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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2005 or o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 Commission File Number: 23346 EMAK WORLDWIDE, INC.  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 offices)
    
    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. Yes þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ 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, 5,779,638 shares as of May 12, 2005.




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EMAK WORLDWIDE, INC. Index To Quarterly Report on Form 10-Q
Filed with the Securities and Exchange Commission
March 31, 2005 PagePart I.
    
    Financial InformationItem 1.Financial Statements
    
    
    3Item 2.Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    18Item 3.Quantitative and Qualitative Disclosures About Market Risk
    
    
    27Item 4.Controls and Procedures
    
    
    27Part II.
    
    Other InformationItem 6.Exhibits
    
    
    28Exhibit 10.1Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
  Cautionary Statement Certain expectations and projections regarding our future performance discussed in this quarterly
report are forward-looking and are made under the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. These expectations and projections are based on
currently available competitive, financial and economic data along with our operating plans and are
subject to future events and uncertainties. Readers should not place undue reliance on any such
forward-looking statements, which speak only as of the date made. Actual results could vary
materially from those anticipated for a variety of reasons. We undertake no obligation to publicly
release the results of any revisions to these forward-looking statements which may be made to
reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated
events. Readers are advised to review Managements Discussion and Analysis of Financial Condition
and Results of Operations  Cautionary Statements and Risk Factors. 2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS EMAK WORLDWIDE, INC. CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED) December 31,
    
    
    March 31,2004
    
    
    2005ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    4,406
    
    
    $
    5,152Accounts receivable (net of allowances of $1,733 and
$1,357 as of December 31, 2004 and March 31, 2005, respectively)
    
    
    47,180
    
    
    
    33,878Inventories (Note 2)
    
    
    18,763
    
    
    
    16,946Prepaid expenses and other current assets
    
    
    5,466
    
    
    
    6,845Total current assets
    
    
    75,815
    
    
    
    62,821Fixed assets, net
    
    
    5,029
    
    
    
    4,941Goodwill (Notes 2 and 6)
    
    
    41,723
    
    
    
    41,254Other intangibles, net (Notes 2 and 6)
    
    
    3,686
    
    
    
    3,553Other assets
    
    
    7,060
    
    
    
    6,945Total assets
    
    $
    133,313
    
    
    $
    119,514
 The accompanying notes are an integral part of these
unaudited condensed consolidated financial statements. 3




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EMAK WORLDWIDE, INC. CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED) LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS EQUITY December 31,
    
    
    March 31,2004
    
    
    2005CURRENT LIABILITIES:Short-term debt
    
    $
    6,025
    
    
    $
    2,822Accounts payable
    
    
    30,996
    
    
    
    24,659Accrued liabilities
    
    
    20,860
    
    
    
    17,700Total current liabilities
    
    
    57,881
    
    
    
    45,181LONG-TERM LIABILITIES
    
    
    6,621
    
    
    
    6,317Total liabilities
    
    
    64,502
    
    
    
    51,498COMMITMENTS
AND CONTINGENCIES (Note 8)Mandatorily redeemable preferred stock, Series AA senior cumulative convertible,
$.001 par value per share, 25,000 issued and outstanding, stated at liquidation
preference of $1,000 per share ($25,000), net of issuance costs
    
    
    22,518
    
    
    
    22,518STOCKHOLDERS EQUITY:Preferred stock,$.001 par value per share, 1,000,000
shares authorized, 25,000 Series AA issued and outstanding
    
    
    
    
    
    
    Common stock,$.001 par value per share, 25,000,000
shares authorized, 5,759,263 and 5,779,638 shares outstanding
as of December 31, 2004 and March 31, 2005, respectively
    
    
    
    
    
    
    Additional paid-in capital
    
    
    27,516
    
    
    
    27,517Retained earnings
    
    
    33,954
    
    
    
    33,162Accumulated other comprehensive income
    
    
    4,972
    
    
    
    4,67366,442
    
    
    
    65,352LessTreasury stock, 3,167,258 shares, at cost, as of
December 31, 2004 and March 31, 2005
    
    
    (17,669
    )
    
    
    (17,669
    )Unearned compensation
    
    
    (2,480
    )
    
    
    (2,185
    )Total stockholders equity
    
    
    46,293
    
    
    
    45,498Total liabilities, mandatorily redeemable preferred stock and stockholders equity
    
    $
    133,313
    
    
    $
    119,514
 The accompanying notes are an integral part of these
unaudited condensed consolidated financial statements. 4




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EMAK WORLDWIDE, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED) Three Months EndedMarch 31,2004
    
    
    2005REVENUES
    
    $
    51,812
    
    
    $
    57,242COST OF SALES
    
    
    38,572
    
    
    
    42,793Gross profit
    
    
    13,240
    
    
    
    14,449OPERATING EXPENSES:Salaries, wages and benefits
    
    
    7,277
    
    
    
    8,330Selling, general and administrative
    
    
    5,896
    
    
    
    6,002Integration costs
    
    
    43
    
    
    
    45Restructuring charge
    
    
    
    
    
    
    583ERP reimplementation costs
    
    
    
    
    
    
    89Total operating expenses
    
    
    13,216
    
    
    
    15,049Income (loss) from operations
    
    
    24
    
    
    
    (600
    )OTHER EXPENSE, net
    
    
    (292
    )
    
    
    (105
    )Loss before benefit for income taxes
    
    
    (268
    )
    
    
    (705
    )BENEFIT FOR INCOME TAXES
    
    
    (102
    )
    
    
    (288
    )Net loss
    
    
    (166
    )
    
    
    (417
    )PREFERRED STOCK DIVIDENDS
    
    
    375
    
    
    
    375NET LOSS AVAILABLE TO COMMON
STOCKHOLDERS
    
    $
    (541
    )
    
    $
    (792
    )BASIC LOSS PER SHARE
    
    $
    (0.09
    )
    
    $
    (0.14
    )BASIC WEIGHTED AVERAGE SHARES OUTSTANDING
    
    
    5,739,603
    
    
    
    5,765,938DILUTED LOSS PER SHARE
    
    $
    (0.09
    )
    
    $
    (0.14
    )DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING
    
    
    5,739,603
    
    
    
    5,765,938
 The accompanying notes are an integral part of these
unaudited condensed consolidated financial statements. 5




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EMAK WORLDWIDE, INC. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS)
(UNAUDITED) Three Months EndedMarch 31,2004
    
    
    2005NET LOSS
    
    $
    (166
    )
    
    $
    (417
    )OTHER COMPREHENSIVE INCOME (LOSS):Foreign currency translation adjustments (Note 2)
    
    
    522
    
    
    
    (647
    )Unrealized gain on foreign currency (Note 2)
forward contracts
    
    
    289
    
    
    
    348COMPREHENSIVE INCOME (LOSS)
    
    $
    645
    
    
    $
    (716
    )
 The accompanying notes are an integral part of these
unaudited condensed consolidated financial statements. 6




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EMAK WORLDWIDE, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED) Three Months EndedMarch 31,2004
    
    
    2005CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
    
    $
    (166

    )
    
    $
    (417
    )Adjustments to reconcile net loss to net cash
Provided by (used in) operating activities:Depreciation and amortization
    
    
    466
    
    
    
    568Provision for doubtful accounts
    
    
    21
    
    
    
    47Gain on asset disposal
    
    
    (8
    )
    
    
    (5
    )Tax benefit from exercise of stock options
    
    
    51
    
    
    
    Amortization of restricted stock
    
    
    86
    
    
    
    181Changes in
operating assets and liabilities, net of effect of acquisition:Increase (decrease) in cash and cash equivalents:Accounts receivable
    
    
    8,226
    
    
    
    12,979Inventories
    
    
    2,750
    
    
    
    1,755Prepaid expenses and other current assets
    
    
    (914
    )
    
    
    (1,118
    )Other assets
    
    
    (682
    )
    
    
    (176
    )Accounts payable
    
    
    (3,433
    )
    
    
    (6,111
    )Accrued liabilities
    
    
    (6,138
    )
    
    
    (2,642
    )Long-term liabilities
    
    
    (463
    )
    
    
    (305
    )Net cash provided by (used in) operating activities
    
    
    (204
    )
    
    
    4,756CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of fixed assets
    
    
    (591
    )
    
    
    (448
    )Proceeds from sale of fixed assets
    
    
    9
    
    
    
    11Purchase of marketable securities
    
    
    (1,300
    )
    
    
    Payment for purchase of Johnson Grossfield
    
    
    (4,508
    )
    
    
    Net cash used in investing activities
    
    
    (6,390
    )
    
    
    (437
    )CASH FLOWS FROM FINANCING ACTIVITIES:Payment of preferred stock dividends
    
    
    (375
    )
    
    
    (375
    )Repayment of short-term debt
    
    
    
    
    
    
    (3,141
    )Proceeds from exercise of stock options
    
    
    477
    
    
    
    Net cash provided by (used in) financing activities
    
    
    102
    
    
    
    (3,516
    )Net increase (decrease) in cash and cash equivalents
    
    
    (6,492
    )
    
    
    803Effects of exchange rate changes on cash and cash equivalents
    
    
    53
    
    
    
    (57
    )CASH AND CASH EQUIVALENTS, beginning of period
    
    
    19,291
    
    
    
    4,406CASH AND CASH EQUIVALENTS, end of period
    
    $
    12,852
    
    
    $
    5,152SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:CASH PAID FOR:Interest
    
    $
    54
    
    
    $
    118Income taxes, net of refunds
    
    $
    566
    
    
    $
    (434
    )
 The accompanying notes are an integral part of these
unaudited condensed consolidated financial statements. 7




