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 September 30, 2006  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, 5,848,849 shares as of November 13, 2006. 
    EMAK WORLDWIDE, INC.  Index To Quarterly Report on Form 10-Q Filed with the Securities and Exchange Commission September 30, 2006  PagePart I.
        Financial InformationItem 1.
        Financial Statements
        3Item 2.
        Management's Discussion and Analysis of Financial Condition and Results of Operations
        20Item 3.
        Quantitative and Qualitative Disclosures About Market Risk
        28Item 4.
        Controls and Procedures
        28Part II.
        Other InformationItem 6.
        Exhibits
        29
  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.  2  PART I. FINANCIAL INFORMATION  ITEM 1. FINANCIAL STATEMENTS  EMAK WORLDWIDE, INC.  CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) (UNAUDITED)  ASSETS  December 31,
        
        September 30,2005
        
        2006CURRENT ASSETS:Cash and cash equivalents
        $
        6,315
        
        $
        3,030Restricted cash
        
        --
        
        
        1,269Accounts receivable (net of allowances of $1,738 and$988 as of December 31, 2005 and September 30, 2006, respectively)
        
        29,375
        
        
        25,024Inventories
        
        11,246
        
        
        15,272Prepaid expenses and other current assets
        
        3,044
        
        
        2,539Total current assets
        
        49,980
        
        
        47,134Fixed assets, net
        
        3,571
        
        
        3,662Goodwill
        
        
        12,855
        
        
        13,035Other intangibles, net
        
        712
        
        
        659Other assets
        
        626
        
        
        431Total assets
        $
        67,744
        
        $
        64,921
  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  December31,
        
        September 30,2005
        
        2006CURRENT LIABILITIES:Short-term debt
        $
        --
        
        $
        5,672Accounts payable
        
        20,118
        
        
        18,824Accrued liabilities
        
        17,342
        
        
        11,937Total current liabilities
        
        37,460
        
        
        36,433LONG-TERM LIABILITIES
        
        3,956
        
        
        3,703Total liabilities
        
        41,416
        
        
        40,136COMMITMENTS AND CONTINGENCIESMandatorily redeemable preferred stock, Series 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
        
        19,914
        
        
        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, 5,799,442 and 5,846,849 shares outstandingas of December 31, 2005 and September 30, 2006, respectively
        
        --
        
        
        --Additional paid-in capital
        
        34,068
        
        
        33,610Accumulated deficit
        
        (10,960)
        
        
        (13,473)Accumulated other comprehensive income
        
        2,699
        
        
        3,276Less--
        
        25,807
        
        
        23,413Treasury stock, 3,167,258 shares, at cost, as ofDecember 31, 2005 and September 30, 2006
        
        (17,669)
        
        
        (17,669)Unearned compensation
        
        (1,724)
        
        
        --Total stockholders' equity
        
        6,414
        
        
        5,744Total liabilities, mandatorily redeemable preferred stock and stockholders' equity
        $
        67,744
        
        $
        64,921
  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
        
        
        Nine Months EndedSeptember 30,
        
        
        September 30,(Unaudited)
        
        
        (Unaudited)2005
        
        2006
        
        
        2005
        
        2006REVENUES
        $
        49,810
        $
        43,078
        
        $
        165,154
        $
        125,858COST OF SALES
        
        35,261
        
        31,531
        
        
        121,596
        
        92,756Minimum royalty guarantee shortfall gain
        
        (399)
        
        --
        
        
        (2,724)
        
        (88)Gross profit
        
        14,948
        
        11,547
        
        
        46,282
        
        33,190OPERATING EXPENSES:Salaries, wages and benefits
        
        8,147
        
        6,589
        
        
        26,134
        
        20,031Selling, general and administrative
        
        5,594
        
        4,611
        
        
        17,392
        
        14,075Restructuring charge (gain)
        
        416
        
        (62)
        
        
        1,318
        
        1,310Impairment of assets
        
        3,431
        
        --
        
        
        3,431
        
        --Total operating expenses
        
        17,588
        
        11,138
        
        
        48,275
        
        35,416Income (loss) from operations
        
        (2,640)
        
        409
        
        
        (1,993)
        
        (2,226)OTHER INCOME (EXPENSE), net
        
        234
        
        (140)
        
        
        131
        
        (189)Income (loss) before provision (benefit) for income taxes
        
        (2,406)
        
        269
        
        
        (1,862)
        
        (2,415)PROVISION (BENEFIT) FOR INCOME TAXES
        
        (866)
        
        50
        
        
        (629)
        
        98NET INCOME (LOSS)
        
        (1,540)
        
        219
        
        
        (1,233)
        
        (2,513)PREFERRED STOCK DIVIDENDS
        
        375
        
        -
        
        
        1,125
        
        375NET INCOME (LOSS) AVAILABLE TO COMMONSTOCKHOLDERS
        $
        (1,915)
        $
        219
        
        $
        (2,358)
        $
        (2,888)BASIC INCOME (LOSS) PER SHARE
        
        (0.33)
        $
        0.04
        
        $
        (0.41)
        $
        (0.50)BASIC WEIGHTED AVERAGE SHARES OUTSTANDING
        $
        5,788,042
        
        5,845,788
        
        
        5,779,727
        
        5,830,259DILUTED INCOME (LOSS) PER SHARE
        $
        (0.33)
        $
        0.03
        
        $
        (0.41)
        $
        (0.50)DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING
        
        5,788,042
        
        8,675,447
        
        
        5,779,727
        
        5,830,259
  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
        
        
        Nine Months EndedSeptember 30,
        
        
        September 30,(Unaudited)
        
        
        (Unaudited)2005
        
        
        2006
        
        
        2005
        
        
        2006NET INCOME (LOSS)
        $
        (1,540)
        
        $
        219
        
        $
        (1,233)
        
        $
        (2,513)OTHER COMPREHENSIVE INCOME (LOSS):Foreign currency translation adjustments
        
        (581)
        
        
        243
        
        
        (2,411)
        
        
        628Unrealized gain (loss) on foreign currencyforward contracts
        
        330
        
        
        15
        
        
        366
        
        
        (51)COMPREHENSIVE INCOME (LOSS)
        $
        (1,791)
        
        $
        477
        
        $
        (3,278)
        
        $
        (1,936)
   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)  Nine Months EndedSeptember 30,2005
        
        
        2006CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
        
        
        $
        (1,233)
        
        $
        (2,513)Adjustments to reconcile net loss to net cashprovided by (used in) operating activities:Depreciation and amortization
        
        1,684
        
        
        1,264Provision for doubtful accounts
        
        (75)
        
        
        -Gain on asset disposal
        
        (17)
        
        
        (2)Stock-based compensation expense
        
        769
        
        
        618Minimum royalty guarantee shortfall gain
        
        (2,724)
        
        
        (88)Impairment of assets
        
        3,431
        
        
        --Changes in operating assets and liabilities:Increase (decrease) in cash and cash equivalents:Accounts receivable
        
        14,880
        
        
        4,772Inventories
        
        2,107
        
        
        (3,867)Prepaid expenses and other current assets
        
        (141)
        
        
        502Other assets
        
        1,045
        
        
        217Accounts payable
        
        (6,550)
        
        
        (1,304)Accrued liabilities
        
        (4,580)
        
        
        (5,448)Long-term liabilities
        
        (682)
        
        
        (275)Net cash provided by (used in) operating activities
        
        7,914
        
        
        (6,124)CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of fixed assets
        
        (1,289)
        
        
        (1,181)Restricted cash
        
        --
        
        
        (1,269)Proceeds from sale of fixed assets
        
        992
        
        
        23Refund for purchase of Upshot
        
        75
        
        
        --Payment for purchase of Johnson Grossfield
        
        (148)
        
        
        --Payment for purchase of Megaprint Group
        
        (1,908)
        
        
        (313)Net cash used in investing activities
        
        (2,278)
        
        
        (2,740)CASH FLOWS FROM FINANCING ACTIVITIES:Payment of preferred stock dividends
        
        (1,125)
        
        
        (375)Proceeds from exercise of stock options
        
        115Transaction costs paid in connection with the modification of preferred stock and warrants
        
        --
        
        
        (79)Borrowings under line of credit
        
        54,625
        
        
        40,546Repayment under line of credit
        
        (58,650)
        
        
        (34,874)Net cash provided by (used in) financing activities
        
        (5,035)
        
        
        5,218Net increase (decrease) in cash and cash equivalents
        
        601
        
        
        (3,646)Effects of exchange rate changes on cash and cash equivalents
        
        (98)
        
        
        361CASH AND CASH EQUIVALENTS, beginning of period
        
        4,406
        
        
        6,315CASH AND CASH EQUIVALENTS, end of period
        $
        4,909
        
        $
        3,030SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:CASH PAID FOR:Interest
        
        $
        324
        
        $
        207Income tax refunds, net
        $
        (118)
        
