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United States
Securities and Exchange Commission Washington, D.C. 20549
 FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 or (  ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 23346 EQUITY MARKETING, INC. (Exact name of registrant as specified in its charter) Delaware
    
    13-3534145(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 6330 San Vicente Blvd.Los Angeles, CA
    
    90048(Address of principal executive offices)
    
    (Zip Code)
 (323) 932-4300
(Registrants telephone number, including area code) 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 [X]  No [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X] 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, 5,758,888 shares as of August 12, 2004.




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EQUITY MARKETING, INC. Index To Quarterly Report on Form 10-Q
Filed with the Securities and Exchange Commission
June 30, 2004  
 PagePart I.
    
    Financial InformationItem 1. Financial Statements
    
    
    3Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    21Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    33Item 4. Controls and Procedures
    
    
    33Part II.
    
    Other InformationItem 2. Change in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    34Item 4. Submission of Matters to a Vote of Security Holders
    
    
    34Item 6. Exhibits and Reports on Form 8-K
    
    
    35Exhibit 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 undertakes 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
Operation  Cautionary Statements and Risk Factors. 2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS EQUITY MARKETING, INC. CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED) ASSETS December 31,
    
    June 30,2003
    
    2004CURRENT ASSETS:Cash and cash equivalents
    
    $
    19,291
    
    
    $
    12,948Marketable securities
    
    
    
    
    
    
    1,300Accounts receivable (net of allowances of $2,143 and
$1,556 as of December 31, 2003 and June 30, 2004, respectively)
    
    
    36,765
    
    
    
    29,367Inventories (Note 2)
    
    
    15,099
    
    
    
    14,240Prepaid expenses and other current assets
    
    
    4,352
    
    
    
    4,384Total current assets
    
    
    75,507
    
    
    
    62,239Fixed assets, net
    
    
    3,809
    
    
    
    3,935Goodwill (Notes 2 and 6)
    
    
    41,893
    
    
    
    44,339Other intangibles, net (Notes 2 and 6)
    
    
    1,252
    
    
    
    3,344Other assets
    
    
    5,869
    
    
    
    6,893Total assets
    
    $
    128,330
    
    
    $
    120,750
 The accompanying notes are an integral part of these
unaudited condensed consolidated financial statements. 3




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EQUITY MARKETING, INC. CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED) LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS EQUITY December 31,
    
    June 30,2003
    
    2004CURRENT LIABILITIES:Accounts payable
    
    $
    28,865
    
    
    $
    24,917Accrued liabilities
    
    
    17,195
    
    
    
    13,623Total current liabilities
    
    
    46,060
    
    
    
    38,540LONG-TERM LIABILITIES
    
    
    5,555
    
    
    
    5,122Total liabilities
    
    
    51,615
    
    
    
    43,662COMMITMENTS AND CONTINGENCIESMandatorily redeemable preferred stock, Series A senior cumulative participating
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
    
    
    23,049
    
    
    
    22,518STOCKHOLDERS EQUITY:Preferred stock, $.001 par value per share, 1,000,000
shares authorized, 25,000 Series A issued and outstanding
    
    
    
    
    
    
    Common stock, $.001 par value per share, 50,000,000
shares authorized, 5,684,953 and 5,758,888 shares outstanding
as of December 31, 2003 and June 30, 2004, respectively
    
    
    
    
    
    
    Additional paid-in capital
    
    
    23,886
    
    
    
    27,661Retained earnings
    
    
    45,138
    
    
    
    43,692Accumulated other comprehensive income
    
    
    3,334
    
    
    
    3,86072,358
    
    
    
    75,213LessTreasury stock, 3,150,708 and 3,167,258 shares, at cost, as of
December 31, 2003 and June 30, 2004, respectively (Note 4)
    
    
    (17,458
    )
    
    
    (17,669
    )Unearned compensation
    
    
    (1,234
    )
    
    
    (2,974
    )Total stockholders equity
    
    
    53,666
    
    
    
    54,570Total liabilities, mandatorily redeemable preferred stock and stockholders equity
    
    $
    128,330
    
    
    $
    120,750
 The accompanying notes are an integral part of these
unaudited condensed consolidated financial statements. 4




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EQUITY MARKETING, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED) Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2004
    
    2003
    
    2004REVENUES
    
    $
    56,953
    
    
    $
    51,778
    
    
    $
    104,520
    
    
    $
    103,590COST OF SALES
    
    
    41,766
    
    
    
    38,015
    
    
    
    77,053
    
    
    
    76,587Gross profit
    
    
    15,187
    
    
    
    13,763
    
    
    
    27,467
    
    
    
    27,003OPERATING EXPENSES:Salaries, wages and benefits
    
    
    5,537
    
    
    
    7,900
    
    
    
    11,398
    
    
    
    15,177Selling, general and administrative
    
    
    6,485
    
    
    
    6,160
    
    
    
    11,510
    
    
    
    12,056Integration costs
    
    
    
    
    
    
    93
    
    
    
    
    
    
    
    136Loss on Chicago lease
    
    
    
    
    
    
    311
    
    
    
    
    
    
    
    311Restructuring charge
    
    
    
    
    
    
    105
    
    
    
    
    
    
    
    105Total operating expenses
    
    
    12,022
    
    
    
    14,569
    
    
    
    22,908
    
    
    
    27,785Income (loss) from operations
    
    
    3,165
    
    
    
    (806
    )
    
    
    4,559
    
    
    
    (782
    )OTHER INCOME (EXPENSE), net
    
    
    205
    
    
    
    (68
    )
    
    
    307
    
    
    
    (360
    )Income (loss) before provision (benefit) for income taxes
    
    
    3,370
    
    
    
    (874
    )
    
    
    4,866

    
    
    
    (1,142
    )PROVISION (BENEFIT) FOR INCOME TAXES
    
    
    1,230
    
    
    
    (344
    )
    
    
    1,748
    
    
    
    (446
    )NET INCOME (LOSS)
    
    
    2,140
    
    
    
    (530
    )
    
    
    3,118
    
    
    
    (696
    )PREFERRED STOCK DIVIDENDS
    
    
    375
    
    
    
    375
    
    
    
    750
    
    
    
    750UNDISTRIBUTED EARNINGS ALLOCATED TO
PARTICIPATING PREFERRED STOCK
    
    
    405
    
    
    
    
    
    
    
    542
    
    
    
    NET INCOME (LOSS) AVAILABLE TO COMMON
STOCKHOLDERS
    
    $
    1,360
    
    
    $
    (905
    )
    
    $
    1,826
    
    
    $
    (1,446
    )BASIC INCOME (LOSS) PER SHARE
    
    $
    0.24
    
    
    $
    (0.16
    )
    
    $
    0.32
    
    
    $
    (0.25
    )BASIC WEIGHTED AVERAGE SHARES OUTSTANDING
    
    
    5,700,016
    
    
    
    5,758,370
    
    
    
    5,704,148
    
    
    
    5,739,603DILUTED INCOME (LOSS) PER SHARE
    

    $
    0.22
    
    
    $
    (0.16
    )
    
    $
    0.31
    
    
    $
    (0.25
    )DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING
    
    
    6,057,801
    
    
    
    5,758,370
    
    
    
    5,970,205
    
    
    
    5,739,603
 The accompanying notes are an integral part of these
unaudited condensed consolidated financial statements. 5




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EQUITY MARKETING, INC. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
(UNAUDITED) Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2004
    
    2003
    
    2004NET INCOME (LOSS)
    
    $
    2,140
    
    
    $
    (530
    )
    
    $
    3,118
    
    
    $
    (696
    )OTHER COMPREHENSIVE INCOME (LOSS):Foreign currency translation adjustments (Note 2)
    
    
    792
    
    
    
    (202
    )
    
    
    506
    
    
    
    320Unrealized gain (loss) on foreign currency
forward contracts (Note 2)
    
    
    (175
    )
    
    
    (83
    )
    
    
    (176
    )
    
    
    206COMPREHENSIVE INCOME (LOSS)
    
    $
    2,757
    
    
    $
    (815
    )
    
    $
    3,448
    
    
    $
    170
 The accompanying notes are an integral part of these
unaudited condensed consolidated financial statements. 6




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EQUITY MARKETING, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED) Six Months EndedJune 30,2003
    
    2004CASH FLOWS FROM OPERATING ACTIVITIES:Net income (loss)
    
    $
    3,118
    
    
    $
    (696
    )Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:Depreciation and amortization
    
    
    936
    
    
    
    987Provision for doubtful accounts
    
    
    255
    
    
    
    110Benefit on disposal of fixed assets
    
    
    
    
    
    
    (8
    )Tax benefit from exercise of stock options
    
    
    60
    
    
    
    65Amortization of restricted stock
    
    
    156
    
    
    
    311Other
    
    
    4
    
    
    
    Changes in operating assets and liabilities:Increase (decrease) in cash and cash equivalents:Accounts receivable
    
    
    8,433
    
    
    
    9,487Inventories
    
    
    1,650
    
    
    
    1,621Prepaid expenses and other current assets
    
    
    (199
    )
    
    
    (829
    )Other assets
    
    
    (989
    )
    
    
    (1,012
    )Accounts payable
    
    
    (9,680
    )
    
    
    (4,141
    )Accrued liabilities
    
    
    (8,804
    )
    
    
    (4,188
    )Long-term liabilities
    
    
    63
    
    
    
    (433
    )Net cash provided by (used in) operating activities
    
    
    (4,997
    )
    
    
    1,274CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of fixed assets
    
    
    (373
    )
    
    
    (936
    )Proceeds from sale of fixed assets
    
    

    16
    
    
    
    9Purchase of marketable securities
    
    
    (1,500
    )
    
    
    (1,300
    )Payment for purchase of JGI
    
    
    
    
    
    
    (4,614
    )Net cash used in investing activities
    
    
    (1,857
    )
    
    
    (6,841
    )CASH FLOWS FROM FINANCING ACTIVITIES:Payment of preferred stock dividends
    
    
    (750
    )
    
    
    (1,125
    )Purchase of treasury stock
    
    
    (845
    )
    