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EMAK WORLDWIDE, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED) NOTE 1    ORGANIZATION AND BUSINESS EMAK Worldwide, Inc., a
Delaware corporation and subsidiaries (EMAK or the Company), 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
its clients. EMAK has
expertise in the areas of: strategic planning and research, entertainment marketing, design
and manufacturing of custom promotional products, promotion, event marketing, collaborative
marketing, retail design and environmental branding. The
Companys clients include Burger King,
Kelloggs, Frito Lay, Kohls, Macys, Kraft, Procter & Gamble, Miller Brewing Company and
Subway Restaurants, among others. EMAK is headquartered in Los Angeles, with operations in
Chicago, Minneapolis, New York, Ontario (California), Dublin, 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 US dollar. NOTE 2    BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES In the opinion of management and subject to year-end audit, 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. In the opinion of management, all adjustments considered
necessary for fair statement have been included. The results of operations for the interim
periods are not necessarily indicative of the results for a full year. These condensed
consolidated financial statements should be read in conjunction with the consolidated financial
statements and footnotes thereto included in the Companys Annual Report on Form 10-K for the year
ended December 31, 2004. 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 and less undistributed earnings allocated to participating
preferred stock. 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. During a loss period, the assumed exercise
of in-the-money stock options has an antidilutive 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 months ended March 31, 2004 and 2005. Options to purchase 2,912,694 and
2,630,528 shares of common stock, $.001 par value per share (the Common Stock), as of March 31,
2004 and 2005, respectively, were excluded from the computation of diluted EPS as they would have
been anti-dilutive. For the three months ended March 31, 2004 and 2005, preferred stock
convertible into 1,694,915 shares of Common Stock was excluded in the computation of diluted EPS. Pursuant to 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), companies with participating
securities calculate earnings per share using a two-class method. The Companys previously
outstanding Series A cumulative participating mandatorily redeemable preferred stock (Series A
Stock) qualified as a participating security since it was entitled to dividends declared on the
Companys common stock; therefore, EITF 03-6 required the allocation of a portion of undistributed
earnings to these preferred stock. The Series A Stock was exchanged by the holder for an
equivalent number of shares of Series AA non-participating preferred stock on December 30, 2004.
As a result, EITF 03-6 will have no impact on the Companys EPS calculations in 2005. EITF 03-6
had no impact on EPS for the quarter ended March 31, 2004 because of the net loss. 8




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The following is a reconciliation of the numerators and denominators of the basic and diluted
EPS computation for income available to common shareholders and other disclosures required
by SFAS No. 128, Earnings per Share and EITF 03-6: For the Three Months Ended March 31,2004
    
    
    2005Loss
    
    
    Shares
    
    
    Per Share
    
    
    Loss
    
    
    Shares
    
    
    Per Share(Numerator)
    
    
    (Denominator)
    
    
    Amount
    
    
    (Numerator)
    
    
    (Denominator)
    
    
    AmountBasic EPS:Loss available to
common stockholders
    
    $
    (541
    )
    
    
    5,739,603
    
    
    $
    (0.09
    )
    
    $
    (792
    )
    
    
    5,765,938
    
    
    $
    (0.14
    )Effect of dilutive securities:Options and warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Dilutive EPS:Loss available to common
stockholders
    
    $
    (541
    )
    
    
    5,739,603
    
    
    $
    (0.09
    )
    
    $
    (792
    )
    
    
    5,765,938
    
    
    $
    (0.14
    )
 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, 2004 and March 31, 2005, inventories consisted of the following: December 31,
    
    
    March 31,2004
    
    
    2005Production-in-process
    
    $
    861
    
    
    $
    2,573Finished goods
    
    
    17,902
    
    
    
    14,373$
    18,763
    
    
    $
    16,946
 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 in stockholders equity. For such subsidiaries, accounts
are translated into United States dollars at the following rates of exchange: assets and
liabilities at period-end exchange rates, equity accounts at historical rates, and income and
expense accounts at average exchange rates during the period. For subsidiaries with transactions denominated in currencies other than their functional currency,
net foreign exchange transaction gains or losses are included in determining net income (loss).
Transaction losses included in net loss for the quarters ended March 31, 2004 and 2005 were $278
and $5, respectively. Derivative Instruments The Company adopted 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 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. 9




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The Company adopted SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and
Hedging Activities, which amends and clarifies accounting for derivative instruments,
including certain derivative instruments embedded in other contracts, and for hedging
activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003 and for hedging relationships designated after June 30, 2003.
The guidance was applied prospectively. 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 and Megaprint Group subsidiaries entered into foreign currency forward
contracts aggregating 5,044 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 November 2005. At March 31, 2005, the foreign currency forward contracts had an
estimated fair value of (64) GBP. The fair value of the foreign currency forward contracts is
recorded in accrued liabilities in the accompanying condensed consolidated balance sheet as of
March 31, 2005. The unrealized loss on the contracts is reflected in accumulated other
comprehensive income. The Companys Johnson Grossfield subsidiary entered into foreign currency forward contracts
aggregating $525 to sell Canadian dollars in exchange for United States dollars. The
contracts will expire by September 2005. At March 31, 2005, the foreign currency forward
contracts had an estimated fair value of $4. Goodwill and Other Intangibles The change in the carrying amount of goodwill from $41,723 as of December 31, 2004 to $41,254 as of
March 31, 2005 reflects: a foreign currency translation adjustment of $469. All of the goodwill
balance relates to the Marketing Services segment. Identifiable intangibles of $3,686 as of December 31, 2004 and, $3,553 as of March 31, 2005 a
portion of which are subject to amortization, are reflected as other intangibles in the condensed
consolidated balance sheets. Royalties The Company enters into agreements to license intellectual properties such as trademarks,
copyrights, and patents. The agreements may call for minimum amounts of royalties to be paid
in advance and throughout the term of the agreement, which are non-refundable in the event
that product sales fail to meet certain minimum levels. Advance royalties resulting from
such transactions are stated at the lower of the amounts paid or the amounts estimated to be
recoverable from future sales of the related products. Furthermore, minimum guaranteed
royalty commitments are reviewed on a periodic basis to ensure that amounts are recoverable
based on estimates of future sales of the products under license. A loss provision will be
recorded in the condensed consolidated statements of operations to the extent that future
minimum royalty guarantee commitments are not recoverable. Estimated future sales are
projected based on historical experience, including that of similar products, and anticipated
advertising and marketing support by the licensor. 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. These shortfalls are the result of the Companys decision
to wind down its consumer products business, Pop Rocket, which resulted in a decrease in
expectations of future sales under several licenses. The Company continues to monitor royalty
accruals in light of the wind down of Pop Rocket and is presently negotiating with its
licensors the terms for terminating several of its license agreements. There were no
significant changes to these estimates during the quarter ended
March 31, 2005. Subsequent to March 31, 2005, the Company
reached a settlement with one of its licensors which reduced its
overall royalty commitment (see Note 9  Subsequent
Events). Management believes the accounting estimate related to minimum guaranteed royalty commitments
is a critical accounting estimate because changes in sales projections could materially
affect key financial measures including, gross profit, net income and other assets. 10




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Stock-Based Compensation As of March 31, 2005, the Company had three stock-based compensation plans  the 2000 Stock
Option Plan, the 2004 Non-Employee Director Stock Incentive Plan and the 2004 Stock Incentive
Plan. In accordance with provisions of SFAS No. 123, the Company applies Accounting
Principles Board (APB) Opinion No. 25 and related interpretations in accounting for its
stock-based compensation plans and, accordingly, does not recognize compensation cost for
grants whose exercise price equals the market price of the stock on the date of grant. If the
Company had elected to recognize compensation cost based on the fair value of the options
granted at grant date as prescribed by SFAS No. 123, net loss and loss per share would have
been increased to the pro forma amounts indicated in the table below: Three Months EndedMarch 31,2004
    
    
    2005Net loss - as reported
    
    $
    (166
    )
    
    $
    (417
    )Plus:Stock-based
compensation expense, net of tax, included in reported
net loss
    
    
    53
    
    
    
    107Less:Compensation expense (a)
    
    
    187
    
    
    
    84Net loss - pro forma
    
    $
    (300
    )
    
    $
    (394
    )Loss per share:Basic loss per share, as reported
    
    $
    (0.09
    )
    
    $
    (0.14
    )Pro forma basic loss per share
    
    $
    (0.12
    )
    
    $
    (0.13
    )Diluted loss per share, as reported
    
    $
    (0.09
    )
    
    $
    (0.14
    )Pro forma diluted loss per share
    
    $
    (0.12
    )
    
    $
    (0.13
    )
   (a)
    
    Determined under fair value based method for all awards, net of tax. ERP reimplementation costs The Company recorded enterprise resource planning (ERP) reimplementation costs of $89
for the three months ended March 31, 2005. This represents consulting
costs which were not capitalized into fixed assets. The costs were incurred in connection
with a significant upgrade and reimplementation of the Companys ERP software which is
designed to enhance management information, financial reporting, inventory management, cost
evaluation and controls while assisting in compliance with the Sarbanes-Oxley Act of 2002. Recent Accounting Pronouncements In December 2004, the FASB released FASB Staff Position No. FAS 109-2 (FSP 109-2). FASB
Staff Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings
Repatriation Provision within the American Jobs Creation Act of 2004, provides companies more
time (beyond the financial-reporting period during which the Act took effect) to evaluate the
Acts impact on the Companys plan for reinvestment or repatriation of certain foreign
earnings for purposes of applying SFAS No. 109, Accounting for Income Taxes. The FSP went
into effect upon being issued. As of March 31, 2005, management had not determined whether,
or to what extent, the Company may repatriate foreign earnings under the Jobs Act. Therefore,
the Companys condensed consolidated financial statements do not include any provision for
income taxes on the $5,705 cumulative balance of unremitted foreign earnings as of year end
2004. Management expects to finalize its assessment related to the Jobs Act in the first half
of 2005. In December 2004, the FASB issued SFAS No. 123 (revised 2004) (SFAS No. 123(R)), Share-Based
Payment, which replaced SFAS No. 123 and superseded APB Opinion No. 25. SFAS No. 123(R) requires
all share-based payments to employees, including grants of employee stock options, to be recognized
in the financial statements based on their fair values. The pro forma disclosures previously
permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition.
Under SFAS No. 123(R), the Company must determine the appropriate fair value method to be used for
valuing share-based payments, the amortization method of compensation cost and the transition
method to be used at the date of adoption. The transition methods include prospective and
retroactive adoption options. Under the retroactive option, prior periods may be restated either as
of the beginning of the year of adoption or for all periods presented. The prospective method
requires that compensation cost be recorded for all unvested stock options and nonvested stock at
the beginning of the first quarter of adoption of SFAS No. 123(R), whereas the retroactive method
requires recording compensation cost for all unvested stock options and nonvested stock beginning
with the first period restated. In April 2005, the Securities Exchange Commission amended Regulation S-X to delay the effective
date for compliance with SFAS No. 123(R). Based on the amended regulation, the Company is required
to adopt SFAS No. 123(R) on January 1, 2006. The
Company is evaluating the requirements of SFAS No. 123(R) and expects that the adoption of SFAS No.
123(R) may have a material adverse effect on its results of operations and earnings per share. The
Company has not yet determined the method of adoption of SFAS No. 11