        $
        (484)
 The accompanying notes are an integral part of these condensed consolidated financial statements.  7  EMAK WORLDWIDE, INC.  NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2006 (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 a leading global integrated marketing services company. The Company focuses on the design and execution of strategy-based marketing programs providing measurable results for our clients. EMAK has expertise in the areas of: strategic planning and research, entertainment marketing, design and manufacturing of custom promotional products, promotional marketing, event marketing, collaborative marketing, retail design and environmental branding. EMAK is headquartered in Los Angeles, with operations in Chicago, Frankfurt, London, Paris, the Netherlands, Hong Kong and Shanghai. The Company primarily sells to customers in the United States and Europe. The Companys functional currency is the U.S. dollar.  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/A for the year ended December 31, 2005.  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 nine months ended September 30, 2005 and the nine months ended September 30, 2006.  Options and warrants to purchase 1,327,612 and 2,365,086 shares of common stock, $.001 par value per share (the Common Stock), as of September 30, 2005 and 2006, respectively, were excluded from
the computation of diluted EPS as they would have been anti-dilutive. For the three and nine months ended September 30, 2005, preferred stock convertible into 1,694,915 shares of Common Stock was excluded in the computation of diluted EPS as they would have been anti-dilutive. For the three months ended September 30, 2006, preferred stock convertible into 2,777,778 shares of Common Stock was included in the computation of diluted EPS as they were dilutive. For the nine months ended September 30, 2006, preferred stock convertible into 2,777,778 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 248,297 and 196,117 units for the three and nine months ended September 30, 2005, respectively, as they would have been anti-dilutive. Excluded from the computation of diluted EPS are restricted stock units of 185,341 and 237,222 units for the three and nine months
ended September 30, 2006, respectively, as they would have been anti-dilutive.  9  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 (EITF 03-6):  For the Three Months Ended September 30,2005
        
        2006Loss
        
        Shares
        
        Per Share
        
        Income
        
        Shares
        
        Per Share(Numerator)
        
        (Denominator)
        
        Amount
        
        (Numerator)
        
        (Denominator)
        
        AmountBasic EPS:Income (loss) available tocommon stockholders
        $
        (1,915)
        
        5,788,042
        
        $
        (0.33)
        
        $
        219
        
        5,845,788
        
        $
        0.04Effect of dilutive securities:Options and warrants
        
        --
        
        --
        
        
        
        
        
        --
        
        --Convertible preferred stock
        
        --
        
        
        
        
        
        
        
        2,777,778Restricted stock units
        
        --
        
        --
        
        
        
        
        
        --
        
        51,881Dilutive EPS:Income (loss) available tocommon stockholders
        $
        (1,915)
        
        5,788,042
        
        $
        (0.33)
        
        $
        219
        
        8,675,447
        
        $
        0.02For the Nine Months Ended September 30,2005
        
        2006Loss
        
        Shares
        
        Per Share
        
        Loss
        
        Shares
        
        Per Share(Numerator)
        
        (Denominator)
        
        Amount
        
        (Numerator)
        
        (Denominator)
        
        AmountBasic EPS:Loss available tocommon stockholders
        $
        (2,358)
        
        5,779,727
        
        $
        (0.41)
        
        $
        (2,888)
        
        5,830,259
        
        $
        (0.50)Effect of dilutive securities:Options and warrants
        
        --
        
        --
        
        
        
        
        
        --
        
        --Restricted stock units
        
        --
        
        --
        
        
        
        
        
        --
        
        --Dilutive EPS:Loss available to commonstockholders
        $
        (2,358)
        
        5,779,727
        
        $
        (0.41)
        
        $
        (2,888)
        
        5,830,259
        
        $
        (0.50)
  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 $1,300) 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 expires on December 15, 2006. 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  In March 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.  Change in Accounting Principle  Prior to January 1, 2006, the Company applied the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, 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. Accordingly, no compensation expense was recognized in the statements of operations for these employee stock options.  10   Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123(R), Share-Based Payment, using the modified-prospective transition method. Accordingly, results for prior periods have not been restated.  Beginning January 1, 2006 and in connection with the adoption of SFAS No. 123(R), the Company recognizes the cost of all new employee share-based payment awards on a straight-line attribution basis over their respective vesting periods, net of estimated forfeitures. In accounting for the income tax benefits associated with employee exercises of share-based payments, the Company has elected to adopt the alternative simplified method as permitted by FASB Staff Position (FSP) No. FAS 123(R)-3, Accounting for the Tax Effects of Share-Based Payment Awards.  FSP No. FAS 123(R)-3 permits the adoption of either the transition guidance described in SFAS No. 123(R) or the alternative simplified method specified in the FSP to account for the income tax effects of share-based payment awards. In determining when additional tax benefits associated with share-based payment
exercises are recognized, the Company follows the ordering of deductions of the tax law, which allows deductions for share-based payment exercises to be utilized before previously existing net operating loss carryforwards. In computing dilutive shares under the treasury stock method, the Company does not reduce the tax benefit amount within the calculation for the amount of deferred tax assets that would have been recognized had the Company previously expensed all share-based payment awards.  Inventories  Inventories consist of (a) production-in-process which primarily represents tooling costs which are deferred and amortized over the life of the products and deferred costs on service contracts 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, 2005 and September 30, 2006, inventories consisted of the following:  December 31, 2005
        
