UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



FORM 10-Q



(X)
        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934




For the quarterly period ended June 30, 2007



or



( )
        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934




Commission File Number: 23346



EMAK WORLDWIDE, INC.

(Exact name of registrant as specified in its charter)





Delaware
(State or other jurisdiction of
incorporation or organization)
        13-3534145
(I.R.S. Employer
Identification No.)






6330 San Vicente Blvd.
Los Angeles, CA
(Address of principal executive office)
        90048
(Zip Code)




(323) 932-4300

(Registrants telephone number, including area code)



(Former name, former address and former fiscal year, if changed since last report)



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.



Yesx
        No [   ]




Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer  [   ]
        Accelerated filer  [   ]
        Non-accelerated filerx




Indicate by check mark whether the registrant is a Shell Company (as defined in Rule 12b-2 of the Exchange Act).



Yes o
        Nox




Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practical date:



Common Stock, $.001 par value, 5,886,229 shares as of August 10, 2007.








EMAK WORLDWIDE, INC.



Index To Quarterly Report on Form 10-Q

Filed with the Securities and Exchange Commission

June 30, 2007



PagePart I.
        Financial InformationItem 1.
        Financial Statements
        3Item 2.
        Management's Discussion and Analysis of FinancialCondition and Results of Operations
        18Item 3.
        Quantitative and Qualitative Disclosures About Market Risk
        29Item 4.
        Controls and Procedures
        29Part II.
        Other InformationItem 4.
        Submission of Matters to a Vote of Security Holders
        30Item 6.
        Exhibits
        30




Cautionary Statement



Certain expectations and projections regarding our future performance discussed in this quarterly report are forward-looking and are made under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These expectations and projections are based on currently available competitive, financial and economic data along with our operating plans and are subject to future events and uncertainties. Readers should not place undue reliance on any such forward-looking statements, which speak only as of the date made. Actual results could vary materially from those anticipated for a variety of reasons. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.  Readers are advised to review
Managements Discussion and Analysis of Financial Condition and Results of Operations  Cautionary Statements and Risk Factors.



2



PART I. FINANCIAL INFORMATION



ITEM 1. FINANCIAL STATEMENTS



EMAK WORLDWIDE, INC.



CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS)

(UNAUDITED)



ASSETS



December 31,
        
        June 30,2006
        
        2007CURRENT ASSETS:Cash and cash equivalents
        $
        8,677
        
        $
        2,998Restricted cash
        
        1,319
        
        
        1,347Accounts receivable (net of allowances of $1,382 and$812 as of December 31, 2006 and June 30, 2007, respectively)
        
        24,327
        
        
        18,530Inventories
        
        6,386
        
        
        7,189Prepaid expenses and other current assets
        
        3,732
        
        
        2,488Total current assets
        
        44,441
        
        
        32,552Fixed assets, net
        
        3,583
        
        
        3,822Goodwill
        
        
        13,136
        
        
        13,190Other intangibles, net
        
        651
        
        
        627Other assets
        
        559
        
        
        425Total assets
        $
        62,370
        
        $
        50,616




The accompanying notes are an integral part of these

condensed consolidated financial statements.



3







EMAK WORLDWIDE, INC.



CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)



LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS EQUITY



December 31,
        
        June 30,2006
        
        2007CURRENT LIABILITIES:Short-term debt
        $
        --
        
        $
        --Accounts payable
        
        20,238
        
        
        14,770Accrued liabilities
        
        14,240
        
        
        11,864Total current liabilities
        
        34,478
        
        
        26,634LONG-TERM LIABILITIES
        
        2,294
        
        
        1,861Total liabilities
        
        36,772
        
        
        28,495COMMITMENTS AND CONTINGENCIESMANDATORILY REDEEMABLE PREFERRED STOCKSeries AA senior cumulative convertible,   $.001 par value per share,25,000 issued and outstanding, stated at liquidationpreference of $1,000 per share ($25,000), net of issuance costsand excess of Preferred Stock warrant redemption
        
        19,041
        
        
        19,041STOCKHOLDERS' EQUITY:Preferred stock, $.001 par value per share, 1,000,000shares authorized, 25,000 Series AA issued and outstanding
        
        --
        
        
        --Common stock, $.001 par value per share, 25,000,000shares authorized, 5,851,663 and 5,886,229 shares outstandingas of December 31, 2006 and June 30, 2007, respectively
        
        --
        
        
        --Additional paid-in capital
        
        33,840
        
        
        34,620Accumulated deficit
        
        (13,225)
        
        
        (17,637)Accumulated other comprehensive income
        
        3,611
        
        
        3,766Less--
        
        
        24,226
        
        
        20,749Treasury stock, 3,167,258 shares, at cost, as ofDecember 31, 2006 and June 30, 2007
        
        (17,669)
        
        
        (17,669)Total stockholders' equity
        
        6,557
        
        
        3,080Total liabilities, mandatorily redeemable preferred stock and stockholders' equity
        $
        62,370
        
        $
        50,616




The accompanying notes are an integral part of these

condensed consolidated financial statements.



4



EMAK WORLDWIDE, INC.



CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)



Three Months Ended
        
        
        Six Months EndedJune 30,
        
        
        June 30,(Unaudited)
        
        
        (Unaudited)2006
        
        
        2007
        
        
        2006
        
        
        2007REVENUE:Revenues from services
        $
        6,417
        
        $
        6,810
        
        $
        13,512
        
        $
        11,874Revenues from tangible products and other revenues
        
        33,677
        
        
        32,729
        
        
        69,268
        
        
        63,913TOTAL REVENUE
        
        40,094
        
        
        39,539
        
        
        82,780
        
        
        75,787Cost of sales:Cost of services
        
        3,002
        
        
        3,296
        
        
        7,957
        
        
        6,822Cost of tangible goods sold
        
        25,870
        
        
        26,022
        
        
        53,268
        
        
        50,781TOTAL COST OF SALES
        
        28,872
        
        
        29,318
        
        
        61,225
        
        
        57,603Minimum royalty guarantee shortfall gain
        
        (88)
        
        
        --
        
        
        (88)
        
        
        --Gross profit
        
        11,310
        
        
        10,221
        
        
        21,643
        
        
        18,184OPERATING EXPENSES:Salaries, wages and benefits
        
        6,587
        
        
        6,871
        
        
        13,442
        
        
        13,534Selling, general and administrative
        
        4,487
        
        
        5,106
        
        
        9,464
        
        
        8,863Restructuring charge
        
        766
        
        
        --
        
        
        1,372
        
        
        --Total operating expenses
        
        11,840
        
        
        11,977
        
        
        24,278
        
        
        22,397Loss from operations
        
        (530)
        
        
        (1,756)
        
        
        (2,635)
        
        
        (4,213)OTHER INCOME (EXPENSE), net
        
        (83)
        
        
        14
        
        
        (49)
        
        
        (3)Loss before provision for income taxes
        
        (613)
        
        
        (1,742)
        
        
        (2,684)
        
        
        (4,216)PROVISION FOR INCOME TAXES
        
        31
        
        
        77
        
        
        48
        
        
        196NET LOSS
        
        
        (644)
        
        
        (1,819)
        
        
        (2,732)
        
        
        (4,412)PREFERRED STOCK DIVIDENDS
        
        --
        
        
        --
        
        
        375
        
        
        --NET LOSS AVAILABLE TO COMMONSTOCKHOLDERS
        $
        (644)
        
        $
        (1,819)
        
        $
        (3,107)
        
        $
        (4,412)BASIC LOSS PER SHARE
        $
        (0.11)
        
        $
        (0.31)
        
        $
        (0.53)
        
        $
        (0.75)BASIC WEIGHTED AVERAGE SHARES OUTSTANDING
        
        5,838,785
        
        
        5,875,991
        
        
        5,822,494
        
        
        5,864,082DILUTED LOSS PER SHARE
        $
        (0.11)
        
        $
        (0.31)
        
        $
        (0.53)
        
        $
        (0.75)DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING
        
        5,838,785
        
        
        5,875,991
        
        
        5,822,494
        
        
        5,864,082




The accompanying notes are an integral part of these

condensed consolidated financial statements.



5



EMAK WORLDWIDE, INC.



CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(IN THOUSANDS)

(UNAUDITED)



Three Months Ended
        
        
        Six Months EndedJune 30,
        
        
        June 30,(Unaudited)
        
        
        (Unaudited)2006
        
        
        2007
        
        
        2006
        
        
        2007NET LOSS
        $
        (644)
        
        $
        (1,819)
        
        $
        (2,732)
        
        $
        (4,412)OTHER COMPREHENSIVE INCOME (LOSS):Foreign currency translation adjustments
        
        (298)
        
        
        116
        
        
        385
        
        
        134Unrealized gain (loss) on foreign currencyforward contracts
        
        9
        
        
        17
        
        
        (66)
        
        
        21COMPREHENSIVE LOSS
        $
        (933)
        
        $
        (1,686)
        
        $
        (2,413)
        
        $
        (4,257)




The accompanying notes are an integral part of these

condensed consolidated financial statements.



6



EMAK WORLDWIDE, INC.



CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(UNAUDITED)



Six Months EndedJune 30,2006
        
        
        2007CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
        $
        (2,732)
        
        $
        (4,412)Adjustments to reconcile net loss to net cashused in operating activities:Depreciation and amortization
        
        840
        
        
        766Benefit for doubtful accounts
        
        (12)
        
        
        (39)Gain on asset disposal
        
        (5)
        
        
        (1)Stock-based compensation expense
        
        449
        
        
        810Minimum royalty guarantee shortfall gain
        
        (88)
        
        
        --Changes in operating assets and liabilities:Increase (decrease) in cash and cash equivalents:Accounts receivable
        
        6,032
        
        
        5,937Inventories
        
        1,429
        
        
        (781)Prepaid expenses and other current assets
        
        100
        
        
        1,260Other assets
        
        27
        
        
        139Accounts payable
        
        (2,294)
        
        
        (5,551)Accrued liabilities
        
        (6,336)
        
        
        (2,458)Long-term liabilities
        
        (213)
        
        
        (441)Net cash used in operating activities
        
        (2,803)
        
        
        (4,771)CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of fixed assets
        
        (1,046)
        
        
        (957)Proceeds from sale of fixed assets
        
        10
        
        
        1Restricted cash
        
        (1,207)
        
        
        --Payment for purchase of Megaprint Group
        
        (313)
        
        
        --Net cash used in investing activities
        
        (2,556)
        
        
        (956)CASH FLOWS FROM FINANCING ACTIVITIES:Payment of preferred stock dividends
        
        (375)
        
        
        --Transaction costs paid in connection with the modification of preferred stock and warrants
        
        (79)
        
        
        --Borrowings under line of credit
        
        12,599
        
        
        --Repayment under line of credit
        
        (11,178)
        
        
        --Net cash provided by financing activities
        
        967
        
        
        -Net decrease in cash and cash equivalents
        
        (4,392)
        
        
        (5,727)Effects of exchange rate changes on cash and cash equivalents
        
        128
        
        
        48CASH AND CASH EQUIVALENTS, beginning of period
        
        6,315
        
        
        8,677CASH AND CASH EQUIVALENTS, end of period
        $
        2,051
        
        $
        2,998SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:CASH PAID FOR:Interest
        
        $
        105
        
        $
        73Income tax refunds, net
        $
        (407)
        
        $
        (1,272)




The accompanying notes are an integral part of these

condensed consolidated financial statements.



