that
make a company profitable have been identified. First, a company must be able to
identify market trends. Finding the market trends, in this context, is defined by the
ability to identify potential popular toys that will generate revenues in the long term.
By recognizing these early, companies will be able to achieve a first mover advantage
within that particular product line through the creation of toys and games or by gaining
licensing rights. Note however, that this industry is very careful in that each company
prefers product lines that are long lasting unlike fads. Second, companies must be able
to market effectively. Advertising in this field is the key to gaining customers. Also, the
ability to show product superiority through marketing will help achieve more shelf space
and therefore more sales. Finally, companies in the toy and game industry must be in
the business of cost leadership. With about 900 companies producing similar products,
it is essential to maintain low input cost, while upholding product quality to be able to
compete with competitors pricing. These three things are what drive value in this
industry. Later we will take a look at how Jakks Pacific Inc. stands in relation to the
rest.
Toy and Games Industry Sales Growth
2003 2004 2005 2006 2007
Jakks Pacific 1.82% 45.01% 13.19% 13.57% 10.70%
Hasbro 10.27% ‐4.71% 2.92% 2.03% 17.88%
Mattel 1.51% 2.80% 1.47% 8.34% 5.36%
Note: Green cells mark increases in sales from the previous year, Red cells
denote a sales decrease.
Traditional toy manufacturers are facing increasing amounts of competition with
the rise of electronic entertainment for children. Video games, however, are only a
small part. Television, as well as advances in the Internet, contributes to this
competition, which makes it harder to get a company’s product noticed. Anyone, who
has the means to design and create a toy, can be considered a potential competitor.
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Although the majority of concentration is in the hands of Mattel, Hasbro, and Jakks
Pacific, entering this industry is fairly straightforward.
Wal-Mart, Target, and Toys ‘R’ Us are the three main customers for the toy
manufacturing industry. New entrants to this industry will find it very hard to establish
relationships among these customers. Finding other means of distributing a new
company’s product will be necessary.
Research and Development in this industry is valuable, if the company is able to
make a product that the market sees as creative and innovative, it will secure demand
for it. However, in the case of Jakks Pacific and other companies, inventing new
products is not part of their stated strategy. For those able to design and create toys
will be popular in the market. In addition, sales along with licensing rights to use brands
will generate revenues.
The main raw materials used in the industry for production purposes include
plastics, zinc alloy, plush, printed fabrics, paper products and electronic components.
Changes in the market for any of these raw materials would affect each company in the
industry. Although there are numerous companies in this industry, only the biggest
companies will be able to gain an advantage by buying raw materials in bulk and thus
receiving a discount.
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Five Forces Model
Rivalry Among Existing Firms
Threat of New Entrants
Threat of Substitute Products
Bargaining Power of Customers
Bargaining Power of Suppliers
High
Average
High
High
Average
Rather than using conventional forms of examining a company, this analysis will
use the Five Forces Model because of its specific application to the context of valuing a
company. This model observes the industry as a whole including competition, potential
entrants, substitute products, and the bargaining power of customers and suppliers.
The importance of identifying these is to find value drivers which are the things that
make a company profitable in the industry. Without recognizing these we would not be
able to make an accurate hypothesis on the future performance of Jakks Pacific Inc.
With the amount of companies in the industry, toy and game companies are
highly competitive. Whether designing new products or acquiring licenses is the
business strategy, each company seeks brands that are profitable now as well as in the
future. Because of this, it was determined that the level of competition was high. This
is misleading since each company has its own set of principle brands and the pricing of
products is not typically based on just licensing and patents.
In the case of perfect competition, each company would be pursing an economic
business strategy by producing toys to achieve equality among marginal revenue and
marginal cost. This would ensure maximum potential profits. Even though perfect
competition does not exist, switching costs disallow companies to price their licensed
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and patent products at any price. Furthermore, if companies want to gain market share
they must engage in price wars. The sources of competition analyzed are rivalry
among existing firms, threat of new entrants, threat of substitute products, bargaining
power of customers, and bargaining power of suppliers.
Rivalry Among Existing Firms
In this section, the basic sources of competition within the industry will be
covered. Profitability can generally be predicted by the level of rivalry among the
existing firms. In this industry, there is an aggressive focus on cost control to maximize
revenues.
Industry Growth
In the short run, the growth in the toy industry has declined mainly due to the
current recession. In the long run, growth is almost non-existent. The main reason for
this is because the industry is well established. This gives rise to the competition in
market share. In rapidly growing industries, gaining market share is not a problem
because of the high demand. However, in the case of the toy and game industry, we
can expect price wars. Another reason behind the declining growth rate is the rate of
growing competitors in other forms of entertainment such as electronic and video
games. Children, growing up in our current state of economy, are able to easily adapt
to technology. As this developing field continues to grow into the future, the demand
for electronic entertainment amongst children will grow as well. In order for current toy
companies to not get left behind, they will have to adapt to this form of technology.
Concentration
The number of firms and there sizes defines the degree of concentration within a
particular industry. The higher the concentration, the more monopolistic that industry
is. In this industry, the level of competition is highly concentrated: the top 50
companies hold 75 percent of the market (MarketResearch). As noted earlier, anyone
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with the ability to design and produce a toy can be considered a competitor. The level
of concentration in this industry can be explained by the total number of companies
(about 900). The Market
Share column chart shows
the publicly traded
competitors and their
market share for the past six
years.
This is a more
accurate representation of
what we would expect the
industry to be composed of
81.07%
Common Size Market Cap
Hasbro
Mattel
65.61% 66.95% 60.09%
66.49% 62.06%
31.26% 28.53% 33.48% 29.41% 31.32%
16.83%
2.10% 3.14% 4.53% 6.43% 4.10% 6.62%
2002 2003 2004 2005 2006 2007
since most of the smaller companies license their products (or the company itself is
acquired by another). Among these companies Hasbro and Mattel combined own 86%
of the market. The spread between the two larger companies and smaller cap
companies makes it difficult to gain market share, considering all the resources that
Mattel and Hasbro own. Even as this is the case, Mattel’s market share has had a
decreasing trend. Jakks Pacific has had an increasing trend and Hasbro has stayed
roughly the same throughout the six years. With this information we know that it is
possible to gain market share, but a company in this industry must have the resources
to compete. In conclusion, the high level of concentration in the toy and games
industry makes it very difficult to gain market share.
Degree of Differentiation
The toy and game industry has a low degree of differentiation. Each company
produces the same type of toys under different brands. For example, Mattel, Hasbro,
and Jakks Pacific all produce similar action figures, dolls, etc. Since each firm in the
industry is producing very similar products, firms have to find other ways to gain a
competitive advantage. One of these ways is to reduce costs to gain a higher gross
profit. Since the differentiation is low in this industry, firms have to compete on price.
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Spreading the gap between cost of goods sold and profit is very important in order to
create value for shareholders. Below is a graph showing the operating profit margins
between Jakks Pacific and its top two competitors.
Operating Profit Margin
18.00%
16.00%
14.00%
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
2003 2004 2005 2006 2007
Jakks Pacific
Hasbro
Mattel
Firms in this industry license products and acquire as many products as viable in
order to get costs as low as possible. As you can see from the graph above, Mattel has
consistently had the highest degree of profit margins. This means that they are
incurring greater profits out of their sales compared to Mattel and Jakks. However, for
the past three year, Jakks has been matching its percent of profit margins to its
competitors that hold most of the market share in the industry. The lower firms in the
toy and game industry can keep their costs down and can use the excess money to
acquire other product lines or gain licenses. Overall, the degree of differentiation in the
toy and game industry is very low. Since many products are very similar, firms have to
find other means of gaining competitive advantages.
Switching Costs
Switching costs refer to how expensive it is for a company to switch industries.
If switching costs are low, companies are able to enter and leave different industries
(creating different products) at relatively low costs. In the case of the toy and game
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industry, switching costs are high. Companies in this industry are not able to change
the type of products they produce without incurring extremely high costs. For example,
firms like Jakks Pacific are able to produce variations in products and make design
changes, but cannot use the same equipment to produce furniture. With switching
costs being high, firms in this highly competitive industry have to become very
specialized in their business activities. This means keeping costs down with a tight cost
control system while maintaining product quality with little defects.
Scale Economies
The size of a company in this industry determines its ability to compete in the
price wars of high competition. Scale economies refer to the advantage a company can
gain in cost leadership due to expansion. Bigger firms are able to buy raw materials in
bulk, making them cheaper. They are also able to spread their cost over a greater
range of output (for example, marketing costs). For smaller firms, similar business
activities become way more expensive because they are not able to spread their costs
over the same scale of operations. To be a successful company in this industry, it is
very important to achieve economies of scale. Since high competition is accompanied
with low selling costs, having a high gross profit margin will show which companies are
the most successful with cost control.
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70.00%
Gross Profit Margin
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
Jakks Pacific
Hasbro
Mattel
Leapfrog
0.00%
2003 2004 2005 2006 2007
Learning Economies
Learning economies refers to the amount of knowledge that a company needs to
be successful. Most of what companies need to know about being successful in an
industry comes through experience. In developing a toy all a person needs is a creative
idea. The learning curve associated with producing the toy itself is not that great.
Competing for market share in this industry does, however, require experience in
knowing what consumers want and how to keep costs down through the product lines.
There is also a great learning curve in knowing where the toy and game industry will be
in the future. Since the value of a firm relies on future performance, it is essential to
have an understanding of where the industry is going in order to gain market share.
Fixed to Variable Costs
Generally the firms in this industry have high fixed to variable cost ratios, giving
them incentive to reduce prices. The fixed costs are high because companies own large
amounts of manufacturing equipment to make each product line. The more equipment
running to create the different products, the higher overhead costs become. One way
that firms are able to keep the overhead costs down is by making bottleneck
procedures within work in process enabling them to produce the same amount of
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products in a smaller period of time. The cost of raw materials used in product
manufacturing can become increasingly expensive. Since most of these materials can
be used across multiple product lines, ordering in bulk can keep these variable costs
way down. Overall, companies in the toy and games industry can become profitable by
keeping variable costs down and managing the overhead expenses associated with
manufacturing facilities.
Excess Capacity
Excess capacity, the amount of product supplied over demand, can lead to very
dangerous outcomes for the toy industry. Say a company acquires a license to produce
and sell the latest fad. If the product does not stay popular for long, companies can be
left with piled up inventories and may be forced to sell them at a discount. When this
occurs, companies must account for inventory impairments. This in fundamental nature
reduces the value of the company.
Exit Barriers
Although there are virtually no barriers to entry, the opposite can be said for exit
barriers. Exit barriers are obstacles that a firm faces when they want to quit producing
or shut down. The obstacles are often financial burdens that make it more costly to exit
than to continue operating. Exit barriers are important to examine because a company
may be distorting accounting figures in a way that makes them look more profitable
than they are in order to avoid incurring shut down costs. Manufacturing companies like
the toy industry that invest heavily in capital equipment can run the risk of not being
able to exit easily. Depending on each company’s manufacturing equipment, they may
fall into the category of non transferable fixed assets. When this is the case, the
machinery cannot be easily used for producing anything else. Since this barrier has the
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potential to be very significant, it may force firms to continue competing rather that
shutting down (the costlier of the two).
Conclusion
In the toy and game industry, there is a high amount of rivalry among the
existing firms with very low industry growth (combined with high internal growth).
With the consistent high to variable costs ratios in the industry, the companies in this
industry compete on price. In order to compete on pricing however, companies must
control their cost and keep them as low as possible. By reducing overhead expenses
and excess capacity, firms should have the ability to keep the costs of production low.
The concentration is very high, with 5 percent of the companies owning 75 percent of
the market share. With this degree of concentration, gaining market share is very
difficult. Toy and game manufacturers feature high switching cost, due to their low
degree of product differentiation. These high costs mean that toy companies are not
able to switch industries easily. Since the top companies are able to benefit from scale
economies they own large amounts of fixed assets, which gives rise to unavoidable exit
barriers.
Threat of New Entrants
The potential for abnormal profits in this industry are very low, mainly due to the
large number of companies. As this is the case, there are very low entry barriers,
giving any company the option to join. Although this is generally a key determinant of
future profitability, joining this industry is not as easy as it seems. Also, the term
“threat” is used loosely here in that new entrants would not be able to efficiently and
effectively compete with the existing top companies.
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Economies of Scale
With the high levels of economies of scale outlined in the previous section, new
entrants have the option to choose between large and optimum capacities. They will
also enter the market at a disadvantage due to costs. For the small toy maker, not
owning a large manufacturing plant will exclude them from the benefits of economies of
scale.
Total Assets
2002 2003 2004 2005 2006 2007
Jakks Pacific $408,810 $529,997 $696,762 $753,955 $881,894 $982,688
Hasbro $3,142,881 $3,163,376 $3,240,660 $3,301,143 $3,096,905 $3,237,063
Mattel $4,459,659 $4,510,950 $4,756,492 $4,372,313 $4,955,884 $4,805,455
Leapfrog $397,682 $552,659 $559,794 $605,829 $450,441 $380,153
Common Size of Total Assets
2002 2003 2004 2005 2006 2007
Jakks Pacific 4.86% 6.05% 7.53% 8.35% 9.40% 10.45%
Hasbro 37.38% 36.12% 35.02% 36.54% 33.00% 34.42%
Mattel 53.03% 51.51% 51.40% 48.40% 52.81% 51.09%
Leapfrog 4.73% 6.31% 6.05% 6.71% 4.80% 4.04%
Comparing the total assets for the top four in terms of market
capitalization, Mattel has the largest asset base. Even though each of these firms
experience economies of scale, Mattel and Hasbro are the most likely to fully utilize this.
That is because the more assets a firm has, the more potential it has to produce more
efficiently. Firms entering this industry face the disadvantage of having to own a
sufficient amount of assets that existing firms already have. In other words, new
entrants to this industry must invest heavily in production equipment and other assets
to have any opportunity at gaining market share.
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First Mover Advantage
A first mover advantage in defined as the initial advantage of entering a new
market segment. Since this traditional toy industry is long lived, industry standards
have already been set. For this reason, obtaining a first mover advantage is very
difficult. In order to achieve this however, a company would have to design a new and
innovative toy, which would either: (1) drastically change the way toys are made, or (2)
set a new standard in the market trend of toys. When a new product is developed,
licensing agreements and patents can be made. These agreements make it legally
impossible for other companies to produce the toy. In some instances, a license can
give only one company an exclusive right to produce the brand. Patents keep other
companies from developing the same toy as well. The first mover advantage in this
instance is acquiring a license to produce a toy, and therefore receiving all the sales for
that particular item. New entrants to the market do not have sufficient resources to
compete with existing firms in acquiring these licenses. Not only do they have to own
sufficient amount of assets, firms trying to enter this industry must also have plenty of
liquid assets to acquire these rights to produce new toys.
Channels of Distribution
New entrants in the toy and games market segment initially would have different
channels of distributions than the top 50 companies. The difficulty they would face in
developing a dealer network, would disallow them to get shelf space for the three main
customers of toys (Wal-Mart, Target, and Toys ‘R’ Us). These relationships make it
very difficult for new entrants to establish a reliable customer base. In the case of
Cranium, Inc., the company found other means of distributing their board game
through Starbucks. This ingenious partnership eventually got the attention of Hasbro,
who bought them out.
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Legal Barriers
As far as legal barriers go, there is no specific set of statutes that would limit
entry. This industry is however highly regulated. Laws regarding safety of products
would be the only concern of new entrants. However, these do not take away the
ability for companies to enter at will.
Conclusion
For companies to enter the market effectively, it will be difficult for them to
obtain economies of scale that the larger companies are currently achieving. First
mover advantages will be granted to the companies that come out will a truly new
product. Although legal barriers do not prevent firms from entering the industry, they
will have to find other means distributing their products to consumers.
Threat of Substitute Products
Substitute products in this sense are not necessarily those products that are
similar, but other products that would take the place of the existing toys. This industry
faces a big threat in this area because toy and games compete with all types of
entertainment among children. One of the biggest factors here is the consumer’s
willingness to switch products.
Relative Price and Performance
The biggest threat to the toy and games industry is the electronic gaming market
segment. As price of technology goes down, traditional toy manufacturers will find it
increasing difficult to compete with electronic games. Depending on the consumer, if
the relative price and performance of the alternative increases enough to where they
value the product more, they will most likely switch.
There are many competing products among the current selection of toys. Even
as this is the case, brand image and identity play a very big role in what products
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children want. For example, even though there are many different action figures,
children demand the characters that are currently being marketed the heaviest via
television or other media outlets. A knock-off product in this example simply will not do
for the child. They want what is popular without regard or knowledge of the price.
With a highly marketed product, producers can charge a premium for having the “best”.
Having this marketed toy effect has different results in different product categories.
Toys without a character or television show to associate them with are much easier for
other producers to compete with. An example of this would be remote controlled cars.
Although there are different styles, they all have the same functions without a relation
to another area of a child’s entertainment.
Buyers Willingness to Switch
In the highly marketed toys, children simply do not want the substitute product.
Only the “best” toy will suffice. This makes buyers (parents) willingness to switch
products very low. In this instance, parents would most likely rather spend the extra
premium for the toy wanted than to get a substitute that has very little value to the
child. Toys with a more general purpose and not related to a child’s favorite television
show can be substituted without question.
The buyers willingness to switch in general purpose toys is very high in which
case the cheaper product with similar features will most likely be bought.
Conclusion
With increases in technology surely headed our way, traditional toy makers are
going to have to make investment decisions based on the direction of electronic
entertainment. Another option would be to invest in brand image, making a company’s
product a must-have toy for any generation. Premiums can be charged for these
marketed toys, resulting in higher profit margins. With general purpose toys producers
cannot charge a premium, but must compete on lower prices. The children who
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demand the toys are the ultimate decision makers however, in which products must
stay and which products must go.
Bargaining Power of Customers
The firm’s ability to have bargaining power to influence price and cost over
customers can give them an advantage in any industry. Price sensitivity and relative
bargaining power are two indicators that determine the level of bargaining power over
customers. Price sensitivity refers to the competitive switching cost. Relative bargaining
power is the firm’s ability to set a price for the customers.
Switching cost is the customer’s or firm’s ability to find similar products or raw
material at other stores and suppliers, respectively. Toy “R” Us, for instance, has the
ability to purchase a similar toy from LeapFrog, Mattel, and Hasbro. The switching cost
is high because each company has its own trademarks and licensing rights. Jakks has
the licensing rights to World Wrestling Entertainment® and Hannah Montana®. Hasbro
has the licensing rights to Spider Man 3® and Star Wars: Revenge of the Sith®. Toys
‘R’ Us, Wal-Mart, and other toy retailers must decide what mix of trademark toys they
want in their sales floor. The cost to make a toy is not too expensive, but the cost to
purchase trademarks and licensing rights can be. Gross Profit divide by cost of goods
sold can give an idea of how much profit can be made.
Incremental Profit
2007 Hasbro Jakk LeapFrog Mattel
Gross Profit 2,260,936 323,650 173,306 2,777,300
COGS 1,576,621 533,435 268,965 3,192,790
GP per
COGS 1.43 0.61 0.64 0.87
Hasbro made $1.43 for every item sold in 2007. They earned the highest profit
per sold item among the competitors, which was double what Jakk’s had. Media can be
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a switching cost factor. The media advertise the next big movie, book, and television
show. The media influences the toy industry to buy trademark rights that consumers
are more fascinated with because of the “hype” that the media instills upon the public.
Three of the four toy companies make some kind of doll, action figure, and dress-up
accessory with a different logo or physical characteristic. LeapFrog is more into making
educational products with a “fun twist.” The variety of products with unique
trademarks among toy companies has created a degree of differentiation. Product
differentiation in firms is the ability to make a product stand out over other similar
products.
The toy industry has medium to high price sensitivity because switching costs
can change due to season, media, trademarks, and licensing rights. The industry
follows media trends such as video games, actors, books, movies, and television shows.
Relative bargaining power is the firm’s ability to set a price to the customers. Wal-Mart,
Toy ‘R’ Us, and Target are the major customers in the U.S. and have the ability to
dictate price because they account for a majority of the sales in the toy industry. The
volume of sales will make toy firms want to negotiate prices because there are no other
retailers that can replace those high purchase amounts. The foreign market makes up
approximately less than 50 percent. In this market, there are no dominating retailers to
buy large portions of products. In this regard, the toy industry does have relative
bargaining power with foreign customers. Toy industry customer leverage will have
medium to high competition in unique commodity goods.
The high cost for trademarks are spread out with the high volume of sales in the
U.S. and the increase of international sales. Media will always play a role in trends and
seasonality. The big three, U.S. toy retailers, can influence toy industry pricing for toys.
The pricing power for Jakk’s and their competitors is medium for their customer
bargaining power.
Annual Gross Profits for the Toy
2002 2003 2004 2005 2006 2007
Mattel 2,360,987 2,429,483 2,410,725 2,372,868 2,611,793 2,777,300
Leap 270,041 340,144 259,045 279,636 147,034 173,306
Hasbro 1,717,068 1,850,695 1,745,853 1,801,356 1,847,596 2,260,936
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Jakk 129,843 126,442 226,007 266,707 294,794 323,650
Industry Profit 4,477,939 4,746,764 4,641,630 4,720,567 4,901,217 5,535,192
Bargaining Power of Suppliers
Suppliers leverage or bargaining power of suppliers is the supplier’s bargaining
power over the firm. A firm that has few alternative products choices and competitors in
the industry can influence prices. The supplier’s leverage allows for firms to gain
advantages in operating costs which in turn increases profit.
Mattel, Jakks Pacific, LeapFrog, and Hasbro dictate leverage because of the
large number of suppliers. The toy industry has third party manufacturers to perform
most of the production. Mattel, Hasbro, LeapFrog have at least one or two domestic
manufacturing facilities. The industry in general has a variety of third party
manufactures that supply their finished products and most third party manufacturers
are located in Asia.
The cost for raw material is transferred to third party manufacturers. The raw
materials are metal alloys, plush, fabrics, paper, and electronic components. The
switching cost is low because the industry has numerous third party manufacturers. An
example would be Jakks Pacific that has 80 suppliers. There is very little differentiation
in suppliers because most of the third party manufacturers are in China. The quality and
standard are held the same. Although, each toy company has at least one testing
facility to make sure products are meeting quality standards. These testing facilities are
usually located in the United States. The supplier’s high competition gives a low
supplier’s leverage.
The operating cost for the toy industry has been lower with third party
manufacturers. The third party manufacturers have taken the risk for high inventory,
work in process, and low consumer demand. These factors can fluctuate at times when
it is not profitable. Toy firms gain profit from outsourcing their production. Toy firms
have spread the amount of production to several third party manufacturers. Toy firms
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have achieved cost leadership for each invests in third party production. The toy
industry is able to minimize its operation expense and invest more in trademarks.
Value Creation
The toy and games industry is highly competitive. The largest firms are
constantly battling over market share. To win customers the companies must
implement strategies that create value and competitive advantages. These advantages
are grouped into two groups: differentiation strategies and cost leadership strategies.
Differentiation is offering something superior, be it unique products, customer service,
variety, or brand image, at a cost less than what the customers are willing to pay for it.
Cost leadership revolves around minimizing costs and maximizing efficiency. This
allows the company to sell the product for the same price as their competitors and
make a greater profit. In the toy industry a mixture of both differentiation and cost
leadership strategies is most effective. However, differentiation is heavily favored. The
largest firms in the industry emphasize the cost leadership strategies of economies of
scale and input costs and production, as well as the differentiation strategies of product
quality and variety, brands and marketing, and a focus on creativity and development.
As said by Mattel “Competition in the manufacture, marketing, and sale of toys is based
primarily on quality, play value, and price” (Mattel 2007 10-K).
Economies of Scale
All of the major players in the toy industry use similar methods to expand and
grow their business. These strategies include selling their products internationally,
growing core brands, and acquiring opportunistic licenses and brands. It is important in
the toy industry to expand sales and offer products to the large international markets.
The largest competitors in the industry report anywhere from 10-50% net sales coming
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from international operations. In efforts to expand their business, Hasbro “operated in
more than twenty other countries” which included Europe, Asia Pacific, Latin America,
and South America (Hasbro 2007 10-K). Similarly, LeapFrog reported international
segments composing 23% of consolidated net sales in 2007 (LeapFrog 2007 10-K).
Many products and brand names have already been established internationally,
but there are many brands with high international potential that have not been
advertised in international markets, at least not yet anyways. Brands such as
Transformers, Monopoly, Barbie, Hot Wheels, and LucasArts are popular worldwide and
generate value for their firms. To create additional value, firms must push the high
potential products into the international markets.
Jakks Pacific reports that they “focus our business on acquiring or licensing wellrecognized
trademarks or brand names” (Jakks Pacific, Inc. 10-K). The industry leaders
are constantly purchasing new licenses and brands to offer the most desired products
to customers. The toy industry is very sensitive to fads. If Hannah Montana is the
newest doll that every girl wants then acquiring the license to make Hannah Montana
dolls would be a high value creator.
Input Costs and Production
Minimizing input costs and maximizing production efficiency is the goal of this
cost leadership strategy. Production in the toy industry is most commonly outsourced
to India, China, Japan, Mexico, Indonesia, and Thailand. The reason for outsourcing is
to achieve lower costs without sacrificing product quality. Some risks of outsourcing
experienced by all corporations as stated by Mattel include “political instability, civil
unrest, economic instability, changes in government policies” (Mattel 2007 10-K). To
diversify such risks companies produce their key products in more than one facility so
that they will never be without one of their leading products.
A wide variety of materials are used in producing toys and games. The most
commonly used materials are plastics, cardboard, fabrics, dies, molds, paper products,
alloys, and electronic components. These materials are obtained both from company
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owned manufacturing facilities and from a wide variety of suppliers. Several of the raw
materials are subject to price fluctuations, which in return alter the profits of the
companies. To use another Mattel example, “Mattel Inc., the world’s largest toymaker,
said third-quarter profit fell 5.2 percent as material costs rose and the company
introduced new Barbie dolls” (www.gamerscircle.net). The firm can choose to absorb
these costs like Mattel did, or charge their distributors more. The distributors can in
turn either absorb the costs or charge customers more.
Quality and Variety
Product variety involves the different toy lines manufactured, and product quality
refers to the quality and safety of the items in these lines. Product quality is of great
importance in the toy and games industry. Competition is based primarily on meeting
consumer entertainment preferences and on the quality and play value of our products
(Hasbro 2007 10-K). Due to many of the toys being designed primarily for use by
children, safety is of utmost importance. If a toy that is unsafe reaches the hands of a
child it would assuredly harm the firm’s reputation, and possibly create a very expensive
liability. To protect against this all products are meticulously inspected with quality
assurance testing. In August of 2007 Mattel was forced to recall millions of toys made
in China due to high levels of lead in the paint. This same incident resulted in a class
action lawsuit forcing Mattel to pay for medical tests for children who played with the
lead-contaminated toys. (www.consumeraffairs.com) other leading companies have
also received negative publicity over the lead paint issues including RC2. Quality is also
achieved by careful and creative product designs. The industry requires the use of
special parts, paints, electronics, and diligent designing to create toys and action figures
that function properly and truly resemble specific characters.
Product variety is a top priority in the toy industry. The leading firms are always
acquiring new licenses and brand names to be used in new product lines. They are also
constantly revising and improving existing products to offer a new, different, and
exciting playing experience. “Mattel regularly refreshes, redesigns, and extends existing
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toy product lines and develops innovative new toy product lines for all segments. Mattel
believes its success is dependent on its ability to continue this activity effectively”
(Mattel 2007 10-K). As mentioned earlier companies must be making predictions of
what will be popular in the upcoming years. It is important that they correctly
determine which licenses to acquire in order to broaden their product lines with high
demand toys.
Brands and Marketing
In the toy industry popular brands are highly sought after. Kids want the
popular toys and the fads. They want what their friends have and what they have seen
on television. A popular brand can turn a simple product into a powerful asset. Just
taking a basic pencil bag and placing a popular children’s star on it immensely increases
the value of the product to kids. The brand alone can determine the success or failure
of a product. This is why the leading firms are always working to acquire the most
popular licenses and brands.
The companies use a combination of commercials, songs, billboards,
magazine ads, comic books, and other media devices to market their products. The
industry standard is to spend around 10%-15% of net sales in advertising expense.
The following chart shows the industry leaders advertising expense as a percentage of
net sales over the last 5 years. Sales are highly seasonal in the toy industry and
marketing efforts tend to increase during the fourth quarter, especially around
Christmas, when sales tend to be their highest.
Advertising Expense as a Percentage of Net Sales
2003 2004 2005 2006 2007
Jakks 3.93% 4.60% 5.87% 4.80% 2.60%
Mattel 12.82% 12.60% 12.15% 11.52% 11.90%
Hasbro 11.59% 12.93% 11.87% 11.71% 11.33%
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Creativity and Development
A focus on creativity and development involves frequent changes and alterations
to existing products, and keeping current products up to date with technological
advances. For toys and games creativity and development plays a large role in
customer satisfaction. In order to have their customers continue to buy products firms
must continue to be innovative in the designs of their items. This applies even more so
today with the growing use of technology in toys. Hasbro states “Our success is
dependent on innovation through the continuing development of new products and the
redesign of existing products for continued market acceptance” (Hasbro 2007 10-K).
An example of this continuing development is the new product lines Hasbro is releasing
at the same time as the biggest movie releases of the summer. “Among the traditional
toy and game categories, highlights include new products in support of several
upcoming blockbusters including Indiana Jones and the Kingdom of the Crystal Skull,
Iron Man and The Incredible Hulk. The entertainment doesn't stop there as a stellar line
of products will be released is support of the upcoming Star Wars: The Clone Wars
theatrical release and animated series” (www.superheroflix.com). Hasbro predicted
these toys would be in very high demand upon the movies releasing. They made
acquiring the licenses and creating the toys a top priority, and then planned the release
of the toys to be at the same time as the cinematic hype of the movies peaked in order
to maximize sales. In an industry this competitive, no company can afford to fall
behind in the advancement and development of products.
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Firm Competitive Advantage Analysis
Jakks Pacific deals with intense competition from rivals in the toy industry. It
must create new products, expand product lines, acquire licenses for popular
trademarks, and market products in a timely manner to remain effective. Jakks Pacific is
able to hold their own against competitors with greater resources, longer histories, and
larger economics of scale. In doing so, they became a leader in the toy industry and
were included in the “Fortune’s 100 Fastest Growing Companies for four years” and
“Forbes’ 100 Best Small Companies for three years” (www.jakkspacific.com).
In differentiation, the company tries to create innovative products that are
superior in quality and variety to those offered by competitors. In doing so, they are
able to market products that others cannot, thereby, gaining the edge over the
competition. In this regard, they must focus on creativity and development to turn
fantastic ideas into fantastic products and must market them successfully to gain
consumer interest.
If the toy industry were to focus on differentiation alone, they may run the risk
of selling products that are too expensive to hold consumer interest. In this regard, the
company can pursue economics of scale, reduce input and production costs, and find
ways to distribute products at a lower cost to remain effective. In the toy industry, the
key to success can be found through a mixture of differentiation and cost leadership. In
this regard, Jakks Pacific has focused on economics of scale (cost leadership), input
costs and production (cost leadership), quality and variety (differentiation), brand and
marketing (differentiation), creativity and development (differentiation), flexible delivery
(differentiation), and customer service (cost leadership) to thrive in the toy industry.
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Economics of Scale
The phrase, economics of scale, can be interpreted to mean that “bigger is
better”. In expanding, the company can gain resources (raw materials, people,
technology, etc) that allow them to make products at a lower cost. It can achieve this
by entering foreign territories (larger customer base and sources for labor and
manufacturing) and through acquisitions (devouring small companies to gain people,
technology, products, distribution channels, etc).
Jakks Pacific sells their products through retailers in the United States, Europe,
Australia, Canada, Latin America, and Asia. In foreign markets, they have sent
representatives, invested resources, and developed relationships with distributers and
retailers to expand into those regions and to increase sales. In foreign territories, there
is the opportunity to hire third party manufacturers (which they do) that can reduce the
cost for products due to the lower cost they charge for their services (information on
that is provided in the next section).
In acquisitions, Jakks Pacific searches for companies with useful product lines
and checks the financial condition, management ability, and distribution channels of
those companies before pursuing them. In 2006, Jakks Pacific acquired Creative
Designs International, a leading manufacturer of dress up and role play toys. In doing
so, they were able to expand their product lines, improve product development, and
bring new marketing talent to the company. In closing, Jakks Pacific pursued economics
of scale by expanding into foreign territories and seeking acquisitions.
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Input Costs and Production
In cost leadership, the desire for lower input costs and efficient production are
self explanatory, they want to make more products for less money and get them out
into the market as soon as possible. Jakks Pacific manufactures most of their products
in China and sells them on a letter of credit or open account to customers. In doing so,
they are able to reduce operating costs and working capital requirements. In addition,
third party manufacturers allow the company to avoid fixed manufacturing costs while
maintaining “flexibility, capacity, and production technology” (Jakks Pacific, Inc. 2007
10-K). In fact, they have ongoing relationships with over 80 different manufacturers.
The raw materials used in production are plastics, zinc alloy, plush, printed
fabrics, paper products, and electronic components, that are sold at reasonable prices
from a variety of sources. It is safe to assume that any fluctuation in the price of raw
material will affect the price paid to the manufacturer. In regards to the risks involved,
there is a chance of dealing with product defects, product delays, cost overruns, or the
inability to meet orders on a timely basis. Jakks Pacific may be able to secure other
manufacturers in the event this occurred but doing so would hurt operations. It,
therefore, realizes the importance of having strong relationships with their
manufacturers and to date have experienced no significant delays in the production or
delivery of their goods.
Jakks Pacific have also hired third parties to provide a portion of the sculpting,
sample making, illustration, and package designs for their products. In addition, they
(like other toy companies) license popular brands instead of purchasing them for doing
so grants them “access to a far greater range of marks than would be available for
purchase” (Jakks Pacific, Inc. 2007 10-K). In closing, by relying on and maintaining
strong relations with third party manufacturers, Jakks Pacific is able to make their
products for a lower cost and by licensing brands instead of purchasing them they are
able to save money.
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Quality and Variety
In the toy industry, companies hunt for licenses on brands to create products of
interest, the problem, however, is that multiple companies can acquire the same
license, meaning that substitute products can be made. In effect, a company, that
neglects to differentiate their product, will earn nothing compared to a company that
invested time and effort to create something more unique. In addition, the quality of
products is relevant, for toys must maintain a level of quality to avoid being rejected
and need to be safe for kids for obvious reasons.
Jakks Pacific is involved in the design of the product prototype, production tools,
dies, and molds needed to make their products. It ensures product quality by checking
the production process and testing the finish goods through quality control inspectors.
In 2007, toy manufacturers (Mattel, RC2, etc) received bad publicity for selling toys
from China with lead paint, but Jakks Pacific was able to escape this hype and assured
analysts and parents of the precautions (having a testing facility in China, certified by
the Chinese government, to conduct real time testing with laser equipment and by
employing third party testing) they take to avoid such incidents (www.fool.com). In the
article, they were not blamed for selling lead based toys due to the simple fact that
they did not sell them, the steps they take to ensure the quality of products is to be
commended.
Jakks Pacific strives to achieve a level of excellence in the products they make
and develop. In this regard, they have used specialized technology, custom parts, and
unique materials to create realistic action figures that appeal to children and collectors
alike due to their superior quality and strong resemblance to their representative
characters. In seeking new products or in expanding product lines, Jakks Pacific can
take advantage of useful acquisitions. In June 2005, they acquired Pet Pal Corp. which
expanded their product lines to include pet toys, treats, and other pet related products.
In addition, the acquisition of other companies, like Creative Designs International,
gives further proof as to how this company can benefit from useful acquisitions. In
closing, Jakks Pacific strives to create products that are fun and safe for kids (product
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quality) and endeavor to find new products (product variety) through development
efforts (explain later) and through meaningful acquisitions.
Brand and Marketing
In brand name, people tend to recognize the company through the products they
make over the name of the company itself. In truth, this is not a major issue for having
their products recognized by consumers for their quality and functionality is of greater
concern than the name itself. In terms of marketing, they have sales and marketing
personal that make on site visits to customers to showcase their products and to
acquire orders from them. It has relied on sales representatives to sell and promote
products in domestic and international markets and works with retailers to test
consumer acceptance of products before committing to large scale production.
Jakks Pacific advertize their products through magazines (along with other
publications) and specialty (international, national, regional, stationary, etc) trade
shows, conventions, and exhibitions. It makes use of printed ads, television ads, and in
store displays to gain consumer interest. In fact, they have television commercials for
most of their product lines (WWE action figures, Disney role play sets, Plug It In & Play
TV Games, Puppy in My Pocket and Friends, EyeClops, Hannah Montana toys, Cabbage
Patch Kids dolls, etc). In recent events, Jakks Pacific launched the Fancy Nancy product
line (features dolls, accessories, activity items, etc) which is based on a popular
children’s book that sold over 2 million copies (online.wsj.com). In marketing products
for those brands, ones that are popular and capture the interest and imagination of
target consumers, Jakks Pacific is able to gain “consumer recognition and retailer
interest” (Jakks Pacific, Inc. 2007 10-K).
In license agreements, they seek brands and trademarks that are recognized or
considered evergreen (brands or trademarks with long product histories). In seeking
those brands, they are able to create products that are resistant to shifting trends. In
doing so, those products tend to live longer and generate greater sales than those
created for the sake of a fad. In this regard, they have acquired licenses from WWE,
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Nickelodeon, Disney ®, and Warner Bros ® along with Marvel and Pokemon to name
just a few. In addition, the license for WWE and the joint venture with THQ gave them
the right to publish and market video games based on the WWE on a global basis. In
finding ways to get the most out of a license, they had demonstrated how resourceful
they can be, but by gaining success from being too creative in that regard can lead to
problems as well. In 2004, Jakks Pacific faced a lawsuit from WWE that demanded
higher royalties due to the video games Jakks Pacific created through the joint venture
with THQ. The lawsuit was settled and Jakks Pacific can sell WWE toys till 2010 (which
they will), but they will have to rely on the TNA brand after that date (www.fool.com).
In closing, Jakks Pacific has a variety of methods that they can employ to
advertize their products and will hunt for licenses (got into a little trouble with this one
but otherwise did a good job) of recognized or evergreen brands to remain effective
against competitors.
Advertising Expense as a Percentage of Net Sales
2003 2004 2005 2006 2007
Jakks 3.93% 4.60% 5.87% 4.80% 2.60%
Mattel 12.82% 12.60% 12.15% 11.52% 11.90%
Hasbro 11.59% 12.93% 11.87% 11.71% 11.33%
Creativity and Development
Jakks Pacific knows that kids tend to outgrow toys at younger ages “in favor of
interactive and high technology products” (Jakks Pacific, Inc. 2007 10-K). It is due to
this factor that products tend to have shorter life cycles and that expectations for those
products have increased. In this regard, they must redesign and extend products and
products lines to meet those demands and to gain customer approval. In pursuing this,
they have used managers to help identify and evaluate products and opportunities. In
addition, they employ a staff of designers to help create new ideas and concepts for the
product lines. Jakks Pacific has relied on third party designers to help gain the edge in
this part of the business. In fact, they believe that “utilizing third party inventors gives
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them access to a wider range of development talent” (Jakks Pacific, Inc. 2007 10-K). In
keeping this in mind, they have hired third party developers to program their Plug It In
& Play TV Games. It is evident that Jakks Pacific taps into a lot of third party resources,
but by delegating tasks and by acquiring ideas from different sources, they are able to
create more innovative and unique products, than they may have been able to if they
handled things alone.
In this company, proof of creativity and resourcefulness can be noted in the
products they make and in the products they plan to release on future dates. In the
fall, Jakks Pacific will release a product called EyeClops Night Vision, a powerful set of
night vision goggles for kids, they were able to secure a deal for the processors
required for that product at a low price, as a result, the product that might have cost
$250 dollars in the past, can now be sold at a price of around $80 dollars
(online.wsj.com). In closing, Jakks Pacific relies on talent from internal sources (people
from the company) and external sources (third party sources) and are able to create
better products in more timely fashion as a result.
Flexible Delivery
In differentiation, the distribution of products at the right time and place is the
key to understanding the idea of flexible delivery. In general, they have sold products
to toy retail stores, department stores, office supply stores, drug stores, and toy
specialty stores. In this regard, the largest customers for them are Wal-Mart, Target,
and Toys ‘R’ Us. In addition, Jakks Pacific has sold products through e-commerce sites
(Toysrus.com and Amazon.com). In the acquisition of Pet Pal, they gained access to pet
supply retailers such as Petco and Petsmart. It was stated in the financials that retailers
tend to avoid dependency on large toy companies giving smaller companies like Jakks
Pacific, the opportunity to grow by granting them access to distribution channels. In
gaining those channels, the company is able to reach a wider range of customers and
may be able to increase sales as a result.
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Jakks Pacific delivers products to customers within three to six months for orders
shipped F.O.B. China or Hong Kong and within three days for orders shipped
domestically. In terms of seasonality, the first quarter sales tend to be the lowest, but
Jakks Pacific is able to counter that loss through sales of their writing instrument and
activity products during the second quarter. In the spring and summer, where they sell
most of the seasonal products, Jakks Pacific believes “that the low retail price of most
of their products may be less subject to seasonal fluctuations than higher priced toy
products” from competitors (Jakks Pacific, Inc. 2007 10-K). In closing, flexible delivery
(right time and place) is achieved by selling products on the basis of seasonality or
popularity (right time) and through the distribution channels they employ (right place).
Customer Service
Jakks Pacific “is an aggressive and passionate company with a commitment to
customers and a dedication to growing their business” (www.jakkspacific.com). It is not
directly stated in their financials but they do have a variety of methods to help their
customers should problems arise. In terms of product issues, they have a guide on their
website that provides tips on what can be done. In addition, they provide information
on removal remedies for messy products. Jakks Pacific has provided information on how
to contact them by phone, by letter, or by email to more directly address the concerns
or problems that customers may face. In their website, there is also information with
respect to the warranty on products and of course on the products themselves. In
closing, this section highlights on the methods that Jakks Pacific employs to help their
customers with their problems. In truth, it could have been left out, but was included
for the sake of gaining a more complete understanding of the company.
Conclusion
Jakks Pacific strives to expand by entering into foreign markets, seeking
acquisitions, and by pursuing licenses for lasting brands. It has created innovative
products of superior quality and worked to develop product lines to gain customer
approval and recognition. It has reduced cost and created products by relying on the
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skills they have and in the talent of third party groups and individuals. In being
resourceful and creative (important traits for any industry), they were able to get more
of what they had, and in spite of a few bumps along the way (lawsuit with WWE), they
have done a fantastic job in pursuing competitive advantages and are likely to remain
successful in their industry for many years to come.
Formal Accounting Analysis
The accounting analysis will look into how well the firms in the industry are
managing their accounting policies and will seek to determine if potential manipulation
exists with respect to Jakks Pacific. This analysis will be done by examining and
thoroughly evaluating the Key Accounting Policies (KAPs). We have identified and
broken the KAPs down into the following groups: goodwill, advertising, research and
design. Additionally, the company’s handling of capital and operating leases and
currency risk will be covered as well. We will assess potential accounting flexibility for
each of these items using knowledge of Generally Accepted Accounting Principles
(GAAP) and the disclosure of the firms in the industry. Next, the actual accounting
strategies used by the firm will be discussed by looking into disclosure as well as the
firm’s level of conservatism or aggression. After the level of disclosure is determined
we will evaluate and inspect the quality of the disclosure to determine if the company
satisfies our decision making information needs. Then we will move onto a quantitative
analysis which will include cross sectional and time series analysis using diagnostic
ratios. Next potential “red flags” will be identified by examining any unexplained or
unusual changes present in the financial statements. Finally, should we find any
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accounting distortions that significantly alter our insights on the company we will
restate the numbers to reduce the distortion as much as possible.
Key Accounting Policies
The industry characteristics along with each company’s own competitive strategy
determine the key value drivers for a particular firm. A firm’s key accounting policies
are items within financial statements that directly relate to these key success factors,
which were identified for the toy and games industry in the five forces model. Our goal
in this part of the accounting analysis is to evaluate the extent to which Jakks Pacific
discloses the information pertaining to the key success factors we have identified. The
principle items that we identified to drive value in this industry are the ability to control
costs, economies of scale, creativity, and marketing. The process used in this section of
the accounting analysis was to first identify the accounting measure that the company
used to capture the key success factors. Then we assessed the policies that determine
how the accounting measures are implemented. Lastly, we identified the estimates
used in these polices. By comparing the disclosure of the company with the guidelines
provided by GAAP, we can make an assessment as to whether or not the firm misused
the allowed flexibility.
Accounting Flexibility
Accounting flexibility is a firm’s ability to use accounting methods to show its
financial performance. Firms have some discretion on how they depreciate assets,
expense accounts, and recognize liabilities. Firms do not have equal accounting
flexibility because some accounting methods can be treated as conservative or
aggressive. Firms, being aggressive or conservative with accounting policies, may deny
outsiders the ability to capture the firm’s true financial performance. The flexibility in
accounting allows firms to hide or reveal financial data to the public.
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Financial Accounting Standard Board sets the accounting flexibility through
Generally Accepted Accounting Principles. Jakk’s key accounting policies and FASB’s
guidelines should be parallel. Looking at Jakk’s key accounting policies will allow us to
determine if the key success factors are really adding value to the firm.
Accounting Strategy
The amount of flexibility that managers have in reporting the key accounting policies
that we have analyzed leads to indentifying accounting strategy that the firm uses. Out
of the range of possibilities allowed by GAAP, we will assess which method chosen by
Jakks Pacific and how it effects the financial statements. This is important to
investigate and infer whether the firm is using this flexibility to accurately communicate
their firm’s economic situation or if they are hiding true performance. If the company is
engaged in earning management, the transparency of the company is greatly reduced.
This can make it difficult to evaluate to true performance of the firm, considering that
managers would be making accounting policy choices not based on representing the
actual business activities.
Each of the principle accounting policies will be assessed based on disclosure
requirements as defined by Generally Accepted Accounting Principles. Based upon the
level of disclosure, the key accounting policies will be indentified as conservative or
aggressive. In conservative accounting, managers do not want to overstate income. If
the company were labeling items based on their historical values rather than their
market value, this would signify a potential red flag. In aggressive accounting,
managers are reporting items in such a way that they lead to higher reported earnings.
This would occur for example, if the firm did not want to violate loan covenants.
Quality of Disclosure
We will examine the amount of flexibility that managers have when reporting the
key accounting policies. The amount of disclosure required is defined in the Generally
Accepted Accounting Principles (GAAP), which is the standard framework for financial
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accounting. For each key accounting policy, we looked at what the minimum
requirements were as defined by GAAP and then compared the quality information from
Jakks Pacific in relation to the industry. Even though GAAP has a minimum
requirement, we are looking to see if Jakks Pacific or other competitors went beyond
this notion, to express to investors the true underlying economic status of the business
activities. Some of the items analyzed were footnotes, Management Discussion and
Analysis, and whether or not accounting rules prevent the company from measuring its
key success factors appropriately. Basically, we determined from the information
presented if the company disclosing the information that is useful in making investment
decisions.
Goodwill
[GAAP Flexibility = Low, Disclosure = High]
Goodwill is a significant part of Jakk’s balance sheet and accounts for about 36%
of their total assets. Assessing the accounting policy and disclosure associated with
goodwill can help reveal the benefit of having goodwill in the accounting book.
Goodwill is the purchase price minus fair market value of net asset. Goodwill is
an intangible asset. Firms create goodwill with the presumption that future cash flows
of the purchase (acquisition or patent) will be greater than the goodwill itself.
Reputation, product line, and location are some reasons why firms pay extra for
trademarks, patents, and companies. Jakk’s large investment in intangible assets allows
Jakk to compete with larger market share than competitors.
Goodwill (thousands)
2003 2004 2005 2006 2007
Jakk 190728 258331 269298 337999 353340
Hasbro 463680 467061 469726 469938 471177
LeapFrog 19549 19549 19549 19549 19549
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Mattel 722249 735680 718069 845324 845649
The chart shows the growth in goodwill for toy companies over the past five
years. Jakk’s goodwill has increased every year without any impairment. Hasbro and
Mattel’s goodwill has grown at a slow pace because of their larger market share in the
toy industry. Hasbro and Mattel’s slow growth in goodwill could be caused by acquiring
fewer companies or purchasing fewer trademarks over time. Leapfrog has not changed
in the past five years with respect to goodwill. LeapFrog could be overstating goodwill
and understating the impairment. A comparison of intangible assets and total assets in
the toy companies may give an indication of how much of the intangible asset
(goodwill) is important or not.
Goodwill / Total Assets
2003 2004 2005 2006 2007
Jakk Goodwill 190728 258331 269298 337999 353340
Total Asset 529997 696762 753955 881894 982688
35.99% 37.08% 35.72% 38.33% 35.96%
Hasbro Goodwill 463680 469726 467061 469938 471777
Total Asset 3163376 3240660 3301143 3096905 3237663
14.66% 14.49% 14.15% 15.17% 14.57%
LeapFrog Goodwill 19549 19549 19549 19549 19549
Total Assets 45595 54303 53727 58529 53727
42.88% 36.00% 36.39% 33.40% 36.39%
Mattel Goodwill 722249 735680 718069 845324 845649
Total Assets 4510950 4756492 4372313 4955884 4805455
16.01% 15.47% 16.42% 17.06% 17.60%
Jakk’s goodwill takes up 35.67% of all total assets in 2007 (Jakks 2007 10-K).
Hasbro’s goodwill takes up 14.57% of total assets. LeapFrog’s goodwill takes up
36.97% of total assets. Mattel’s goodwill takes up 17.60% of total assets. In truth,
these percentages are a bit misleading because Jakks and LeapFrog are small compared
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to Mattel and Hasbro. Mattel and Hasbro have large goodwill accounts but their
goodwill is small compared to their total assets. On the other hand, Jakk’s and
LeapFrog’s goodwill is large compared to their total assets.
Goodwill’s accounting policy for Jakk is important because goodwill counts for
more than a third of all total assets. The acquisition of companies over time has made
goodwill a large factor in the accounting book. Jakks Pacific has designed and
researched some of their products, but they have claimed to have gained a competitive
edge by buying companies with better products and known brands.
Jakk’s disclosure for goodwill has detailed descriptions on what has been
acquired. Jakks puts dollar amount to acquisition cost. For example, Jakks purchased
Creative Design and shows the acquired fair value of net total assets, recognized total
liabilities, and the account for the goodwill in a chart for the acquisition. Jakks also
adjusted sales based on what was contributed from Creative Design.
Jakks listed its products as being traditional toys, creative toys, activity toys,
writing toys, and pet toys and adjusted goodwill through “performance criteria” for each
product line. Jakk’s competitors talk about the procedures and guidelines and puts
goodwill in their balance sheet, but, competitors never go into discussion about the
value of the goodwill acquired through their purchases. The competitors probably do
not go into detail because their strategy does not rely heavily on acquisitions.
Goodwill is tested for impairment annually. First, the manager needs to
determine the fair value of net assets for the current year. Second, the manager needs
to calculate the previous year carrying value of the firm for goodwill. If the current fair
value of the entity is greater than the historic carrying value of net assets then goodwill
has not been impaired. If the current carrying value of the entity is less than the
previous carrying value, then goodwill has been impaired. Managers need to find the
implied goodwill, which is found by taking the current fair value of the entity minus the
current carrying value without goodwill. Lastly, managers need to adjust implied
goodwill to the current carrying value of goodwill [debit to the impairment account
(expense) and credit to contra asset account (accumulated goodwill)].
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The accounting flexibility for goodwill has changed to allow for more judgment in
indicating the impairment of goodwill. Generally Accepted Accounting Principles (GAAP)
has allowed goodwill to be amortized over a maximum of 40 years. GAAP did not allow
any leeway in the impairment of goodwill. If goodwill exists during a purchase then
accountants mark the book for the fair value of the entity and count the excess as
goodwill. Then, the accountants amortize the goodwill over several years. Nowadays,
FASB allows accountants to calculate the fair value and test for impairment. The recent
procedures to determine goodwill has a pitfall and that is the judgment of the manager.
Manager’s judgment can manipulate the asset and expense accounts due to the
accounting flexibility in goodwill. If goodwill is never impaired, expenses will be
understated, assets will be overstated, and net income is going to be higher every year.
The balance sheet will have higher retained earnings due to the adjusted net income
balance. If impairment does occur then net income will be smaller. Total assets and
retain earnings on the balance sheet will gradually decrease in dollars. In either case,
liabilities will not be affected by the change. Goodwill impairment should be recognized
so that the cost of doing business is recognizable to investors. If goodwill stays constant
or has incremental growth then it can overstate total assets.
Jakk has a high level of disclosure with an aggressive accounting policy in
regards to goodwill, but there are some doubts, based on how large it is on the balance
sheet. Overall transparency of Jakks 10K is not so clear but is good enough to meet
FASB guidelines. Jakks does a good job in showing how they take in a company’s net
assets and net liabilities. But, the management has enough accounting flexibility to
misjudge the true value of goodwill. The annual impairment may not be enough to keep
goodwill current. Jakk’s competitors are not big on acquisitions and do not reveal
goodwill as well as Jakk does. But, when Jakks debits goodwill for “performance
criteria”, analysts should be worried. The “performance criteria” could raise some red
flags. The future benefit of goodwill can be difficult to determine without any consistent
impairment. Jakk’s 10K gives sufficient information to the public to enable them to
predict and forecast Jakk’s performance.
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Advertising Expense
[GAAP Flexibility = Low, Disclosure = Low]
In the toy industry, the largest companies all use extensive advertising
campaigns to promote their product lines. These campaigns include advertisements in
magazines, television commercials, billboards, newspapers, and online ads. Jakks
charges the cost of commercials and programming to operations in the year in which
the production first aired. Other advertisements are charged to operations in the year
incurred (Jakks 2007 10-K). The Mattel, Hasbro, and LeapFrog 10-Ks each directly
state that they use these same accounting policies to record advertising expenses.
As can be seen in the chart below, Jakks has spent far less of a percentage of
their net sales on advertising than its competitors. Jakks partially explains this in their
10-K by stating that there was a “decrease of advertising and promotional expenses of
$6.4 million in 2006 to support several of our product lines” and that “from time to
time, we may increase or decrease our advertising efforts, if we deem it appropriate for
52