    
    (211
    )Proceeds from exercise of stock options
    
    
    389
    
    
    
    538Net cash used in financing activities
    
    
    (1,206
    )
    
    
    (798
    )Net decrease in cash and cash equivalents
    
    
    (8,060
    )
    
    
    (6,365
    )Effects of exchange rate changes on cash and cash equivalents
    
    
    165
    
    
    
    22CASH AND CASH EQUIVALENTS, beginning of period
    
    
    25,833
    
    
    
    19,291CASH AND CASH EQUIVALENTS, end of period
    
    $
    17,938
    
    
    $
    12,948SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:CASH PAID FOR:Interest
    
    $
    113
    
    
    $
    102Income taxes, net of refunds
    
    $
    2,045
    
    
    $
    7
 The accompanying notes are an integral part of these
unaudited condensed consolidated financial statements. 7




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EQUITY MARKETING, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED) NOTE 1    ORGANIZATION AND BUSINESS Equity Marketing, Inc., a Delaware corporation and subsidiaries (EMAK or
the Company), is a leading global integrated marketing services company
based in Los Angeles, with offices in Chicago, Minneapolis, New York,
Ontario (CA), London, Paris, Hong Kong and Shanghai. The Company focuses on
the design and execution of strategy-based marketing programs providing
measurable results for its clients. The Company 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 Corporation, Diageo, Kelloggs,
Kohls, Macys, Nordstrom, Procter & Gamble, and Subway Restaurants, among
others. The Company complements its core marketing services business by
developing and marketing distinctive consumer products, based on emerging
and evergreen licensed properties, which are sold through specialty and
mass-market retailers. The Company primarily sells to customers in the
United States and Europe. The Companys functional currency is the United
States dollar. Equity Marketing Hong Kong, Ltd., a Delaware corporation (EMHK), is a
100% owned subsidiary of the Company. EMHK manages production of the
Companys products by third parties in the Far East and currently is
responsible for performing and/or procuring product sourcing, product
engineering, quality control inspections, independent safety testing and
export/import documentation. Logistix Limited, a United Kingdom corporation (Logistix), is a 100%
owned subsidiary of the Company which was acquired on July 31, 2001.
Logistix is a marketing services agency which focuses primarily on
assisting consumer packaged goods companies in their efforts to market to
children between the ages of seven and fourteen by developing and executing
premium-based promotions and by providing marketing consulting services.
Logistix also derives a portion of its revenues from a consumer products
business. The Companys UPSHOT division (UPSHOT), which was acquired on July 17, 2002
is a marketing agency, specializing in promotion, event, collaborative
marketing, retail design and environmental branding. The Companys SCI Promotion division (SCI), which was acquired on
September 3, 2003, is a promotional marketing services business
specializing in the development and execution of promotional campaigns that
utilize purchase-with-purchase, gift-with-purchase and incentives,
promotional licenses and promotional retail programs, principally for the
retail department store industry. Johnson Grossfield, Inc., a Delaware corporation (JGI), is 100% owned
subsidiary of the Company, which was formed in January 2004 to acquire the
promotions business of Johnson Grossfield, Inc., a Minnesota corporation.
The JGI business, which was acquired on February 2, 2004
(effective January 31, 2004), is a promotional
marketing services business specializing in providing custom licensed
premiums for the kids marketing program of Subway Restaurants. 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 presentation have
been included. The results of operations for the interim periods are not
necessarily indicative of the results for a full year. These condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements and footnotes thereto included in the
Companys Annual Report on Form 10-K for the year ended December 31, 2003. 8




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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 and six month periods ended June 30, 2004.
Options to purchase 1,226,166 and 1,373,666 shares of common stock, $.001 par
value per share (the Common Stock), as of June 30, 2003 and 2004,
respectively, were excluded from the computation of diluted EPS as they would
have been anti-dilutive. For the three and six months ended June 30, 2003 and
2004, preferred stock convertible into 1,694,915 shares of common stock was
excluded from the computation of diluted EPS as it would have been
anti-dilutive. Earnings per share for the second quarter and six months ended June 30, 2003
reflect a restatement 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). EITF 03-6 requires that companies with participating
securities calculate earnings per share using a two-class method. The
Companys cumulative participating mandatorily redeemable preferred stock
qualifies as participating securities since it is entitled to dividends
declared on the Companys common stock; therefore, EITF 03-6 requires the
allocation of a portion of undistributed earnings to preferred stock. As a
result, earnings per diluted common share were reduced by $0.06 for the second
quarter of 2003, to $0.22 from $0.28 as reported in the prior year. The
earnings results per diluted common share were reduced by $0.09 for the six
months ending June 30, 2003, to $0.31 from $0.40 as reported in the prior year.
EITF 03-6 had no impact on 2004 per share amounts because of the net loss. 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 Statement of Financial Accounting Standards
(SFAS) No. 128, Earnings per Share: For the Three Months Ended June 30,2003
    
    2004Income
    
    Shares
    
    Per Share
    
    Loss
    
    Shares
    
    Per Share(Numerator)
    
    (Denominator)
    
    Amount
    
    (Numerator)
    
    (Denominator)
    
    AmountBasic EPS:Income (loss) available to
common stockholders
    
    $
    1,360
    
    
    
    5,700,016
    
    
    $
    0.24
    
    
    $
    (905
    )
    
    
    5,758,370
    
    
    $
    (0.16
    )Effect of dilutive securities:Options and warrants
    
    
    
    
    
    
    357,785
    
    
    
    
    
    
    
    
    
    
    
    Dilutive EPS:Income (loss) available to common
stockholders and assumed conversion
    
    $
    1,360
    
    
    
    6,057,801
    
    
    $
    0.22
    
    
    $
    (905
    )
    
    
    5,758,370
    
    
    $
    (0.16
    )
 For the Six Months Ended June 30,2003
    
    2004Income
    
    Shares
    
    Per Share
    
    Loss
    
    Shares
    
    Per Share(Numerator)
    
    (Denominator)
    
    Amount
    
    (Numerator)
    
    (Denominator)
    
    AmountBasic EPS:Income (loss) available to
common stockholders
    
    $
    1,826
    
    
    
    5,704,148
    
    
    $
    0.32
    
    
    $
    (1,446
    )
    
    
    5,739,603
    
    
    $
    (0.25
    )Effect of dilutive securities:Options and warrants
    
    
    
    
    
    
    266,057
    
    
    
    
    
    
    
    
    
    
    
    Dilutive EPS:Income (loss) available to common
stockholders and assumed conversion
    
    $
    1,826
    
    
    
    5,970,205
    
    
    $
    0.31
    
    
    $
    (1,446
    )
    
    
    5,739,603
    
    
    $
    (0.25
    )
 9




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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, 2003 and June 30, 2004, inventories consisted of
the following: December 31,
    
    June 30,2003
    
    2004Production-in-process
    
    $
    3,363
    
    
    $
    1,293Finished goods
    
    
    11,736
    
    
    
    12,947$
    15,099
    
    
    $
    14,240
 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. Transaction gains or (losses) included in
net income (loss) for the quarters ended June 30, 2003 and 2004 were $260 and
$(44), respectively. Transaction gains or (losses) included in net income
(loss) for the six months ended June 30, 2003 and 2004 were $374 and $(322),
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. 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 nine months in original maturity. 10




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##### Table of Contents



The Companys Logistix subsidiary entered into foreign currency forward
contracts aggregating GBP 6,481 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 March 14, 2005. At
June 30, 2004, the foreign currency forward contracts had an estimated fair
value of $45. The fair value of the foreign currency forward contracts is
recorded in prepaid expenses and other current assets in the accompanying
condensed consolidated balance sheet as of June 30, 2004. The unrealized
gain on the contracts is reflected in accumulated other comprehensive
income. The Companys JGI
subsidiary entered into foreign currency forward contracts
aggregating $439 to sell Canadian dollars in exchange for United
States dollars. The contracts will expire by December 31, 2004. At
June 30, 2004, the foreign currency forward contracts had an
estimated fair value of $(18). Goodwill and Other Intangibles SFAS No. 141, Business Combinations and SFAS No. 142, Goodwill and Other
Intangible Assets were approved by the Financial Accounting Standards Board
(FASB) effective June 30, 2001 for business combinations consummated after
June 30, 2001. SFAS No. 141 eliminates the pooling-of-interests method for
business combinations and requires use of the purchase method. SFAS No. 142
changes the accounting for goodwill and certain other intangible assets from an
amortization approach to a non-amortization (impairment) approach. The
statement requires amortization of goodwill recorded in connection with
previous business combinations to cease upon adoption of the statement by
calendar year companies on January 1, 2002. Accordingly, beginning on January
1, 2002, the Company has foregone all related goodwill amortization expense. The change in the carrying amount of goodwill from $41,893 as of December 31,
2003 to $44,339 as of June 30, 2004 reflects: a foreign currency translation
adjustment of $246, an adjustment to reflect the net increase to goodwill for
the SCI acquisition of $878 (see Note 6) and $1,322 for the acquisition of JGI
(see Note 6). Of the goodwill balance, $0 relates to the consumer products
segment and $44,339 relates to the marketing services segment. Identifiable intangibles of $1,252 as of December 31, 2003 and, $3,344 as of
June 30, 2004 a portion of which are subject to amortization, are included in
other intangibles in the condensed consolidated balance sheets. Under the provisions of SFAS No. 142, the carrying value of assets
acquired, including goodwill, are reviewed annually. During such a review
the Company will estimate the fair value of the reporting unit to which the
assets were assigned by discounting the reporting units estimated future
cash flows before interest. The Company will compare the discounted cash
flows to the carrying value of the acquired net assets to determine if an
impairment loss has occurred. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by
which the carrying value of the assets exceeds their estimated fair values.
In the fourth quarter of 2003, the Company performed the annual impairment
test required by SFAS No. 142 and determined that its goodwill was not
impaired as of December 31, 2003. 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 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. Stock-Based Compensation In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure. SFAS No. 148 amends SFAS No.
123, Accounting for Stock-Based Compensation, to provide alternative
methods of transition for a voluntary change to the fair-value for
stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting
for stock-based employee compensation and the effect of the method used on
reported results. 11