7



EMAK WORLDWIDE, INC.



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2007

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)



NOTE 1  -  ORGANIZATION AND BUSINESS



EMAK Worldwide, Inc., a Delaware corporation and subsidiaries (the Company or EMAK), is the parent company of a family of marketing services agencies including Equity Marketing, Logistix and Upshot.  Its agencies are experts in consumer activation by offering strategy-based marketing programs that directly impact consumer behavior.  The agencies provide strategic planning and research, consumer insight development, entertainment marketing, design and manufacturing of custom promotional products, kids marketing, event marketing, shopper marketing and environmental branding. EMAK is headquartered in Los Angeles, with offices in Chicago, Amsterdam, Frankfurt, London, Paris and Hong Kong. The Company primarily sells to customers in the United States and Europe. The Companys functional currency is the U.S. dollar.



The Company is focused on a return to meaningful profitability in 2008 and is deeply engaged in a comprehensive review of its business to assure not only that its operating expenses are aligned with revenues, but also that its client-by-client and program-by-program revenue models meet minimum profitability standards.  As part of this review, the Company recently initiated a Lean enterprise process improvement program, which is designed to streamline its operations.  The Company anticipates this business review will result in near-term changes to our structure and operating model as the Company addresses changes in its level of business.



NOTE 2  -  BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. All adjustments considered necessary for fair presentation have been included. The results of operations for the interim periods are not necessarily indicative of the results for a full year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Companys Annual Report on Form 10-K for the year ended December 31, 2006.



Net Income Per Share



Basic net income (loss) per share (EPS) is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during each period. Net income (loss) available to common stockholders represents reported net income (loss) less preferred stock dividend requirements.



Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Diluted EPS includes in-the-money options using the treasury stock method and also includes the assumed conversion of preferred stock using the if-converted method. During a loss period, the assumed exercise of in-the-money stock options and the assumed conversion of preferred stock have an anti-dilutive effect. As a result, these shares are not included with the weighted average shares outstanding used in the calculation of diluted loss per share for the three and six months ended June 30, 2006 and 2007.  Options and warrants to purchase 2,382,586 and 1,908,536 shares of common stock, $.001 par value per share (the Common Stock), as of June 30, 2006 and 2007, respectively, were excluded from the computation of diluted EPS as they would
have been anti-dilutive. For the three and six months ended June 30, 2006 and 2007, preferred stock convertible into 2,777,777 shares of Common Stock was excluded in the computation of diluted EPS as they would have been anti-dilutive. Excluded from the computation of diluted EPS are restricted stock units of 228,947 and 112,383 units for the three months ended June 30, 2006 and 2007, respectively, as they would have been anti-dilutive. Excluded from the computation of diluted EPS are restricted stock units of 210,197 and 126,866 units for the six months ended June 30, 2006 and 2007, respectively, as they would have been anti-dilutive.



8



The following is a reconciliation of the numerators and denominators of the basic and diluted EPS computation for loss available to common shareholders and other disclosures required by SFAS No. 128, Earnings per Share Emerging Issues Task Force Issue No. 03-6, Participating Securities and the Two-Class Method under SFAS No. 128, Earnings Per Share.



For the Three Months Ended June 30,2006
        
        
        2007Loss
        
        Shares
        
        
        Per Share
        
        
        Loss
        
        Shares
        
        
        Per Share(Numerator)
        
        (Denominator)
        
        
        Amount
        
        
        (Numerator)
        
        (Denominator)
        
        
        AmountBasic EPS:Loss available tocommon stockholders
        $
        (644)
        
        5,838,785
        
        $
        (0.11)
        
        $
        (1,819)
        
        5,875,991
        
        $
        (0.31)Effect of dilutive securities:Options and warrants
        
        --
        
        --
        
        
        
        
        
        --
        
        --Restricted stock units
        
        --
        
        --
        
        
        
        
        
        --
        
        --Dilutive EPS:Loss available to commonstockholders
        $
        (644)
        
        5,838,785
        
        $
        (0.11)
        
        $
        (1,819)
        
        5,875,991
        
        $
        (0.31)For the Six Months Ended June 30,2006
        
        
        2007Loss
        
        Shares
        
        
        Per Share
        
        
        Loss
        
        Shares
        
        
        Per Share(Numerator)
        
        (Denominator)
        
        
        Amount
        
        
        (Numerator)
        
        (Denominator)
        
        
        AmountBasic EPS:Loss available tocommon stockholders
        $
        (3,107)
        
        5,822,494
        
        $
        (0.53)
        
        $
        (4,412)
        
        5,864,082
        
        $
        (0.75)Effect of dilutive securities:Options and warrants
        
        --
        
        --
        
        
        
        
        
        --
        
        --Restricted stock units
        
        --
        
        --
        
        
        
        
        
        --
        
        --Dilutive EPS:Loss available to commonstockholders
        $
        (3,107)
        
        5,822,494
        
        $
        (0.53)
        
        $
        (4,412)
        
        5,864,082
        
        $
        (0.75)




Restricted Cash



During the first quarter of 2006, the Companys Logistix (U.K.) subsidiary entered into an agreement with Hong Kong Shanghai Bank Corp. (HSBC), under which HSBC issued a guarantee of up to 1,000 EURO (approx $1,347) to one of Logistixs vendors in exchange for the deposit of the same amount into an interest bearing restricted cash account with HSBC. Logistix (U.K.) does not have access to the cash until the guarantee is released by the end of the third quarter of 2007. The guarantee from HSBC enabled Logistix (U.K.) to secure more favorable payment terms from a new vendor supplying significant quantities of goods.



Supplemental Cash Flow Information



During 2006, the Company issued 36,142 shares with a market value of $306 as a partial payment of contractual bonuses for two executives. The contractual bonuses earned by the two executives for 2005 performance totaled $1,224 and were recorded as accrued liabilities in the Companys consolidated balance sheet as of December 31, 2005. Under the terms of the employment agreements, such bonuses are payable 25% in common stock and the remainder in cash. The cash portion of the bonuses was also paid in March 2006.



9



Inventories



Inventories consist of (a) production-in-process which primarily represents tooling costs which are deferred and amortized over the life of the related promotional program (which is typically less than six months) and deferred costs on service contracts for which revenue has been deferred and (b) purchased finished goods held for sale to customers and purchased finished goods in transit to customers distribution centers.  Inventories are stated at the lower of average cost or market. As of December 31, 2006 and June 30, 2007, inventories consisted of the following:



December 31,
        
        June 30,2006
        
        2007Production-in-process
        $
        1,171
        
        $
        2,174Finished goods
        
        5,215
        
        
        5,015Total inventories
        $
        6,386
        
        $
        7,189




Foreign Currency Translation



Net foreign exchange gains or losses resulting from the translation of foreign subsidiaries accounts whose functional currency is not the United States dollar are recognized as a component of accumulated other comprehensive income (loss) in stockholders equity. For such subsidiaries, accounts are translated into United States dollars at the following rates of exchange: assets and liabilities at period-end exchange rates, equity accounts at historical rates, and income and expense accounts at average exchange rates during the period.



For subsidiaries with transactions denominated in currencies other than their functional currency, net foreign exchange transaction gains or losses are included in determining net income (loss). Transaction losses included in net loss for the three months ended June 30, 2006 and 2007 were $54 and $60, respectively. Transaction losses included in net loss for the six months ended June 30, 2006 and 2007 were $13 and $79, respectively.



Derivative Instruments



The Company follows SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, which establishes accounting and reporting standards for derivative instruments and for hedging activities. SFAS No. 133 as amended, requires that an entity recognize derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.



The Company designates its derivatives based upon criteria established by SFAS No. 133. For a derivative designated as a fair value hedge, the gain or loss is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributed to the risk being hedged. For a derivative designated as a cash flow hedge, the effective portion of the derivatives gain or loss is initially reported as a component of accumulated other comprehensive income and subsequently reclassified into earnings when the hedged exposure affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately.



The Company uses derivatives to manage exposures to foreign currency. The Companys objective for holding derivatives is to decrease the volatility of earnings and cash flows associated with changes in foreign currency. The Company enters into foreign exchange forward contracts to minimize the short-term impact of foreign currency fluctuations on foreign currency receivables, investments, and payables. The gains and losses on the foreign exchange forward contracts offset the transaction gains and losses on the foreign currency receivables, investments, and payables recognized in earnings. The Company does not enter into foreign exchange forward contracts for trading purposes. Gains and losses on the contracts are included in other income (expense) in the condensed consolidated statements of operations and offset foreign exchange gains or losses from the revaluation of intercompany balances or other
current assets, investments, and liabilities denominated in currencies other than the functional currency of the reporting entity. The Companys foreign exchange forward contracts related to current assets and liabilities generally range from one to eleven months in original maturity.



The Companys Logistix (U.K.) subsidiary entered into a foreign currency forward contract aggregating 79 GBP to sell Euros in exchange for British pounds. The contract will expire August 13, 2007. At June 30, 2007, the foreign currency forward contract had an estimated fair value of (0) GBP. The fair value of the foreign currency forward contract is recorded in accrued liabilities in the accompanying condensed consolidated balance sheet as of June 30, 2007. The unrealized loss on the contract is reflected in accumulated other comprehensive income.



10



Income Taxes



The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109). Under SFAS 109, deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.



