JAKKS PACIFIC INC (JAKK)

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

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

Critical Accounting Estimates

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

Allowance for Current Expected Credit Losses.
Our allowance for current expected credit losses is based upon management’s assessment of the business environment, customers’
risk profile characteristics, historical collection and loss information, aging of accounts receivables, and other matters specific to
customer accounts in the establishment of pools. If there were a deterioration of a major customer’s creditworthiness, or actual
defaults were higher than our current expected credit losses, our estimates of the recoverability of amounts due to us could be misstated,
which could have an adverse impact on our operating results. Our allowance for current expected credit losses is also affected by the
time at which uncollectible accounts receivable balances are actually written off. Management believes the accounting estimate related
to the allowance for current expected credit losses is a “critical accounting policy” because judgement is required in the
establishment of pools based on customer risk profile characteristics and the historical loss rates applied to each pool. In addition,
the allowance requires judgement since it involves estimation of the impact of both current and future economic factors in relation to
its customers’ risk profile characteristics. Changes in the assumptions used to develop the estimates could materially affect key
financial measures, including other selling and administrative expenses, net income and accounts receivable.

Royalties. We enter into license
agreements with strategic partners, inventors, designers and others for the use of intellectual properties in its products. These agreements
may call for payment in advance or future payment of minimum guaranteed amounts. Amounts paid in advance are recorded as an asset and
charged to expense when the related revenue is recognized in the consolidated statements of operations. If all or a portion of the minimum
guaranteed amounts appear not to be recoverable through future use of the rights obtained under the license, the non-recoverable portion
of the guaranty is charged to expense at that time. On a quarterly basis, we evaluate the recoverability of minimum guarantee amounts
based on forecast revenues to be received for the products and record a shortfall reserve for expected unrecoverable amounts. If our actual
revenue generated differs from our projections, the recoverability of our minimum guarantees would be impacted and could materially affect
key financial measures, including gross profit, net income and prepaid assets.

Fair value measurements. Fair value
is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants
at the measurement date. In determining fair value, we use various methods including market, income and cost approaches. Based upon these
approaches, we often utilize certain assumptions that market participants would use in pricing the asset or liability, including assumptions
about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market-corroborated,
or unobservable inputs. We utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable
inputs. Based upon observable inputs used in the valuation techniques, we are required to provide information according to the fair value
hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values into three broad
levels as follows:

In instances where the determination of the fair
value measurement is based upon inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within
which the entire fair value measurement falls is based upon the lowest level input that is significant to the fair value measurement in
its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment
and considers factors specific to the asset or liability (see Item 8 “Consolidated Financial Statements and Supplementary Data Note
15 - Fair Value Measurements” for further information).

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

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

Management’s estimates are monitored on a
quarterly basis, and a further adjustment to reduce inventory to its net realizable value is recorded as an increase in the cost of sales
when deemed necessary under the lower of cost or net realizable value standard. Significant changes in the assumptions used to develop
the estimate could materially affect key financial measures, including gross profit, net income and inventories.

Reserve for Sales Returns and Allowances.
We routinely enter into arrangements with our customers to provide sales incentives, support customer promotions and provide allowances
for returns and defective merchandise. Such programs are based primarily on customer purchases, customer performance of specified promotional
activities and other specified factors such as sales to consumers. Management believes that the accounting estimates related to sales
adjustments are “critical accounting policies” because significant judgment is required to estimate related accruals, such
as estimating volumes of defective products to support reserves for defective merchandise and estimating future customer performance and
consumer preferences that could impact the discretionary sales promotions. Significant changes in the assumptions used to develop the
estimates could materially affect key financial measures, such as net sales, gross profit, net income, and reserve for sales returns and
allowances.

Income Allocation for Income Taxes.
Our annual income tax provision and related income tax assets and liabilities are based upon actual income as allocated to the various
tax jurisdictions based upon our transfer pricing study, US and foreign statutory income tax rates and tax regulations and planning opportunities
in the various jurisdictions in which we operate. Significant judgment is required in interpreting tax regulations in the U.S. and foreign
jurisdictions, and in evaluating worldwide uncertain tax positions. Actual results could differ materially from those judgments, and changes
from such judgments could materially affect our consolidated financial statements.

Income taxes. We do not file a consolidated
return for our foreign subsidiaries. We file federal and state returns and our foreign subsidiaries each file returns in their respective
jurisdictions, as applicable. Deferred taxes are provided on an asset and liability method. Deferred tax assets are recognized as deductible
temporary differences, operating losses, or tax credit carry-forwards. Deferred tax liabilities are recognized as taxable temporary differences.
Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets
are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax
assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the
date of enactment.

We must assess the likelihood that we will be able
to recover our deferred tax assets. Deferred tax assets are reduced by a valuation allowance, if, based upon the weight of available evidence,
it is more likely than not that we will not realize some portion or all of the deferred tax assets. We consider all available positive
and negative evidence when assessing whether it is more likely than not that deferred tax assets are recoverable. We consider evidence
such as our past operating results, the existence of cumulative losses or cumulative income in previous periods and our forecast of future
taxable income. We believe this to be a critical accounting policy because should there be a change in our ability to recover our deferred
tax assets, our tax provision would increase in the period in which we determine that the recovery is not likely, as well as decrease
in the period in which the assessment of the recoverability of the deferred tax assets reverses, which could have a material impact on
our results of operations.

We accrue a tax reserve for additional income taxes
and interest, which may become payable in future years as a result of audit adjustments by tax authorities. The reserve is based upon
management’s assessment of all relevant information and is periodically reviewed and adjusted as circumstances warrant. As of December
31, 2024, our income tax reserves were approximately $3.2 million and relate to federal and state income taxes.

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

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Recent Accounting Pronouncements.

See Item 8 “Consolidated Financial Statements
and Supplementary Data Note 2 - Summary of Significant Accounting Policies.”

Results of Operations

The following table sets forth, for the periods
indicated, certain statement of operations data as a percentage of net sales. A discussion of the operating results for 2023 can be found
in our Annual Report on Form 10-K for the year ended December 31, 2023, as filed with the SEC on March 15, 2024, in Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations.

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

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Comparison of the Years Ended December 31, 2024 and 2023

Net Sales

Toys/Consumer Products. Net sales of our
Toys/Consumer Products segment were $570.0 million in 2024, compared to $580.7 million in 2023, representing a decrease of $10.7 million,
or 1.8%. The decrease in net sales was primarily due to lower sales in the 1-2% range in each of our Dolls, Role Play and Dress Up Division,
Action Play & Collectibles Division and Seasonal Division. Movie properties such as Sonic the Hedgehog 3 and Disney’s Moana
2 helped sales in 2024, but were offset by lower shipping from prior year movie properties such as The Super Mario Bros. Movie, Disney’s
The Little Mermaid, Disney’s Wish and Disney’s Encanto.