        September 30, 2006Production-in-process
        $
        2,483
        
        $
        7,710Finished goods
        
        8,763
        
        
        7,562Total inventories
        $
        11,246
        
        $
        15,272
  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 gains (losses) included in net income (loss) for the three months ended September 30, 2005 and 2006 were $257 and $(1), respectively. Transaction gains (losses) included in net loss for the nine months ended September 30, 2005 and 2006 were $354 and $(14), 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.  11  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 foreign currency forward contracts aggregating 563 GBP to sell Euros in exchange for British pounds and United States dollars and to sell British pounds in exchange for United States dollars. The contracts will expire by April 2007. At September 30, 2006, the foreign currency forward contracts had an estimated fair value of 8 GBP. The fair value of the foreign currency forward contracts is recorded in accrued liabilities in the accompanying condensed consolidated balance sheet as of September 30, 2006. The unrealized gain on the contracts is reflected in accumulated other comprehensive income.  Goodwill and Other Intangibles  The change in the carrying amount of goodwill from $12,855 as of December 31, 2005 to $13,035 as of September 30, 2006 reflects an increase due to a foreign currency translation adjustment of $180. $8,245 of the goodwill balance relates to the Agency Services segment and $4,790 relates to the Promotional Products segment.  The change in the carrying amount of identifiable intangibles from $712 as of December 31, 2005 to $659 as of September 30, 2006 reflects: a decrease of $108 for amortization expense and an increase due to a foreign currency translation adjustment of $55. 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. As a result, the release of the holdback had no impact on goodwill for the nine months ended September 30, 2006.  Recent Accounting Pronouncements  In July 2006, the Financial Accounting Standards Board, or FASB, issued Interpretation No. 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109, or FIN 48. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements according to SFAS No. 109, Accounting for Income Taxes.  FIN 48 provides for the recognition of only those uncertain tax positions that are more-likely-than-not to be sustained upon examination, measured at the largest amount which has a greater than 50% likelihood of being realized upon settlement.  Additionally, FIN 48 gives guidance on derecognition, classification, interest, penalties, accounting in interim periods and disclosure related to uncertain tax positions.  The adoption of FIN 48 on January 1, 2007, as required, could result in an adjustment to the amount of recorded tax
assets and liabilities related to uncertain tax positions by recording a corresponding adjustment to retained earnings in the condensed consolidated balance sheets.  The Company is currently assessing the effect, if any, of FIN 48 on the Companys condensed consolidated results of operations and financial position.  In September 2006, the FASB issued SFAS No.157, Fair Value Measurements, or SFAS No. 157. SFAS No. 157 defines fair value, sets out a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements of assets and liabilities. SFAS No. 157 applies under other accounting pronouncements previously issued by the Board that require or permit fair value measurements. The adoption of SFAS No. 157 on January 1, 2007, as required, could result in a transition adjustment that would be recognized as a cumulative-effect adjustment to the opening balance of retained earnings. The Company is currently assessing the effect SFAS No. 157 may have, if any, on its consolidated results of operations and financial position.  In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108), which provides guidance for quantifying financial statement misstatements. SAB 108 will be effective for the Company beginning January 1, 2007. The Company is in the process of determining the effect, if any, this statement will have on its financial statements.  13  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. 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. The Facility does not permit the payment of dividends on Series AA Preferred Stock for 2006. The restriction on dividends may be removed in 2007 subject to 2006 audited results and compliance with covenants. On May 10, 2006 certain covenants under the facility were amended. On August 11, 2006, the Company amended the Facility to provide for a temporary bridge facility to increase the Companys available borrowings by up to $7,000 to fund working capital for a specific client program.  The finance charges for borrowings under the bridge facility will be 300 basis points greater than the interest charges under the Facility.  This bridge facility expires November 30, 2006. As of December 31, 2005 and September 30, 2006, the marginal interest rate on available borrowings under the Facility was 7.5%
and 8.0%, respectively. As of September 30, 2006, the Company was in compliance with the restrictions and covenants. As of September 30, 2006, $5,672 was outstanding under the Facility.  Letters of credit outstanding under the Companys prior credit facility and the Facility as of December 31, 2005 and September 30, 2006 totaled $2,763 and $515, respectively.  In addition to the Facility, in October, 2003 the Companys Logistix (U.K.) agency established an import/letter of credit facility with Hong Kong Shanghai Bank Corp. (HSBC) to provide short-term financing of product purchases in Asia. The total availability under this facility is 1,500 GBP. The total availability under this facility was increased from 1,000 GBP to 1,500 GBP in 2005. Under this facility HSBC may pay the agencys vendors directly upon receipt of invoices and shipping documentation. Logistix (U.K.) in turn is obligated to repay HSBC within 120 days. As of December 31, 2005 and September 30, 2006, $0 was outstanding under this facility.  NOTE 4  RESTRUCTURING AND MINIMUM ROYALTY GUARANTEE SHORTFALLS  In 2004, the Company finalized a decision to pursue the wind-down of a substantial majority of its Consumer Products business. The Companys determination was to significantly scale back this business during 2005 while exiting a substantial majority of the business permanently as soon as is feasible. As a result of the wind-down, in the fourth quarter of 2004, the Company recorded a pre-tax charge of $7,722 relating to minimum royalty guarantee shortfalls on several Consumer Products licenses. This charge was determined based on contractual commitments as of December 31, 2004 and reflected our decision not to fully exploit these licenses. Approximately $3,000 of this pre-tax charge was non-cash for write-offs of long-term royalty advances. The charge was recorded as minimum royalty guarantee shortfalls in the consolidated statement of operations for the year ended December 31, 2004.  On May 18, 2005, the Company reached a settlement with one of its licensors affecting several licenses. Under the terms of the settlement, the Company agreed to forgo its rights to certain licensed properties for 2006 and 2007 in exchange for a reduction in the overall royalty guarantees. The Company retained product distribution rights under the licenses for 2005. As a result of this settlement, the Companys overall commitment for royalty guarantees was reduced by approximately $4,000. The Company paid the licensor a total of $1,800 through June 30, 2006. As a result of this settlement and higher than expected Scooby-Doo revenues that exceeded initial estimates, $2,325 of the 2004 charge for minimum royalty guarantee shortfalls was reversed during the three months ended June 30, 2005. An additional amount of $399 and $113 was reversed during the three months ended September 30, 2005 and December
31, 2005, respectively, as a result of higher than expected Scooby-Doo revenues for that period.  For the three months ended June 30, 2006, the Company reached a settlement with a different licensor which resulted in a reversal of $88. These reversals were recorded as minimum royalty guarantee shortfall gains in the condensed consolidated statements of operations for the three and nine months ended September 30, 2005 and 2006.  In 2005, in connection with the Consumer Products wind-down, the Company incurred a charge for one-time employee termination benefits and other costs totaling approximately $797. For the three months ended September 30, 2005, the Company incurred $40.  For the three months ended September 30, 2006, the Company recorded a gain of $13 for the reversal of previously recorded accruals for employee termination costs as a result of lower costs than initially estimated.  For the nine months ended September 30, 2005 and 2006, the Company incurred $672 and $38, respectively. Such costs are recorded as a restructuring charge in the condensed consolidated statement of operations. The entire amount is attributable to the Consumer Products segment.  In 2005, the Company eliminated several centralized corporate positions as a result of a realignment of centralized resources. As a result, we incurred a charge for one-time employee termination benefits and other costs totaling approximately $622 in 2005. For the nine months ended September 30, 2006, the Company incurred an additional $58 for employee termination benefits. For the three months ended September 30, 2005, the Company incurred $51.  For the three months ended September 30, 2006, the Company recorded a gain of  14  $107 for the reversal of previously recorded accruals for employee termination costs as a result of lower costs than initially estimated. For the nine months ended September 30, 2005 and 2006, the Company incurred $321 and $58, respectively. Such costs are recorded as a restructuring charge in the condensed consolidated statement of operations. The entire amount is attributable to the corporate segment.  In 2005, 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 totaling $568 in the year ended December 31, 2005. For the three months ended September 30, 2005, the Company incurred $219.  For the three months ended September 30, 2006, the Company recorded a gain of $31 for the reversal of previously recorded accruals for employee termination costs as a result of lower costs than initially estimated.  For the nine months ended September 30, 2005 and 2006, the Company incurred $219 and $53, respectively. Such costs are recorded as a restructuring charge in the condensed consolidated statements of operations. The entire amount is attributable to the Promotional Products segment.  In 2005, the Company made the determination to close the Companys Minneapolis office effective October 31, 2005.  The Company recorded a charge of approximately $192 in the six months ended December 31, 2005 for one-time employee termination benefits related to the closure of the Minneapolis office. For the three and nine months ended September 30, 2005, the Company incurred $106. Such costs are recorded as a restructuring charge in the consolidated statement of operations for 2005.  The entire amount is attributable to the Promotional Products segment.  In 2005, the Company made a 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 $640 in 2005. For the three months ended September 30, 2006, the Company recorded a gain of $5 for the reversal of previously recorded accruals for employee termination costs as a result of lower costs than initially estimated. For the nine months ended September 30, 2006, the Company incurred an additional $784 for employee termination benefits and other costs.  The entire amount is attributable to the Promotional Products segment.  In 2005, the Company made the determination to sublease approximately 15,000 square feet of its Los Angeles office space.  The space was sublet effective December 15, 2005 for a term ending December 31, 2009 (the expiration of the master lease term).  The Company recorded a charge of $184 in the quarter ending December 31, 2005 for the estimated loss on the sublease over the term. Such costs are recorded as a restructuring charge in the consolidated statement of operations for 2005.  The entire amount is attributable to the corporate segment.  In 2006, in connection with the Companys decision to consolidate the SCI Promotion, Pop Rocket and Megaprint Group agencies into Logistix, the Company made a decision to eliminate two senior management positions. The Company recorded a charge for one-time employee termination benefits and other costs totaling $0 and $283 for the three and nine months ended September 30, 2006, respectively. The entire amount is attributable to the Promotional Products segment.  In 2006, the Company made a decision to reorganize our Hong Kong office to better align the Companys operations with the current business needs. As a result, the Company recorded a charge of $94 for one-time termination benefits associated with staff reductions in the Companys Hong Kong office.  For the three and nine months ended September 30, 2006, the Company recorded a charge of $94.  16  The following table summarizes activity in the Companys restructuring reserve.  Pop Rocket *
        Centralized Corporate *
        Logistix (U.K.) *
        Johnson Grossfield *
        SCI Promotion *
        Los Angeles Office Sublease
        Logistix Consolidation *
        Hong Kong *
        TotalOriginal charge
        $
        746
        $
        622
        $
        568
        $
        192
        $
        640
        $
        184
        $
        -
        $
        -
        $
        2,952Utilization in 2005
        
        (513)
        
        (261)
        
        (137)
        
        (96)
        
        (110)
        
        -
        
        -
        
        -
        
        (1,117)Reserve at December 31, 2005
        
        233
        
        361
        
        431
        
        96
        
        530
        
        184
        
        -
        
        -
        
        1,835Additional charge
        
        -
        
        165
        
        78
        
        -
        
        363
        
        -
        
        -
        
        -
        
        606Utilization
        
        (164)
        
        (235)
        
        (4)
        
        (74)
        
        (306)
        
        (101)
        
        -
        
        -
        
        (884)Reserve at March 31, 2006
        
        69
        
        291
        
        505
        
        22
        
        587
        
        83
        
        -
        
        -
        
        1,557Additional charge
        
        51
        
        -
        
        6
        
        -
        
        426
        
        -
        
        283
        
        -
        
        766Utilization
        
        (83)
        
        (155)
        
        (318)
        
        (20)
        
        (589)
        
        (5)
        
        (37)
        
        -
        
        (1,207)Reserve at June 30, 2006
        
        37
        
        136
        
        193
        
        2
        
        424
        
        78
        
        246
        
        -
        
        1,116Partial reversal of previously recorded one-time employee termination benefits and other related costs
        
        (13)
        
        (107)
        
        (31)
        
        -
        
        (5)
        
        -
        
        -
        
        -
        
        (156)Additional charge
        
        -
        
        -
        
        -
        
        -
        
        -
        
        -
        
        -
        
        94
        
        94Utilization
        
        (24)
        
        (29)
        
        (40)
        
        (2)
        
        (236)
        
        (6)
        
        (134)
        
        (94)
        
