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. 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.

Goodwill and other indefinite-lived intangible assets. Goodwill and indefinite-lived intangible assets are not amortized, but are tested for impairment at least annually at the reporting unit level.

Factors we consider important 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.

As of June 30, 2009, the Company determined that the significant decline in its market capitalization is likely to be sustained. The Company's market capitalization was not significantly affected by the substantial resolution of the WWE lawsuit, and the lower revenue expectations for 2009 versus 2008 were factors that indicated that an interim goodwill impairment test was required. As a result, the Company determined that $407.1 million, or all of the goodwill related to previous acquisitions, including the acquisition of Disguise in December 2008, was impaired. This amount is included in "Write-down of Goodwill" in the accompanying consolidated statements of operations.

As of June 30, 2009, the Company determined that the tradenames "Child Guidance" and "Play Along" and certain tradenames associated with our Craft and Activity product lines would either be discontinued, or were under performing. Consequently, the intangible assets associated with these tradenames were written off to "Write-down of Intangible Assets", resulting in a non-cash charge of $8.2 million.

Intangible assets amounted to $40.3 million as of September 30, 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 annual 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.

Discrete Items for Income Taxes. Significant discrete tax items were recognized in the nine months ended September 30, 2009. As previously indicated in the Income Taxes note, the discrete items included goodwill impairment, trademark impairment, the THQ/Jakks joint venture settlement, and uncertain tax positions. A portion of the goodwill impairment is treated as a permanent adjustment for the tax provision and is considered non-deductible for tax purposes. Further explanation of the impairment can be found in the Goodwill and other indefinite-lived intangible assets section above. Further explanation on the THQ/Jakks joint venture settlement can be found in the Litigation note.

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 and liability method whereby deferred tax assets are recognized as deductible temporary differences and operating loss and tax credit carry-forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax 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 a 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 threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return, 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 September 30, 2009, our income tax reserves are approximately $14.8 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. 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 $25.7 million consisted of $12.0 million in cash and the assumption of liabilities in the amount of $13.7 million, and resulted in goodwill of $3.1 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 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 $23.3 million consisted of $20.4 million in cash and the assumption of liabilities in the amount of $2.9 million, and resulted in goodwill of $12.7 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 $60.6 million consisted of $38.6 million in cash and the assumption of liabilities in the amount of $22.0 million, and resulted in goodwill of $30.6 million. We have not finalized our purchase price allocation for Disguise and have engaged 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.

The goodwill from all of these acquisitions (as well as all other acquisitions) has been written down. See Note 11 of the Notes to Condensed Consolidated Financial Statements, supra.

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               Nine Months Ended
                                                  September 30,                    September 30,
                                               2008             2009            2008           2009
                                            As Adjusted                       As Adjusted
Net sales                                          100.0 %        100.0 %          100.0 %       100.0 %
Cost of sales                                       64.6           67.1             64.0          75.8
Gross profit                                        35.4           32.9             36.0          24.2
Selling, general and administrative                 17.5           18.0             24.8          28.3
expenses
Write-down of intangible assets                      2.5              -              1.4           1.4
Write-down of goodwill                                 -              -                -          67.3
Income (loss) from operations                       15.4           14.9              9.8         (72.8 )
Profit (loss) from video game joint                  0.2           (0.5 )            0.7         (3.6)
venture
Interest income                                      0.2              -              0.4             -
Interest expense, net of benefit                     0.6           (0.4 )           (0.2 )        (0.6 )
Income (loss) before provision (benefit)            16.4           14.0             10.7         (77.0 )
for income taxes
Provision (benefit) for income taxes                 1.7            4.4              1.4         (13.6 )
Net income (loss)                                   14.7 %          9.6 %            9.3 %       (63.4 )%