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123(R), or whether the amounts
recorded in the consolidated statements of income in future periods will be similar to the current
pro forma disclosures under SFAS No. 123. In November 2004, the FASB issued SFAS No. 151, Inventory Costs  An Amendment of ARB No. 43,
Chapter 4. SFAS No. 151 amends the guidance in Chapter 4, Inventory Pricing, of Accounting
Research Bulletin (ARB) No. 43, Restatement and Revision of Accounting Research Bulletins, to
clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage). Among other provisions, the statement requires that items such as
idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as
current-period charges regardless of whether they meet the criterion of so abnormal as stated in
ARB No. 43. Additionally, SFAS No. 151 requires that the allocation of fixed production overhead to
the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151
is effective for fiscal years beginning after June 15, 2005. The Company is currently evaluating
the effect that the adoption of SFAS No. 151 will have on its results of operations and financial
position, but does not expect it to have a material impact. NOTE 3  LINE OF CREDIT On April 24, 2001, the Company signed a credit facility (the Facility) with Bank of America. On
April 26, 2004, the maturity date of the Facility was extended through June 30, 2005. Effective
March 30, 2005, the maturity date of the Facility was further extended through March 31, 2006. The
credit facility is secured by substantially all of the Companys assets and provides for a line of
credit of up to $35,000 with borrowing availability determined by a formula based on qualified
assets. The March 30, 2005 amendment reduced the line of credit to $20,000. The Company sought a
reduction in the size of the Facility to better align the size and cost of the Facility with its
borrowing needs. Interest on outstanding borrowings will be based on either a fixed rate
equivalent to LIBOR plus an applicable spread of between 1.50 and 2.25 percent or a variable rate
equivalent to the banks reference rate plus an applicable spread of between zero and 0.50 percent.
The Company is also required to pay an unused line fee of between zero and 0.60 percent per annum
and certain letter of credit fees. The applicable spread is based on the achievement of certain
financial ratios. The Facility also requires the Company to comply with certain restrictions and
covenants as amended from time to time. On November 14, 2001, February 8, 2002, September 30,
2002, November 14, 2003, April 26, 2004, August 12, 2004, November 15, 2004 and March 30, 2005,
certain covenants under the facility were amended. As of
December 31, 2004 and March 31, 2005, the Company was in
compliance with the amended restrictions and covenants. In addition to amending certain covenants,
the November 15, 2004 amendment imposed a temporary $12,000 cap on total outstanding borrowings and
letters of credit. This amendment also increased the maximum interest rate on outstanding
borrowings by 0.25 percent. The March 30, 2005 amendment eliminated the temporary $12,000 cap.
The Facility may be used for working capital and acquisition financing purposes. As of March 31,
2005, $1,650 was outstanding under the Facility. In addition to the Facility, in October, 2003 our Logistix subsidiary 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 1,000 GBP. Under this facility HSBC may pay Logistixs vendors directly upon receipt of
invoices and shipping documentation. Logistix in turn is obligated to repay HSBC within 120
days. As of March 31, 2005, there were no outstanding advances under this facility. In connection with the acquisition of the Megaprint Group, the Company assumed a mortgage loan
secured by a building in Holland. The mortgage loan has a 24 year term and carries an
interest rate fixed at 5 percent per annum for three years from December 2002. The mortgage
loan is repayable in equal monthly installments of 4 Euros. The outstanding balance on the
mortgage loan is 908 Euros (approximately US $1,172) as of March 31, 2005. Notwithstanding
the terms of the mortgage loan, it will be repaid in the second quarter of 2005. The Company
will offset the balance of the mortgage loan against monies owed to the sellers of the
Megaprint Group (see Note 6  Acquisitions). This mortgage loan is recorded as short-term
debt in the accompanying balance sheet as of March 31, 2005. Megaprint Group has an overdraft facility of 750 Euros from ING Bank, Nederland. As of March
31, 2005, there were no amounts outstanding under this facility. NOTE 4  RESTRUCTURING On February 24, 2005,
the Company finalized a decision to pursue the wind down of a
substantial majority of its consumer products business, Pop Rocket. The Companys determination is to significantly
scale back this business during 2005 while exiting the business permanently as soon as is feasible.
In the near term, this includes restructuring the Pop Rocket division and exiting certain licenses.
In connection with this decision, we expect to incur charges for one-time employee termination
benefits and other costs
totaling approximately $700 in 2005. During the first quarter of 2005, $583 of such costs was
incurred for employee terminations completed through March 31, 2005. Such costs are recorded as a
restructuring charge in the condensed consolidated statement of operations for the three months
ended March 31, 2005. The entire amount is attributable to the Consumer Products segment. The
remaining costs are expected to be incurred and expensed throughout the remainder of 2005 for
employees expected to be terminated by December 31, 2005. Of the
$583 of costs incurred to date, $95 has been paid as of March 31, 2005. 12




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NOTE 5  SEGMENTS The Company has identified two reportable segments through which it conducts its continuing
operations: marketing services and consumer products. The factors for determining the reportable
segments were based on the distinct nature of their operations. They are managed as separate
business units because each requires and is responsible for executing a unique business strategy.
The marketing services segment designs and produces promotional products used as free premiums or
sold in conjunction with the purchase of other items at a retailer or quick service restaurant and
provides various services such as strategic planning and research, entertainment marketing,
promotion, event marketing, collaborative marketing, retail design, and environmental branding.
Marketing services programs 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 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. Earnings of industry segments and geographic areas exclude interest income, interest expense,
depreciation expense, restructuring charges/gains, 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. Industry Segments As of and For the Three Months Ended March 31, 2004Marketing
    
    
    ConsumerServices
    
    
    Products
    
    
    Corporate
    
    
    TotalTotal revenues
    
    $
    46,488
    
    
    $
    5,324
    
    
    $
    
    
    
    $
    51,812Income (loss) before provision (benefit)
for income taxes
    
    $
    4,307
    
    
    $
    (123
    )
    
    $
    (4,452
    )
    
    $
    (268
    )Provision (benefit) for income taxes
    
    
    1,639
    
    
    
    (47
    )
    
    
    (1,694
    )
    
    
    (102
    )Net income (loss)
    
    $
    2,668
    
    
    $
    (76
    )
    
    $
    (2,758
    )
    
    $
    (166
    )Fixed asset additions
    
    $
    
    
    
    $
    
    
    
    $
    591
    
    
    $
    591Depreciation and amortization
    
    $
    70
    
    
    $
    
    
    
    $
    396
    
    
    $
    466Total assets
    
    $
    83,571
    
    
    $
    8,020
    
    
    $
    29,359
    
    
    $
    120,950
 As of and For the Three Months Ended March 31, 2005Marketing
    
    
    ConsumerServices
    
    
    Products
    
    
    Corporate
    
    
    TotalTotal revenues
    
    $
    50,658
    
    
    $
    6,584
    
    
    $
    
    
    
    $
    57,242Income (loss) before provision (benefit)
for income taxes
    
    $
    4,100
    
    
    $
    (545
    )
    
    $
    (4,260
    )
    
    $
    (705
    )Provision (benefit) for income taxes
    
    
    1,676
    
    
    
    (222
    )
    
    
    (1,742
    )
    
    
    (288
    )Net income (loss)
    
    $
    2,424
    
    
    $
    (323
    )
    
    $
    (2,518
    )
    
    $
    (417
    )Fixed asset additions
    
    $
    
    
    
    $
    
    
    
    $
    448
    
    
    $
    448Depreciation and amortization
    
    $
    106
    
    
    $
    
    
    
    $
    462
    
    
    $
    568Total assets
    
    $
    86,057
    
    
    $
    9,442
    
    
    $
    24,015
    
    
    $
    119,514
 13




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NOTE 6  ACQUISITIONS On February 2, 2004 (effective January 31, 2004), the Company acquired certain assets of Johnson
Grossfield, Inc. (JGI-MN), a privately held promotional marketing services company based in
Minneapolis, Minnesota. The Company financed the acquisition through its existing cash reserves.
The acquisition was consummated pursuant to an Asset Purchase Agreement dated January 16, 2004 (the
Johnson Grossfield Purchase Agreement). Under the terms of the Purchase Agreement, the Company
purchased the assets of JGI-MNs promotional agency business for approximately $4,325 in cash (net
of a holdback of $250) and 35,785 shares of the Companys Common Stock (which, based upon the
January 30, 2004 closing market price of $14.80, had a value of $530), plus related transaction
costs of $184 and a commitment to pay additional earnout consideration of up to $4,500 based upon
future performance of the acquired business. The Company also assumed the operating liabilities of
the promotional agency business in connection with the acquisition. The earnout consideration is
based upon the acquired business achieving targeted levels of EBITDA over the period from 2004
through 2008. The earnout payments, if required, are payable 50% in cash and 50% in shares of the
Companys Common Stock. The amount of earnout consideration attributable to 2004 performance will
be determined and paid in the second quarter of 2005. The additional consideration, if any, will
be recorded as goodwill. On April 19, 2005, the Company reached agreement with the sellers of
Johnson Grossfield on the amount of earnout attributable to 2004 performance. Such earnout
consideration totaled $257, of which $148 is payable in cash and the remainder payable in shares of
our common stock (10,616 shares valued at $109 as of April 19, 2005). This earnout consideration
will be recorded as goodwill in the second quarter of 2005. The Johnson Grossfield acquisition has been accounted for under the purchase method of accounting.
The financial statements reflect the allocation of the purchase price to the acquired net assets
based on their estimated fair values as of the acquisition date. The Companys allocation of
purchase price for the Johnson Grossfield acquisition, based upon estimated fair values is as
follows: Net current assets
    