        (565)Reserve at September 30, 2006
        $
        -
        $
        -
        $
        122
        $
        -
        $
        183
        $
        72
        $
        112
        $
        -
        $
        489
  * 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. As a result of recent changes in management and agency structure and to be consistent with the way management now views business units internally, the Company now reports its marketing services business as two separate reportable segments: Agency Services and Promotional Products. This reflects the changes in 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. Certain information
presented in the tables below have been restated to conform to the current management structure as of January 1, 2006.  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.  16  The primary measure of segment profit or loss reviewed by the chief operating decision maker is segment income (loss) before provision (benefit) for income taxes.  Industry Segments  As of and For the Three Months Ended September 30, 2005Agency
        
        Promotional
        
        ConsumerServices
        
        Products
        
        Products
        
        Corporate
        
        TotalTotal revenues
        $
        5,250
        $
        36,504
        $
        8,056
        $
        --
        $
        49,810Segment income (loss) before provision (benefit) for income taxes
        $
        1,885
        $
        (510)
        $
        436
        $
        (4,217)
        $
        (2,406)Fixed asset additions
        $
        --
        $
        --
        $
        --
        $
        297
        $
        297Depreciation and amortization
        $
        --
        $
        99
        $
        --
        $
        456
        $
        555Total assets
        $
        15,122
        $
        60,708
        $
        13,424
        $
        19,697
        $
        108,951As of and For the Three Months Ended September 30, 2006Agency
        
        Promotional
        
        ConsumerServices
        
        Products
        
        Products
        
        Corporate
        
        TotalTotal revenues
        $
        7,683
        $
        32,061
        $
        3,334
        $
        --
        $
        43,078Segment income (loss) before provision (benefit) for income taxes
        $
        1,537
        $
        1,975
        $
        63
        $
        (3,306)
        $
        269Fixed asset additions
        $
        --
        $
        --
        $
        --
        $
        135
        $
        135Depreciation and amortization
        $
        --
        $
        35
        $
        --
        $
        389
        $
        424Total assets
        $
        14,876
        $
        35,299
        $
        3,808
        $
        10,938
        $
        64,921As of and For the Nine Months Ended September 30, 2005Agency
        
        Promotional
        
        ConsumerServices
        
        Products
        
        Products
        
        Corporate
        
        TotalTotal revenues
        $
        15,423
        $
        130,641
        $
        19,090
        $
        --
        $
        165,154Segment income (loss) before provision (benefit) for income taxes
        $
        3,606
        $
        6,865
        $
        1,773
        $
        (14,106)
        $
        (1,862)Fixed asset additions
        $
        --
        $
        --
        $
        --
        $
        1,289
        $
        1,289Depreciation and amortization
        $
        --
        $
        312
        $
        --
        $
        1,372
        $
        1,684Total assets
        $
        15,122
        $
        60,708
        $
        13,424
        $
        19,697
        $
        108,951As of and For the Nine Months Ended September 30, 2006Agency
        
        Promotional
        
        ConsumerServices
        
        Products
        
        Products
        
        Corporate
        
        TotalTotal revenues
        $
        23,525
        $
        94,501
        $
        7,832
        $
        --
        $
        125,858Segment income (loss) before provision (benefit) for income taxes
        $
        5,131
        $
        2,832
        $
        136
        $
        (10,514)
        $
        (2,415)Fixed asset additions
        $
        --
        $
        --
        $
        --
        $
        1,181
        $
        1,181Depreciation and amortization
        $
        --
        $
        104
        $
        --
        $
        1,160
        $
        1,264Total assets
        $
        14,876
        $
        35,299
        $
        3,808
        $
        10,938
        $
        64,921
   17  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 September 30, 2006 are as follows:  Year2006 (remainder of)
        $
        1,0352007
        
        4,0362008
        
        3,9882009
        
        3,8072010
        
        787Thereafter
        
        1,911Total
        $
        15,564
  Aggregate rental expenses for operating leases were $945 and $725 for the three months ended September 30, 2005 and 2006, respectively. Aggregate rental expenses for operating leases were $3,024 and $2,499 for the nine months ended September 30, 2005 and 2006, respectively.  Guaranteed Royalties For the three months ended September 30, 2005 and 2006, the Company incurred $1,165 and $637, respectively, in royalty expense. For the nine months ended September 30, 2005 and 2006, the Company incurred $3,063 and $1,167, respectively, in royalty expense. License agreements for certain copyrights and trademarks require minimum guaranteed royalty payments over the respective terms of the licenses. As of September 30, 2006, the Company has committed to pay total minimum guaranteed royalties as follows:  Year2006 (remainder of)
        $
        1072007
        
        2702008
        
        300Total
        $
        677
  Employment Agreements The Company has employment agreements with key executives. Guaranteed compensation under these agreements as of September 30, 2006 are as follows:  Year2006 (remainder of)
        $
        6342007
        
        1,838Total
        $
        2,472
  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 2005 Annual Report on Form 10-K/A. 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 four years from the date of grant. Such stock options were granted with exercise prices at or above the fair market value of the Companys common stock on the date of grant.  19  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 nine months ended September 30, 2006. Excess tax benefits reflected as an operating cash inflow totaled $0 during the nine months ended September 30, 2005.  On December 15, 2005, the Board of Directors approved the acceleration of vesting of unvested and out-of-the-money non-qualified stock options previously awarded to employees, officers and directors with option exercise prices equal to or greater than $7.18 effective as of December 15, 2005. Both the Companys non-employee directors and the Chief Executive Officer have entered into a Resale Restriction Agreement which imposes restrictions on the sale of any shares received through the exercise of accelerated options until the earlier of the original vesting dates set forth in the option or their termination of service. The accelerated options represented all of the outstanding Company options.  The Board of Directors decision to accelerate the vesting of these options was based upon the elimination of compensation expense to be recorded subsequent to the effective date of SFAS 123(R). In addition, the Board of Directors considered that because these options had exercise prices in excess of the current market value, they were not fully achieving their original objectives of incentive compensation and employee retention. The future compensation expense that was eliminated as a result of the acceleration of the vesting of these options is approximately $1,100. No options were granted during the nine months ended September 30, 2005 and 2006.  The Company recognized no compensation expense for stock options during the three and nine months ended September 30, 2006 as a result of the Companys decision to accelerate the vesting of options mentioned above. As discussed above, prior to January 1, 2006, no compensation expense was recognized in the statements of operations for stock options. Had compensation expense in 2005 for nonqualified stock options granted been determined based on their fair value at the grant date, consistent with the fair value method of accounting prescribed by SFAS No. 123, the Companys net income and net income per common share for the three and nine months ended September 30, 2005 would have been adjusted as follows:  Three Months Ended
        
        Nine Months EndedSeptember 30, 2005
        
        September 30, 2005Net loss - as reported
        $
        (1,540)
        
        $
        (1,233)Plus:Stock-based compensation expense, net of tax, included in reportednet loss
        
        189
        
        
        462Less:Compensation expense (a)
        
        264
        
        
        503Net loss - pro forma
        $
        (1,615)
        
        $
        (1,274)Loss per share:Basic loss per share, as reported
        $
        (0.33)
        
        
        (0.41)Pro forma basic loss per share
        $
        (0.34)
        
        
        (0.42)Diluted loss per share, as reported
        $
        (0.33)
        
        $
        (0.41)Pro forma diluted loss per share
        $
        (0.34)
        
        $
        (0.42)(a) Determined under fair value based method for all awards, net of tax.
   20   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 nine months ended September 30, 2006:   Number
        
        
        Average Exercise Price
        
        Average Remaining Contractual Term
        
        
        Aggregate Intrinsic ValueOutstanding at January 1, 2006
        1,733,970
        
        $
        12.64Granted
        --
        
        
        --Exercised
        --
        
        
        --Forfeited
        --
        
        
        --Cancelled
        (285,550)
        
        
        12.20Outstanding at September 30, 2006
        1,448,420
        
        $
        12.73
        
        6.0
        
        $
        --Exercisable at September 30, 2006
        1,448,420
        
        $
        12.73
        
        6.0
        
        $
        --
  The intrinsic value of stock options is the difference between the current market value and the exercise price. No options were exercised during the nine months ended September 30, 2006.  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 4 years). Compensation expense recognized related to grants of restricted stock and RSUs to certain employees and non-employee Board members was $769 and $618 for the nine months ended September 30, 2005 and 2006, respectively. As of September 30, 2006, there was $1,266 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 September 30, 2006:  Weighted AverageGrant DateShares
        
        
        Fair ValueUnvested at January 1, 2006
        177,110
        
        $
        12.00Granted
        67,000
        
        
        6.29Vested
        (60,160)
        
        
        12.28Forfeited
        (50,603)
        