Costumes. Net sales of our Costumes segment
were $121.0 million in 2024, compared to $130.9 million in 2023, representing a decrease of $9.9 million, or 7.6%. The decrease in net
sales was primarily driven by US customers recalibrating their order levels down based on Halloween 2023 sell-through. Despite the lower
sales in the US, our International sales grew in 2024 to the highest year ever.

Cost of Sales

Toys/Consumer Products. Cost of sales of
our Toys/Consumer Products segment was $389.5 million, or 68.3% of related net sales in 2024 compared to $388.3 million, or 66.9% of related
net sales in 2023 representing an increase of $1.2 million or 0.3%. Although royalty rates were lower year-over-year, the increase in
the cost of sales percentage of net sales, year-over-year is due to higher inventory obsolescence costs.

Costumes. Cost of sales of our Costumes segment
was $88.5 million, or 73.1% of related net sales for 2024 compared to $99.9 million, or 76.3% of related net sales for 2023 representing
a decrease of $11.4 million, or 11.4%. The year-over-year decrease in dollars is directly attributable to lower volume. The decrease in
percent of net sales is attributable lower royalty expense due to lower royalty guarantee shortfalls and marginal improvements in product
cost of goods attributable to mix and design for improved margin.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were
$173.3 million in 2024 and $164.2 million in 2023, constituting 25.1% and 23.1% of net sales, respectively. Selling, general and administrative
expenses increased from the prior year primarily driven by higher media costs, product development expenses and employee compensation.

Loss on Debt Extinguishment

In 2023, we recognized a loss on debt extinguishment
of $1.0 million in connection with the extinguishment of the 2021 BSP Term Loan in June 2023.

Change in fair value of the preferred stock derivative
liability

The change in fair value of the preferred stock derivative liability
for year ended December 31, 2024, was nil, as the Company had redeemed all the outstanding preferred shares on March 11, 2024. The change
in fair value for the year ended December 31, 2023, was $8.0 million reflecting the results of the fair value estimation driven mainly
by the accrual of dividends and changes in unobservable inputs such as discount rate and change-in-control-assumptions.

Interest Income

Interest Income was $0.8 million for the year ended
December 31, 2024, as compared to $1.3 million in the prior year period. Interest income earned is primarily due to the Company’s
money market investments.

Interest Expense

Interest expense was $1.1 million for the year ended
December 31, 2024, as compared to $6.5 million in the prior year period. In 2024, we recorded interest expense of $1.1 million related
to our revolving credit facility. In 2023, we recorded interest expense of $3.2 million related to our 2021 BSP Term Loan, $0.7 million
related to our revolving credit facility and $2.6 million related to other borrowing costs.

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Provision for Income Taxes

During 2024, our income tax expense, which includes
federal, state and foreign income taxes and discrete items, was $5.5 million, or an effective tax rate of 13.9%. The 2024 tax expense
included a discrete tax benefit of $1.4 million primarily comprised of return to provision adjustments. Absent these discrete tax benefits,
our effective tax rate for 2024 was 17.4%, primarily due to taxes on federal, state, and foreign income.

During 2023, our income tax expense, which includes
federal, state and foreign income taxes and discrete items, was $6.8 million, or an effective tax rate of 15.2%. The 2023 tax expense
included a discrete tax benefit of $2.7 million primarily comprised of valuation allowance adjustments. Absent these discrete tax benefits,
our effective tax rate for 2023 was 21.3%, primarily due to taxes on federal, state, and foreign income.

We assess the available positive and negative evidence
to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets by jurisdiction. Based on our
evaluation of all positive and negative evidence, as of December 31, 2024, a valuation allowance of $0.7 million has been recorded against
the deferred tax assets that more likely than not will not be realized. The net deferred tax asset change of $2.3 million consists of
the net deferred tax asset changes in the US and foreign jurisdictions, where we are in a cumulative income position.

Uncertainties that may have a significant impact on net sales
and income (loss) from operations

Significant outbreaks of contagious diseases, and
other adverse public health developments, could have a material impact on our business operations and operating results. The immediate
and lingering impact of the 2019 COVID-19 pandemic added additional risk and complexity to the Company’s operations. In addition,
the history of smaller scale epidemics in Hong Kong/China (e.g., “bird flu”) highlights an additional risk given that substantially
all of our product is sourced from China and our Hong Kong operation is foundational to our business model. We cannot quantify the extent
that any new outbreak might have on our sales, net income and cash flows, but it could be significant.

In the first quarter of 2022, Russia and Ukraine
engaged in an armed conflict that continues. We cannot predict at this time the length of this conflict and if it will spread to other
countries. Accordingly, we cannot quantify at this time if, or the extent, this conflict will adversely impact our business operations.

The suggestion that the U.S. will take unilateral
action to impose tariffs on products imported from China creates significant uncertainty about our ability to source products with a cost
structure consistent with our recent history. The additional suggestion that the U.S. will take unilateral action to impose tariffs on
products imported from Canada and/or Mexico also creates significant uncertainty about which additional markets could be targeted for
new tariffs. It also increases the possibility that markets outside the U.S. could institute retaliatory tariffs that would ultimately
increase the cost of our doing business in those markets where we import product. In addition, our customer base may face significant
increased costs in importing our product from Hong Kong into their home markets. In the event our customers choose to raise consumer prices
to offset these costs, negative consumer reaction could substantially reduce unit demand for our product line, and by extension lower
sales. Lower sales could negatively impact our profitability and cash flows.

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Quarterly Fluctuations and Seasonality

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

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

Quarterly and year-to-date computations of income
(loss) per share amounts are made independently. Therefore, the sum of the per share amounts for the quarters may not agree with the per
share amounts for the year.

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Liquidity and Capital Resources

As of December 31, 2024, we had working capital
of $119.3 million compared to $106.1 million as of December 31, 2023.

Operating activities provided net cash of $38.9
million in 2024 and $66.4 million in 2023. The decrease in cash flows provided by operating activities, year-over-year, was primarily
due to a lower net income and higher working capital usage, partially offset by higher non-cash charges related to valuation adjustments
for our preferred stock derivative liability and an increase in deferred income tax assets due to inventory cost and other expense capitalization
matters, both in 2023. Other than open purchase orders issued in the normal course of business related to shipped product, we have no
obligations to purchase inventory from our manufacturers. However, we may incur costs or other losses as a result of not placing orders
consistent with our forecasts for products manufactured by our suppliers or manufacturers for a variety of reasons including customer
order cancellations or a decline in demand. As part of our strategy to develop and market new products, we have entered into various character
and product licenses with royalties/obligations generally ranging from 1% to 25% payable on net sales of such products. As of December
31, 2024, these agreements required future aggregate minimum royalty guarantees of $74.6 million, exclusive of $0.9 million in advances
already paid. Of this $74.6 million future minimum royalty guarantee, $53.7 million is due over the next twelve months.

