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United States
Securities and Exchange Commission Washington, D.C. 20549
 [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 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.  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, 5,766,038 shares
as of May 13, 2004.




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EQUITY MARKETING, INC. Index To Quarterly Report on Form 10-Q
Filed with the Securities and Exchange Commission
March 31, 2004 PagePart I.
    
    Financial InformationItem 1. Financial Statements
    
    
    3Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    19Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    26Item 4. Controls and Procedures
    
    
    27Part II.
    
    Other InformationItem 2. Changes in Securities and Use of Proceeds
    
    
    28Item 6. Exhibits and Reports on Form 8-K
    
    
    28EXHIBIT 10.1EXHIBIT 10.2EXHIBIT 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. Forward-looking statements can be
identified by the use of forward looking terminology, such as may, will,
should, expect, anticipate, estimate, continue, plans, intends or other similar
terminology. Management cautions that the following factors, among others,
could cause the actual consolidated results of operations and financial
position in 2004 and thereafter to differ significantly from those expressed in
forward-looking statements. 2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS EQUITY MARKETING, INC. CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS) December 31,
    
    March 31,2003
    
    2004(Unaudited)ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    19,291
    
    
    $
    12,852Marketable securities
    
    
    
    
    
    
    1,300Accounts receivable (net of allowances of $2,143 and
$1,718 as of December 31, 2003 and March 31, 2004, respectively)
    
    
    36,765
    
    
    
    30,708Inventories (Note 2)
    
    
    15,099
    
    
    
    13,201Prepaid expenses and other current assets
    
    
    4,352
    
    
    
    4,543Total current assets
    
    
    75,507
    
    
    
    62,604Fixed assets, net
    
    
    3,809
    
    
    
    4,023Goodwill (Notes 2 and 6)
    
    
    41,893
    
    
    
    44,313Other intangibles, net (Notes 2 and 6)
    
    
    1,252
    
    
    
    3,441Other assets
    
    
    5,869
    
    
    
    6,569Total assets
    
    $
    128,330
    
    
    $
    120,950
 The accompanying notes are an integral part of these
condensed consolidated financial statements. 3




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EQUITY MARKETING, INC. CONDENSED CONSOLIDATED BALANCE SHEETS
LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS EQUITY
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) December 31,
    
    March 31,2003
    
    2004(Unaudited)CURRENT LIABILITIES:Accounts payable
    
    $
    28,865
    
    
    $
    26,045Accrued liabilities
    
    
    17,195
    
    
    
    11,725Total current liabilities
    
    
    46,060
    
    
    
    37,770LONG-TERM LIABILITIES
    
    
    5,555
    
    
    
    5,092Total liabilities
    
    
    51,615
    
    
    
    42,862COMMITMENTS 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 5,761,238 shares outstanding
as of December 31, 2003 and March 31, 2004, respectively
    
    
    
    
    
    
    Additional paid-in capital
    
    
    23,886
    
    
    
    25,648Retained earnings
    
    
    45,138
    
    
    
    44,597Accumulated other comprehensive income
    
    
    3,334
    
    
    
    4,14572,358
    
    
    
    74,390LessTreasury stock, 3,150,708 shares, at cost, as of
December 31, 2003 and March 31, 2004 (Note 4)
    
    
    (17,458
    )
    
    
    (17,458
    )Unearned compensation
    
    
    (1,234
    )
    
    
    (1,362
    )Total stockholders equity
    
    
    53,666
    
    
    
    55,570Total liabilities, mandatorily redeemable preferred stock and stockholders equity
    
    $
    128,330
    
    
    $
    120,950
 The accompanying notes are an integral part of these
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 EndedMarch 31,2003
    
    2004REVENUES
    
    $
    47,567
    
    
    $
    51,812COST OF SALES
    
    
    35,287
    
    
    
    38,572Gross profit
    
    
    12,280
    
    
    
    13,240OPERATING EXPENSES:Salaries, wages and benefits
    
    
    5,861
    
    
    
    7,277Selling, general and administrative
    
    
    5,025
    
    
    
    5,896Integration costs
    
    
    
    
    
    
    43Total operating expenses
    
    
    10,886
    
    
    