        
        10.70Unvested at September 30, 2006
        133,347
        
        $
        9.50
    21  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 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.  Also in connection with the closing of the Crown Transaction, effective as of May 31, 2006, the Company entered into an Amendment No. 1 to Rights Agreement with Continental Stock Transfer & Trust Company as rights agent (Amendment No. 1) with respect to the Companys Preferred Share Purchase Rights Plan (the Plan). Amendment No. 1 provides that the shares of Common Stock issuable upon conversion of the Series AA Stock, as may be amended from time to time, or upon the exercise of any options or warrants Crown holds to acquire capital stock of the Company (as the same may be amended from time to time), in each case held by Crown as of May 31, 2006 or issuable to Crown as a result of the transactions approved by the Companys stockholders at the Companys 2006 Annual Meeting of Stockholders, will not result in a triggering of rights under the Plan.  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.  21  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 integrated marketing services company. We focus on the design and execution of strategy-based marketing programs providing measurable results for our clients. EMAK has expertise in the areas of: strategic planning and research, entertainment marketing, design and manufacturing of custom promotional products, promotional marketing, event marketing, collaborative marketing, retail design and environmental branding. EMAK is headquartered in Los Angeles, with operations in Chicago, Frankfurt, London, Paris, the Netherlands, Hong Kong and Shanghai. 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, in the second half of 2004, Equity Marketing expanded its role with Burger King and is now the agency of record 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 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.  Our Logistix agency is comprised of Logistix (U.K.), Logistix (U.S.), SCI Promotion, Megaprint Group and Pop Rocket. Logistix is an insight driven marketing services agency specializing in product-based solutions. Logistix operates in our Promotional Products, Agency Services and Consumer Products segments.  Overview  Revenues for the third quarter of 2006 decreased 13.5% or $6,732 to $43,078 as compared to $49,810 recorded in the prior year. Despite this decrease, a significant reduction in operating expenses resulted in net income of $219 in the current year quarter compared to net loss of $1,540 in the third quarter of 2005. The net loss in the third quarter of 2005 was negatively impacted by an impairment charge of $3,431 for the write-off the remaining balance of goodwill and other intangibles related to the Johnson Grossfield agency as a result of the loss of that agencys primary client in August 2005. As a result of this loss, we decided to close the Johnson Grossfield office.  The decrease in revenues is primarily due to lower unit volumes purchased by our largest client. This decrease was anticipated, as the clients promotional calendar for the third quarter of 2005 was boosted by programs tied to a blockbuster film series (Lucasfilms Star Wars® movies). Revenues were also lower compared to the prior year period because of the loss of revenues from Johnson Grossfield due to the loss of that agencys primary client and the wind-down of our non-core Consumer Products business. The decreased revenues were partially offset by an increase in revenues at Upshot resulting from work performed for new clients.  Our efforts to streamline the organizations cost structure are having a visible impact as operating expenses in the third quarter of 2006 are significantly lower than in the third quarter of 2005.  The $10,000 to $15,000 in annualized operating expense savings, depending on variable selling costs, as compared to 2005 expense levels better aligns our cost model with current client needs.  We have streamlined the organization and established a more efficient operating structure that can be leveraged to support profitable growth.  While we expect our fourth quarter 2006 revenues will be up compared to our third quarter, in line with expected seasonality, it will be down as compared to the prior year.  This expected decrease is the result of the wind-down of Consumer Products, the loss of Johnson Grossfields primary client and lower unit volumes expected for our largest client.  For our Consumer Products segment, we have only three significant remaining toy lines for all of 2006, JoJos Circus , Crayola® and Mighty Helmet Racers®.  In 2005, JoJos Circus and Crayola® represented 40% ($10,500) of our Consumer Products revenues.  With modest revenue growth and as a result of the significantly reduced cost structure, we expect to return to profitability in 2007 and to be poised for further improvements in 2008 and beyond.  22  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
        
        
        Nine Months EndedSeptember 30,
        
        
        September 30,2005
        
        
        2006
        
        
        2005
        
        
        2006Revenues
        100.0
        %
        
        100.0
        %
        
        100.0
        %
        
        100.0
        %Cost of sales
        70.8
        
        
        73.2
        
        
        73.6
        
        
        73.7Minimum royalty shortfall gain
        (0.8)
        
        
        -
        
        
        (1.6)
        
        
        (0.1)Gross profit
        30.0
        
        
        26.8
        
        
        28.0
        
        
        26.4Operating expenses:Salaries, wages and benefits
        16.4
        
        
        15.3
        
        
        15.8
        
        
        15.9Selling, general and administrative
        11.2
        
        
        10.7
        
        
        10.5
        
        
        11.2Restructuring charge (gain)
        0.8
        
        
        (0.1)
        
        
        0.8
        
        
        1.0Impairment of assets
        6.9
        
        
        -
        
        
        2.1
        
        
        -Total operating expenses
        35.3
        
        
        25.9
        
        
        29.2
        
        
        28.1Income (loss) from operations
        (5.3)
        
        
        0.9
        
        
        (1.2)
        
        
        (1.7)Other income (expense), net
        0.5
        
        
        (0.3)
        
        
        0.1
        
        
        (0.2)Income (loss) before provision (benefit) for income taxes
        (4.8)
        
        
        0.6
        
        
        (1.1)
        
        
        (1.9)Provision (benefit) for income taxes
        (1.7)
        
        
        0.1
        
        
        (0.4)
        