    $
    2,758Property, plant and equipment
    
    
    8Other non-current assets
    
    
    7Net current liabilities
    
    
    (1,214
    )Estimated fair value, net assets acquired
    
    
    1,559Goodwill
    
    
    1,192Other intangible assets
    
    
    2,393Total purchase price
    
    $
    5,144
 The other intangible assets of $2,393 are comprised of customer relationships and a non-competition
agreement, and are being amortized over estimated useful lives ranging from 2 years to 12 years. On November 10, 2004, the Company acquired all of the outstanding capital stock of Megaprint Group
Limited (Megaprint Group), a privately held creative promotions agency headquartered in the
United Kingdom. The Company financed the Megaprint Group acquisition through short-term debt. The
Company paid 1,824 GBP (approximately US $3,388) in cash (net of a hold back for working capital
adjustments of 180 GBP), plus related transaction costs of 283 GBP (approximately US $526). Under
the terms of the Stock Purchase Agreement, the Company is committed to pay, subject to offset for
any shortfall in the target level of net working capital at December 31, 2004, a minimum of 850 GBP
and up to a maximum of 1,300 GBP in 2005 based on the performance of Megaprint Group for the year
ended December 31, 2004 (2004 Earnout Payment). The Company has accrued a liability for the
minimum payment of 850 GBP as purchase price as of the acquisition date. The Company is also
committed to pay additional consideration up to a maximum of 2,450 GBP based on future performance
through 2009. The additional consideration is based upon the business achieving targeted levels of
margin after direct overhead (MADO) over the period from 2005 through 2009. The additional
consideration, if any, will be recorded as goodwill. The Companys preliminary allocation of
purchase price for the acquisition, based upon estimated fair values is as follows: Net current assets
    
    $
    8,512Property, plant and equipment
    
    
    1,265Net current liabilities
    
    
    (7,289
    )Estimated fair value, net assets acquired
    
    
    2,488Goodwill
    
    
    2,665Other intangible assets
    
    
    338Total purchase price
    
    $
    5,491
 14




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Included in net current liabilities for the Megaprint Group is a mortgage loan for a building in
Holland (see Note 3). The balance of the mortgage loan as of the acquisition date totaled
approximately 900 Euros (approximately US $1,200). The building is recorded under fixed assets and
is recorded at the same value as the balance of the mortgage loan. The building and mortgage loan
are held in trust by the Megaprint Group on behalf of its former shareholders (the Sellers). The
building is currently held for sale. The proceeds of any sale would be used to pay-off the
mortgage loan and any excess proceeds would be remitted to the Sellers. Because the Megaprint
Group was unable to sell the building by March 31, 2005, the
Company will apply the balance of the
mortgage loan against monies owed to the Sellers for the 2004 Earnout Payment. The other intangible assets of $338 are comprised of sales order backlog and customer relationships, and
are being amortized over estimated useful lives ranging from 7 months to 15 years. The following selected unaudited pro forma consolidated results of operations are presented as
if the Johnson Grossfield and Megaprint acquisitions had occurred as of the beginning of the
period immediately preceding the period of acquisition after giving effect to certain
adjustments for the amortization of intangibles, reduced interest income and related income
tax effects. The pro forma data is for informational purposes only and does not necessarily
reflect the results of operations had the businesses operated as one during the period. No
effect has been given for synergies, if any, that may have been realized through the
acquisitions. Three Months EndedMarch 31,2004Pro forma revenues
    
    $
    56,964Pro forma net income
    
    $
    264Pro forma basic loss per share
    
    $
    (0.02
    )Pro forma diluted loss per share
    
    $
    (0.02
    )
 Refer to Note 2 for further discussion of the method of computation of earnings per share. NOTE 7  MANDATORILY REDEEMABLE PREFERRED STOCK On March 29, 2000, Crown EMAK Partners, LLC, a Delaware limited liability company (Crown),
invested $11,900 in the Company in exchange for Preferred Stock and warrants to purchase
additional Preferred Stock. Under the terms of the investment, Crown acquired 11,900 shares of
Series A mandatorily redeemable senior cumulative participating convertible preferred stock,
par value $.001 per share, (the Series A Stock) with a conversion price of $14.75 per common
share. In connection with such purchase, the Company granted to Crown five year warrants
(collectively, the Warrants) to purchase 5,712 shares of Series B senior cumulative
participating convertible preferred stock, par value $.001 per share, (the Series B Stock)
at an exercise price of $1,000 per share, and 1,428 shares of Series C senior cumulative
participating convertible preferred stock, par value $.001 per share, (the Series C Stock)
at an exercise price of $1,000 per share. The Warrants were immediately exercisable. The
conversion prices of the Series B Stock and the Series C Stock were $16.00 and $18.00 per
common share, respectively. On June 20, 2000, Crown paid an additional $13,100 in exchange for
an additional 13,100 shares of Series A Stock with a conversion price of $14.75 per common
share. In connection with such purchase, the Company granted to Crown additional Warrants to
purchase another 6,288 shares of Series B Stock and another 1,572 shares of Series C Stock.
Each share of Series A Stock is convertible into 67.7966 shares of Common Stock, representing
1,694,915 shares of Common Stock in aggregate. Each share of Series B Stock and Series C Stock
was convertible into 62.5 and 55.5556 shares of Common Stock, respectively, representing
916,666 shares of Common Stock in aggregate. Also in connection with such purchase, the
Company agreed to pay Crown a commitment fee in the aggregate amount of $1,250, paid in equal
quarterly installments of $62.5 commencing on June 30, 2000 and ending on March 31, 2005. A
payment of $62.5 was made during the quarter ended March 31, 2005. On March 19, 2004, the Company entered into a Warrant Exchange Agreement with Crown whereby Crown
received new warrants to purchase an aggregate of 916,666 shares of Common Stock (New Warrants)
in exchange for cancellation of the existing Warrants to purchase shares of Series B Stock and
Series C Stock (which, upon issuance, would also have been convertible into 916,666 shares of
Common Stock). The New Warrants consist of warrants to purchase 750,000 shares and 166,666 shares
of Common Stock at exercise 15




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##### Table of Contents



prices of $16.00 and $18.00 per common share, respectively. Of each
tranche, 47.6% expire on March 29, 2010 and 52.4% expire on June 20, 2010. As a result of the
exchange transaction, Crown received an extension of time in which to exercise its right to
purchase additional equity in the Company, and the Company obtained an elimination of the preferred
rights and preferences as well as the preferred dividend associated with the Series B Stock and
Series C Stock. The exchange was recorded as a reduction to preferred stock of $531 and an increase
to additional paid-in-capital of $487, net of transaction costs of $44. The exchange was approved
by an independent committee of our Board, which relied upon a fairness opinion provided by an
outside advisory firm. On December 30, 2004, the Company entered into an Exchange Agreement with Crown whereby Crown
received 25,000 shares of Series AA mandatorily redeemable senior cumulative preferred stock, par
value $0.001 per share, (the Series AA Stock) with a conversion price of $14.75 per common share,
in exchange for 25,000 shares of Series A Stock. The Series AA Stock has substantially the same
rights and preferences as the Series A Stock, but does not participate in cash dividends paid on
Common Stock. The exchange was effected in response to the impact of EITF 03-6 on reported
earnings. (See Note 1) Upon any voluntary or involuntary liquidation, dissolution or winding-up of
the Companys affairs, Crown, as holder of the Series AA Stock, will be entitled to payment out of
assets of the Company available for distribution of an amount equal to the greater of (a) the
liquidation preference of $1,000 per share (the Liquidation Preference) plus all accrued and
unpaid dividends or (b) the aggregate amount of payment that the outstanding preferred stock holder
would have received assuming conversion to Common Stock immediately prior to the date of
liquidation of capital stock, before any payment is made to other stockholders. The Series AA Stock is subject to mandatory redemption at the option of the holder at 101% of the
aggregate Liquidation Preference plus accrued and unpaid dividends if a change in control occurs. Crown has voting rights equivalent to the number of shares of Common Stock into which their
Series AA Stock is convertible on the relevant record date. Crown is also entitled to receive
a quarterly dividend equal to 6% of the Liquidation Preference per share outstanding, payable
in cash. The dividends for the quarter ended March 31, 2004 totaled $375 and were paid in April
2004 and recorded in accounts payable in the accompanying condensed consolidated balance
sheet as of March 31, 2004. The dividends for the quarter ended March 31, 2005 totaled $375 and were paid in
April 2005 and recorded in accounts payable in the accompanying condensed consolidated balance
sheet as of March 31, 2005. Crown currently holds 100% of the outstanding shares of Series AA Stock and has designated one
individual to the Board of Directors of the Company. The Series AA Stock is recorded in the accompanying condensed consolidated balance sheets at
its Liquidation Preference net of issuance costs. The issuance costs total approximately
$1,951 and include an accrual of approximately $1,000 for the present value of the commitment
fee discussed above. NOTE 8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 March 31, 2005 are
as follows: Year2005
(remainder of)
    
    $
    3,9102006
    
    
    4,7342007
    
    
    4,4052008
    
    
    3,9082009
    
    
    3,791Thereafter
    
    
    2,699Total
    
    $
    23,447
 Aggregate rental expenses for operating leases were $942 and $956 for the three months ended
March 31, 2004 and 2005, respectively. 16




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##### Table of Contents



Guaranteed Royalties For the three months ended March 31, 2004 and 2005, the Company incurred $671 and $1,026,
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
March 31, 2005, the Company has committed to pay total minimum guaranteed royalties as
follows: Year2005
(remainder of)
    
    $
    3,8242006
    
    
    2,6132007
    
    
    1,076Total
    
    $
    7,513
 License agreements for certain copyrights and trademarks in the Consumer Products segment
require minimum commitments for advertising over the respective terms of the licenses. The
commitment for advertising expenditures is determined as a percentage of the sales (typically
up to 10 percent) of certain licensed properties over the terms of their respective
agreements. Subsequent to March 31,
2005, the Company reached a settlement with one of its licensors
which reduced its overall commitment by approximately $4,000. (See
Note 9  Subsequent Events). Employment Agreements The Company has employment agreements with key executives. Guaranteed compensation under
these agreements as of March 31, 2005 are as follows: Year2005
(remainder of)
    