On January 1, 2007, the Company adopted the Financial Accounting Standards Boards (FASB) Interpretation Number 48, Accounting for Uncertainty in Income TaxesAn Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarified the accounting for uncertainty in an enterprises financial statements by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 requires management to evaluate its open tax positions that exist on the date of initial adoption in each jurisdiction. The Company did not have any unrecognized tax benefits and there was no effect on its financial condition or results of operations as a result of implementing FIN 48.



When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits
associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.  The Companys policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. As of the date of adoption of FIN 48, the Company did not have any accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest expense recognized during the quarter. The Companys effective tax rate differs from the federal statutory rate primarily due to losses sustained for which no tax benefit has been recognized.

As of January 1, 2007, the Company had a valuation allowance equal to its total net deferred tax assets due to the uncertainty of ultimately realizing tax benefits of approximately $15,243.  The Company files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The Company is no longer subject to U.S. federal tax examinations for years before 2003. State jurisdictions that remain subject to examination range from 2002 to 2005. The Company does not believe there will be any material changes in its unrecognized tax positions over the next 12 months.



Goodwill and Other Intangibles



The change in the carrying amount of goodwill from $13,136 as of December 31, 2006 to $13,190 as of June 30, 2007 reflects an increase due to a $54 foreign currency translation adjustment. $8,245 of the goodwill balance relates to the Agency Services segment and $4,945 relates to the Promotional Products segment.



The change in the carrying amount of identifiable intangibles from $651 as of December 31, 2006 to $627 as of June 30, 2007 reflects: a decrease of $39 for amortization expense and an increase due to a foreign currency translation adjustment of $15. The identifiable intangibles are subject to amortization and are reflected as other intangibles in the condensed consolidated balance sheets.



On March 31, 2006, the Company released 180 GBP ($313) to the former shareholders of Megaprint Group Limited (acquired November 10, 2004) related to a purchase price holdback under the terms of the Stock Purchase Agreement between the Company and Megaprint Group Limited. The holdback was recorded as an accrued liability as of the acquisition date.



Recent Accounting Pronouncements



In September 2006, the Financial Accounting Standards Board, or FASB issued SFAS No. 157, Fair Value Measurements, which provides guidance for using fair value to measure assets and liabilities. The standard also responds to investors requests expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS No. 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. Under SFAS No. 157, fair value refers to the price that would be received to sell an asset or paid to transfer a



11



liability in an orderly transaction between market participants in the market in which the reporting entity transacts. SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data, for example, the reporting entitys own data. Fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not expect the adoption of SFAS No. 157 to have a material impact on
its results of operations and financial position.



In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which provides companies with an option to report selected financial assets and liabilities at fair value. The objective of SFAS No. 159 is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective for us as of January 1, 2008. The Company does not expect the adoption of SFAS No. 159 to have a material impact on its results of operations or financial position.



NOTE 3  SHORT-TERM DEBT



On March 29, 2006, the Company entered into a credit facility (the Facility) with Bank of America. The maturity date of the Facility is March 29, 2009. The Facility is collateralized by substantially all of the Companys assets and provides for a line of credit of up to $25,000 with borrowing availability determined by a formula based on qualified assets.  Borrowing availability is determined on a weekly basis and fluctuates primarily with the levels of eligible accounts receivable which vary based on the timing of promotional programs.  For the six months ended June 30, 2007, borrowing availability has ranged from $4,311 to $11,268.  During this same period, there were no borrowings under the Facility.  The Facility was used to issue letters of credit.



Interest on outstanding borrowings will be based on either a fixed rate equivalent to LIBOR plus an applicable spread of between 2.50 and 3.00 percent or a variable rate equivalent to the banks reference rate plus an applicable spread of between 0.75 and 1.25 percent. The Company is also required to pay an unused line fee of between 0.375 and 0.50 percent per annum and certain letter of credit fees. The applicable spread is based on the levels of borrowings relative to qualified assets. The Facility also requires the Company to comply with certain restrictions and covenants as amended from time to time. The Facility may be used for working capital and other corporate financing purposes.  As of December 31, 2006 and June 30, 2007, the marginal interest rate on available borrowings under the Facility was 9.0%.   As of June 30, 2007, the Company was in compliance with the restrictions and covenants.



As of June 30, 2007, zero was outstanding under the Facility.  Letters of credit outstanding under the Facility as of December 31, 2006 and June 30, 2007 totaled $310 and $3,010, respectively.



NOTE 4  RESTRUCTURING AND MINIMUM ROYALTY GUARANTEE SHORTFALLS



As a result of the wind-down of a substantial majority of its Consumer Products business, in 2004 the Company recorded a charge relating to minimum royalty guarantee shortfalls on several Consumer Products licenses.  In 2006, the Company reached a settlement with one of its licensors which resulted in a reversal of $88. The gain was recorded as minimum royalty guarantee shortfall gains in the consolidated statements of operations for the three and six months ended June 30, 2006.



In connection with the Consumer Products wind-down, the Company incurred a charge for one-time employee termination benefits and other costs of $51 for three and six months ended June 30, 2006.  The entire amount is attributable to the Consumer Products segment.



In 2006, the Company eliminated several centralized corporate positions as a result of an ongoing realignment of centralized resources. As a result, the Company incurred a charge for one-time employee termination benefits and other costs totaling approximately $165 for the six months ended June 30, 2006. The entire amount is attributable to the corporate segment.



In 2006, the Company eliminated several positions at Logistix (U.K.) as a result of a less than optimal staff utilization rate resulting from a decrease in revenues. In connection with this decision, the Company incurred charges for one-time employee termination benefits and other costs of $6 and $84 for the three and six months ended June 30, 2006, respectively.  The entire amount is attributable to the Promotional Products segment.



As part of the Companys decision to reorganize and consolidate SCI Promotions offices in Ontario, California with its Los Angeles office, the Company recorded a charge for one-time employee termination benefits and other costs totaling $426 and $789 for the three and six months ended June 30, 2006, respectively. The entire amount is attributable to the Promotional Products segment.



12



As part of  the Companys decision to consolidate the SCI Promotion, Pop Rocket and Megaprint Group agencies into Logistix, the Company eliminated two senior management positions. The Company recorded a charge for one-time employee termination benefits and other costs totaling $283 for the three and six months ended June 30, 2006. The entire amount is attributable to the Promotional Products segment.



The following table summarizes activity in the Companys restructuring reserve.



Pop Rocket*
        Centralized Corporate*
        Los Angeles Office Sublease
        Logistix (U.K.)*
        SCI Promotion*
        Logistix Consolidation*
        Hong Kong*
        TotalOriginal charge
        $
        746
        $
        622
        $
        184
        $
        568
        $
        640
        $
        -
        $
        -
        $
        2,760Utilization in 2005
        
        (513)
        
        (261)
        
        -
        
        (137)
        
        (110)
        
        -
        
        -
        
        (1,021)Reserve at December 31, 2005
        
        233
        
        361
        
        184
        
        431
        
        530
        
        -
        
        -
        
        1,739Additional charge
        
        -
        
        165
        
        -
        
        78
        
        363
        
        -
        
        -
        
        606Utilization
        
        (164)
        
        (235)
        
        (101)
        
        (4)
        
        (306)
        
        -
        
        -
        
        (810)Reserve at March 31, 2006
        
        69
        
        291
        
        83
        
        505
        
        587
        
        -
        
        -
        
        1,535Additional charge
        
        51
        
        -
        
        -
        
        6
        
        426
        
        283
        
        -
        
        766Utilization
        
        (83)
        
        (155)
        
        (5)
        
        (318)
        
        (589)
        
        (37)
        
        -
        
        (1,187)Reserve at June 30, 2006
        
        37
        
        136
        
        78
        
        193
        
        424
        
        246
        
        -
        
        1,114Partial reversal of previously recorded one-time employee termination benefits and other related costs
        
        (13)
        
        (107)
        
        -
        
        (31)
        
        (5)
        
        -
        
        -
        
        (156)Additional charge
        
        -
        
        -
        
        -
        
        -
        
        -
        
        -
        
        94
        
        94Utilization
        
        (24)
        
        (29)
        
        (6)
        
        (40)
        
        (236)
        
        (134)
        
        (94)
        
        (563)Reserve at September 30, 2006
        
        -
        
        -
        
        72
        
        122
        
        183
        
        112
        
        -
        
        489Partial reversal of previously recorded one-time employee termination benefits and other related costs
        
        -
        
        -
        
        -
        
        (36)
        
        (61)
        
        -
        
        -
        
        (97)Utilization
        
        -
        
        -
        
        (5)
        
        (65)
        
        (113)
        
        (90)
        
        -
        
        (273)Reserve at December 31, 2006
        
        -
        
        -
        
        67
        
        21
        
        9
        
        22
        
        -
        
        119Utilization
        
        -
        
        -
        
        (6)
        
        (21)
        
        (6)
        
        -
        
        -
        
        (33)Reserve at March 31, 2007
        
        -
        
        -
        
        61
        
        -
        
        3
        
        22
        
        -
        
        86Utilization
        
        -
        
        -
        
        (5)
        
        -
        
        -
        
        -
        
        -
        
        (5)Reserve at June 30, 2007
        $
        -
        $
        -
        $
        56
        $
        -
        $
        3
        $
        22
        $
        -
        $
        81




* One-time employee termination benefits and other related costs.



NOTE 5 -- SEGMENTS



The Company has identified three reportable segments through which it conducts its operations: Agency Services, Promotional Products and Consumer Products. This reflects the structure and format of internal management reports provided to the chief operating decision maker. The factors for determining the reportable segments were based on the distinct nature of their operations. Each segment is responsible for executing a unique business strategy. The Agency Services segment provides various services such as strategic planning and research, entertainment marketing, promotion, event marketing, collaborative marketing, retail design, and environmental branding. The Agency Services segment is a service-based business whose revenues are derived either from fees for hours worked or from fixed price retainer contracts. The Promotional Products segment designs and contracts for the manufacture of promotional products
used as free premiums or sold in conjunction with the purchase of other items at a retailer or quick service restaurant. Promotional Products are used for marketing purposes by both the companies sponsoring the promotions and the licensors of the entertainment properties on which the promotional programs are often based. The Promotional Products segment manufactures product to order and derives its revenues primarily from the sale of such product to its clients. The Consumer Products segment designs and contracts for the manufacture of toys and other consumer products for sale to major mass market and specialty retailers, who in turn sell the products to consumers.