particular products” (Jakks 2007 10-K). While this explains some of the discrepancy
between Jakks and its competitors, suggesting a rather low year in advertising costs,
there is still a large difference in present. If the $6.4 million is added to the $36.7
million total Jakks spent in 2006, Jakks would still only reach 5.6% of net sales spent on
advertising. From this research we are able to conclude that Jakks implements a less
extensive advertising campaign relative to the industry standard.
Advertising Expense [Percentage of Net Sales]
2003 2004 2005 2006 2007
Jakks 3.93% 4.60% 5.87% 4.80% 2.60%
Mattel 12.82% 12.60% 12.15% 11.52% 11.90%
Hasbro 11.59% 12.93% 11.87% 11.71% 11.33%
All of the firms are recording their advertising expenses in the same way. This is
because there is very little flexibility allowed. The Generally Accepted Accounting
Principles (GAAP) has clear and specific standards addressing the recording of
advertising expenses. The requirements of GAAP are documented in Statement of
Position (SOP) 93-7, which applies to any promotional activity intended to stimulate,
directly or indirectly, a customer’s purchase of goods or services. This includes but is
not limited to: commercials, mailings, catalogues, brochures, billboards, and other
means of advertisement (www.sec.gov). SOP 93-7 commands that all advertising costs
must be handled in one of two ways. They may either be expensed as incurred or
deferred until the advertising program commences. The exception to this rule is direct
response advertising, such as catalogs and mailing costs, which are capitalized and
amortized over the period of expected benefits. Of the four major competitors in the
industry only Mattel has categorized any advertising as direct response. This is due to
very strict criteria to qualify advertising as direct response, and the fact that the amount
of expense to be deferred from catalogues and mailing expenses is immaterial in the
big picture. In summary, Jakks, Mattel, Hasbro, and LeapFrog are all in accordance
with GAAP. Each company directly states how advertising expenses are being recorded,
and they are all within the boundaries outlined by SOP 93-7.
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Jakks Pacific, Inc. is a company of low disclosure when it comes to advertising
expenses. The only information is a short paragraph informing the reader that Jakks is
in compliance with GAAP. The only other piece of information provided by the
paragraph is the amount of advertising expenses for 2005, 2006, and 2007. Jakks has
reported just above the bare minimum to satisfy GAAP. Since there is almost no
flexibility with the subject of advertising expense, Jakks doesn’t have the ability to be
aggressive or conservative on this topic. Their earnings cannot be skewed up or down
by changing the recording of advertising expense, because doing so would quickly
violate SOP 93-7.
Overall, the information provided by Jakks is not transparent. All we know is
how much has been spending on advertising, and that they are in compliance with
GAAP. Jakks disclosed just above the minimum amount of information required. Our
information needs are not nearly satisfied. More specifics would be very useful. How
much money is being spent on each product line? How much money is put into each of
the advertising mediums? What are the differences in quarterly advertising costs?
Answers to these questions would greatly increase our understanding of Jakks
advertising strategy.
Research and Development
[GAAP Flexibility = Low, Disclosure = None]
In terms of accounting, Jakks Pacific did not provide any information on the cost
involved in the research and development of their products. In contrast, Hasbro and
Leapfrog treated it like an operating expense. In the definition, “research” refers to the
task of getting information and “development” deals with using that knowledge to
create or improve something. In that regard, it is important to note that lasting
development requires investing in research (keep up with the times or lose to the
competition). In Jakks Pacific, they may have included research and development in
operating expenses [SG&A] or treated it as part of cost of sales, but the reason as to
why may provoke some concerns in the red flags section. In reality, it is difficult to
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determine what the company did but talking about this section is nonetheless
important.
In the first case, R&D can be charged to SG&A due to GAAP (SFAS No. 2) which
requires that R&D be expensed as incurred. In general, both, IFRS and GAAP, require
that research be expensed as incurred but differ on their treatment of developmental
cost. In either aspect, the treatment of R&D seems to violate the matching principle of
accrual accounting that requires that expenses be recognized alongside the revenues
they create, but with R&D, the effect on revenue is not easy to determine, which is why
it is expensed when incurred and treated the way it is.
In the second case, the IFRS, International Financial Reporting Standards, stated
in IAS 38.45, that research costs can be classified as cost of sales and that the
amortization of development costs after it has been capitalized as an intangible asset
and amortized over its useful life can be included to that cost as well (www.pwc.com).
Jakks Pacific relies on manufacturing facilities in Asia (China and Hong Kong) and may
be able to use IAS 38.45 to include their R&D in cost of sales.
In relation to R&D, if an acquisition is involved in the R&D of products in the
process of being developed (not yet sold) then GAAP allows the acquirer to capitalize an
amount of IPR&D (In Process R&D) as part of the acquisition price. In terms of IPR&D,
the acquirer can distort earnings by manipulating the “fair value” perceived for the
IPR&D of the acquisition, leading to lower earnings in the current year but “minimizing
earnings changes in future periods due to the lower value associated with goodwill”
(findarticles.com). In regards to that, Jakks Pacific (if they treat R&D as a operating
expense) did not seem to have manipulated their earnings in such a way for they have
a lot of goodwill on the balance sheet and because earnings seem to grow consistently
from year to year, except between 2003 and 2004, but that was stated in the company
overview section as being attributed to selling the right product at the right time.
In logical terms, we can think of this company as having treated R&D as part of
SG&A or cost of sales based on the competition and what is permissible by accounting
standards. In that regard, there is no disclosure with respect to research and
development, which is disappointing and can be considered a red flag for the company.
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In closing, there is some flexibility (regarding GAAP) in recording R&D expense, but
they must abide by a strict set of rules in doing so.
Capital and Operating Leases
[GAAP Flexibility = High, Disclosure = Low]
Capital and operating leases are used in the toy industry. Jakks uses operating
leasing for their fixed assets. Their operating leases incorporate “office, warehouse,
showroom facilities, and certain equipment” (Jakk 2007 10-K). In Jakks 10-K from
2003-2007, they estimated operating leases for 5 years for each of them. For instance,
if 2003 operating lease was $4.2 million, then they will estimate it for 2004, 2005, 2006,
and 2007. Operating lease in 2007 was $10.2 million. Rent expense in 2007 was 4.2
million out $10.2 million.
The other competitors in the industry use a mixture of capital and operating
leases in their books. Hasbro gives the same amount of information as Jakks does
about their operating leases. LeapFrog has a mixture of capital and operating leases.
Mattel also has a mixture of capital and operating leases. Half of the main competitors
use operating leases, and the other half uses a mixture of capital and operating leases.
Jakks separate their operating leases values from the income statement. They
put the amount of the operating lease cost in the disclosure and show a future chart for
operating leases. Only the companies that use capital leases put their value in the
balance sheet. These companies hide the values in the general expense account. It may
be that operating leases account for the majority of general expenses.
There is plenty of accounting flexibility to distinguish between capital leases and
operating leases. In the United States, accounting standards allow for four possible
conditions to create a capital lease. If the firm does not meet one of these guidelines,
then it is an operating lease. First, ownership of the asset is transferred to the lessee at
the end of the lease term. Second, the lessee has the option to purchase the asset for a
bargain price at the end of the lease. Third, the lease term is 75 percent or more of the
expected useful life of the asset. Last, the present value of the lease payments is 90
56

percent or more of the fair value of the asset (Conditions from Palepu & Healy). These
conditions make it difficult for an analyst to access a firm capitalization of a lease. The
risk in accounting flexibility comes from the managers in the firm that can collude on
hiding the distinction between the two types of leases.
The actual accounting implementation in Jakks 10-k is low disclosure. They
follow exactly what Financial Accounting Standard Board (FASB) requires. GAAP does
not require you to have an account for operating leases. The operating lease expense is
mixed with all other operating expense. Operating method does not need to recognize
an obligation or asset in the accounting book. Jakks is conservative in their report on
the operating lease cost. The estimation for the future operating lease cost in the 10-K
is lower compared to the actual cost. For example, Jakks 10-K between 2003 through
2007 has operating lease estimation that is always less than the actual incurred. The
difference between estimation and actual is large and increases as time passes. For
example, Jakks 10-K from 2003 to 2007 has operating lease estimations. The
estimations are always less than the actual operating leases incurred. As time passes,
the difference in these numbers (estimation and actual operating leases) increases. The
estimate and actual operating leases may create distortion over long periods of time.
The overall transparency is good enough to meet GAAP guideline. Jakk could
make operating lease clearer by giving out who they lease from and for how long. In
addition, they could also make their estimation for future lease more accurate. The
managers know when they are going acquire a new company and renew a lease. Mattel
does exactly what is recommended. Jakks 10-K gives enough to see how much
operating lease are in operating expenses under the Income Statement.
Currency Risk
[Flexibility = Low, Disclosure = Average]
Currency risk is associated with the change in price from one currency to
another. This is a very important factor to examine considering that all of Jakks
product line production is outsourced to another country. In our current state of the
57

economy (recession), the value of the dollar has declined in relation to other foreign
currency. This would indicate bad news for Jakks considering that with a weak dollar
means more expensive imports. However this is not the case for Jakks Pacific. “The
exchange rate of the Hong Kong dollar to the U.S. dollar has been fixed by the Hong
Kong government since 1983 at HK$7.80 to US$1.00 and, accordingly, has not
represented a currency exchange risk to the U.S. dollar” (Jakks Pacific Inc., 10-K). This
fixed rate between the two currencies ensures that the company will not be affected by
the current U.S. recession.
According to the Generally Accepted Accounting Principle (GAAP), companies are
to, “inform investors of the nature and extent of the currency risks to which the
registrant is exposed and to explain the effects of changes in exchange rates on its
financial statements.” It also states that managers should describe any material effects
of changes in currency exchange rates on reported revenues, costs, and business
practices and plans. The flexibility that GAAP offers managers in the area of currency
risk is small. If a company is exposed to operations outside of the country, they
basically include every detail that is valuable to investors. Managers must include any
material effects in currency, as well as discuss their strategies for the management of
currency risk (ex. Hedging). The disclosure of Jakks Pacific in this area meets the
minimum requirements but does not go into further detail.
Even though the requirements of GAAP extensively cover foreign transactions,
we would like to be able to acquire more information on Jakks foreign operations. For
example, Mattel lists the forward exchange contracts that were used to hedge firm
foreign currency commitments in every country of their dealing. In Jakks defense
however, they have chosen not to enter into foreign currency hedging transactions
because they do not believe that changes in these exchange rates will result in a
material effect on their future earnings, fair values, or cash flows. Therefore, they have
less information to disclose than what their competitors do. Compared to the industry,
Jakks Pacific is very cautious when it comes to accepting unnecessary risk. This is the
most likely reason as to why the third party producers are located in China and Honk
Hong (fixed currency exchange rate for the latter).
58

JAKKS PACIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME
Years Ended December 31,
2005 2006 2007
(In thousands)
Other comprehensive income:
Net income $63,493 $72,375 $88,991
Foreign currency translation adjustment ($1,042) ($638) ($19)
Other comprehensive income $62,451 $71,737 $88,972
Translation adjustment to Net Income 1.64% 0.88% 0.02%
In the table above, note that the item labeled, “foreign currency translation
adjustment” shows the translation differences arising from changes in foreign currency
rates with respect to the U.S. Dollar. As you can see, they have incurred a loss in the
past three years resulting from currency risk exposure. According to the percentage of
net income that this risk affects, we have concluded that this business activity does not
account for a potential red flag. Seeing as the differences in currency exchange rates
hasn’t had a material effect on net income for Jakks Pacific of at least ten percent in the
past three years, we consider this information to not be distorted.
59

Quantitative Analysis
In the quantitative analysis, we will use sales manipulation diagnostics and
expense manipulation diagnostics to determine if the numbers reported in the financial
statements are accurate (reflects true value of the firm) or distorted (more profitable
than it actually is). In accounting, the flexibility in recording information along with the
level of disclose, can allow companies to manipulate their reported numbers to seem
more profitable to investors. In using diagnostics ratios, we attempt to see if
manipulations exist (spotting red flags) and may be able to determine the true value of
the company as a result. In the sales manipulation diagnostics, we look into the factors
related with sales (cash, accounts receivables, inventory, etc). In the expense
manipulation diagnostics, we look into the factors related with expenses. In these
ratios, we will look for irregularities (should the ratio be that high or low?) and for
inconsistencies in how it stacks up to the competition (does it follow the general trend
or have a unique pattern of its own). In addition, the charts for the ratios will be
represented in “raw” form (value for the ratio in each year) and “change” form (how
60

often that ratio fluctuates in each year), doing so lets us see if the numbers for the
ratios are favorable and if they are consistent on a yearly basis.
Sales Manipulation Diagnostics
In this diagnostic, we are assessing the credibility of reported sales and will be
using these ratios to do so: cash from sales (selling products is good but getting paid is
better), account receivables (how much do creditors owe), unearned revenues
(received the money before the product is exchanged or the service is performed),
warranty liabilities (how much is reserved to compensate customers for faulty
products), and inventory (goods available for sale now and goods on hand to save for a
later period). In comparing the revenue diagnostic ratios across companies for a period
of five years, we will be able to more easily determine where Jakks Pacific stands in
relation to the industry. Not only will the ratios review the differences in operating
activities, but they will show if changes were industry wide or company specific.
61

Net Sales/Cash from Sales
The net sales divided by cash from sales is a ratio used to determine the amount
of sales that are supported by the cash collected from sales. Cash from sales is
determined by the difference in net sales and the change in accounts receivable. This
is an important ratio because it shows how much cash a company is receiving from its
sales. If the ratio were to go below one, this would be signal that the company is
having trouble collecting on accounts receivable. A ratio in net sales divided by cash
from sales equal to one would be a good indicator that a company is collecting on sales
made in a reasonable amount of time. In regards to the ratios given in the graph
above, Jakks Pacific seems to be moving with the industry. Leapfrog on the other
hand, would signal a red flag because of the unpredictability from year to year within
the ratio. Although Jakks Pacific tends to fluctuate slightly, the level of change gives no
cause for concern. This could simply be explained by any minute changes within the
components of the ratio.
In terms of the variation in the ratio, Leapfrog is the only company that had a
significant change. The great change in Leapfrog compared to its competitors was
62

cause by their 45% decrease in accounts receivable as well as a 23% decrease in sales.
The rest of the industry has had relatively consistent net sales to cash from sales ratios.
Δ Net Sales / Δ Cash from Sales 2003 2004 2005 2006 2007
Jakks Pacific ‐0.28 0.95 0.74 4.54 0.67
Hasbro 1.28 2.36 0.77 ‐2.59 1.11
Mattel ‐0.49 ‐7.36 0.26 1.63 0.70
Leapfrog 1.61 ‐0.32 ‐0.13 73.35 0.35
Net Sales/Account Receivables
The accounts receivable turnover ratio shows what quantity of sales where sold
on account. Not only does this show the portion of sales made on account, it
determines if accounts receivables support changes in net income. In 2005, Jakks
Pacific had a 14.7% decrease in accounts receivable from 2004. Other than that,
increases in net sales have been supported by comparable increases in accounts
receivable.
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With respect to the fluctuations in the accounts receivable turnover ratio, the
obvious variance occurs with Mattel. Because sales and accounts receivable both went
up by small increments, it caused a larger ratio. In this context, this is not a concern.
However, slight changes in sales compared to the industry in 2005 for Mattel would be
alarming in a company specific valuation. Although Jakks Pacific has inconsistencies in
this ratio from 2003 to 2005, the company has been on par with the industry for the
past three years.
64

Δ Sales / Δ Accounts Receivables 2003 2004 2005 2006 2007
Jakks Pacific 0.19 16.01 ‐5.79 1.58 4.30
Hasbro 6.15 4.89 ‐1.62 1.93 6.97
Mattel 1.41 0.66 47.35 2.57 6.75
Leapfrog 1.34 0.77 0.32 1.27 11.56
Net Sales/Inventory
Due to spoilage, theft, storage, and other costs of inventories, holding an excess
amount can be very costly for the company. This is why it is important to assess the
net sales to inventory ratio, to get a sense of whether or not the inventory of a
company supports their sales. For the past four years, the industry with the exception
of Leapfrog has had comparable ratios for net sales to inventory. Note however that
Hasbro and Mattel have had a recent declining trend, whereas Jakks Pacific and
Leapfrog have had increasing trends. Although the Jakks and Leapfrog both have lower
inventory turnover than the other competitors, they are become increasingly efficient.
65

Jakks Pacific and Mattel had a greater variability in their ratios. In the scope of
the past five years, it is not uncommon to have variability in reported inventories from
year to year in the toy and games industry. Because of this, greater changes in these
ratios are allowable.
66

Net Sales/Unearned Revenue
In spite of tireless efforts, we could not find unearned revenue for the company
or competitors, therefore, we cannot compute this ratio.
Net Sales/Warranty Liabilities
In spite of tireless efforts, we could not find warranty liabilities for the company
or competitors, therefore, we cannot compute this ratio.
Conclusion
The revenue diagnostic ratios did not raise any concerns, or “red flags”, for Jakks
Pacific. We determined that Jakks moved with the industry with the net sales to cash
from sales and the accounts receivable turnover ratios. However, on net sales to
inventory the company is not performing as well as their competitors, but it is becoming
more efficient in turning over inventory (we would expect this ratio to increase in the
years immediately following).
67