Investing activities used net cash of $12.9 million
and $8.9 million for the years ended December 31, 2024 and 2023, respectively, and consisted primarily of cash paid for the purchase of
molds and tooling used in the manufacture of our products.

Financing activities used net cash of $26.9 million
in 2024 and $72.3 million in 2023. The cash used in 2024 primarily consists of the cash portion for the redemption of the Series A Preferred
stock of $20 million and the repurchase of common stock for employee tax withholding of $6.9 million. The cash used in 2023 primarily
consists of the repayment of our 2021 BSP Term Loan of $69.2 million and the repurchase of common stock for employee tax withholding of
$3.1 million.

The following is a summary of our significant contractual
cash obligations for the periods indicated that existed as of December 31, 2024 and is based upon information appearing in the notes to
the consolidated financial statements (in thousands):

The above table excludes any potential uncertain
income tax liabilities that may become payable upon examination of our income tax returns by taxing authorities. Such amounts and periods
of payment cannot be reliably estimated (see Item 8 “Consolidated Financial Statements and Supplementary Data Note 12 - Income
Taxes” for further explanation of our uncertain tax positions).

As of December 31, 2024, we had no outstanding indebtedness
under our senior secured revolving credit facility (the “JPMorgan ABL Facility”), aside from utilizing $4.4 million in letters
of credit. In June 2023 we had fully paid off our first-lien secured term loan (the “2021 BSP Term Loan Agreement”).

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The First Lien Term Loan Facility Credit Agreement
(the “2021 BSP Term Loan Agreement”) and the Credit Agreement with JPMorgan Chase Bank, N.A., as agent and lender (the “JPMorgan
ABL Credit Agreement”) each contained negative covenants that, subject to certain exceptions, limited our ability and our subsidiaries
ability to, among other things, incur additional indebtedness, make restricted payments, pledge our assets as security, make investments,
loans, advances, guarantees and acquisitions, undergo fundamental changes and enter into transactions with affiliates. The terms of the
2021 BSP Term Loan Agreement also required us to maintain a Net Leverage Ratio of 4:00x, with step-downs occurring each fiscal year starting
with the quarter ending March 31, 2022 through the quarter ending September 30, 2024 in which we were required to maintain a Net Leverage
Ratio of 3:00x. On April 26, 2022, we entered into a First Amendment to the 2021 BSP Term Loan Agreement, to provide, among other things,
that we must maintain Qualified Cash of at least: (a) at all times after the Closing Date and prior to the First Amendment Effective Date,
$20.0 million; (b) at all times during the period commencing on the First Amendment Effective Date through and including June 30, 2022,
$15.0 million; and (c) at all times on and after July 1, 2022, through September 30, 2022, $17.5 million; provided, however, that if the
Total Net Leverage Ratio exceeded 1.75:1.00 as of the last day of the most recently ended month for which financial statements were required
to have been delivered, then the amount set forth in this clause shall be increased to $20.0 million. Notwithstanding the foregoing, the
Applicable Minimum Cash Amount shall be reduced by $1.0 million for every $5.0 million principal prepayment or repayment of the Term Loans
following the First Amendment Effective Date; provided however, that, the Applicable Minimum Cash Amount shall in no event be reduced
below $15.0 million.

On January 3, 2023, as permitted by the terms within
the 2021 BSP Term Loan Agreement, we made a voluntary $15.0 million prepayment towards the outstanding principal amount of the 2021 BSP
Term Loan and incurred a $0.2 million prepayment penalty.

On March 3, 2023, as required by the terms within
the 2021 BSP Term Loan Agreement under the Excess Cash Flow (“ECF”) Sweep provision, we made a mandatory $23.1 million payment
towards the outstanding principal amount of the 2021 BSP Term Loan.

On June 5, 2023, we paid in full the 2021 BSP Term
Loan and terminated the 2021 BSP Term Loan Agreement by making a $30.2 million prepayment towards the outstanding principal amount. Additionally,
we made a $0.4 million payment towards the outstanding accrued interest, and a $0.3 million payment for the prepayment penalty and other
related fees. In connection with this transaction, we recognized a loss on debt extinguishment of $1.0 million on our consolidated statements
of operations.

The JPMorgan ABL Agreement contains events of default
that are customary for a facility of this nature, including (subject in certain cases to grace periods and thresholds) nonpayment of principal,
nonpayment of interest, fees or other amounts, material inaccuracy of representations and warranties, violation of covenants, cross-default
to certain other existing indebtedness, bankruptcy or insolvency events, certain judgment defaults and a change of control as specified
in each Agreement. If an event of default occurs under the Agreement, the maturity of the amounts owed under the JPMorgan ABL Agreement
may be accelerated.

We were in compliance with the financial covenants
under the JPMorgan ABL Agreement as of December 31, 2024.

(See Item 8 “Consolidated Financial Statements
and Supplementary Data, Note 9 – Debt and Note 10 – Credit Facilities” for additional information pertaining to our
Debt and Credit Facilities.)

As of December 31, 2024 and 2023, we held cash and
cash equivalents, including restricted cash, of $70.1 million and $72.6 million, respectively. Cash, and cash equivalents, including restricted
cash held outside of the United States, in various foreign subsidiaries totaled $16.5 million and $21.5 million as of December 31, 2024
and 2023, respectively. The cash and cash equivalents, including restricted cash balances in our foreign subsidiaries have either been
fully taxed in the U.S. or tax has been accounted for in connection with the Tax Cuts and Jobs Act, or may be eligible for a full foreign
dividends received deduction under such Act, and thus would not be subject to additional U.S. tax should such amounts be repatriated in
the form of dividends or deemed distributions. Any such repatriation may result in foreign withholding taxes, which we expect would not
be significant as of December 31, 2024.

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Our primary sources of working capital are cash
flows from operations and borrowings under our JPMorgan ABL Facility (See Item 8 “Consolidated Financial Statements and Supplementary
Data Note 10 – Credit Facilities”).

Typically, cash flows from operations are impacted
by the effect on sales of (1) the appeal of our products, (2) the success of our licensed brands in motivating consumer purchase of related
merchandise, (3) the highly competitive conditions existing in the toy industry and in securing commercially-attractive licenses, (4)
dependency on a limited set of large customers, and (5) general economic conditions. A downturn in any single factor or a combination
of factors could have a material adverse impact upon our ability to generate sufficient cash flows to operate the business. In addition,
our business and liquidity are dependent to a significant degree on our vendors and their financial health, as well as the ability to
accurately forecast the demand for products. The loss of a key vendor, or material changes in support by them, or a significant variance
in actual demand compared to the forecast, can have a material adverse impact on our cash flows and business. Given the conditions in
the toy industry environment in general, vendors, including licensors, may seek further assurances or take actions to protect against
non-payment of amounts due to them. Changes in this area could have a material adverse impact on our liquidity.

As of December 31, 2024, off-balance sheet arrangements
include letters of credit issued by JPMorgan of $4.4 million.