    $
    1,6682006
    
    
    4762007
    
    
    3252008
    
    
    2002009
    
    
    200Thereafter
    
    
    1,600Total
    
    $
    4,469
 NOTE 9SUBSEQUENT
EVENTS In connection with the
Companys decision to wind down its Pop Rocket consumer products business, the
Company has been negotiating the termination of several of its license agreements with more than one of
its major licensors (see Royalties under Note 1  Basis of Presentation and Summary of Significant
Accounting Policies).  On May 18, 2005, the Company reached a settlement with one of its licensors
affecting several such licenses.  Under the terms of the settlement, the Company has 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 retains product distribution rights under the licenses for 2005.  As a result of
this settlement, the Companys overall commitment for royalty guarantees is reduced by approximately
$4,000.  The Company is required to pay the licensor a total of $1,800 through March 31, 2006.  The
Company expects to reverse a portion of the fourth quarter 2004 charge for minimum royalty guarantee
shortfalls in the second quarter of 2005 as a result of this settlement.  The total amount of this reversal is
expected to range between $2,000 and $2,500 depending on estimated future sales of product for the
remainder of 2005. On May 19, 2005, the Company announced the resignation of Donald A. Kurz as President and Chief
Executive Officer effective May 13, 2005.  Mr. Kurz remains a member
of the Companys Board of
Directors as well as the largest common stockholder of the Company.  Stephen P. Robeck, non-executive
Chairman of the Board of Directors, will serve as interim Chief Executive Officer while an external search
is conducted for a new Chief Executive Officer. In connection with Mr.
Kurz departure, the Company entered into a separation agreement and mutual
release with Mr. Kurz on May 18, 2005.  The material terms of the separation agreement and mutual
release include a continuation of his current base compensation of $635,000 per annum through December
31, 2006, continuation of substantially all of his current health and welfare benefits and perquisites through
December 31, 2006, and a one time payment of $100,000 upon signing.  The agreement also provides that
Mr. Kurz will provide consulting services for a period of six months to assist with transitional matters
without additional compensation.  Mr. Kurz is bound by certain
restrictive covenants through December 31, 2006. 17




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##### Table of Contents



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, means EMAK 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, promotion, event marketing, collaborative marketing, retail design and
environmental branding. Our clients include Burger King, Kelloggs, Frito Lay, Kohls,
Macys, Kraft, Procter & Gamble, Miller Brewing Company and Subway Restaurants, among others.
EMAK is headquartered in Los Angeles, with operations in Chicago, Minneapolis, New York,
Ontario (California), Dublin, Frankfurt, London, Paris, The Netherlands, Hong Kong and
Shanghai. The Company primarily sells to customers in the United States and Europe. In July 2001, EMAK acquired Logistix, gaining a presence in Europe with broad-based strategic
client relationships, including research, new concept development, licensing guidance and the
development of premium-based promotions. In July 2002, EMAK acquired Upshot, a strategic marketing agency with expertise in
promotional, event and collaborative marketing, retail design and environmental branding,
thereby providing us with a broader range of services and the ability to develop a more
diverse client base. In September 2003, EMAK acquired SCI Promotion, establishing us as a leading provider of
gift-with-purchase and purchase-with-purchase promotional programs to the retail department
store industry. In February 2004, EMAK acquired Johnson Grossfield, expanding our client base in the Quick
Service Restaurant category with the addition of the kids marketing program of Subway
Restaurants. In November 2004, EMAK acquired Megaprint Group, a pan-European market leader in the design
and production of innovative paper and board engineered (2-D) premiums, providing EMAKs
family of companies with an important complementary service offering and expanding our client
roster and geographic presence in Europe. Overview Revenues for the first quarter of 2005 increased $5,430 to $57,242 as compared to $51,812 recorded
in the prior year primarily as a result of revenue contributions from our recent acquisitions as
well as revenue growth in our existing marketing services business. The combined impact of the
Johnson Grossfield and Megaprint Group acquisitions was to increase revenues by approximately
$4,600 during the quarter. Excluding the impact of acquisitions, our overall Marketing Services
revenues decreased slightly as a result of reduced revenues at Logistix and as a result of reduced
revenues for certain low margin logistical services that we decided not to pursue this year.
Excluding the impact of these low margin logistical services and excluding the impact of
acquisitions, Marketing Services revenues grew by 9.4% during the first quarter of 2005 as compared
to 2004. Despite the revenue growth, our first quarter 2005 performance was negatively impacted by
reduced gross margins and a restructuring charge in our Consumer Products segment. We recorded a net loss of $417 for the first quarter of 2005 compared to a net loss of $166 in the
prior year quarter. The net loss was primarily attributable to a pre-tax restructuring charge of
$583 for severance costs associated with the wind down of a significant portion of our consumer
products business. Furthermore, gross profit margins in our Consumer Products segment decreased
from the prior year due to a competitive retail pricing environment and increased costs for plastic
resin resulting from higher oil prices. Due to the seasonal nature of a large portion of our business, the first quarter tends to be the
lowest volume quarter of the year. This results in higher operating expenses as a percentage of
revenues as our cost structure is largely fixed. 18




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##### Table of Contents



As we have previously discussed, the economics of the toy industry have become increasingly
challenging for smaller participants, and we are not prepared to invest more resources into the
consumer products business because it no longer complements our core offerings as a family of
integrated marketing services agencies. As a result, on February 24, 2005, we finalized a decision
to pursue the wind down of Pop Rocket. We will significantly scale back this business during 2005
and exit the business permanently as soon as is feasible. In the near term, this includes
restructuring the Pop Rocket division and exiting certain licenses. We may keep other licenses
through the current term, depending on negotiations with our licensing partners, and we are
committed to the Crayola® brand for the long term. The Crayola®-branded bath line carries modest
inventory risk as it replenishes perpetually. It is also a brand that lends itself well to
promotional opportunities and is complementary to our retail-oriented agency, SCI Promotion. During the first quarter of 2005, we experienced positive trends in our Marketing Services segment:  
    Our Burger King business, Equity Marketing, performed well during the quarter. Burger
King revenues grew as compared to the prior year first quarter despite reduced revenues for
certain low margin logistical services that we decided not to pursue this year. During the
first quarter we implemented three domestic premium programs and two international ones.
This is essentially the same number of promotional programs that we have typically produced
for Burger King. However, we are seeing the continuation of a trend of higher unit volumes
for domestic programs as a result of recent improvements in Burger King system sales of
Kids Meals. 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.
    Upshot is aggressively pursuing new business and has managed to more than replace lost
revenues due to the loss of an important client in the fourth quarter of 2004. In March of
2005, Upshot was one of two agencies of record selected for the promotional business of
Miller Brewing Company. In its new role, Upshot began providing promotional work for most
of Millers beer brand portfolio including trademark brands such as Miller Lite and Miller
Genuine Draft in the U.S., beginning in April 2005. With this win, Upshots outlook for
2005 is the strongest since we acquired the agency in 2002.
    The first quarter performance of SCI Promotion improved albeit as compared to a
relatively low base in first quarter of 2004. SCI Promotion had a variety of programs
in-market in the first quarter of 2005, including programs for Winn Dixie, Kohls and
Kraft. A portion of SCI Promotions growth was attributable to the deferral of programs
from the fourth quarter of 2004 to the first quarter of 2005. Our Logistix agency, on the other hand, experienced a decrease in revenues this year after posting
exceptionally strong first quarter results in 2004. During the first quarter of 2004, Logistix
executed several large promotional programs for Kelloggs as compared to several smaller programs
in the first quarter of 2005. Decreased revenues for Logistix were more than offset by the
addition of revenues from the Megaprint Group acquisition. With continued positive trends at our Equity Marketing agency as well as the improved outlook for
Upshot, we are cautiously optimistic for 2005. 19




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##### Table of Contents



Results of Operations The following table sets forth, for the periods indicated, the Companys operating results as a
percentage of total revenues: Three MonthsEnded March 31,2004
    
    
    2005Revenues
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    74.4
    
    
    
    74.8Gross profit
    
    
    25.6
    
    
    
    25.2Operating expenses:Salaries, wages and benefits
    
    
    14.0
    
    
    
    14.5Selling, general and administrative
    
    
    11.4
    
    
    
    10.5Integration costs
    
    
    0.1
    
    
    
    0.1Restructuring charge
    
    
    
    
    
    
    1.0ERP reimplementation costs
    
    
    
    
    
    
    0.2Total operating expenses
    
    
    25.5
    
    
    
    26.3Income (loss) from operations
    
    
    0.1
    
    
    
    (1.1
    )Other expense, net
    
    
    (0.6
    )
    
    
    (0.2
    )Loss before benefit for income taxes
    
    
    (0.5
    )
    
    
    (1.3
    )Benefit for income taxes
    
    
    (0.2
    )
    
    
    (0.5
    )Net loss
    
    
    (0.3
    )%
    
    
    (0.8
    )%
 Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004 (In Thousands): Revenues Revenues for the three months ended March 31, 2005 increased $5,430, or 10.5%, to $57,242 from
$51,812 in the comparable period in 2004. Marketing Services revenues increased $4,170, or 9.0%,
to $50,658 as a result of the Megaprint Group acquisition, as well as revenue growth in our SCI
Promotion and our Equity Marketing businesses, partially offset by decreased revenues in our
Logistix business. Growth in revenues for SCI Promotion are attributable to new client wins as
well as programs that were deferred from the fourth quarter of 2004 into the first quarter of 2005.
Revenues for the Equity Marketing business increased as the volume of units for Burger King
domestic promotional programs were higher in the first quarter of 2005 compared to the same period
in 2004. Burger King revenues grew during the first quarter as compared to the prior year quarter
despite reduced revenues for certain low margin logistical services that we decided not to pursue
this year. The increase in revenues from Megaprint, SCI Promotion and Equity Marketing was
partially offset by a decrease in the Logistix revenues due to an exceptional first quarter in
2004. During the first quarter of 2004, Logistix executed several large promotional programs for
Kelloggs as compared to several smaller programs in the first quarter of 2005. Net foreign
currency translation impact contributed approximately $338 to revenues for Logistix versus the
prior year period average exchange rates. Results for the first quarter of 2004 include two months of revenues for Johnson Grossfield
(acquired February 2, 2004) and exclude Megaprint Group (acquired November 10, 2004). The combined
impact of the Johnson Grossfield and Megaprint Group acquisitions was to increase revenues by
approximately $4,600 during the quarter. Excluding the impact of the Johnson Grossfield and
Megaprint Group Acquisitions, Marketing Services revenues decreased 0.9% for the three months ended
March 31, 2005 compared to the same period in 2004. Excluding both the impact of acquisitions and
the impact of the low margin logistical services that we decided not to pursue this year, Marketing
Services revenues grew by 9.4 % during the first quarter of 2005 as compared to 2004. Consumer Product revenues increased $1,260, or 23.7%, to $6,584. The increase is primarily
attributable to the introduction of Disneys JoJos Circus in the first quarter of 2005 and
continued revenue growth of Baby Einstein and Crayola® products. Our first quarter
2005 Consumer Product revenues were primarily comprised of Crayola®, Scooby-Doo, Baby
Einstein, and JoJos Circus product. In the first quarter 2005, we began distributing the first
toy products based on JoJos Circus, the popular Disney series produced in stop-motion animation.
The continued growth in our Crayola® line of bath toys was attributable to an expanded
product line and expanded distribution channels. The growth was partially offset by a decline in
our Scooby-Doo sales. 20