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As of June 30, 2004, the Company had three stock-based compensation plans 
the 2000 Stock Option Plan, the 2004 Stock Incentive Plan and the 2004
Non-Employee Director 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 income (loss) and earnings (loss)
per share would have been reduced to the pro forma amounts indicated in the
table below: Three Months Ended

    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2004
    
    2003
    
    2004Net income (loss) available to common stockholders  as reported
    
    $
    1,360
    
    
    $
    (905
    )
    
    $
    1,826
    
    
    $
    (1,446
    )Less:Compensation expense (a)
    
    
    357
    
    
    
    189
    
    
    
    838
    
    
    
    323Net income (loss) available to common stockholders  pro forma
    
    $
    1,003
    
    
    $
    (1,094
    )
    
    $
    988
    
    
    $
    (1,769
    )Earnings (loss) per share:Basic earnings (loss) per share, as reported
    
    $
    0.24
    
    
    $
    (0.16
    )
    
    $
    0.32
    
    
    $
    (0.25
    )Pro forma basic earnings (loss) per share
    
    $
    0.18
    
    
    $
    (0.19
    )
    
    $
    0.17
    
    
    $
    (0.31
    )Diluted earnings (loss) per share, as reported
    
    $
    0.22
    
    
    $
    (0.16
    )
    
    $
    0.31
    
    
    $
    (0.25
    )Pro forma diluted earnings (loss) per share
    
    $
    0.17
    
    
    $
    (0.19
    )
    
    $
    0.17
    
    
    $
    (0.31
    )
  (a)
    
    Determined under fair value based method for all awards, net of tax. Recent Accounting Pronouncements In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest
Entities, which addresses the consolidation of business enterprises (variable
interest entities) to which the usual condition (ownership of a majority voting
interest) of consolidation does not apply. The interpretation focuses on
financial interests that indicate control. It concludes control through voting
interests, a companys exposure (variable interest) to the economic risks and
potential rewards from the variable interest entitys assets and activities are
the best evidence of control. Variable interests are rights and obligations
that convey economic gains or losses from changes in the values of the variable
interest entitys assets and liabilities. Variable interests may arise from
financial instruments, service contracts, nonvoting ownership interests and
other arrangements. If an enterprise holds a majority of the variable
interests of an entity, it would be considered the primary beneficiary. The
primary beneficiary would be required to include the assets, liabilities and
the results of operations of the variable interest entity in its financial
statements. In December 2003, the FASB issued a revision to FIN 46 to address
certain implementation issues. The adoption of FIN 46 and FIN 46 (revised) did
not have an impact on the Companys results of operations or financial
position. In March 2004, the FASB published an Exposure Draft, Share-Based Payment, an
Amendment of FASB Statements No. 123 and 95. The proposed change in accounting
would replace existing requirements under SFAS No. 123 and APB Opinion No. 25.
The proposed statement would require public companies to recognize the cost of
employee services received in exchange for equity instruments, based on the
grant-date fair value of those instruments, with limited exceptions. The
proposed statement would also affect the pattern in which compensation cost
would be recognized, the accounting for employee share purchase plans, and the
accounting for income tax effects of share-based payment transactions. The
Exposure Draft also notes that the use of a lattice model, such as the binomial
model, to determine the fair value of employee stock options, is preferable.
The Company currently uses the Black-Scholes pricing model to determine the
fair value of its employee stock options. Use of a lattice model to determine
the fair value of employee stock options may result in compensation cost
materially different from those pro forma costs disclosed above under
Stock-Based Compensation in this Note 2 to the condensed consolidated
financial statements. The Company is currently determining what impact the
proposed statement would have on its results of operations or financial
position. In November 2003 and March 2004, the Emerging Issues Task Force (EITF)
reached final consensus on EITF Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments.
The EITF requires a company to apply a three-step model to determine whether an
impairment of an investment, within the scope of SFAS No. 115, Accounting for
Certain Investments in Debt and Equity Securities, is other-than-temporary.
EITF Issue No. 03-1 shall be applied prospectively to all current and future
investments, in interim or annual reporting periods beginning after June 15,
2004. The Company believes the adoption of EITF Issue No. 03-1 will not have a
material impact on its results of operations or financial position. 12




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In April 2004, the EITF reached final consensus on EITF 03-6, Participating
Securities and the Two-Class Method under FASB Statement No. 128, which
requires companies that have participating securities to calculate earnings per
share using the two-class method. This method requires the allocation of undistributed earnings to the
common shares and participating securities based on the proportion of
undistributed earnings that each would have been entitled to had all the
periods earnings been distributed. EITF 03-6 is effective for fiscal periods
beginning after June 30, 2004 and earnings per share reported in prior periods
presented must be retroactively adjusted in order to comply with EITF 03-6.
The Company has adopted EITF 03-6 for the quarter ended June 30, 2004.
Earnings per diluted common share were reduced by $0.06 for the second quarter
of 2003, to $0.22 from $0.28 as reported in the prior year. The earnings
results per diluted common share were reduced by $0.09 for the six months
ending June 30, 2003, to $0.31 from $0.40 as reported in the prior year. EITF
03-6 had no impact on 2004 per share amounts because of the net loss. 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. 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. 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 and August 12, 2004, certain covenants under the
facility were amended. As of June 30, 2004, the Company was in compliance with
the amended restrictions and covenants. The Facility may be used for working
capital and acquisition financing purposes. As of June 30, 2004, there were no
amounts outstanding under the Facility. Letters of credit outstanding under the Facility as of December 31, 2003 and
June 30, 2004 totaled $823 and $3,083, respectively. In addition to the Facility, in October, 2003 the Companys Logistix subsidiary
established an import/letter of credit facility with Hong Kong Shanghai Bank
Corp. (HSBC) to provide short-term financing of product purchases from 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 December 31, 2003, advances outstanding under this facility totaled
approximately $626 and were recorded in accounts payable in the accompanying
consolidated balance sheet. As of June 30, 2004, no amounts were outstanding
under this facility. NOTE 4  STOCK REPURCHASE On July 21, 2000, the Companys Board of Directors authorized up to $10,000
for the repurchase of the Companys common stock over a twelve month
period. In the period from July 21, 2000 to July 21, 2001, the Company
spent $6,430 to purchase an aggregate of 523,594 shares at an average price
of $12.28 per share including commissions. On July 24, 2001, the Companys
Board of Directors authorized up to an additional $10,000 for the
repurchase of the Companys common stock over a twelve month period. In
the period from August 2, 2001 through July 11, 2002, the Company spent
$5,605 to purchase 454,715 shares at an average price of $12.33 per share
including commissions. On July 12, 2002, the Companys Board of Directors
authorized up to an additional $10,000 for the repurchase of the Companys
common stock. The Company spent $3,505 to repurchase 267,650 shares at an
average price of $13.10 per share including commissions under this
authorization through June 30, 2004. The duration of the current buyback
program is indefinite; provided, however, that the Companys Board of
Directors intends to review the program quarterly. Purchases are conducted
in the open market at prevailing prices, based on market conditions when
the Company is not in a quiet period. The Company may also transact
purchases effected as block trades, as well as certain negotiated,
off-exchange purchases not in the open market. Since initiating the
overall buyback program on July 20, 2000, the Company has spent $15,540 to
purchase a total of 1,245,959 shares at an average price of $12.47 per
share including commissions through June 30, 2004. This repurchase program
is being funded through working capital. 13




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##### Table of Contents



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, asset impairment charges,
restructuring 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. Certain information presented in the tables below has been restated to
conform to the current management structure as of January 1, 2004.
Specifically, the results and assets of the USI division, which had
previously been reported as part of Consumer Products, are now being
reported as part of Marketing Services, which is consistent with management
responsibility for this business. Effective January 1, 2004, the USI
division was carved out of the Companys Consumer Products division and
consolidated with the Companys SCI division (acquired September 3, 2003)
which is part of the Marketing Services segment. The vast majority of the
revenues for the USI division represent sales of made-to-order custom
product to oil & gas and other retailers who in turn sell the products to
consumers. 14




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##### Table of Contents



Industry Segments As of and For the Three Months Ended June 30, 2003Marketing
    
    ConsumerServices
    
    Products
    
    Corporate
    
    TotalTotal revenues
    
    $
    46,163
    
    
    $
    10,790
    
    
    $
    
    
    
    $
    56,953Income (loss) before provision (benefit)
for income taxes
    
    $
    6,437
    
    
    $
    1,919
    
    
    $
    (4,986
    )
    
    $
    3,370Provision (benefit) for income taxes
    
    
    2,398
    
    
    
    726
    
    
    
    (1,894
    )
    
    
    1,230Net income (loss)
    
    $
    4,039
    
    
    $
    1,193
    
    
    $
    (3,092
    )
    
    $
    2,140Fixed asset additions
    
    $
    
    
    
    $
    
    
    
    $
    256
    
    
    $
    256Depreciation and amortization
    
    $
    3
    
    
    $
    45
    
    
    $
    416
    
    
    $
    464Total assets
    
    $
    76,736
    
    
    $
    10,820
    
    
    $
    34,886
    
    
    $
    122,442
 As of and For the Three Months Ended June 30, 2004Marketing
    
    ConsumerServices
    
    Products
    
    Corporate
    
    TotalTotal revenues
    
    $
    47,195
    
    
    $
    4,583
    
    
    $
    
    
    
    $
    51,778Income (loss) before provision (benefit)
for income taxes
    
    $
    4,938
    
    
    $
    (716
    )
    
    $
    (5,096
    )
    
    $
    (874
    )Provision (benefit) for income taxes
    
    
    1,946
    
    
    
    (282
    )
    
    
    (2,008
    )
    
    
    (344
    )Net income (loss)
    
    $
    2,992
    
    
    $
    (434
    )
    
    $
    (3,088
    )
    
    $
    (530
    )Fixed asset additions
    
    $
    
    
    
    $
    
    
    
    $
    345
    
    
    $
    345Depreciation and amortization
    
    $
    90
    
    
    $
    
    
    