On July 1, 2022, we entered into an ATM Agreement
with B. Riley, as agent pursuant to which we may, from time to time, sell shares of our common stock, up to $75 million in common stock,
in one or more offerings in amounts, at prices and in the terms that we will determine at the time of the offering. On July 1, 2022, we
filed a Form S-3 shelf registration statement (File No. 333-266009) with the SEC. On Aug 1, 2022, the SEC declared the Form S-3 shelf
registration statement filed by us to be effective.

As of March 6, 2025, we have not sold any shares
of common stock under the ATM Agreement.

We have on file with the SEC an effective registration
statement pursuant to which we may issue, from time to time, up to $150 million of securities (which will be reduced by any amount of
securities sold pursuant to the ATM Agreement) consisting of, or any combination of, common stock, preferred stock, debt securities, warrants,
rights and/or units, in one or more offerings in amounts, prices and at terms that we will determine at the time of the offering.

As of March 6, 2025, we have not sold any securities
pursuant to our shelf registration statement.

The nature of our business is several factors influence
the price we offer product to our customers, and by extension they sell to our end customer. Our products are manufactured by third-party
vendors who deal with increases in labor rates as a normal course of their respective businesses. The costing of the plastic components
of our toys can be sensitive to sudden swings in oil prices. Currency exchange can also create a degree of volatility, although the majority
of our products are sourced in USD or Hong Kong dollars. Increased volumes ideally generate increased scale at various points in the value
chain. Often times, in the toy industry when cost pressures result in price increases, the development teams will reengineer subsequent
year refreshes to cost-reduce the items down to support traditional price points and preserve historical margins. With those considerations
in mind as well as others, during the last three fiscal years ending December 31, we do not believe that inflation has had a material
impact on our net sales and income from continuing operations.

Exchange Rates

Sales from our United States and Hong Kong operations
are denominated in U.S. dollars and our manufacturing costs are denominated in either U.S. or Hong Kong dollars. Local sales (other than
in Hong Kong) and operating expenses of our operations in Hong Kong, the United Kingdom, Germany, the Netherlands, France, Italy, Canada,
Mexico and China are denominated in local currency, thereby creating exposure to changes in exchange rates. Changes in the various exchange
rates against the U.S. dollar may positively or negatively affect our operating results. We cannot assure you that the exchange rate between
the United States and other currencies will not have a material adverse effect on our business, financial condition or results of operations.

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

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

Critical Accounting Estimates

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

Allowance for Current Expected Credit Losses. Our allowance for current expected credit losses is based upon management’s assessment of the business environment, customers’ risk profile characteristics, historical collection and loss information, aging of accounts receivables, and other matters specific to customer accounts in the establishment of pools. If there were a deterioration of a major customer’s creditworthiness, or actual defaults were higher than our current expected credit losses, our estimates of the recoverability of amounts due to us could be misstated, which could have an adverse impact on our operating results. Our allowance for current expected credit losses is also affected by the time at which uncollectible accounts receivable balances are actually written off. Management believes the accounting estimate related to the allowance for current expected credit losses is a “critical accounting policy” because judgement is required in the establishment of pools based on customer risk profile characteristics and the historical loss rates applied to each pool. In addition, the allowance requires judgement since it involves estimation of the impact of both current and future economic factors in relation to its customers’ risk profile characteristics. Changes in the assumptions used to develop the estimates could materially affect key financial measures, including other selling and administrative expenses, net income and accounts receivable.

Royalties. We enter into license agreements with strategic partners, inventors, designers and others for the use of intellectual properties in its products. These agreements may call for payment in advance or future payment of minimum guaranteed amounts. Amounts paid in advance are recorded as an asset and charged to expense when the related revenue is recognized in the consolidated statements of operations. If all or a portion of the minimum guaranteed amounts appear not to be recoverable through future use of the rights obtained under the license, the non-recoverable portion of the guaranty is charged to expense at that time. On a quarterly basis, we evaluate the recoverability of minimum guarantee amounts based on forecasted revenues to be received for the products and record a shortfall reserve for expected un-recoverable amounts. If our actual revenue generated differs from our projections, recoverability of our minimum guarantees would be impacted and could materially affect key financial measures, including gross profit, net income and prepaid assets.

Fair value measurements. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, we use various methods including market, income and cost approaches. Based upon these approaches, we often utilize certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market-corroborated, or unobservable inputs. We utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based upon observable inputs used in the valuation techniques, we are required to provide information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values into three broad levels as follows:

In instances where the determination of the fair value measurement is based upon inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based upon the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability (see Item 8 "Consolidated Financial Statements and Supplementary Data Note 15 - Fair Value Measurements” for further information).

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

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

Management’s estimates are monitored on a quarterly basis, and a further adjustment to reduce inventory to its net realizable value is recorded as an increase to cost of sales when deemed necessary under the lower of cost or net realizable value standard. Significant changes in the assumptions used to develop the estimate could materially affect key financial measures, including gross profit, net income and inventories.

Reserve for Sales Returns and Allowances. We routinely enter into arrangements with our customers to provide sales incentives, support customer promotions and provide allowances for returns and defective merchandise. Such programs are based primarily on customer purchases, customer performance of specified promotional activities and other specified factors such as sales to consumers. Management believes that the accounting estimates related to sales adjustments are “critical accounting policies” because significant judgment is required to estimate related accruals, such as estimating volumes of defective products to support reserves for defective merchandise and estimating future customer performance and consumer preferences that could impact the discretionary sales promotions. Significant changes in the assumptions used to develop the estimates could materially affect key financial measures, such as net sales, gross profit, net income, and reserve for sales returns and allowances.

Income Allocation for Income Taxes. Our annual income tax provision and related income tax assets and liabilities are based upon actual income as allocated to the various tax jurisdictions based upon our transfer pricing study, US and foreign statutory income tax rates and tax regulations and planning opportunities in the various jurisdictions in which we operate. Significant judgment is required in interpreting tax regulations in the U.S. and foreign jurisdictions, and in evaluating worldwide uncertain tax positions. Actual results could differ materially from those judgments, and changes from such judgments could materially affect our consolidated financial statements.

Income taxes. We do not file a consolidated return for our foreign subsidiaries. We file federal and state returns and our foreign subsidiaries each file returns in their respective jurisdictions, as applicable. Deferred taxes are provided on an asset and liability method. Deferred tax assets are recognized as deductible temporary differences, operating losses, or tax credit carry-forwards. Deferred tax liabilities are recognized as taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

We must assess the likelihood that we will be able to recover our deferred tax assets. Deferred tax assets are reduced by a valuation allowance, if, based upon the weight of available evidence, it is more likely than not that we will not realize some portion or all of the deferred tax assets. We consider all available positive and negative evidence when assessing whether it is more likely than not that deferred tax assets are recoverable. We consider evidence such as our past operating results, the existence of cumulative losses or cumulative income in previous periods and our forecast of future taxable income. We believe this to be a critical accounting policy because should there be a change in our ability to recover our deferred tax assets, our tax provision would increase in the period in which we determine that the recovery is not likely, as well as decrease in the period in which the assessment of the recoverability of the deferred tax assets reverses, which could have a material impact on our results of operations.