Sales Manipulation Diagnostics
Net Sales / Cash from Sales 2003 2004 2005 2006 2007
Jakks Pacific 1.10 1.03 0.98 1.09 1.03
Hasbro 1.02 0.99 0.98 1.01 1.03
Mattel 1.01 1.04 1.00 1.03 1.01
Leapfrog 1.19 0.93 1.05 0.81 0.99
Δ Net Sales / Δ Cash from Sales 2003 2004 2005 2006 2007
Jakks Pacific ‐0.28 0.95 0.74 4.54 0.67
Hasbro 1.28 2.36 0.77 ‐2.59 1.11
Mattel ‐0.49 ‐7.36 0.26 1.63 0.70
Leapfrog 1.61 ‐0.32 ‐0.13 73.35 0.35
Sales / Account Receivables 2003 2004 2005 2006 2007
Jakks Pacific 3.67 5.62 7.59 5.00 4.91
Hasbro 5.17 5.18 5.90 5.67 5.86
Mattel 9.12 6.72 6.81 5.99 6.02
Leapfrog 2.43 2.81 2.52 3.54 3.24
Δ Sales / Δ Accounts
Receivables 2003 2004 2005 2006 2007
Jakks Pacific 0.19 16.01 ‐5.79 1.58 4.30
Hasbro 6.15 4.89 ‐1.62 1.93 6.97
Mattel 1.41 0.66 47.35 2.57 6.75
Leapfrog 1.34 0.77 0.32 1.27 11.56
Net Sales / Inventory 2003 2004 2005 2006 2007
Jakks Pacific 7.11 11.49 9.91 9.97 11.35
Hasbro 18.57 15.39 17.21 15.50 14.81
Mattel 12.76 12.19 13.74 14.75 13.93
Leapfrog 7.48 4.88 3.84 6.88 8.44
Δ Net Sales / Δ Inventory 2003 2004 2005 2006 2007
Jakks Pacific 0.90 46.16 5.22 10.32 ‐70.43
Hasbro ‐15.23 ‐5.47 ‐5.86 2.67 12.31
Mattel 1.49 4.76 ‐1.83 75.36 7.02
Leapfrog 23.03 ‐0.99 0.25 1.54 2.91
68

Expense Manipulation Diagnostics
In this diagnostic, we assess the credibility of reported expenses to see if
potential expense manipulation exists. The following ratios link business activities to
incurred expenses: asset turnover (are we generating revenue from our assets?), cash
flow from operations divided by income from operations (does the cash we generate
from operations equal the cash we earned from them?), cash flow from operations
divided by net operating assets (are we generating revenue from our property and
equipment?), pension expense divided by SG&A (selling, general and administrative
expenses), and other employment expenses divided by SG&A (do we care about the
workers?).
Asset Turnover
The asset turnover is found by dividing net sales by total assets. In doing so, we
can determine if assets were manipulated for the sake of distorting expenses. In this
ratio, we expect it to be consistent with no significant increases or decreases over time.
In review, the ratio has been stable for Jakks Pacific, except for 2003, and tends to be
the most consistent compared to the competition. In addition, we examined the size of
the ratio and compared it to the competition to look for irregularities. In this, we found
that Jakks Pacific had the lowest ratio and found their assets to be larger than their
sales. In a prior section, we found that goodwill accounted for 36% of total assets,
which we deemed to be a red flag and is likely the reason why the ratio is so low for
Jakks Pacific. In this ratio, along with improper impairment (assets like goodwill) there
is also the possibility that a company did not depreciate their assets (like property and
equipment). In the chart, Hasbro, had a ratio below one, but that only held true for
three years. At present, their ratio falls in line with other competitors such as Mattel and
Leapfrog. It did not seem to be the case, but it would be a red flag if the ratio were too
high (or suddenly became too high for one year) for this might indicate that the
company was trying to overstate expenses for the purpose of understating net income.
This could be done (once again) through improper impairment or depreciation, meaning
69

they impaired or depreciated too much, leading to smaller total assets, which results in
overstated expenses (recording that impairment or depreciation expense), which in turn
leads to a smaller net income. In closing, this ratio confirmed prior analysis regarding
goodwill for it is definitely a red flag for Jakks Pacific that needs to be addressed in the
undo accounting distortions section.
Cash Flow from Operations / Income from Operations
The CFFO (cash flow from operations) divided by OI (income from operations)
should be close to one (cash we get for operations matches income we earned from
operations). In this ratio, there was stability for most years, except in 2004, for Jakks
Pacific. In 2004, CFFO increased by 1677% and OI increased by 371.73%, this led to a
high ratio for that year, which may be an indication that expenses were overstated for
the purpose of understating net income. In 2003, CFFO decreased by 89.67% and OI
decreased by 54.47% (lowest in the time considered) which may indicate that the
company had a less productive year but recovered in 2004. In terms of the competition,
except for Leapfrog, they seem to follow the same basic trend, meaning that for Jakks
Pacific, the values reported in their ratio, at least from an industry perspective, does not
defy expectations (except for 2004) or provoke serious concern. In addition, the
companies, except for Hasbro (2003 to 2005) and Leapfrog, tend to have ratios that are
70

close to one. On a side note, if we were analyzing Leapfrog, we would be concerned for
not only does their ratio defy the industry trend, but the losses in CFFO and OI, would
be a red flag, not just in terms of accounting, but for the company itself. In closing,
Jakks Pacific did not raise significant concern in the CFFO to OI ratio (except for 2004)
and seems to be doing a reasonable job in this ratio.
In the chart, negative values arise from decreases in CFFO or OI and positive
values arise from increases in CFFO and OI or decreases in CFFO and OI (negatives
cancel each other out). In truth, an increase or decrease in OI should be followed by an
increase or decrease in CFFO (meaning they have a direct relationship) and should
therefore be greater than zero. In most cases the fluctuations are small but in some
cases the difference in the ratio can be far greater or far lower than that of the previous
year. In this regard, Jakks Pacific did a good job for the fluctuations in their ratio tend
to be stable over time (except for 2004) and the only competitor that showed better
stability was Leapfrog (but their ratio is far from favorable otherwise). On a side note,
the reason we excluded Mattel for 2007 was because it was different from the previous
year (far too small) and including it would distort our analysis. In 2007, CFFO for Mattel
decreased by 36.01% and OI for Mattel increased by only 0.17%, resulting in a
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negative 250.33 change in their ratio for that year. In Jakks Pacific, it seems that the
company did a good job and seemed to be following the basic trend of the industry
leader (Hasbro).
Δ CFFO / Δ OI 2003 2004 2005 2006 2007
Jakks Pacific 4.71 2.93 ‐1.77 ‐1.66 1.63
Hasbro ‐0.15 1.85 7.89 ‐2.67 1.97
Mattel ‐10.57 0.63 1.56 6.37 ‐250.33
Leapfrog 0.11 0.22 ‐0.71 ‐0.79 ‐4.50
Cash Flow from Operations / Net Operating Assets
NOA refers to long term assets that are used in operations (property, plant, and
equipment). The ratio determines if CFFO is supported by NOA and if NOA is properly
accounted for (properly depreciated). In this ratio, if CFFO is equal to NOA then a dollar
invested in NOA leads to a dollar increase in CFFO. In addition, if the ratio were greater
than one, each dollar invested in NOA leads to greater dollar increases in CFFO. In the
same way as the asset turnover ratio, if NOA were not depreciated (properly) then it
could lead to overly high or overly low ratios and would be an indication of a red flag. If
the ratio, were overly high (general terms or one year discrepancy) that might indicate
72

that they depreciated too much, leading to smaller total assets, which results in
overstated expenses (recording the depreciation expense), which in turn leads to a
smaller net income. In 2004, the large CFFO (largest in the time frame considered)
resulted in a large ratio being reported for that year (Jakks Pacific), which may be an
indication that expenses were overstated for the purpose of understating net income. In
other years, Jakks Pacific seems to follow the industry trend (similar to Hasbro in 2005
to 2007) and tend to have higher ratios than the competition. In regards to the
competition, Hasbro and Mattel showed greater stability over time, whereas Leapfrog
and Jakks Pacific (prior to 2005) were a bit more erratic. In closing, Jakks Pacific did
not raise significant concern in the CFFO to OI ratio (except for 2004) and seems to be
doing a reasonable job in this ratio, getting on average $4.5 dollars for every dollar
invested in NOA.
The “change” form for this ratio shows that fluctuations tend to be erratic. In the
chart, negative values arise from decreases in CFFO or NOA and positive values arise
from increases in CFFO and NOA or decreases in CFFO and NOA (negatives cancel each
other out). In 2004, the change in the ratio for Jakks Pacific was so large (negative)
that including it would distort the analysis of this chart. It was due to the 1677%
73

increase in CFFO and the 6.67% decrease in NOA that this ratio ended up the way it did
for that year. In regards to the “raw” form of the ratio and that of the “change” form,
the drastic change in 2004 does provoke some concern.
Δ CFFO / Δ NOA 2003 2004 2005 2006 2007
Jakks Pacific 20.68 ‐158.56 ‐34.38 ‐1.76 5.29
Hasbro 1.39 ‐13.51 ‐3.22 ‐9.95 45.10
Mattel ‐20.97 0.87 2.63 ‐39.52 17.39
Leapfrog 14.06 ‐6.27 25.06 28.94 ‐17.01
Total Accruals / Net Sales
The total accruals are found by taking cash flow from operations (CFFO) and
subtracting out net income (NI). In this ratio, any distortion in expenses might be noted
in this ratio for if expenses were understated this ratio would be too small (smaller
expenses = larger NI = smaller accruals) and if expenses were overstated this ratio
would be too large (larger expenses = smaller NI = larger accruals). In this ratio, Jakks
Pacific, seems to follow the industry trend and tends to be fairly stable over time
(except for 2004). In Leapfrog, we find it to be the only company to display such erratic
behavior, which from analysis involving prior ratios, is not surprising. In general terms,
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it seems that companies in the toy industry have values for this ratio that are close to
zero, which indicates to us that accruals have a negligible effect for companies in the
toy industry and may not be a good indicator of whether expenses were manipulated.
In the chart, negative values arise from decreases in CFFO or NOA and positive
values arise from increases in CFFO and NOA or decreases in CFFO and NOA (negatives
cancel each other out). It seems that fluctuations tend be small and the biggest
changes can be noted by Jakks Pacific and Mattel in 2003. In truth, aside from that,
there is little to be said, other than that what was stated in the “raw” form, that
accruals do not seem to play a big part for companies in the industry.
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Pension Expense / SG&A
In spite of tireless efforts, we could not find pension expense for the company or
competitors, aside from the contributions made by Jakks Pacific to the retirement plan,
therefore, we cannot compute this ratio.
Other Employment Expenses / SG&A
In spite of tireless efforts, we could not find warranty liabilities for the company
or competitors, therefore, we cannot compute this ratio.
Conclusion
The expense diagnostic ratios did raise a few concerns (2004) but nothing too
serious aside from the goodwill issue that will be discussed later. The CFFO to OI ratio
though low is close to one, but does not show signs of drastically changing in the next
year. The CFFO to NOA is where this company has distinctly outperformed the
competitors, meaning they are able to get the most out of their operating assets, which
does make sense, if you consider the firm competitive advantage analysis, which details
upon the efforts they take to get the most out of what they have.
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Expense Manipulation Diagnostics
Asset Turnover 2003 2004 2005 2006 2007
Jakks Pacific 0.60 0.82 0.88 0.87 0.87
Hasbro 0.99 0.92 0.94 1.02 1.19
Mattel 1.10 1.07 1.18 1.14 1.24
Leapfrog 1.23 1.14 1.07 1.12 1.16
CFFO / OI 2003 2004 2005 2006 2007
Jakks Pacific 0.65 2.45 0.81 0.69 0.82
Hasbro 1.32 1.22 1.60 0.85 1.16
Mattel 0.77 0.78 0.70 1.20 0.77
Leapfrog 0.24 ‐0.01 ‐1.18 ‐0.73 0.15
Δ CFFO / Δ OI 2003 2004 2005 2006 2007
Jakks Pacific 4.71 2.93 ‐1.77 ‐1.66 1.63
Hasbro ‐0.15 1.85 7.89 ‐2.67 1.97
Mattel ‐10.57 0.63 1.56 6.37 ‐250.33
Leapfrog 0.11 0.22 ‐0.71 ‐0.79 ‐4.50
CFFO / OI 2003 2004 2005 2006 2007
Jakks Pacific 0.63 12.01 5.60 3.77 4.09
Hasbro 2.27 1.73 3.03 1.76 3.20
Mattel 0.97 0.97 0.85 1.63 1.08
Leapfrog 1.30 0.00 ‐1.04 3.25 ‐0.45
Δ CFFO / Δ OI 2003 2004 2005 2006 2007
Jakks Pacific 20.68 ‐158.56 ‐34.38 ‐1.76 5.29
Hasbro 1.39 ‐13.51 ‐3.22 ‐9.95 45.10
Mattel ‐20.97 0.87 2.63 ‐39.52 17.39
Leapfrog 14.06 ‐6.27 25.06 28.94 ‐17.01
Accruals / Net Sales 2003 2004 2005 2006 2007
Jakks Pacific ‐0.027 0.153 0.011 ‐0.011 ‐0.002
Hasbro 0.094 0.054 0.092 0.029 0.070
Mattel 0.014 0.000 0.010 0.050 ‐0.007
Leapfrog ‐0.067 0.010 ‐0.065 0.469 0.194
Δ Accruals / Δ Net Sales 2003 2004 2005 2006 2007
Jakks Pacific ‐9.05 0.37 ‐0.92 ‐0.16 0.08
Hasbro ‐1.08 0.95 1.35 ‐3.04 0.26
Mattel ‐11.49 ‐0.49 0.68 0.50 ‐1.01
Leapfrog ‐0.17 ‐1.32 ‐5.16 ‐1.88 2.49
77

Potential Red Flags
As noted in the Accounting Analysis Introduction, step 5 in the
implementation of an accounting analysis is to identify potential red flags. We outlined
the following items as initial potential red flags: unexplained changes in accounting,
unexplained transactions boosting profitability, unusual increases in certain asset
balances in relation to sales increases, increased gap between profits and cash flow
from operations, unexpected large asset write-offs or year-end adjustments, qualified
audit opinions or unexplained changes in independent auditors, executive compensation
incentive to enhance reported profits, litigation marked by potential outcomes
degrading profits and subsequent events. We conducted a review of Jakks 2007 10-K
filing accordingly. Additionally, we reviewed Jakks 1 st quarter 2008 10-Q as well as
various business articles.
Items Not Resulting in Suspicion
Our review did not reveal any unexplained changes in accounting or the
application of accounting principles. Jakks 10-K for 2007 contained no unexplained
transactions, nor were any unusual transactions serving to materially enhance
profitability in existence. Jakks has received a clean opinion in all years presented and
there have been no unexplained changes in independent auditors. The Company did
not record any large asset write-offs, nor did it make any sizeable year-end adjustments
in any of the periods represented in its 2007 10-K.
Unusual Increases in Certain Asset Balances In Relation To Sales Increases
The following chart examines the relative increase in Net Sales vs. Accounts
Receivable, vs. Inventory for the 3-year periods ending December 31, 2005, 2006 &
2007, respectively. All amounts are in thousands.
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2005 2006 2007
Net Sales $661,536 $765,386 $857,085
% Increase from ‘05 N/A 15.7% 29.6%
Accounts Receivable 100,231 153,116 174,451
% Increase from ‘05 N/A 52.8% 74.0%
Inventory 68,436 76,788 75,486
% Increase. from ‘05 N/A 12.2% 10.3%
The chart reveals a possible red flag regarding the growth in accounts receivable
relative to the growth in net sales. We see that net sales have experienced a 29.6%
increase from 2005 versus a 74.0% increase in accounts receivable over the same
period. Further analysis into accounts receivable turnover indicates a turnover of 6.04
or every 60 days for 2006, as compared to 5.23 or every 70 days. The Company has
disclosed that it performs ongoing credit evaluations of its top customers and maintains
an allowance for potential credit losses. However, further analysis is in order to help
understand the almost 17% increase in the collection period from 2005 to 2007.
Increased Gap between Profits and Cash Flow from Operations
The information in the chart below summarizes the growth in net income versus
the concurrent increase in cash flow from operations from 2005 to 2007.
2005 2006 2007
Net Income $63,493 $72,375 $88,991
% Increase from ‘05 N/A 14.0% 40.2%
Cash Flow from Operations 71,001 63,710 87,660
% Incr./-Decr from ‘05 N/A -10.3% 23.5%
Obviously, cash flow from operations is not keeping pace with the expansion of
net sales. This is most probably due to the rising accounts receivable balance caused
by the inequitable increase in Jakks collection period as noted above. Therefore, the
increased gap between profits and cash flow from operations serves to substantiate the
need to further investigate the Company’s credit policy on a larger bisection of its
customer base than just the major customers as indicated in Jakks 2007 10-K.
79