    13,216Income from operations
    
    
    1,394
    
    
    
    24OTHER INCOME (EXPENSE), net
    
    
    102
    
    
    
    (292
    )Income (loss) before provision for income taxes
    
    
    1,496
    
    
    
    (268
    )PROVISION (BENEFIT) FOR INCOME TAXES
    
    
    518
    
    
    
    (102
    )Net income (loss)
    
    
    978
    
    
    
    (166
    )PREFERRED STOCK DIVIDENDS
    
    
    375
    
    
    
    375NET INCOME (LOSS) AVAILABLE TO COMMON
STOCKHOLDERS
    
    $
    603
    
    
    $
    (541
    )BASIC INCOME (LOSS) PER SHARE
    
    $
    0.11
    
    
    $
    (0.09
    )BASIC WEIGHTED AVERAGE SHARES OUTSTANDING
    
    
    5,708,279
    
    
    
    5,739,603DILUTED INCOME (LOSS) PER SHARE
    
    $
    0.10
    
    
    $
    (0.09
    )DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING
    
    
    5,882,609
    
    
    
    5,739,603
 The accompanying notes are an integral part of these
condensed consolidated financial statements. 5




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EQUITY MARKETING, INC. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
(UNAUDITED) Three Months EndedMarch 31,2003
    
    2004NET INCOME (LOSS)
    
    $
    978
    
    
    $
    (166
    )OTHER COMPREHENSIVE INCOME (LOSS):Foreign currency translation adjustments (Note 2)
    
    
    (286
    )
    
    
    522Unrealized gain (loss) on foreign currency (Note 2)
forward contracts
    
    
    (1
    )
    
    
    289COMPREHENSIVE INCOME
    
    $
    691
    
    
    $
    645
 The accompanying notes are an integral part of these
condensed consolidated financial statements. 6




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EQUITY MARKETING, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED) Three Months EndedMarch 31,2003
    
    2004CASH FLOWS FROM OPERATING ACTIVITIES:Net income (loss)
    
    $
    978
    
    
    $
    (166
    )Adjustments to reconcile net income (loss) to net cash
used in operating activities:Depreciation and amortization
    
    
    472
    
    
    
    466Provision for doubtful accounts
    
    
    89
    
    
    
    21Loss (benefit) on disposal of fixed assets
    
    
    3
    
    
    
    (8
    )Tax benefit from exercise of stock options
    
    
    11
    
    
    
    51Amortization of restricted stock
    
    
    41
    
    
    
    86Other
    
    
    (1
    )
    
    
    Changes in operating assets and liabilities:Increase (decrease) in cash and cash equivalents:Accounts receivable
    
    
    18,472
    
    
    
    8,226Inventories
    
    
    2,822
    
    
    
    2,750Prepaid expenses and other current assets
    
    
    (370
    )
    
    
    (914
    )Other assets
    
    
    (869
    )
    
    
    (682
    )Accounts payable
    
    
    (20,765
    )
    
    
    (3,433
    )Accrued liabilities
    
    
    (8,725
    )
    
    
    (6,138
    )Long-term liabilities
    
    
    40
    
    
    
    (463
    )Net cash used in operating activities
    
    
    (7,802
    )
    
    
    (204
    )CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of fixed assets
    
    
    (117
    )
    
    
    (591
    )Proceeds from sale of fixed assets
    
    
    16
    
    
    
    9Purchase of marketable securities
    
    
    (3,500
    )
    
    
    (1,300
    )Payment for purchase of JGI
    
    
    
    
    
    
    (4,508
    )Net cash used in investing activities
    
    
    (3,601
    )
    
    
    (6,390
    )CASH FLOWS FROM FINANCING ACTIVITIES:Payment of preferred stock dividends
    
    
    (375
    )
    
    
    (375
    )Purchase of treasury stock
    
    
    (333
    )
    
    
    Proceeds from exercise of stock options
    
    
    154
    
    
    
    477Net cash provided by (used in) financing activities
    
    
    (554
    )
    
    
    102Net decrease in cash and cash equivalents
    
    
    (11,957
    )
    