We accrue a tax reserve for additional income taxes and interest, which may become payable in future years as a result of audit adjustments by tax authorities. The reserve is based upon management’s assessment of all relevant information and is periodically reviewed and adjusted as circumstances warrant. As of December 31, 2023, our income tax reserves were approximately $3.2 million and relate to federal and state income taxes.

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

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Recent Accounting Pronouncements.

See Item 8 “Consolidated Financial Statements and Supplementary Data Note 2 - Summary of Significant Accounting Policies.”

Results of Operations

The following table sets forth, for the periods indicated, certain statement of operations data as a percentage of net sales. A discussion of the operating results for 2022 can be found in our Annual Report on Form 10-K for the year ended December 31, 2022, as filed with the SEC on April 14, 2023, in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations.

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

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Comparison of the Years Ended December 31, 2023 and 2022

Net Sales

Toys/Consumer Products. Net sales of our Toys/Consumer Products segment were $580.7 million in 2023, compared to $647.3 million in 2022, representing a decrease of $66.6 million, or 10.3%. The decrease in net sales was primarily due to lower sales in our Dolls, Role Play and Dress Up Division, partially offset by increased sales in our Action Play & Collectibles Division.

Costumes. Net sales of our Costumes segment were $130.9 million in 2023, compared to $148.9 million in 2022, representing a decrease of $18.0 million, or 12.1%. The decrease in net sales was primarily driven by US customers recalibrating their order levels down based on Halloween 2022 sell-through.

Cost of Sales

Toys/Consumer Products. Cost of sales of our Toys/Consumer Products segment was $388.3 million, or 66.9% of related net sales in 2023 compared to $465.4 million, or 71.9% of related net sales in 2022 representing a decrease of $77.1 million or 16.6%. The decrease in dollars is due to lower overall sales in 2023, while the decrease in percentage of net sales, year-over-year is due to lower inbound freight costs.

Costumes. Cost of sales of our Costumes segment was $99.9 million, or 76.3% of related net sales for 2023 compared to $119.5 million, or 80.3% of related net sales for 2022 representing a decrease of $19.6 million, or 16.4%. The decrease in dollars is due to lower overall sales in 2023. The decrease as a percentage of net sales, year-over-year, is due to lower inbound freight costs.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $164.2 million in 2023 and $150.0 million in 2022, constituting 23.1% and 18.8% of net sales, respectively. Selling, general and administrative expenses increased from the prior year primarily driven by higher outbound freight and warehouse expenses for 3rd party warehouses and less scale at operated warehouses coupled with lower capitalization of such cost, as well as higher compensation expense.

Loss on Debt Extinguishment

In 2023, we recognized a loss on debt extinguishment of $1.0 million in connection with the extinguishment of the 2021 BSP Term Loan in June 2023.

Interest Income

Interest Income was $1.3 million for the year ended December 31, 2023, as compared to $0.1 million in the prior year period. Interest income earned is primarily due to the Company’s money market investments.

Interest Expense

Interest expense was $6.5 million for the year ended December 31, 2023, as compared to $11.2 million in the prior year period. In 2023, we recorded interest expense of $3.2 million related to our 2021 BSP Term Loan, $0.7 million related to our revolving credit facility and $2.6 million related to other borrowing costs. In 2022, we recorded interest expense of $9.3 million related to our 2021 BSP Term Loan, $0.6 million related to our revolving credit facility and $1.3 million related to other borrowing costs.

Provision for Income Taxes

During 2023, our income tax expense, which includes federal, state and foreign income taxes and discrete items, was $6.8 million, or an effective tax rate of 15.2%. The 2023 tax expense included a discrete tax benefit of $2.7 million primarily comprised of valuation allowance adjustments. Absent these discrete tax benefits, our effective tax rate for 2023 was 21.3%, primarily due to taxes on federal, state, and foreign income.

During 2022, our income tax benefit was $41.0 million, or an effective tax rate of (81.9)%. The 2022 tax benefit of $41.0 million included a discrete tax benefit of $49.8 million primarily comprised of a valuation allowance release. Absent these discrete tax benefits, our effective tax rate for 2022 was 17.6%, primarily due to taxes on federal, state, and foreign income.

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We assess the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets by jurisdiction. Based on our evaluation of all positive and negative evidence, as of December 31, 2023, a valuation allowance of $0.7 million has been recorded against the deferred tax assets that more likely than not will not be realized. The net deferred tax asset change of $10.3 million consists of the net deferred tax asset changes in the US and foreign jurisdictions, where we are in a cumulative income position.

Uncertainties that may have a significant impact on net sales and income (loss) from operations

Significant outbreaks of contagious diseases, and other adverse public health developments, could have a material impact on our business operations and operating results. The immediate and lingering impact of the 2019 COVID-19 pandemic added additional risk and complexity to the Company’s operations. In addition, the history of smaller scale epidemics in Hong Kong/China (e.g., “bird flu”) highlights an additional risk given that substantially all of our product is sourced from China and our Hong Kong operation is foundational to our business model. We cannot quantify the extent that any new outbreak might have on our sales, net income and cash flows, but it could be significant.

In the first quarter of 2022, Russia and Ukraine engaged in an armed conflict that continues. We cannot predict at this time the length of this conflict and if it will spread to other countries. Accordingly, we cannot quantify at this time if, or the extent, this conflict will adversely impact our business operations.

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Quarterly Fluctuations and Seasonality

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

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

Quarterly and year-to-date computations of income (loss) per share amounts are made independently. Therefore, the sum of the per share amounts for the quarters may not agree with the per share amounts for the year.

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Liquidity and Capital Resources

As of December 31, 2023, we had working capital of $106.1 million compared to $101.9 million as of December 31, 2022.

Operating activities provided net cash of $66.4 million in 2023 and $86.1 million in 2022. The decrease in cash flows provided by operating activities, year-over-year, was primarily due to a lower net income and higher working capital usage, partially offset by higher non-cash charges related to valuation adjustments for our preferred stock derivative liability and an increase in deferred income tax assets due to inventory cost and other expense capitalization matters, offset by income tax activities payable. Other than open purchase orders issued in the normal course of business related to shipped product, we have no obligations to purchase inventory from our manufacturers. However, we may incur costs or other losses as a result of not placing orders consistent with our forecasts for product manufactured by our suppliers or manufacturers for a variety of reasons including customer order cancellations or a decline in demand. As part of our strategy to develop and market new products, we have entered into various character and product licenses with royalties/obligations generally ranging from 1% to 22% payable on net sales of such products. As of December 31, 2023, these agreements required future aggregate minimum royalty guarantees of $53.1 million, exclusive of $1.5 million in advances already paid. Of this $53.1 million future minimum royalty guarantee, $45.1 million is due over the next twelve months.