13





Earnings of industry segments and geographic areas exclude interest income, interest expense, depreciation expense, integration costs, and other unallocated corporate expenses. Income taxes are allocated to segments on the basis of operating results. Identified assets are those assets used in the operations of the segments and include inventory, receivables, goodwill and other intangibles. Corporate assets consist of cash, certain corporate receivables, fixed assets, and certain trademarks.



The primary measure of segment profit or loss reviewed by the chief operating decision maker is segment income (loss) from operations.



Industry Segments



As of and For the Three Months Ended June 30, 2006Agency
        
        Promotional
        
        ConsumerServices
        
        Products
        
        Products
        
        Corporate
        
        TotalTotal revenues
        
        $
        7,547
        $
        30,554
        $
        1,993
        $
        --
        $
        40,094Segment income (loss) from operations
        $
        2,202
        $
        1,683
        $
        166
        $
        (4,581)
        $
        (530)Fixed asset additions
        
        $
        --
        $
        --
        $
        --
        $
        577
        $
        577Depreciation and amortization
        $
        --
        $
        40
        $
        --
        $
        399
        $
        439Total assets
        
        $
        15,891
        $
        28,418
        $
        2,862
        $
        12,870
        $
        60,041As of and For the Three Months Ended June 30, 2007Agency
        
        Promotional
        
        ConsumerServices
        
        Products
        
        Products
        
        Corporate
        
        TotalTotal revenues
        
        $
        7,711
        $
        30,538
        $
        1,290
        $
        --
        $
        39,539Segment income (loss) from operations
        $
        769
        $
        1,854
        $
        393
        $
        (4,772)
        $
        (1,756)Fixed asset additions
        
        $
        --
        $
        --
        $
        --
        $
        463
        $
        463Depreciation and amortization
        $
        --
        $
        18
        $
        --
        $
        391
        $
        409Total assets
        
        $
        13,663
        $
        23,988
        $
        1,881
        $
        11,084
        $
        50,616As of and For the Six Months Ended June 30, 2006Agency
        
        Promotional
        
        ConsumerServices
        
        Products
        
        Products
        
        Corporate
        
        TotalTotal revenues
        
        $
        15,842
        $
        62,440
        $
        4,498
        $
        --
        $
        82,780Segment income (loss) from operations
        $
        3,478
        $
        3,190
        $
        140
        $
        (9,443)
        $
        (2,635)Fixed asset additions
        
        $
        --
        $
        --
        $
        --
        $
        1,046
        $
        1,046Depreciation and amortization
        $
        --
        $
        69
        $
        --
        $
        771
        $
        840Total assets
        
        $
        15,891
        $
        28,418
        $
        2,862
        $
        12,870
        $
        60,041As of and For the Six Months Ended June 30, 2007Agency
        
        Promotional
        
        ConsumerServices
        
        Products
        
        Products
        
        Corporate
        
        TotalTotal revenues
        
        $
        14,270
        $
        58,459
        $
        3,058
        $
        --
        $
        75,787Segment income (loss) from operations
        $
        1,423
        $
        2,584
        $
        861
        $
        (9,081)
        $
        (4,213)Fixed asset additions
        
        $
        --
        $
        --
        $
        --
        $
        957
        $
        957Depreciation and amortization
        $
        --
        $
        36
        $
        --
        $
        730
        $
        766Total assets
        
        $
        13,663
        $
        23,988
        $
        1,881
        $
        11,084
        $
        50,616






14



NOTE 6COMMITMENTS AND CONTINGENCIES



Operating Leases

The Company has operating leases for its properties and equipment, which expire at various dates through 2014.



Future minimum lease payments under non-cancelable operating leases as of June 30, 2007 are as follows:



Year2007 (remainder of)
        $
        2,1602008
        
        3,9812009
        
        3,7952010
        
        6652011
        
        546Thereafter
        
        1,112Total
        $
        12,259




Aggregate rental expenses for operating leases were $950 and $932 for the three months ended June 30, 2006 and 2007, respectively. Aggregate rental expenses for operating leases were $1,774 and $1,714 for the six months ended June 30, 2006 and 2007, respectively.



Guaranteed Royalties

For the three months ended June 30, 2006 and 2007, the Company incurred $254 and $63, respectively, in royalty expense. For the six months ended June 30, 2006 and 2007, the Company incurred $530 and $328, respectively, in royalty expense. As of June 30, 2007, the Company has committed to pay total minimum guaranteed royalties as follows:



Year2007 (remainder of)
        $
        672008
        
        280Total
        $
        347




NOTE 7STOCK BASED COMPENSATION

The Company has three stock compensation plans, which are more fully described in Note 8 to the Consolidated Financial Statements in its 2006 Annual Report on Form 10-K. Under the plans, the Company has the ability to grant stock options, restricted stock, restricted stock units (RSUs), stock bonuses, stock appreciation rights or performance units. Stock options expire no later than ten years from the date of grant and generally provide for vesting over a period of three or four years from the date of grant. Stock options are granted with exercise prices at or above the fair market value of the Companys common stock on the date of grant.



Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123(R) using the modified-prospective transition method. Prior to January 1, 2006, the Company applied the recognition and measurement principles of APB Opinion No. 25, and related interpretations in accounting for its employee stock compensation plans. All employee stock options were granted at or above the grant date market price and, accordingly, no compensation expense was recognized in the statements of operations for these employee stock options. Instead, the amount of compensation expense that would have resulted if the Company had applied the fair value recognition provisions of SFAS No. 123 was included as a proforma disclosure in the financial statement footnotes.



In accordance with SFAS No. 123(R), the Company reclassified $1,724 from the unearned compensation line item within stockholders equity to additional paid-in capital. The Company recorded this reclassification upon adoption of SFAS No. 123(R) on January 1, 2006.



Prior to January 1, 2006, the Company presented all benefits of tax deductions resulting from the exercise of share-based compensation as operating cash flows in the statements of cash flows. SFAS No. 123(R) requires the benefits of tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) be classified as financing cash flows. Excess tax benefits reflected as a financing cash inflow totaled $0 during the six months ended June 30, 2006 and 2007. Excess tax benefits reflected as an operating cash inflow totaled $0 during the six months ended June 30, 2006 and 2007.



15





The Company recognized no compensation expense for stock options during the six months ended June 30, 2006 and 2007. No options were granted during the six months ended June 30, 2006 and 2007.



Stock Options



The following is a summary of stock option information and weighted average exercise prices for the Companys stock option plans during the six months ended June 30, 2007:



Number
        
        
        Average Exercise Price
        
        Average Remaining Contractual Term
        
        
        Aggregate Intrinsic ValueOutstanding at January 1, 2007
        1,047,070
        
        $
        12.21Granted
        --
        
        
        --Exercised
        --
        
        
        --Forfeited
        --
        
        
        --Cancelled
        (80,200)
        
        
        13.76Outstanding at June 30, 2007
        966,870
        
        $
        12.09
        
        5.1
        
        $
        --Exercisable at June 30, 2007
        966,870
        
        $
        12.09
        
        5.1
        
        $
        --




The intrinsic value of stock options is the difference between the current market value and the exercise price. No options were exercised during the three and six months ended June 30, 2007.



Restricted Stock and Restricted Stock Units



The aggregate fair market value of the Companys restricted stock and RSU grants is being amortized to compensation expense over the vesting period (typically 3 or 4 years).  Compensation expense recognized related to grants of restricted stock and RSUs to certain employees and non-employee Board members was $255 and $394 for the three months ended June 30, 2006 and 2007, respectively.  Compensation expense recognized related to grants of restricted stock and RSUs to certain employees and non-employee Board members was $449 and $810 for the six months ended June 30, 2006 and 2007, respectively. As of June 30, 2007, there was $3,101 of unrecognized compensation cost related to unvested restricted stock and RSUs. This cost is expected to be recognized over a weighted average of 2.3 years.



The following table summarizes the number and weighted average grant date fair value of the Companys unvested restricted stock and RSUs as of June 30, 2006:



Weighted AverageGrant DateShares
        
        
        Fair ValueUnvested at January 1, 2007
        516,640
        
        $
        7.01Granted
        53,303
        
        
        5.21Vested
        (74,447)
        
        
        9.23Forfeited
        (16,650)
        
        
        6.66Unvested at June 30, 2007
        478,846
        
        $
        6.48




NOTE 8MANDATORILY REDEEMABLE PREFERRED STOCK



On June 30, 2006, the Company entered in an Exchange and Extension Agreement with Crown EMAK Partners, LLC (Crown) providing that: (a) the conversion price of the Companys Series AA Senior Cumulative Convertible Preferred Stock (Series AA Stock) would be reduced from $14.75 per share of Common Stock to $9.00 per share of Common Stock; (b) the 6% cumulative perpetual dividend on the $25,000 face value of the Series AA Stock ($1,500 per annum) would be permanently eliminated effective April 1, 2006; (c) the provisions pertaining to election of Series AA directors would be revised to permit the holders of the Series AA Stock to elect two directors except (i) if the number of Common Stock directors exceeds seven or (ii) in situations involving a potential Change of Control (as defined in the Certificate of Designation of Series AA Stock) at a
time when the total number of directors (inclusive of Common Stock directors and Series AA Stock directors) exceeds eight, in either of which instances the holders



16



of the Series AA Stock would be permitted to elect three directors; and (d) the terms of the Common Stock warrants held by Crown which previously expired on March 29 and June 20, 2010 would be extended until March 29 and June 20, 2012 (collectively, the Crown Transaction).



At the Companys Annual Meeting held on May 31, 2006, the Companys stockholders approved an amendment to the Certificate of Designation of the Companys Series AA Stock (the Certificate of Designation) in order to permit the closing of the Crown Transaction. The Certificate of Amendment of Certificate of Designation provides for the changes in the rights and preferences of the Series AA Stock.



The Crown Transaction was closed on June 30, 2006.  The Company accounted for the transaction as a modification of equity instruments.  As a result, the decrease in the fair value of the Series AA Stock was recorded as a reduction to mandatorily redeemable preferred stock of $873 with an offset to net income available to common stockholders.  The increased in the value of the common stock warrants was recorded as an increase to additional paid-in capital of $873 with an offset to net income available to common stockholders.  The net impact to income available to common stockholders is zero.  Direct outside costs related to this transaction totaled $157 and were recorded as a reduction to additional paid-in capital.



The Series AA Stock is recorded in the accompanying condensed consolidated balance sheets at its Liquidation Preference net of issuance costs and excess of Preferred Stock warrant redemption. The issuance costs total approximately $1,951.



