The following discussion and analysis of financial condition and results of operations should be read together with our Condensed Consolidated Financial Statements and Notes thereto which appear elsewhere herein.

Critical Accounting Policies and 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 set forth in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2008. Inherent in the application of many of these accounting policies is the need for management to make estimates and judgments in the determination of certain revenues, expenses, assets and liabilities. As such, materially different financial results can occur as circumstances change and additional information becomes known. The policies with the greatest potential effect on our results of operations and financial position include:

Allowance for Doubtful Accounts. Our allowance for doubtful accounts is based on 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. The allowance for doubtful accounts is also affected by the time at which uncollectible accounts receivable balances are actually written off.

Major customers' accounts are monitored on an ongoing basis; more in depth reviews are performed based on changes in customer's financial condition and/or the level of credit being extended. When a significant event occurs, such as a bankruptcy filing by a specific customer, and on a quarterly basis, the allowance is reviewed for adequacy and the balance or accrual rate is adjusted to reflect current risk prospects.

Revenue Recognition. Our revenue recognition policy is to recognize revenue when persuasive evidence of an arrangement exists, title transfer has occurred (product shipment), the price is fixed or readily determinable, and collectability is probable. We recognize revenue in accordance with Staff Accounting Bulletin No. 104, "Revenue Recognition." Sales are recorded net of sales returns and discounts, which are estimated at the time of shipment based upon historical data. JAKKS routinely enters into arrangements with its 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. Accruals for these programs are recorded as sales adjustments that reduce gross revenue in the period the related revenue is recognized. Accruals for these programs are recorded as sales adjustments that reduce gross revenue in the period the related revenue is recognized.

Goodwill and other indefinite-lived intangible assets. In accordance with Statement of Financial Accounting Standards 142 ("FAS 142"), Goodwill and Other Intangible Assets, goodwill and indefinite-lived intangible assets are not amortized, but are tested for impairment at least annually at the reporting unit level.

Factors we consider important which could trigger an impairment review include the following:
· significant underperformance relative to expected historical or projected future operating results;

· significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and

· significant negative industry or economic trends.

Due to the subjective nature of the impairment analysis significant changes in the assumptions used to develop the estimate could materially affect the conclusion regarding the future cash flows necessary to support the valuation of long-lived assets, including goodwill. The valuation of goodwill involves a high degree of judgment and consists of a comparison of the fair value of a reporting unit with its book value. Based on the assumptions underlying the valuation, impairment is determined by estimating the fair value of a reporting unit and comparing that value to the reporting unit's book value. If the implied fair value is more than the book value of the reporting unit, an impairment loss is not indicated. If impairment exists, the fair value of the reporting unit is allocated to all of its assets and liabilities excluding goodwill, with the excess amount representing the fair value of goodwill. An impairment loss is measured as the amount by which the book value of the reporting unit's goodwill exceeds the estimated fair value of that goodwill.

FAS 142 requires that goodwill be allocated to various reporting units, which are either at the operating segment level or one reporting level below the operating segment, for purposes of evaluating whether goodwill is impaired. For 2009, JAKKS' reporting units are: Traditional Toys, Craft and Writing, and Pet products. Goodwill is allocated within JAKKS' reporting units based on an allocation of brand-specific goodwill to the reporting units selling those brands. As of October 1, 2008, JAKKS performed the annual impairment test required by FAS 142 and determined that its goodwill was not impaired. There were no events or circumstances that indicated the impairment test should be performed again at March 31, 2009.

During the third quarter of 2008, we decided to discontinue the use of the "Toymax" and "Trendmaster" tradenames on products and market these products under the JAKKS Pacific trademark. Consequently, the intangible assets associated with these tradenames were written off to Write-down of Intangible Assets, resulting in a charge of $3.5 million. Also, we adjusted the value of the Child Guidance trademark to reflect lower sales expectations for this tradename, resulting in a charge to Write-down of Intangible Assets of $5.6 million.

To determine the fair value of our reporting units, we generally use a present value technique (discounted cash flow) corroborated by market multiples when available and as appropriate. The factor most sensitive to change with respect to our discounted cash flow analyses is the estimated future cash flows of each reporting unit which is, in turn, sensitive to our estimates of future revenue growth and margins for these businesses. If actual revenue growth and/or margins are lower than our expectations, the impairment test results could differ. We applied what we believe to be the most appropriate and consistent valuation methodology for each of the reporting units. If we had established different reporting units or utilized different valuation methodologies, the impairment test results could differ.

Goodwill and intangible assets amounted to $460.8 million as of March 31, 2009.

Reserve for Inventory Obsolescence. We value our inventory at the lower of cost or market. 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 the Company 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 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 market standard.