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##### Table of Contents



Cost of sales and gross profit Cost of sales increased $4,221 to $42,793 (74.8% of revenues) for the three months ended March 31,
2005 from $38,572 (74.4% of revenues) in the comparable period in 2004 primarily due to the higher
sales volume in 2005. The gross margin percentage decreased to 25.2% for the three months ended March 31, 2005 from 25.6%
in the comparable period for 2004. The gross profit percentage for Marketing Services for the
three months ended March 31, 2005 increased to 25.4% compared to 24.9% for the comparable period in
2004. This increase is attributable to reduced revenues for certain low margin logistical services
as compared to the same period in 2004. The gross profit percentage for Consumer Products
decreased to 23.8% for the three months ended March 31, 2005 from 30.9% in the comparable period in
2004. This decrease is primarily the result of a highly competitive retail pricing environment
resulting in pricing and markdown concessions to retailers and to increased costs for plastic resin
resulting from higher oil prices. Salaries, wages and benefits Salaries, wages and benefits increased $1,053, or 14.5%, to $8,330 (14.5% of revenues) for the
three months ended March 31, 2005 from $7,277 (14.0% of revenues) in the comparable period for
2004. This increase was primarily attributable to the addition of approximately 34 employees from
the Johnson Grossfield and Megaprint Group acquisitions, annual employee merit pay increases,
additional compensation expense resulting from grants of restricted
stock units in the second and fourth quarters of 2004 and an increase in recruiting costs. Selling, general and administrative expenses Selling, general and administrative expenses increased $106, or 1.8%, to $6,002 (10.5% of revenues)
for the three months ended March 31, 2005 from $5,896 (11.4% of revenues) in the comparable period
for 2004. The increase is attributable to additional operating expenses resulting from the
inclusion of the Johnson Grossfield and Megaprint Group businesses in the current year
quarter. The prior year included only two months of Johnson Grossfield results. This increase was
partially offset by reduced spending on marketing. Integration costs We recorded integration costs of $45 (0.1% of revenues) for the three months ended March 31, 2005
compared to $43 (0.1% of revenues) for the same period in 2004. These are primarily travel,
training and consulting costs directly related to the integration of Megaprint Group. The costs in
2004 are primarily travel costs directly related to the integration of SCI Promotion and Johnson
Grossfield. Restructuring charge We recorded a restructuring charge of $583 (1.0% of revenues) for the three months ended March 31,
2005. This charge represents severance expenses and other termination costs resulting from our
decision to wind down substantially all of our consumer products business, Pop Rocket. See
Restructuring below. ERP reimplementation costs We recorded enterprise resource planning (ERP) reimplementation costs of $89 (0.2% of
revenues) for the three months ended March 31, 2005. This represents consulting costs which
were not capitalized into fixed assets. The costs were incurred in connection with a
significant upgrade and reimplementation of the Companys ERP software which is designed to
enhance management information, financial reporting, inventory management, cost evaluation and
controls while assisting in compliance with the Sarbanes-Oxley Act of 2002. Other expense Other expense, net decreased $187 to $105 for the three months ended March 31, 2005 from $292
in the comparable period for 2004. The reduction is primarily due to a reduction in foreign
currency transaction losses. This was partially offset by an increase in interest expense
relating to increased short-term borrowings compared to the same period in 2004. 21




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##### Table of Contents



Benefit for income taxes The effective tax rate for the three months ended March 31, 2005 was 40.9% compared to 38.1% for
the same period in 2004. The increase in the effective tax rate is the result of an increase in
the relative mix of earnings being generated in the United States, which has a less favorable tax
rate as well as an increase in our state income tax rate as a result
of changes in business operations in the United States. Net loss Net loss increased $251 to a net loss of $417 ((0.8)% of revenues) in 2005 from a net loss of $166
((0.3)% of revenues) in 2004 primarily due to the restructuring charge and increased salaries,
wages and benefits. This was partially offset by an increase in gross margins earned on higher
revenues in 2005 as compared to 2004. Financial Condition and Liquidity At March 31, 2005, cash and cash equivalents were $5,152, compared to $4,406 as of December 31,
2004. The increase in cash and cash equivalents was attributable to cash flows generated from
operating activities. As of March 31, 2005, working capital was $17,640 compared to $17,934 at December 31, 2004.
Cash provided by operations for the three months ended March 31, 2005 were $4,756 compared to
cash used of $204 in the prior year. Cash flows provided by operations in the three months
ended March 31, 2005 were primarily the result of the collections of accounts receivable from
large fourth quarter 2004 promotional programs. Cash flows used in investing activities for
the three months ended March 31, 2005 were $437 compared to $6,390 in the prior year. This
decrease is primarily the result of the acquisition of Johnson Grossfield in the first quarter
of 2004 as well as the result of reduced purchases of marketable securities and decreased
purchases of fixed assets. Cash flows used in financing activities for the three months ended
March 31, 2005 were $3,516 compared to cash provided of $102 in the prior year primarily as a
result of the repayment of short-term borrowings to finance the purchase of the Megaprint
Group and the repayment of bank advances at Logistix. In addition there was a decrease in
proceeds from the exercise of stock options compared to the same period in 2004. As of March 31, 2005, our net accounts receivable decreased $13,302 to $33,878 from $47,180 at
December 31, 2004. This decrease was attributable to decreased revenues in the first quarter of
2005 compared to the fourth quarter of 2004. Due to the seasonal nature of our business, the
fourth quarter tends to be the highest volume quarter of the year and the first quarter tends to be
the lowest. As of March 31, 2005, inventories decreased $1,817 to $16,946 from $18,763 at December 31, 2004.
This decrease in inventories is primarily the result of shipments of Consumer Products inventory to
meet Easter holiday in-store dates. Marketing Services inventories represent 71% and 65% of total
inventories as of March 31, 2005 and December 31, 2004, respectively. Promotional product
inventory used in Marketing Services generally has lower risk than Consumer Product inventory, as
it usually represents product made to order. As of March 31, 2005, short-term debt decreased $3,203 to $2,822 from $6,025 at December 31,
2004. This decrease is associated with the repayment of short-term borrowings to finance the
purchase of the Megaprint Group and the reduction in bank advances at Logistix. As of March 31, 2005, accounts payable decreased $6,337 to $24,659 from $30,996 at December 31,
2004. This decrease was attributable to the payment of liabilities related to fourth quarter 2004
promotional programs. Due to the seasonal nature of our business, the fourth quarter tends to be
the highest volume quarter of the year and the first quarter tends to be the lowest. As of March 31, 2005, accrued liabilities decreased $3,160 to $17,700 from $20,860 at December 31,
2004. This decrease is primarily attributable to the payment of administrative fees collected from
distribution companies during the fourth quarter of 2004 on behalf of promotional customers, as
well as the payment of royalties and commissions on fourth quarter 2004 revenues. As of the date hereof, we believe that cash from operations, cash on hand at March 31, 2005 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. 22




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##### Table of Contents



Future minimum annual commitments for guaranteed minimum royalty payments under license
agreements, non-cancelable operating leases and employment agreements as of March 31, 2005 are
as follows: 2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    Thereafter
    
    
    TotalOperating Leases
    
    $
    3,910
    
    
    $
    4,734
    
    
    $
    4,405
    
    
    $
    3,908
    
    
    $
    3,791
    
    
    $
    2,699
    
    
    $
    23,447Guaranteed Royalties
    
    
    3,824
    
    
    
    2,613
    
    
    
    1,076
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,513Employment Agreements
    
    
    1,668
    
    
    
    476
    
    
    
    325
    
    
    
    200
    
    
    
    200
    
    
    
    1,600
    
    
    