17



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



Except as expressly indicated or unless the context otherwise requires, as used herein, EMAK, the Company, we, our, or us, meansEMAK Worldwide, Inc., a Delaware corporation and its subsidiaries. Unless otherwise specifically indicated, all dollar amounts herein are expressed in thousands.



Organization and Business



EMAK Worldwide, Inc., a Delaware corporation and subsidiaries, is a leading global marketing services company. We are the parent company of a family of marketing services agencies including Equity Marketing, Logistix and Upshot.  Our agencies are experts in consumer activation by offering strategy-based marketing programs that directly impact consumer behavior.  The agencies provide strategic planning and research, consumer insight development, entertainment marketing, design and manufacturing of custom promotional products, kids marketing, event marketing, shopper marketing and environmental branding. EMAK is headquartered in Los Angeles, with offices in Chicago, Amsterdam, Frankfurt, London, Paris and Hong Kong. The Company primarily sells to customers in the United States and Europe.



Our Equity Marketing agency services our largest client, Burger King. Equity Marketing serves as Burger Kings primary creative and manufacturing agency for its Kids Meals business. In addition, Equity Marketing provides agency services to Burger King for promotional categories outside of the kids segment, including Adult Promotions and Youth & Family Promotions. Equity Marketing operates in both our Promotional Products and Agency Services segments.



Our Logistix agency is an insight driven marketing services agency specializing in product-based solutions. Logistix operates in our Promotional Products, Agency Services and Consumer Products segments.



Our Upshot agency is a strategic marketing agency with expertise in promotional, event and collaborative marketing, retail design and environmental branding. Upshot has experience across a broad array of industries, including apparel, automotive, beer, candy, consumer packaged goods, financial services, greeting cards, home electronics, hospitality, government services, pharmaceuticals, soft drinks, spirits, telecommunications and timeshares. Upshot operates in our Agency Services segment.



Overview



Revenues for the second quarter of 2007 decreased 1.4% or $555 to $39,539 as compared to $40,094 recorded in the prior year. Cost of sales for the second quarter increased $446 to $29,318 as compared to $28,872 for the comparable period in 2006. This resulted in a net loss of $1,819 in the current year quarter compared to a net loss of $644 in the second quarter of 2006.



The decrease in revenues is primarily due to lower Promotional Products revenues from our Logistix agency and the wind-down of our Consumer Products business. The decreased revenues were partially offset by an increase in revenues at Upshot resulting from an increase in retainer revenues and work performed for new clients. We expect an increase in revenues for the second half of the year, which due to seasonal factors, is typically stronger than the first half.



We are focused on a return to meaningful profitability in 2008 and are deeply engaged in a comprehensive review of our business to assure not only that our operating expenses are aligned with revenues, but also that our client-by-client and program-by-program revenue models meet minimum profitability standards.  As part of this review, we recently initiated a Lean enterprise process improvement program, which is designed to streamline our operations.  We anticipate that this business review will result in near-term changes to our structure and operating model as we address changes in our level of business.



Our business review, as well as pending changes in key employees (discussed below under Cautionary Statements and Risk Factors), are expected to have an impact on our 2008 revenue mix and profitability.  While we expect that there will be a moderate decline in Agency Services revenues from our largest client, such declines should be offset by expected growth in revenues at Upshot.  While we currently do not expect significant near-term growth in revenues in our Promotional Products segment, cost reductions and process improvements are expected to improve our overall profitability in 2008 and beyond.



18



Results of Operations



The following table sets forth, for the periods indicated, the Companys operating results as a percentage of total revenues:



Three Months Ended
        
        
        Six Months EndedJune 30,
        
        
        June 30,2006
        
        
        2007
        
        
        2006
        
        
        2007Revenues
        100.0
        %
        
        100.0
        %
        
        100.0
        %
        
        100.0
        %Cost of sales
        72.0
        
        
        74.1
        
        
        74.0
        
        
        76.0Minimum royalty shortfall gain
        (0.2)
        
        
        --
        
        
        (0.1)
        
        
        --Gross profit
        28.2
        
        
        25.9
        
        
        26.1
        
        
        24.0Operating expenses:Salaries, wages and benefits
        16.4
        
        
        17.4
        
        
        16.2
        
        
        17.9Selling, general and administrative
        11.2
        
        
        12.9
        
        
        11.4
        
        
        11.7Restructuring charge
        1.9
        
        
        --
        
        
        1.7
        
        
        --Total operating expenses
        29.5
        
        
        30.3
        
        
        29.3
        
        
        29.6Loss from operations
        (1.3)
        
        
        (4.4)
        
        
        (3.2)
        
        
        (5.6)Other income (expense), net
        (0.2)
        
        
        --
        
        
        --
        
        
        --Loss before provision for income taxes
        (1.5)
        
        
        (4.4)
        
        
        (3.2)
        
        
        (5.6)Provision for income taxes
        0.1
        
        
        0.2
        
        
        0.1
        
        
        0.2Net loss
        (1.6)
        %
        
        (4.6)
        %
        
        (3.3)
        %
        
        (5.8)
        %




Three Months Ended June 30, 2007 Compared to Three Months Ended June 30, 2006 (In Thousands):



Revenues



Revenues for the three months ended June 30, 2007 decreased $555, or 1.4%, to $39,539 from $40,094 in the comparable period in 2006.



Promotional Products revenues decreased $16, or 0.1%, to $30,538 primarily as a result of lower revenues at our Logistix agency resulting from a challenging environment in Europe and fewer promotional programs. This was partially offset by an increase in revenues from our largest client.  Net foreign currency translation had a favorable impact to revenues of approximately $265 for Logistix (U.K.) versus the prior year period average exchange rates.



Our Agency Services segment revenues increased $164, or 2.2%, to $7,711. This increase is attributable to an increase in project work from new business and higher levels of retainer revenues from our existing clients at our Upshot agency.  This increase was partially offset by lower revenues for our Logistix (U.K.) business and lower agency services fees from our largest client.



Our Consumer Products segment revenues decreased $703, or 35.3%, to $1,290. The decrease is primarily attributable to the wind-down of the non-core business. For the three months ended June 30, 2007, the only remaining license agreement after the wind-down was for Crayola®product.  Our second quarter 2006 Consumer Product revenues were primarily comprised of Crayola®and JoJos Circus product.



Cost of sales and gross profit



Cost of sales increased $446 to $29,318 (74.1% of revenues) for the three months ended June 30, 2007 from $28,872 (72.0% of revenues) in the comparable period in 2006 primarily as a result of an increase in direct outside costs associated with our increased agency services revenues.



Our gross margin percentage decreased to 25.9% for the three months ended June 30, 2007 from 28.2% in the comparable period for 2006.



The gross profit percentage for our Promotional Products segment for the three months ended June 30, 2007 decreased slightly to 24.1% compared to 25.1% for the comparable period in 2006. This decrease is attributable to normal margin fluctuation for promotional programs.



The gross profit percentage for our Agency Services segment for the three months ended June 30, 2007 decreased to 30.0% compared to 39.0% for the comparable period in 2006.  This decrease is primarily attributable to a lower level of fee-based revenues from our largest client as compared to the same period last year.  The decrease is also attributable to an increase in



19



direct outside costs associated with an increase in project work at our Upshot agency.  Agency Services gross profit includes direct outside costs which fluctuate, making period-over-period comparables of the gross profit percentages difficult.  Typically billings for direct outside costs, which are included in revenues, have very low gross margins. In periods in which segment revenues contain significant direct outside costs, the overall gross profit percentage will be lower.



The gross profit percentage for our Consumer Products segment for the three months ended June 30, 2007 increased to 41.2% compared to 35.1% for the comparable period in 2006. This increase in the margin is attributable to a better sales mix of Crayola product and fewer close-out sales of older product lines as compared to the same period last year. For the three months ended June 30, 2006, a gain of $88 was recorded on the partial reversal of a previously recorded minimum royalty guarantee shortfall charge recorded in the fourth quarter of 2004. Excluding the impact of the gain on the reversal of previously recorded minimum royalty guarantee shortfalls, the gross profit percentage would have been 30.7% in 2006.



Salaries, wages and benefits



Salaries, wages and benefits increased $284, or 4.3%, to $6,871 (17.4% of revenues) for the three months ended June 30, 2007 from $6,587 (16.4% of revenues) in the comparable period for 2006. This increase was primarily attributable to annual employee merit increases, an increase in retention and signing bonuses and an increase in expense for restricted stock units.



Selling, general and administrative expenses



Selling, general and administrative expenses increased $619, or 13.8%, to $5,106 (12.9% of revenues) for the three months ended June 30, 2007 from $4,487 (11.2% of revenues) in the comparable period for 2006. The increase is attributable increased spending on information technology consulting, higher spending on marketing and public relations, consulting related to Sarbanes-Oxley compliance and higher legal fees.



Restructuring charge



We recorded a restructuring charge of $766 (1.9% of revenues) during the three months ended June 30, 2006. This charge represents severance expenses and other termination costs related to the reorganization of the SCI Promotion agency and the elimination of two senior management positions as a result of the consolidation of SCI Promotion, Pop Rocket and Megaprint Group into the new Logistix agency. See Restructuring and Minimum Royalty Guarantee Shortfalls below.



Other income (expense)



Other income (expense) increased $97 to $14 for the three months ended June 30, 2007 from $(83) in the comparable period for 2006. The increase is primarily due to an increase in net interest income of $70 from net interest expense of $34 in the comparable period for 2006.



Provision for income taxes



The effective tax rate for the three months ended June 30, 2007 was (4.4)% compared to (5.1)% for the same period in 2006. In 2006 and 2007, we recorded a tax provision for our Asia-based operations and recognized no tax provision (benefit) from our operations in the United States and the United Kingdom due to our valuation allowance.



Net loss



Net loss increased $1,175 to $(1,819) ((4.6)% of revenues) in 2007 from $(644) ((1.6)% of revenues) in 2006. This increase is primarily due to lower gross margins as well as increased salaries, wages and benefits, and selling, general and administrative expenses. This increase was partially offset by a restructuring charge recorded in 2006.



Six Months Ended June 30, 2007 Compared to Six Months Ended June 30, 2006 (In Thousands):



Revenues



Revenues for the six months ended June 30, 2007 decreased $6,993, or 8.4%, to $75,787 from $82,780 in the comparable period in 2006. Promotional Products revenues decreased $3,981, or 6.4%, to $58,459 primarily as a result of lower revenues at our Logistix agency resulting from the challenging environment in Europe and fewer promotional programs. Net foreign currency translation had a favorable impact to revenues of approximately $1,358 for Logistix (U.K.) versus the prior year period average exchange rates.