    
    (6,492
    )Effects of exchange rate changes on cash and cash equivalents
    
    
    64
    
    
    
    53CASH AND CASH EQUIVALENTS, beginning of period
    
    
    25,833
    
    
    
    19,291CASH AND CASH EQUIVALENTS, end of period
    
    $
    13,940
    
    
    $
    12,852SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:CASH PAID FOR:Interest
    
    $
    57
    
    
    $
    54Income taxes
    
    $
    1,286
    
    
    $
    566
 The accompanying notes are an integral part of these
condensed consolidated financial statements. 7




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EQUITY MARKETING, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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 marketing services company based in Los
Angeles, with offices in Chicago, Minneapolis, New York, Ontario (CA),
London, Paris and Hong Kong. The Company focuses on the design and
execution of strategy-based marketing programs, with 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 and promotions
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. UPSHOT has a reputation
for creating highly successful integrated marketing programs for world class
brands such as Diageo, Discover Financial Services, and Procter & Gamble. 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. The Companys Johnson
Grossfield division (JGI), which was acquired on February 2, 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. 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. 8




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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 and warrants using the
treasury stock method and also includes the dilutive effect of the assumed
conversion of preferred stock using the if-converted method. During a
loss period, the assumed exercise of in-the-money stock options and
warrants has an antidilutive effect. As a result, these shares are
not included with the weighted average shares outstanding of
5,739,603 used in the calculation of diluted loss per share for the
three months ended March 31, 2004. Options and
warrants to purchase 1,694,166 and 2,912,694 shares of common stock, $.001 par
value per share (the Common Stock), as of March 31, 2003 and 2004,
respectively, were excluded from the computation of diluted EPS as they would
have been anti-dilutive. For the three months ended March 31, 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. 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 March 31,2003
    
    2004Income/(Loss)
    
    Shares
    
    Per Share
    
    Income
    
    Shares
    
    Per Share(Numerator)
    
    (Denominator)
    
    Amount
    
    (Numerator)
    
    (Denominator)
    
    AmountBasic EPS:Income (loss) available to
common stockholders
    
    $
    603
    
    
    
    5,708,279
    
    
    $
    0.11
    
    
    $
    (541
    )
    
    
    5,739,603
    
    
    $
    (0.09
    )Effect of dilutive securities:Options and warrants
    
    
    
    
    
    
    174,330
    
    
    
    
    
    
    
    
    
    
    
    Dilutive EPS:Income (loss) available to common
stockholders and assumed conversion
    
    $
    603
    
    
    
    5,882,609
    
    
    $
    0.10
    
    
    $
    (541
    )
    
    
    5,739,603
    
    
    $
    (0.09
    )
 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 March 31, 2004, inventories consisted of
the following: December 31,
    
    March 31,2003
    
    2004Production-in-process
    
    $
    3,363
    
    
    $
    1,982Finished goods
    
    
    11,736
    
    
    
    11,219$
    15,099
    
    
    $
    13,201
 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 March 31, 2003 and 2004 were $114 and $(278),
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. 9




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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 statement 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
six months in original maturity. The Companys Logistix subsidiary entered into foreign currency forward
contracts aggregating GBP 3,296 to sell Euros in exchange for pound
sterling and United States dollars and to sell pound sterling in exchange for United States dollars.
The contracts will expire by September 7, 2004. At March 31, 2004, the
foreign currency forward contracts had an estimated fair value of $104. 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 March 31, 2004. The unrealized gain on
the contracts is reflected in accumulated other comprehensive income. 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 $44,313 as of March 31, 2004 reflects: a foreign currency translation
adjustment of $406, an adjustment to reflect the net increase to goodwill for
the SCI acquisition of $878 (see Note 6) and $1,136 for the acquisition of JGI
(see Note 6). Of the goodwill balance, $0 relates to the consumer products
segment and $44,313 relates to the marketing services segment. Identifiable intangibles of $1,252 as of
December 31, 2003 and $3,441 as of March 31, 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. 10