    $
    431
    
    
    $
    521Total assets
    
    $
    82,539
    
    
    $
    8,730
    
    
    $
    29,481
    
    
    $
    120,750
 As of and For the Six Months Ended June 30, 2003Marketing
    
    ConsumerServices
    
    Products
    
    Corporate
    
    TotalTotal revenues
    
    $
    89,998
    
    
    $
    14,522
    
    
    $
    
    
    
    $
    104,520Income (loss) before provision (benefit)
for income taxes
    
    $
    12,272
    
    
    $
    1,765
    
    
    $
    (9,171
    )
    
    $
    4,866Provision (benefit) for income taxes
    
    
    4,567
    
    
    
    665
    
    
    
    (3,484
    )
    
    
    1,748Net income (loss)
    
    $
    7,705
    
    
    $
    1,100
    
    
    $
    (5,687
    )
    
    $
    3,118Fixed asset additions
    
    $
    
    
    
    $
    
    
    
    $
    373
    
    
    $
    373Depreciation and amortization
    
    $
    47
    
    
    $
    62
    
    
    $
    827
    
    
    $
    936Total assets
    
    $
    76,736
    
    
    $
    10,820
    
    
    $
    34,886
    
    
    $
    122,442
 As of and For the Six Months Ended June 30, 2004Marketing
    
    ConsumerServices
    
    Products
    
    Corporate
    
    TotalTotal revenues
    
    $
    93,683
    
    
    $
    9,907
    
    
    $
    
    
    
    $
    103,590Income (loss) before provision (benefit)
for income taxes
    
    $
    9,245
    
    
    $
    (839
    )
    
    $
    (9,548
    )
    
    $
    (1,142
    )Provision (benefit) for income taxes
    
    
    3,585
    
    
    
    (329
    )
    
    
    (3,702
    )
    
    
    (446
    )Net income (loss)
    
    $
    5,660
    
    
    $
    (510
    )
    
    $
    (5,846
    )
    
    $
    (696
    )Fixed asset additions
    
    $
    
    
    
    $
    
    
    
    $
    936
    
    
    $
    936Depreciation and amortization
    
    $
    160
    
    
    $
    
    
    
    $
    827
    
    
    $
    987Total assets
    
    $
    82,539
    
    
    $
    8,730
    
    
    $
    29,481
    
    
    $
    120,750
 15




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##### Table of Contents



NOTE 6  ACQUISITIONS On September 3, 2003, the Company acquired substantially all of the assets of
SCI Promotion Group, LLC (SCI-LLC), a privately held promotional marketing
services company based in Ontario, California (the SCI Acquisition). The
Company financed the SCI Acquisition through its existing cash reserves. The
SCI Acquisition was consummated pursuant to an Asset Purchase Agreement dated
September 3, 2003, by and among the Company, SCI-LLC and Joseph J. Schmidt, III
(the Purchase Agreement). Under the terms of the Purchase Agreement, the
Company acquired substantially all of the assets of SCI-LLC for a cash purchase
price of approximately $5,900 (before closing balance sheet working capital
adjustment), plus additional earnout consideration of up to $3,500 based upon
future performance of the acquired business. Net of a holdback of $250, the
Company paid $5,683 in cash plus related transaction costs of $538. The Company
also assumed the operating liabilities of the 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 2003 through 2006. The earnout
payments, if required, are payable 50% in cash and 50% in shares of the
Companys common stock. The additional consideration, if any, will be recorded
as goodwill. The SCI Acquisition has been accounted for under the purchase method of
accounting. The financial statements reflect the preliminary allocation of the
purchase price to the acquired net assets based on their estimated fair values
as of the acquisition date. The Company is in the process of finalizing
valuations of the individual assets and liabilities which may result in an
adjustment to goodwill and other intangibles. The allocation of the purchase
price may change based upon these valuations. During the six months ended June
30, 2004, the preliminary allocation of the purchase price was adjusted to
revise the estimated value of prepaid expenses ($64 decrease) and accrued
liabilities ($13 increase). The allocation reflects a receivable from SCI-LLC
resulting from a closing balance sheet working capital adjustment of $855,
accruing interest at the rate of 5% per annum, that will offset additional
earnout consideration. Based on the results for 2003, additional consideration
of $800 was earned and partially offset the receivable from SCI-LLC. The
remaining balance of this receivable is recorded in prepaid expenses and other
current assets in the Companys consolidated balance sheet as of June 30, 2004.
The additional earnout consideration was recorded as additional goodwill as of
June 30, 2004. The Companys preliminary allocation of purchase price for the
acquisition, based upon estimated fair values is as follows: Net current assets
    
    $
    6,373Receivable from SCI
    
    
    855Property, plant and equipment
    
    
    37Other non-current assets
    
    
    13Net current liabilities
    
    
    (5,755
    )Estimated fair value, net assets acquired
    
    
    1,523Goodwill
    
    
    3,986Other intangible assets
    
    
    728Total purchase price
    
    $
    6,237
 The intangible assets of $728 are comprised of customer contracts and related
customer relationships and sales order backlog, and are being amortized over
estimated useful lives ranging from 4 months to 5 years. 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 JGI
Acquisition). The Company financed the JGI Acquisition through its existing
cash reserves. The acquisition was consummated pursuant to an Asset Purchase
Agreement dated January 16, 2004, by and among the Company, JGI, JGI-MN, Marc
Grossfield and Thom Johnson (the Purchase Agreement). Under the terms of the
Purchase Agreement, the Company purchased the assets of JGI-MNs promotional
agency business for approximately $4,600 in cash 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 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 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 the Companys common stock. The additional consideration,
if any, will be recorded as goodwill. 16




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##### Table of Contents



The JGI Acquisition has been accounted for under the purchase method of
accounting. The financial statements reflect the preliminary allocation of the
purchase price to the acquired net assets based on their estimated fair values
as of the acquisition date. The Company is in the process of finalizing
valuations of the individual assets and liabilities which may result in an
adjustment to goodwill and other intangibles. The allocation of the purchase
price may change based upon these valuations. However, the Company does not
expect significant changes to the preliminary allocation of the purchase price.
During the three months ended June 30, 2004, the preliminary allocation of the
purchase price was adjusted to revise the estimated value of accounts
receivable ($31 decrease), inventory ($68 decrease) and accrued liabilities
($19 decrease). During the second quarter of 2004, additional consideration
was paid in the amount of $105 as a working capital adjustment. The Companys
preliminary allocation of purchase price for the JGI Acquisition, based upon
estimated fair values is as follows: Net current assets
    
    $
    2,758Property, plant and equipment
    
    
    8Other non-current assets
    
    
    7Net current liabilities
    
    
    (1,194
    )Estimated fair value, net assets acquired
    
    
    1,579Goodwill
    
    
    1,322Other intangible assets
    
    
    2,243Total purchase price
    
    $
    5,144
 The intangible assets of $2,243 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. In connection with the SCI and JGI Acquisitions, the Company formulated and
implemented an integration plan and incurred integration costs, including
travel, training and consulting costs. Such costs totaled $93 and $136 for the
three month and six month periods ended June 30, 2004, respectively, and were
recorded as integration costs in the condensed consolidated statements of
operations. The following selected unaudited pro forma consolidated results of
operations are presented as if the SCI and JGI Acquisitions had occurred as
of the beginning of the year 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 Ended
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2004
    
    2003
    
    2004Pro forma revenues
    
    $
    66,754
    
    
    $
    51,778
    
    
    $
    122,215
    
    
    $
    105,054Pro forma net income (loss)
    
    $
    2,716
    
    
    $
    (530
    )
    
    $
    3,745
    
    
    $
    (538
    )Pro forma basic earnings (loss) per share
    
    $
    0.32
    
    
    $
    (0.16
    )
    
    $
    0.40
    
    
    $
    (0.22
    )Pro forma diluted earnings (loss) per share
    
    $
    0.30
    
    
    $
    (0.16
    )
    
    $
    0.39
    
    
    $
    (0.22
    )
 Refer to Note 2 for further discussion of the method of computation of earnings
per share. 17




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NOTE 7  RELATED PARTIES On July 15, 2003, the Company entered into an agreement with U.S. Capital
Investors, Inc. (USCI), an entity controlled by Jeffrey S. Deutschman,
pursuant to which USCI will serve as an advisor to the Company with respect
to potential mergers and acquisitions through December 31, 2003. Mr.
Deutschman currently serves on the Board of Directors of the Company as the
representative of the holder of the Companys Series A Preferred Stock.
The Companys agreement with USCI provides for the payment of a
discretionary success fee for completed acquisition transactions in an
amount determined by an independent committee of the Board in accordance
with certain guidelines and criteria. The guidelines for fees payable upon
successful completion of an acquisition transaction are $200 for up to
$10,000 of consideration, 1.5% of consideration from $10,000 to $25,000 and
1% of consideration over $25,000; provided, however, that the success fee
for the first transaction under the agreement has an initial fee guideline
of $275 for up to $10,000 of consideration. Notwithstanding the
guidelines, the independent committee has absolute discretion in
determining the amount, if any, of the success fee for any transaction.
The USCI agreement provides for the payment of a refundable advance against
success fees in the aggregate amount of $275. The USCI agreement was
approved by the Board and consented to by the holder of the Series A
Preferred Stock. The Company believes that this agreement has enhanced its
ability to analyze and close merger and acquisition transactions in a
manner that is more cost effective than traditional outside advisory firms.
In connection with the acquisition of SCI (see Note 6), USCI earned a
success fee of $275. This success fee is recorded as a transaction cost of
the SCI acquisition. In connection with the February 2004 acquisition of
JGI, USCI earned a success fee of $125. This success fee is recorded as a
transaction cost of the JGI acquisition. The Company is currently in
discussions with USCI to continue the advisory related services through
2004 which may or may not be on the same terms. NOTE 8  MANDATORILY REDEEMABLE 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 mandatory redeemable
senior cumulative participating convertible preferred stock, par value
$.001 per share, (the Series A Stock) with a conversion price of $14.75
per 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 share, respectively. On
June 20, 2000, Crown paid EMAK an additional $13,100 in exchange for an
additional 13,100 shares of Series A Stock with a conversion price of
$14.75 per share. In connection with such purchase, EMAK 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
June 30, 2005. Two payments of $62.5 each were made during the quarter ended
June 30, 2004. 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 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 tranch, 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. 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. Upon any voluntary or involuntary liquidation, dissolution or winding-up of
the Companys affairs, Crown, as holder of the Series A 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. 18