20



Our Agency Services segment revenues decreased $1,572, or 9.9%, to $14,270. The decrease is attributable to lower revenues at our Logistix (U.K.) business as a result of a large program in 2006 that was not repeated in 2007 and a decrease in agency fee revenues from our largest client. This decrease was partially offset by an increase attributable to new business and higher levels of retainer revenues from our existing clients at our Upshot agency.



Our Consumer Products segment revenues decreased $1,440, or 32.0%, to $3,058. The decrease is primarily attributable to the wind-down of the non-core business. For the six months ended June 30, 2007, the only remaining license agreement after the wind-down was for Crayola®product. Our first half of 2006 Consumer Product revenues were primarily comprised of Crayola®and JoJos Circus product.



Cost of sales and gross profit



Cost of sales decreased $3,622 to $57,603 (76.0% of revenues) for the six months ended June 30, 2007 from $61,225 (74.0% of revenues) in the comparable period in 2006 primarily due to lower sales volume in 2007.



Our gross margin percentage decreased to 24.0% for the six months ended June 30, 2007 from 26.1% in the comparable period for 2006.



The gross profit percentage for our Promotional Products segment for the six months ended June 30, 2007 decreased to 22.0% compared to 24.5% for the comparable period in 2006. This decrease is attributable to the deferral of high margin creative fees due to the timing of certain promotional programs.



The gross profit percentage for our Agency Services segment for the six months ended June 30, 2007 decreased to 28.9% compared to 31.4% for the comparable period in 2006.  This decrease is primarily attributable to a lower level of fee-based revenues from our largest client as compared to the same period last year.  This decrease was partially offset by a higher level of retainer revenues and project fees from new and existing clients at our Upshot agency.  The decreased margins were also offset by a decrease in the level of direct outside costs relative to the same period in 2006.  Agency Services gross profit includes direct outside costs which fluctuate, making period-over-period comparables of the gross profit percentages difficult.  Typically billings for direct outside costs, which are included in revenues, have very low gross margins. In periods in which segment revenues contain significant direct
outside costs, the overall gross profit percentage will be lower.



The gross profit percentage for our Consumer Products segment for the six months ended June 30, 2007 increased to 39.0% compared to 30.9% for the comparable period in 2006. This increase in the margin is attributable to a better sales mix of Crayola product and fewer close-out sales of older product lines as compared to the same period last year. For the six months ended June 30, 2006, a gain of $88 was recorded on the partial reversal of a previously recorded minimum royalty guarantee shortfall charge recorded in the fourth quarter of 2004. Excluding the impact of the gain on the reversal of previously recorded minimum royalty guarantee shortfalls, the gross profit percentage would have been 28.9% in 2006.



Salaries, wages and benefits



Salaries, wages and benefits increased $92, or 0.7%, to $13,534 (17.9% of revenues) for the six months ended June 30, 2007 from $13,442 (16.2% of revenues) in the comparable period for 2006. This increase was primarily attributable to annual employee merit increases, an increase in retention and signing bonuses and an increase in expense for restricted stock units, partially offset by a lower average headcount in 2007 compared to the same period in 2006.  We completed the bulk of the cost reductions associated with our previous restructuring efforts by the end of the second quarter of 2006.



Selling, general and administrative expenses



Selling, general and administrative expenses decreased $601, or 6.4%, to $8,863 (11.7% of revenues) for the six months ended June 30, 2007 from $9,464 (11.4% of revenues) in the comparable period for 2006. The decrease is attributable to a decrease in freight out and third party warehousing expenses as a result of lower revenues and inventory levels for Consumer Products.  The decrease is also attributable to lower occupancy costs resulting from the termination of an office and warehouse lease in Ontario, California.  These decreases were partially offset by higher costs for information technology consulting, higher spending on marketing and public relations and consulting related to Sarbanes-Oxley compliance.



Restructuring charge



We recorded a restructuring charge of $1,372 (1.7% of revenues) during the six months ended June 30, 2006. This charge represents severance expenses and other termination costs related to the reorganization of the SCI Promotion agency and the elimination of two senior management positions as a result of the consolidation of SCI Promotion, Pop Rocket and Megaprint Group into the new Logistix agency. See Restructuring and Minimum Royalty Guarantee Shortfalls below.



21





Other expense



Other expense decreased $46 to $3 for the six months ended June 30, 2007 from $49 in the comparable period for 2006. The decrease is primarily due to an increase in net interest income of $72 from net interest expense of $46 in the comparable period for 2006.



Provision for income taxes



The effective tax rate for the six months ended June 30, 2007 was (4.6)% compared to (1.8)% for the same period in 2006. In 2006 and 2007, we recorded a tax provision for our Asia-based operations and recognized no tax provision (benefit) from our operations in the United States and the United Kingdom due to our valuation allowance.



Net loss



Net loss increased $1,680 to $(4,412) ((5.8)% of revenues) in 2007 from $(2,732) ((3.3)% of revenues) in 2006. This increase is primarily due to a decrease in sales volume in 2007 and fewer high margin creative fees earned. This increase was partially offset by a restructuring charge recorded in 2006.



Financial Condition and Liquidity



At June 30, 2007, cash and cash equivalents were $2,998, compared to $8,677 as of December 31, 2006. At June 30, 2007, restricted cash was $1,347, compared to $1,319 as of December 31, 2006. The decrease in cash and cash equivalents was attributable to cash flows used in operating activities.



As of June 30, 2007, working capital was $5,918 compared to $9,963 at December 31, 2006. Cash used in operations for the six months ended June 30, 2007 was $4,771 compared to $2,803 in the prior year period. Cash flows used in operations in the three months ended June 30, 2007 were primarily the result of cash used to pay down accounts payable and accrued liabilities from fourth quarter 2006 promotional programs. Cash flows used in investing activities for the six months ended June 30, 2007 were $956 compared to $2,556 in the prior year. This decrease is primarily the result of restricted cash used to fund a bank guarantee to a new vendor of our Logistix (U.K.) subsidiary in 2006. Furthermore in 2006, the former Megaprint shareholders were paid $313 upon release of a purchase price holdback. Cash flows from financing activities for the six months ended June 30, 2007 were zero compared to cash provided of $967
as a result of short-term borrowings that was partially offset by the payment of preferred stock dividends for the six months ended June 30, 2006. The reduction in cash used in financing activities is due to the elimination of preferred stock dividends effective April 1, 2006 (see Preferred Stock below).



As of June 30, 2007, our net accounts receivable decreased $5,797 to $18,530 from $24,327 at December 31, 2006. The decrease was due to the seasonal nature of our business, as the fourth quarter tends to be the highest volume quarter of the year resulting in our highest accounts receivable levels each year.



As of June 30, 2007, inventories increased $803 to $7,189 from $6,386 at December 31, 2006. This increase is attributable to the timing of shipments of products in the Promotional Products segment related to third quarter 2007 programs.  Consumer Products inventories represent 23.6% and 24.6% of total inventories as of December 31, 2006 and June 30, 2007, respectively. Promotional product inventory used in Promotional Products generally has lower risk than Consumer Product inventory, as it usually represents product made to order.



As of June 30, 2007, accounts payable decreased $5,468 to $14,770 from $20,238 at December 31, 2006. This decrease was attributable to the payment of liabilities related to fourth quarter 2006 promotional programs. Due to the seasonal nature of our business, the fourth quarter tends to be the highest volume quarter of the year.



As of June 30, 2007, accrued liabilities decreased $2,376 to $11,864 from $14,240 at December 31, 2006. This decrease is primarily attributable to the payment of administrative fees collected from distribution companies on behalf of a Promotional Products customer for a large program that occurred in the fourth quarter of 2006. The decrease is also attributable to the payments of payroll and payroll related liabilities.



As of the date hereof, we believe that cash from operations, cash on hand at June 30, 2007 and our credit facility will be sufficient to fund our working capital needs for the next twelve months and for the foreseeable future. The statements set forth herein are forward-looking and actual results may differ materially.



22



Future minimum annual commitments for guaranteed minimum royalty payments under license agreements, non-cancelable operating leases and employment agreements as of June 30, 2007 are as follows:



2007
        
        2008
        
        2009
        
        2010
        
        2011
        Thereafter
        
        TotalOperating Leases
        $
        2,160
        $
        3,981
        $
        3,795
        $
        665
        $
        546
        $
        1,112
        $
        12,259Guaranteed Royalties
        
        67
        
        280
        
        --
        
        --
        
        --
        
        --
        
        347Employment Agreements
        
        1,834
        
        618
        
        --
        
        --
        
        --
        
        --
        
        2,452Total
        $
        4,061
        $
        4,879
        $
        3,795
        $
        665
        $
        546
        $
        1,112
        $
        15,058




We had no material commitments for capital expenditures at June 30, 2007. Letters of credit outstanding as of December 31, 2006 and June  30, 2007 totaled $310 and $3,010, respectively.



Restructuring and Minimum Royalty Guarantee Shortfalls



As a result of the wind-down of a substantial majority of our Consumer Products business, in 2004 we recorded a charge relating to minimum royalty guarantee shortfalls on several Consumer Products licenses.  In 2006, we reached a settlement with one of our licensors which resulted in a reversal of $88. The gain was recorded as minimum royalty guarantee shortfall gains in the consolidated statements of operations for the three and six months ended June 30, 2006.



In connection with the Consumer Products wind-down, we incurred a charge for one-time employee termination benefits and other costs of $51 for three and six months ended June 30, 2006.  The entire amount is attributable to the Consumer Products segment.



In 2006, we eliminated several centralized corporate positions as a result of an ongoing realignment of centralized resources. As a result, we incurred a charge for one-time employee termination benefits and other costs totaling approximately $165 for the six months ended June 30, 2006. The entire amount is attributable to the corporate segment.



In 2006, we eliminated several positions at Logistix (U.K.) as a result of a less than optimal staff utilization rate resulting from a decrease in revenues. In connection with this decision, we incurred charges for one-time employee termination benefits and other costs of $6 and $84 for the three and six months ended June 30, 2006, respectively.  The entire amount is attributable to the Promotional Products segment.