Executive Compensation Incentive to Enhance Reported Profits
Compensation for the Chief Executive, Jack Friedman, and Chief Operating
Officer, Stephen Berman, includes a cash bonus tied to earnings per share. A
compensation committee sets the target level and the maximum payout if the target is
achieved is purportedly limited to 200% of base salary. However for 2007, EPS was
almost 22%, far exceeding set target levels thereby invoking a cash bonus for each of
the two executives at 250% base, for a combined total of $2,662,500 (Jakks 2007 10-
K). Most certainly, these executives have tremendous incentive to enhance reported
profitability.
Jakks has a recent history where compensation of top executives has received
much publicity. A 2005 article states that “top executives at the Malibu-based toy
maker received $13.6 million in stock-related compensation last year, to go along with
their already healthy salaries. The report didn't say who received the awards, but in
the past such payments have been limited to three officials: Chairman and Chief
Executive, Jack Friedman, Chief Operating Officer, Stephen Berman, and Chief Financial
Officer, Joel Bennett. The pretax payments amount to about 22 percent of 2004
operating profits of $62 million, at a time the company is fighting a federal bribery,
money-laundering and racketeering lawsuit that threatens to undo one of its most
lucrative income streams” (goliath.ecnext.com). This is not the only case of executive
compensation being scrutinized. “Jakks has long been criticized for pay doled out to its
executives. In 2003, Friedman and Berman each earned a salary of $965,000 plus a
bonus of $1.3 million and $2.5 million in restricted stock” (goliath.ecnext.com). These
three men are still in their respective positions with the company. It seems that the
owners of the company have too much of their personal interests in mind when making
financial decisions. Additionally, Jakks was found violating GAAP in 2002-2004. The
same article reads “Jakks also was forced by the Securities and Exchange Commission
to restate both its 2002 and 2003 earnings. Its 2004 earnings were issued on a
preliminary basis, after an SEC review found that the company failed to abide by
generally accepted accounting principles.” These greedy actions combined with a
failure to abide by GAAP in earnings reports should make investors wary of putting their
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money into the company. It is natural to believe that if these men have been
unscrupulous in the past, then they will continue to do so in the future.
Heavy Litigation Marked By Potential Outcomes Degrading Profits
Jakks is involved in several ongoing legal disputes, the outcomes of which could
have a material adverse effect on revenues, results of operations, and cash flows.
Accordingly, it is prudent in our analysis to review these matters as part of our
observance of potential red flags. The following review encompasses our opinion as to
the significance of each of these matters presently under litigation.
Class Action Suit
A class action lawsuit commenced in the United States District Court for the
Southern District of New York on behalf of purchasers of JAKKS Pacific, Inc. ("JAKKS")
(NASDAQ:JAKK) common stock during the period between February 17, 2004 and
October 19, 2004 (the "Class Period"). In this suit, Plaintiff sought damages on behalf
of all purchasers of JAKKS common stock during the Class Period. The complaint
charged JAKKS and certain of its officers and directors with violations of the Securities
Exchange Act of 1934 (2004 Business Wire). Although a motion to dismiss the Class
Actions was granted January 2008, an amended complaint has been filed and a briefing
schedule established for October 2008. Round one has favored the Company, but the
following details of the suit bring into question the ethics of the Company’s major
players, namely the CEO, COO and CFO.
The complaint alleged that throughout the period from February 17 th through
October 19, 2004, defendants issued numerous positive statements concerning the
increasing sales of Jakk’s products licensed through the World Wrestling Entertainment
Inc. ("WWE"). As alleged in the complaint, these statements were materially false and
misleading because defendants knew but failed to disclose: (a) that the WWE was
contending that the WWE licenses had been obtained through a pattern of commercial
bribery; (b) that the company's relationship with the WWE was being negatively
impacted by the WWE's contention that the licenses it had granted to the Company
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were improperly obtained; and (c) given the foregoing, the Company was subject to the
heightened risk that the WWE would seek some modification to its WWE licensing
agreements or complete nullification of those agreements, which would negatively
impact the Company's future financial results (www.action-figure.com).
It wasn’t until October 19, 2004, that JAKKS issued a press release announcing
that it was "engaged in discussions with WWE concerning the restructuring of its toy
license and with WWE and THQ with respect to the restructuring of the JAKKS THQ
Joint Venture video games license agreement with WWE. In response to the
announcement of the problems with the WWE licenses, the price of JAKKS stock
declined from $24.15 per share to $18.81 per share. Then, after the market closed for
trading, it was reported that the WWE had just filed a lawsuit against JAKKS, which
alleged that the videogame license and certain toy licenses that the WWE previously
granted to JAKKS were obtained through a pattern of racketeering and commercial
bribery and seeking, among other things, that the licensing agreements should be
declared void. Following this announcement, on the next day of trading, the price of
JAKKS common stock continued to fall to close at $12.96 per share on extremely heavy
trading volume (www.action-figure.com).
Subsequent to the filing of the complaint, on November 16, 2004, JAKKS issued
a press release announcing that it entered into a worldwide licensing agreement with
WWE to develop and market WWE(R) TV Games. The press release gave the
impression that JAKKS and WWE had resolved their differences. However, it was later
disclosed, by WWE, that the deal was only an amendment to an earlier agreement that
was later found to be in dispute and where litigation between the two companies was
occurring.
A motion was granted in January 2008 to the extent that the Class Actions were
dismissed without prejudice to the plaintiffs’ right to seek leave, to file an amended
complaint based on statements that the WWE licenses were obtained from the WWE as
a result of the long-term relationship with WWE. A motion seeking leave to file an
amended complaint was granted and an amended complaint was filed. A briefing
schedule has been established, with respect to a motion for dismissal, which is
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scheduled for argument in October 2008. While THQ has come out on top, in this bit of
WWE related litigation to date, the ethics and integrity of the Company’s management
are certainly questionable. Additionally, yet another licensing abuse is under scrutiny
by the wrestling organization's attorneys.
WWE Claims Publisher Illegally Sublicensing Out Rights
(Gamespot News, October 23, 2006)
In October 2006, the WWE filed suit regarding the Publisher's sublicensing of
Asian distribution rights to SmackDown franchise developer Yuke's (details follow).
WWE is claiming that THQ sublicensed out the rights to games based on the wrestling
organization for at least the last five years when it didn't have the rights to do so. For
one thing, WWE says that THQ never had any kind of a license agreement with the
wrestling company in the first place; its deals were made with THQ-Jakks Pacific, a
separate joint venture half owned by the publisher and half owned by WWE's toy
license-holder Jakks Pacific.
Furthermore, WWE says that the licensing agreement it does have with THQ-
Jakks Pacific specifically forbids sublicensing to any company that is not wholly owned
by the joint venture without prior written consent from WWE. WWE said that it never
received a request for nor granted any such written consent. As to whom, THQ was
licensing the rights to, WWE claims it was, SmackDown! Franchise developer, Yuke’s (of
which THQ is only a part owner), which handles the distribution of WWE games in
Japan and other Asian countries. The wrestling organization also claims that THQ was
collecting royalties from Yuke’s that should have gone straight to the WWE instead.
As to why the WWE had not brought the issue to court before now, the company
claims that THQ concealed the sublicensing agreements from them. It says that when
THQ submitted package approval request forms in 2004 for a game to be sold in Japan,
the publisher listed Yuke's as "THQ's regional distributor," and not a sub licensee. THQ-
Jakks Pacific has held the WWE game license since June of 1998, according to the suit,
and the agreement currently extends throughout 2009. THQ-Jakks also holds the
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option to extend that by another five years "provided that certain conditions are met."
Those conditions are not specified in the lawsuit.
The WWE is asking for a declaration that it is entitled to terminate its licensing
agreement with THQ-Jakks Pacific, for THQ to give up whatever money it made from
the sublicensing agreement, and for monetary damages with interest. When WWE first
brought the charges to THQ's attention earlier this year, the publisher denied them as
follows. "The WWE had been aware and had consented to the manner of distribution in
Japan and the payment of royalties with respect to such sales and, in addition, had
separately released the joint venture from any claims with respect to such matter as a
result of a settlement of a royalty audit of the THQ/JAKKS joint venture." This dispute
again brings into question the ethics of the company’s major players, as well as the
potential effect on future operating results. Per Jakks, “this action is in its preliminary
stage, we cannot assure you as to the outcome, nor can we estimate the range of our
potential losses, if any” (Form S-SA, Registration Statement of the Securities Act of
1933 for Jakks Pacific, Inc. as filed March 5, 2008).
Exclusive License to Publish WWE Video Games Uncertain
Jakks joint venture with THQ, a developer, publisher and distributor of interactive
entertainment software for the leading game platforms in the video game market is on
shaky ground. The joint venture entered into a license agreement with the WWE,
under which it acquired the exclusive worldwide right to publish WWE video games on
all hardware platforms. The terms of the license agreement expires on December 31,
2009, and the joint venture has a right to renew the license for an additional five
years provided that there is an absence of a material breach of the license agreement
and that certain royalty minimums are met. Although those minimums have been met,
Jakks and the joint venture are named as defendants in lawsuits commenced by WWE,
pursuant to which WWE is claiming that there have been material breaches with respect
to the video game license and is seeking treble, punitive and other damages (including
disgorgement of profits) in an undisclosed amount and a declaration that the video
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game license with the joint venture and an extension of our toy licenses with WWE are
void and unenforceable (“Legal Proceedings”, Jakks 2007 Form 10-K)).
On December 21, 2007 the Court dismissed the WWE Action with prejudice (the
"December 2007 Order") based on (1) the failure to plead RICO injury; (2) the bar of
the RICO statute of limitations; (3) the denial of WWE’s motion for reconsideration of
the Sherman Act claim; and (4) the lack of subject matter jurisdiction with respect to
the pendent state law claims. Thereafter, WWE filed an appeal to the Second Circuit
Court of Appeals (Form S-SA, Registration Statement of the Securities Act of 1933 for
Jakks Pacific, Inc. as filed March 5, 2008). An adverse outcome against Jakks, THQ or
the joint venture in the lawsuit commenced by WWE would adversely impact the
company’s rights under the joint venture’s single license, which would in turn adversely
affect the joint venture and Jakks: business, financial condition, and results of
operation.
Preferred Returns on Joint Venture Net Sales Unsettled
The joint venture agreement with THQ provides for Jakks to have received
guaranteed preferred returns through June 30 th , 2006 at varying rates of the joint
ventures net sales, depending on the cumulative unit sales and platform of each
particular game. The preferred return was subject to change after June 30 th , 2006 and
was to be set for the distribution period beginning July 1 st , 2006 and ending
December 31 st , 2009 (the “Next Distribution Period”). The agreement with THQ
provides for the parties to agree on the reset of the preferred return or, if no
agreement is reached, for arbitration of the issue. No agreement had been reached and
the preferred return for the Next Distribution Period is to be determined through
arbitration. The preferred return is accrued in the quarter in which the licensed games
are sold and the preferred return is earned. Based on the same rates as set forth under
the original joint venture agreement, an estimated receivable of $37.9 million has been
accrued for the twenty one months ended March 31, 2008, pending the resolution of
this outstanding issue (Form 10-Q, Quarterly Period Ended March 31, 2008) up from
$35.3 million for the eighteen months ended December 31, 2007 (Jakks 2007 Form 10-
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K). Any adverse change to the preferred return for the next distribution period may
result in the Company experiencing reduced net income, which would adversely affect
results of operations.
Subsequent Events
Our review for red flags also included a search for any events in the last few
months that might have a material influence on Jakks revenues, results of operations or
cash flows. Our review revealed the following:
Mattel Takes Toy Rights to WWE in Multi-Year Licensing Agreement
Mattel has taken toy rights to World Wrestling Entertainment in a multiyear
licensing agreement covering all global territories upon the expiration of WWE’s current
toy license with Jakks expiring January 2010. Under the terms of the agreement, Mattel
will develop and market products in a wide variety of categories, including action
figures, accessories and play sets, games and puzzles, activity toys, plush products,
vehicles (including R/C) and role-play products. The first line of products will be
available in 2010 (playthings.com, 02/13/2008). Certainly, it is practical that this
subsequent event will have an adverse effect on company revenues and operating
results. However, Jakks announced in February 2008 of a new 5 year contract to
produce toys based on competing pro wrestling league, TNA Wrestling. The toymaker’s
master toy license includes rights for action figures, play sets, accessories and role-play
toys, as well as collectible items based on TNA Wrestling’s top talent. While having
nowhere near WWE’s name recognition, TNA has experienced increasing popularity
since its inception in 2002 (playthings.com, 02/13/2008).
It is not ascertainable what the offsetting effect of TNA rights will be, but it is
certainly feasible that without the degree of brand recognition of the WWE, revenue
from this line of toy action figures will suffer, as well as operating income and cash
flows from this product line.
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Undo Accounting Distortions
Jakks invests a great deal of money into companies and puts the net assets of an
acquired firm into their accounting book. Jakk stockpiles goodwill over time through the
purchase of these firms. Jakks does not have to recognize impairment if the impairment
test does not fail. The GAAP impairment test gives leeway to allow for the judgment of
managers. Jakks has a “performance criteria” clause where they pay additional money
to former owners of the company. The payment is added to goodwill, but should be a
fee that is expensed as a cost of doing business. If their goodwill increases without fair
and reasonable impairment then it would create large overstatements for total assets.
We impaired goodwill by 20 percent per year because a new acquisition tends to
have a five years life span and we used straight line depreciation (1 over 5 is twenty
percent). Jakk’s goodwill accounts for about 36 percent of total assets. The balance
sheet and income statement will be affected by any change to goodwill. We believe
taking into account the impairment of goodwill will give realistic and fair values in the
financial statements.
In looking at the consolidated statement of operation data, we see how
operation expense has increased with the adjustment to goodwill. The “goodwill effect”
will change the income from operation and reduce net income. We first analyzed the
consolidated statement of operations because it is the most transparent in seeing if
changes occurred. The change in the income statement will also affect the other
financial statements.
Income Statement: Expense
2002 2003 2004 2005 2006 2007
Gross profit 129,843 126,442 226,007 266,707 294,794 323,650
SG&A 98,111 113,053 172,282 178,722 202,482 216,652
Acquisition Shut Down and Product
Recall Costs 6,718 2,000
Income from Operations 25,014 11,389 53,725 87,985 92,312 106,998
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Restated Income Statement: Expense
2002 2003 2004 2005 2006 2007
Gross profit 129,843 126,442 226,007 266,707 294,794 323,650
SG&A 98,111 113,053 172,282 178,722 202,482 216,652
Acquisition Shut Down and Product
Recall Costs 6,718 2,000
Impairment for Goodwill 37,867 38,146 51,666 53,860 67,600 70,668
Income from Operations (12,853) (26,757) 2,059 34,125 24,712 36,330
We suspect that net income would decrease for all years. The impairment
account increased operation expenses for each year. Before the adjustment, the
operation expense over sales was about 33.8% in 2002. After the adjustment,
operation expense over sales rose to 46% in 2002. The only amortizing they did was
for trademarks and licensing. These numbers were hidden in the “SG&A”. The
amortization for these indefinite assets was less than ten percent of operating
expenses.
2002 2003 2004 2005 2006 2007
Net sales 310,016 315,776 574,266 661,536 765,386 857,085
Between 2003 and 2004, Jakks has leapt in sales. If the 2003 net income loss
occurred (after adjusting for goodwill) Jakks may not have been aggressive with its
growth strategy. Their growth strategy includes several elements. For example, some of
them were “expanding core products, entering new product category, and pursing
strategic acquisitions (Jakk’s 10-K)”. The growth strategy has a lot of money flowing
around to expand in all areas. The growth strategy would be less aggressive in buying
trademarks, licenses, and acquisitions if they had recognized the impairment in all these
items.
We are concerned with two components in the balance sheet: goodwill and
retaining earnings. We need to look at how significantly the “goodwill effect” will
change goodwill. Retaining earnings is found by taking the previous year’s retained
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earnings adding net income for the year and subtracting dividends for the year (Jakks
does not have dividends so it is just RE previous year + NI this year). In this analysis,
we wanted to see if the drop in net income has a noticeable change in retain earnings.
Balance Sheet
2002 2003 2004 2005 2006 2007
Goodwill 189,336 190,728 258,331 269,298 337,999 353,340
Trademarks 11,568 15,468 17,768 17,768 19,568 19,568
Total Non Current Assets 232,017 245,187 324,223 328,638 430,156 456,605
Total Assets 408,810 529,997 696,762 753,955 881,894 982,688
Restated Balance Sheet
2002 2003 2004 2005 2006 2007
Goodwill 189,336 190,728 258,331 269,298 337,999 353,340
Accumulated Goodwill 37,867 38,146 51,666 53,860 67,600 70,668
Adjusted Goodwill 151,469 152,582 206,665 215,438 270,399 282,672
Trademarks 11,568 15,468 17,768 17,768 19,568 19,568
Total Non Current Assets 194,150 207,041 272,557 274,778 362,556 385,937
Total Assets 370,943 491,851 645,096 700,095 814,294 912,020
The balance sheet has a new account called “accumulated goodwill” that they
never used in their accounting book. Accumulated goodwill is a contra asset account
that deals with the impairment for the year (we used a 20% rate). Goodwill has grown
every year. In 2004, goodwill jumped because acquisitions increased. In 2007, goodwill
accounted for 36% of total assets before the adjustment but accounted for 31% of
total assets after the adjustment. Goodwill changed by five percent with the
adjustment.
In retained earnings, it has dropped by a significant amount for a few years but
dropped by a smaller amount in later years. In 2004, Jakk starts to get a positive net
income. In 2005, retained earnings over total equity was 45.7% before the adjustment
and after the adjustment, it was 39.5%. Dividends did not have any effect because the
company has not paid dividends during their business life span.
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Preferred Stock
Equity
2002 2003 2004 2005 2006 2007
Common Stock 24 25 26 27 28 28
Additional Paid-In Capital 240,102 246,008 276,642 287,356 300,255 312,127
Retained Earnings 120,451 133,005 176,564 240,057 312,432 382,288
Deferred Compensation Form (789)
Accumulated Other Comprehensive
Loss (349) (1,747) (2,789) (3,427) (3,446)
Total Shareholder Equity 360,577 377,900 451,485 524,651 609,288 690,997
Preferred Stock
Restated Equity
2002 2003 2004 2005 2006 2007
Common Stock 24 25 26 27 28 28
Additional Paid-In Capital 240,102 246,008 276,642 287,356 300,255 312,127
Adjusted Retained Earnings 82,584 94,859 124,898 186,197 244,832 311,620
Deferred Compensation Form (789)
Accumulated Other Comprehensive
Loss (349) (1,747) (2,789) (3,427) (3,446)
Total Shareholder Equity 322,710 339,754 399,819 470,791 541,688 620,329
“Goodwill effect” did not have a big change in the balance sheet compared to the
income statement. Balance sheet is the accumulation of total assets, liabilities, and
owner’s equity over years. Goodwill might be proportional to other accounts in the
accounting formula. Income statement is a year by year dollar amount. “Goodwill
effect” did affect net income significantly. Overall impairment of goodwill gave fair and
reasonable values to assume for the financial statements. The twenty percent
adjustment did impact the financial statements. The income statement was transparent
to see how significant “goodwill effect” would be as an expense account. The balance
sheet showed slight effect for the adjustment. In the forecasting section, the
adjustment for goodwill and its effect on the balance sheet, income statement, and
statement of cash flows can be noted.
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Financial Analysis
We will begin this section by computing and analyzing many different financial
ratios for Jakks and its competitors. These ratios can be broken down into three
sections: liquidity ratios, profitability ratios, and capital structure ratios. Next, we will
be using these ratios, patterns from previous years, industry knowledge, and our
knowledge of the firm to forecast certain items on the balance sheet, income
statement, and statement of cash flows ten years into the future. Finally, we will
estimate cost of capital for Jakks to gain insight on how operations are funded, and to
increase our knowledge of the value of the firm.
Liquidity Ratio Analysis
The firm’s ability to sell off assets for cash is liquidity. Cash, market securities,
account receivables, and inventory are the most liquid of assets. The liquidity ratios
can evaluate a firm’s credit risk and the firm’s ability to pay off liabilities. In this analysis
, we look at the current ratio, inventory turnover, and working capital turnover for Jakk
and its competitors.
Current Ratio
Current ratio equals current assets divided by current liabilities. Current ratio is
one of the liquidity ratios that can help analyze how well recent obligations can be paid
through liquid assets. The ratio should be at least 1 or greater. If the ratio is less than
1, the firm may have to borrow money to pay off current or long-term debt when it is
due. In addition, lenders, potential investors, and financial analysts want the ratio to be
at least 2 to cover any unexpected financial crisis. The current ratio is a good indicator
of solvency.
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Jakk’s current ratio average is 2.67 between 2002 and 2007. The current ratio
for Jakk’s fluctuated between 2.6 and 5.5 from 2002 to 2007. Current liabilities jumped
from about 52 million to 142 million in 2003 to 2004, respectively. Jakk’s current ratio
fell between 2003 and 2004. Jakk’s account payables increased. Current assets
increased by 58 million during this time. The increase in account payable was greater
than the increase in current assets. Hasbro and Mattel have lower current asset ratios in
the toy industry. Both firms have slightly favorable positions to pay off liabilities. Hasbro
and Mattel’s consistent solvency can be due to its longevity in the industry compared to
Jakk and LeapFrog. Hasbro and Mattel’s current liabilities and assets have grown at a
slow rate without any significant jumps in the numerator or denominator in the current
ratio. Jakk has inconsistent solvency. The inconsistent solvency is shown in the
movement of the graph. The inconsistent solvency can be due to acquisitions because
Jakk has to put acquisition liabilities and assets in their accounting book. Jakk and
LeapFrog have small current liabilities (denominator) making their ratio. Jakk and
LeapFrog are managing their liabilities well compared to other competitors. But,
LeapFrog has done a better job overall.
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Acid Test
The acid test ratio, also called the quick asset ratio, is a ratio that only includes
quick assets and current liabilities. Quick assets include cash, marketable securities, and
account receivables. The acid test equals quick assets divided by current liabilities. Acid
test ratio is more liquid compared to the current ratio. Acid test ratio excludes prepaid
expenses, inventory, and other current assets that may not be very “liquid”. Account
receivables are the exception to the acid test ratio because it might be difficult to collect
on them. Acid test ratio is a good indicator for the liquidity of current assets owned by
the firm.
Acid test ratio for Jakks had a range of 2.1 to 4.3 during the past six years. The
acid test ratio is lower than the current ratio, which was expected. The solvency for
Jakk is still strong in the toy industry. Jakk has enough cash, marketable investments,
and account receivables to pay any current or long term obligation without any
problem. Mattel and Hasbro have no favorable change in their solvency. LeapFrog’s
acid test ratio is unpredictable but still has high solvency. Palepu and Healy mention
“mean revert”. “Mean revert” is supposed to be the industry average over a period of
time. Mattel and Hasbro have been in the toy industry for a long time and their ratios
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are consistent year by year. Jakk and LeapFrog will probably “mean revert” to Mattel
and Hasbro. In this, we mean to say that over time the ratio for Jakk and LeapFrog may
become similar to that of Hasbro and Mattel.
Accounts Receivable Turnover
Receivable turnover can allow us to see how promptly cash is collected.
Receivable turnover is found by dividing net sales by account receivables. The cash
received from account receivables can increase the liquidity and solvency of a firm. A
prompt cash collection can be used to help operations, such as buying large volumes of
inventory at a lower price and might allow the firm to pay out dividends to
shareholders.
Jakk’s receivable turnover ratio has fluctuated over time, but has smoothed out
during the last two years. Mattel has decreased its receivable turnover and smoothed
out in the last two years. It seems that all four companies are “smoothing” out in the
last two years, but at different levels. Sales growth did not change as much during the
last two years. U.S. toy retailer may be cutting back purchases because the holiday
sales have decreased over the past 3 or4 years.
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Days Sales Outstanding
It is computed by taking 365 (number of days in the year) and dividing it by the
accounts receivable turnover. It is an indication of how quickly a company is able to
collect on its accounts receivables.
Jakk needs to worry about the number of days sales outstanding because it may
create insolvency. LeapFrog also needs to change its credit term to decrease the
number of days needed to collect receivables. The industry in general must wait sixty
days to collect on receivables, which needs to decrease to around 30 to 45 days.
Decreasing the days sales outstanding will make the “cash merry go round” spin fast.
Account receivable will be more liquid if they decreased the days’ sales outstanding.
Inventory Turnover
Inventory turnover can help us see if the firms are selling their products versus
holding it in inventory. Inventory turnover can be calculated by cost of goods sold (or
cost of sales) divided by inventory. A firm wants to have enough inventory to meet their
customer needs and operations. Overstocked inventory, however, can reduce solvency
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y stalling the company’s ability to convert products into cash. Increased inventory with
a low turnover may lead to increased storage costs, insurance expenses, property
taxes, and other indirect expenses. The analysis of inventory turnover can indicate how
efficient the firm is.
Jakk’s inventory turnover had a range from 4.3 to 7.1 over time. Jakk has
climbed up in the inventory turnover ratio to compete with the top competitors and
made their operations more efficient in doing so. Mattel and Hasbro have kept steady
between 6 and 8. Their fluctuation has been more stable and predictable. Although,
LeapFrog’s turnover is low compared to competitors, they have changed their product
strategy to focus on educational products, instead of traditional toys.
Days Supply of Inventory
It is computed by taking 365 (number of days in the year) and dividing it by the
inventory turnover. It tells us how quickly the company is able to get rid of their
inventory and may be an indication of the level of management in the firm.
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The day’s supply of inventory seems to be between 55 and 80 days, which is
long compared to companies in other industries, but may be the result of relying on
third party manufacturers, which many of them tend to do. Jakk decreased their days
supply of inventory after 2003. This could mean they have a good relationship with
suppliers and may have been able to reduce the number of days supply of inventory as
a result. Hasbro and Mattel have kept a smooth number of days supply of inventory.
LeapFrog increased its number of days supply of inventory. This could mean that
LeapFrog is becoming more insolvent.
Working Capital Turnover
Working capital turnover is a measure of sales divided by excess capital, this
capital (working capital) is found by taking the difference in current assets minus
current liabilities. This ratio allows us to see if working capital is generating sales. The
working capital can help a firm invest into their company, such as getting new
equipment, trademarks, inventory, and acquisitions. An increase in working capital
turnover is a good sign.
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Jakk and LeapFrog have low working capital turnovers compared to Hasbro and
Mattel, but this may be due to the fact, that Hasbro and Mattel have double the assets
and sales compared to Jakk and LeapFrog. Jakks has been consistent in its working
capital turnover. This could be a good sign that excess capital is being used in a positive
manner.
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Profitability Analysis
In analyzing the profitability of the toy and game industry, we looked at how
efficient each company is at generating sales. To measure this, ratios relating items
such as gross profit, operating income, and net income to sales were used. Also, for
each company in the industry, we calculated the return on assets, return on equity and
the asset turnover to determine asset productivity as well. These ratios will allow sideby-side
comparisons of each company on the profitability of their core business
activities using the same scale. That is, we can distinguish between which companies
are doing well in the industry and which companies are not competing at industry
standards.
Gross Profit Margin
The gross profit margin is calculated by dividing the gross profit (sales minus
cost of goods sold) of a company by their sales. After a company has covered
manufacturing cost from their products, the money left over is their gross profit. This
ratio helps determine what percentage of sales that companies can use to pay
additional expenses or retain for future savings.
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The first and most obvious observation from this table is that Leapfrog has a
gross profit margin way under the industry average. The drop in 2006 was caused by a
29% decrease in sales followed by an incredible 90% decrease in gross profit. This
may be evidence of a big bath considering it is highly improbable that the cost of goods
sold truly went up by that proportion. Mattel and Hasbro have leveled out their gross
profit margin over the past five years. Jakks on the other hand has had a declining
ratio over the past four years. This means that even though sales may be going up,
they are not able to keep costs down where they should be.
Operating Profit Margin
Operating profit margin can be viewed as how much a company makes on each
dollar of sales. It is calculated by dividing a company’s operating income by their sales
of the same year. Not only does this ratio show efficiency in operating activities, it
clues us in on a company’s pricing strategy. If a firm has too low of an operating profit
margin, it may be an indication that the company is pricing their items lower in order to
compete within the industry. The negative effect of this however is that it affects the
company’s overall profitability.
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In the graph on the previous page, the industry is converging to an operating
profit margin of about 13%. Leapfrog is again way off industry standards. Three of
the past four years, they had a negative operating profit margin. This again may be an
indication of Leapfrog taking a big bath.
The restated operating profit margin accounts for impairments in goodwill for
Jakks Pacific and their competitors. The biggest difference in this ratio with restated
financials is with Jakks Pacific. In the first year, Jakks’ operating profit margin dropped
from 3.61% to -5.45%. The reason behind this is the greater effect that goodwill has
on reported assets (almost 30%) for this company. Although the impairment greatly
affects this ratio, it does not materially affect our view of the company. For 2005,
2006, and 2007, sales for Jakks has increased by 13%, 14%, and 11% respectively.
Because of this increase in sales, we are confident in the company’s abilities to continue
to generate revenue into the future.
Net Profit Margin
The net profit margin is a ratio that is used to determine the amount of dollars
that a company actually keeps in earnings. It is calculated by dividing the net income
by sales. A higher profit margin indicates a company with a higher profitability. In
general, companies that are able to benefit through economies of scale have a higher
profit margin than competitors who are smaller. By looking at the trends in this number
over time, we will be able to see if the company has improved their profitability or not.
If this ratio goes down for a company, it may indicate that their recent business
activities have diminished their profit margin. The net profit margin for the toy and
game industry shows convergence at 10%. Leapfrog, like in operating profit margin, is
way below the industry average. This significant decrease is caused by their reductions
in sales on average, along with increasing costs since 2004.
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In the restated for net profit margin, the major difference lies within Jakks. With
a negative ratio in 2002 (not shown), 2003, and 2004, this greatly affects our view of
the company. Although the trend is increasing, the negative ratios hint at a not so
promising future. This ratio unlike operating profit margin does in fact materially affect
our view of Jakks Pacific. The restated net profit margin indicates that Jakks is not able
to control their cost as well as the industry. In this case, goodwill may be overstated to
prevent this view of the company from being revealed.
Asset Turnover
Asset turnover is a measure of the amount of sales generated by every dollar
that a company has in assets. In other words, how productive is a company at using
their assets to create sales. The ratio is calculated by dividing sales in one year by the
total assets of the previous year. The higher the asset turnover, the better the
company is at using their assets to generate sales.
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In the chart above, there are no significant abnormal findings. The average
asset turnover ratio in 2007 is 1.1, up from 1.02 in 2006. Jakks is slightly below this
industry average with a .97 in 2007. Although Leapfrog has been highly volatile, they
have held a higher average asset turnover than Jakks. The restated ratios for each year
of the four companies show no significant changes. They are higher than the originals
because total assets have decreased as a result of the impairment on goodwill. With
Jakks’ restated asset turnover increasing by an average of .07 every year, this does not
affect our view of the company. This is a favorable restatement for both companies.
Return on Assets
Return on assets (ROA) is a ratio used by investors and financial analysts to get
an idea of how effective a company is at converting its investments in assets to
earnings. It is measured by dividing net income in one year by total assets of the
previous year. This lag in time of the calculation is used to show what assets were
invested at the beginning of the year and how well they were used throughout the
year. Similar to asset turnover, ROA shows how efficient management is at using the
company’s assets to generate earnings. A higher ROA for a company means it is
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investing less money in assets to generate a higher return in earnings, therefore, the
bigger the return on assets the better (less risk for a higher return).
The industry is meeting together at about 11%. Jakks Pacific is showing really
good signs in return on assets with increasing figures since 2003. Hasbro has been
increasing every year as well. The line representing Leapfrog shows how bad the
company has been doing in the past several years. The low ratios show that the
company is investing in assets that are not producing sales.
With restated financials for the four companies in the graph above, our position
on Jakks changes greatly. Not only is the ratio negative for 2003, it does not go above
2.01%. At this rate of return, we recommend investing in risk-free Treasury Bonds.
Return on Equity
Return on equity is the relationship between net income and owners equity. It
shows shareholders how much profit that the company is generating with the money
that they have invested. Again this ratio is calculated with a lag effect, representing the
amount invested by shareholders at the beginning of the year and relating that to how
management used these investments throughout the year.
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For the companies in the graph above, each have a resemblance to their returns
on assets. There does appear to be a predictable convergence within the industry, but
the returns are still somewhat volatile among the top three. Leapfrog is way below the
standard, for in consecutive years they had negative net income. They have a lot of
ground to cover for investors to regain confidence.
Hasbro still maintained a high return on equity with the impairment in goodwill.
Jakks Pacific on the other hand topped out in 2007 at 2.95%. Without the restatement,
Jakks had a return of 12.88%. This affects their return by nearly 10%, which materially
changes our view on the company.
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Capital Structure Analysis
The first objective of the Capital Structure Analysis is to determine how the firms
are financing their activities. There are two ways for corporations to raise funds. One
method is debt financing, which consists of long-term liabilities. The other method is
equity financing, involving the issuance of common and/or preferred stock. Capital
structure affects leverage, which, in turn, affects the expected return and risk facing
owners and creditors (www.cbdd.wsu.edu). Our analysis will include these ratios
indicative of capital structure: debt to equity, times interest earned, debt service
margin, sustainable growth rate, and altman z score. Analysis of these ratios will give
insight on how the firms are raising money, and inform us of how efficiently each
method is being used.
Debt to Equity Ratio
The debt to equity ratio is a measure of a company’s financial leverage,
calculated by dividing total liabilities by stockholder’s equity. It indicates what
proportion of equity and debt the company is using to finance its assets
(www.investopedia.com). A higher ratio means greater use of debt.
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As indicated by the chart above, the 2003 relative ranking of the use of debt for
the companies researched from highest to lowest is Hasbro, Mattel, Jakks and Leapfrog.
By 2007, Leapfrog surpassed Jakks in the relative usage of debt. Hasbro and Mattel
use 2 to 3 times more debt in their capital structure than Jakks and Leapfrog. Note
that Jakks’ debt to equity ratio gently swayed up and down over the 5-year period, but
never changed more than .14 in 1 year. The largest increase was 2003 to 2004 when
Jakks purchased almost all of Play Along. The total purchase price was $85.7 million.
Jakks funded the acquisition by paying $70.8 million in cash, and issuing 749,005
shares of common stock valued at $14.9 million. Along with this increase in equity,
Jakks also assumed liabilities of $32 million (Jakks 2003 10-K). This large increase in
liabilities contributed to the increase in the ratio. Although Jakks’ ratio never changed
too drastically, the overall amount of both debt and equity financing used increased
over the period. This tells us that Jakks is expanding their operations and growing as a
corporation.
Mattel moved even less than Jakks, never wavering more than .09 in a single
year. This is partially due to Mattel being a much larger and mature company than
Jakks. It would take a very large amount of financing to alter its ratio. Hasbro’s capital
structure over the same timeframe was a bit more volatile. The decrease from 2003 to
2004 was due to Hasbro’s repurchase of an aggregate of $55,658 in principal amount of
long-term debt, as part of management’s goal to reduce the Company's debt-tocapitalization
ratio and improve its liquidity situation by decreasing cash required to
service outstanding debt. The ultimate reason behind this strategy was to enhance the
ability of the Company to obtain additional financing should the need to do so arise
(Hasbro 2003 10-K). The increase in debt to equity in 2007 was due to the issuance of
$350,000 of notes due in 2017, for which the majority of the proceeds were used to
repay short-term debt resulting from repurchases of common stock as well as
outstanding warrants. The repurchase activity showed evidence of Hasbro’s initiative at
that time to return excess cash to its shareholders through share repurchases and
dividends (Hasbro 2007 10-K).
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LeapFrog’s debt to equity ratio was very steady until 2007, where it increased
by .21. This is largely due to an almost $20 million increase in liabilities caused by
employee-related costs, which included severance and bonus of over $10 million.
These severance and bonus amounts were associated with the resignation of former
corporate officers and reduction in LeapFrog’s school segment workforce (LeapFrog
2007 10-K).
The adjusted debt to equity ratio shows the same patterns but adjusts the
entries to decrease equity by the amount of goodwill impairment that should have been
recorded.
Times Interest Earned
The Times Interest Earned (TIE) ratio is calculated by dividing Net Income
Before Interest and Taxes (NIBIT) by interest expense. “TIE represents an ability to
meet debt obligations, and an indicator of how many times a company can cover its
interest charges on a pretax basis” (www.investopedia.com). A lower TIE ratio means
less earnings are available to meet interest payments and that the business is more
vulnerable to increases in interest rates. Ensuring interest payments to debt holders
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and preventing bankruptcy depends mainly on a company's ability to sustain earnings
(www.financial-dictionary.thefreedictionary.com).
LeapFrog has been graphed separately, given the quite different performance of
TIE relative to the other three companies. First, we will compare the other companies
and address LeapFrog later independently. From the first chart, we see that Jakks TIE
starts out comparable to Mattel and Hasbro, but by 2004 it is more than double the
other two and the gap remains relatively constant through 2007, when Jakk’s TIE
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eaches 25. While Hasbro’s TIE experiences a steady incline over the 5-year period
from about 5 to almost 15, Mattel’s remains relatively flat, not venturing too far from 10
in any given year. All three company ratios are healthy, but LeapFrog’s TIE is faltering
endlessly. 2003 and 2005 are the exceptions. 2003 is explained mostly by dramatic
annual sales growth of 28%, from $532 million in 2002 to $680 million in 2003
(LeapFrog 2003 10-K). Also, LeapFrog’s initial public offering wasn’t until 2002, so
equity financing was more predominant than debt financing prior to 2005.
2005 TIE approximated 500 due to increased revenues, specifically the more
than doubling of revenue from screen-based products (LeapFrog 2005 10-K). LeapFrog
experienced negative NIBIT in 2004, 2006 and 2007. In 2004, negative NIBIT was due
largely to decreased revenue of $39.7 million and approximately a 10% drop in gross
margin from 2003 (LeapFrog 2004 10-K). In 2006, the company suffered from a
decline in revenue, coupled with a 13.7% decline in gross margin owing significantly to
the write-off of obsolete inventory. 2007 was plagued with further erosion of revenue,
down to $442 million from $502 million in 2006. Clearly, LeapFrog has not
demonstrated the ability to sustain earnings, thus causing doubt as to its ability to meet
ongoing debt service requirements.
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The adjusted times interest earned ratios show the changes to decrease NIBIT
by the amount of goodwill impairment that should have been recorded.
Debt Service Margin
Debt service margin (DSM) is calculated by taking operating cash flows and
dividing it by the previous year’s current notes payable. This ratio represents a
company’s ability to pay back its long term debt. A higher number represents a greater
ability to repay debt. So, bigger is better in this case.
300
Debt Service Margin
T
250
200
150
100
50
Mattel
Hasbro
0
2003 2004 2005 2006 2007
Mattel 3.32 10.91 2.47 8.76 8.72
Hasbro 2.25 268.95 1.53 9.78
Time
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Current portion of notes payable was nonexistent on Jakks and LeapFrog’s
balance sheets for the 5-year period. Therefore, only Hasbro and Mattel are charted
above. Generally, we see that the two companies’ debt service margins are
comparable, with the exception of 2004 and 2007. Excluding 2004 and 2007, the range
for Hasbro is between 1.5 and 9.8, whereas it is 2.5 to 10.9 for Mattel. The spike up to
269.0 for Hasbro in 2004 is due to the repayment of over $200,000 in principal on
7.95% notes due March 2003. Similarly, in 2006 Hasbro had $0 current notes payable,
yielding an undefined result for DSM.
Altman Z Scores
The Altman Z-Score is a method of calculating a company’s risk of bankruptcy.
Scores below 1.81 are considered poor and represent a higher risk, and scores between
1.81 and 2.67 lie in the grey area. A score above 3 is considered healthy. The lower a
company’s risk of bankruptcy (higher Z-Score) the better interest rate they will receive
on loans. Likewise, the higher the risk of bankruptcy (lower Z-Score) the higher the
interest rate will be. The model uses 5 variables in this calculation. The formula is 1.2
(working capital / total assets) + 1.4 (retained earnings / total assets) + 3.3 (operating
income / total assets) + .6 (market value of equity / book value of liabilities) + .1 (sales
/ total assets). We have graphed the Z-Scores of the leaders of the toy industry and
they are plotted in the graph below.
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Jakks has performed in the high end of the grey area, or just above it for the last
6 years, and with sales and operating income steadily increasing by 11% to 20% for
each of the last three years they seem to be on their way up. Likewise, Mattel has
consistently scored well always landing between 3.05 and 3.89 during the sample.
Hasbro has been as low as 1.78 in 2002, but has recovered since and has scored
between 2.69 and 3.53 since. Hasbro’s increase can be attributed to gradual increases
in operating income and net revenues over the past 5 years. LeapFrog has been very
sporadic, ranging between 5.5 and 0.36 during the sample. They have scored very
poorly in the past two years and are now considered at high risk for bankruptcy. This is
explained by LeapFrog’s net sales having declined from (in thousands) 649,757 in 2005,
to 502,255 in 2006, to 442,271 in 07, a total of a 32% decrease in two years. During
this same period operating expenses have increased from 258,683 in 2005, to 271,697
in 2006, to 274,476 in 2007.
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The adjustment for goodwill affected retained earnings, operating income, and total
assets, how this affected each company is shown in the chart above. In this chart, we
see that Jakks Pacific is (in terms of financial stability) “okay but not great” for 2003 to
2007 (except for 2004) which defers from the non adjusted z score in that were
considered “great” for three years, instead of the two seen here. Leapfrog, as was
expected based on prior analysis of the industry and the firms therein, is considered
both for this year and the one before as being in “financial distress” for having a score
below 1.81, of course this measurement is not perfect, but it does not seem too far off
based on what was already noted.
Sustainable Growth Rate
The IGR and SGR are methods of calculating a company’s potential for growth.
The IGR is defined as being equal to ROA (1 – dividends / net income), and is the
highest level of growth achievable without outside financing (www.investopedia.com).
The SGR is the maximum growth rate that a firm can sustain without having to increase
financial leverage (www.investopedia.com), calculated as being equal to IGR (1 + debt
previous year / equity previous year). The SGR represents how much a firm can grow
on their own; without borrowing more money. To pass this rate the firm must borrow
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funds from outside sources. Since Jakks Pacific does not pay dividends their IGR is
simply equal to return on assets (discussed in the profitability analysis section). Due to
this fact we will only be discussing SGR.
Jakks has shown a very consistent SGR ranging from 11.43% to 14.61%, except for
2003 which is an outlier at 4.41%. This outlier is due to Jakk’s having only (in
thousands) 48,223 total liabilities in 2002, as opposed to 151,414 in 2003. Hasbro is
consistently between 12.93% and 21.65%, except for the beginning of the graph in
2002. Mattel also follows a very steady path, never veering outside of 13.24% to
28.21%. LeapFrog once again is very sporadic, showing a hard decline from 53.15% in
2002 all the way down to -30.34% in 2007. This is due to LeapFrog having a net loss
in 2006 and 2007 of (in thousands) 145,092 and 101,315, while having total
stockholder’s equities of 19,034 and 22,438, respectively. These numbers yield returns
on equity of approximately -762% in 2006 and -452% in 2007. Since LeapFrog has no
dividends these large, negative returns on equity are the multipliers in the SGR
equation, bringing their total SGR way down.
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SGR ‐ Goodwill Adj 2002 2003 2004 2005 2006 2007
Jakks Pacific ‐1.22% ‐5.91% 1.61% 7.03% 5.56% 7.47%
Hasbro ‐19.75% 8.29% 9.53% 9.60% 10.23% 18.36%
Mattel 8.36% 23.54% 21.80% 14.52% 22.79% 20.13%
Leapfrog 53.01% 26.51% ‐2.99% 3.40% ‐32.03% ‐29.59%
The adjustment for goodwill affected ROA for it changed net income and total
assets. In addition, it also affected total equity through the impact it had on retained
earnings. In taking away the “excess” goodwill, we find that Jakks Pacific performed
differently than what was seen before (meaning a whole lot worse). In fact, it seems
that the company would not have been able to sustain themselves through internal
financing for 2002 and 2003.
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Financial Statement Forecast
In this, we are using our knowledge and understanding of what the company is and
does to reasonably predict what might happen in the future. In doing so, we are able to
determine if the company is fairly valued through the use of valuation models which are
discussed later. Our task is to use logic and reason to find patterns in items in the
financial statements and to make educated decisions as to what those items will be in
the future. In making such assumptions, it is important to note that the income
statement tends to be the easiest to forecast and that the statement of cash flows
tends to be the hardest due to the amount of the things that can affect it and due to
the relative inconsistency of the items reported there in. The balance sheet is
somewhere in between these two as far as difficulty in forecasting goes.
Goodwill Adjustment
In forecasting, we will focus on the raw statements (what the company
provided) and then on adjusted statements (what would happen if we accounted for
goodwill). In terms of what is affected: income from operations is decreased by the
impairment of goodwill, which decreases net income, which in turn decreases retained
earnings, which leads to a decrease in total equity, this decrease, however is countered
by the decrease in total non-current assets (which houses goodwill), which in turn
decreases total assets to match the decrease in total equity. In order to keep things
simple, we shall first forecast the raw statements (including predictions on goodwill)
and then based on how the impairment of goodwill affects financials (which we outlined
above) we will make those adjustments accordingly to create the “adjusted
statements”.
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Income Statement
Sales
Sales in prior years indicate growth but that growth is unstable. If the growth
found in 2005 to 2007 is an indication of future performance, then it seems probable
that growth will be about 13.7% for future years [(15.7% + 15.2% + 11.98% +
11.98%)/4]. In 2005 and 2006, we felt that sales growth had reached a stable point
but found that it dropped by 3.7% in 2007. In 2007, they may have had a slower year
or it may have been a side effect of having to deal with legal issues regarding the WWE
brand. In either case, this fluctuation is small compared to the changes in sales growth
for 2003 and 2004. We, therefore, assumed that the 11.98% sales growth in 2007 was
the “lower limit” for possible sales growth in future periods, whereas the growth seen in
2005 and 2006 can be treated as the “upper limit”. In using this logic, we took the
growth seen in 2005 and 2006 and averaged it with the growth seen in 2007 (we
counted it twice to counter balance the “upper limits” used in the calculation).
Cost of Sales
The cost of sales growth, except for 2005, tends to be 1.37% to 3.49% more
than growth in sales for those years. In reviewing the quarters, it was revealed that the
difference in these rates tends to be around ±0.6% in the remaining quarters (first
quarter excluded) for these years, which is relatively small, and allows us to make a
reasonable approximation as to what the cost of sales might be for the rest of 2008.
This was calculated to be 0.3% (average of the cost of sales growth minus sales growth
for the remaining quarters in those years) more than sales growth for quarters after the
first quarter in 2008. In simpler terms, this means that we took the sales growth in
“2008 rest”, which was 15.1% [(843571 - 733023) / 733023] and added 0.3% to that
value to get cost of sales growth in “2008 rest”, which was 15.4% (15.08% + 0.3%),
then after that, we computed the cost of sales for “2008 rest” using that growth rate,
and added that value to “2008 Q1” (first quarter, which was given to us) to get our
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total cost of sales for the year. In terms of what cost of sales will be for years after
2008, please read the section below on gross profit.
Gross Profit
If we look into the gross profit margin (profitability ratio) for this company, we
find that after 2004, this ratio has dropped from 40.32% in 2005 to 38.52% in 2006 to
37.76% in 2007, and in 2008 (based on forecasting) this ratio was 37.5%. If we
consider the difference in the ratio we found that it decreased by 1.8% in 2006, by
0.76% in 2007, and by 0.26% in 2008. This indicated to us that the gross profit margin
(gross profit divided by sales) may be reaching a sort of “stable point” (due to the
smaller decreases in this ratio over time), which by our reasoning should be a little
smaller than the ratio for 2008. In seeking that value (or rather a close approximation)
we estimated the future gross profit margin to be 37.1% [37.17% - 0.26%*0.2%]
where the “0.2% times 0.26%” is an estimate based on the difference in gross profit
margin over time. In relation to what was stated in the cost of sales section, we can
predict cost of sales based on our prediction for sales minus this prediction for the gross
profit.
SG&A
In “acquisition shut down and product recalls”, this played a part in calculating
the income for 2002 and 2003, but was negligible in later years, which is why we are
ignoring it in our analysis. In SG&A (selling, general and administrative expenses), it
has increased over time but tends to fluctuate between 15.23% and 3.74% (excluded
2004). In this item, the variation seems to have no discernable pattern, making it
difficult to make an accurate forecast. In terms of income from operations (which along
with gross profit can be used to find SG&A), we found that it increased over time, but
demonstrated a far greater volatility than SG&A expenses. In this, we are forced,
despite the level of uncertainty, to determine a growth for SG&A in 2008, for it is for all
intents and purposes more stable than the growth in income from operations. In
discussing this matter over, we have agreed that a simple average for the growth for
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SG&A in prior years (excluding 2004) may be the best approach in determining a
“reasonable” growth for 2008, this was calculated to be 9.8% [(15.23% + 3.74% +
13.29% + 7%) / 4]. In reviewing income from operations, we noticed that the first
quarter yielded a negative result, but given the volatility in growth for this item in prior
quarters and due to the unstable growth in income from operations in general, we have
assumed that the “2008 rest” (excludes first quarter) for 2008, will make up for the loss
found in the “2008 Q1” (first quarter). In terms of years after 2008, we simply used our
prediction for gross profit and subtracted out income from operations to find SG&A for
future periods.
Income from Operations
In the common size, we found that income from operations showed relative
consistency between 2005 and 2008, because these years are recent, we used them as
a basis for finding this item in future periods (excluded 2003 and 2004). In doing so, we
have calculated that income from operations would be equal to 12.56% [(13.30% +
12.06% + 12.48% + 12.76%) / 4] times net sales, this of course, does not apply to
2008, where we had determined income from operations in a different manner (gross
profit minus SG&A).
Profit from Joint Venture
The profit from the joint venture has increased in prior years and that growth
tends to become larger in each year (except for 2003). In this growth, it has increased
by 12.7% from 2004 to 2005, by 20.8% from 2005 to 2006, and by 19.65% from 2006
and 2007. If 2005 to 2007 are an indication, then it seems reasonable to assume that
growth in this item should increase by 20.2% [(20.8%+19.65%)/2] to 80.3% for 2008.
In truth, it is expected that the return from the venture will decrease over time due to
the legal issues regarding WWE and the loss of their brand in later years. In this, we
have concluded that the growth should decrease in later years (after 2009). But by how
much is difficult to determine, therefore for the sake of simplicity, the prediction for this
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item in future periods will be found by taking the income before income taxes
subtracting off the income from operations and adding the net interest.
Income Before Income Taxes [Includes Information on Net Interest]
Except for 2003, growth in this item, though positive, is extremely unstable. In
order to predict it, we decided to take the income from operations add the profit from
the joint venture and subtract the net interest (for 2008). In regards to this, the growth
in net interest is similar to this item, in that both are extremely unstable. In seeking
some common ground for an analysis, we took net interest and divided it by income
from operations. In doing so, we found that in recent years (2005, 2006, and 2007)
that net interest decreased income from operations by 0.8% [(0.73% + 0.43% +
1.27%) / 3], and though the fluctuations are volatile in this ratio, they are small. In
this, we assumed that net interest is equal to 0.8% of income from operations, which is
reasonable, for both 2008 and years after. In summary, taking income from operations
adding the profit from the joint venture and subtracting the estimated net interest gives
us a prediction for income before income taxes for 2008. In looking at the common size
for this item (including 2008) we see (excluding 2002) that the ratio has steadily grown
(except for 2006) over time (from 5.49% in 2002 to 16.78 in 2008). The difference in
this ratio was 4.8% in 2004, 4.32% in 2005, 0.5% in 2007 (with respect to 2005), and
1.61% in 2008. It is evident that this ratio has increased over time (excluded 2003 and
2004) but that increase has been relatively small, which to us has indicated that the
ratio may be on average close to 17.8% in future periods [which we estimated based
on the differences in that ratio over time].
Provision for Taxes
Income tax for 2002 was 18.9%, for 2003 was 8.3%, for 2004 was 26.3%, for
2005 was 34.3%, for 2006 was 31.7%, and for 2007 was 31.3% for this company. It is
difficult to determine what the income tax will be in future years for it does vary and is
not consistent with the tax rates used by competitors.
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Income Tax 2002 2003 2004 2005 2006 2007
Jakks
Pacific 18.90% 8.30% 26.30% 34.30% 31.70% 31.30%
Hasbro 27.90% 28.30% 24.60% 31.80% 32.60% 28.00%
Mattel 26.80% 27.40% 17.70% 36.00% 13.30% 14.70%
Leapfrog 39.90% 37.00%
‐
47.60% 26.50% 22.46% 3.80%
In reviewing the tax rate for 2005 to 2007 for Jakks Pacific, the rate tends to be
around 31% and has shown slight decreases over time. In considering this, we have
taken the average for the rates in 2005 to 2007 along with 2004, to make a reasonable
guess as to what the income tax rate might be in future years for this company, which
we calculated to be 30.5% for future years.
Net Income
Since we have the other pieces of the puzzle, all that is required to “predict” net
income, is to take “income before income taxes” and subtract the “provision for income
taxes”. In minority interest, we ignored this factor, for it only played a part in
calculating net income in 2002.
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Income Statement [Raw]
Jakks Pacific - Income Statement - (in thousands) Actual Financial Statements Average Assume Forcasted Financial Statements
Ended 12/31 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Net sales
310,016 315,776 574,266 661,536 765,386 857,085 974,506 1,108,013 1,259,811 1,432,405 1,628,644 1,851,768 2,105,461 2,393,909 2,721,874 3,094,771
Cost of sales
180,173 189,334 348,259 394,829 470,592 533,435 60.35% 608,341 62.90% 696,940 792,421 900,983 1,024,417 1,164,762 1,324,335 1,505,769 1,712,059 1,946,611
Gross profit
129,843 126,442 226,007 266,707 294,794 323,650 39.65% 366,165 37.10% 411,073 467,390 531,422 604,227 687,006 781,126 888,140 1,009,815 1,148,160
SG&A
98,111 113,053 172,282 178,722 202,482 216,652 29.37% 237,884 24.54% 271,906 309,158 351,512 399,669 454,424 516,680 587,465 667,948 759,457
Acquisition Shut Down and Product Recall Costs
6,718 2,000 1.40%
Income from Operations
25,014 11,389 53,725 87,985 92,312 106,998 9.81% 128,281 12.56% 139,166 158,232 179,910 204,558 232,582 264,446 300,675 341,867 388,703
Profit from Joint Venture
8,004 7,351 7,865 9,414 13,226 21,180 1.98% 38,188 5.14% 56,933 64,732 73,601 83,684 95,149 108,184 123,005 139,857 159,018
Other Expense
(1,401)
Net Interest
Interest Income
Interest Expense
Total Net Interest
Income Before Income Taxes
Provision for Income Taxes
Income Before Minority Interest
Minority interest
Net income
2,052 5,183 4,930 6,819 0.65%
(4,550) (4,544) (4,533) (5,456) -0.68%
(1,141) 1,405 2,498 (639) (397) (1,363) 0.03% (1,026) -0.10% (1,127) (1,282) (1,457) (1,657) (1,884) (2,142) (2,435) (2,769) (3,148)
34,159 17,335 59,092 96,637 105,935 129,541 11.73% 167,495 17.80% 197,226 224,246 254,968 289,899 329,615 374,772 426,116 484,494 550,869
6,466 1,440 15,533 33,144 33,560 40,550 3.23% 51,086 5.43% 60,154 68,395 77,765 88,419 100,533 114,305 129,965 147,771 168,015
27,693 15,895 43,559 63,493 72,375 88,991 8.50% 116,409 12.37% 137,072 155,851 177,203 201,480 229,082 260,467 296,150 336,723 382,854
(237)
27,930 15,895 43,559 63,493 72,375 88,991 8.51% 116,409 12.37% 137,072 155,851 177,203 201,480 229,082 260,467 296,150 336,723 382,854
Common Sized - Income Statement 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Sales Growth Percentage N/A 1.86% 81.86% 15.20% 15.70% 11.98% 25.32% 13.70% 13.70% 13.70% 13.70% 13.70% 13.70% 13.70% 13.70% 13.70% 13.70% 13.70%
Net sales
Cost of sales
Gross profit
SG&A
Acquisition Shut Down and Product Recall Costs
Income from Operations
Profit from Joint Venture
Other Expense
Net Interest
Interest Income
Interest Expense
Total Net Interest
Income Before Income Taxes
Provision for Income Taxes
Income Before Minority Interest
Minority interest
Net income
100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
58.12% 59.96% 60.64% 59.68% 61.48% 62.24% 60.35% 62.43% 62.90% 62.90% 62.90% 62.90% 62.90% 62.90% 62.90% 62.90% 62.90% 62.90%
41.88% 40.04% 39.36% 40.32% 38.52% 37.76% 39.65% 37.57% 37.10% 37.10% 37.10% 37.10% 37.10% 37.10% 37.10% 37.10% 37.10% 37.10%
31.65% 35.80% 30.00% 27.02% 26.45% 25.28% 29.37% 24.41% 24.54% 24.54% 24.54% 24.54% 24.54% 24.54% 24.54% 24.54% 24.54% 24.54%
2.17% 0.63% 1.40%
8.07% 3.61% 9.36% 13.30% 12.06% 12.48% 9.81% 13.16% 12.56% 12.56% 12.56% 12.56% 12.56% 12.56% 12.56% 12.56% 12.56% 12.56%
2.58% 2.33% 1.37% 1.42% 1.73% 2.47% 1.98% 3.92% 5.14% 5.14% 5.14% 5.14% 5.14% 5.14% 5.14% 5.14% 5.14% 5.14%
-0.21% -0.21%
0.36% 0.78% 0.64% 0.80% 0.65%
-0.79% -0.69% -0.59% -0.64% -0.68%
-0.37% 0.44% 0.43% -0.10% -0.05% -0.16% 0.03% -0.43% -0.10% -0.10% -0.10% -0.10% -0.10% -0.10% -0.10% -0.10% -0.10% -0.10%
11.02% 5.49% 10.29% 14.61% 13.84% 15.11% 11.73% 17.19% 17.80% 17.80% 17.80% 17.80% 17.80% 17.80% 17.80% 17.80% 17.80% 17.80%
2.09% 0.46% 2.70% 5.01% 4.38% 4.73% 3.23% 5.24% 5.43% 5.43% 5.43% 5.43% 5.43% 5.43% 5.43% 5.43% 5.43% 5.43%
8.93% 5.03% 7.59% 9.60% 9.46% 10.38% 8.50% 11.95% 12.37% 12.37% 12.37% 12.37% 12.37% 12.37% 12.37% 12.37% 12.37% 12.37%
-0.08% -0.08%
9.01% 5.03% 7.59% 9.60% 9.46% 10.38% 8.51% 11.95% 12.37% 12.37% 12.37% 12.37% 12.37% 12.37% 12.37% 12.37% 12.37% 12.37%
123