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The Series A 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 A 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 June 30, 2004 totaled $375 and were paid in
June 2004. Crown currently holds 100% of the outstanding shares of Series A Stock, and
has designated one individual to the Board of Directors of the Company.
Crown currently has the right to designate two additional directors. The Series A 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 9COMMITMENTS AND CONTINGENCIES Operating Leases The Company has operating leases for its properties and equipment, which
expire at various dates through 2014. Future minimum lease payments under non-cancelable operating leases as of
June 30, 2004 are as follows: Year2004
    
    $
    2,6552005
    
    
    4,7772006
    
    
    4,2242007
    
    
    4,0182008
    
    
    3,614Thereafter
    
    
    6,183Total
    
    $
    25,471
 Aggregate rental expenses for operating leases were $937 and $915 for the
three months ended June 30, 2003 and 2004, respectively. Guaranteed Royalties For the three months ended June 30, 2003 and 2004, the Company incurred
$1,683 and $666, 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 June 30, 2004,
the Company has committed to pay total minimum guaranteed royalties as
follows: Year2004
    
    $
    1,7142005
    
    
    4,2712006
    
    
    2,5462007
    
    
    1,076Total
    
    $
    9,607
 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. Employment Agreement The Company has employment agreements with key executives. Guaranteed
compensation under these agreements as of June 30, 2004 are as follows: Year2004
    
    $
    1,0962005
    
    
    6002006
    
    
    3252007
    
    
    3252008
    
    
    200Thereafter
    
    
    1,800Total
    
    $
    4,346
 19




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NOTE 10  RESTRUCTURING During the second quarter of 2004, the Company formulated and implemented a
restructuring plan in connection with the realignment of centralized resources
in its Marketing Services business in order to combine and streamline the
operations. In connection with this plan the Company recorded a restructuring
charge of $105. This charge represents severance for one employee in the
Companys Los Angeles office, who was terminated, and is reflected as a restructuring charge
in the accompanying condensed consolidated statement of operations. As of June
30, 2004, none of the restructuring charge was paid. NOTE 11  LOSS ON CHICAGO LEASE In 2003, the Company finalized its exit plan with respect to vacating half of
its leased space (approximately thirty thousand square feet) at UPSHOTs
Chicago, Illinois office. In June 2003, this resulted in an adjustment to the
liabilities recorded and an increase to goodwill of $1,900 for the present
value of the remaining lease payments for the vacated office space in excess of
the estimated sub-lease income. The liabilities assumed in connection with this
restructuring plan totaled $3,535 and are included as part of goodwill in
accordance with EITF Issue No. 95-3, Recognition of Liabilities in Connection
with a Purchase Business Combination. In June 2004, the Company recorded
expense of $311 due to lower than estimated sublease income for the vacated
office space. The office space has been subleased at rates modestly below the
Companys initial estimates, due to softness in the current Chicago real estate
market. 20




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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 Equity Marketing,
Inc., a Delaware corporation and its subsidiaries. Unless otherwise
specifically indicated, all dollar amounts herein are expressed in thousands. Organization and Business Equity Marketing, Inc., a Delaware corporation and subsidiaries, is a
leading integrated global marketing services company based in Los Angeles,
with offices in Chicago, Minneapolis, New York, Ontario (CA), London,
Paris, Hong Kong and Shanghai. We focus on the design and execution of
strategy-based marketing programs providing measurable results for our
clients. We have 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
Corporation, Diageo, Kelloggs, Kohls, Macys, Nordstrom, Procter &
Gamble, and Subway Restaurants, among others. We complement our core
marketing services business by developing and marketing distinctive
consumer products, based on emerging and evergreen licensed properties,
which are sold through specialty and mass-market retailers. Equity Marketing Hong Kong, Ltd., a Delaware corporation (EMHK), is a
100% owned subsidiary. EMHK manages production of our products by third
parties in the Far East and currently is responsible for performing and/or
procuring product sourcing, product engineering, quality control
inspections, independent safety testing and export/import documentation. Logistix Limited, a United Kingdom corporation (Logistix), is a 100%
owned subsidiary which was acquired on July 31, 2001. Logistix is a
marketing services agency which focuses primarily on assisting consumer
packaged goods companies in their efforts to market to children between the
ages of seven and fourteen by developing and executing premium-based
promotions and by providing marketing consulting services. Logistix also
derives a small portion of its revenues from a consumer products business. Our UPSHOT division (UPSHOT), which was acquired on July 17, 2002 is a
marketing agency, specializing in promotion, event, collaborative marketing,
retail design and environmental branding. Our SCI Promotion division (SCI), which was acquired on September 3,
2003, is a promotional marketing services business specializing in the
development and execution of promotional campaigns that utilize
purchase-with-purchase, gift-with-purchase, promotional licenses and
promotional retail programs, principally for the retail department store
industry. Johnson Grossfield, Inc. (JGI), is a 100% owned subsidiary, the
operations of which were acquired on February 2, 2004 (effective January
31, 2004). JGI is a promotional marketing services business specializing
in providing custom licensed premiums for the kids marketing program of
Subway Restaurants. Overview Despite contributions from our recent acquisitions, revenues for the second
quarter of 2004 decreased $5,175 to $51,778 as compared to $56,953 recorded in
the prior year. Our second quarter 2004 performance was hurt by revenue and
margin shortfalls primarily in our Consumer Products segment. This was
partially offset by moderate revenue growth in our Marketing Services segment
as a result of our recent acquisitions of SCI and JGI, which more than offset a
year-over-year decline in volumes for Burger King promotional programs. SCI
and JGI combined generated approximately $5,900 of revenues during the quarter. We recorded a net loss of $0.16 per diluted share for the second quarter of
2004 compared to net income of $0.22 per diluted share in the prior year
quarter. The net loss per share was primarily attributable to the following
factors:  
    
    A decrease in revenues and margin shortfalls in the Consumer Products
segment. Sales in the Consumer Product segment decreased $6,207 from
the prior year quarter and gross profit margins decreased to 20.9% of
sales from 36.5% in the prior year quarter. The gross profit margin for
Consumer Products was negatively impacted by pricing pressure, a higher
mix of international sales which carry lower margins and a changing
product sales mix. The decrease in sales was attributable to a large
shipment of Kim Possible product in the second quart of 2003 to stock
Wal-Mart for their exclusive launch of this product line. 21




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##### Table of Contents




    
    Collectively, SCI and JGI were $0.05 dilutive per share. The first half
of the year is seasonally SCIs lowest. As a result, we didnt have the
sales volume to absorb the largely fixed cost structure of this business.
This resulted in increased operating expenses as a percentage of revenues.  
    
    Charges for the integration of SCI and JGI totaling $93, or $0.01 per
diluted share.  
    
    A restructuring charge for $105, or $0.01 per diluted share related
to the realignment of centralized resources in the Marketing Services
business.  
    
    A charge of $311, or $0.03 per diluted share due to lower than
estimated sub-lease income for vacated office space in the UPSHOT
business. The office space has been subleased at rates modestly below
the Companys initial estimates, due to softness in the current Chicago
real estate market.  
    
    Operating expenses in the second quarter of 2004 include
approximately $194, or $0.02 per diluted share, in non-cash expense
related to grants of restricted stock units, compared with $61, or $0.01
recognized in the same period of 2003. We began using restricted stock
units as our primary means of stock based compensation in the second
quarter of 2003 and made additional grants at the beginning of the
second quarter of 2004. Our Burger King business performed in line with our expectations. During the
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 in the second quarter but the unit volume of
the domestic programs was lower than in the past, which has reduced our total
revenues and profits from this business. This decrease was partially offset by
an increase in volumes in our international Burger King business. We expect
the trend of lower domestic unit volumes as compared to prior years to begin to
turn around towards the end of 2004 and into 2005 as a result of recent
improvements in Burger King system sales of kids meals. With the exception of the Kim Possible product line discussed above, sales for
our other Consumer Products brands have increased. This is attributable to our
expanded line-up of products. Revenues in 2003 were primarily comprised of
sales of Scooby-Doo and Kim Possible product. This year we received
contribution from Scooby-Doo, Kim Possible, from our expanded line-up of
Crayola® branded bath toys, and from our newest line of toys, Baby Einstein.
As a result of the expanded product lines, we expect our Consumer Products
business to grow in 2004 relative to 2003. Due to the seasonality of our business, we expect to generate the bulk of our
revenues and net income in the second half of the year. 22




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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 Months
    
    Six MonthsEnded June 30,
    
    Ended June 30,2003
    
    2004
    
    2003
    
    2004Revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    73.3
    
    
    
    73.4
    
    
    
    73.7
    
    
    
    73.9Gross profit
    
    
    26.7
    
    
    
    26.6
    
    
    
    26.3
    
    
    
    26.1Operating expenses:Salaries, wages and benefits
    
    
    9.7
    
    
    
    15.3
    
    
    
    10.9
    
    
    
    14.7Selling, general and administrative
    
    
    11.4
    
    
    
    11.9
    
    
    
    11.0
    
    
    
    11.7Integration costs
    
    
    
    
    
    
    0.2
    
    
    
    
    
    
    
    0.1Loss on Chicago lease
    
    
    
    
    
    
    0.6
    
    
    
    
    
    
    
    0.3Restructuring charge
    
    
    
    
    
    
    0.2
    
    
    
    
    
    
    
    0.1Total operating expenses
    
    
    21.1
    
    
    
    28.2
    
    
    
    21.9
    
    
    
    26.9Income
(loss) from operations
    
    
    5.6
    
    
    
    (1.6
    )
    
    
    4.4
    
    
    