        
        0.1Net income (loss)
        (3.1)
        %
        
        0.5
        %
        
        (0.7)
        %
        
        (2.0)
        %
  Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005 (In Thousands):  Revenues  Revenues for the three months ended September 30, 2006 decreased $6,732, or 13.5%, to $43,078 from $49,810 in the comparable period in 2005. Promotional Products revenues decreased $4,443, or 12.2%, to $32,061 primarily as a result of lower revenues at our Equity Marketing agency due to a reduction in unit volumes for promotional programs from its largest client. This decrease was anticipated, as the clients promotional calendar for the third quarter of 2005 was boosted by large programs tied to a blockbuster film series. The revenue decrease in Promotional Products is also attributable to the loss of revenues from Johnson Grossfield due to the loss of that agencys primary client.  Net foreign currency translation had a favorable impact to revenues of approximately $366 for Logistix (U.K.) versus the prior year period average exchange rates.  Our Agency Services segment revenues increased $2,433, or 46.3%, to $7,683. The increase is primarily attributable to increased Upshot revenues for promotional work performed for a new large client in the U.S.  In March 2005, Upshot was one of two agencies selected for the promotional business of this large client and promotional work began in April 2005. The increase in Agency Services revenues is also attributable to higher levels of retainer revenues for other existing clients.  Our Consumer Products segment revenues decreased $4,722, or 58.6%, to $3,334. The decrease is primarily attributable to the wind-down of the non-core business. The majority of the Consumer Products license agreements expired in December 2005. Our Consumer Product revenues for the three months ended September 30, 2005 were primarily comprised of Mighty Helmet Racers and Crayola®product.  Cost of sales and gross profit  Cost of sales decreased $3,730 to $31,531 (73.2% of revenues) for the three months ended September 30, 2006 from $35,261 (70.8% of revenues) in the comparable period in 2005 primarily due to lower sales volume in 2006.  Our gross margin percentage decreased to 26.8% for the three months ended September 30, 2006 from 30.0% in the comparable period for 2005.  23  The gross profit percentage for our Promotional Products segment for the three months ended September 30, 2006 decreased to 27.1% compared to 29.3% for the comparable period in 2005. This decrease is attributable to a few high volume but low margin Logistix (U.K.) promotional programs in 2006.  The gross profit percentage for our Agency Services segment for the three months ended September 30, 2006 decreased to 30.9% compared to 37.0% for the comparable period in 2005. This decrease is primarily attributable to a higher level of direct outside cost as compared to the same period last year.  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 September 30, 2006 decreased to 14.8% compared to 28.5% for the comparable period in 2005. This decrease in the margin is attributable to a higher level of close-out sales as compared to the same period last year and the write-off of a pre-paid royalty related to discontinued products. The three months ended September 30, 2005 include a $399 gain 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 decreased from 23.6% in 2005.  Salaries, wages and benefits  Salaries, wages and benefits decreased $1,558, or 19.1%, to $6,589 (15.3% of revenues) for the three months ended September 30, 2006 from $8,147 (16.4% of revenues) in the comparable period for 2005. This decrease was primarily attributable to a reduction in personnel as a result of restructuring initiatives designed to streamline operations.  Selling, general and administrative expenses  Selling, general and administrative expenses decreased $983, or 17.6%, to $4,611 (10.7% of revenues) for the three months ended September 30, 2006 from $5,594 (9.7% of revenues) in the comparable period for 2005. The decrease is attributable to a reduction in commissions, advertising, 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 and an office lease in Minneapolis as well as the sublease of a portion of our Los Angeles office. This decrease was partially offset by an increase in bank charges for our credit facility with Bank of America.  Restructuring charge (gain)  We recorded a restructuring gain of $62 ((0.1)% of revenues) for the three months ended September 30, 2006 compared to a charge of $416 (0.8% of revenues) for the same period in 2005. This gain is primarily related to a partial reversal of previously recorded employee termination benefits as a result of lower costs than initially estimated.  This gain was partially offset by charges related to staff reductions in our Hong Kong office. The restructuring charge in 2005 consists primarily of severance expense and other termination costs related to staff reductions at Logistix (U.K), to the closure of the Johnson Grossfield office in Minneapolis, and resulting from our decision to wind down substantially all of our non-core consumer products business, Pop Rocket. See Restructuring below.  Impairment of assets  We recorded a charge for the impairment of assets of $3,431 (6.9% of revenues) for the three months ended September 30, 2005. This charge relates to impairment of goodwill and other intangible assets of Johnson Grossfield as a result of the loss of the Johnson Grossfields primary client in August 2005.  Other income (expense)  Other income (expense) decreased $374 to $(140) for the three months ended September 30, 2006 from $234 in the comparable period for 2005. The decrease is primarily due to foreign currency losses as a result of the strengthening of the British pound relative to the U.S. dollar.  This decrease is also attributable to an increase in interest expense as a result of increased short-term borrowings as compared to the same period in 2005.  Provision (benefit) for income taxes  The effective tax rate for the three months ended September 30, 2006 was 18.6% compared to 36.0% for the same period in 2005. In 2006, we recorded a tax provision for our Asia-based operations and recognized no tax provision from our operations in the United States  24  and the United Kingdom due to our valuation allowance.  Net Income (loss)  Net income (loss) increased $1,759 to $219 (0.5% of revenues) in 2006 from $(1,540) ((3.1)% of revenues) in 2005 primarily due to the impairment of assets and restructuring charge recorded for the three months ended September 30, 2005. This increase is also attributable to a decrease in salaries, wages and benefits and selling, general and administrative expenses as a result of our restructuring initiatives.  Nine Months Ended September 30, 2006 Compared to Nine Months Ended September 30, 2005 (In Thousands):  Revenues  Revenues for the nine months ended September 30, 2006 decreased $39,296, or 23.8%, to $125,858 from $165,154 in the comparable period in 2005. Promotional Products revenues decreased $36,140, or 27.7%, to $94,501 primarily attributable to lower revenues at our Equity Marketing agency as a result of a reduction in unit volumes for promotional programs from its largest client and the loss of revenues from Johnson Grossfield due to the loss of that agencys primary client. The lower Promotional Products revenues are also attributable to lower revenues at our Logistix (U.K.) business as a result of a reduction in the number and size of promotional programs for its largest client. Net foreign currency translation had an unfavorable impact to revenues of approximately $423 for Logistix (U.K.) versus the prior year period average exchange rates.  Our Agency Services segment revenues increased $8,102, or 52.5%, to $23,525. The increase is primarily attributable to increased Upshot revenues for promotional work performed for a large client in the U.S. In March 2005, Upshot was one of two agencies selected for the promotional business of this large client and promotional work began in April 2005. The increase in Agency Services revenues is also attributable to higher levels of retainer revenues for other existing clients.  Our Consumer Products segment revenues decreased $11,258, or 59.0%, to $7,832. The decrease is primarily attributable to the wind-down of the non-core business. The majority of the Consumer Products license agreements expired in December 2005. Our first nine months of 2006 Consumer Product revenues were primarily comprised of Crayola®, JoJos Circus and Mighty Helmet Racers product.  Cost of sales and gross profit  Cost of sales decreased $28,840 to $92,756 (73.7% of revenues) for the nine months ended September 30, 2006 from $121,596 (73.6% of revenues) in the comparable period in 2005 primarily due to lower sales volume in 2006.  Our gross margin percentage decreased to 26.4% for the nine months ended September 30, 2006 from 28.0% in the comparable period for 2005. This decrease is the result of a gain of $2,724 recorded for the nine months ended September 30, 2005 as compared with $88 for the nine months ended September 30, 2006 on the partial reversal of a previously recorded minimum royalty guarantee shortfall charge recorded in the fourth quarter of 2004. Excluding the impact of this gain, the gross profit percentage decreased to 26.3% from 26.4% in 2005.  The gross profit percentage for our Promotional Products segment for the nine months ended September 30, 2006 decreased to 25.4% compared to 26.0% for the comparable period in 2005.  This decrease is attributable to a few high volume but low margin Logistix (U.K.) promotional programs in 2006  The gross profit percentage for our Agency Services segment for the nine months ended September 30, 2006 decreased to 31.2% compared to 34.0% for the comparable period in 2005. This decrease is attributable to a higher level of direct outside costs in the first nine months of 2006, partially offset by higher retainer revenues which carry higher overall margins.  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 nine months ended September 30, 2006 decreased to 24.0% compared to 37.0% for the comparable period in 2005. This decrease in the margin is attributable to the gain of $2,724 discussed above. Excluding the impact of this gain, the gross profit percentage increased to 22.9% from 22.7% in 2005. This increase is the result of the fact that our primary remaining toy lines, Crayola®, Mighty Helmet Racers and JoJos Circus® are our strongest.  This increase was partially offset by higher level of close-out sales of discontinued products and by a write-off of a pre-paid royalty related to discontinued products.   26  Salaries, wages and benefits  Salaries, wages and benefits decreased $6,103, or 23.4%, to $20,031 (15.9% of revenues) for the nine months ended September 30, 2006 from $26,134 (15.8% of revenues) in the comparable period for 2005. This decrease was primarily attributable to a reduction in personnel as a result of our restructuring initiatives designed to streamline operations.  In the nine months ended September 30, 2005, costs of $1,350 were recorded relating to the departure of the Companys former CEO.  Selling, general and administrative expenses  Selling, general and administrative expenses decreased $3,317, or 19.1%, to $14,075 (11.2% of revenues) for the nine months ended September 30, 2006 from $17,392 (10.5% of revenues) in the comparable period for 2005. The decrease is attributable to a reduction in marketing expense, commissions, freight out, third party warehousing and other selling expenses as a result of lower revenues and inventory levels for Consumer Products. The decrease was also attributable to lower occupancy costs resulting from the termination of an office and warehouse lease in Ontario, California and an office lease in Minneapolis as well as the sublease of a portion of our Los Angeles office. This was partially offset by an increase in legal fees and other outside services costs incurred in connection with a now resolved proxy contest and an increase in bank charges for our credit facility with Bank of America.  Restructuring charge  We recorded a restructuring charge of $1,310 (1.0% of revenues) for the nine months ended September 30, 2006 compared to $1,318 (0.8% of revenues) for the same period in 2005. This charge represents severance expenses and other termination costs related to the reorganization of the SCI Promotion agency, the elimination of three centralized senior management positions, 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 and staff reductions in our Hong Kong office. The restructuring charge in 2005 represents termination costs for the elimination of certain centralized management positions and severance expenses and other termination costs resulting from our decision to wind down a substantial majority of our non-core consumer products business, Pop Rocket. See Restructuring below.  Other income (expense)  Other income (expense) decreased $320 to $(189) for the nine months ended September 30, 2006 from $131 in the comparable period for 2005. The decrease is primarily due to foreign currency losses as a result of the strengthening of the British pound relative to the U.S. dollar. This decrease was partially offset by a decrease in interest expense relating to short-term borrowings compared to the same period in 2005.  Provision (benefit) for income taxes  The effective tax rate for the nine months ended September 30, 2006 was (4.1)% compared to 33.8% for the same period in 2005. In 2006, we recorded a tax provision for our Asia-based operations and recognized no tax benefit from our losses in the United States and the United Kingdom due to our valuation allowance.  Net loss  Net loss increased $1,280 to $(2,513) ((2.0)% of revenues) in 2006 from a $(1,233) ((0.7)% of revenues) in 2005 primarily due to the decrease in gross margins on lower revenues in 2006 compared to 2005 and a gain recorded for the nine months ended September 30, 2005 on the partial reversal of a previously recorded minimum royalty guarantee shortfall charge. This was partially offset by a decrease in salaries, wages and benefits and selling, general and administrative expenses as a result of our restructuring initiatives.  Financial Condition and Liquidity  At September 30, 2006, cash and cash equivalents were $3,030, compared to $6,315 as of December 31, 2005. At September 30, 2006, restricted cash was $1,269, compared to $0 as of December 31, 2005. The decrease in cash and cash equivalents was attributable to cash flows used in operating and investing activities.  As of September 30, 2006, working capital was $10,701 compared to $12,520 at December 31, 2005. Cash used in operations for the nine months ended September 30, 2006 was $6,124 compared to cash provided by operations of $7,914 in the prior year period. Cash flows used in operations in the nine months ended September 30, 2006 were primarily the result of cash used to pay down accounts payable and accrued liabilities from fourth quarter 2005 promotional programs. Cash flows provided from operations for the nine months ended September 30, 2005 were primarily attributable to collections of receivables from large fourth quarter 2004 programs which shipped later in that year. Cash flows used in investing activities for the nine months ended  27  September 30, 2006 were $2,740 compared to $2,278 in the prior year. This increase is primarily the result of restricted cash used to fund a bank guarantee to a new vendor of our Logistix (U.K.) subsidiary. In addition, the former Megaprint shareholders were paid $313 upon release of a purchase price holdback. Cash flows used in investing activities for the nine months ended September 30, 2005, were reduced by $976 of proceeds from the sale of a building acquired in connection with the Megaprint acquisition. Cash flows provided by financing activities for the nine months ended September 30, 2006 were $5,218 compared to cash used of $5,035 in the prior year as a result of repayment of short-term borrowings for the nine months ended September 30, 2005 compared to borrowings of $5,672 for the nine months ended September 30, 2006. Our borrowings were to fund a portion of our development costs for a large holiday
program for our largest client. The reduction in cash used in financing activities is also attributable to the elimination of preferred stock dividends effective April 1, 2006 (see Preferred Stock below).  As of September 30, 2006, our net accounts receivable decreased $4,351 to $25,024 from $29,375 at December 31, 2005. The decrease was expected 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. The decrease is also attributable to the wind-down of our non-core Consumer Products business.  As of September 30, 2006, inventories increased $4,026 to $15,272 from $11,246 at December 31, 2005. This increase is attributable to the expected shipment of promotional products to our largest client in the fourth quarter 2006. This increase is partially offset by reduced inventory levels in the non-core Consumer Products segment as a result of the wind-down.  Consumer Products inventories represent 24.2% and 12.0% of total inventories as of December 31, 2005 and September 30, 2006, 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 September 30, 2006, accounts payable decreased $1,294 to $18,824 from $20,118 at December 31, 2005. This decrease was attributable to the payment of liabilities related to fourth quarter 2005 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 September 30, 2006, accrued liabilities decreased $5,405 to $11,937 from $17,342 at December 31, 2005. This decrease is primarily attributable to royalty payments resulting from the remaining amount of minimum royalty guarantee shortfall obligations recorded in 2004, the payment of 2005 contractual bonuses, payments of severance and other costs related to the 2005 restructurings.  As of the date hereof, we believe that cash from operations, cash on hand at September 30, 2006 and our credit facility will be sufficient to fund our working capital needs for at least the next twelve months. The statements set forth herein are forward-looking and actual results may differ materially.  Future minimum annual commitments for guaranteed minimum royalty payments under license agreements, non-cancelable operating leases and employment agreements as of September 30, 2006 are as follows:  2006
        