As part of our decision to reorganize and consolidate SCI Promotions offices in Ontario, California with its Los Angeles office, we recorded a charge for one-time employee termination benefits and other costs totaling $426 and $789 for the three and six months ended June 30, 2006, respectively. The entire amount is attributable to the Promotional Products segment.



As part of our decision to consolidate the SCI Promotion, Pop Rocket and Megaprint Group agencies into Logistix, we eliminated two senior management positions. We recorded a charge for one-time employee termination benefits and other costs totaling $283 for the three and six months ended June 30, 2006. The entire amount is attributable to the Promotional Products segment.



24



The following table summarizes activity in our restructuring reserve.



Pop Rocket*
        Centralized Corporate*
        Los Angeles Office Sublease
        Logistix (U.K.)*
        SCI Promotion*
        Logistix Consolidation*
        Hong Kong*
        TotalOriginal charge
        $
        746
        $
        622
        $
        184
        $
        568
        $
        640
        $
        -
        $
        -
        $
        2,760Utilization in 2005
        
        (513)
        
        (261)
        
        -
        
        (137)
        
        (110)
        
        -
        
        -
        
        (1,021)Reserve at December 31, 2005
        
        233
        
        361
        
        184
        
        431
        
        530
        
        -
        
        -
        
        1,739Additional charge
        
        -
        
        165
        
        -
        
        78
        
        363
        
        -
        
        -
        
        606Utilization
        
        (164)
        
        (235)
        
        (101)
        
        (4)
        
        (306)
        
        -
        
        -
        
        (810)Reserve at March 31, 2006
        
        69
        
        291
        
        83
        
        505
        
        587
        
        -
        
        -
        
        1,535Additional charge
        
        51
        
        -
        
        -
        
        6
        
        426
        
        283
        
        -
        
        766Utilization
        
        (83)
        
        (155)
        
        (5)
        
        (318)
        
        (589)
        
        (37)
        
        -
        
        (1,187)Reserve at June 30, 2006
        
        37
        
        136
        
        78
        
        193
        
        424
        
        246
        
        -
        
        1,114Partial reversal of previously recorded one-time employee termination benefits and other related costs
        
        (13)
        
        (107)
        
        -
        
        (31)
        
        (5)
        
        -
        
        -
        
        (156)Additional charge
        
        -
        
        -
        
        -
        
        -
        
        -
        
        -
        
        94
        
        94Utilization
        
        (24)
        
        (29)
        
        (6)
        
        (40)
        
        (236)
        
        (134)
        
        (94)
        
        (563)Reserve at September 30, 2006
        
        -
        
        -
        
        72
        
        122
        
        183
        
        112
        
        -
        
        489Partial reversal of previously recorded one-time employee termination benefits and other related costs
        
        -
        
        -
        
        -
        
        (36)
        
        (61)
        
        -
        
        -
        
        (97)Utilization
        
        -
        
        -
        
        (5)
        
        (65)
        
        (113)
        
        (90)
        
        -
        
        (273)Reserve at December 31, 2006
        
        -
        
        -
        
        67
        
        21
        
        9
        
        22
        
        -
        
        119Utilization
        
        -
        
        -
        
        (6)
        
        (21)
        
        (6)
        
        -
        
        -
        
        (33)Reserve at March 31, 2007
        
        -
        
        -
        
        61
        
        -
        
        3
        
        22
        
        -
        
        86Utilization
        
        -
        
        -
        
        (5)
        
        -
        
        -
        
        -
        
        -
        
        (5)Reserve at June 30, 2007
        $
        -
        $
        -
        $
        56
        $
        -
        $
        3
        $
        22
        $
        -
        $
        81




* One-time employee termination benefits and other related costs.



Credit Facilities



On March 29, 2006, we entered into a credit facility (the Facility) with Bank of America. The maturity date of the Facility is March 29, 2009.  The Facility is collateralized by substantially all of our assets and provides for a line of credit of up to $25,000 with borrowing availability determined by a formula based on qualified assets.  Borrowing availability is determined on a weekly basis and fluctuates primarily with the levels of eligible accounts receivable which vary based on the timing of promotional programs.  For the six months ended June 30, 2007, borrowing availability has ranged from $4,311 to $11,268.  During this same period, there were no borrowings under the Facility.  The Facility was used to issue letters of credit.



Interest on outstanding borrowings will be based on either a fixed rate equivalent to LIBOR plus an applicable spread of between 2.50 and 3.00 percent or a variable rate equivalent to the banks reference rate plus an applicable spread of between 0.75 and 1.25 percent.  We are also required to pay an unused line fee of between 0.375 and 0.50 percent per annum and certain letter of credit fees.  The applicable spread is based on the levels of borrowings relative to qualified assets.  The Facility also requires us to comply with certain restrictions and covenants as amended from time to time.  The Facility may be used for working capital and other corporate financing purposes. As of December 31, 2006 and June 30, 2007, the marginal interest rate on available borrowings under the Facility was 9.0%, respectively.  As of June 30, 2007, we were in compliance with the restrictions and covenants.



As of June 30, 2007, zero was outstanding under the Facility.  Letters of credit outstanding under the Facility as of December 31, 2006 and June 30, 2007 totaled $310 and $3,010, respectively.



25





Preferred Stock



On June 30, 2006, we entered in an Exchange and Extension Agreement with Crown EMAK Partners, LLC (Crown) providing that: (a) the conversion price of the our Series AA Senior Cumulative Convertible Preferred Stock (Series AA Stock) would be reduced from $14.75 per share of Common Stock to $9.00 per share of Common Stock; (b) the 6% cumulative perpetual dividend on the $25,000 face value of the Series AA Stock ($1,500 per annum) would be permanently eliminated effective April 1, 2006; (c) the provisions pertaining to election of Series AA directors would be revised to permit the holders of the Series AA Stock to elect two  directors except (i) if the number of Common Stock directors exceeds seven or (ii) in situations involving a potential Change of Control (as defined in the Certificate of Designation of Series AA Stock) at a time when the total
number of directors (inclusive of Common Stock directors and Series AA Stock directors) exceeds eight, in either of which instances the holders of the Series AA Stock would be permitted to elect three directors; and (d) the terms of the Common Stock warrants held by Crown which previously expired on March 29 and June 20, 2010 would be extended until March 29 and June 20, 2012 (collectively, the Crown Transaction).



At our Annual Meeting held on May 31, 2006, our stockholders approved an amendment to the Certificate of Designation of the Companys Series AA Stock (the Certificate of Designation) in order to permit the closing of the Crown Transaction. The Certificate of Amendment of Certificate of Designation provides for the changes in the rights and preferences of the Series AA Stock.



The Crown Transaction was closed on June 30, 2006.  We accounted for the transaction as a modification of equity instruments.  As a result, the decrease in the fair value of the Series AA Stock was recorded as a reduction to mandatorily redeemable preferred stock of $873 with an offset to net income available to common stockholders.  The increased in the value of the common stock warrants was recorded as an increase to additional paid-in capital of $873 with an offset to net income available to common stockholders.  The net impact to income available to common stockholders is zero.  Direct outside costs related to this transaction totaled $157 and were recorded as a reduction to additional paid-in capital.



The Series AA Stock is recorded in the accompanying condensed consolidated balance sheets at its Liquidation Preference net of issuance costs and excess of Preferred Stock warrant redemption. The issuance costs total approximately $1,951.



Recent Accounting Pronouncements



In September 2006, the Financial Accounting Standards Board, or FASB issued SFAS No. 157, Fair Value Measurements, which provides guidance for using fair value to measure assets and liabilities. The standard also responds to investors requests expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS No. 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. Under SFAS No. 157, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. SFAS No. 157
clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data, for example, the reporting entitys own data. Fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We do not expect the adoption of SFAS No. 157 to have a material impact on our results of operations and financial position.



In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which provides companies with an option to report selected financial assets and liabilities at fair value. The objective of SFAS No. 159 is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective for the Company as of January 1, 2008. We do not expect the adoption of SFAS No. 159 to have a material impact on our results of operations or financial position.



Cautionary Statements and Risk Factors



Set forth below and elsewhere in this Form 10-Q and in other documents we file with the Securities and Exchange Commission are important risks and uncertainties that could cause our actual results of operation, business and financial condition to differ materially from the results contemplated by the forward looking statements contained in this Form 10-Q.



26





We Depend Significantly on One Key Customer



Our success is partly dependent on a single customer, Burger King (including its franchise purchasing cooperative Restaurant Services, Inc. (RSI) and various distribution companies), which accounted for approximately 51%, 52% and 48% of our revenues for the years ended December 31, 2004, 2005 and 2006, respectively.  The termination or a significant reduction by Burger King of its business with us, particularly our promotional products business, would adversely affect our business.  The Burger King business is subject to significant year-to-year variability, and over recent periods has materially declined.  The revenues generated by our business with Burger King decreased from $120,606 in 2004 to $117,257 in 2005 and $87,865 in 2006.  Due to this volatility, the profitability of our business with Burger King is dependent on our ability to control related costs, many of which are fixed and cannot be
reduced in response to decreases in the level of business.  The success of our business with Burger King is also partially dependent on the overall success of the Burger King system, whose sales could be negatively impacted by such factors as increased competition and product recalls.  A continued reduction in our revenues from Burger King, if material, would adversely affect our business.



We depend on key employees.



We depend on the continued service of our senior management and other key employees.  The loss of a key employee could hurt our business, particularly in the case of key employees who hold strategic relationships with our clients.  Two of our key employees have advised us that they do not currently intend to continue their employment after the end of the current fiscal year.  We currently believe that, based upon discussions with the client served by these executives and other restructuring initiatives being pursued, these departures will not have a material adverse effect on our business.  However, if the outcomes of discussions with the client or other initiatives fail to achieve the anticipated results, our business could be materially adversely affected.  Our future success depends on our ability to identify, attract, train, motivate and retain other highly skilled personnel.  Failure to do so may
adversely affect our results.  We do not maintain key person life insurance policies on any of our employees.



We Face Credit Risk



We regularly extend credit to distribution companies in connection with our business with the Burger King system, which includes Supply Chain Services, LLC (SCS), which is a subsidiary of RSI.  We began selling product to SCS in October 2003.  Sales to SCS represented 65.1% of our sales to the Burger King System in 2006.  Failure by SCS to honor their payment obligations to us could have a material adverse effect on our operations.  Because of SCSs established credit history with us, we do not believe that the concentration of receivables has a negative impact to our overall credit risk.  We occasionally provide SCS with extended payment terms of up to 60 days.  We also extend credit to several retailers in connection with various promotional programs as well as with our Consumer Products business.  The mass-market retail channel has experienced significant shifts in market share among
competitors in recent years, causing some large retailers to experience liquidity problems.  Failure by one or more of these retailers to honor their payment obligations to us could have a material adverse effect on our business.