Income Statement [Adjusted]
Jakks Pacific - Income Statement - (in thousands) Actual Financial Statements Average Assume Forcasted Financial Statements
Ended 12/31 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Net sales
310,016 315,776 574,266 661,536 765,386 857,085 974,506 1,108,013 1,259,811 1,432,405 1,628,644 1,851,768 2,105,461 2,393,909 2,721,874 3,094,771
Cost of sales
180,173 189,334 348,259 394,829 470,592 533,435 60.35% 608,341 62.90% 696,940 792,421 900,983 1,024,417 1,164,762 1,324,335 1,505,769 1,712,059 1,946,611
Gross profit
129,843 126,442 226,007 266,707 294,794 323,650 39.65% 366,165 37.10% 411,073 467,390 531,422 604,227 687,006 781,126 888,140 1,009,815 1,148,160
SG&A
98,111 113,053 172,282 178,722 202,482 216,652 29.37% 237,884 24.54% 362,316 411,954 468,391 532,561 605,522 688,478 782,800 890,043 1,011,979
Acquisition Shut Down and Product Recall Costs
6,718 2,000 1.40%
Impairment for Goodwill
37,867 38,146 51,666 53,860 67,600 70,668 79,516 90,410 102,796 116,879 132,892 151,098 171,798 195,335 222,095 252,522
Income from Operations
(12,853) (26,757) 2,059 34,125 24,712 36,330 0.06% 48,765 12.56% 48,756 55,436 63,031 71,666 81,484 92,648 105,340 119,772 136,181
Profit from Joint Venture
8,004 7,351 7,865 9,414 13,226 21,180 1.98% 38,188 5.14% 56,933 64,732 73,601 83,684 95,149 108,184 123,005 139,857 159,018
Other Expense
(1,401)
Net Interest
Interest Income
Interest Expense
Total Net Interest
Income Before Income Taxes
Provision for Income Taxes
Income Before Minority Interest
Minority interest
Net income
2,052 5,183 4,930 6,819 0.65%
(4,550) (4,544) (4,533) (5,456) -0.68%
(1,141) 1,405 2,498 (639) (397) (1,363) 0.03% (1,026) -0.10% (1,127) (1,282) (1,457) (1,657) (1,884) (2,142) (2,435) (2,769) (3,148)
(3,708) (20,811) 7,426 42,777 38,335 58,873 1.98% 87,979 17.80% 106,816 121,450 138,089 157,007 178,517 202,974 230,781 262,398 298,347
(702) (1,729) 1,952 14,672 12,145 18,429 0.92% 26,834 2.94% 32,579 37,042 42,117 47,887 54,448 61,907 70,388 80,031 90,996
(3,006) (19,082) 5,474 28,106 26,191 40,444 1.05% 61,145 6.70% 74,237 84,408 95,972 109,120 124,069 141,067 160,393 182,367 207,351
(237)
(2,769) (19,082) 5,474 28,106 26,191 40,444 1.07% 61,145 6.70% 74,237 84,408 95,972 109,120 124,069 141,067 160,393 182,367 207,351
Common Sized - Income Statement 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Sales Growth Percentage N/A 1.86% 81.86% 15.20% 15.70% 11.98% 25.32% 13.70% 13.70% 13.70% 13.70% 13.70% 13.70% 13.70% 13.70% 13.70% 13.70% 13.70%
Net sales
Cost of sales
Gross profit
SG&A
Acquisition Shut Down and Product Recall Costs
Impairment for Goodwill
Income from Operations
Profit from Joint Venture
Other Expense
Net Interest
Interest Income
Interest Expense
Total Net Interest
Income Before Income Taxes
Provision for Income Taxes
Income Before Minority Interest
Minority interest
Net income
100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
58.12% 59.96% 60.64% 59.68% 61.48% 62.24% 60.35% 62.43% 62.90% 62.90% 62.90% 62.90% 62.90% 62.90% 62.90% 62.90% 62.90% 62.90%
41.88% 40.04% 39.36% 40.32% 38.52% 37.76% 39.65% 37.57% 37.10% 37.10% 37.10% 37.10% 37.10% 37.10% 37.10% 37.10% 37.10% 37.10%
31.65% 35.80% 30.00% 27.02% 26.45% 25.28% 29.37% 24.41% 32.70% 32.70% 32.70% 32.70% 32.70% 32.70% 32.70% 32.70% 32.70% 32.70%
2.17% 0.63% 1.40%
-4.15% -8.47% 0.36% 5.16% 3.23% 4.24% 0.06% 5.00% 4.40% 4.40% 4.40% 4.40% 4.40% 4.40% 4.40% 4.40% 4.40% 4.40%
2.58% 2.33% 1.37% 1.42% 1.73% 2.47% 1.98% 3.92% 5.14% 5.14% 5.14% 5.14% 5.14% 5.14% 5.14% 5.14% 5.14% 5.14%
-0.21% -0.21%
0.36% 0.78% 0.64% 0.80% 0.65%
-0.79% -0.69% -0.59% -0.64% -0.68%
-0.37% 0.44% 0.43% -0.10% -0.05% -0.16% 0.03% -0.43% -0.10% -0.10% -0.10% -0.10% -0.10% -0.10% -0.10% -0.10% -0.10% -0.10%
-1.20% -6.59% 1.29% 6.47% 5.01% 6.87% 1.98% 9.03% 9.64% 9.64% 9.64% 9.64% 9.64% 9.64% 9.64% 9.64% 9.64% 9.64%
-0.23% -0.55% 0.34% 2.22% 1.59% 2.15% 0.92% 2.75% 2.94% 2.94% 2.94% 2.94% 2.94% 2.94% 2.94% 2.94% 2.94% 2.94%
-0.97% -6.04% 0.95% 4.25% 3.42% 4.72% 1.05% 6.27% 6.70% 6.70% 6.70% 6.70% 6.70% 6.70% 6.70% 6.70% 6.70% 6.70%
-0.08% -0.08%
-0.89% -6.04% 0.95% 4.25% 3.42% 4.72% 1.07% 6.27% 6.70% 6.70% 6.70% 6.70% 6.70% 6.70% 6.70% 6.70% 6.70% 6.70%
124

Balance Sheet
Total Current Assets
In 2003 to 2006, growth in current assets decreased from 61.1% to 6.21%,
however, in 2007, it increased to 16.46%. In the prior section, we found a negative
growth in 2006 for cash and cash equivalents (current asset) that made it difficult to
forecast expected growth for future periods (if we had not excluded it). In current
assets, the same thing can be said, for the decrease in cash and cash equivalents
(2006) did affect the growth in current assets (total) for that year. In this, we excluded
2006 and looked at growth for 2005 (growth of 14.17%) and 2007 (growth of 16.46%)
the difference is remarkably small, compared to the decreases in growth seen in 2003
and 2004. In using the simplest route to forecast growth for current assets, we took the
average of 14.17% and 16.46% to give us (for 2008) a growth of 15.3%. In the
common size, we find (except for 2002), that the ratio of current assets to total assets
is consistent over time, with the range being less than 5% in most cases, therefore, in
seeking to predict the future growth in this ratio (years after 2008), we took the
average seen in prior years (2003 to 2008) and found it to be 54.37% [(55.84% +
53.54% + 51.22% + 56.41% + 53.47% + 55.74%) / 6].
Accounts Receivable
In seeking a pattern, we found growth to be inconsistent over time, in one
instance, growth decreased by 62% in 2007 and increased by 90% the year before. In
the common size, except for 2006 and 2007, the ratio was unstable. In discussion, we
determined that using 2 years of stability was reasonable since they were the most
recent in our analysis. In forecasting, we predicted that the ratio (accounts receivable
over total assets) might be 17.56% [(17.36% + 17.75%) / 2] for future years.
Inventory
In seeking a pattern, we found growth to be inconsistent over time, in one
instance, growth decreased by 18.38% in 2006 and increased by 20.85% the year
125

efore. In the common size, except for 2002, the ratio fluctuated between 8.85% and
7.68%, meaning there was less than a 1.2% difference, which is reasonable. In
forecasting, we decided to take the average of prior years (except 2002) to determine
what the ratio might be for future years, which we calculated to be 8.16% [(8.38% +
7.18% + 8.85% + 8.71% + 7.68%) / 5].
Property and Equipment
In seeking to forecast this item, we considered three factors: the growth in
property and equipment over time, the difference in growth over time, and the portion
of total assets that are taken by property and equipment over time (common size). In
reviewing those factors, a reasonable forecast for property and equipment can be made
by using the ratio of property and equipment over total assets. In this ratio, the number
fluctuated between 2.21% and 1.57%, which is small, and allowed us to approximate
the property and equipment to total asset ratio for future years by using the average of
that ratio in prior years, which we found to be 1.91% [(2.18% + 1.91% + 1.68% +
1.57% + 2.21%)/5].
Goodwill
In seeking to forecast this item, we considered three factors, the growth in
goodwill over time, the difference in growth over time, and the portion of total assets
that are taken by goodwill. In reviewing those factors, a reasonable forecast for
goodwill can be made by considering the ratio of goodwill over total assets. In this
ratio, the number fluctuated between 38.33% and 35.99%, which is small, and allowed
us to approximate the goodwill to total asset ratio for future years (2008 and later
years) by using the average of this ratio for prior years (2003 to 2007), which we found
to be 36.6% [(35.96% + 38.33% + 35.72% + 37.08% + 35.99%) / 5]. In retrospect,
it is alarming that property and equipment is so small compared to goodwill and in that
regard it is shocking that goodwill can be so high for this company. In the adjusted
forecasted statements, we impaired goodwill to get a more accurate view of the
126

company, the effect this has on the financial statements can be noted in the “adjusted
financial statements”.
Trademarks
In the common size, the ratio for trademarks (trademarks/total assets) has
(except for 2002) steadily decreased by about 9% {1 – [(2.55% / 2.92%) + (2.36% /
2.55%) + (2.22% / 2.36%) + (1.99% / 2.22%) / 4]} from the year before, therefore,
we can assume (within reason) that the ratio will continue to decrease by 9% for each
forecasted year.
Total Non Current Assets
This item can be found by subtracting forecasted total assets by forecasted total
current assets for the year in question.
Total Assets
There is way too much volatility in the yearly and quarterly values to make an
accurate assessment of what total assets might be, therefore, we have taken look at
the ratio for asset turnover (expense diagnostic and profitability ratio) which despite
showing some volatility tends to be close to one. In this, we have assumed that for
2008 and future years, that an average of those ratios (except 2003) would be
appropriate (which was calculated to be 1.02). In 2008, we looked at the forecasted
sales for 2009 (which totaled $1,108,013) and divided this value by 1.02, giving us
forecasted total assets as being $1,113,065 (in thousands).
Accounts Payable and Accrued Expenses
In seeking to forecast this item, we considered three factors, the growth in this
item over time, the difference in growth over time, the portion of total current liabilities
taken by this item, and the portion of total liabilities taken by this item. In reviewing
these factors, the ratio for this item over current liabilities and the ratio for this item
over total liabilities, seems consistent over time (excluded 2003). In comparison of the
127

difference in value for those ratios over time, the one that divided the item by total
liabilities was deemed the most consistent (difference was 3.02% versus the 6.49%
seen in the other ratio). In the same way that we approached forecasting items with
relatively small ranges (but inconsistent as far as whether it may increase or decrease
slightly for the next year), we took the average and found that the item over total
liabilities may be about 42.98% [(44.43% + 41.41% + 44.11% + 41.95%)/4] for 2008
and future years.
Total Current Liabilities
The volatility in the yearly and quarterly values makes it difficult to make a
reasonable assumption over a long period of time. In forecasting this item, we shall use
the working capital turnover (instead of current ratio for it is inconsistent). In this ratio,
except for 2003, the values tend to range between 2.73 and 2.40, which is reasonable
and in determining the ratio for future years, we used the average (except 2003) of
previous ratios, which was calculated to be 2.45 (by dividing sales by this ratio and
subtracting current assets, we can find current liabilities). But, we adjusted it for each
year to better accommodate noncurrent liabilities, which we felt would have at least
$98,000 (in thousands) in them, based on values noted in “convertible senior notes” in
prior years.
Total Non Current Liabilities
This item can be found by subtracting forecasted total liabilities by forecasted
total current liabilities for the year in question. In forecasting, our concern is equity,
therefore the estimations for liabilities, except for total liabilities, are less “accurate”
compared to the estimations for equity.
Total Liabilities
This item can be found by subtracting forecasted total assets by forecasted total
equity for the year in question.
128

Retained Earnings
The retained earnings for the current year is equal to the retained earnings for
the previous year plus the net income for the current year, this allows us to calculate
retained earnings for future years with a degree of certainty.
Total Equity
The total equity for the current year is equal to the total equity for the previous
year plus the net income for the current years and this allows us to calculate total
equity for future years with a degree of certainty.
129

Balance Sheet [Raw]
Jakks Pacific - Balance Sheet - (in thousands) Actual Financial Statements Average Assume
Ended 12/31 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Cash and Cash Equivalents 68,413 118,182 176,544 240,238 184,489 241,250 23.62%
Marketable Securities 19,345 19,047 210 218 1.61%
Accounts Receivable 56,195 86,120 102,266 87,199 153,116 174,451 15.23% 190,752 17.56% 216,885 246,598 280,382 318,795 362,470 412,128 468,589 532,786 605,778
Inventory 38,010 44,400 50,000 66,729 76,788 75,486 8.35% 88,641 8.16% 100,785 114,592 130,292 148,141 168,437 191,513 217,750 247,582 281,500
Deferred Income Taxes 4,446 6,161 13,618 10,592 12,945 1.26%
Prepaid Expenses and Other 9,729 16,763 18,521 17,533 26,543 21,733 2.62%
Total Current Assets 176,793 284,810 372,539 425,317 451,738 526,083 51.94% 606,574 54.37% 671,529 763,528 868,131 987,065 1,122,293 1,276,047 1,450,866 1,649,634 1,875,634
Office Furniture and Equipment 5,932 6,563 6,823 7,619 8,299 9,961 1.11%
Molds and Tooling 31,069 34,481 28,818 26,948 36,600 44,333 5.08%
Leasehold Improvements 2,464 2,429 2,572 3,522 4,882 5,186 0.50%
Less Accumulated Depreciation and Amortization 24,640 31,751 27,273 25,394 32,898 38,073 4.48%
Total Property and Equipment 14,825 11,722 10,940 12,695 16,883 21,407 2.20% 20,748 1.91% 23,591 26,822 30,497 34,675 39,426 44,827 50,968 57,951 65,890
Intangibles and Others 8,169 18,172 27,368 18,512 40,833 26,200 3.18%
Investment in Video Game Joint Venture 8,119 9,097 9,816 10,365 14,873 36,090 1.97%
Goodwill 189,336 190,728 258,331 269,298 337,999 353,340 38.23% 397,581 36.60% 452,050 513,981 584,396 664,458 755,489 858,991 976,673 1,110,477 1,262,612
Trademarks 11,568 15,468 17,768 17,768 19,568 19,568 2.48% 19,684 20,367 21,073 21,803 22,559 23,341 24,151 24,988 25,854 26,751
Total Non Current Assets 232,017 245,187 324,223 328,638 430,156 456,605 48.06% 479,713 46.36% 563,580 640,790 728,579 828,394 941,884 1,070,922 1,217,639 1,384,455 1,574,125
Total Assets 408,810 529,997 696,762 753,955 881,894 982,688 1,086,287 1,235,109 1,404,318 1,596,710 1,815,459 2,064,177 2,346,969 2,668,504 3,034,089 3,449,760
Accounts Payable 8,994 31,610 59,569 50,533 65,574 52,287 21.29%
Accrued Expenses 19,394 10,805 49,407 44,415 54,664 70,085 21.82%
Accounts Payable and Accrued Expenses 28,388 42,415 108,976 94,948 120,238 122,372 43.11% 119,863 42.98% 124,913 130,654 137,183 144,605 153,044 162,640 173,550 185,955 200,060
Reserve for Sale Returns and Allowances 13,579 7,753 23,173 25,123 32,589 26,036 12.42%
Current Portion of Long Term Debt 18 19 0.02%
Income Tax Payable 5,625 2,021 10,847 3,792 18,548 21,997 5.57%
Total Current Liabilities 47,610 52,208 142,996 123,863 171,375 170,405 61.11% 158,969 162,602 184,879 210,207 232,070 247,645 252,567 287,168 320,047 348,979
Convertible Senior Notes [Long Term Debt, Net of Current Po 60 98,042 98,000 98,000 98,000 98,000 36.14%
Other Liabilities [Deferred Rent Liability: Till 2007] 995 854 6,432 0.98%
Income Tax Payable 11,294 3.87%
Deferred Income Taxes 563 1,847 4,281 6,446 2,377 5,560 1.62%
Total Non-Current Liabilities 623 99,889 102,281 105,441 101,231 121,286 38.89% 119,912 128,028 119,110 108,971 104,378 108,438 125,842 116,625 112,608 116,492
Total Liabilities 48,233 152,097 245,277 229,304 272,606 291,691 278,881 290,630 303,989 319,178 336,447 356,083 378,409 403,793 432,655 465,471
Preferred Stock
Common Stock 24 25 26 27 28 28 0.01%
Additional Paid-In Capital 240,102 246,008 276,642 287,356 300,255 312,127 57.03%
Retained Earnings 120,451 133,005 176,564 240,057 312,432 382,288 43.34% 498,697 635,769 791,620 968,823 1,170,303 1,399,385 1,659,852 1,956,002 2,292,725 2,675,579
Deferred Compensation Form (789) -0.21%
Accumulated Other Comprehensive Loss (349) (1,747) (2,789) (3,427) (3,446) -0.35%
Total Shareholder Equity 360,577 377,900 451,485 524,651 609,288 690,997 807,406 944,478 1,100,329 1,277,532 1,479,012 1,708,094 1,968,561 2,264,711 2,601,434 2,984,288
Total Liabilities and Shareholders Equity 408,810 529,997 696,762 753,955 881,894 982,688 1,086,287 1,235,109 1,404,318 1,596,710 1,815,459 2,064,177 2,346,969 2,668,504 3,034,089 3,449,760
Retained Earnings for the Current Year = Retained Earnings for the Previous Year + Net Income for the Current Year
Total Equity for the Current Year = Total Equity for the Previous Year + Net Income for the Current Year
130

Common Sized - Balance Sheet 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Cash and Cash Equivalents 16.73% 22.30% 25.34% 31.86% 20.92% 24.55% 23.62% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Marketable Securities 3.65% 2.73% 0.02% 0.02% 1.61%
Accounts Receivable 13.75% 16.25% 14.68% 11.57% 17.36% 17.75% 15.23% 17.56% 17.56% 17.56% 17.56% 17.56% 17.56% 17.56% 17.56% 17.56% 17.56% 17.56%
Inventory 9.30% 8.38% 7.18% 8.85% 8.71% 7.68% 8.35% 8.16% 8.16% 8.16% 8.16% 8.16% 8.16% 8.16% 8.16% 8.16% 8.16% 8.16%
Deferred Income Taxes 1.09% 0.88% 1.81% 1.20% 1.32% 1.26%
Prepaid Expenses and Other 2.38% 3.16% 2.66% 2.33% 3.01% 2.21% 2.62%
Total Current Assets 43.25% 53.74% 53.47% 56.41% 51.22% 53.54% 51.94% 55.84% 54.37% 54.37% 54.37% 54.37% 54.37% 54.37% 54.37% 54.37% 54.37% 54.37%
Office Furniture and Equipment 1.45% 1.24% 0.98% 1.01% 0.94% 1.01% 1.11%
Molds and Tooling 7.60% 6.51% 4.14% 3.57% 4.15% 4.51% 5.08%
Leasehold Improvements 0.60% 0.46% 0.37% 0.47% 0.55% 0.53% 0.50%
Less Accumulated Depreciation and Amortization 6.03% 5.99% 3.91% 3.37% 3.73% 3.87% 4.48%
Total Property and Equipment 3.63% 2.21% 1.57% 1.68% 1.91% 2.18% 2.20% 1.91% 1.91% 1.91% 1.91% 1.91% 1.91% 1.91% 1.91% 1.91% 1.91% 1.91%
Intangibles and Others 2.00% 3.43% 3.93% 2.46% 4.63% 2.67% 3.18%
Investment in Video Game Joint Venture 1.99% 1.72% 1.41% 1.37% 1.69% 3.67% 1.97%
Goodwill 46.31% 35.99% 37.08% 35.72% 38.33% 35.96% 38.23% 36.60% 36.60% 36.60% 36.60% 36.60% 36.60% 36.60% 36.60% 36.60% 36.60% 36.60%
Trademarks 2.83% 2.92% 2.55% 2.36% 2.22% 1.99% 2.48% 1.81% 1.65% 1.50% 1.37% 1.24% 1.13% 1.03% 0.94% 0.85% 0.78%
Total Non Current Assets 56.75% 46.26% 46.53% 43.59% 48.78% 46.46% 48.06% 44.16% 45.63% 45.63% 45.63% 45.63% 45.63% 45.63% 45.63% 45.63% 45.63% 45.63%
Total Assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Accounts Payable 18.65% 20.78% 24.29% 22.04% 24.05% 17.93% 21.29%
Accrued Expenses 40.21% 7.10% 20.14% 19.37% 20.05% 24.03% 21.82%
Accounts Payable and Accrued Expenses 58.86% 27.89% 44.43% 41.41% 44.11% 41.95% 43.11% 42.98% 42.98% 42.98% 42.98% 42.98% 42.98% 42.98% 42.98% 42.98% 42.98% 42.98%
Reserve for Sale Returns and Allowances 28.15% 5.10% 9.45% 10.96% 11.95% 8.93% 12.42%
Current Portion of Long Term Debt 0.04% 0.01% 0.02%
Income Tax Payable 11.66% 1.33% 4.42% 1.65% 6.80% 7.54% 5.57%
Total Current Liabilities 98.71% 34.33% 58.30% 54.02% 62.87% 58.42% 61.11% 57.00% 55.95% 60.82% 65.86% 68.98% 69.55% 66.74% 71.12% 73.97% 74.97%
Convertible Senior Notes [Long Term Debt, Net of Current Po 0.12% 64.46% 39.95% 42.74% 35.95% 33.60% 36.14%
Other Liabilities [Deferred Rent Liability: Till 2007] 0.43% 0.31% 2.21% 0.98%
Income Tax Payable 3.87% 3.87%
Deferred Income Taxes 1.17% 1.21% 1.75% 2.81% 0.87% 1.91% 1.62%
Total Non-Current Liabilities 1.29% 65.67% 41.70% 45.98% 37.13% 41.58% 38.89% 43.00% 44.05% 39.18% 34.14% 31.02% 30.45% 33.26% 28.88% 26.03% 25.03%
Total Liabilities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Preferred Stock
Common Stock 0.01% 0.01% 0.01% 0.01% 0.01%
Additional Paid-In Capital 66.59% 65.10% 61.27% 54.77% 49.28% 45.17% 57.03%
Retained Earnings 33.41% 35.20% 39.11% 45.76% 51.28% 55.32% 43.34% 61.77% 67.31% 71.94% 75.84% 79.13% 81.93% 84.32% 86.37% 88.13% 89.66%
Deferred Compensation Form -0.21% -0.21%
Accumulated Other Comprehensive Loss 0.00% -0.09% -0.39% -0.53% -0.56% -0.50% -0.35%
Total Shareholder Equity 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
131

Balance Sheet [Adjusted]
Jakks Pacific - Balance Sheet - (in thousands) Actual Financial Statements Average Assume
Ended 12/31 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Cash and Cash Equivalents 68,413 118,182 176,544 240,238 184,489 241,250 23.62%
Marketable Securities 19,345 19,047 210 218 1.61%
Accounts Receivable 56,195 86,120 102,266 87,199 153,116 174,451 15.23% 190,752 18.95% 216,885 246,598 280,382 318,795 362,470 412,128 468,589 532,786 605,778
Inventory 38,010 44,400 50,000 66,729 76,788 75,486 8.35% 88,641 8.00% 100,785 114,592 130,292 148,141 168,437 191,513 217,750 247,582 281,500
Deferred Income Taxes 4,446 6,161 13,618 10,592 12,945 1.26%
Prepaid Expenses and Other 9,729 16,763 18,521 17,533 26,543 21,733 2.62%
Total Current Assets 176,793 284,810 372,539 425,317 451,738 526,083 51.94% 606,574 58.66% 671,529 763,528 868,131 987,065 1,122,293 1,276,047 1,450,866 1,649,634 1,875,634
Office Furniture and Equipment 5,932 6,563 6,823 7,619 8,299 9,961 1.11%
Molds and Tooling 31,069 34,481 28,818 26,948 36,600 44,333 5.08%
Leasehold Improvements 2,464 2,429 2,572 3,522 4,882 5,186 0.50%
Less Accumulated Depreciation and Amortization 24,640 31,751 27,273 25,394 32,898 38,073 4.48%
Total Property and Equipment 14,825 11,722 10,940 12,695 16,883 21,407 2.20% 20,748 2.06% 23,591 26,822 30,497 34,675 39,426 44,827 50,968 57,951 65,890
Intangibles and Others 8,169 18,172 27,368 18,512 40,833 26,200 3.18%
Investment in Video Game Joint Venture 8,119 9,097 9,816 10,365 14,873 36,090 1.97%
Goodwill 189,336 190,728 258,331 269,298 337,999 353,340 38.23% 397,581 452,050 513,981 584,396 664,458 755,489 858,991 976,673 1,110,477 1,262,612
Accumulated Goodwill 37,867 38,146 51,666 53,860 67,600 70,668 79,516 90,410 102,796 116,879 132,892 151,098 171,798 195,335 222,095 252,522
Adjusted Goodwill 151,469 152,582 206,665 215,438 270,399 282,672 318,065 31.59% 361,640 411,184 467,517 531,566 604,391 687,193 781,338 888,381 1,010,090
Trademarks 11,568 15,468 17,768 17,768 19,568 19,568 2.48% 19,657 20,367 21,073 21,803 22,559 23,341 24,151 24,988 25,854 26,751
Total Non Current Assets 194,150 207,041 272,557 274,778 362,556 385,937 48.06% 400,197 41.34% 473,170 537,994 611,700 695,502 790,786 899,124 1,022,304 1,162,360 1,321,603
Total Assets 370,943 491,851 645,096 700,095 814,294 912,020 1,006,771 1,144,699 1,301,522 1,479,831 1,682,568 1,913,079 2,175,171 2,473,170 2,811,994 3,197,237
Accounts Payable 8,994 31,610 59,569 50,533 65,574 52,287 21.29%
Accrued Expenses 19,394 10,805 49,407 44,415 54,664 70,085 21.82%
Accounts Payable and Accrued Expenses 28,388 42,415 108,976 94,948 120,238 122,372 43.11% 119,863 42.98% 167,187 198,311 233,699 273,936 319,685 371,701 430,844 498,090 574,548
Reserve for Sale Returns and Allowances 13,579 7,753 23,173 25,123 32,589 26,036 12.42%
Current Portion of Long Term Debt 18 19 0.02%
Income Tax Payable 5,625 2,021 10,847 3,792 18,548 21,997 5.57%
Total Current Liabilities 47,610 52,208 142,996 123,863 171,375 170,405 61.11% 158,969 162,602 184,879 210,207 232,070 247,645 252,567 287,168 320,047 348,979
Convertible Senior Notes [Long Term Debt, Net of Current Po 60 98,042 98,000 98,000 98,000 98,000 36.14%
Other Liabilities [Deferred Rent Liability: Till 2007] 995 854 6,432 0.98%
Income Tax Payable 11,294 3.87%
Deferred Income Taxes 563 1,847 4,281 6,446 2,377 5,560 1.62%
Total Non-Current Liabilities 623 99,889 102,281 105,441 101,231 121,286 38.89% 119,912 226,385 276,524 333,533 405,287 496,154 612,257 715,261 838,840 987,800
Total Liabilities 48,233 152,097 245,277 229,304 272,606 291,691 278,881 388,987 461,403 543,740 637,356 743,799 864,824 1,002,429 1,158,887 1,336,779
Preferred Stock
Common Stock 24 25 26 27 28 28 0.01%
Additional Paid-In Capital 240,102 246,008 276,642 287,356 300,255 312,127 57.03%
Adjusted Retained Earnings 82,584 94,859 124,898 186,197 244,832 311,620 372,765 447,003 531,411 627,382 736,502 860,572 1,001,638 1,162,031 1,344,398 1,551,749
Deferred Compensation Form (789) -0.21%
Accumulated Other Comprehensive Loss (349) (1,747) (2,789) (3,427) (3,446) -0.35%
Total Shareholder Equity 322,710 339,754 399,819 470,791 541,688 620,329 681,474 755,712 840,120 936,091 1,045,211 1,169,281 1,310,347 1,470,740 1,653,107 1,860,458
Total Liabilities and Shareholders Equity 370,943 491,851 645,096 700,095 814,294 912,020 960,355 1,144,699 1,301,522 1,479,831 1,682,568 1,913,079 2,175,171 2,473,170 2,811,994 3,197,237
Retained Earnings for the Current Year = Retained Earnings for the Previous Year + Net Income for the Current Year
Total Equity for the Current Year = Total Equity for the Previous Year + Net Income for the Current Year
132

Common Sized - Balance Sheet 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Cash and Cash Equivalents 18.44% 24.03% 27.37% 34.32% 22.66% 26.45% 25.54% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Marketable Securities 3.93% 2.95% 0.03% 0.02% 1.73%
Accounts Receivable 15.15% 17.51% 15.85% 12.46% 18.80% 19.13% 16.48% 18.95% 18.95% 18.95% 18.95% 18.95% 18.95% 18.95% 18.95% 18.95% 18.95% 18.95%
Inventory 10.25% 9.03% 7.75% 9.53% 9.43% 8.28% 9.04% 8.80% 8.00% 8.80% 8.80% 8.80% 8.80% 8.80% 8.80% 8.80% 8.80% 8.80%
Deferred Income Taxes 1.20% 0.96% 1.95% 1.30% 1.42% 1.36%
Prepaid Expenses and Other 2.62% 3.41% 2.87% 2.50% 3.26% 2.38% 2.84%
Total Current Assets 47.66% 57.91% 57.75% 60.75% 55.48% 57.68% 56.20% 60.25% 58.66% 58.66% 58.66% 58.66% 58.66% 58.66% 58.66% 58.66% 58.66% 58.66%
Office Furniture and Equipment 1.60% 1.33% 1.06% 1.09% 1.02% 1.09% 1.20%
Molds and Tooling 8.38% 7.01% 4.47% 3.85% 4.49% 4.86% 5.51%
Leasehold Improvements 0.66% 0.49% 0.40% 0.50% 0.60% 0.57% 0.54%
Less Accumulated Depreciation and Amortization 6.64% 6.46% 4.23% 3.63% 4.04% 4.17% 4.86%
Total Property and Equipment 4.00% 2.38% 1.70% 1.81% 2.07% 2.35% 2.38% 2.06% 2.06% 2.06% 2.06% 2.06% 2.06% 2.06% 2.06% 2.06% 2.06% 2.06%
Intangibles and Others 2.20% 3.69% 4.24% 2.64% 5.01% 2.87% 3.45%
Investment in Video Game Joint Venture 2.19% 1.85% 1.52% 1.48% 1.83% 3.96% 2.14%
Goodwill
Accumulated Goodwill
Adjusted Goodwill 40.83% 31.02% 32.04% 30.77% 33.21% 30.99% 31.59% 31.59% 31.59% 31.59% 31.59% 31.59% 31.59% 31.59% 31.59% 31.59% 31.59%
Trademarks 3.12% 3.14% 2.75% 2.54% 2.40% 2.15% 2.68% 1.95% 1.78% 1.62% 1.47% 1.34% 1.22% 1.11% 1.01% 0.92% 0.84%
Total Non Current Assets 52.34% 42.09% 42.25% 39.25% 44.52% 42.32% 43.80% 39.75% 41.34% 41.34% 41.34% 41.34% 41.34% 41.34% 41.34% 41.34% 41.34% 41.34%
Total Assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Accounts Payable 18.65% 20.78% 24.29% 22.04% 24.05% 17.93% 21.29%
Accrued Expenses 40.21% 7.10% 20.14% 19.37% 20.05% 24.03% 21.82%
Accounts Payable and Accrued Expenses 58.86% 27.89% 44.43% 41.41% 44.11% 41.95% 43.11% 42.98% 42.98% 42.98% 42.98% 42.98% 42.98% 42.98% 42.98% 42.98% 42.98% 42.98%
Reserve for Sale Returns and Allowances 28.15% 5.10% 9.45% 10.96% 11.95% 8.93% 12.42%
Current Portion of Long Term Debt 0.04% 0.01% 0.02%
Income Tax Payable 11.66% 1.33% 4.42% 1.65% 6.80% 7.54% 5.57%
Total Current Liabilities 98.71% 34.33% 58.30% 54.02% 62.87% 58.42% 61.11% 57.00% 41.80% 40.07% 38.66% 36.41% 33.29% 29.20% 28.65% 27.62% 26.11%
Convertible Senior Notes [Long Term Debt, Net of Current Po 0.12% 64.46% 39.95% 42.74% 35.95% 33.60% 36.14%
Other Liabilities [Deferred Rent Liability: Till 2007] 0.43% 0.31% 2.21% 0.98%
Income Tax Payable 3.87% 3.87%
Deferred Income Taxes 1.17% 1.21% 1.75% 2.81% 0.87% 1.91% 1.62%
Total Non-Current Liabilities 1.29% 65.67% 41.70% 45.98% 37.13% 41.58% 38.89% 43.00% 58.20% 59.93% 61.34% 63.59% 66.71% 70.80% 71.35% 72.38% 73.89%
Total Liabilities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Preferred Stock
Common Stock 0.01% 0.01% 0.01% 0.01% 0.01%
Additional Paid-In Capital 74.40% 72.41% 69.19% 61.04% 55.43% 50.32% 63.80%
Retained Earnings
Goodwill Effect
Adjusted Retained Earnings 25.59% 27.92% 31.24% 39.55% 45.20% 50.23% 54.70% 59.15% 63.25% 67.02% 70.46% 73.60% 76.44% 79.01% 81.33% 83.41%
Deferred Compensation Form -0.23% -0.23%
Accumulated Other Comprehensive Loss 0.00% -0.10% -0.44% -0.59% -0.63% -0.56% -0.39%
Total Shareholder Equity 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
133