        2007
        
        2008
        
        2009
        
        2010
        
        Thereafter
        
        TotalOperating Leases
        $
        1,035
        $
        4,036
        $
        3,988
        $
        3,807
        $
        787
        $
        1,911
        $
        15,564Guaranteed Royalties
        
        107
        
        270
        
        300
        
        --
        
        --
        
        --
        
        677Employment Agreements
        
        634
        
        1,838
        
        --
        
        --
        
        --
        
        --
        
        2,472Total
        $
        1,776
        $
        6,144
        $
        4,288
        $
        3,807
        $
        787
        $
        1,911
        $
        18,713
  We had no material commitments for capital expenditures at September 30, 2006. Letters of credit outstanding as of December 31, 2005 and September 30, 2006 totaled $2,763 and $515, respectively.  Restructuring and Minimum Royalty Guarantee Shortfalls  In 2004, we finalized a decision to pursue the wind-down of a substantial majority of our Consumer Products business. Our determination was to significantly scale back this business during 2005 while exiting a substantial majority of the business permanently as soon as is feasible. As a result of the wind-down, in the fourth quarter of 2004, we recorded a pre-tax charge of $7,722 relating to minimum royalty guarantee shortfalls on several Consumer Products licenses. This charge was determined based on contractual commitments as of December 31, 2004 and reflected our decision not to fully exploit these licenses. Approximately $3,000 of this pre-tax charge was non-cash for write-offs of long-term royalty advances. The charge was recorded as minimum royalty guarantee shortfalls in the consolidated statement of operations for the year ended December 31, 2004.  On May 18, 2005, we reached a settlement with one of our licensors affecting several licenses. Under the terms of the settlement, we agreed to forgo our rights to certain licensed properties for 2006 and 2007 in exchange for a reduction in the overall royalty guarantees. We retained product distribution rights under the licenses for 2005. As a result of this settlement, our overall commitment  28  for royalty guarantees was reduced by approximately $4,000. We paid the licensor a total of $1,800 through March 31, 2006. As a result of this settlement and higher than expected Scooby-Doo revenues that exceeded our initial estimates, $2,325 of the 2004 charge for minimum royalty guarantee shortfalls was reversed during the three months ended June 30, 2005. An additional amount of $399 and $113 was reversed during the three months ended September 30, 2005 and December 31, 2005, respectively, as a result of higher than expected Scooby-Doo revenues for that period.  For the three months ended June 30, 2006, we reached a settlement with a different licensor which resulted in a reversal of $88. These reversals were recorded as  minimum royalty guarantee shortfall gains in the condensed consolidated statements of operations for the three and nine months ended September 30, 2005 and 2006.  In 2005, in connection with the Consumer Products wind-down, we incurred a charge for one-time employee termination benefits and other costs totaling approximately $797. For the three months ended September 30, 2005, we incurred $40. For the three months ended September 30, 2006, we recorded a gain of $13 for the reversal of previously recorded accruals for employee termination costs as a result of lower costs than initially estimated. For the nine months ended September 30, 2005 and 2006, we incurred $672 and $38, respectively. Such costs are recorded as a restructuring charge in the condensed consolidated statement of operations. The entire amount is attributable to the Consumer Products segment.  In 2005, we eliminated several centralized corporate positions as a result of a realignment of centralized resources. As a result, we incurred a charge for one-time employee termination benefits and other costs totaling approximately $622 in 2005. For the nine months ended September 30, 2006, we incurred an additional $58 for employee termination benefits. For the three months ended September 30, 2005, we incurred $51. For the three months ended September 30, 2006, we recorded a gain of $107 for the reversal of previously recorded accruals for employee termination costs as a result of lower costs than initially estimated. For the nine months ended September 30, 2005 and 2006, we incurred $321 and $58, respectively. Such costs are recorded as a restructuring charge in the condensed consolidated statement of operations. The entire amount is attributable to the corporate segment.  In 2005, 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 totaling $568 in the year ended December 31, 2005. For the three months ended September 30, 2005 and 2006, we incurred $219 and $(31), respectively. For the nine months ended September 30, 2005 and 2006, we incurred $219 and $53, respectively. Such costs are recorded as a restructuring charge in the condensed consolidated statements of operations. The entire amount is attributable to the Promotional Products segment.  In 2005, we made the determination to close our Minneapolis office effective October 31, 2005. We recorded a charge of approximately $192 in the six months ended December 31, 2005 for one-time employee termination benefits related to the closure of the Minneapolis office. For the three and nine months ended September 30, 2005, we incurred $106. Such costs are recorded as a restructuring charge in the consolidated statement of operations for 2005. The entire amount is attributable to the Promotional Products segment.  In 2005, we made a decision to reorganize and consolidate SCI Promotions offices in Ontario, California with our Los Angeles office. We recorded a charge for one-time employee termination benefits and other costs totaling $640 in 2005. For the three months ended September 30, 2006, we recorded a gain of $5 for the reversal of previously recorded accruals for employee termination costs as a result of lower costs than initially estimated. For the nine months ended September 30, 2006, we incurred an additional $784 for employee termination benefits and other costs. The entire amount is attributable to the Promotional Products segment.  In 2005, we made the determination to sublease approximately 15,000 square feet of our Los Angeles office space. The space was sublet effective December 15, 2005 for a term ending December 31, 2009 (the expiration of the master lease term). We recorded a charge of $184 in the quarter ended December 31, 2005 for the estimated loss on the sublease over the term. Such costs are recorded as a restructuring charge in the consolidated statement of operations for 2005. The entire amount is attributable to the corporate segment.  In 2006, in connection with our decision to consolidate the SCI Promotion, Pop Rocket and Megaprint Group agencies into Logistix, we made a decision to eliminate two senior management positions. We recorded a charge for one-time employee termination benefits and other costs totaling $283 for the nine months ended September 30, 2006. The entire amount is attributable to the Promotional Products segment.  In 2006, we made a decision to reorganize our Hong Kong office to better align our operations with the current business needs. As a result, we recorded a charge of $94 for one-time termination benefits associated with staff reductions in our Hong Kong office. For the three and nine months ended September 30, 2006, we recorded a charge of $94.  29  The following table summarizes activity in our restructuring reserve.  Pop Rocket *
        Centralized Corporate *
        Logistix (U.K.) *
        Johnson Grossfield *
        SCI Promotion *
        Los Angeles Office Sublease
        Logistix Consolidation *
        Hong Kong *
        TotalOriginal charge
        $
        746
        $
        622
        $
        568
        $
        192
        $
        640
        $
        184
        $
        -
        $
        -
        $
        2,952Utilization in 2005
        