    (0.8
    )Other income
(expense), net
    
    
    0.4
    
    
    
    (0.1
    )
    
    
    0.3
    
    
    
    (0.3
    )Income
(loss) before provision for income taxes
    
    
    6.0
    
    
    
    (1.7
    )
    
    
    4.7
    
    
    
    (1.1
    )Provision
(benefit) for income taxes
    
    
    2.2
    
    
    
    (0.7
    )
    
    
    1.7
    
    
    
    (0.4
    )Net income
(loss)
    
    
    3.8
    %
    
    
    (1.0
    )%
    
    
    3.0
    %
    
    
    (0.7
    )%
 Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003
(In Thousands): Revenues Revenues for the three months ended June 30, 2004 decreased $5,175, or 9.1%, to
$51,778 from $56,953 in the comparable period in 2003. Marketing Services
revenues increased $1,032, or 2.2%, to $47,195 primarily as a result of
increased revenues resulting from the SCI and JGI Acquisitions. The increase
in Marketing Services revenues was also attributable to net foreign currency
translation impact which contributed approximately $734 to revenues for
Logistix versus the prior year period average exchange rates. Revenues for the
Burger King business decreased as the volume of units for domestic promotional
programs were lower compared to the same period in 2003. The results for 2003 exclude SCI (acquired September 3, 2003) and JGI (acquired
February 2, 2004). Excluding the impact of the SCI and JGI Acquisitions,
Marketing Services revenues decreased 10.5% for the three months ended June 30,
2004 compared to the same period in 2003. SCI and JGI combined generated
approximately $5,900 of revenues during the quarter. Consumer Product revenues decreased $6,207, or 57.5%, to $4,583. The decrease
is primarily attributable to a significant one-time stocking of Kim Possible
merchandise in the second quarter 2003. Our Kim Possible line was launched in
the second quarter of 2003 as a Wal-Mart exclusive. The decrease in Kim
Possible product was partially offset by increased international sales of
Scooby-Doo product, the continued growth of Crayola® branded bath toys, and
the addition of the Baby Einsteinproducts. Our second quarter 2003 Consumer
Product revenues were primarily comprised of Kim Possible, Scooby-Doo and Crayola® product.
In January 2004, we also began distributing the first toy products based upon
Baby Einstein, the best selling brand of videos specifically designed for
infants and toddlers. We have granted exclusive distribution to Target and
Babies R Us for 2004. The growth in our Crayola® line of bath toys, which was
launched in the second half of 2003, was attributable to an expanded product
line and expanded distribution channels. The growth in Scooby-Doo revenues
for the quarter was the result of international sales, which is attributable to
the brand receiving more exposure on television in Europe and Latin America. 23




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##### Table of Contents



Cost of sales and gross profit Cost of sales decreased $3,751 to $38,015 (73.4% of revenues) for the three
months ended June 30, 2004 from $41,766 (73.3% of revenues) in the comparable
period in 2003 due to the lower sales volume in 2004. The gross margin percentage slightly decreased to 26.6% for the three months
ended June 30, 2004 from 26.7% in the comparable period for 2003. This
decrease is the result of a decrease in Consumer Products gross margins. The
gross profit percentage for Marketing Services for the three months ended June
30, 2004 increased to 27.1% compared to 24.4% for the comparable period in
2003. This increase is attributable to an increase in the relative mix of
non-Burger King business, which tends to carry higher gross profit margins.
The gross profit percentage for Consumer Products decreased to 20.9% for the
three months ended June 30, 2004 from 36.5% in the comparable period in 2003.
This decrease is primarily the result of pricing pressure, a higher mix of
international sales which carry lower margins and a changing product sales mix.
International sales, which are sold through distributors who bear more of the
risk and incur the bulk of the selling expenses, tend to carry lower gross
margins than domestic sales. Salaries, wages and benefits Salaries, wages and benefits increased $2,363, or 42.7%, to $7,900 (15.3% of
revenues) for the three months ended June 30, 2004 from $5,537 (9.7% of
revenues) in the comparable period for 2003. This increase was primarily
attributable to the addition of approximately 55 employees from the SCI and JGI
Acquisitions as well as annual employee merit pay increases and
additional compensation expense resulting from grants of restricted
stock units. Salaries, wages and benefits increased as a percentage of revenues from 9.7% to
15.3% as a result of the revenue decrease. The first half of the year is
seasonally SCIs lowest. As a result, we didnt have the sales volume to
absorb the largely fixed cost structure of this business. In addition, the
reduction in Burger King unit volume had a significant impact on this metric,
as our staffing levels required to service this account are largely fixed. Selling, general and administrative expenses Selling, general and administrative expenses decreased $325, or 5%, to $6,160
(11.9% of revenues) for the three months ended June 30, 2004 from $6,485 (11.4%
of revenues) in the comparable period for 2003. The decrease is attributable
to lower selling expenses associated with a decrease in sales compared to the
second quarter 2003. The decrease was partially offset by additional operating
expenses resulting from the SCI and JGI Acquisitions. Selling, general and administrative expenses increased as a percentage of
revenues from 11.4% to 11.9% as a result of the revenue decrease. The first
half of the year is seasonally SCIs lowest. As a result, we didnt have the
sales volume to absorb the largely fixed cost structure of this business. In
addition, the reduction in Burger King unit volume had a significant impact on
this metric, as our cost structure required to service this account is largely
fixed. Integration costs We recorded integration costs of $93 (0.2% of revenues) for the three months
ended June 30, 2004. These are primarily travel, training and consulting costs
directly related to the integration of SCI and JGI. Loss on Chicago lease We recorded a charge for the loss on the Chicago office lease of $311 (0.6% of
revenues) for the three months ended June 30, 2004. This is due to lower than
estimated sublease income for vacated office space in the Upshot business. The
office space has been subleased at rates modestly below our initial estimates,
due to softness in the current Chicago real estate market. Restructuring charge We recorded a restructuring charge of $105 (0.2% of revenues) for the three
months ended June 30, 2004. This is associated with the realignment of
centralized resources in our Marketing Services business. 24




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##### Table of Contents



Other income (expense) Net other income (expense) decreased $273 to $(68) for the three months ended
June 30, 2004 from $205 in the comparable period for 2003. This decrease was
due to modest foreign currency transaction losses in 2004 as compared to
foreign currency gains recorded in 2003 due to the strengthening of the British
pound relative to the U.S. dollar. Provision (benefit) for taxes The effective tax rate for the three months ended June 30, 2004 was 39.4 %
compared to 36.5% for the same period in 2003. The increase in the effective
tax rate is the result of a net loss being generated domestically in 2004
relative to net income in 2003 which was primarily generated internationally in
territories which have more favorable tax rates. Net income (loss) Net income (loss) decreased $2,670 to a net loss of $530 ((1.0)% of revenues)
in 2004 from net income of $2,140 (3.8% of revenues) in 2003 primarily due to
lower sales and increased salaries, wages and benefits attributable to the SCI and JGI Acquisitions. Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003 (In
Thousands): Revenues Revenues for the six months ended June 30, 2004 decreased $930, or 0.9%, to
$103,590 from $104,520 in the comparable period in 2003. Marketing Services
revenues increased $3,685, or 4.1%, to $93,683 primarily as a result of
increased revenues resulting from the SCI and JGI Acquisitions. The increase
in Marketing Services revenues was also attributable to additional revenues
generated by our Logistix subsidiary. Our Logistix business had increased
revenues from Kelloggs promotional programs compared to the same period in
2003. In addition, net foreign currency translation impact contributed
approximately $2,200 to revenues for Logistix versus the prior year period
average exchange rates. Revenues for the Burger King business decreased as the
volume of units for domestic promotional programs were lower compared to the
same period in 2003. The results for 2003 exclude SCI (acquired September 3, 2003) and JGI (acquired
February 2, 2004). Excluding the impact of the SCI and JGI Acquisitions,
Marketing Services revenues decreased 8.5% for the six months ended June 30,
2004 compared to the same period in 2003. SCI and JGI combined generated
approximately $10,700 of revenues in the current year period. Consumer Product revenues decreased $4,615, or 31.8%, to $9,907. The decrease
is primarily attributable to a significant one-time stocking of Kim Possible
merchandise in the first half of 2003. Our Kim Possible line was launched in
the first half of 2003 as a Wal-Mart exclusive; distribution expanded to other
major retailers beginning in January 2004. The decrease was partially offset
by increased international sales of Scooby-Doo product, the continued growth
of Crayola® branded bath toys, and the addition of the Baby Einsteinproducts.
Revenues for the first half of 2003 were primarily comprised of Scooby-Doo ,
Crayola® and Kim Possible product. In January 2004, we also began
distributing the first toy products based upon Baby Einstein, the best selling
brand of videos specifically designed for infants and toddlers. We have
granted exclusive distribution to Target and Babies R Us for 2004. The growth
in our Crayola® line of bath toys, which was launched in the second half of
2003, was attributable to an expanded product line and expanded distribution
channels. The growth in Scooby-Doo revenues for the first half was the result
of international sales, which is attributable to the brand receiving more
exposure on television in Europe and Latin America. Cost of sales and gross profit Cost of sales decreased $466 to $76,587 (73.9% of revenues) for the six months
ended June 30, 2004 from $77,053 (73.7% of revenues) in the comparable period
in 2003 due to the lower sales volume in 2004. The gross margin percentage decreased to 26.1% for the six months ended June
30, 2004 from 26.3% in the comparable period for 2003. This decrease is the
result of a decrease in Consumer Product gross margins. The gross profit
percentage for Marketing Services for the six months ended June 30, 2004
increased to 26.0% compared to 24.6% for the comparable period in 2003. This
increase is attributable to an increase in the relative mix of non-Burger King
business, which tends to carry higher gross profit margins. The gross profit
percentage for Consumer Products decreased to 26.3% for the six months ended
June 30, 2004 from 36.5% in the comparable period in 2003. This decrease is
primarily the result of pricing pressure, a higher mix of international sales
which carry lower margins and a changing product sales mix. International
sales, which are sold through distributors who bear more of the risk and incur
the bulk of the selling expenses, tend to carry lower gross margins than
domestic sales. 25