Net Income
Derived from the Income Statement
Statement of Cash Flows
Cash flows from Operations
In spite of employing various ratios and methodologies, we were unable to find a
truly consistent pattern for the growth of CFFO. In selecting the ratio demonstrating the
least erratic behavior, we went with CFFO divided by Net Sales, which is an expense
manipulation diagnostic ratio. In this ratio, we looked for some degree of consistency
and found that in 2002 and 2004 that the ratio was 23.08% and 22.88% (0.2%
difference), respectively, and that in 2005 and 2007 this ratio was at 10.74% and
10.23% (0.51% difference). It seems that the ratio, though erratic, has “declined” by
54.4% {[(23.08% + 22.88%) / 2 – (10.74% + 10.23%) / 2] / (23.08% + 22.88%)}
every 3 years. But if we made that assumption and applied it to forecasting then the
total adjustments to net income would be far too large and far too inconsistent with
previous year adjustments. In that regard, let us consider the ratio from 2005 to 2007
and assume that what we see here is the “stable point” for the company. The reason
we may be able to assume that this is the “stable point” is because the difference
between the highest and lowest ratios is only 2.4%, therefore, let us take the average
of the highest and lowest in determining an estimate for this ratio in future periods
(which is equal to about 10%). The problem with this however is that adjustments
become too high and that too is inconsistent with what is seen in prior years. In a last
attempt, let us take the average between the highest and lowest ratios across the
years, this ratio would be 12.7% [(23.08% + 2.34%)/2]. In applying this average
across the years, we find that the “prediction” is more reasonable and for the sake of
simplicity, we shall assume that it holds true for the intent of forecasting.
134

Cash flows from Investing Activities
In spite of employing various ratios and methodologies, we were unable to find a
truly consistent pattern for the growth of CFFI. In selecting the ratio demonstrating the
least erratic behavior, we went with CFFI divided by Net Sales (same as with CFFO). To
avoid needless strain in attempting to forecast inconsistent item with no stable pattern
to be found, which regrettably we must do, in the case of CFFO and CFFI. In our
approach to “predicting” CFFO, we will simply say that the latest year holds true (other
methods failed to give something reasonable), meaning that for future years, the CFFI,
will be equal to predicted sales for that year times -3.93%.
135

Statement of Cash Flows [Raw]
Jakks Pacific - Statement of Cash Flows - (in thousands) Actual Financial Statements Average Assume Forcasted Financial Statements
Ended 12/31 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Net income
27,930 15,895 43,559 63,493 72,375 88,991 116409 137072 155851 177203 201480 229082 260467 296150 336723 382854
Depreciation and Amortization
15,456 16,029 21,518 15,527 26,166 26,663
Share Based Compensation Expense
(1,308) 8,370 13,641 3,424 6,482 9,054
Compensation for Fully Vested Stock Options
(1,308) 6 5,365 (1,706)
Restricted stock compensation
8,364 8,276 5,130
Acquisition Earn Out
494
Investment in Joint Venture
(225) 79 (719) (548) (5,147) (21,856)
Loss on Disposal of Property and Equipment
1,096 104 48 1,781
Forgiveness of Officer Note Receivable
285
Write-Off of Investment in Chinese Joint Venture 1,401
Minority interest
(237)
Changes in Operating Assets and Liabilities
Net Sale (Purchase) of Marketable Securities
37,119
Accounts Receivable
(3,307) (28,224) (4,333) 16,697 (52,885) (21,334)
Inventory
(10,996) (2,654) 784 (13,272) (8,352) 1,329
Prepaid Expenses and Other
507 (5,643) (3,613) 1,088 (8,293) 4,817
Accounts Payable and Accrued Expenses
(13,232) 13,005 38,934 (11,352) 14,490 1,432
Accounts payable
(3,698) 16,264 19,192 (9,437) 12,608 (13,061)
Accrued expenses
(9,534) (3,259) 19,742 (1,915) 1,882 14,493
Income taxes payable
7,056 (1,397) 5,945 (2,936) 14,756 (891)
Reserve for sales returns and allowances
8,626 (5,827) 13,289 1,732 5,253 (6,489)
Deferred rent liability
995 (140) 1,519
Deferred income taxes
3,879 (2,240) 795 (5,292) (1,043) 2,644
Total Adjustments
43,623 (8,502) 87,831 7,568 (8,665) (1,331) 7353 2.59% 3645 4145 4713 5358 6092 6927 7876 8955 10182
Net Cash from Operating Activities
71,553 7,393 131,390 71,061 63,710 87,660 123762 140718 159996 181915 206838 235175 267394 304026 345678 393036
Purchases of property and equipment
Change in Other Assets
Sale (Purchases) of Deposits
Purchases of Other Assets
Cash Paid for Net Assets
Net (Purchases) Sales of Marketable Securities
Notes Receivable — Officers
Net Cash from Investing Activities
(6,594) (4,472) (5,917) (8,270) (11,204) (18,116)
(123) 46 (6)
241 (701) 17
(21,159) (4,936) (26,863) 118 (655) 11
(66,232) (19,676) (41,438) (20,362) (109,845) (15,605)
(19,345) 967 19,047 (210) (7)
861 1,113
(93,124) (47,316) (73,251) (9,467) (121,914) (33,717) (38298) (43545) (49511) (56294) (64006) (72775) (82745) (94081) (106970) (121625)
136

Common Sized - Statement of Cash Flows 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Net income
39.03% 215.00% 33.15% 89.35% 113.60% 101.52% 98.61% 94.06% 97.41% 97.41% 97.41% 97.41% 97.41% 97.41% 97.41% 97.41% 97.41% 97.41%
Depreciation and Amortization
21.60% 216.81% 16.38% 21.85% 41.07% 30.42% 58.02%
Share Based Compensation Expense
-1.83% 113.22% 10.38% 4.82% 10.17% 10.33% 24.52%
Compensation for Fully Vested Stock Options
-1.83% 0.08% 4.08% -2.40% -0.02%
Restricted stock compensation
113.13% 6.30% 7.22% 42.22%
Acquisition Earn Out
0.38% 0.38%
Investment in Joint Venture
-0.31% 1.07% -0.55% -0.77% -8.08% -24.93% -5.60%
Loss on Disposal of Property and Equipment
0.83% 0.15% 0.08% 2.03% 0.77%
Forgiveness of Officer Note Receivable
0.40% 0.40%
Write-Off of Investment in Chinese Joint Venture 1.97% 1.97%
Minority interest
-0.33% -0.33%
Changes in Operating Assets and Liabilities
Net Sale (Purchase) of Marketable Securities
Accounts Receivable
Inventory
Prepaid Expenses and Other
Accounts Payable and Accrued Expenses
Accounts payable
Accrued expenses
Income taxes payable
Reserve for sales returns and allowances
Deferred rent liability
Deferred income taxes
Total Adjustments
Net Cash from Operating Activities
51.88% 51.88%
-4.62% -381.77% -3.30% 23.50% -83.01% -24.34% -78.92%
-15.37% -35.90% 0.60% -18.68% -13.11% 1.52% -13.49%
0.71% -76.33% -2.75% 1.53% -13.02% 5.50% -14.06%
-18.49% 175.91% 29.63% -15.98% 22.74% 1.63% 32.58%
-5.17% 219.99% 14.61% -13.28% 19.79% -14.90% 36.84%
-13.32% -44.08% 15.03% -2.69% 2.95% 16.53% -4.26%
9.86% -18.90% 4.52% -4.13% 23.16% -1.02% 2.25%
12.06% -78.82% 10.11% 2.44% 8.25% -7.40% -8.89%
1.40% -0.22% 1.73% 0.97%
5.42% -30.30% 0.61% -7.45% -1.64% 3.02% -5.06%
60.97% -115.00% 66.85% 10.65% -13.60% -1.52% 1.39% 5.94% 2.59% 2.59% 2.59% 2.59% 2.59% 2.59% 2.59% 2.59% 2.59% 2.59%
100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Purchases of property and equipment
Change in Other Assets
Sale (Purchases) of Deposits
Purchases of Other Assets
Cash Paid for Net Assets
Net (Purchases) Sales of Marketable Securities
Notes Receivable — Officers
Net Cash from Investing Activities
7.08% 9.45% 8.08% 87.36% 9.19% 53.73% 29.15%
1.30% -0.04% 0.02% 0.43%
-2.55% 0.57% -0.05% -0.67%
22.72% 10.43% 36.67% -1.25% 0.54% -0.03% 11.51%
71.12% 41.58% 56.57% 215.08% 90.10% 46.28% 86.79%
40.88% -1.32% -201.19% 0.17% 0.02% -32.29%
-0.92% -2.35% -1.64%
100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
137

Statement of Cash Flows [Adjusted]
Jakks Pacific - Statement of Cash Flows - (in thousands) Actual Financial Statements Average Assume Forcasted Financial Statements
Ended 12/31 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Net income
(2,769) (19,082) 5,474 28,106 26,191 40,444 61,145 74,237 84,408 95,972 109,120 124,069 141,067 160,393 182,367 207,351
Depreciation and Amortization
15,456 16,029 21,518 15,527 26,166 26,663
Goodwill Effect
37,867 38,146 51,666 53,860 67,600 70,668 79,516 53.72% 90,410 102,796 116,879 132,892 151,098 171,798 195,335 222,095 252,522
Share Based Compensation Expense
(1,308) 8,370 13,641 3,424 6,482 9,054
Compensation for Fully Vested Stock Options
(1,308) 6 5,365 (1,706)
Restricted stock compensation
8,364 8,276 5,130
Acquisition Earn Out
494
Investment in Joint Venture
(225) 79 (719) (548) (5,147) (21,856)
Loss on Disposal of Property and Equipment
1,096 104 48 1,781
Forgiveness of Officer Note Receivable
285
Write-Off of Investment in Chinese Joint Venture 1,401
Minority interest
(237)
Changes in Operating Assets and Liabilities
Net Sale (Purchase) of Marketable Securities
Accounts Receivable
Inventory
Prepaid Expenses and Other
Accounts Payable and Accrued Expenses
Accounts payable
Accrued expenses
Income taxes payable
Reserve for sales returns and allowances
Deferred rent liability
Deferred income taxes
Total Adjustments
Net Cash from Operating Activities
37,119
(3,307) (28,224) (4,333) 16,697 (52,885) (21,334)
(10,996) (2,654) 784 (13,272) (8,352) 1,329
507 (5,643) (3,613) 1,088 (8,293) 4,817
(13,232) 13,005 38,934 (11,352) 14,490 1,432
(3,698) 16,264 19,192 (9,437) 12,608 (13,061)
(9,534) (3,259) 19,742 (1,915) 1,882 14,493
7,056 (1,397) 5,945 (2,936) 14,756 (891)
8,626 (5,827) 13,289 1,732 5,253 (6,489)
995 (140) 1,519
3,879 (2,240) 795 (5,292) (1,043) 2,644
81,490 29,644 139,497 61,428 58,935 69,337 86869 55.89% 94055 106941 121592 138250 157190 178725 203210 231050 262704
78,721 10,562 144,971 89,533 85,125 109,781 148015 168293 191349 217564 247370 281259 319792 363603 413417 470055
Purchases of property and equipment
Change in Other Assets
Sale (Purchases) of Deposits
Purchases of Other Assets
Cash Paid for Net Assets
Net (Purchases) Sales of Marketable Securities
Notes Receivable — Officers
Net Cash from Investing Activities
(6,594) (4,472) (5,917) (8,270) (11,204) (18,116)
(123) 46 (6)
241 (701) 17
(21,159) (4,936) (26,863) 118 (655) 11
(66,232) (19,676) (41,438) (20,362) (109,845) (15,605)
(19,345) 967 19,047 (210) (7)
861 1,113
(93,124) (47,316) (73,251) (9,467) (121,914) (33,717) (38298) (43545) (49511) (56294) (64006) (72775) (82745) (94081) (106970) (121625)
138

Common Sized - Balance Sheet 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Net income
-3.52% -180.67% 3.78% 31.39% 30.77% 36.84% -13.57% 41.31% 44.11% 44.11% 44.11% 44.11% 44.11% 44.11% 44.11% 44.11% 44.11% 44.11%
Depreciation and Amortization
19.63% 151.77% 14.84% 17.34% 30.74% 24.29% 43.10%
Goodwill Effect
48.10% 361.17% 35.64% 60.16% 79.41% 64.37% 53.72% 53.72% 53.72% 53.72% 53.72% 53.72% 53.72% 53.72% 53.72% 53.72% 53.72%
Share Based Compensation Expense
-1.66% 79.25% 9.41% 3.82% 7.61% 8.25% 17.78%
Compensation for Fully Vested Stock Options
-1.66% 0.06% 3.70% -1.91% 0.05%
Restricted stock compensation
79.19% 5.71% 5.73% 30.21%
Acquisition Earn Out
0.34% 0.34%
Investment in Joint Venture
-0.29% 0.75% -0.50% -0.61% -6.05% -19.91% -4.43%
Loss on Disposal of Property and Equipment
0.76% 0.12% 0.06% 1.62% 0.64%
Forgiveness of Officer Note Receivable
0.36% 0.36%
Write-Off of Investment in Chinese Joint Venture 1.56% 1.56%
Minority interest
-0.30% -0.30%
Changes in Operating Assets and Liabilities
Net Sale (Purchase) of Marketable Securities
47.15% 47.15%
Accounts Receivable
-4.20% -267.23% -2.99% 18.65% -62.13% -19.43% -56.22%
Inventory
-13.97% -25.13% 0.54% -14.82% -9.81% 1.21% -10.33%
Prepaid Expenses and Other
0.64% -53.43% -2.49% 1.22% -9.74% 4.39% -9.90%
Accounts Payable and Accrued Expenses
-16.81% 123.13% 26.86% -12.68% 17.02% 1.30% 23.14%
Accounts payable
-4.70% 153.99% 13.24% -10.54% 14.81% -11.90% 25.82%
Accrued expenses
-12.11% -30.86% 13.62% -2.14% 2.21% 13.20% -2.68%
Income taxes payable
8.96% -13.23% 4.10% -3.28% 17.33% -0.81% 2.18%
Reserve for sales returns and allowances
10.96% -55.17% 9.17% 1.93% 6.17% -5.91% -5.48%
Deferred rent liability
1.11% -0.16% 1.38% 0.78%
Deferred income taxes
4.93% -21.21% 0.55% -5.91% -1.23% 2.41% -3.41%
Total Adjustments
103.52% 280.67% 96.22% 68.61% 69.23% 63.16% 113.57% 58.69% 55.89% 55.89% 55.89% 55.89% 55.89% 55.89% 55.89% 55.89% 55.89% 55.89%
Net Cash from Operating Activities
100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Purchases of property and equipment
Change in Other Assets
Sale (Purchases) of Deposits
Purchases of Other Assets
Cash Paid for Net Assets
Net (Purchases) Sales of Marketable Securities
Notes Receivable — Officers
Net Cash from Investing Activities
7.08% 9.45% 8.08% 87.36% 9.19% 53.73% 29.15%
1.30% -0.04% 0.02% 0.43%
-2.55% 0.57% -0.05% -0.67%
22.72% 10.43% 36.67% -1.25% 0.54% -0.03% 11.51%
71.12% 41.58% 56.57% 215.08% 90.10% 46.28% 86.79%
40.88% -1.32% -201.19% 0.17% 0.02% -32.29%
-0.92% -2.35% -1.64%
100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
139

Cost of Capital
Cost of Equity
The cost of equity is defined as the minimum rate of return that shareholders
require to be compensated for the time waiting for returns and the risk involved. The
components of the return for a particular company are derived from dividends and
increases in stock prices. The higher the cost of equity, the higher the returns that
investors would expect to receive from their investments. This required rate of return
varies from company to company depending on the specific business risk. We
computed the cost of equity by using the Capital Asset Pricing Model (CAPM). This
model was used to determine the appropriate rate of return for Jakks Pacific assets.
These assets (in any company or industry) are put at risk in business activities to
generate revenues.
The CAPM model has three main components; the risk-free rate of return,
market risk premium, and the beta of the firm. The risk-free rates were taken from the
3 month, 6 month, 1 year, 5 year, and 10 year treasury constant maturity rates. The
difference in maturity rates served to calculate the most accurate beta for the firm
within different time spans. Taking returns for the S&P 500 index for the past 7 years,
we calculated monthly market returns. By subtracting the risk-free rates from the
market returns, we obtained the market risk premium for each month. To calculate
Jakks Pacific returns, we used the monthly stock prices for the past 7 years. Beta for
the firm was computed by running a regression analysis with different numbers of
observations. The numbers observations we used for each of the market risk premiums
were 72, 60, 48, 36, and 24 (representing the number of months). The beta chosen
was 1.33. This was derived from the regression results using the 10-year risk free rate
(3.88%) with 72 observations because it had the highest explanatory power. Below is a
summary of our regression results for Jakks Pacific.
140

Cost of Debt
The cost of debt is the rate at which the firm borrows money. To calculate this
rate, we computed the weighted average of each line item liability. The interest rates that
were not listed in Jakks Pacific’s 10-K where found on the St. Louis Federal Reserve Bank’s
website using comparable commercial paper rate’s. The weight of each line item was
found by dividing that number by total liabilities. By adding all the weighted rates
together, we calculated Jakks Pacific’s cost of debt to be 7.04%. Below is the summary of
this computation.
141

Cost of Debt
Current Liabilities
Weight
Rate
Weighted
Rate
Accounts Payable 52,287 0.179 0.0261 0.47%
Accrued Expenses 70,085 0.240 0.0261 0.63%
Reserve for sales returns & allowances 26,036 0.089 0.0261 0.23%
Incomes taxes payable 21,997 0.075 0.3500 2.64%
Total current liabilities 170,405 0.584
Long Term Liabilities
Convertible senior notes 98,000 0.336 0.0463 1.55%
*Other liabilities 6,432 0.022 0.0425 0.09%
Incomes taxes payable 11,294 0.039 0.3500 1.36%
Deferred income taxes 5,560 0.019 0.0388 0.07%
Total Long Term Liabilities 121,286 0.416
Total Liabilities 291,691 1.000
Weighted Average Cost of Debt
= 7.04%
*average of convertible senior notes and deferred income taxes
The 3-month non-financial commercial paper was the interest rate used for
accounts payable, accrued expenses, and reserve for sales returns and allowances. The
interest rate for other liabilities was found by taking the average of the long term
liabilities rates (income taxes payable was not including in this computation).
Weighted Average Cost of Capital
The weighted average cost of capital (WACC) is calculated by considering the
weights of a company’s capital structure (debt and equity). This is the minimum rate that
a firm must earn to satisfy the requirements of owners and creditors. In this model, we
used the cost of equity and cost of debt that were explained above in the previous
sections. Below are tables showing the computations for before and after tax weighted
average costs of capital.
142

Weighted Average Cost of Capital
K d BVL/MVA Tax K e BVE/MVA WACC
Before Tax 7.04% 0.297 15.80% 0.703 13.20%
After Tax 7.04% 0.297 31.3% 15.80% 0.703 12.55%
Adjusted Weighted Average Cost of Capital
K d BVL/MVA Tax K e BVE/MVA WACC
Before Tax 7.04% 0.320 15.80% 0.680 13.00%
After Tax 7.04% 0.320 31.3% 15.80% 0.680 12.29%
As you can see, the rates did not change much when accounting for impairments
to goodwill. The difference between the before-tax WACC’s is .2%, whereas the change in
before tax is .25%. These variations between the stated and restated weighted average
cost of capital are caused by the changes in book value of equity.
143

Valuation Analysis
In this report, we seek to determine the true value of the firm by using the
method of comparables and the intrinsic valuation models. In the first, we use the
industry average of ratios (price to earnings, etc) to calculate a share price for the
company and will compare that price to the stated price to determine if the company is
fairly valued. In truth, this is easy to compute but it is not a reliable method for we are
basing our analysis on competitor values (what others believe hold true) and not the
company itself. In addition, it is not very sound from a financial perspective and does
not offer a fair interpretation of the firm in question. It is only for the sake of
conducting a complete analysis that we have included it in this report. In the second,
the intrinsic valuation models, we are using our forecasted numbers along with theory
and methodology to analyze the firm. In this, we are using our assessment of the
company and not a “consensus” to calculate a share price. In truth, some intrinsic
valuation models are more reliable than others, but overall, these models give a fairer
and more detailed assessment of the company than the method of comparables and
will be the primary basis for our valuation.
144

Method of Comparables
In this, we are using the industry average of ratios (price to earnings, etc) to
calculate a share price and determine if the company is fairly valued. It is not a reliable
method (as stated before) and it is a simple thing for any individual to do. It is not
based on sound financial theory and does a poor job in analyzing the company. In this
method, we will use the ratios of Hasbro, Mattel, and Leapfrog to calculate a share
price and compare it to the actual share price as of June 2 nd , 2008 for Jakks Pacific (we
would have used June 1 st , 2008 if it were available). In reality, using ratios for Hasbro
and Mattel, older and larger firms, is not a fair basis for valuing a company like Jakks
Pacific (which is younger and smaller), nor is using Leapfrog, a company (though the
same age as Jakks Pacific) is showing signs of financial instability, but they are the only
ones that can reasonably be used for this analysis (please keep in this mind when
reviewing the ratios discussed later). In these ratios, we will exclude any negative
values reported by competitors. In addition, we will use a 10% margin, meaning if the
calculated share price is between $25.06 and $20.51 or equal to $22.79 (actual share
price) then the company is fairly valued, if the calculated price is below the range it is
undervalued, and if it is above that range it is overvalued.
145

P / E Trailing PPS EPS P / E
Price to Earnings (Trailing)
Industry
Average
Jakks Pacific 22.79 3.11 7.33 15.80 49.11
Jakks Pacific
(Restated) 22.79 1.41 16.13 15.80 22.32
Hasbro 36.18 2.06 17.56
Mattel 19.92 1.42 14.03
Leapfrog 8.47 (1.55) (5.46)
Jakks Pacific Calculated
PPS
In this ratio, we used the price per share (June 2 nd , 2008) and divided it by the
earnings per share from yahoo finance to calculate the P to E (price to earnings) ratio
for the competitors. In addition, we calculated the EPS for Jakks Pacific by dividing the
net income for 2007 (both raw and adjusted) by the total number of shares outstanding
(based on the 2007 10-K). In this ratio, we found that Leapfrog had a negative EPS, so
that company was excluded from our calculation of the industry average. The average
(15.8) was multiplied with the EPS for Jakks Pacific to give us a calculated share price
of $49.11 (before the goodwill adjustment) and $22.32 (after the adjustment). In using
the margin of safety, we find that the firm is undervalued (prior to goodwill adjustment)
and fairly valued (after the adjustment for goodwill). In this ratio, the problem is that it
looks into the past, but in valuing the company we are concerned with the future.
146

P / E Forward PPS EPS P / E
Price to Earnings (Forward)
Industry
Average
Jakks Pacific 22.79 4.07 5.60 13.56 55.13
Jakks Pacific
(Restated) 22.79 1.41 16.13 13.56 28.96
Hasbro 36.18 2.29 15.77
Mattel 19.92 1.76 11.34
Leapfrog 8.47 0.39 21.50
Jakks Pacific Calculated
PPS
It is found the same way as the trailing P to E ratio, except this time, we are
using the one year ahead EPS (forecast). In this ratio, we used the forward P to E ratio
from yahoo finance for the competitors along with the PPS from June 2 nd , 2008. In
addition, we calculated the forward EPS for the competitors by dividing the PPS by the
forward P to E ratio, and calculated the forward EPS for Jakks Pacific by dividing the
forecasted net income for 2008 (both raw and adjusted) by the total number of shares
outstanding (based on the 2007 10-K). In this ratio, we excluded Leapfrog (inconsistent
with the other companies) from our calculation of the industry average. The average
(13.56) was multiplied with the forward EPS for Jakks Pacific to give us a calculated
share price of $55.13 (before the goodwill adjustment) and $28.96 (after the
adjustment). In using the margin of safety, we find that the firm is undervalued (both
prior to goodwill adjustment and after the adjustment for goodwill). In closing, this ratio
is more reliable than the trailing P to E, because it involves forecasted numbers, but is
still not an accurate measure of the value of the firm.
147

Price to Book
P / B PPS BPS P / B
Industry
Average
Jakks Pacific 22.79 24.14 0.94 2.76 66.63
Jakks Pacific
(Restated) 22.79 21.67 1.05 2.76 59.81
Hasbro 36.18 8.68 4.17
Mattel 19.92 6.73 2.96
Leapfrog 8.47 3.31 2.56
Jakks Pacific Calculated
PPS
It is found by taking the price per share and dividing it by the book value of
equity per share. In this ratio, we used the P to B ratio from yahoo finance for the
competitors along with the PPS from June 2 nd , 2008. In addition, we calculated the BPS
for the competitors by dividing the PPS by the P to B ratio, and calculated the BPS for
Jakks Pacific by dividing total equity for 2007 (both raw and adjusted) by the total
number of shares outstanding (based on the 2007 10-K). In this ratio, we excluded
Hasbro (inconsistent with the other companies) from our calculation of the industry
average. The average (2.76) was multiplied with the BPS for Jakks Pacific to give us a
calculated share price of $66.63 (before the goodwill adjustment) and $59.81 (after the
adjustment). In using the margin of safety, we find that the firm is undervalued (both
prior to goodwill adjustment and after the adjustment for goodwill).
148

Price Earnings Growth
PEG PPS P to E EGR PEG
Industry
Average
Jakks Pacific 22.79 7.33 13.70 0.53 1.54 65.40
Jakks Pacific
(Restated) 22.79 16.16 13.70 1.18 1.54 29.65
Hasbro 36.18 17.56 10.04 1.75
Mattel 19.92 14.03 10.63 1.32
Leapfrog 8.47 (5.46)
Jakks Pacific Calculated
PPS
It is found by taking the P to E ratio and dividing it by the EGR (five year
earnings growth rate). In this ratio, we used the PEG ratio (price earnings growth) from
yahoo finance for the competitors along with the PPS from June 2 nd , 2008. In addition,
we calculated the EGR for the competitors by dividing the P to E ratio (calculated prior
to this section) by the PEG ratio and calculated the EGR for Jakks Pacific by using the
five year growth rate noted in the forecast for net income. In this ratio, we excluded
Leapfrog (negative EPS) from our calculation of the industry average. The average
(1.54) was multiplied with the EPS and EGR for Jakks Pacific to give us a calculated
share price of $65.40 (before the goodwill adjustment) and $29.65 (after the
adjustment). In using the margin of safety, we find that the firm is undervalued (both
prior to goodwill adjustment and after the adjustment for goodwill).
149

Price to EBITDA
P / EBITDA PPS Market Cap Shares EBITDA
P /
EBITDA
Industry
Avg
Jakks Pacific 22.79 646 28.62 128.18 5.04 7.99 35.77
Hasbro 36.18 5270 145.66 682.33 7.72
Mattel 19.92 6970 349.90 844.39 8.25
Leapfrog 8.47 (67.15)
Jakks Pacific Cal.
PPS
It is found by dividing market cap (price multiplied by the number of shares
outstanding) by EBITDA (earnings before interest, depreciation, tax, and amortization).
In this ratio, we used EBIDTA and Market Cap from yahoo finance for the competitors
along with the PPS from June 2 nd , 2008. In addition, we calculated P to EBITDA for the
competitors by dividing Market Cap by EBITDA and calculated the EBITDA for Jakks
Pacific by taking net income and adding back interest, taxes, and amortization. In this
ratio, we excluded Leapfrog (negative EBITDA) from our calculation of the industry
average. The average (7.99) was multiplied with the EBITDA for Jakks Pacific to give us
a calculated market cap of 1024 (in millions) and we divided that by the number of
shares outstanding (in millions) based on the 2007 10-K to get a share price. The price
was calculated to be $35.77 and in using the margin of safety we find that the firm is
undervalued.
Jakks Pacific NI Interest Taxes Amortization EBITDA
Raw 88991 (1363) 40550 N/A 128
Adjusted 40444 (1363) 18429 70668 128
150

P / FCF PPS Shares FCF
Price to Free Cash Flows
FCF /
Share
P / FCF
Industry
Avg
Jakks Pacific 22.79 28.62 53.94 1.88 12.09 11.22 21.14
Jakks Pacific
(Restated) 22.79 28.62 76.06 2.66 8.58 11.22 29.82
Hasbro 36.18 142.60 489.33 3.43 10.54
Mattel 19.92 361.36 275.24 0.76 26.15
Leapfrog 8.47 35.90 25.56 0.71 11.90
Jakks Pacific Cal.
PPS
It is found by taking the price and dividing it by the FCF (free cash flows) of the
firm, which was divided by the number of shares outstanding to get it on a per share
basis. In this ratio, we got FCF (cash flows from operations minus cash flows from
investing activities) and number of shares outstanding from the 2007 10-K of the
companies along with the PPS from yahoo finance for June 2 nd , 2008. In this ratio, we
excluded Mattel (inconsistent with other companies) from our calculation of the industry
average. The average (11.22) was multiplied with the FCF per Share for Jakks Pacific to
give us a calculated a price of $21.14 (before the goodwill adjustment) and $29.82
(after the adjustment). In using the margin of safety, we find that the firm is fairly
valued (before the goodwill adjustment) and undervalued (after the goodwill
adjustment).
151

EV / EBITDA PPS Shares EBITDA
Price to Free Cash Flows
EV /
EBITDA
Industry
Avg
Jakks Pacific 22.79 28.62 128.18 5.20 7.99 35.28
Hasbro 36.18 142.60 682.33 7.72
Mattel 19.92 361.36 844.39 8.25
Leapfrog 8.47 35.90 (67.15)
Jakks Pacific Cal.
PPS
It is found by dividing EV (enterprise value) by EBITDA (earnings before interest,
depreciation, tax, and amortization). In this ratio, we used the EV to EBITDA ratio from
yahoo finance for the competitors along with the PPS from June 2 nd , 2008. In this ratio,
we excluded Leapfrog (negative EBITDA) from our calculation of the industry average.
The average (7.99) was multiplied with the EBITDA for Jakks Pacific and the book value
of liabilities was subtracted from this number, afterwards cash (cash and cash
equivalents) along with financial investments (found by taking Marketable Securities
[Current Asset] and adding it to the Investment in Joint Venture [Non Current Asset])
was added to the number and finally this number was divided by the number of shares
outstanding (2007 10-K) to calculated a share price. The price was calculated to be
$35.28 and in using the margin of safety we find that the firm is undervalued.
Conclusion
In the comparables, we found that Jakks Pacific was undervalued (prior to
goodwill adjustment) for the P to E (trailing and forward), P to B, PEG, P to EBITDA, P
to FCF, and EV to EBITDA and found it to be fairly valued for the P to FCF ratio. In
addition, we found that Jakks Pacific was undervalued (after the goodwill adjustment)
for the P to E (forward), P to B, PEG, and P to FCF and found it to be fairly valued for
the P to E (trailing). In closing, it seems based on this method that the company is, for
the most part, undervalued. In contrast, keep in mind that this methodology is not
known for its accuracy but rather its simplicity. In order to get a fairer understanding of
whether this firm is fairly valued, overvalued, or undervalued
152

Intrinsic Valuation Models
The intrinsic models used for our valuation of Jakks Pacific were the Free Cash
Flows Model (FCFM), Residual Income Model (RIM), Long-Run Residual Income Model
(LRIM) and the Abnormal Earnings Growth Model (AEGM). Intrinsic valuation models
give us a more precise value of the firm compared to the method of comparables.
These models are computed using forecasted information whereas the method of
comparables uses historical information. Since these models use forecasted
information, we will be valuing the company based on our predictions future free cash
flows to the firm, residual income, and net income. Additionally, a sensitivity analysis
will be done to show how much the stock price would change as a result of changes in
our predictions of cost of equity, growth rates, and weighted average cost of capital.
Once all of the models have been computed we will have a better understanding of the
true value of the firm.
Free Cash Flows Model
The free cash flows model values the firm by taking the present value of the
forecasted free cash flows along with the perpetuity after 2010. Forecasted free cash
flows are calculated by taking forecasted cash flows from operations (CFFO) minus cash
flows from investing activities (CFFI). Then we discount the free cash flows back to
2007 using the before tax WACC. Next, we add to this the present value of the
terminal value perpetuity which is found by taking the free cash flows for 2018, dividing
it by the WACC minus the growth rate, then dividing that value by (1+WACC)^10. We
then subtract the book value of debt from this number and divide by total number of
shares to calculate the intrinsic share price. We then adjust the calculated share price
to get the time consistent value using the formula [share price*(1+WACC)^(5/12)].
We can then compare actual and estimated share prices to determine whether we
believe the company is under or overvalued. We used a 20% sensitivity, meaning that
if the calculated price is within 20% of the actual share price of $22.79 (as of 6/1/08)
then it is still considered fairly valued.
153