Investing activities used net cash of $8.9 million and $10.4 million for the years ended December 31, 2023 and 2022, respectively, and consisted primarily of cash paid for the purchase of molds and tooling used in the manufacture of our products.

Financing activities used net cash of $72.3 million in 2023 and $31.0 million in 2022. The cash used in 2023 primarily consists of the repayment of our 2021 BSP Term Loan of $69.2 million and the repurchase of common stock for employee tax withholding of $3.1 million. The cash used in 2022 primarily consists of the repayment of our 2021 BSP Term loan of $29.6 million and repurchase of common stock for employee tax withholding of $1.4 million.

The following is a summary of our significant contractual cash obligations for the periods indicated that existed as of December 31, 2023 and is based upon information appearing in the notes to the consolidated financial statements (in thousands):

The above table excludes any potential uncertain income tax liabilities that may become payable upon examination of our income tax returns by taxing authorities. Such amounts and periods of payment cannot be reliably estimated (see Item 8 “Consolidated Financial Statements and Supplementary Data Note 12 - Income Taxes” for further explanation of our uncertain tax positions).

As of December 31, 2023, we had no outstanding indebtedness under our senior secured revolving credit facility (the “JPMorgan ABL Facility”), aside from utilizing $9.4 million in letters of credit. In June 2023 we had fully paid off our first-lien secured term loan (the “2021 BSP Term Loan Agreement”).

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The First Lien Term Loan Facility Credit Agreement (the “2021 BSP Term Loan Agreement”) and the Credit Agreement with JPMorgan Chase Bank, N.A., as agent and lender (the “JPMorgan ABL Credit Agreement”) each contained negative covenants that, subject to certain exceptions, limited our ability and our subsidiaries ability to, among other things, incur additional indebtedness, make restricted payments, pledge our assets as security, make investments, loans, advances, guarantees and acquisitions, undergo fundamental changes and enter into transactions with affiliates. The terms of the 2021 BSP Term Loan Agreement also required us to maintain a Net Leverage Ratio of 4:00x, with step-downs occurring each fiscal year starting with the quarter ending March 31, 2022 through the quarter ending September 30, 2024 in which we were required to maintain a Net Leverage Ratio of 3:00x. On April 26, 2022, we entered into a First Amendment to the 2021 BSP Term Loan Agreement, to provide, among other things, that we must maintain Qualified Cash of at least: (a) at all times after the Closing Date and prior to the First Amendment Effective Date, $20.0 million; (b) at all times during the period commencing on the First Amendment Effective Date through and including June 30, 2022, $15.0 million; and (c) at all times on and after July 1, 2022, through September 30, 2022, $17.5 million; provided, however, that if the Total Net Leverage Ratio exceeded 1.75:1.00 as of the last day of the most recently ended month for which financial statements were required to have been delivered, then the amount set forth in this clause shall be increased to $20.0 million. Notwithstanding the foregoing, the Applicable Minimum Cash Amount shall be reduced by $1.0 million for every $5.0 million principal prepayment or repayment of the Term Loans following the First Amendment Effective Date; provided however, that, the Applicable Minimum Cash Amount shall in no event be reduced below $15.0 million.

On June 27, 2022, as permitted by the terms within the 2021 BSP Term Loan Agreement, we made a voluntary fee-free $10.0 million prepayment towards the outstanding principal amount of the 2021 BSP Term Loan.

On September 28, 2022, as permitted by the terms within the 2021 BSP Term Loan Agreement, we made a voluntary $17.5 million prepayment towards the outstanding principal amount of the 2021 BSP Term Loan and incurred a $0.5 million prepayment penalty.

On January 3, 2023, as permitted by the terms within the 2021 BSP Term Loan Agreement, we made a voluntary $15.0 million prepayment towards the outstanding principal amount of the 2021 BSP Term Loan and incurred a $0.2 million prepayment penalty.

On March 3, 2023, as required by the terms within the 2021 BSP Term Loan Agreement under the Excess Cash Flow (“ECF”) Sweep provision, we made a mandatory $23.1 million payment towards the outstanding principal amount of the 2021 BSP Term Loan.

On June 5, 2023, we paid in full the 2021 BSP Term Loan and terminated the 2021 BSP Term Loan Agreement by making a $30.2 million prepayment towards the outstanding principal amount. Additionally, we made a $0.4 million payment towards the outstanding accrued interest, and a $0.3 million payment for the prepayment penalty and other related fees. In connection with this transaction, we recognized a loss on debt extinguishment of $1.0 million on our consolidated statements of operations.

The JPMorgan ABL Agreement contains events of default that are customary for a facility of this nature, including (subject in certain cases to grace periods and thresholds) nonpayment of principal, nonpayment of interest, fees or other amounts, material inaccuracy of representations and warranties, violation of covenants, cross-default to certain other existing indebtedness, bankruptcy or insolvency events, certain judgment defaults and a change of control as specified in each Agreement. If an event of default occurs under the Agreement, the maturity of the amounts owed under the JPMorgan ABL Agreement may be accelerated.

We were in compliance with the financial covenants under the JPMorgan ABL Agreement as of December 31, 2023.

(See Item 8 “Consolidated Financial Statements and Supplementary Data, Note 9 – Debt and Note 10 – Credit Facilities” for additional information pertaining to our Debt and Credit Facilities.)

As of December 31, 2023 and 2022, we held cash and cash equivalents, including restricted cash, of $72.4 million and $85.5 million, respectively. Cash, and cash equivalents, including restricted cash held outside of the United States, in various foreign subsidiaries totaled $21.5 million and $39.4 million as of December 31, 2023 and 2022, respectively. The cash and cash equivalents, including restricted cash balances in our foreign subsidiaries have either been fully taxed in the U.S. or tax has been accounted for in connection with the Tax Cuts and Jobs Act, or may be eligible for a full foreign dividends received deduction under such Act, and thus would not be subject to additional U.S. tax should such amounts be repatriated in the form of dividends or deemed distributions. Any such repatriation may result in foreign withholding taxes, which we expect would not be significant as of December 31, 2023.

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Our primary sources of working capital are cash flows from operations and borrowings under our JPMorgan ABL Facility (See Item 8 “Consolidated Financial Statements and Supplementary Data Note 10 – Credit Facilities”).

Typically, cash flows from operations are impacted by the effect on sales of (1) the appeal of our products, (2) the success of our licensed brands in motivating consumer purchase of related merchandise, (3) the highly competitive conditions existing in the toy industry and in securing commercially-attractive licenses, (4) dependency on a limited set of large customers, and (5) general economic conditions. A downturn in any single factor or a combination of factors could have a material adverse impact upon our ability to generate sufficient cash flows to operate the business. In addition, our business and liquidity are dependent to a significant degree on our vendors and their financial health, as well as the ability to accurately forecast the demand for products. The loss of a key vendor, or material changes in support by them, or a significant variance in actual demand compared to the forecast, can have a material adverse impact on our cash flows and business. Given the conditions in the toy industry environment in general, vendors, including licensors, may seek further assurances or take actions to protect against non-payment of amounts due to them. Changes in this area could have a material adverse impact on our liquidity.