        (513)
        
        (261)
        
        (137)
        
        (96)
        
        (110)
        
        -
        
        -
        
        -
        
        (1,117)Reserve at December 31, 2005
        
        233
        
        361
        
        431
        
        96
        
        530
        
        184
        
        -
        
        -
        
        1,835Additional charge
        
        -
        
        165
        
        78
        
        -
        
        363
        
        -
        
        -
        
        -
        
        606Utilization
        
        (164)
        
        (235)
        
        (4)
        
        (74)
        
        (306)
        
        (101)
        
        -
        
        -
        
        (884)Reserve at March 31, 2006
        
        69
        
        291
        
        505
        
        22
        
        587
        
        83
        
        -
        
        -
        
        1,557Additional charge
        
        51
        
        -
        
        6
        
        -
        
        426
        
        -
        
        283
        
        -
        
        766Utilization
        
        (83)
        
        (155)
        
        (318)
        
        (20)
        
        (589)
        
        (5)
        
        (37)
        
        -
        
        (1,207)Reserve at June 30, 2006
        
        37
        
        136
        
        193
        
        2
        
        424
        
        78
        
        246
        
        -
        
        1,116Partial reversal of previously recorded one-time employee termination benefits and other related costs
        
        (13)
        
        (107)
        
        (31)
        
        -
        
        (5)
        
        -
        
        -
        
        -
        
        (156)Additional charge
        
        -
        
        -
        
        -
        
        -
        
        -
        
        -
        
        -
        
        94
        
        94Utilization
        
        (24)
        
        (29)
        
        (40)
        
        (2)
        
        (236)
        
        (6)
        
        (134)
        
        (94)
        
        (565)Reserve at September 30, 2006
        $
        -
        $
        -
        $
        122
        $
        -
        $
        183
        $
        72
        $
        112
        $
        -
        $
        489
  * 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. 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. The Facility does not permit the payment of dividends on Series AA Preferred Stock in 2006. The restriction on dividends may be removed in 2007 subject to 2006 audited results and compliance with covenants. On May 10, 2006, certain covenants under the Facility were amended. On August 11, 2006, we amended the Facility to provide for a temporary bridge facility to increase our available borrowings by up to $7,000 to fund working capital for a specific client program.  The finance charges for borrowings under the bridge facility will be 300 basis points greater than the interest charges under the Facility.  This bridge facility expires November 30, 2006. As of December 31, 2005 and September 30, 2006, the marginal interest rate on available borrowings under the Facility was 7.5% and 8.0%, respectively. As of September 30, 2006, we
were in compliance with the restrictions and covenants. As of September 30, 2006, $5,672 was outstanding under the Facility.  In addition to the Facility, in October, 2003 our Logistix (U.K.) agency established an import/letter of credit facility with Hong Kong Shanghai Bank Corp. (HSBC) to provide short-term financing of product purchases in Asia. The total availability under this facility is 1,500 GBP. The total availability under this facility was increased from 1,000 GBP to 1,500 GBP in 2005. Under this facility HSBC may pay the agencys vendors directly upon receipt of invoices and shipping documentation. Logistix (U.K.) in turn is obligated to repay HSBC within 120 days. As of December 31, 2005 and September 30, 2006, $0 was outstanding under this facility.  Issuance of 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  30  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.  Also in connection with the closing of the Crown Transaction, effective as of May 31, 2006, we entered into an Amendment No. 1 to Rights Agreement with Continental Stock Transfer & Trust Company as rights agent (Amendment No. 1) with respect to our Preferred Share Purchase Rights Plan (the Plan). Amendment No. 1 provides that the shares of Common Stock issuable upon conversion of the Series AA Stock, as may be amended from time to time, or upon the exercise of any options or warrants Crown holds to acquire our capital stock (as the same may be amended from time to time), in each case held by Crown as of May 31, 2006 or issuable to Crown as a result of the transactions approved by our stockholders at our 2006 Annual Meeting of Stockholders, will not result in a triggering of rights under the Plan.  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.  Recent Accounting Pronouncements  In July 2006, the Financial Accounting Standards Board, or FASB, issued Interpretation No. 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109, or FIN 48. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements according to SFAS No. 109, Accounting for Income Taxes.  FIN 48 provides for the recognition of only those uncertain tax positions that are more-likely-than-not to be sustained upon examination, measured at the largest amount which has a greater than 50% likelihood of being realized upon settlement. Additionally, FIN 48 gives guidance on derecognition, classification, interest, penalties, accounting in interim periods and disclosure related to uncertain tax positions. The adoption of FIN 48 on January 1, 2007, as required, could result in an adjustment to the amount of recorded tax assets and liabilities related to uncertain tax positions by recording a corresponding adjustment to retained earnings in the consolidated
balance sheets. We are currently assessing the effect, if any, of FIN 48 on our consolidated results of operations and financial position.  In September 2006, the FASB issued SFAS No.157, Fair Value Measurements, or SFAS No. 157. SFAS No. 157 defines fair value, sets out a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements of assets and liabilities. SFAS No. 157 applies under other accounting pronouncements previously issued by the Board that require or permit fair value measurements. The adoption of SFAS No. 157 on January 1, 2007, as required, could result in a transition adjustment that would be recognized as a cumulative-effect adjustment to the opening balance of retained earnings. We are currently assessing the effect SFAS No. 157 may have, if any, on our consolidated results of operations and financial position.  In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108), which provides guidance for quantifying financial statement misstatements. SAB 108 will be effective for the Company beginning January 1, 2007. We are in the process of determining the effect, if any, this statement will have on our financial statements.  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/A for the year ended December 31, 2005. Our exposure to market risks has not changed materially since December 31, 2005.  ITEM 4. CONTROLS AND PROCEDURES  Evaluation of Disclosure Controls and Procedures  The Company maintains disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934 (the Exchange Act) , that are designed to ensure that information required to be disclosed by the Company in the reports  31  that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms and that such information is accumulated and communicated to the Companys management, including its Chief Executive Officer and Principal Accounting Officer, as appropriate to allow timely decisions regarding required disclosure.  The Company carried out an evaluation, under the supervision and with the participation of the Companys management, including the Companys Chief Executive Officer and Principal Accounting Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures as of September 30, 2006.  As a result of this evaluation, our Chief Executive Officer and Principal Accounting Officer concluded that our disclosure controls and procedures
were effective as of September 30, 2006 and are designed to provide management with the appropriate information to allow timely decisions regarding required disclosure.  Remediation of Material Weakness in Internal Control Over Financial Reporting  Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.  A material weakness is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.  As discussed in the Form 10-K/A filing for the year ended December 31, 2005, the Company did not maintain effective controls over the completeness and accuracy of mandatorily redeemable preferred stock.  Specifically, the Company did not maintain effective controls over the accounting for the redemption of preferred stock warrants to ensure that such transactions were recorded in accordance with generally accepted accounting principles.  This control deficiency resulted in the restatement of the Companys consolidated financial statements as of December 31, 2005 as well as an audit adjustment to the interim condensed consolidated financial statements for the second
quarter of 2006.  Additionally, this control deficiency could result in a misstatement of mandatorily redeemable preferred stock, additional paid-in capital, accumulated deficit, net income (loss) available to common stockholders and net income (loss) per share that would result in a material misstatement to the Companys annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, management has determined that this control deficiency constitutes a material weakness.  The Company has made changes to its internal control over financial reporting during the third quarter of 2006 that were intended to remediate the material weakness described above, including the establishment of additional controls to improve the design of internal controls with respect to accounting for transactions with preferred stockholders.  Specifically, the changes include a more formal process to document and review the accounting treatment of any future preferred stock transactions, to ensure that such transactions are recorded in accordance with generally accepted accounting principles. This process will be completed at the inception of any such transaction to ensure any such transactions are accounted for appropriately.  Management believes that this change in the design of internal controls has strengthened our disclosure controls and procedures, as well as our internal control over financial reporting, and has remediated the material weakness described above.  We have discussed this material weakness and our remediation program with our Audit Committee.  Changes in Internal Control over Financial Reporting  The changes in the third quarter implemented as a result of the remediation of the material weakness, as noted above, were the only changes in our internal control structure over financial reporting, as defined in Rule 13a-15(f) promulgated under the Exchange Act, during the quarter ended September 30, 2006, that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.  PART II. OTHER INFORMATION  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
  33  Section 906 of the Sarbanes-Oxley Act of 2002.  34    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
        November 14, 2006
        
        /s/ Roy DarRoy Dar
Vice President, Controller
(Principal Accounting Officer)
    34