Discounted Free Cash Flow Sensitivity Analysis
Growth Rates
0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00%
10.56% 60.43 64.51 69.54 75.91 84.22 95.51 111.76
11.44% 53.44 56.64 60.52 65.31 71.39 79.36 90.25
12.32% 47.54 50.08 53.11 56.79 61.36 67.17 74.83
WACC (BT) 13.20% 42.49 44.53 46.94 49.81 53.32 57.67 63.24
14.08% 38.14 39.80 41.73 44.01 46.74 50.07 54.23
14.96% 34.35 35.71 37.27 39.10 41.27 43.86 47.04
15.84% 31.03 32.15 33.43 34.92 36.65 38.70 41.17
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
Using the growth rate of 1%, and the before tax weighted average cost of
capital, which we found to be 13.20%, the discounted free cash flows model gives us a
share price of $44.53. When compared to the original share price of $22.79 and using
a sensitivity of 20% we have determined that the company is undervalued. In our
analysis, we have found that Jakks is undervalued for all growth rates from 0% to 6%,
and for all before tax weighted average costs of capital from 10.56% to 15.84%, which
is within 20% of 13.20%.
Adjusted Discounted Free Cash Flow Sensitivity Analysis
Growth Rates
0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00%
10.40% 82.40 87.88 94.67 103.30 114.62 130.14 152.71
11.27% 73.25 77.54 82.77 89.26 97.53 108.44 123.49
12.13% 65.60 69.02 73.12 78.11 84.34 92.31 102.88
WACC (BT) 13.00% 58.98 61.73 64.98 68.88 73.65 79.61 87.27
13.87% 53.28 55.51 58.12 61.21 64.92 69.48 75.19
14.73% 48.37 50.20 52.33 54.81 57.76 61.31 65.67
15.60% 44.02 45.53 47.27 49.28 51.64 54.45 57.84
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
After adjusting for goodwill we noticed that the calculated share prices were
higher. This is because the adjustment for goodwill increases CFFO which is used to
calculate free cash flows.
154

Residual Income Model
The residual income model has the most powerful explanatory power of all the
models. It also has a lower sensitivity to changes in the growth rates and costs of
equity. The model is less sensitive because it puts less stock into the terminal
perpetuity, and more stock into the values of annual residual income and book value of
equity. A potential drawback is the fact that the model uses accounting information
that could be skewed and misleading.
In the residual income model we value the company based on the current book value of
equity and the present value of the value added or destroyed by the firm. Value added
or destroyed is calculated by taking the previous year’s net income minus the
benchmark (cost of equity X previous year’s book value of equity). Another name for
this value is the residual income. If net income for the current year is larger than the
benchmark, then value has been created, and there is a positive residual income. If net
income for the current year is less than the benchmark, then value has been destroyed,
and residual income is negative.
Residual Income Sensitivity Analysis
Growth Rates
0.00% -5.00% -10.00% -15.00% -20.00% -25.00% -30.00%
12.64% 38.75 37.21 36.35 35.80 35.42 35.14 34.93
13.69% 32.75 32.15 31.80 31.57 31.41 31.29 31.20
Cost 14.75% 27.83 27.85 27.85 27.86 27.87 27.87 27.87
of 15.80% 23.82 24.24 24.50 24.67 24.79 24.89 24.96
Equity 16.85% 20.50 21.17 21.60 21.89 22.10 22.26 22.38
17.91% 17.70 18.53 19.06 19.43 19.70 19.91 20.08
18.96% 15.37 16.28 16.88 17.30 17.62 17.86 18.05
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
As seen in the chart above a 30% change in the growth rate only moves the
share price from $23.82 to $24.96 at 15.80% cost of equity. This is an example of how
changes in cost of equity or growth rates have a minimal effect on our calculated share
price. Using our cost of equity of 15.80% and the growth rate of -15% resulted in a
155

share price of $24.67, which is within the 20% range of our stated share price $22.79,
and is therefore fairly valued.
Adjusted Residual Income Sensitivity Analysis
Growth Rates
0.00% -5.00% -10.00% -15.00% -20.00% -25.00% -30.00%
12.64% 20.61 20.66 20.68 20.70 20.71 20.72 20.73
13.69% 17.40 17.83 18.08 18.24 18.35 18.44 18.50
Cost 14.75% 14.76 15.43 15.82 16.09 16.27 16.41 16.52
of 15.80% 12.62 13.41 13.90 14.23 14.47 14.65 14.79
Equity 16.85% 10.84 11.70 12.25 12.62 12.89 13.09 13.26
17.91% 9.35 10.23 10.80 11.19 11.49 11.71 11.89
18.96% 8.10 8.98 9.56 9.96 10.26 10.50 10.68
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
The adjusted residual income analysis varies greatly from our initial analysis.
Using the same cost of equity of 15.80% and the growth rate of -15% we calculated a
share price of $14.23, which is below the range of our stated share price of $22.79, and
is therefore overvalued. It seems that after the adjustment for goodwill is implemented
Jakks becomes overvalued. This is because the goodwill adjustment decreases net
income and the book value of equity, the two main components that are used in the
residual income valuation.
156

Long-Run Residual Income Model
The long-run residual income model is computed by using book value of
equity, return on equity, cost of equity and forward earnings growth rate. The model
begins with finding the long run return on equity. This is computed by taking the
average of net income and dividing it by the book value of equity for the forecasted
years. Our estimated return on equity for Jakks was 15.80%. We then estimated that
our earnings are going to grow by 13.70% per year. Our forecasted return on equity is
15.76%. The formula to compute the share price is found by using the market value of
equity [MVE = BVE*(1+ (ROE – Ke) / (Ke-G))] and dividing by the number of shares
outstanding. We then adjust the calculated share price to get the time consistent value
using the formula [share price*(1+Ke)^(5/12)]. In using these values we calculated
the share price to be $25.17. Based on our sensitivity of 20% the company is fairly
valued. The charts below show how the calculated share price changes when two
variables are changed while one is left constant. The variables are return on equity,
growth rate, and cost of equity.
Long Run Residual Sensitivity Analysis
Growth Rates
9.00% 10.00% 11.00% 12.00% 13.00% 14.00% 15.00%
16.00% 24.85 24.97 25.15 25.41 25.86 26.82 30.18
16.25% 25.74 26.01 26.40 27.00 28.02 30.18 37.72
Return 16.50% 26.63 27.05 27.66 28.59 30.18 33.53 45.26
on 16.75% 27.51 28.09 28.92 30.18 32.33 36.88 52.81
Equity 17.00% 28.40 29.13 30.18 31.76 34.49 40.23 60.35
17.25% 29.29 30.18 31.43 33.35 36.64 43.59 67.89
17.50% 30.18 31.22 32.69 34.94 38.80 46.94 75.44
Cost of Equity = 15.80%
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
157

Long Run Residual Sensitivity Analysis
Growth Rates
9.00% 10.00% 11.00% 12.00% 13.00% 14.00% 15.00%
15.50% 25.11 25.28 25.54 25.93 26.65 28.32 36.69
15.75% 24.18 24.18 24.19 24.20 24.23 24.28 24.46
Cost 16.00% 23.31 23.17 22.98 22.69 22.21 21.24 18.35
of 16.25% 22.51 22.25 21.89 21.36 20.50 18.88 14.68
Equity 16.50% 21.76 21.39 20.89 20.17 19.04 16.99 12.23
16.75% 21.06 20.60 19.98 19.11 17.77 15.45 10.48
17.00% 20.40 19.86 19.15 18.15 16.66 14.16 9.17
Return on Equity = 15.76%
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
Long Run Residual Sensitivity Analysis
Cost of Equity
15.50% 15.75% 16.00% 16.25% 16.50% 16.75% 17.00%
15.50% 24.14 20.79 17.43 14.08 10.73 7.38 4.02
15.75% 27.08 24.14 21.20 18.25 15.31 12.36 9.42
Return 16.00% 29.39 26.76 24.14 21.52 18.89 16.27 13.64
on 16.25% 31.24 28.87 26.51 24.14 21.77 19.41 17.04
Equity 16.50% 32.76 30.61 28.45 26.30 24.14 21.98 19.83
16.75% 34.03 32.06 30.08 28.10 26.12 24.14 22.16
17.00% 35.11 33.28 31.46 29.63 27.80 25.97 24.14
Growth Rate = 13.7%
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
The follow charts show what changes occur when we adjust for goodwill. When
we computed the share price for this model using the adjusted return on equity, we
noticed that the calculated share price was negative. This is because the new return on
equity was 4% lower than the cost of equity.
Adjusted Long Run Residual Sensitivity Analysis
Growth Rates
1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00%
11.00% 14.64 14.13 13.54 12.86 12.04 11.06 9.85
13.00% 17.57 17.27 16.93 16.53 16.05 15.48 14.78
Return 15.00% 20.50 20.42 20.32 20.20 20.07 19.90 19.70
on 17.00% 23.43 23.56 23.70 23.88 24.08 24.33 24.63
Equity 19.00% 26.36 26.70 27.09 27.55 28.09 28.75 29.55
21.00% 29.29 29.84 30.48 31.22 32.11 33.17 34.48
23.00% 32.21 32.98 33.86 34.89 36.12 37.59 39.40
Cost of Equity = 15.80%
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
158

Adjusted Long Run Residual Sensitivity Analysis
Growth Rates
1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00%
9.00% 28.74 29.75 31.10 32.98 35.81 40.53 49.95
10.00% 25.55 26.03 26.66 27.49 28.65 30.39 33.30
Cost 11.00% 22.99 23.14 23.32 23.56 23.87 24.32 24.98
of 12.00% 20.90 20.83 20.73 20.61 20.46 20.26 19.98
Equity 13.00% 19.16 18.93 18.66 18.32 17.91 17.37 16.65
14.00% 17.69 17.36 16.96 16.49 15.92 15.20 14.27
15.00% 16.42 16.02 15.55 14.99 14.32 13.51 12.49
Return on Equity = 11.61%
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
Adjusted Long Run Residual Sensitivity Analysis
Cost of Equity
9.00% 10.00% 11.00% 12.00% 13.00% 14.00% 15.00%
8.00% 25.47 29.28 33.08 36.88 40.68 44.48 48.29
8.50% 23.76 27.92 32.09 36.26 40.43 44.59 48.76
Return 9.00% 21.67 26.28 30.89 35.50 40.12 44.73 49.34
on 9.50% 19.09 24.25 29.41 34.57 39.73 44.89 50.05
Equity 10.00% 15.81 21.67 27.53 33.39 39.24 45.10 50.96
10.50% 11.51 18.29 25.06 31.83 38.60 45.37 52.15
11.00% 5.62 13.64 21.67 29.70 37.72 45.75 53.78
Growth Rate = 13.7%
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
Abnormal Earnings Growth Model
The abnormal earnings growth model is calculated by taking forecasted net
earnings, adding dividend reinvestment earnings, and subtracting normal income.
Dividend reinvestment earnings are found by taking the previous year’s dividend
payment and multiplying it by the cost of equity. This value is also known as “DRIP”
income. The DRIP income is essentially shareholder’s reinvesting their earnings at their
cost of equity. When dividends are reinvested the indirect earnings are considered a
component of the abnormal earnings of the firm. Then we add net income to the DRIP
income to find cumulative dividend income. Next, to find abnormal earnings growth we
subtract from this total the benchmark income (previous years book value of equity X
cost of equity). Abnormal earnings growth has a check figure that can be used to
determine if the valuation was done properly. The change in the current year’s residual
159

income should be similar to the same year’s abnormal earnings growth. The table
below proves our valuation was performed correctly.
Raw 2009 2010 2011 2012 2013 2014 2015 2016 2017
Annual AEG 2271 (2879) (3273) (3721) (4231) (4811) (5470) (6219) (7071)
Change in Residual Income 2271 (2879) (3273) (3721) (4231) (4811) (5470) (6219) (7071)
Adjusted 2009 2010 2011 2012 2013 2014 2015 2016 2017
Annual AEG 3431 (1559) (1773) (2015) (2292) (2605) (2962) (3368) (3830)
Change in Residual Income 3431 (1559) (1773) (2015) (2292) (2605) (2962) (3368) (3830)
Abnormal Earnings Growth Sensitivity Analysis
Growth Rates
0.00% -5.00% -10.00% -15.00% -20.00% -25.00% -30.00%
12.64% 41.29 40.38 39.88 39.55 39.33 39.17 39.04
13.69% 32.50 32.50 32.49 32.49 32.49 32.49 32.49
Cost 14.75% 25.86 26.36 26.66 26.85 27.00 27.10 27.18
of 15.80% 20.84 21.61 22.08 22.39 22.62 22.80 22.93
Equity 16.85% 16.96 17.85 18.41 18.79 19.07 19.29 19.45
17.91% 13.89 14.82 15.42 15.83 16.14 16.38 16.56
18.96% 11.49 12.41 13.01 13.43 13.75 13.99 14.19
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
Using our cost of equity of 15.80% and the growth rate of -15% resulted in a
share price of $22.39, which is within the 20% range of our stated share price $22.79,
and is therefore fairly valued.
Adjusted Abnormal Earnings Growth Sensitivity Analysis
Growth Rates
0.00% -5.00% -10.00% -15.00% -20.00% -25.00% -30.00%
12.64% 38.41 37.92 37.65 37.47 37.35 37.26 37.20
13.69% 32.48 32.48 32.48 32.47 32.47 32.47 32.47
Cost 14.75% 27.86 28.14 28.30 28.41 28.48 28.54 28.58
of 15.80% 24.28 24.69 24.95 25.15 25.24 25.34 25.41
Equity 16.85% 21.41 21.89 22.20 22.40 22.56 22.67 22.76
17.91% 19.07 19.57 19.90 20.12 20.29 20.42 20.52
18.96% 17.17 17.67 17.99 18.22 18.39 18.53 18.63
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
Since Jakks does not pay dividends, net income is the primary factor for this
model. After the adjustment for goodwill was made, net income decreased causing a
160

decrease in calculated share prices. Using our cost of equity of 15.8% and growth rate
of -15% resulted in a share price of $25.15, which is within the 20% range of our
stated share price of $22.79 and is therefore fairly valued.
Analyst Opinion
In our analysis of the method of comparables, we concluded that the company
was undervalued, but this model is unreliable. In using the intrinsic valuation models
we found that when using the free cash flow model that the company was undervalued
both prior to the goodwill adjustment and after. In the more reliable and less sensitive
residual income model, we found that the company was fairly valued prior to the
goodwill adjustment. In the long-run residual income model we found that the
company was again fairly valued. Once again, the abnormal earnings growth model
supported the company being fairly valued. Our overall conclusion based upon the
intrinsic valuation models is that the company is fairly valued.
161

Appendix
Sales Manipulation Diagnostics
Net Sales / Cash from Sales 2003 2004 2005 2006 2007
Jakks Pacific 1.10 1.03 0.98 1.09 1.03
Hasbro 1.02 0.99 0.98 1.01 1.03
Mattel 1.01 1.04 1.00 1.03 1.01
Leapfrog 1.19 0.93 1.05 0.81 0.99
Δ Net Sales / Δ Cash from Sales 2003 2004 2005 2006 2007
Jakks Pacific ‐0.28 0.95 0.74 4.54 0.67
Hasbro 1.28 2.36 0.77 ‐2.59 1.11
Mattel ‐0.49 ‐7.36 0.26 1.63 0.70
Leapfrog 1.61 ‐0.32 ‐0.13 73.35 0.35
Sales / Account Receivables 2003 2004 2005 2006 2007
Jakks Pacific 3.67 5.62 7.59 5.00 4.91
Hasbro 5.17 5.18 5.90 5.67 5.86
Mattel 9.12 6.72 6.81 5.99 6.02
Leapfrog 2.43 2.81 2.52 3.54 3.24
Δ Sales / Δ Accounts
Receivables 2003 2004 2005 2006 2007
Jakks Pacific 0.19 16.01 ‐5.79 1.58 4.30
Hasbro 6.15 4.89 ‐1.62 1.93 6.97
Mattel 1.41 0.66 47.35 2.57 6.75
Leapfrog 1.34 0.77 0.32 1.27 11.56
Net Sales / Inventory 2003 2004 2005 2006 2007
Jakks Pacific 7.11 11.49 9.91 9.97 11.35
Hasbro 18.57 15.39 17.21 15.50 14.81
Mattel 12.76 12.19 13.74 14.75 13.93
Leapfrog 7.48 4.88 3.84 6.88 8.44
Δ Net Sales / Δ Inventory 2003 2004 2005 2006 2007
Jakks Pacific 0.90 46.16 5.22 10.32 ‐70.43
Hasbro ‐15.23 ‐5.47 ‐5.86 2.67 12.31
Mattel 1.49 4.76 ‐1.83 75.36 7.02
Leapfrog 23.03 ‐0.99 0.25 1.54 2.91
162

Expense Manipulation Diagnostics
Asset Turnover 2003 2004 2005 2006 2007
Jakks Pacific 0.60 0.82 0.88 0.87 0.87
Hasbro 0.99 0.92 0.94 1.02 1.19
Mattel 1.10 1.07 1.18 1.14 1.24
Leapfrog 1.23 1.14 1.07 1.12 1.16
CFFO / OI 2003 2004 2005 2006 2007
Jakks Pacific 0.65 2.45 0.81 0.69 0.82
Hasbro 1.32 1.22 1.60 0.85 1.16
Mattel 0.77 0.78 0.70 1.20 0.77
Leapfrog 0.24 ‐0.01 ‐1.18 ‐0.73 0.15
Δ CFFO / Δ OI 2003 2004 2005 2006 2007
Jakks Pacific 4.71 2.93 ‐1.77 ‐1.66 1.63
Hasbro ‐0.15 1.85 7.89 ‐2.67 1.97
Mattel ‐10.57 0.63 1.56 6.37 ‐250.33
Leapfrog 0.11 0.22 ‐0.71 ‐0.79 ‐4.50
CFFO / OI 2003 2004 2005 2006 2007
Jakks Pacific 0.63 12.01 5.60 3.77 4.09
Hasbro 2.27 1.73 3.03 1.76 3.20
Mattel 0.97 0.97 0.85 1.63 1.08
Leapfrog 1.30 0.00 ‐1.04 3.25 ‐0.45
Δ CFFO / Δ OI 2003 2004 2005 2006 2007
Jakks Pacific 20.68 ‐158.56 ‐34.38 ‐1.76 5.29
Hasbro 1.39 ‐13.51 ‐3.22 ‐9.95 45.10
Mattel ‐20.97 0.87 2.63 ‐39.52 17.39
Leapfrog 14.06 ‐6.27 25.06 28.94 ‐17.01
Accruals / Net Sales 2003 2004 2005 2006 2007
Jakks Pacific ‐0.027 0.153 0.011 ‐0.011 ‐0.002
Hasbro 0.094 0.054 0.092 0.029 0.070
Mattel 0.014 0.000 0.010 0.050 ‐0.007
Leapfrog ‐0.067 0.010 ‐0.065 0.469 0.194
Δ Accruals / Δ Net Sales 2003 2004 2005 2006 2007
Jakks Pacific ‐9.05 0.37 ‐0.92 ‐0.16 0.08
Hasbro ‐1.08 0.95 1.35 ‐3.04 0.26
Mattel ‐11.49 ‐0.49 0.68 0.50 ‐1.01
Leapfrog ‐0.17 ‐1.32 ‐5.16 ‐1.88 2.49
163

Liquidity Ratios
Current Ratio 2003 2004 2005 2006 2007
Jakks Pacific 5.46 2.61 3.43 2.64 3.09
Hasbro 1.62 1.50 2.01 1.90 2.13
Mattel 1.63 1.53 1.65 1.80 1.65
Leapfrog 3.69 4.18 4.41 3.98 2.78
Quick Asset ratio 2003 2004 2005 2006 2007
Jakks Pacific 4.28 2.08 2.64 1.97 2.44
Hasbro 1.21 1.14 1.62 1.40 1.61
Mattel 1.16 1.11 1.20 1.36 1.20
Leapfrog 2.38 2.44 2.54 2.15 2.01
Accounts Receivable Turnover 2003 2004 2005 2006 2007
Jakks Pacific 3.67 5.62 7.59 5.00 4.91
Hasbro 5.17 5.18 5.90 5.67 5.86
Mattel 9.12 6.72 6.81 5.99 6.02
Leapfrog 2.43 2.81 2.52 3.54 3.24
Days Supply of Receivables 2003 2004 2005 2006 2007
Jakks Pacific 99.54 65.00 48.11 73.02 74.29
Hasbro 70.65 70.47 61.85 64.43 62.28
Mattel 40.02 54.29 53.61 60.97 60.60
Leapfrog 150.33 130.08 144.79 103.06 112.76
Inventory Turnover 2003 2004 2005 2006 2007
Jakks Pacific 4.26 6.97 5.92 6.13 7.07
Hasbro 7.62 6.43 7.17 6.41 6.09
Mattel 6.51 6.43 7.45 7.93 7.45
Leapfrog 3.74 2.91 2.19 4.86 5.13
Days Supply of Inventory 2003 2004 2005 2006 2007
Jakks Pacific 85.59 52.40 61.69 59.56 51.65
Hasbro 47.89 56.80 50.91 56.92 59.98
Mattel 56.06 56.76 49.02 46.03 49.01
Leapfrog 97.62 125.60 166.73 75.03 71.13
Working Capital Turnover 2003 2004 2005 2006 2007
Jakks Pacific 1.36 2.50 2.19 2.73 2.41
Hasbro 5.42 5.26 3.36 3.88 3.84
Mattel 5.35 5.61 5.46 4.46 5.84
Leapfrog 1.85 1.70 1.58 1.73 2.18
164

Profitability Ratios
*Raw
*Adjusted
Gross Profit Margin 2003 2004 2005 2006 2007
Jakks Pacific 40.04% 46.32% 40.32% 38.52% 37.76%
Hasbro 58.96% 58.24% 58.34% 58.63% 58.92%
Mattel 48.98% 47.24% 45.82% 46.23% 46.52%
Leapfrog 50.02% 40.46% 43.04% 29.27% 39.19%
Operating Profit Margin 2003 2004 2005 2006 2007
Jakks Pacific 3.61% 9.36% 13.30% 12.06% 12.48%
Hasbro 10.98% 9.78% 10.06% 11.94% 13.53%
Mattel 15.84% 14.32% 12.83% 12.90% 12.23%
Leapfrog 16.10% ‐2.18% 3.22% ‐24.82% ‐22.88%
Jakks Pacific* ‐5.45% 0.36% 5.16% 3.23% 4.24%
Hasbro* 8.03% 6.64% 7.03% 8.96% 11.08%
Mattel* 12.93% 11.44% 10.06% 9.91% 9.40%
Leapfrog* 16.10% ‐2.18% 2.62% ‐25.60% ‐23.76%
Net Profit Margin 2003 2004 2005 2006 2007
Jakks Pacific 5.03% 7.59% 9.60% 9.46% 10.38%
Hasbro 5.02% 6.54% 6.87% 7.30% 8.68%
Mattel 10.84% 11.22% 8.05% 10.49% 10.05%
Leapfrog 10.69% ‐1.02% 2.69% ‐28.89% ‐22.91%
Jakks Pacific* ‐4.03% ‐1.41% 1.46% 0.62% 2.14%
Hasbro* 2.62% 3.40% 3.84% 7.30% 6.22%
Mattel* 7.93% 8.34% 5.28% 7.50% 7.22%
Leapfrog* 10.69% ‐1.02% 2.09% ‐29.67% ‐23.79%
Asset Turnover 2003 2004 2005 2006 2007
Jakks Pacific 0.77 1.08 0.95 1.02 0.97
Hasbro 1.00 0.95 0.95 0.95 1.24
Mattel 1.11 1.13 1.09 1.29 1.20
Leapfrog 1.71 1.16 1.16 0.83 0.98
Jakks Pacific* 0.62 1.13 1.03 1.09 1.05
Hasbro* 1.03 0.98 0.98 0.98 1.28
Mattel* 1.15 1.17 1.12 1.34 1.25
Leapfrog* 1.73 1.17 1.17 0.83 0.99
Return on Assets 2003 2004 2005 2006 2007
Jakks Pacific 3.89% 8.22% 9.11% 9.60% 10.09%
Hasbro 5.02% 6.20% 6.54% 6.97% 10.75%
Mattel 12.06% 12.70% 8.77% 13.56% 12.11%
Leapfrog 18.27% ‐1.18% 3.13% ‐23.95% ‐22.49%
Jakks Pacific* ‐2.50% ‐1.26% 1.38% 0.59% 2.01%
Hasbro* 2.68% 3.24% 3.70% 7.66% 7.60%
Mattel* 9.01% 9.23% 6.47% 8.85% 9.29%
Leapfrog* 13.24% ‐1.17% 2.26% ‐33.37% ‐27.97%
Return on Equity 2003 2004 2005 2006 2007
Jakks Pacific 4.21% 9.65% 12.10% 11.88% 12.88%
Hasbro 11.22% 11.95% 12.31% 14.96% 24.04%
Mattel 24.26% 24.01% 19.84% 24.37% 26.01%
Leapfrog 17.51% ‐1.50% 3.75% ‐43.45% ‐41.61%
Jakks Pacific* ‐3.56% ‐2.03% 2.05% 0.88% 2.95%
Hasbro* 6.27% 6.60% 7.28% 15.93% 18.50%
Mattel* 18.98% 19.01% 13.96% 18.72% 20.15%
Leapfrog* 17.67% ‐1.52% 2.94% ‐45.14% ‐43.92%
165

Capital Structure Ratios
Debt to Equity Ratio 2003 2004 2005 2006 2007
Jakks 0.4 0.54 0.44 0.45 0.35
Mattel 1.04 0.99 1.08 1.04 1.08
Hasbro 1.25 0.98 0.92 1.01 1.34
LeapFrog 0.33 0.29 0.3 0.35 0.56
Debt to Equity (Adj.) 2003 2004 2005 2006 2007
Jakks 0.46 0.70 1.08 0.58 0.53
Mattel 1.19 1.13 1.25 1.20 1.27
Hasbro 1.44 1.10 1.03 1.15 1.55
LeapFrog 0.34 0.29 0.30 0.36 0.58
Times Interest Earned 2003 2004 2005 2006 2007
Jakks 11.34 22.66 22.27 24.37 24.74
Mattel 10.19 9.95 9.53 9.56 10.91
Hasbro 5.45 9.21 11.18 13.41 14.36
LeapFrog 11,530.50 ‐829.47 350.96 ‐1220.45 ‐878.21
Times Interest Earned (Adj.) 2003 2004 2005 2006 2007
Jakks ‐14.73 ‐8.72 ‐1.44 ‐5.46 ‐1.16
Mattel 5.61 5.17 4.77 4.33 5.14
Hasbro 3.03 3.32 4.05 6.85 9.56
LeapFrog ‐10747.54 1351.77 ‐234.96 1302.07 949.65
Debt Service Margin 2003 2004 2005 2006 2007
Jakks NA NA NA NA NA
Mattel 11.57 3.02 4.67 13.63 11.21
Hasbro 340.7 1.11 12.15 NA 4.45
LeapFrog NA NA NA NA NA
SGR 2003 2004 2005 2006 2007
Jakks Pacific 4.41% 11.53% 14.06% 13.79% 14.61%
Hasbro 13.23% 13.95% 12.93% 13.35% 21.65%
Mattel 27.17% 25.84% 17.48% 28.21% 24.66%
Leapfrog 27.04% ‐1.57% 4.03% ‐31.11% ‐30.34%
SGR (Adj.) 2003 2004 2005 2006 2007
Jakks Pacific ‐5.91% 1.61% 7.03% 5.56% 7.47%
Hasbro 8.29% 9.53% 9.60% 10.23% 18.36%
Mattel 23.54% 21.80% 14.52% 22.79% 20.13%
Leapfrog 26.51% ‐2.99% 3.40% ‐32.03% ‐29.59%
Altman Z Scores 2003 2004 2005 2006 2007
Jakks Pacific 2.53 2.52 3.25 2.75 3.06
Hasbro 2.69 2.73 2.94 3.53 3.22
Mattel 3.26 3.36 3.05 3.89 3.25
Leapfrog 5.50 2.82 3.05 1.83 0.36
Altman Z Score (Adj.) 2003 2004 2005 2006 2007
Jakks Pacific 2.25 2.23 3.00 2.47 2.81
Hasbro 2.58 2.63 2.84 3.44 3.14
Mattel 3.15 3.25 2.94 3.77 3.13
Leapfrog 5.48 2.79 3.03 1.79 0.30
166

Forecasting Computations
growth in Sales
Analysis - Income Statement
difference in growth of Sales
2002 2003 Q1 2003 Rest 2003 2004 Q1 2004 Rest 2004 2005 Q1 2005 Rest 2005 2006 Q1 2006 Rest 2006 2007 Q1 2007 Rest 2007
1.86% 101.71% 81.86% 5.31% 15.20% 24.92% 15.70% 11.38% 11.98%
80.00% -96.40% -66.66% 19.60% 0.50% -13.54% -3.72%
Sales Growth versus Cost of Sales Growth -3.23% -2.79% -2.08% 2.15% 1.82% -4.71% -3.49% -0.25% -1.37%
growth in SG&A
15.23% 58.50% 52.39% -6.37% 3.74% 16.19% 13.29% 8.66% 7.00%
difference in growth of SG&A
37.16% -64.86% -48.65% 22.56% 9.56% -7.53% -6.30%
growth in Income from Operations -54.47% 1134.30% 371.73% 54.95% 63.77% 21.21% 4.92% 15.11% 15.91%
difference in growth of Income from Operations 426.20% -1079.36% -307.96% -33.74% -58.85% -6.10% 10.99%
growth in Profit from Joint Venture -8.16% 4.59% 6.99% 23.44% 19.69% 34.60% 40.49% 57.87% 60.14%
difference in growth of Profit from Joint Venture 15.15% 18.84% 12.70% 11.16% 20.80% 23.28% 19.65%
growth in Net Interest -223.14% 28.69% 77.79% -141.50% -125.58% -86.26% -37.87% 1134.78% 243.32%
Net Interest Over Income from Operations 4.56% -40.34% -12.34% -4.21% -4.65% 1.13% 0.73% 0.13% 0.43% 1.37% 1.27%
growth in Income Before Income Taxes -49.25% 462.98% 240.88% 55.32% 63.54% 23.66% 9.62% 21.56% 22.28%
difference in growth of Income Before Taxes 290.13% -407.66% -177.35% -31.65% -53.91% -2.11% 12.66%
Analysis - Balance Sheet 2002 2003 Q1 2003 Rest 2003 2004 Q1 2004 Rest 2004 2005 Q1 2005 Rest 2005 2006 Q1 2006 Rest 2006 2007 Q1 2007 Rest 2007
growth in Cash and Cash Equivalents
72.75% -27.50% 49.38% 106.15% 36.08% -12.45% -23.21% -18.99% 30.77%
difference in growth of Cash and Cash Equivalents -23.36% 133.65% -13.30% -118.60% -59.28% -6.54% 53.97%
growth in Total Current Assets 61.10% -29.28% 30.80% -8.69% 14.17% 119.04% 6.21% 5.61% 16.46%
difference in growth of Total Current Assets -30.30% 20.59% -16.64% 127.73% -7.96% -113.43% 10.25%
growth in Property and Equipment -20.93% -95.27% -6.67% -2385.00% 16.04% 16.59% 32.99% 93.28% 26.80%
difference in growth of Property and Equipment 14.26% -2289.73% 22.71% 2401.59% 16.95% 76.69% -6.19%
Property and Equipment versus Total Assets -1.71% 2.21% -0.07% 1.57% 2.77% 1.68% 1.61% 1.91% 2.77% 2.18%
growth in Goodwill 0.74% 5362.75% 35.44% -76.99% 4.25% -160.25% 25.51% -317.43% 4.54%
difference in growth in Goodwill 34.71% -5439.74% -31.20% -83.26% 21.27% -157.18% -20.97%
Goodwill versus Total Assets 0.75% 35.99% 33.66% 37.08% 14.21% 35.72% -4.26% 38.33% 8.24% 35.96%
growth in Total Non Current Assets 5.68% 312.17% 32.23% -81.10% 1.36% 16.57% 30.89% 71.33% 6.15%
difference in growth of Total Non Current Assets 26.56% -393.27% -30.87% 97.67% 29.53% 54.76% -24.74%
growth in Total Assets 29.64% 22.08% 31.47% -45.46% 8.21% 101.00% 16.97% 12.32% 11.43%
difference in growth of Total Assets 1.82% -67.54% -23.26% 146.47% 8.76% -88.69% -5.54%
growth in Accounts Payable and Accrued Expenses 49.41% 1130.77% 156.93% -63.69% -12.87% 190.24% 26.64% -4.45% 1.77%
difference in growth for Accounts Payable and Accrued Expenses 49.41% 107.52% -1194.46% -169.80% 253.93% 39.51% -194.69% -24.86%
Accounts Payable and Accrued Expenses versus Total Current Liabilities 59.48% 81.24% 67.01% 76.21% 124.26% 76.66% 69.46% 70.16% 74.00% 71.81%
Accounts Payable and Accrued Expenses versus Total Liabilities 4.73% 27.89% 64.88% 44.43% 106.03% 41.41% 73.10% 44.11% 68.03% 41.95%
growth in Total Non Current Liabilities 15933.55% -96.90% 2.39% 2.47% 3.09% -250.22% -3.99% -258.22% 19.81%
difference in growth of Total Non Current Liabilities -15931.15% 99.36% 0.69% -252.69% -7.08% -7.99% 23.80%
growth in Total Liabilities 215.34% -10.23% 61.26% -77.78% -6.51% 320.99% 18.88% 2.67% 7.00%
difference in growth of Total Liabilities -154.07% -67.55% -67.78% 398.77% 25.40% -318.32% -11.88%
growth in Total Equity 4.80% 241.07% 19.47% 12.18% 16.21% 23.29% 16.13% 23.95% 13.41%
difference in growth of Total Equity 14.67% -228.89% -3.27% 11.11% -0.07% 0.66% -2.72%
Total Equity versus Total Assets 12.86% 71.30% 35.92% 64.80% 73.89% 69.59% 45.32% 69.09% 50.02% 70.32%
167

Analysis - Statement of Cash Flow 2002 2003 Q1 2003 Rest 2003 2004 Q1 2004 Rest 2004 2005 Q1 2005 Rest 2005 2006 Q1 2006 Rest 2006 2007 Q1 2007 Rest 2007
Total Adjustments versus CFFO
60.97% -1368.89% -115.00% 64.93% 66.85% 16.82% 10.65% 1.81% -13.60% -31.47% -1.52%
Net Income versus Total Adjustments
64.03% -107.31% -186.96% 54.02% 49.59% 494.50% 838.97% 5415.51% -835.26% -417.73% -6686.03%
Net Income versus CFFO
39.03% 1468.89% 215.00% 35.07% 33.15% 83.18% 89.35% 98.19% 113.60% 131.47% 101.52%
Net Income versus CFFI
-29.99% -21.33% -33.59% -51.29% -59.47% 1111.02% -670.68% -574.71% -59.37% -493.17% -263.94%
Additional Analysis - Statement of Cash Flows
CFFO / Net Sales
CFFO / Net Income
CFFO / Income From Operations
CFFO / Property and Equipment
CFFI / Net Sales
CFFI / Net Income
CFFI / Income From Operations
CFFI / Property and Equipment
CFFI / CFFO
Change in CFFI
Change in Total Non Current Assets
Change in Total Property and Equipment
2002 2003 2004 2005 2006 2007
23.08% 2.34% 22.88% 10.74% 8.32% 10.23%
256.19% 46.51% 301.64% 111.92% 88.03% 98.50%
286.05% 64.91% 244.56% 80.76% 69.02% 81.93%
482.65% 63.07% 1201.01% 559.76% 377.36% 409.49%
-30.04% -14.98% -12.76% -1.43% -15.93% -3.93%
-333.42% -297.68% -168.17% -14.91% -168.45% -37.89%
-372.29% -415.45% -136.34% -10.76% -132.07% -31.51%
-628.16% -403.65% -669.57% -74.57% -722.11% -157.50%
-130.15% -640.01% -55.75% -13.32% -191.36% -38.46%
45808 -25935 63784 -112447 88197
13170 79036 4415 101518 26449
-3103 -782 1755 4188 4524
Analysis - Ratios 2002 2003 2004 2005 2006 2007 Average 2008 Assume
Working Capital Turnover 2.40 1.36 2.50 2.19 2.73 2.41 2.45 2.45 2.45
Gross Profit Margin 41.88% 40.04% 39.36% 40.32% 38.52% 37.76% 39.65% 37.50% 37.10%
Operating Profit Margin 8.07% 3.61% 9.36% 13.30% 12.06% 12.48% 9.81% 13.09%
Net Profit Margin 9.01% 5.03% 7.59% 9.60% 9.46% 10.38% 8.51% 11.90%
Asset Turnover 1.09 0.77 1.08 0.95 1.02 0.97 1.02 0.99 1.02
Return on Assets 9.83% 3.89% 8.22% 9.11% 9.60% 10.09% 8.46% 11.80%
Return on Equity 11.43% 4.41% 11.53% 14.06% 13.79% 14.61% 11.64% 16.78%
Debt to Equity 0.13 0.40 0.54 0.44 0.45 0.42 0.45 0.43
168