As of December 31, 2023, off-balance sheet arrangements include letters of credit issued by JPMorgan of $9.4 million.

On July 1, 2022, we entered into an ATM Agreement with B. Riley, as agent pursuant to which we may, from time to time, sell shares of our common stock, up to $75 million in common stock, in one or more offerings in amounts, at prices and in the terms that we will determine at the time of the offering. On July 1, 2022, we filed a Form S-3 shelf registration statement (File No. 333-266009) with the SEC. On Aug 1, 2022, the SEC declared the Form S-3 shelf registration statement filed by us to be effective.

As of March 15, 2024, we have not sold any shares of common stock under the ATM Agreement.

We have on file with the SEC an effective registration statement pursuant to which we may issue, from time to time, up to $150 million of securities (which will be reduced by any amount of securities sold pursuant to the ATM Agreement) consisting of, or any combination of, common stock, preferred stock, debt securities, warrants, rights and/or units, in one or more offerings in amounts, prices and at terms that we will determine at the time of the offering.

As of March 15, 2024, we have not sold any securities pursuant to our shelf registration statement.

The nature of our business is a number of factors influence the price we offer product to our customers, and by extension they sell to our end customer. Our products are manufactured by third-party vendors who deal with increases in labor rates as a normal course of their respective businesses. The costing of the plastic components of our toys can be sensitive to sudden swings in oil prices. Currency exchange can also create a degree of volatility, although the majority of our products are sourced in USD or Hong Kong dollars. Increased volumes ideally generate increased scale at various points in the value chain. Often times, in the toy industry when cost pressures result in price increases, the development teams will reengineer subsequent year refreshes to cost-reduce the items down to support traditional price points and preserve historical margins. With those considerations in mind as well as others, during the last three fiscal years ending December 31, we do not believe that inflation has had a material impact on our net sales and income from continuing operations.

Exchange Rates

Sales from our United States and Hong Kong operations are denominated in U.S. dollars and our manufacturing costs are denominated in either U.S. or Hong Kong dollars. Local sales (other than in Hong Kong) and operating expenses of our operations in Hong Kong, the United Kingdom, Germany, the Netherlands, France, Italy, Canada, Mexico and China are denominated in local currency, thereby creating exposure to changes in exchange rates. Changes in the various exchange rates against the U.S. dollar may positively or negatively affect our operating results. The exchange rate of the Hong Kong dollar to the U.S. dollar has been linked to the U.S. dollar by the Hong Kong Monetary Authority at HK$7.75 - HK$7.85 to US$1.00 since 2005 and, accordingly, has not represented a meaningful currency exchange risk to the U.S. dollar. We cannot assure you that the exchange rate between the United States and Hong Kong currencies will continue to be fixed or that exchange rate fluctuations between the United States and Hong Kong, or all other currencies will not have a material adverse effect on our business, financial condition or results of operations.

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

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

Critical Accounting Estimates

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

Allowance for Doubtful Accounts. Our allowance for doubtful accounts is based upon management’s assessment of the business environment, customers’ financial condition, historical collection experience, accounts receivable aging, customer disputes and the collectability of specific customer accounts. If there were a deterioration of a major customer’s creditworthiness, or actual defaults were higher than our historical experience, our estimates of the recoverability of amounts due to us could be overstated, which could have an adverse impact on our operating results. Our allowance for doubtful accounts is also affected by the time at which uncollectible accounts receivable balances are actually written off. Management believes the accounting estimate related to the allowance for doubtful account is a “critical accounting policy” because significant judgement is required to evaluate the creditworthiness of its customers when estimating the collectability of its accounts receivable. In addition, the allowance requires a high degree of judgement since it involves estimation of the impact of both current and future economic factors in relation to its customers’ ability to pay amounts due to us. Significant changes in the assumptions used to develop the estimates could materially affect key financial measures, including other selling and administrative expenses, net income and accounts receivable.

Royalties. We enter into license agreements with strategic partners, inventors, designers and others for the use of intellectual properties in its products. These agreements may call for payment in advance or future payment of minimum guaranteed amounts. Amounts paid in advance are recorded as an asset and charged to expense when the related revenue is recognized in the consolidated statements of operations. If all or a portion of the minimum guaranteed amounts appear not to be recoverable through future use of the rights obtained under the license, the non-recoverable portion of the guaranty is charged to expense at that time. On a quarterly basis, we evaluate the recoverability of minimum guarantee amounts based on forecasted revenues to be received for the products and record a shortfall reserve for expected un-recoverable amounts. If our actual revenue generated differs from our projections, recoverability of our minimum guarantees would be impacted and could materially affect key financial measures, including gross profit, net income and prepaid assets.

Fair value measurements. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, we use various methods including market, income and cost approaches. Based upon these approaches, we often utilize certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market-corroborated, or unobservable inputs. We utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based upon observable inputs used in the valuation techniques, we are required to provide information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values into three broad levels as follows:

In instances where the determination of the fair value measurement is based upon inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based upon the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability (see Item 8 "Consolidated Financial Statements and Supplementary Data Note 16 - Fair Value Measurements” for further information).

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

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

Management’s estimates are monitored on a quarterly basis, and a further adjustment to reduce inventory to its net realizable value is recorded as an increase to cost of sales when deemed necessary under the lower of cost or net realizable value standard. Significant changes in the assumptions used to develop the estimate could materially affect key financial measures, including gross profit, net income and inventories.

Reserve for Sales Returns and Allowances. We routinely enter into arrangements with our customers to provide sales incentives, support customer promotions and provide allowances for returns and defective merchandise. Such programs are based primarily on customer purchases, customer performance of specified promotional activities and other specified factors such as sales to consumers. Management believes that the accounting estimates related to sales adjustments are “critical accounting policies” because significant judgment is required to estimate related accruals, such as estimating volumes of defective products to support reserves for defective merchandise and estimating future customer performance and consumer preferences that could impact the discretionary sales promotions. Significant changes in the assumptions used to develop the estimates could materially affect key financial measures, such as net sales, gross profit, net income, and reserve for sales returns and allowances.

Income Allocation for Income Taxes. Our annual income tax provision and related income tax assets and liabilities are based upon actual income as allocated to the various tax jurisdictions based upon our transfer pricing study, US and foreign statutory income tax rates and tax regulations and planning opportunities in the various jurisdictions in which we operate. Significant judgment is required in interpreting tax regulations in the U.S. and foreign jurisdictions, and in evaluating worldwide uncertain tax positions. Actual results could differ materially from those judgments, and changes from such judgments could materially affect our consolidated financial statements.