    4,469Total
    
    $
    9,402
    
    
    $
    7,823
    
    
    $
    5,806
    
    
    $
    4,108
    
    
    $
    3,991
    
    
    $
    4,299
    
    
    $
    35,429
 Subsequent to March 31,
2005, we reached a settlement with one of our licensors
which reduced our overall royalty commitment by approximately $4,000
(see Subsequent Events). We had no material commitments for capital expenditures at March 31, 2005. Letters of credit
outstanding as of December 31, 2004 and March 31, 2005 totaled $2,694 and $1,141, respectively. Restructuring On February 24, 2005, we
finalized a decision to pursue the wind down of a substantial majority of our
consumer products business, Pop Rocket. Our determination is to significantly scale back this
business during 2005 while exiting the business permanently as soon as is feasible. In the near
term, this includes restructuring the Pop Rocket division and exiting certain licenses. In
connection with this decision, we expect to incur charges for one-time employee termination
benefits and other costs totaling approximately $700 in 2005. During the first quarter of 2005,
$583 of such costs was incurred for employee terminations completed through March 31, 2005. Such
costs are recorded as a restructuring charge in the condensed consolidated statement of operations
for the three months ended March 31, 2005. The entire amount is attributable to the Consumer
Products segment. The remaining costs are expected to be incurred and expensed throughout the
remainder of 2005 for employees expected to be terminated by December 31, 2005. Of the $583 of
costs incurred to date, $95 has been paid as of March 31, 2005. Credit Facilities On April 24, 2001, we signed a credit facility (the Facility) with Bank of America. On April 26,
2004, the maturity date of the Facility was extended through June 30, 2005. Effective March 30,
2005 the maturity date of the Facility was further extended through March 31, 2006. The credit
facility is secured by substantially all of our assets and provides for a line of credit of up to
$35,000 with borrowing availability determined by a formula based on qualified assets. The March
30, 2005 amendment reduced the line of credit to $20,000. We sought a reduction in the size of the
Facility to better align the size and cost of the Facility with our borrowing needs. Interest on
outstanding borrowings will be based on either a fixed rate equivalent to LIBOR plus an applicable
spread of between 1.50 and 2.25 percent or a variable rate equivalent to the banks reference rate
plus an applicable spread of between zero and 0.50 percent. We are also required to pay an unused
line fee of between zero and 0.60 percent per annum and certain letter of credit fees. The
applicable spread is based on the achievement of certain financial ratios. The Facility also
requires us to comply with certain restrictions and covenants as amended from time to time. On
November 14, 2001, February 8, 2002, September 30, 2002, November 14, 2003, April 26, 2004, August
12, 2004, November 15, 2004 and March 30, 2005, certain covenants under the facility were amended.
As of March 31 2005, we were in compliance with the amended restrictions and covenants. In
addition to amending certain covenants, the November 15, 2004 amendment imposed a temporary $12,000
cap on total outstanding borrowings and letters of credit. This amendment also increased the
maximum interest rate on outstanding borrowings by 0.25 percent. The March 30, 2005 amendment
eliminated the temporary $12,000 cap. The Facility may be used for working capital and acquisition
financing purposes. As of March 31, 2005, $1,650 was outstanding under the Facility and letters of
credit of $1,141. In addition to the Facility, in October, 2003 our Logistix subsidiary 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 1,000 GBP. Under this
facility HSBC may pay Logistixs vendors directly upon receipt of invoices and shipping
documentation. Logistix in turn is obligated to repay HSBC within 120 days. As of March 31, 2005,
there were no advances outstanding under this facility. In connection with the acquisition of the Megaprint Group, we assumed a mortgage loan secured by a
building in Holland. The mortgage loan has a 24 year term and carries an interest rate fixed at 5
percent per annum for three years from December 2002. The mortgage loan is repayable in equal
monthly installments of 4 Euros. The outstanding balance on the mortgage loan is 908 Euros
(approximately US $1,172) as of March 31, 2005. Notwithstanding the terms of the mortgage loan, it
will be repaid in the second quarter of 2005. We will apply the balance of the mortgage loan
against monies owed to the sellers of the Megaprint Group. This mortgage loan is recorded as
short-term debt in the accompanying condensed consolidated balance sheet as of March 31, 2005. Megaprint Group has an overdraft facility of 750 Euros from ING Bank, Nederland. As of March 31,
2005, there were no amounts outstanding under this facility. 23




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##### Table of Contents



Acquisitions On February 2, 2004, we acquired certain assets of Johnson Grossfield, Inc. (JGI-MN) a privately
held promotional marketing services company based in Minneapolis, Minnesota (the Johnson
Grossfield Acquisition). We financed the Johnson Grossfield Acquisition through our existing cash
reserves. The Johnson Grossfield Acquisition was consummated pursuant to an Asset Purchase
Agreement dated January 16, 2004, by and among the Company, Johnson Grossfield, Inc., a Delaware
corporation wholly owned by us (Johnson Grossfield), JGI-MN, Marc Grossfield and Thom Johnson
(the Johnson Grossfield Purchase Agreement). Under the terms of the Johnson Grossfield Purchase
Agreement, we purchased the assets of JGI-MNs promotional agency business for approximately $4,600
in cash and 35,785 shares of our common stock (which, based upon the January 30, 2004 closing
market price of $14.80, had a value of $530), plus additional earnout consideration of up to $4,500
based upon future performance of the acquired business. We also assumed the operating liabilities
of the promotional agency business in connection with the acquisition. The earnout consideration
is based upon the acquired business achieving targeted levels of earnings before interest, taxes,
depreciation and amortization (EBITDA) over the period from 2004 through 2008. The earnout
payments, if required, are payable 50% in cash and 50% in shares of our common stock. The
additional consideration, if any, will be recorded as goodwill. On April 19, 2005, we reached
agreement with the sellers of Johnson Grossfield on the amount of earnout attributable to 2004
performance. Such earnout consideration totaled $257, of which $148 is payable in cash and the
remainder payable in shares of our common stock (10,616 shares valued at $109 as of April 19,
2005). This earnout consideration will be recorded as goodwill in the second quarter of 2005. On November 10, 2004, we acquired all of the outstanding capital stock of Megaprint Group Limited
(Megaprint Group), a privately held creative promotions agency headquartered in the United
Kingdom. We financed the Megaprint Group acquisition through short-term debt. We paid 1,824 GBP
(approximately US $3,388) in cash (net of a hold back for working capital adjustments of 180 GBP),
plus related transaction costs of 283 GBP (approximately US $526). Under the terms of the Stock
Purchase Agreement, we are committed to pay, subject to offset for any shortfall in the target
level of net working capital at December 31, 2004, a minimum of 850 GBP and up to a maximum of
1,300 GBP in 2005 based on the performance of Megaprint Group for the year ended December 31, 2004.
The Company has accrued a liability for the minimum payment of 850 GBP as purchase price as of the
acquisition date. We are also committed to pay additional consideration up to a maximum of 2,450
GBP based on future performance through 2009. The additional consideration is based upon the
business achieving targeted levels of margin after direct overhead (MADO) over the period from
2005 through 2009. The additional consideration, if any, will be recorded as goodwill. Issuance of Preferred Stock On March 29, 2000, Crown EMAK Partners, LLC, a Delaware limited liability company (Crown),
invested $11,900 in EMAK in exchange for preferred stock and warrants to purchase additional
preferred stock. Under the terms of the investment, Crown acquired 11,900 shares of Series A
mandatorily redeemable senior cumulative participating convertible preferred stock, par value
$.001 per share, (the Series A Stock) with a conversion price of $14.75 per common share.
In connection with such purchase, we granted to Crown five year warrants (collectively, the
Warrants) to purchase 5,712 shares of Series B senior cumulative participating convertible
preferred stock, par value $.001 per share, (the Series B Stock) at an exercise price of
$1,000 per share, and 1,428 shares of Series C senior cumulative participating convertible
preferred stock, par value $.001 per share, (the Series C Stock) at an exercise price of
$1,000 per share. The Warrants were immediately exercisable. The conversion prices of the
Series B Stock and the Series C Stock were $16.00 and $18.00 per common share, respectively.
On June 20, 2000, Crown paid us an additional $13,100 in exchange for an additional 13,100
shares of Series A Stock with a conversion price of $14.75 per common share. In connection
with such purchase, we granted to Crown additional Warrants to purchase another 6,288 shares
of Series B Stock and another 1,572 shares of Series C Stock. Each share of Series A Stock is
convertible into 67.7966 shares of Common Stock, representing 1,694,915 shares of Common Stock
in aggregate. Each share of Series B Stock and Series C Stock is convertible into 62.5 and
55.5556 shares of Common Stock, respectively, representing 916,666 shares of Common Stock in
aggregate. Also in connection with such purchase, we agreed to pay Crown a commitment fee in
the aggregate amount of $1,250, paid in equal quarterly installments of $62.5 commencing on
June 30, 2000 and ending on March 31, 2005. A payment of $62.5 was made during the quarter
ended March 31, 2005. On March 19, 2004, we entered into a Warrant Exchange Agreement with Crown whereby Crown
received new warrants to purchase an aggregate of 916,666 shares of Common Stock (New
Warrants) in exchange for cancellation of the existing Warrants to purchase shares of Series
B Stock and Series C Stock (which, upon issuance, would also have been convertible into
916,666 shares of Common Stock). The New Warrants consist of warrants to purchase 750,000
shares and 166,666 shares of Common Stock at exercise prices of $16.00 and $18.00 per share, respectively. Of each
tranche, 47.6% expire on March 29, 2010 and 52.4% expire on June 20, 2010. As a result of the
exchange transaction, Crown received an extension of time in which to exercise its right to
purchase additional equity in EMAK, and EMAK obtained an elimination of the preferred rights
and preferences as well as the preferred dividend associated with the now eliminated Series B
Stock and Series C Stock. 24