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##### Table of Contents



Salaries, wages and benefits Salaries, wages and benefits increased $3,779, or 33.2%, to $15,177 (14.7% of
revenues) for the six months ended June 30, 2004 from
$11,398 (10.9% of revenues) in the comparable period for 2003. This increase
was primarily attributable to the addition of approximately 55 employees from
the SCI and JGI Acquisitions as well as annual employee merit pay increases and
additional compensation expense resulting from grants of restricted stock units. Salaries, wages and benefits increased as a percentage of revenues from 10.9%
to 14.7% as a result of the revenue decrease. The first half of the year is
seasonally SCIs lowest. As a result, we didnt have the sales volume to
absorb the largely fixed cost structure of this business. In addition, the
reduction in Burger King unit volume had a significant impact on this metric,
as our staffing levels required to service this account are largely fixed. Selling, general and administrative expenses Selling, general and administrative expenses increased $546, or 4.7%, to
$12,056 (11.7% of revenues) for the six months ended June 30, 2004 from $11,510
(11.0% of revenues) in the comparable period for 2003. The increase is
primarily the result of additional operating expenses resulting from the SCI
and JGI Acquisitions. Selling, general and administrative expenses increased as a percentage of
revenues from 11.0% to 11.7% as a result of the revenue decrease. The first
half of the year is seasonally SCIs lowest. As a result, we didnt have the
sales volume to absorb the largely fixed cost structure of this business. In
addition, the reduction in Burger King unit volume had a significant impact on
this metric, as our cost structure required to service this account is largely
fixed. Integration costs We recorded integration costs of $136 (0.1% of revenues) for the six months
ended June 30, 2004. These are primarily travel, training and consulting costs
directly related to the integration of SCI and JGI. Loss on Chicago lease We recorded a charge for the loss on the Chicago office lease of $311 (0.3% of
revenues) for the six months ended June 30, 2004. This is due to lower than
estimated sublease income for vacated office space in the Upshot business. The
office space has been subleased at rates modestly below our initial estimates,
due to softness in the current Chicago real estate market. Restructuring charge We recorded a restructuring charge of $105 (0.1% of revenues) for the six
months ended June 30, 2004. This is associated with the realignment of
centralized resources in our Marketing Services business. Other income (expense) Net other income (expense) decreased $667 to $(360) for the six months ended
June 30, 2004 from $307 in the comparable period for 2003. This decrease was
due to foreign currency transaction losses as a result of the strengthening
Euro relative to the British Pound. The growth in the pan-European business at
Logistix during the first quarter of 2004 surpassed the currency hedges in place covering the
British pound against the Euro. Provision (Benefit) for taxes The effective tax rate for the six months ended June 30, 2004 was 39.1%
compared to 36.5% for the same period in 2003. The increase in the effective
tax rate is the result of a net loss being generated domestically in 2004
relative to net income in 2003 which was primarily generated internationally in
territories which have more favorable tax rates. Net income (loss) Net income (loss) decreased $3,814 to a net loss of $696 ((0.7)% of revenues)
in 2004 from net income of $3,118 (3.0% of revenues) in 2003 primarily due to increased
salaries, wages and benefits and selling, general and administrative expenses
attributable to the acquisitions of SCI and JGI. The decrease is also the
result of foreign currency transaction losses as a result of the strengthening
Euro relative to the British pound. 26




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##### Table of Contents



Financial Condition and Liquidity Our financial position remained strong in the second quarter of 2004 and we
extended the maturity of our $35,000 credit facility with Bank of America
through June 30, 2005. See Credit Facility below. At June 30, 2004, we had
no debt; and cash, cash equivalents and marketable securities were $14,248,
compared to $19,291 as of December 31, 2003. The decrease in cash, cash
equivalents and marketable securities was attributable to the JGI Acquisition,
purchases of fixed assets and the payment of current liabilities, partially
offset by the collection of receivables. As of June 30, 2004, our net accounts receivable decreased $7,398 to $29,367
from $36,765 at December 31, 2003. This decrease is a result of the lower
level of sales volume in the second quarter compared to the fourth quarter of
2003. Historically, second quarter sales are substantially lower than sales in
the fourth quarter, which tends to be the highest volume quarter of the year.
This decrease was partially offset by additional receivables acquired as a
result of the JGI Acquisition. As of June 30, 2004, inventories decreased $859 to $14,240 from $15,099 at
December 31, 2003. This decrease in inventories is primarily the result of the
timing of promotional programs expected to be delivered later in the third
quarter of 2004 relative to the first quarter of 2004. This decrease was
partially offset by an increase in Consumer Products inventories as a result of
the addition of new product lines which were introduced in 2004. The decrease
was also partially offset by additional inventories acquired as a result of the
JGI Acquisition. Marketing Services inventories represent 62% and 71% of total
inventories as of June 30, 2004 and December 31, 2003, 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 June 30, 2004, accounts payable decreased $3,948 to $24,917 from $28,865
at December 31, 2003. This decrease is associated with the payment of
liabilities related to fourth quarter 2003 promotional programs. This decrease
was partially offset by additional payables as a result of the JGI Acquisition. As of June 30, 2004, accrued liabilities decreased $3,572 to $13,623 from
$17,195 at December 31, 2003. This decrease is primarily attributable to the
payment of administrative fees collected from distribution companies during the
fourth quarter of 2003 on behalf of promotional customers, as well as, the
payment of royalties and income taxes. This decrease was partially offset by
additional accrued liabilities as a result of the JGI Acquisition. As of June 30, 2004, working capital was $23,699 compared to $29,447 at
December 31, 2003. Cash flows provided by operations for the six months ended
June 30, 2004 were $1,274 compared to cash used of $(4,997) in the prior year.
Cash flows used in operations in the first half of 2003 were impacted by the
reduction of current assets and liabilities to more normalized levels
subsequent to the West Coast port dispute which caused shipping delays in the
fourth quarter of 2002. These shipping delays resulted in higher than normal
levels of receivables and payables as of December 31, 2002. Cash flows used in
investing activities for the six months ended June 30, 2004 were $6,841
compared to $1,857 in the prior year. This increase is the result of the JGI
Acquisition and increased purchases of fixed assets partially offset by reduced
purchases of marketable securities. Cash flows used by financing activities
for the six months ended June 30, 2004 were $798 compared to $1,206 in the
prior year primarily as a result of a decrease in the repurchase of treasury
stock and an increase in proceeds from the exercise of stock options. Our current strategy and business plan calls for the consummation of additional
acquisitions as well as the continued repurchase of our common stock. We plan
to evaluate the level of such expenditures in the context of the capital
available to us and to changing market conditions. As of the date hereof, we believe that cash from operations, cash on hand at
June 30, 2004 and our credit facility will be sufficient to fund our working
capital needs for at least the next twelve months. The statements set forth
herein are forward-looking and actual results may differ materially. Future minimum annual commitments for guaranteed minimum royalty payments
under license agreements, non-cancelable operating leases and employment
agreements as of June 30, 2004 are as follows: 2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Thereafter
    
    TotalOperating Leases
    
    $
    2,655
    
    
    $
    4,777
    
    
    $
    4,224
    
    
    $
    4,018
    
    
    $
    3,614
    
    
    $
    6,183
    
    
    $
    25,471Guaranteed Royalties
    
    
    1,714
    
    
    
    4,271
    
    
    
    2,546
    
    
    
    1,076
    
    
    
    
    
    
    
    
    
    
    
    9,607Employment Agreements
    
    
    1,096
    
    
    
    600
    
    
    
    325
    
    
    
    325
    
    
    
    200
    
    
    
    1,800
    
    
    
    4,346Total
    
    $
    5,465
    
    
    $
    9,648
    
    
    $
    7,095
    
    
    $
    5,419
    
    
    $
    3,814
    
    
    $
    7,983
    
    
    $
    39,424
 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. 27




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We had no material commitments for capital expenditures at June 30, 2004.
Letters of credit outstanding as of December 31, 2003 and June 30, 2004 totaled
$823 and $3,803, respectively. 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. 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. 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 and
August 12, 2004, certain
covenants under the facility were amended. As of June 30, 2004, we were in
compliance with the amended restrictions and covenants. The Facility may be
used for working capital and acquisition financing purposes. As of June 30,
2004, there were no amounts outstanding under the Facility except for letters
of credit of $3,803. 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 from 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 December 31, 2003, advances outstanding under this facility totaled
approximately $626 and were recorded in accounts payable in the accompanying
consolidated balance sheet. As of June 30, 2004, no amounts were outstanding
under this facility. Acquisitions On September 3, 2003, we acquired substantially all of the assets of SCI
Promotion Group, LLC (SCI-LLC), a privately held promotional marketing
services company based in Ontario, California (the SCI Acquisition). We
financed the SCI Acquisition through our existing cash reserves. The SCI
Acquisition was consummated pursuant to an Asset Purchase Agreement dated
September 3, 2003, by and among EMAK, SCI-LLC and Joseph J. Schmidt, III (the
Purchase Agreement). Under the terms of the Purchase Agreement, we acquired
substantially all of the assets of SCI-LLC for a cash purchase price of
approximately $5,900 (before the closing balance sheet working capital
adjustment), plus additional earnout consideration of up to $3,500 based upon
future performance of the acquired business. Net of a holdback of $250, we paid
$5,683 in cash plus related transaction costs of $538. We also assumed the
operating liabilities of the 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 2003 through 2006. 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. Based on the
results for 2003, additional consideration of $800 was earned and recorded as
goodwill. 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 JGI Acquisition). We financed the JGI Acquisition
through our existing cash reserves. The JGI 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 (JGI), JGI-MN, Marc Grossfield and Thom Johnson (the Purchase
Agreement). Under the terms of the 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. 28