We Rely on the Continued Development of New Promotional Programs



A large portion of our revenues come from a relatively limited number of promotional programs which are in effect for only a limited period of time and generally are not repeated.  We must continually develop and sell new products and services for utilization in new promotional programs as part of our clients annual promotions calendars.  There can be no assurance that we, or our customers, will be able to secure licenses for additional entertainment properties on which to base our promotional programs or that, if secured, such licenses will result in successful products.



The Success of Our Products Depends on the Popularity of Licensed Materials



Our promotional products are typically based on entertainment properties, such as characters from current motion pictures or television programs.  The success of these products largely depends on the popularity of the entertainment properties on which they are based.  Each motion picture and television program is an individual artistic work, and its commercial success is dependent on unpredictable consumer preferences.  Our results of operations may be adversely affected if the entertainment properties upon which our products are based turn out to be less popular than we anticipate.  Also, delays in the release of motion pictures or television programs could result in delays or cancellations of our promotions.



Our Future Operating Results are Difficult to Predict



We experience significant quarter-to-quarter variability in our revenues and net income (loss).  The promotions business tends to include larger promotions in the summer and during the winter holiday season.  Major movie and television release schedules also vary year-to-year, influencing the promotional schedules of our customers, as well as the particular promotions for which



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we are retained.  The motion picture or television characters on which the promotions business is often based may only be popular for short periods of time or not at all.  There may not be comparable popular characters or similar promotional campaigns in the future.  Due to the foregoing factors, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance.  It is likely that in some future quarter our operating results may fall below the expectations of securities analysts and investors.



Our Business is Subject to Extensive Government Regulation and to Potential Product Liability Claims



Our business is subject to the provisions of, among other laws, the Federal Consumer Products Safety Act and the Federal Hazardous Substances Act, and rules and regulations promulgated under these acts.  These statutes are administered by the Consumer Product Safety Commission (CPSC), which has the authority to remove from the market products that are found to be defective and present a substantial hazard or risk of serious injury or death.  The CPSC can require a manufacturer to recall, repair, or replace these products under certain circumstances.  We cannot assure that defects in our products will not be alleged or found.  Products that we develop and sell may expose us to liability from claims by users of such products for damages including, but not limited to, bodily injury or property damage.  We currently maintain product liability insurance coverage in amounts that we believe are adequate.
There can be no assurance that we will be able to maintain such coverage or obtain additional coverage on acceptable terms in the future, or that such insurance will provide adequate coverage against all potential claims.  Products that we develop or sell may also expose us to liability for the costs related to product recalls.  These costs can include legal expenses, advertising, collection and destruction of product, and free goods.  Our product liability insurance coverage generally excludes such costs and damages resulting from product recall.



Our Markets Are Highly Competitive



The markets in which our businesses operate are highly competitive.  Our competitors, and in many cases their parent companies, include companies which have far more extensive sales and development staffs and significantly greater financial, marketing and other resources than we do.  There can be no assurance that we will be able to compete effectively against such companies.



We Rely on Foreign Manufacturers



During 2006, approximately 93% of our products were manufactured in China.  Foreign manufacturing is subject to a number of risks, including transportation delays and interruptions, political and economic disruptions, the imposition of tariffs, quotas and other import or export controls, and changes in governmental policies.  In addition, past outbreaks of Severe Acute Respiratory Syndrome (SARS) have been significantly concentrated in Asia, particularly in Hong Kong and in the Guangdong province of China, where many of our contract manufacturers are located.  The development and manufacture of our products could suffer if a significant number of our employees in Hong Kong or the employees of our contract manufacturers in China contract SARS or other communicable diseases, or are otherwise unable to fulfill their responsibilities.



We do not have long-term contracts with our foreign manufacturers.  Although we believe we could secure other third-party manufacturers to produce our products, our operations could be adversely affected if we lost our relationship with several of our current foreign manufacturers.



Virtually all of the raw materials used in our products are available to our contract manufacturers from numerous suppliers.  Our manufacturers do not have long-term supply contracts in place with their raw materials suppliers.  Accordingly, we are subject to variations in the prices we pay to our manufacturers for products, depending on what they pay for their raw materials.  An increase in the cost of raw materials, such as petroleum, could result in price increases that we may not be able to fully pass on to our customers.  Any such increase could negatively impact our business, financial condition or results of operations.



We Face Foreign Currency Risk



As part of our business, we enter into contracts for the purchase and sale of products with entities in foreign countries.  While the vast majority of our contracts are denominated in U.S. dollars, significant fluctuations in the local currencies of the entities with which we transact business may adversely affect these entities abilities to fulfill their obligations under their contracts.



Logistix (U.K.) enters into contracts denominated primarily in U.S. dollars, GBP and Euros.  Although we attempt to reduce its exposure to changes in foreign currency exchange rates through the use of certain hedging techniques, changes in such exchange rates may result in changes in the value of our commitments and anticipated foreign currency cash flows.



We May Issue Preferred Stock



Our Board of Directors has authority to issue up to one million shares of preferred stock, and to fix the rights, preferences,



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privileges and restrictions of those shares without any further vote or action by our stockholders.  The potential issuance of preferred stock may have the effect of delaying, deferring or preventing a change in control and may discourage bids for the Common Stock at a premium over the market price of the Common Stock and may adversely affect the market price of, and the voting and other rights of, the holders of Common Stock.  The outstanding Series AA Stock is senior to any class of preferred stock that might be authorized by the Board of Directors in the future.



The market price of our common stock is likely to be volatile.



Our stock price has fluctuated widely, ranging from $2.50 to $7.88 per share during the twelve month period ended June 30, 2007.  Our stock price will likely continue to fluctuate in response to factors such as quarterly variations in operating results, operating results that vary from the expectations of securities analysts and investors, changes in financial estimates, changes in market valuations of competitors, announcements by us or our competitors of a material nature, additions or departures of key personnel, future sales of Common Stock and stock volume fluctuations.



We may have limited ability to fully use our recorded tax loss carryforwards.



We have accumulated approximately $8,582 of tax loss carryforwards to be used in future periods if we become profitable.  If we were to experience a significant change in ownership, Internal Revenue Code Section 382 may restrict the future utilization of these tax loss carryforwards even if we become profitable.



We undertake no obligation to publicly release the results of any revisions to forward-looking statements, which may be made to reflect events or circumstance after the date hereof or to reflect the occurrence of unanticipated events.  The risks highlighted herein should not be assumed to be the only items that could affect future performance.  In addition to the information contained in this document, readers are advised to review our Form 10-K for the year ended December 31, 2006, under the heading Managements Discussion and Analysis of Financial Condition and Results of Operation - Cautionary Statements and Risk Factors.



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



For quantitative and qualitative disclosures about market risk affecting the Company, see Item 7A Quantitative and Qualitative Disclosures About Market Risk of our Annual Report on Form 10-K for the year ended December 31, 2006. Our exposure to market risks has not changed materially since December 31, 2006.



ITEM 4. CONTROLS AND PROCEDURES



Evaluation of Disclosure Controls and Procedures



The Companys management, including its Principal Executive Officer and Principal Accounting Officer, has evaluated the effectiveness of the Companys disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) as of the end of the reporting period covered by this quarterly report on Form 10-Q. Based on such evaluation, the Principal Executive Officer and Principal Accounting Officer have concluded that, as of the end of the period covered by this quarterly report on Form 10-Q, the Companys disclosure controls and procedures are effective such that material information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified by the Securities and Exchange
Commissions rules and forms relating to the Company.



Changes in Internal Control Over Financial Reporting



The Company made no change to its internal control over financial reporting or in other factors that materially affected, or were reasonably likely to have materially affected, its internal control over financial reporting during the quarter ended June 30, 2007.



The Company continues to implement a conversion to new and upgraded financial and human resources information technology systems that is expected to be completed in 2008. The Company has evaluated the effect on its internal control over financial reporting of this conversion and determined that this conversion has not materially affected, and is not reasonably likely to materially affect, as defined in Rule 13a-15(f) promulgated under the Exchange Act, the Companys internal control over financial reporting. The Company has not made any material changes to its internal control over financial reporting or in other factors that could materially affect these controls subsequent to June 30, 2007.



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PART II. OTHER INFORMATION



ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



The Annual Meeting of Stockholders of the Company was held on May 31, 2007. Proxies for the Annual Meeting were solicited pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, and there was no solicitation in opposition to that of management. All of managements nominees for directors as listed in the proxy statement were elected. At the Annual Meeting, the following matters were approved by the stockholders:



Votes For
        
        Votes Withheld1.
        
        Election of Directors by holders of Common StockHoward D. Bland
        
        3,933,408
        
        1,767,654James L. Holbrook, Jr.
        
        3,932,908
        
        1,768,154Daniel W. OConner
        
        3,933,308
        
        1,767,754Alfred E. Osborne, Jr.
        
        3,917,455
        
        1,773,607Charles H. Rivkin
        
        3,933,408
        
        1,767,654Stephen P. Robeck
        
        3,825,387
        
        1,875,6752.
        
        Election of Director by holders of Series A Preferred StockJeffrey S. Deutschman
        
        25,000
        
        --




Votes For
        
        Votes Against
        
        Abstain3
        
        Proposal to approve amendment and restatement of certificate of designation Series AA senior cumulative convertible preferred stock.
        
        6,168,613
        
        175,780
        
        1,517,3734
        
        Proposal to ratify appointment of Deloitte & Touche LLP as independent registered public accounting firm
        
        6,891,022
        
        118,881
        
        1,468,736




ITEM 6. EXHIBITS



Exhibit 31.1
        Certification of Chief Executive Officer pursuant to Section 302 of the SarbanesOxley Act of 2002.




Exhibit 31.2
        Certification of Principal Accounting Officer pursuant to Section 302 of the SarbanesOxley Act of 2002.




Exhibit 32.1
        Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.




Exhibit 32.2
        Certification of Principal Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.




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SIGNATURES




Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



EMAK Worldwide, Inc.








Date
        August 14, 2007
        
        /s/ Roy DarRoy Dar
Senior Vice President, Controller
(Principal Accounting Officer)








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