Income Allocation for Income Taxes. Our quarterly income tax provision and related income tax assets and liabilities are based on estimated 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 the Company operates. Significant judgment is required in interpreting tax regulations in the US 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 and interest and penalties related to income tax payable. We do not file a consolidated return with our foreign subsidiaries. We file federal and state returns and our foreign subsidiaries each file Hong Kong returns, as applicable. Deferred taxes are provided on an asset or liability method whereby deferred tax assets are recognized as deductible temporary differences and operating loss and tax credit carry-forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

As of January 1, 2007, we adopted the provisions of FASB Interpretation No. 48 ("FIN 48"), Accounting for Uncertainty in Income Taxes, which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. As of the date of adoption, tax benefits that are subject to challenge by tax authorities are analyzed and accounted for in the income tax provision. The cumulative effect of the potential liability for unrecognized tax benefits prior to the adoption of FIN 48, along with the associated interest and penalties, are recognized as a reduction in the January 1, 2007 balance of retained earnings.

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 on management's assessment of all relevant information, and is periodically reviewed and adjusted as circumstances warrant. As of March 31, 2009, our income tax reserves are approximately $11.9 million and relate to the potential income tax audit adjustments, primarily in the areas of income allocation and transfer pricing.

We recognize current period interest expense and the reversal of previously recognized interest expense 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 interest expense, and penalties and penalty reversals related to the income taxes payable as other expense in our consolidated statements of operations.

Share-Based Compensation. We grant restricted stock and options to purchase our common stock to our employees (including officers) and non-employee directors under our 2002 Stock Award and Incentive Plan (the "Plan"), which incorporated the shares remaining under our Third Amended and Restated 1995 Stock Option Plan. The benefits provided under the Plan are share-based payments subject to the provisions of revised Statement of Financial Accounting Standards No. 123 (Revised) (FAS 123R), Share-Based Payment. Effective January 1, 2006, we began to use the fair value method to apply the provisions of FAS 123R. We estimate the value of share-based awards on the date of grant using the Black-Scholes option-pricing model. The determination of the fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price, as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, cancellations, terminations, risk-free interest rates and expected dividends.

Recent Developments

In October 2008, we acquired substantially all of the assets of Tollytots Limited. The total initial consideration of $25.5 million consisted of $11.8 million in cash and the assumption of liabilities in the amount of $13.7 million, and resulted in goodwill of $3.0 million. In addition, we agreed to pay an earn-out of up to an aggregate amount of $5.0 million in cash over the three calendar years following the acquisition based on the achievement of certain financial performance criteria, which will be recorded as goodwill when and if earned. Tollytots is a leading designer and producer of licensed baby dolls and baby doll pretend play accessories based on well-known brands and was included in our results of operations from the date of acquisition.

In October 2008, we acquired substantially all of the stock of Kids Only, Inc. and a related Hong Kong company, Kids Only Limited (collectively, "Kids Only"). The total initial consideration of $23.2 million consisted of $20.3 million in cash and the assumption of liabilities in the amount of $2.9 million, and resulted in goodwill of $12.6 million. In addition, we agreed to pay an earn-out of up to an aggregate amount of $5.6 million in cash over the three calendar years following the acquisition based on the achievement of certain financial performance criteria, which will be recorded as goodwill when and if earned. Kids Only is a leading designer and producer of licensed indoor and outdoor kids' furniture, and has an extensive portfolio which also includes baby dolls and accessories, room décor and a myriad of other children's toy products and was included in our results of operations from the date of acquisition.

In December 2008, we acquired certain assets of Disguise, Inc. and a related Hong Kong company, Disguise Limited (collectively, "Disguise"). The total initial consideration of $60.8 million consisted of $38.8 million in cash and the assumption of liabilities in the amount of $22.0 million, and resulted in goodwill of $30.5 million. We have not finalized our purchase price allocation for Disguise and will engage a third party to perform studies and valuations of the estimated fair value of assets and liabilities assumed. Disguise is a leading designer and producer of Halloween and everyday costume play and was included in our results of operations from the date of acquisition

Results of Operations

The following unaudited table sets forth, for the periods indicated, certain
statement of income data as a percentage of net sales.