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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. As of March 31, 2004, the Company has one stock option 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 option plan and, accordingly, does not recognize compensation
cost for grants whose exercise price equals the market price of the stock
on the date of grant. If the Company had elected to recognize compensation
cost based on the fair value of the options granted at grant date as
prescribed by SFAS No. 123, net (loss) income and earnings (loss) per share would have
been reduced to the pro forma amounts indicated in the table below: Three Months EndedMarch 31,2003
    
    2004Net income
(loss) available to common stockholders - as reported
    
    $
    603
    
    
    $
    (541
    )Less:Compensation expense (a)
    
    
    481
    
    
    
    134Net income
(loss) available to common stockholders - pro forma
    
    $
    122
    
    
    $
    (675
    )Earnings (loss) per share:Basic earnings (loss) per share, as reported
    
    $
    0.11
    
    
    $
    (0.09
    )Pro forma basic earnings (loss) per share
    
    $
    0.02
    
    
    $
    (0.12
    )Diluted earnings (loss) per share, as reported
    
    $
    0.10
    
    
    $
    (0.09
    )Pro forma diluted earnings (loss) per share
    
    $
    0.02
    
    
    $
    (0.12
    )
  (a)
    
    Determined under fair value based method for all awards, net of tax. Because the SFAS No. 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma
compensation cost may not be representative of the cost to be expected in
future years. 11




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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 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 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 in Note 2 to the
condensed consolidated financial information. 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. 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 March 31, 2004 and earnings per share reported
in prior periods presented must be retroactively adjusted in order to comply
with EITF 03-6. The Company will adopt EITF 03-6 for the quarter ended June 30,
2004. The Company is currently determining what impact the adoption
of EITF 03-6 will have on its earnings per share calculation. 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 and April 26, 2004, certain covenants under the facility were amended.
As of March 31, 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 March 31, 2004, there were no amounts
outstanding under the Facility. Letters of credit outstanding as of December 31, 2003 and March 31, 2004
totaled $823 and $1,001, respectively. 12




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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 March 31, 2004, there were no amounts 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 $3,294 to repurchase 251,100 shares at an
average price of $13.12 per share including commissions under this
authorization through March 31, 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 $15,329 to
purchase a total of 1,229,409 shares at an average price of $12.47 per
share including commissions through March 31, 2004. This repurchase
program is being funded through working capital. 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. 13




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##### Table of Contents



Industry Segments As of and For the Three Months Ended March 31, 2003Marketing
    
    ConsumerServices
    
    Products
    
    Corporate
    
    TotalTotal revenues
    
    $
    43,835
    
    
    $
    3,732
    
    
    $
    
    
    
    $
    47,567Income (loss) before provision (benefit)
for income taxes
    
    $
    5,835
    
    
    $
    (154
    )
    
    $
    (4,185
    )
    
    $
    1,496Provision (benefit) for income taxes
    
    
    2,169
    
    
    
    (61
    )
    
    
    (1,590
    )
    
    
    518Net income (loss)
    
    $
    3,666
    
    
    $
    (93
    )
    
    $
    (2,595
    )
    
    $
    978Fixed asset additions
    
    $
    
    
    
    $
    
    
    
    $
    117
    
    
    $
    117Depreciation and amortization
    
    $
    44
    
    
    $
    17
    
    
    $
    411
    
    
    $
    472Total assets
    
    $
    69,030
    
    
    $
    3,768
    
    
    $
    31,079
    
    
    $
    103,877
 As of and For the Three Months Ended March 31, 2004Marketing
    
    ConsumerServices
    
    Products
    
    Corporate
    
    TotalTotal revenues
    
    $
    46,488
    
    
    $
    5,324
    
    
    $
    
    
    
    $
    51,812Income (loss) before provision (benefit)
for income taxes
    
    $
    4,307
    
    
    $
    (123
    )
    
    $
    (4,452
    )
    
    $
    (268
    )Provision (benefit) for income taxes
    
    
    1,639
    
    
    
    (47
    )
    
    
    (1,694
    )
    
    
    (102
    )Net income (loss)
    
    $
    2,668
    
    
    $
    (76
    )
    
    $
    (2,758
    )
    
    $
    (166
    )Fixed asset additions
    
    $
    
    
    
    $
    
    
    