Income taxes. We do not file a consolidated return for our foreign subsidiaries. We file federal and state returns and our foreign subsidiaries each file returns in their respective jurisdictions, as applicable. Deferred taxes are provided on an asset and liability method. Deferred tax assets are recognized as deductible temporary differences, operating losses, or tax credit carry-forwards. Deferred tax liabilities are recognized as taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

We must assess the likelihood that we will be able to recover our deferred tax assets. Deferred tax assets are reduced by a valuation allowance, if, based upon the weight of available evidence, it is more likely than not that we will not realize some portion or all of the deferred tax assets. We consider all available positive and negative evidence when assessing whether it is more likely than not that deferred tax assets are recoverable. We consider evidence such as our past operating results, the existence of cumulative losses or cumulative income in previous periods and our forecast of future taxable income. We believe this to be a critical accounting policy because should there be a change in our ability to recover our deferred tax assets, our tax provision would increase in the period in which we determine that the recovery is not likely, as well as decrease in the period in which the assessment of the recoverability of the deferred tax assets reverses, which could have a material impact on our results of operations.

We accrue a tax reserve for additional income taxes and interest, which may become payable in future years as a result of audit adjustments by tax authorities. The reserve is based upon management’s assessment of all relevant information and is periodically reviewed and adjusted as circumstances warrant. As of December 31, 2022, our income tax reserves were approximately $2.9 million and relates to federal and state taxes.

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

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Recent Accounting Pronouncements.

See Item 8 “Consolidated Financial Statements and Supplementary Data Note 2 - Summary of Significant Accounting Policies.”

Results of Operations

The following table sets forth, for the periods indicated, certain statement of operations data as a percentage of net sales. A discussion of the operating results for 2020 can be found in our Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the SEC on March 16, 2022, in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations.

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

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Comparison of the Years Ended December 31, 2022 and 2021

Net Sales

Toys/Consumer Products. Net sales of our Toys/Consumer Products segment were $647.3 million in 2022, compared to $513.5 million in 2021, representing an increase of $133.8 million, or 26.1%. The increase in net sales was primarily due to higher sales of Disney Encanto™. In addition, net sales from video game properties, Sonic the Hedgehog® and Nintendo®, also added to the yearly increase in net sales.

Costumes. Net sales of our Costumes segment were $148.9 million in 2022, compared to $107.6 million in 2021, representing an increase of $41.3 million, or 38.4%. The increase in net sales was primarily driven by the Disney® and Microsoft® lines of costumes and expanded retail distribution.

Cost of Sales

Toys/Consumer Products. Cost of sales of our Toys/Consumer Products segment was $465.4 million, or 71.9% of related net sales in 2022 compared to $357.2 million, or 69.6% of related net sales in 2021 representing an increase of $108.2 million or 30.3%. The increase in dollars is due to higher overall sales in 2022, while the increase in percentage of net sales, year-over-year is due to a higher average royalty rate and higher freight charges.

Costumes. Cost of sales of our Costumes segment was $119.5 million, or 80.3% of related net sales for 2022 compared to $80.9 million, or 75.2% of related net sales for 2021 representing an increase of $38.6 million, or 47.7%. The increase in dollars is due to higher overall sales in 2022. The increase as a percentage of net sales, year-over-year, is due to higher freight charges.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $150.0 million in 2022 and $144.2 million in 2021, constituting 18.8% and 23.2% of net sales, respectively. Selling, general and administrative expenses increased from the prior year primarily driven by higher outbound freight and warehouse expenses related to higher domestic shipping, as well as higher compensation expense.

Gain on loan forgiveness

In 2021, we recognized a gain on loan forgiveness of $6.2 million as a result of the forgiveness of the Paycheck Protection Program Loan secured under the Coronavirus Aid Relief and Economic Security Act.

Loss on debt extinguishment

In 2021, we recognized a loss on debt extinguishment of $7.4 million in connection with the refinance of the 2019 Recap Term Loan.

Interest Expense

Interest expense was $11.2 million for the year ended December 31, 2022, as compared to $14.1 million in the prior year period. In 2022, we recorded interest expense of $9.3 million related to our 2021 BSP Term Loan, $0.6 million related to our revolving credit facility and $1.3 million related to other borrowing costs. In 2021, we booked interest expense of $7.3 million related to our 2019 Recap Term Loan, $5.4 million related to our 2021 BSP Term Loan, $0.8 million related to our revolving credit facility and $0.6 million related to our convertible senior notes due in 2023.

Provision for Income Taxes

Our income tax benefit, which includes federal, state and foreign income taxes and discrete items, was $41.0 million, or an effective tax rate of (81.9%) for 2022. During 2021, the income tax expense was $0.2 million, or an effective tax rate of (4.0%).

The 2022 tax benefit of $41.0 million included a discrete tax benefit of $49.8 million primarily comprised of a valuation allowance release. Absent these discrete tax benefits, our effective tax rate for 2022 was 17.6%, primarily due to taxes on federal, state, and foreign income.

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The 2021 tax expense of $0.2 million included a discrete tax benefit of ($0.4) million primarily comprised of return to provision and uncertain tax position adjustments. Absent these discrete tax benefits, our effective tax rate for 2021 was (10.7%), primarily due to state taxes and taxes on foreign income.

We assess the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets by jurisdiction. Based on our evaluation of all positive and negative evidence, as of December 31, 2022, a valuation allowance of $0.7 million has been recorded against the deferred tax assets that more likely than not will not be realized. The net deferred tax assets of $57.8 million consists of the net deferred tax assets in the US and foreign jurisdictions, where we are in a cumulative income position.

Uncertainties that may have a significant impact on net sales and income (loss) from operations

Significant outbreaks of contagious diseases, and other adverse public health developments, could have a material impact on our business operations and operating results. In December 2019, a strain of Novel Coronavirus causing respiratory illness and death emerged in the city of Wuhan in the Hubei province of China. The Chinese government took certain emergency measures to combat the spread of the virus, including extension of the Lunar New Year holiday, implementation of travel bans and closure of factories and businesses. The majority of our materials and products are sourced from suppliers located in China.

In 2020, the Novel Coronavirus was declared a global pandemic by the World Health Organization and has been spreading throughout the world, including the United States, resulting in emergency measures, including travel bans, closure of retail stores, and restrictions on gatherings of more than a maximum number of people. To the extent that these outbreaks are disruptive to local economies and commercial activity, that development creates downward pressure on our ability to make our product line available to consumers or for consumers to purchase our products, even if our products are available. At this time, we cannot quantify the extent of the impact this disease has had or will have on our sales, net income and cash flows, but it could be significant.

In the first quarter of 2022, Russia and Ukraine were engaged in an armed conflict. We cannot predict at this time the length of this conflict and if it will spread to other countries. Accordingly, we cannot quantify at this time if, or the extent, this conflict will adversely impact our business operations.

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Quarterly Fluctuations and Seasonality

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

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