                                                              Three Months Ended
                                                                   March 31,
                                                              2008           2009

Net sales                                                       100.0 %       100.0 %
Cost of sales                                                    63.8          66.0
Gross profit                                                     36.2          34.0
Selling, general and administrative expenses                     36.9          50.2
Loss from operations                                             (0.7 )       (16.2 )
Profit from video game joint venture                              1.9           2.7
Interest income                                                   1.0           0.2
Interest expense, net of benefit                                 (1.2 )        (1.2 )
Income (loss) before provision (benefit) for income taxes         1.0         (14.5 )
Provision (benefit) for income taxes                              0.3          (4.6 )
Net income (loss)                                                 0.7 %        (9.9 %)

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

                                    Three Months Ended
                                         March 31,
                                    2008          2009

Net Sales
Traditional Toys                  $ 119,518     $  97,592
Craft/Activity/Writing Products       6,088         7,560
Pet Products                          5,329         3,533
                                    130,935       108,685
Cost of Sales
Traditional Toys                     75,525        63,207
Craft/Activity/Writing Products       4,684         5,207
Pet Products                          3,285         3,290
                                     83,494        71,704
Gross Profit
Traditional Toys                     43,993        34,385
Craft/Activity/Writing Products       1,404         2,353
Pet Products                          2,044           243
                                  $  47,441     $  36,981

Comparison of the Three Months Ended March 31, 2009 and 2008

Net Sales

Traditional Toys. Net sales of our Traditional Toys segment were $97.6 million in 2009, compared to $119.5 million in 2008, representing a decrease of $21.9 million, or 18.3%. The decrease in net sales was primarily due to lower sales of our WWE® and Pokemon® action figures and accessories, and other JAKKS products, including Plug It In & Play TV Games™, JAKKS' Eye Clops®, G2 Game Girl™ and UltiMotion™ brands, Fly Wheels® XPV products®, Neopets® plush, Doodle Bears®, Care Bears®, Cabbage Patch Kids®, Speedstacks®, JAKKS™ dolls based on Hannah Montana®, Puppy In My Pocket & Friends™ and Narnia® and junior sports products. This was offset in part by increases in sales of some products including Club Penguin™ toys, Discovery Kids® line of toys, and role-play and dress-up toys, including those based on Disney characters Hannah Montana® and classic princesses, and the contribution to sales from our Tollytots, Kids Only and Disquise acquisitions of $9.6 million.

Craft/Activity/Writing Product. Net sales of our Craft/Activity/Writing Products were $7.6 million in 2009, compared to $6.1 million in 2008, representing an increase of $1.5 million, or 24.6%. The increase in net sales was primarily due to increases in sales of our Girl Gourmet™ and Spa Factory™ activity toys, offset in part by decreases in sales of our Flying Colors® and Vivid Velvet® activities products, our Spinz™ writing instruments and our Pentech™ and Color Workshop® writing instruments and related products.

Pet Products. Net sales of our Pet Products were $3.5 million in 2009, compared to $5.3 million in 2008, representing a decrease of $1.8 million, or 34.0%. The decrease is mainly attributable to the less available shelf space for pet products at some of our major customer retail stores, and lower sales of consumable pet products. Sales of pet products were led by our AKG licensed line of products.

Cost of Sales

Traditional Toys. Cost of sales of our Traditional Toys segment was $63.2 million, or 64.8% of related net sales, in 2009, compared to $75.5 million, or 63.2% of related net sales, in 2008, representing a decrease of $12.3 million, or 16.3%. The decrease primarily consisted of a decrease in product costs of $9.4 million, which is in line with the lower volume of sales. Product costs as a percentage of sales increased primarily due to the mix of the product sold with higher product cost. Furthermore, royalty expense for our Traditional Toys segment decreased by $2.2 million and as a percentage of net sales due to lower volume of sales and to changes in the product mix. Our depreciation of molds and tools decreased by $0.7 million primarily due to depreciation now being expensed to correlate with production of goods, instead of it being straight-lined evenly across quarters throughout the year.

Craft/Activity/Writing Products. Cost of sales of our Craft/Activity/Writing Products segment was $5.2 million, or 68.9% of related net sales, in 2009, compared to $4.7 million, or 76.9% of related net sales, in 2008, representing an increase of $0.5 million, or 10.6%. Product costs decreased by $0.7 million and as a percentage of net sales primarily due to the mix of the product sold and lower sales of closeout product. Royalty expense increased by $1.2 million and as a percentage of net sales due to changes in the product mix to more products with higher royalty rates from products with lower royalty rates or proprietary products with no royalty rates. Our depreciation of molds and tools is comparable year over year.