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##### Table of Contents



On December 30, 2004, we entered into an Exchange Agreement with Crown whereby Crown received
25,000 shares of Series AA mandatorily redeemable senior cumulative preferred stock, par value
$0.001 per share, (the Series AA Stock) with a conversion price of $14.75 per common share,
in exchange for 25,000 shares of Series A Stock. The Series AA Stock has substantially the
same rights and preferences as the Series A Stock, but does not participate in cash dividends
paid on Common Stock. The exchange was effected in response to the requirements of Emerging
Issues Task Force (EITF) Issue No. 03-6, Participating Securities and the Two-Class Method
under Financial Accounting Standards Board (FASB) No. 128, which requires companies having
participating securities to calculate earnings per share using the two-class method. Upon any voluntary or involuntary liquidation, dissolution or winding-up of our affairs,
Crown, as holder of the Series AA Stock, will be entitled to payment out of our assets
available for distribution of an amount equal to the greater of (a) the liquidation preference
of $1,000 per share (the Liquidation Preference) plus all accrued and unpaid dividends or
(b) the aggregate amount of payment that the outstanding preferred stock holder would have
received assuming conversion to Common Stock immediately prior to the date of liquidation of
capital stock, before any payment is made to other stockholders. The Series AA Stock is
subject to mandatory redemption at the option of the holder at 101% of the aggregate
Liquidation Preference plus accrued and unpaid dividends if a change in control occurs. Crown
has voting rights equivalent to the number of shares of Common Stock into which their Series
AA Stock is convertible on the relevant record date. Crown is also entitled to receive a
quarterly dividend equal to 6% of the Liquidation Preference per share outstanding, payable in
cash. The dividends for the quarter ended March 31, 2004 totaled $375 and were paid in April
2004 and recorded in accounts payable in the accompanying condensed consolidated balance
sheet as of March 31, 2004. The dividends for the quarter ended March 31, 2005 totaled $375 and were paid in April
2005 and recorded in accounts payable in the accompanying condensed consolidated balance sheet
as of March 31, 2005. The holders of the Series AA Stock, voting separately as a class, are entitled to elect two
directors of the Company, provided however, at ant time the Board of Directors is increased to
include more than eight members, the holders of the Series AA Stock are entitled to elect one
additional director. Crown currently holds 100% of the outstanding shares of Series AA Stock,
and has designated one individual to our Board of Directors. The Series AA Stock is recorded in the accompanying consolidated balance sheets at its
Liquidation Preference net of issuance costs. The issuance costs total approximately $1,951
and include an accrual of approximately $1,000 for the present value of the commitment fee
discussed above. Subsequent Events In connection with our decision to wind down our Pop Rocket consumer products business, we have been
negotiating the termination of several of its license agreements with more than one of our major licensors.
On May 18, 2005, we reached a settlement with one of our licensors affecting several such licenses.  Under
the terms of the settlement, we have agreed to forgo our rights to certain licensed properties for 2006 and
2007 in exchange for a reduction in the overall royalty guarantees.  We retain product distribution rights
under the licenses for 2005.  As a result of this settlement, our overall commitment for royalty guarantees is
reduced by approximately $4,000.  We are required to pay the licensor a total of $1,800 through March 31,
2006.  We expect to reverse a portion of the fourth quarter 2004 charge for minimum royalty guarantee
shortfalls in the second quarter of 2005 as a result of this settlement.  The total amount of this reversal is
expected to range between $2,000 and $2,500 depending on estimated future sales of product for the
remainder of 2005. On May 19, 2005, we announced the resignation of Donald A. Kurz as President and Chief Executive
Officer effective May 13, 2005.  Mr. Kurz remains a member of the
Companys Board of Directors as well
as the largest common stockholder of the Company.  Stephen P. Robeck, non-executive Chairman of the
Board of Directors, will serve as interim Chief Executive Officer while an external search is conducted for
a new Chief Executive Officer. In connection with Mr.
Kurz departure, the Company entered into a separation agreement and mutual
release with Mr. Kurz on May 18, 2005.  The material terms of the separation agreement and mutual
release include a continuation of his current base compensation of
$635,000 per annum through December 31, 2006, continuation of substantially all of his current health and welfare benefits and perquisites through
December 31, 2006, and a one time payment of $100,000 upon signing.  The agreement also provides that
Mr. Kurz will provide consulting services for a period of six months to assist with transitional matters
without additional compensation.  Mr. Kurz is bound by certain
restrictive covenants through December 31, 2006. Recent Accounting Pronouncements In December 2004, the FASB released FASB Staff Position No. FAS 109-2 (FSP 109-2). FASB
Staff Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings
Repatriation Provision within the American Jobs Creation Act of 2004, provides companies more
time (beyond the financial-reporting period during which the Act took effect) to evaluate the
Acts impact on our plan for reinvestment or repatriation of certain foreign earnings for
purposes of applying SFAS No. 109, Accounting for Income Taxes. The FSP went into effect
upon being issued. As of March 31, 2005, we had not determined whether, or to what extent, we
may repatriate foreign earnings under the Jobs Act. Therefore, our condensed consolidated
financial statements do not include any provision for income taxes on the $5,705 cumulative
balance of unremitted foreign earnings as of year end 2004. Management expects to finalize
its assessment related to the Jobs Act in the first half of 2005. In December 2004, the FASB issued SFAS No. 123 (revised 2004) (SFAS No. 123(R)), Share-Based
Payment, which replaced SFAS No. 123 and superseded APB Opinion No. 25. SFAS No. 123(R) requires
all share-based payments to employees, including grants of employee stock options, to be recognized
in the financial statements based on their fair values. The pro forma disclosures previously
permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition.
Under SFAS No. 123(R), we must determine the appropriate fair value method to be used for valuing
share-based payments, the amortization method of compensation cost and the transition method to be
used at the date of adoption. The transition methods include prospective and retroactive adoption
options. Under the retroactive option, prior periods may be restated either as of the beginning of
the year of adoption or for all periods presented. The prospective method requires that
compensation cost be recorded for all unvested stock options and nonvested stock at the beginning
of the first quarter of adoption of SFAS No. 123(R), whereas the retroactive method requires
recording compensation cost for all unvested stock options and nonvested stock beginning with the
first period restated. In April 2005, the Securities Exchange Commission amended Regulation S-X to delay the effective
date for compliance with SFAS No. 123(R). Based on the amended regulation, we are required to adopt
SFAS No. 123(R) on January 1, 2006. We are evaluating the requirements of SFAS No. 123(R) and
expects that the adoption of SFAS No. 123(R) may have a material adverse effect on its results of
operations and earnings per share. We have not yet determined the method of adoption of SFAS No.
123(R), or whether the amounts recorded in the consolidated statements of income in future periods
will be similar to the current pro forma disclosures under SFAS No. 123. 25




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In November 2004, the FASB issued SFAS No. 151, Inventory Costs  An Amendment of ARB No.
43, Chapter 4. SFAS No. 151 amends the guidance in Chapter 4, Inventory Pricing, of
Accounting Research Bulletin (ARB) No. 43, Restatement and Revision of Accounting Research
Bulletins, to clarify the accounting for abnormal amounts of idle facility expense, freight,
handling costs, and wasted material (spoilage). Among other provisions, the statement
requires that items such as idle facility expense, excessive spoilage, double freight, and
rehandling costs be recognized as current-period charges regardless of whether they meet the
criterion of so abnormal as stated in ARB No. 43. Additionally, SFAS No. 151 requires that
the allocation of fixed production overhead to the costs of conversion be based on the normal
capacity of the production facilities. SFAS No. 151 is effective for fiscal years beginning
after June 15, 2005. We are currently evaluating the effect that the adoption of SFAS No. 151
will have on its results of operations and financial position, but do not expect it to have a
material impact. Cautionary Statements and Risk Factors Marketplace Risks  
    Dependence on a single customer, Burger King, which may adversely affect our financial condition and results of operations.  
    Concentration risk associated with accounts receivable. We regularly extend credit to several distribution companies in
connection with our business with Burger King and more recently to a subsidiary of Burger Kings purchasing cooperative
which accounts for approximately 80% of our sales to the Burger King.  
    Dependence on nonrenewable product orders by Burger King, which promotions are in effect for a limited period of time.  
    Dependence on the popularity of licensed entertainment properties, which may adversely affect our financial condition and
results of operations.  
    Significant quarter-to-quarter variability in revenues and net income, which may result in operating results below the
expectations of securities analysts and investors.  
    Increased competitive pressure, which may affect our sales of products and services.  
    Dependence on foreign manufacturers, which may increase the costs of our products and affect the demand for such products.  
    Variations in product costs due to fluctuations in raw materials prices, including plastic resin. Financing Risks  
    Currency fluctuations, which may affect our suppliers and reportable income. Other Risks  
    Products that we develop or sell may expose us to liability from claims by users of such products for damages including,
but not limited to, bodily injury or property damage. We currently maintain product liability insurance coverage in
amounts that we believe are adequate. There can be no assurance that we will be able to maintain such coverage or obtain
additional coverage on acceptable terms in the future, or that such insurance will provide adequate coverage against all
potential claims.  
    Exposure to liability for the costs related to product recalls. These costs can include legal expenses, advertising,
collection and destruction of product, and free goods. Our product liability insurance coverage generally excludes such
costs and damages resulting from product recall.  
    Potential negative impact of past or future acquisitions, which may disrupt our ongoing business, distract senior
management and increase expenses (including risks associated with the financial condition and integration of the
businesses which we acquire).  
    Adverse results of litigation, governmental proceedings or environmental matters, which may lead to increased costs or
interruption in normal business operations.  
    Changes in laws or regulations, both domestically and internationally, including those affecting consumer products or
environmental activities or trade restrictions, which may lead to increased costs.  
    Strike and other labor disputes which may negatively impact the distribution channels for our products.  
    Exposure to liabilities for minimum royalty commitments in connection with license agreements for entertainment
properties.  
    Potential negative impact of Severe Acute Respiratory Syndrome (SARS), which could adversely affect our vendors in the
Far East. We undertake no obligation to publicly release the results of any revisions to forward-looking
statements, which may be made to reflect events or circumstance after the date hereof or to reflect the occurrence of unanticipated
events. The risks highlighted herein should not be assumed to be the only items that could affect
future performance. In addition to the information contained in this document, readers are advised
to review our Form 10-K for the year ended December 31, 2004, under the heading Managements
Discussion and Analysis of Financial Condition and Results of Operation  Cautionary Statements and
Risk Factors. 26




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK For quantitative and qualitative disclosures about market risk affecting the Company, see
Item 7A Quantitative and Qualitative Disclosures About Market Risk of our Annual Report on
Form 10-K for the year ended December 31, 2004. Our exposure to market risks has not changed
materially since December 31, 2004. 
 ITEM 4. 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 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 Chief Financial 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 Chief Financial Officer, of the effectiveness of the design and
operation of the Companys disclosure controls and procedures as of March 31, 2005. Based on
the evaluation of these disclosure controls and procedures, the Chief Executive Officer and
Chief Financial Officer concluded that the Companys disclosure controls and procedures were
effective. The Company continues to implement a conversion to new and upgraded financial and human
resources information technology systems that began in the fourth quarter of 2004. The Company has
evaluated the effect on its internal control over financial reporting of this conversion and
determined that this conversion has not materially affected, and is not reasonably likely to
materially affect, as defined in Rule 13a-15(f) promulgated under the Exchange Act, The Companys
internal control over financial reporting. The Company has not made any significant changes to its
internal control over financial reporting or in other factors that could significantly affect these
controls subsequent to March 31, 2005. 27




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PART II. OTHER INFORMATION 
 ITEM 6. EXHIBITS Exhibit 10.1
    
    Eighth Amendment and Waiver to Credit Agreement by and between Bank of America, N.A. and EMAK Worldwide, Inc.,
dated March 30, 2005.Exhibit 31.1
    
    Certification of Chief Executive
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.Exhibit 31.2
    
    Certification of Chief Financial
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 Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized. EMAK Worldwide, Inc.Date May 19, 2005
    /s/ ZOHAR ZIVZohar ZivSenior Vice President and Chief Financial Officer

(Principal Financial and Accounting Officer) 29