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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 mandatory redeemable
senior cumulative participating convertible preferred stock, par value
$.001 per share, (the Series A Stock) with a conversion price of $14.75
per 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 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
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 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, 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 June 30,
2005. Two payments of $62.5 each were made during the quarter ended June 30,
2004. 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 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 tranch, 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 we 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. 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. Upon any voluntary or involuntary liquidation, dissolution or winding-up of
our affairs, Crown, as holder of the Series A 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 A 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 A 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 June 30, 2004 totaled $375 and were paid in
June 2004. Crown currently holds 100% of the outstanding shares of Series A Stock, and
has designated one individual to our Board of Directors. Crown currently
has the right to designate two additional directors. The Series A 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. 29




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##### Table of Contents



Stock Repurchase On July 21, 2000, our Board of Directors authorized up to $10,000 for the
repurchase of our common stock over a twelve month period. In the period
from July 21, 2000 to July 21, 2001, we spent $6,430 to purchase an
aggregate of 523,594 shares at an average price of $12.28 per share
including commissions. On July 24, 2001, our Board of Directors authorized
up to an additional $10,000 for the repurchase of our common stock over a
twelve month period. In the period from August 2, 2001 through July 11,
2002, we spent $5,605 to purchase 454,715 shares at an average price of
$12.33 per share including commissions. On July 12, 2002, our Board of
Directors authorized up to an additional $10,000 for the repurchase of our
common stock. We spent $3,505 to repurchase 267,650 shares at an average
price of $13.10 per share including commissions under this authorization
through June 30, 2004. The duration of the current buyback program is
indefinite; provided, however, that our Board of Directors intends to
review the program quarterly. Purchases are conducted in the open market
at prevailing prices, based on market conditions when we are not in a quiet
period. We may also transact purchases effected as block trades, as well
as certain negotiated, off-exchange purchases not in the open market.
Since initiating the overall buyback program on July 20, 2000, we has spent
$15,540 to purchase a total of 1,245,959 shares at an average price of
$12.47 per share including commissions through June 30, 2004. This
repurchase program is being funded through working capital. Recent Accounting Pronouncements In January 2003, the Financial Accounting Standards Board (FASB) issued
FIN 46, Consolidation of Variable Interest Entities, which addresses the
consolidation of business enterprises (variable interest entities) to which
the usual condition (ownership of a majority voting interest) of
consolidation does not apply. The interpretation focuses on financial
interests that indicate control. It concludes that in the absence of clear
control through voting interests, a companys exposure (variable interest)
to the economic risks and potential rewards from the variable interest
entitys assets and activities are the best evidence of control. Variable
interests are rights and obligations that convey economic gains or losses
from changes in the values of the variable interest entitys assets and
liabilities. Variable interests may arise from financial instruments,
service contracts, nonvoting ownership interests and other arrangements.
If an enterprise holds a majority of the variable interests of an entity,
it would be considered the primary beneficiary. The primary beneficiary
would be required to include the assets, liabilities and the results of
operations of the variable interest entity in its financial statements. In
December 2003, the FASB issued a revision to FIN 46 to address certain
implementation issues. The adoption of FIN 46 and FIN 46 (revised) did not
have an impact on our results of operations or financial position. In March 2004, the FASB published an Exposure Draft, Share-Based Payment,
an Amendment of FASB Statements No. 123 and 95. The proposed change in
accounting would replace existing requirements under Statement of Financial
Accounting Standards (SFAS) No. 123 and APB Opinion No. 25. The proposed
statement would require public companies to recognize the cost of employee
services received in exchange for equity instruments, based on the
grant-date fair value of those instruments, with limited exceptions. The
proposed statement would also affect the pattern in which compensation cost
would be recognized, the accounting for employee share purchase plans, and
the accounting for income tax effects of share-based payment transactions.
The Exposure Draft also notes that the use of a lattice model, such as the
binomial model, to determine the fair value of employee stock options, is
preferable. We currently use the Black-Scholes pricing model to determine
the fair value of its employee stock options. Use of a lattice model to
determine the fair value of employee stock options may result in
compensation cost materially different from those pro forma costs disclosed
in Note 2 to the consolidated financial statements. We are currently
determining what impact the proposed statement would have on our results of
operations or financial position. In November 2003 and March 2004, the Emerging Issues Task Force (EITF)
reached final consensus on EITF Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments. The EITF requires a company to apply a three-step model to
determine whether an impairment of an investment, within the scope of SFAS
No. 115, Accounting for Certain Investments in Debt and Equity
Securities, is other-than-temporary. EITF Issue No. 03-1 shall be applied
prospectively to all current and future investments, in interim or annual
reporting periods beginning after June 15, 2004. We believe the adoption of
EITF Issue No. 03-1 will not have a material impact on our results of
operations or financial position. 30




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In April 2004, the EITF reached final consensus on EITF 03-6,
Participating Securities and the Two-Class Method under FASB Statement No.
128, which requires companies that have participating securities to
calculate earnings per share using the two-class method. This method
requires the allocation of undistributed earnings to the common shares and
participating securities based on the proportion of undistributed earnings
that each would have been entitled to had all the periods earnings been
distributed. EITF 03-6 is effective for fiscal periods beginning after June
30, 2004 and earnings per share reported in prior periods presented must be
retroactively adjusted in order to comply with EITF 03-6. We have adopted
EITF 03-6 for the quarter ended June 30, 2004. Earnings per diluted common
share were reduced by $0.06 for the second quarter of 2003, to $0.22 from
$0.28 as reported in the prior year. The earnings results per diluted
common share were reduced by $0.09 for the six months ending June 30, 2003,
to $0.31 from $0.40 as reported in the prior year. EITF 03-6 had no impact
on 2004 per share amounts because of the net loss. 31




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##### Table of Contents



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 is expected to increase to 70% of our sales to the Burger King system by the end of 2004.  
    
    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 SCI and
JGI businesses which we recently acquired).  
    
    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. We enter into significant minimum royalty commitments from time to time in connection with its consumer
products business.  
    
    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, 2003, under the heading Managements Discussion and Analysis of
Financial Condition and Results of Operation - Cautionary Statements and Risk
Factors. 32




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##### Table of Contents



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, 2003. Our exposure to market risks has not changed materially since
December 31, 2003. 
 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 June 30, 2004. 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 There were no changes in the Companys internal control over financial
reporting, as defined in Rule 13a-15(f) promulgated under the Exchange Act,
during the quarter ended June 30, 2004, that have materially affected, or
are reasonably likely to materially affect, the Companys internal control
over financial reporting. 33




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##### Table of Contents



PART II. OTHER INFORMATION 
 ITEM 2. CHANGE IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES During the second quarter of 2004, EMAK repurchased its common stock in the
open market as follows: ISSUER PURCHASES OF EQUITY SECURITIES Total Number of Shares
    
    Maximum Dollar ValuePurchased as Part of
    
    of Shares that May Yet BeTotal Number of
    
    Average Price Paid
    
    Publicly Announced
    
    Purchased Under the ProgramPeriod
    
    SharesPurchased
    
    per Share
    
    Program
    
    (in thousands)April 1  April 30
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    6,706May 1  May 31
    
    
    2,200
    
    
    
    12.97
    
    
    
    2,200
    
    
    
    6,678June 1  June 30
    
    
    14,350
    
    
    
    12.69
    
    
    
    14,350
    
    
    
    6,495Total
    
    
    16,550
    
    
    $
    12.73
    
    
    
    16,550
    
    
    $
    6,495
 In July 2002, EMAKs board of directors approved a share repurchase program of
up to $10,000. Through June 30, 2004, EMAK repurchased 267,650 shares at a cost
of $3,505 pursuant to this program. In the first half of 2004, EMAK
repurchased 16,550 shares at a cost of $211 pursuant to this program. EMAKs
share repurchase program has no expiration date. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Annual Meeting of Stockholders of the Company was held on May 20, 2004.
Proxies for the Annual Meeting were solicited pursuant to Regulation 14A of the
Securities Exchange Act of 1934, as amended, and there was no solicitation in
opposition to that of management. All of managements nominees for directors
as listed in the proxy statement were elected. At the Annual Meeting, the
following matters were approved by the stockholders: Votes For
    
    Votes Withheld1.
    
    
    Election of Directors by
holders of Common StockHoward D. Bland
    
    
    5,343,269
    
    
    
    7,800Sanford R. Climan
    
    
    5,343,269
    
    
    
    7,800Jonathan D. Kaufelt
    
    
    5,343,219
    
    
    
    7,850Donald A. Kurz
    
    
    5,342,569
    
    
    
    8,500Alfred E. Osborne Jr.
    
    
    5,343,269
    
    
    
    7,800Bruce Raben
    
    
    5,343,269
    
    
    
    7,800Stephen P. Robeck
    
    
    5,108,084
    
    
    
    242,9852.
    
    
    Election of Director by holders
of Series A Preferred StockJeffrey S. Deutschman
    
    
    25,000
    
    
    
    
 34




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Votes For
    
    Votes Against
    
    Abstain3.
    
    Amendment of Certificate of Incorporation to change name to EMAK Worldwide, Inc.
    
    
    7,030,394
    
    
    
    2,100
    
    
    
    13,4904.
    
    Amendment of Certificate of Incorporation to decrease authorized shares of common stock from 50 million to 25 million
    
    
    7,031,444
    
    
    
    100
    
    
    
    14,4405.
    
    Approval of 2004 Non-Employee Director Stock Incentive Plan
    
    
    4,261,238
    
    
    
    446,234
    
    
    
    114,9206.
    
    Approval of 2004 Stock Incentive Plan
    
    
    4,125,465
    
    
    
    581,843
    
    
    
    115,0847.
    
    Ratification of PricewaterhouseCooper s LLP as independent registered public accounting firm
    
    
    7,031,794
    
    
    
    650
    
    
    
    13,540
 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K  (a)
    
    Exhibits: Exhibit 31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of the SarbanesOxley Act of 2002.Exhibit 31.2
    
    Certification of 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.
  (b)
    
    Reports on Form 8-K:Report on Form 8-K filed with the Securities and Exchange Commission on
May 3, 2004 (Items 7 and 12). 35




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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. EQUITY MARKETING, INC.Date August 16, 2004

    
    /s/ ZOHAR ZIVZohar ZivSenior Vice President and Chief Financial Officer(Principal Financial and Accounting Officer)
 36