Pet Products. Cost of sales of our Pet Pal line of products was $3.3 million, or 93.1% of related net sales, in 2009, compared to $3.3 million, or 61.6% of related net sales, in 2008. Product costs decreased by $0.5 million, which is in line with the lower volume of sales. Product costs as a percentage of net sales increased primarily due to the mix of the product sold and sell-off of closeout product. Royalty expense increased by $0.5 million and as a percentage of sales. Additionally, our depreciation of molds and tools remained consistent year over year.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $54.6 million in 2009 and $48.3 million in 2008, constituting 50.2% and 36.9% of net sales, respectively. The overall increase of $6.3 million in such costs was primarily due to the addition of overhead related to the operations of Tollytots, Kids Only and Disguise ($8.3 million) and increases in product development ($1.8 million), and, offset in part by decreases in direct selling expenses ($0.2 million), general and administrative expenses ($3.1 million) and amortization expense related to intangible assets other than goodwill ($0.5 million). The increase in the acquired companies' overhead is mainly due to the fixed overhead and high seasonality of the Disguise acquisition, with the majority of its sales projected in the third quarter of 2009. Product development expenses increased as a result of continued product testing expenses and development of new product. The decrease in direct selling expenses is primarily due to a decrease in advertising and promotional expenses of $0.9 million in 2009 in support of several of our product lines and sales commissions ($0.1 million), offset in part by an increase in other direct selling expenses of $0.8 million to support the increase in domestic sales. From time to time, we may increase or decrease our advertising efforts, if we deem it appropriate for particular products. The decrease in general and administrative expenses is primarily due to decreases in legal expense ($1.9 million), net of insurance reimbursements, bad debt expense ($0.6 million), bonus expense which is based on EPS growth ($0.5 million) and other office cost savings ($0.5 million) implemented at the end of 2008, offset in part by an increase in rent expense ($0.7 million) as a result of additional office rent for new space.

Profit from Video Game Joint Venture

Profit from our video game joint venture in 2009 increased to $2.9 million, as compared to $2.4 million in 2008, due to stronger sales of existing titles. The amount of the preferred return we will receive from the joint venture after June 30, 2006 became subject to change (see "Risk Factors", infra, and Note 4 of the Notes to Condensed Consolidated Financial Statements, supra).

Interest income in 2009 was $0.2 million, as compared to $1.3 million in 2008. The decrease is due to lower interest rates during 2008 compared to 2007 and lower average cash balances.

Interest expense was $1.3 million in 2009, as compared to $1.6 million in 2008. In 2009, we booked interest expense of $1.1 million related to our convertible senior notes payable and net interest expense of $0.2 million related to FIN 48 pursuant to our January 1, 2007 adoption of the provisions of FIN 48. In 2008, we booked interest expense of $1.1 million related to our convertible senior notes payable and net interest expense $0.5 million related to FIN 48 pursuant to our January 1, 2007 adoption of the provisions of FIN 48.

Provision for Income Taxes

For the first quarter of 2009, our income tax benefit, including federal, state and foreign income taxes, was $5.0 million, or an effective rate of 31.5%, compared to the first quarter of 2008, an income tax provision of $0.4 million, or an effective rate of 32.5%. As of March 31, 2009, we had net deferred tax liabilities of approximately $8.2 million for which an allowance of $0.9 million has been provided since, in the opinion of management, realization of the future benefit is uncertain.

Seasonality and Backlog

The retail toy industry is inherently seasonal. Generally, our sales have been highest during the third and fourth quarters, and collections for those sales have been highest during the succeeding fourth and first fiscal quarters. Sales of writing instrument products are likewise seasonal, with sales highest during the second and third quarters, as are our Go Fly a Kite®, Funnoodle® pool toys and junior sports products, which are largely sold in the first and second quarters. Our working capital needs have been highest during the third and fourth quarters.

While we have taken steps to level sales over the entire year, sales are expected to remain heavily influenced by the seasonality of our toy products. The result of these seasonal patterns is that operating results and demand for working capital may vary significantly by quarter. Orders placed with us for shipment are cancelable until the date of shipment. The combination of seasonal demand and the potential for order cancellation makes accurate forecasting of future sales difficult and causes us to believe that backlog may not be an accurate indicator of our future sales. Similarly, financial results for a particular quarter may not be indicative of results for the entire year.

Recent Accounting Pronouncements

In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 141 (Revised) ("FAS 141(R)"), Business Combinations. This statement contains specific guidance regarding the accounting for costs of business acquisitions and for estimating contingent consideration provisions at the time of acquisition. This new guidance replaces the previous guidance in FAS 141. We will apply guidance of FAS 141(R) for any acquisitions.

Liquidity and Capital Resources

As of March 31, 2009, we had working capital of $313.5 million, compared to $325.1 million as of December 31, 2008. This decrease was primarily attributable to our operating activities earn-out and working capital adjustment payments related to our acquisitions.

Operating activities used net cash of $6.9 million in 2009, as compared to providing cash of $15.4 million in 2008. Net cash was used primarily due to our net loss and changes in working capital, offset in part by non-cash charges. Our accounts receivable turnover as measured by days sales for the quarter outstanding in accounts receivable was 59 days as of March 31, 2009, which is comparable to 56 days as of March 31, 2008. Other than open purchase orders issued in the normal course of business, we have no obligations to purchase finished goods from our manufacturers. As of March 31, 2009, we had cash and cash equivalents of $145.8 million.

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