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

                                      Three Months Ended               Nine Months Ended
                                         September 30,                   September 30,
                                      2008            2009            2008            2009
                                   As Adjusted                      As Adjusted
Net Sales
Traditional Toys                  $     332,395     $ 324,092     $     583,040     $ 548,142
Craft/Activity/Writing Products          20,616        23,787            37,274        46,165
Pet Products                              4,813         3,559            13,736        10,625
                                        357,824       351,438           634,050       604,932
Cost of Sales
Traditional Toys                        218,240       216,873           375,299       412,961
Craft/Activity/Writing Products           8,939        15,344            20,263        34,335
Pet Products                              3,966         3,512            10,387        11,022
                                        231,145       235,729           405,949       458,318
Gross Profit (Loss)
Traditional Toys                        114,155       107,219           207,741       135,181
Craft/Activity/Writing Products          11,677         8,443            17,011        11,830
Pet Products                                847            47             3,349          (397 )
                                  $     126,679     $ 115,709     $     228,101     $ 146,614

Comparison of the Three Months Ended September 30, 2009 and 2008

Net Sales

Traditional Toys. Net sales of our Traditional Toys segment were $324.1 million in 2009, compared to $332.4 million in 2008, representing a decrease of $8.3 million, or 2.5%. The decrease in net sales was primarily due to lower unit sales of our WWE®, Narnia® and Pokemon® action figures and accessories, and other JAKKS products, including Plug It In & Play TV Games™, UltiMotion™, G2 Game Girl™ and EyeClops® electronics, Neopets®, Cabbage Patch Kids® and Care Bears® plush, JAKKS™ dolls and pretend play products based on Hannah Montana®, Camp Rock™ dolls, our role-play and dress-up toys, including those based on Disney classic princesses and fairies characters, and junior sports products. This was offset in part by increases in unit sales of some products, including Club Penguin™, Hello Kitty® and Smurfs® plush, In My Pocket & Friends™, SpongeBob SquarePants® and Discovery Kids® toys, Fly Wheels®, Lucky BeeBee™ activities and Nascar® vehicles, and the contribution to sales from our Tollytots, Kids Only and Disguise acquisitions of $106.3 million.

Craft/Activity/Writing Product. Net sales of our Craft/Activity/Writing Products were $23.8 million in 2009, compared to $20.6 million in 2008, representing an increase of $3.2 million, or 15.5%. The increase in net sales was primarily due to increases in unit sales of our Girl Gourmet™ and our Flying Colors® and Vivid Velvet® activities products, offset in part by decreases in unit sales of Spa Factory™ activity toys, Creepy Crawlers® 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 $3.6 million in 2009, compared to $4.8 million in 2008, representing a decrease of $1.2 million, or 25.0%. The decrease is mainly attributable to the less available shelf space for pet products at some of our major customer retail stores, and lower unit 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 $216.9 million, or 66.9% of related net sales, in 2009, compared to $218.2 million, or 65.7% of related net sales, in 2008, representing a decrease of $1.3 million, or 0.6%. This decrease primarily consisted of a decrease in royalty expense for our Traditional Toys segment of $5.2 million and as a percentage of net sales due to changes in the product mix to more products with lower royalty rates or proprietary products with no royalty rates from products with higher royalty rates. This was partially offset by an increase in product costs of $2.8 million due to the mix of the product sold with higher product cost and higher sales of closeout product. Our depreciation of molds and tools increased by $1.0 million primarily due to increased purchases of molds and tools in this segment.

Craft/Activity/Writing Products. Cost of sales of our Craft/Activity/Writing Products segment was $15.3 million, or 64.5% of related net sales, in 2009, compared to $8.9 million, or 43.4% of related net sales, in 2008, representing an increase of $6.4 million, or 71.9%. This increase primarily consisted of an increase in product costs of $4.7 million, which is in line with the higher volume of sales and higher sales of closeout product. Product costs as a percentage of net sales increased primarily due to the mix of the product sold and higher 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 increased by $0.5 million primarily due to increased purchases of molds and tools in this segment.