Current Liabilities
Cost of Debt
Weight
Rate
Weighted
Rate
Accounts Payable 52,287 0.179 0.0261 0.47%
Accrued Expenses 70,085 0.240 0.0261 0.63%
Reserve for sales returns & allowances 26,036 0.089 0.0261 0.23%
Incomes taxes payable 21,997 0.075 0.3500 2.64%
Total current liabilities 170,405 0.584
Long Term Liabilities
Convertible senior notes 98,000 0.336 0.0463 1.55%
*Other liabilities 6,432 0.022 0.0425 0.09%
Incomes taxes payable 11,294 0.039 0.3500 1.36%
Deferred income taxes 5,560 0.019 0.0388 0.07%
Total Long Term Liabilities 121,286 0.416
Total Liabilities 291,691 1.000
Weighted Average Cost of Debt
= 7.04%
*average of convertible senior notes and deferred income taxes
Weighted Average Cost of Capital
K d BVL/MVA Tax K e BVE/MVA WACC
Before Tax 7.04% 0.297 15.80% 0.703 13.20%
After Tax 7.04% 0.297 31.3% 15.80% 0.703 12.55%
Adjusted Weighted Average Cost of Capital
K d BVL/MVA Tax K e BVE/MVA WACC
Before Tax 7.04% 0.320 15.80% 0.680 13.00%
After Tax 7.04% 0.320 31.3% 15.80% 0.680 12.29%
169

3 Month
Regression Statistics
Multiple R 0.384874626
R Square 0.148128478
Adjusted R Square 0.135958885
Standard Error 0.111141208
Observations 72
ANOVA
df SS MS F Significance F
Regression 1 0.150353218 0.150353218 12.1720156 0.000843235
Residual 70 0.864665769 0.012352368
Total 71 1.015018987
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.008152804 0.013121884 0.621313511 0.536411486 ‐0.018017968 0.034323576 ‐0.018017968 0.034323576
X Variable 1 1.329967264 0.381205977 3.488841584 0.000843235 0.569675926 2.090258601 0.569675926 2.090258601
Regression Statistics
Multiple R 0.107822543
R Square 0.011625701
Adjusted R Square ‐0.005415235
Standard Error 0.110397606
Observations 60
ANOVA
df SS MS F Significance F
Regression 1 0.00831467 0.00831467 0.682221954 0.412207399
Residual 58 0.706882626 0.012187631
Total 59 0.715197296
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.012688219 0.014442895 0.878509367 0.383292353 ‐0.016222377 0.041598815 ‐0.016222377 0.041598815
X Variable 1 0.482141711 0.583729792 0.825967284 0.412207399 ‐0.686320411 1.650603832 ‐0.686320411 1.650603832
Regression Statistics
Multiple R 0.157195636
R Square 0.024710468
Adjusted R Square 0.003508522
Standard Error 0.117698412
Observations 48
ANOVA
df SS MS F Significance F
Regression 1 0.016145312 0.016145312 1.165481114 0.285959864
Residual 46 0.637234143 0.013852916
Total 47 0.653379455
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.011394823 0.017043385 0.668577482 0.507106393 ‐0.022911731 0.045701378 ‐0.022911731 0.045701378
X Variable 1 0.744475053 0.689600439 1.079574506 0.285959864 ‐0.643618614 2.13256872 ‐0.643618614 2.13256872
170

Regression Statistics
Multiple R 0.064171695
R Square 0.004118006
Adjusted R Square ‐0.02517264
Standard Error 0.106643179
Observations 36
ANOVA
df SS MS F Significance F
Regression 1 0.001598911 0.001598911 0.140591175 0.710022835
Residual 34 0.386674099 0.011372768
Total 35 0.38827301
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.008632618 0.017803351 0.484887244 0.63086585 ‐0.027548144 0.04481338 ‐0.027548144 0.04481338
X Variable 1 0.266906543 0.711836397 0.374954897 0.710022835 ‐1.179719057 1.713532143 ‐1.179719057 1.713532143
Regression Statistics
Multiple R 0.040869724
R Square 0.001670334
Adjusted R Square ‐0.043708287
Standard Error 0.111493483
Observations 24
ANOVA
df SS MS F Significance F
Regression 1 0.000457563 0.000457563 0.036808839 0.849614572
Residual 22 0.273477526 0.012430797
Total 23 0.27393509
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.0134021 0.022775499 0.588443779 0.562227677 ‐0.033831393 0.060635593 ‐0.033831393 0.060635593
X Variable 1 0.1600628 0.83428484 0.191856297 0.849614572 ‐1.570138052 1.890263652 ‐1.570138052 1.890263652
171

6 Month
Regression Statistics
Multiple R 0.385086446
R Square 0.148291571
Adjusted R Square 0.136124308
Standard Error 0.111130568
Observations 72
ANOVA
df SS MS F Significance F
Regression 1 0.15051876 0.15051876 12.18775067 0.000837207
Residual 70 0.864500226 0.012350003
Total 71 1.015018987
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.008309651 0.013117977 0.633455245 0.528500723 ‐0.017853329 0.034472631 ‐0.017853329 0.034472631
X Variable 1 1.330760351 0.381186993 3.491095912 0.000837207 0.570506877 2.091013826 0.570506877 2.091013826
Regression Statistics
Multiple R 0.108266438
R Square 0.011721622
Adjusted R Square ‐0.00531766
Standard Error 0.110392249
Observations 60
ANOVA
df SS MS F Significance F
Regression 1 0.008383272 0.008383272 0.687917562 0.410274215
Residual 58 0.706814024 0.012186449
Total 59 0.715197296
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.012747564 0.014429277 0.883451279 0.380639821 ‐0.016135773 0.0416309 ‐0.016135773 0.0416309
X Variable 1 0.484076928 0.583641527 0.829407959 0.410274215 ‐0.684208513 1.652362368 ‐0.684208513 1.652362368
Regression Statistics
Multiple R 0.157878154
R Square 0.024925512
Adjusted R Square 0.00372824
Standard Error 0.117685435
Observations 48
ANOVA
df SS MS F Significance F
Regression 1 0.016285817 0.016285817 1.175883019 0.283846574
Residual 46 0.637093638 0.013849862
Total 47 0.653379455
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.011506258 0.01703312 0.675522648 0.502725688 ‐0.022779633 0.04579215 ‐0.022779633 0.04579215
X Variable 1 0.747929003 0.689728728 1.084381399 0.283846574 ‐0.640422896 2.136280902 ‐0.640422896 2.136280902
172

Regression Statistics
Multiple R 0.065212162
R Square 0.004252626
Adjusted R Square ‐0.02503406
Standard Error 0.106635971
Observations 36
ANOVA
df SS MS F Significance F
Regression 1 0.00165118 0.00165118 0.145206795 0.705529462
Residual 34 0.38662183 0.01137123
Total 35 0.38827301
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.008663685 0.017796785 0.486811803 0.629515348 ‐0.027503734 0.044831104 ‐0.027503734 0.044831104
X Variable 1 0.27142759 0.712296025 0.381060094 0.705529462 ‐1.176132088 1.718987268 ‐1.176132088 1.718987268
Regression Statistics
Multiple R 0.041992831
R Square 0.001763398
Adjusted R Square ‐0.04361099
Standard Error 0.111488286
Observations 24
ANOVA
df SS MS F Significance F
Regression 1 0.000483057 0.000483057 0.038863284 0.845529712
Residual 22 0.273452033 0.012429638
Total 23 0.27393509
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.013414698 0.022771229 0.589107332 0.561790358 ‐0.03380994 0.060639336 ‐0.03380994 0.060639336
X Variable 1 0.164593787 0.834917743 0.197137728 0.845529712 ‐1.566919626 1.8961072 ‐1.566919626 1.8961072
173

1 Year
Regression Statistics
Multiple R 0.385109516
R Square 0.148309339
Adjusted R Square 0.13614233
Standard Error 0.111129409
Observations 72
ANOVA
df SS MS F Significance F
Regression 1 0.150536795 0.150536795 12.18946527 0.000836553
Residual 70 0.864482192 0.012349746
Total 71 1.015018987
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.008408857 0.013116257 0.64110185 0.523550018 ‐0.017750693 0.034568406 ‐0.017750693 0.034568406
X Variable 1 1.330752735 0.381158001 3.491341472 0.000836553 0.570557083 2.090948386 0.570557083 2.090948386
Regression Statistics
Multiple R 0.108074469
R Square 0.011680091
Adjusted R Square ‐0.00535991
Standard Error 0.110394569
Observations 60
ANOVA
df SS MS F Significance F
Regression 1 0.008353569 0.008353569 0.685451402 0.411109605
Residual 58 0.706843727 0.012186961
Total 59 0.715197296
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.012781335 0.014423872 0.88612374 0.379210231 ‐0.016091181 0.041653851 ‐0.016091181 0.041653851
X Variable 1 0.483558717 0.584064597 0.827919925 0.411109605 ‐0.68557359 1.652691024 ‐0.68557359 1.652691024
Regression Statistics
Multiple R 0.157943193
R Square 0.024946052
Adjusted R Square 0.003749227
Standard Error 0.117684196
Observations 48
ANOVA
df SS MS F Significance F
Regression 1 0.016299238 0.016299238 1.176876833 0.283645729
Residual 46 0.637080217 0.01384957
Total 47 0.653379455
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.011528493 0.017031398 0.676896448 0.50186161 ‐0.022753933 0.045810919 ‐0.022753933 0.045810919
X Variable 1 0.748417903 0.689888111 1.084839543 0.283645729 ‐0.640254818 2.137090623 ‐0.640254818 2.137090623
174

Regression Statistics
Multiple R 0.065865535
R Square 0.004338269
Adjusted R Square ‐0.0249459
Standard Error 0.106631385
Observations 36
ANOVA
df SS MS F Significance F
Regression 1 0.001684433 0.001684433 0.148143825 0.702712787
Residual 34 0.386588577 0.011370252
Total 35 0.38827301
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.008653604 0.017796913 0.486241847 0.629915163 ‐0.027514075 0.044821283 ‐0.027514075 0.044821283
X Variable 1 0.27424921 0.712530743 0.384894564 0.702712787 ‐1.173787473 1.722285892 ‐1.173787473 1.722285892
Regression Statistics
Multiple R 0.04250543
R Square 0.001806712
Adjusted R Square ‐0.04356571
Standard Error 0.111485867
Observations 24
ANOVA
df SS MS F Significance F
Regression 1 0.000494922 0.000494922 0.039819597 0.843666609
Residual 22 0.273440168 0.012429099
Total 23 0.27393509
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.013404339 0.022772247 0.588626093 0.562107504 ‐0.033822411 0.06063109 ‐0.033822411 0.06063109
X Variable 1 0.166667888 0.835225029 0.199548484 0.843666609 ‐1.565482796 1.898818573 ‐1.565482796 1.898818573
175

5 Year
Regression Statistics
Multiple R 0.385281542
R Square 0.148441867
Adjusted R Square 0.136276751
Standard Error 0.111120763
Observations 72
ANOVA
df SS MS F Significance F
Regression 1 0.150671313 0.150671313 12.20225638 0.000831689
Residual 70 0.864347673 0.012347824
Total 71 1.015018987
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.008836786 0.01310911 0.674095006 0.502470956 ‐0.01730851 0.034982081 ‐0.01730851 0.034982081
X Variable 1 1.331014485 0.381033104 3.493172825 0.000831689 0.571067931 2.090961039 0.571067931 2.090961039
Regression Statistics
Multiple R 0.107468284
R Square 0.011549432
Adjusted R Square ‐0.00549282
Standard Error 0.110401866
Observations 60
ANOVA
df SS MS F Significance F
Regression 1 0.008260123 0.008260123 0.677694045 0.41375398
Residual 58 0.706937173 0.012188572
Total 59 0.715197296
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.012909645 0.014403452 0.896288286 0.373803884 ‐0.015921996 0.041741287 ‐0.015921996 0.041741287
X Variable 1 0.481903136 0.58538679 0.823221747 0.41375398 ‐0.689875827 1.653682099 ‐0.689875827 1.653682099
Regression Statistics
Multiple R 0.157991497
R Square 0.024961313
Adjusted R Square 0.00376482
Standard Error 0.117683275
Observations 48
ANOVA
df SS MS F Significance F
Regression 1 0.016309209 0.016309209 1.17761523 0.283496621
Residual 46 0.637070246 0.013849353
Total 47 0.653379455
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.011608943 0.017026005 0.681835987 0.498761508 ‐0.022662627 0.045880514 ‐0.022662627 0.045880514
X Variable 1 0.748790257 0.690014914 1.085179815 0.283496621 ‐0.640137706 2.13771822 ‐0.640137706 2.13771822
176

Regression Statistics
Multiple R 0.067327047
R Square 0.004532931
Adjusted R Square ‐0.02474551
Standard Error 0.106620961
Observations 36
ANOVA
df SS MS F Significance F
Regression 1 0.001760015 0.001760015 0.154821458 0.696426398
Residual 34 0.386512995 0.011368029
Total 35 0.38827301
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.008634555 0.017796676 0.485177986 0.630661748 ‐0.027532641 0.044801752 ‐0.027532641 0.044801752
X Variable 1 0.280401034 0.712629891 0.393473579 0.696426398 ‐1.167837141 1.728639209 ‐1.167837141 1.728639209
Regression Statistics
Multiple R 0.043672738
R Square 0.001907308
Adjusted R Square ‐0.04346054
Standard Error 0.111480249
Observations 24
ANOVA
df SS MS F Significance F
Regression 1 0.000522479 0.000522479 0.042040962 0.839426941
Residual 22 0.273412611 0.012427846
Total 23 0.27393509
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.013384049 0.022774037 0.587688905 0.562725395 ‐0.033846414 0.060614512 ‐0.033846414 0.060614512
X Variable 1 0.17126346 0.835272905 0.205038927 0.839426941 ‐1.560986514 1.903513435 ‐1.560986514 1.903513435
177

10 Year
Regression Statistics
Multiple R 0.385406687
R Square 0.148538314
Adjusted R Square 0.136374576
Standard Error 0.11111447
Observations 72
ANOVA
df SS MS F Significance F
Regression 1 0.150769209 0.150769209 12.21156767 0.000828167
Residual 70 0.864249777 0.012346425
Total 71 1.015018987
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.009879875 0.013098264 0.754288898 0.453205812 ‐0.016243788 0.036003538 ‐0.016243788 0.036003538
X Variable 1 1.330815921 0.380830986 3.494505354 0.000828167 0.571272478 2.090359363 0.571272478 2.090359363
Regression Statistics
Multiple R 0.107206197
R Square 0.011493169
Adjusted R Square ‐0.00555005
Standard Error 0.110405008
Observations 60
ANOVA
df SS MS F Significance F
Regression 1 0.008219883 0.008219883 0.674354256 0.414900318
Residual 58 0.706977413 0.012189266
Total 59 0.715197296
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.013226056 0.014353948 0.921422889 0.360646624 ‐0.015506492 0.041958605 ‐0.015506492 0.041958605
X Variable 1 0.480900597 0.58561375 0.821190755 0.414900318 ‐0.691332675 1.653133869 ‐0.691332675 1.653133869
Regression Statistics
Multiple R 0.157704944
R Square 0.024870849
Adjusted R Square 0.003672389
Standard Error 0.117688734
Observations 48
ANOVA
df SS MS F Significance F
Regression 1 0.016250102 0.016250102 1.173238502 0.284381918
Residual 46 0.637129353 0.013850638
Total 47 0.653379455
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.01192905 0.017009242 0.701327577 0.486631656 ‐0.022308777 0.046166877 ‐0.022308777 0.046166877
X Variable 1 0.745157767 0.687947156 1.083161346 0.284381918 ‐0.639608013 2.129923547 ‐0.639608013 2.129923547
178

Regression Statistics
Multiple R 0.068584032
R Square 0.004703769
Adjusted R Square ‐0.02456965
Standard Error 0.106611811
Observations 36
ANOVA
df SS MS F Significance F
Regression 1 0.001826347 0.001826347 0.160683979 0.691035605
Residual 34 0.386446663 0.011366078
Total 35 0.38827301
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.008709792 0.017785119 0.48972359 0.627474545 ‐0.027433918 0.044853503 ‐0.027433918 0.044853503
X Variable 1 0.284423217 0.709543057 0.400854062 0.691035605 ‐1.157541757 1.726388191 ‐1.157541757 1.726388191
Regression Statistics
Multiple R 0.045170061
R Square 0.002040334
Adjusted R Square ‐0.04332147
Standard Error 0.11147282
Observations 24
ANOVA
df SS MS F Significance F
Regression 1 0.000558919 0.000558919 0.04497913 0.833995005
Residual 22 0.27337617 0.01242619
Total 23 0.27393509
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.013443998 0.022762152 0.590629499 0.560787828 ‐0.033761815 0.060649812 ‐0.033761815 0.060649812
X Variable 1 0.176210718 0.83085798 0.212082838 0.833995005 ‐1.546883261 1.899304698 ‐1.546883261 1.899304698
179

Method of Comparables
P / E Trailing PPS EPS P / E Industry Average Jakks Pacific Calculated PPS
Jakks Pacific 22.79 3.11 7.33 15.80 49.12
Jakks Pacific (Restated) 22.79 1.41 16.16 15.80 22.27
Hasbro 36.18 2.06 17.56
Mattel 19.92 1.42 14.03
Leapfrog 8.47 (1.55) (5.46)
P / E Forward PPS EPS P / E Industry Average Jakks Pacific Calculated PPS
Jakks Pacific 22.79 4.07 5.60 13.56 55.13
Jakks Pacific (Restated) 22.79 1.41 16.13 13.56 28.96
Hasbro 36.18 2.29 15.77
Mattel 19.92 1.76 11.34
Leapfrog 8.47 0.39 21.50
P / B PPS BPS P / B Industry Average Jakks Pacific Calculated PPS
Jakks Pacific 22.79 24.14 0.94 2.76 66.63
Jakks Pacific (Restated) 22.79 21.67 1.05 2.76 59.81
Hasbro 36.18 8.68 4.17
Mattel 19.92 6.73 2.96
Leapfrog 8.47 3.31 2.56
PEG PPS P to E EGR PEG Industry Average Jakks Pacific Calculated PPS
Jakks Pacific 22.79 7.33 13.70 0.53 1.54 65.40
Jakks Pacific (Restated) 22.79 16.16 13.70 1.18 1.54 29.65
Hasbro 36.18 17.56 10.04 1.75
Mattel 19.92 14.03 10.63 1.32
Leapfrog 8.47 (5.46)
P / EBITDA PPS Market Cap Shares EBITDA P / EBITDA Industry Avg Jakks Pacific Cal. PPS
Jakks Pacific 22.79 646 28.62 128.18 5.04 7.99 35.77
Hasbro 36.18 5270 145.66 682.33 7.72
Mattel 19.92 6970 349.90 844.39 8.25
Leapfrog 8.47 (67.15)
P / FCF PPS Shares FCF FCF / Share P / FCF Industry Avg Jakks Pacific Cal. PPS
Jakks Pacific 22.79 28.62 53.94 1.88 12.09 11.22 21.14
Jakks Pacific (Restated) 22.79 28.62 76.06 2.66 8.58 11.22 29.82
Hasbro 36.18 142.60 489.33 3.43 10.54
Mattel 19.92 361.36 275.24 0.76 26.15
Leapfrog 8.47 35.90 25.56 0.71 11.90
EV / EBITDA PPS Shares EBITDA EV / EBITDA Industry Avg Jakks Pacific Cal. PPS
Jakks Pacific 22.79 28.62 128.18 5.20 7.99 35.28
Hasbro 36.18 142.60 682.33 7.72
Mattel 19.92 361.36 844.39 8.25
Leapfrog 8.47 35.90 (67.15)
180

Intrinsic Valuation Models
Discounted Free Cash Flow
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
CFFO 87660 123762 140718 159996 181915 206838 235175 267394 304026 345678 393036
CFFI (33717) (38298) (43545) (49511) (56294) (64006) (72775) (82745) (94081) (106970) (121625)
FCF 53943 85464 97173 110485 125622 142832 162400 184649 209946 238708 271411 308595
PV Factor 0.883 0.780 0.689 0.609 0.538 0.475 0.420 0.371 0.328 0.289
PV FCF 75498 75832 76167 76503 76841 77181 77521 77864 78208 78553
PV YBY FCF 770168
Terminal Value Perp 676629 2337839
Market Value Assets 1446797
Book Value Debt 291691
Discounted Free Cash Flow Sensitivity Analysis
MVE per Model at 12/31/07 1155106
Growth Rates
Divide by Shares 28624 0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00%
Model Share Price 40.35 10.56% 60.43 64.51 69.54 75.91 84.22 95.51 111.76
11.44% 53.44 56.64 60.52 65.31 71.39 79.36 90.25
WACC(BT) 13.20% 12.32% 47.54 50.08 53.11 56.79 61.36 67.17 74.83
G 0.00% WACC (BT) 13.20% 42.49 44.53 46.94 49.81 53.32 57.67 63.24
14.08% 38.14 39.80 41.73 44.01 46.74 50.07 54.23
14.96% 34.35 35.71 37.27 39.10 41.27 43.86 47.04
Time Consistent Price 42.49 15.84% 31.03 32.15 33.43 34.92 36.65 38.70 41.17
Observed Share Price 22.79
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
Adj. Discounted Free Cash Flow
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
CFFO 109781 148015 168293 191349 217564 247370 281259 319792 363603 413417 470055
CFFI (33717) (38298) (43545) (49511) (56294) (64006) (72775) (82745) (94081) (106970) (121625)
FCF 76064 109717 124748 141838 161270 183364 208485 237047 269523 306447 348431 396166
PV Factor 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295
PV FCF 97094 97696 98301 98910 99523 100139 100759 101384 102012 102644
PV YBY FCF 998461
Terminal Value Perp 897737 3047429
Market Value Assets 1896199
Book Value Debt 291691
Adjusted Discounted Free Cash Flow Sensitivity Analysis
MVE per Model at 12/31/07 1604508
Growth Rates
Divide by Shares 28624 0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00%
Model Share Price 56.05 10.40% 82.40 87.88 94.67 103.30 114.62 130.14 152.71
11.27% 73.25 77.54 82.77 89.26 97.53 108.44 123.49
WACC(BT) 13.00% 12.13% 65.60 69.02 73.12 78.11 84.34 92.31 102.88
G 0.00% WACC (BT) 13.00% 58.98 61.73 64.98 68.88 73.65 79.61 87.27
13.87% 53.28 55.51 58.12 61.21 64.92 69.48 75.19
14.73% 48.37 50.20 52.33 54.81 57.76 61.31 65.67
Time Consistent Price 58.98 15.60% 44.02 45.53 47.27 49.28 51.64 54.45 57.84
Observed Share Price 22.79
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
Residual Income Model
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Net Income 88991 116409 137072 155851 177203 201480 229082 260467 296150 336723 382854
Book Value of Equity 690997 807406 944478 1100329 1277532 1479012 1708094 1968561 2264711 2601434 2984288
Annual Normal Income 109178 127570 149228 173852 201850 233684 269879 311033 357824 411027
Annual Residual Income 7232 9502 6624 3351 (371) (4602) (9412) (14882) (21101) (28172) (32032)
PV Factor 0.864 0.746 0.644 0.556 0.480 0.415 0.358 0.309 0.267 0.231
PV of Annual Residual Income 6245 7086 4265 1863 (178) (1908) (3371) (4603) (5635) (6497)
PV YBY RI (2733)
Terminal Value Perpetuity (46757) (202735)
MVE [12/31/07] 641508
Divide by Shares 28624
Model Price at 12/31/07 22.41
Residual Income Sensitivity Analysis
Growth Rates
0.00% -5.00% -10.00% -15.00% -20.00% -25.00% -30.00%
12.64% 38.75 37.21 36.35 35.80 35.42 35.14 34.93
13.69% 32.75 32.15 31.80 31.57 31.41 31.29 31.20
Cost of Equity 15.80% Cost 14.75% 27.83 27.85 27.85 27.86 27.87 27.87 27.87
G 0.00% of 15.80% 23.82 24.24 24.50 24.67 24.79 24.89 24.96
Equity 16.85% 20.50 21.17 21.60 21.89 22.10 22.26 22.38
17.91% 17.70 18.53 19.06 19.43 19.70 19.91 20.08
Time Consistent Price 23.82 18.96% 15.37 16.28 16.88 17.30 17.62 17.86 18.05
Observed Share Price 22.79
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
181

Adj. Residual Income Model
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Net Income 40444 61145 74237 84408 95972 109120 124069 141067 160393 182367 207351
Book Value of Equity 620329 681474 755712 840120 936091 1045211 1169281 1310347 1470740 1653107 1860458
Annual Normal Income 98012 107673 119402 132739 147902 165143 184746 207035 232377 261191
Annual Residual Income (36867) (33436) (34995) (36767) (38783) (41074) (43679) (46642) (50010) (53840) (61216)
PV Factor 0.864 0.746 0.644 0.556 0.480 0.415 0.358 0.309 0.267 0.231
PV of Annual Residual Income (31837) (24934) (22536) (20447) (18625) (17034) (15643) (14425) (13356) (12417)
PV YBY RI (191253)
Terminal Value Perpetuity (89356) (387443)
MVE [12/31/07] 339721
Divide by Shares 28624
Model Price at 12/31/07 11.87
Adjusted Residual Income Sensitivity Analysis
Growth Rates
0.00% -5.00% -10.00% -15.00% -20.00% -25.00% -30.00%
12.64% 20.61 20.66 20.68 20.70 20.71 20.72 20.73
13.69% 17.40 17.83 18.08 18.24 18.35 18.44 18.50
Cost of Equity 15.80% Cost 14.75% 14.76 15.43 15.82 16.09 16.27 16.41 16.52
G 0.00% of 15.80% 12.62 13.41 13.90 14.23 14.47 14.65 14.79
Equity 16.85% 10.84 11.70 12.25 12.62 12.89 13.09 13.26
17.91% 9.35 10.23 10.80 11.19 11.49 11.71 11.89
Time Consistent Price 12.62 18.96% 8.10 8.98 9.56 9.96 10.26 10.50 10.68
Observed Share Price 22.79
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
Abnormal Earnings Growth
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Net Income 88991 116409 137072 155851 177203 201480 229082 260467 296150 336723 382854
Annual Normal Income 103052 134802 158730 180476 205201 233313 265277 301620 342942 389925
Annual AEG 2271 (2879) (3273) (3721) (4231) (4811) (5470) (6219) (7071) (8040)
PV Factor 0.864 0.746 0.644 0.556 0.480 0.415 0.358 0.309 0.267
PV of AEG 1961 (2147) (2108) (2069) (2032) (1995) (1959) (1923) (1888)
Change in Residual Income 2271 (2879) (3273) (3721) (4231) (4811) (5470) (6219) (7071)
Core Income Perpetuity 116409
PV YBY RI (14161)
Terminal Value Perpetuity (13590) (50886)
Total Adjusted Earnings Perpetuity 88658
MVE [12/31/07] 561129
Divide by Shares 28624
Model Price at 12/31/07 19.60
Abnormal Earnings Growth Sensitivity Analysis
Growth Rates
0.00% -5.00% -10.00% -15.00% -20.00% -25.00% -30.00%
12.64% 41.29 40.38 39.88 39.55 39.33 39.17 39.04
13.69% 32.50 32.50 32.49 32.49 32.49 32.49 32.49
Cost of Equity 15.80% Cost 14.75% 25.86 26.36 26.66 26.85 27.00 27.10 27.18
G 0.00% of 15.80% 20.84 21.61 22.08 22.39 22.62 22.80 22.93
Equity 16.85% 16.96 17.85 18.41 18.79 19.07 19.29 19.45
17.91% 13.89 14.82 15.42 15.83 16.14 16.38 16.56
Time Consistent Price 20.84 18.96% 11.49 12.41 13.01 13.43 13.75 13.99 14.19
Observed Share Price 22.79
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
Adj. Abnormal Earnings Growth
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Net Income 40444 61145 74237 84408 95972 109120 124069 141067 160393 182367 207351
Annual Normal Income 46834 70806 85967 97744 111135 126361 143672 163355 185735 211181
Annual AEG 3431 (1559) (1773) (2015) (2292) (2605) (2962) (3368) (3830) (4354)
PV Factor 0.864 0.746 0.644 0.556 0.480 0.415 0.358 0.309 0.267
PV of AEG 2963 (1163) (1142) (1121) (1100) (1081) (1061) (1042) (1023)
Change in Residual Income 3431 (1559) (1773) (2015) (2292) (2605) (2962) (3368) (3830)
Core Income Perpetuity 116409
PV YBY RI (5768)
Terminal Value Perpetuity (7360) (27559)
Total Adjusted Earnings Perpetuity 103280
MVE [12/31/07] 653674
Divide by Shares 28624
Model Price at 12/31/07 22.84
Adjusted Abnormal Earnings Growth Sensitivity Analysis
Growth Rates
0.00% -5.00% -10.00% -15.00% -20.00% -25.00% -30.00%
12.64% 38.41 37.92 37.65 37.47 37.35 37.26 37.20
13.69% 32.48 32.48 32.48 32.47 32.47 32.47 32.47
Cost of Equity 15.80% Cost 14.75% 27.86 28.14 28.30 28.41 28.48 28.54 28.58
G 0.00% of 15.80% 24.28 24.69 24.95 25.15 25.24 25.34 25.41
Equity 16.85% 21.41 21.89 22.20 22.40 22.56 22.67 22.76
17.91% 19.07 19.57 19.90 20.12 20.29 20.42 20.52
Time Consistent Price 24.28 18.96% 17.17 17.67 17.99 18.22 18.39 18.53 18.63
Observed Share Price 22.79
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
182

Long Run Residual Income Model
BV of Equity 690997
ROE 15.76% Average Forecasted ROE 15.76%
Cost of Equity 15.80% Cost of Equity 15.80%
Forward Earnings Growth Rate 13.70% Earnings Growth Rate 13.70%
Estimated MVE 677835
Number of Shares 28624
Price Per Share 23.68
Time Consistent Price 25.17
PPS [6/1/08] 22.77
Long Run Residual Sensitivity Analysis
Growth Rates
9.00% 10.00% 11.00% 12.00% 13.00% 14.00% 15.00%
16.00% 24.85 24.97 25.15 25.41 25.86 26.82 30.18
16.25% 25.74 26.01 26.40 27.00 28.02 30.18 37.72
Return 16.50% 26.63 27.05 27.66 28.59 30.18 33.53 45.26
on 16.75% 27.51 28.09 28.92 30.18 32.33 36.88 52.81
Equity 17.00% 28.40 29.13 30.18 31.76 34.49 40.23 60.35
17.25% 29.29 30.18 31.43 33.35 36.64 43.59 67.89
17.50% 30.18 31.22 32.69 34.94 38.80 46.94 75.44
Cost of Equity = 15.80%
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
Long Run Residual Sensitivity Analysis
Growth Rates
9.00% 10.00% 11.00% 12.00% 13.00% 14.00% 15.00%
15.50% 25.11 25.28 25.54 25.93 26.65 28.32 36.69
15.75% 24.18 24.18 24.19 24.20 24.23 24.28 24.46
Cost 16.00% 23.31 23.17 22.98 22.69 22.21 21.24 18.35
of 16.25% 22.51 22.25 21.89 21.36 20.50 18.88 14.68
Equity 16.50% 21.76 21.39 20.89 20.17 19.04 16.99 12.23
16.75% 21.06 20.60 19.98 19.11 17.77 15.45 10.48
17.00% 20.40 19.86 19.15 18.15 16.66 14.16 9.17
Return on Equity = 15.76%
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
Long Run Residual Sensitivity Analysis
Cost of Equity
15.50% 15.75% 16.00% 16.25% 16.50% 16.75% 17.00%
15.50% 24.14 20.79 17.43 14.08 10.73 7.38 4.02
15.75% 27.08 24.14 21.20 18.25 15.31 12.36 9.42
Return 16.00% 29.39 26.76 24.14 21.52 18.89 16.27 13.64
on 16.25% 31.24 28.87 26.51 24.14 21.77 19.41 17.04
Equity 16.50% 32.76 30.61 28.45 26.30 24.14 21.98 19.83
16.75% 34.03 32.06 30.08 28.10 26.12 24.14 22.16
17.00% 35.11 33.28 31.46 29.63 27.80 25.97 24.14
Growth Rate = 13.7%
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
183

Adj. Long Run Residual Income Model
BV of Equity 620329
ROE 16.00% Average Forecasted ROE 11.61%
Cost of Equity 15.80% Cost of Equity 15.80%
Forward Earnings Growth Rate 7.00% Earnings Growth Rate 13.70%
Estimated MVE 634427
Number of Shares 28624
Price Per Share 22.16
Time Consistent Price 23.56
PPS [6/1/08] 22.77
Long Run Residual Sensitivity Analysis
Growth Rates
1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00%
11.00% 14.64 14.13 13.54 12.86 12.04 11.06 9.85
13.00% 17.57 17.27 16.93 16.53 16.05 15.48 14.78
Return 15.00% 20.50 20.42 20.32 20.20 20.07 19.90 19.70
on 17.00% 23.43 23.56 23.70 23.88 24.08 24.33 24.63
Equity 19.00% 26.36 26.70 27.09 27.55 28.09 28.75 29.55
21.00% 29.29 29.84 30.48 31.22 32.11 33.17 34.48
23.00% 32.21 32.98 33.86 34.89 36.12 37.59 39.40
Cost of Equity = 15.80%
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
Long Run Residual Sensitivity Analysis
Growth Rates
1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00%
9.00% 28.74 29.75 31.10 32.98 35.81 40.53 49.95
10.00% 25.55 26.03 26.66 27.49 28.65 30.39 33.30
Cost 11.00% 22.99 23.14 23.32 23.56 23.87 24.32 24.98
of 12.00% 20.90 20.83 20.73 20.61 20.46 20.26 19.98
Equity 13.00% 19.16 18.93 18.66 18.32 17.91 17.37 16.65
14.00% 17.69 17.36 16.96 16.49 15.92 15.20 14.27
15.00% 16.42 16.02 15.55 14.99 14.32 13.51 12.49
Return on Equity = 11.61%
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
Long Run Residual Sensitivity Analysis
Cost of Equity
9.00% 10.00% 11.00% 12.00% 13.00% 14.00% 15.00%
8.00% 25.47 29.28 33.08 36.88 40.68 44.48 48.29
8.50% 23.76 27.92 32.09 36.26 40.43 44.59 48.76
Return 9.00% 21.67 26.28 30.89 35.50 40.12 44.73 49.34
on 9.50% 19.09 24.25 29.41 34.57 39.73 44.89 50.05
Equity 10.00% 15.81 21.67 27.53 33.39 39.24 45.10 50.96
10.50% 11.51 18.29 25.06 31.83 38.60 45.37 52.15
11.00% 5.62 13.64 21.67 29.70 37.72 45.75 53.78
Growth Rate = 13.7%
Overvalued: Less Than $18.23 $18.23 < Fairly Valued < $27.35 Undervalued: Greater Than $27.35
184

References
Jakks Pacific, Inc. (2007-2003) 10-K
Hasbro, Inc. (2007 – 2003) 10-Ks
Leapfrog Enterprises, Inc. (2007-2003) 10-K
Mattel, Inc. (2007-2003) 10-K
Jakks Pacific, Inc. (2008 - 2002) First Quarter 10-Q
Form S-SA: Registration Statement of the Securities Act of 1933 for Jakks Pacific, Inc; March 5, 2008
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