    $
    591
    
    
    $
    591Depreciation and amortization
    
    $
    70
    
    
    $
    
    
    
    $
    396
    
    
    $
    466Total assets
    
    $
    83,571
    
    
    $
    8,020
    
    
    $
    29,359
    
    
    $
    120,950
 NOTE 6  ACQUISITIONS On September 3, 2003, the Company acquired substantially all of the assets of
SCI, a privately held promotional marketing services company based in Ontario,
California. The Company financed the acquisition through its existing cash
reserves. The acquisition was consummated pursuant to an Asset Purchase
Agreement dated September 3, 2003, by and among the Company, SCI 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 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 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. 14




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##### Table of Contents



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 would result in an
adjustment to goodwill and other intangibles. The allocation of the purchase
price may change based upon these valuations. During the three months ended
March 31, 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
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. The remaining
balance of this receivable is recorded in prepaid expenses and other current
assets in the Companys consolidated balance sheet as of March 31, 2004. The
additional earnout consideration was recorded as additional goodwill as of
March 31, 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, the
Company acquired certain assets of
JGI, a privately held promotional marketing services company based in
Minneapolis, Minnesota. The Company financed the acquisition through its
existing cash reserves. The acquisition was consummated pursuant to an Asset
Purchase Agreement dated January 16, 2004, by and among the Company, Johnson
Grossfield, Inc., a Delaware corporation wholly owned by the Company, JGI, Marc
Grossfield and Thom Johnson (the Purchase Agreement). Under the terms of the
Purchase Agreement, the Company purchased the assets of JGI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 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
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. 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 would 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.
The Companys preliminary allocation of purchase price for the acquisition,
based upon estimated fair values is as follows: Net current assets
    
    $
    2,857Property, plant and equipment
    
    
    8Other non-current assets
    
    
    7Net current liabilities
    
    
    (1,214
    )Estimated fair value, net assets acquired
    
    
    1,658Goodwill
    
    
    1,136Other intangible assets
    
    
    2,243Total purchase price
    
    $
    5,037
 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. 15




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##### Table of Contents



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 period immediately preceding the period of
acquisition after giving effect to certain adjustments for the amortization
of intangibles, reduced interest income and related income tax effects. The
pro forma data is for informational purposes only and does not necessarily
reflect the results of operations had the businesses operated as one during
the period. No effect has been given for synergies, if any, that may have
been realized through the acquisitions. Three Months EndedMarch 31,2003
    
    2004Pro forma revenues
    $
    55,461
    
    
    $
    53,276Pro forma net income (loss)
    $
    1,029
    
    
    $
    (8
    )Pro forma basic earnings (loss) per share
    $
    0.11
    
    
    $
    (0.07
    )Pro forma diluted earnings (loss) per share
    $
    0.11
    
     
   $
    (0.07
    )
 Refer to Note 2 for further discussion of the method of computation of earnings
per share. 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 was $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 is convertible into 62.5 and 55.5556 shares of Common Stock,
respectively, representing 916,666 shares of Common Stock in aggregate.
Also in connection with such purchase, the Company agreed to pay Crown a
commitment fee in the aggregate amount of $1,250, paid in equal quarterly
installments of $62.5 commencing on June 30, 2000 and ending on March 31,
2005. A payment of $62.5 was made for the quarter ended March 31, 2004. 16




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##### Table of Contents



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 be 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. 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 March 31, 2004 totaled $375 and were paid
in April 2004. These dividends were recorded in accounts payable in the
accompanying condensed consolidated balance sheets. 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
March 31, 2004 are as follows: Year2004
    
    $
    3,0822005
    
    
    4,0382006
    
    
    4,0092007
    
    
    3,9782008
    
    
    3,614Thereafter
    
    
    6,183Total
    
    $
    24,904
 Aggregate rental expenses for operating leases were $962 and $825 for the
three months ended March 31, 2003 and 2004, respectively. 17




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##### Table of Contents



Guaranteed Royalties For the three months ended March 31, 2003 and 2004, the Company incurred
$386 and $671, respectively, in royalty expense. License agreements for
certain copyrights and trademarks require minimum guaranteed royalty
payments over the respective terms of the licenses. As of March 31, 2004,
the Company has committed to pay total minimum guaranteed royalties as
follows: Year2004
    