Pet Product. Cost of sales of our Pet Pal line of products was $3.5 million, or 98.7% of related net sales, in 2009, compared to $4.0 million, or 82.4% of related net sales, in 2008, representing a decrease of $0.5 million, or 12.5%. This decrease primarily consisted of a decrease in products costs of $0.4 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 higher sales of closeout product. Royalty expense decreased by $0.2 million and as a percentage of sales due to changes in the product mix to products with lower royalty rates or proprietary products with no royalty rates from more products with higher royalty rates. Our depreciation of molds and tools increased by $0.1 million primarily due to increased purchases of molds and tools in this segment.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $63.4 million in 2009 and $62.7 million in 2008, constituting 18.0% and 17.5% of net sales, respectively. The overall increase of $0.7 million in such costs was primarily due to the addition of overhead related to the operations of Tollytots, Kids Only and Disguise ($12.7 million) and an increase in depreciation and amortization ($3.8 million), offset in part by decreases in general and administrative expenses ($3.2 million), product development ($2.5 million), share-based compensation ($2.7 million) and direct selling expenses ($7.3 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 booked in the third quarter of 2009. The increase in depreciation and amortization is mainly due to an increase in amortization expensed related to intangible assets other than goodwill ($4.4 million), offset in part by a decrease in depreciation of tangible assets. The decrease in general and administrative expenses is primarily due to decreases in bonus expense ($6.5 million) and travel and entertainment expense ($1.1 million), offset in part by increases in legal expense ($1.1 million), net of insurance reimbursements, the reversal of penalty reserves related to uncertain tax positions taken or expected to be taken in a tax return ($1.9 million) in 2008 with no such reversals in 2009 and foreign currency expense ($0.9 million). Product development expenses decreased ($2.5 million) as a result of tighter control of spending on product development, offset in part by higher product testing expenses. The decrease in direct selling expenses is primarily due to decreases in advertising and promotional expenses of $2.6 million in 2009 in support of several of our product lines), sales commissions ($1.4 million) and other direct selling expenses of $3.4 million. From time to time, we may increase or decrease our advertising efforts, if we deem it appropriate for particular products.

Write-down of Intangible Assets

As of June 30, 2009, we determined that the tradenames "Child Guidance," "Play Along" and certain tradenames associated with our Crafts and Activities product lines would either be discontinued, or were under-performing. Consequently, the intangible assets associated with these tradenames were written off to "Write-down of Intangible Assets", resulting in a non-cash charge of $8.2 million. During the third quarter of 2008, the Company discontinued 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, the Company 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.

Write-down of Goodwill

As of June 30, 2009, we determined that the significant decline in our market capitalization is likely to be sustained. Our market capitalization did not change significantly despite the dismissals subject to appeal of the WWE lawsuit, and the lower revenue expectations for 2009 versus 2008 were factors that indicated that an interim goodwill impairment test was required. As a result, we determined that $407.1 million, or all of the goodwill related to previous acquisitions, including the acquisition of Disguise in December 2008, was impaired. This amount is included in "Write-down of Goodwill" in the accompanying condensed consolidated statements of operations

Profit from Video Game Joint Venture

We incurred a loss from our video game joint venture in 2009 of $1.9 million, as compared to profit of $0.7 million in 2008, primarily due to an additional write-down of $1.1 million as a result of the arbitration ruling which lowered the preferred return payment from a rate of 10% of net sales of the WWE video games sold by the joint venture to a rate of 6% of net sales and to legal fees of $1.2 million which was partially offset by the joint venture's profit of $0.4 million. Net loss for 2009 was $0.8 million before the additional write-down to the receivable. The joint venture's right to renew the WWE video game license expires December 31, 2009 subject to renewal through December 31, 2014. If extended, the amount of the preferred return we will receive from the joint venture after December 31, 2009 is subject to change (see "Risk Factors", infra, and Note 16 of the Notes to Condensed Consolidated Financial Statements, supra).

Interest income in 2009 was $28,219, as compared to $0.7 million in 2008. The decrease is due to lower interest rates during 2009 compared to 2008 and lower average cash balances.

Interest Expense

Interest expense was $1.3 million in 2009, as compared to income of 2.0 million . . .