    $
    2,7442005
    
    
    4,2582006
    
    
    2,4582007
    
    
    1,076Total
    
    $
    10,536
 Employment Agreement The Company has employment agreements with key executives. Guaranteed
compensation under these agreements as of March 31, 2004 are as follows: Year2004
    
    $
    1,7112005
    
    
    6002006
    
    
    3252007
    
    
    3252008
    
    
    200Thereafter
    
    
    1,800Total
    
    $
    4,961
 18




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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 global marketing services company based in Los Angeles, with
offices in Chicago, Minneapolis, New York, Ontario (CA), London, Paris and
Hong Kong. We focus on the design and execution of strategy-based marketing
programs, with 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 and promotions 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 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. UPSHOT has a reputation for creating
highly successful integrated marketing programs for world class brands such as
Diageo, Discover Financial Services, and Procter & Gamble. 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 and incentives, promotional
licenses and promotional retail programs, principally for the retail
department store industry. Our Johnson Grossfield division (JGI), which was acquired on February 2, 2004, is a
promotional marketing services business specializing in providing custom
licensed premiums for the kids marketing program of Subway Restaurants. Overview Contributions from our recent acquisitions resulted in the highest level of
first quarter revenues in our companys history. For the three months ended
March 31, 2004, we saw good revenue growth at Logistix and in our Consumer
Products business, and combined with the addition of our recent acquisitions
SCI and JGI, this more than offset a year-over-year decline in volumes for
Burger King promotional programs. SCI and JGI combined generated approximately
$4,800 of revenues during the quarter. Despite the record revenues, we recorded a net loss of $0.09 per diluted share
for the quarter compared to net income of $0.10 per diluted share in the prior
year quarter. The net loss per share was primarily attributable to the
following two factors:  
    
    Collectively, SCI and JGI were $0.07 dilutive per share. This is in
line with our expectations as 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.
    
    We incurred foreign currency transaction losses totaling $0.03 per
diluted share at our Logistix subsidiary. This is primarily due to the
strengthening of the Euro relative to the British Pound. This compares
with foreign currency gains of $0.01 per diluted share in the first
quarter of 2003. 19




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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 first 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 continue
in 2004. During the quarter, our Consumer Products business was able to largely offset
the Burger King decrease by increasing its revenues 43% compared to the prior
year. This is attributable to our expanded line-up of products. Revenues in
2003 were primarily comprised of sales of Scooby-Doo product. This year we
received contribution from Scooby-Doo, from our expanded line-up of Crayola®
branded bath toys, from Kim Possible which was launched in the second quarter
of 2003 and from our newest line of toys, Baby Einstein. As a result of the
expanded product lines, we expect our Consumer Products business to continue to
grow in 2004 relative to 2003. However, we do expect a decline in Consumer
Product revenues for the second quarter of 2004 as compared to 2003. In the
second quarter of 2003, we made unusually large shipments of Kim Possible
product to Wal-Mart for their exclusive launch of this product line. 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. Results of Operations The following table sets forth, for the periods indicated, the Companys
operating results as a percentage of total revenues: Three MonthsEnded March 31,2003
    
    2004Revenues
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    74.2
    
    
    
    74.4Gross profit
    
    
    25.8
    
    
    
    25.6Operating expenses:Salaries, wages and benefits
    
    
    12.3
    
    
    
    14.0Selling, general and administrative
    
    
    10.6
    
    
    
    11.4Integration costs
    
    
    
    
    
    
    0.1Total operating expenses
    
    
    22.9
    
    
    
    25.5Income from operations
    
    
    2.9
    
    
    
    0.1Other income (loss), net
    
    
    0.2
    
    
    
    (0.6
    )Income (loss) before provision for income taxes
    
    
    3.1
    
    
    
    (0.5
    )Provision (benefit) for income taxes
    
    
    1.1
    
    
    
    (0.2
    )Net income (loss)
    
    
    2.0
    %
    
    
    (0.3
    )%
 Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003
(In Thousands): Revenues Revenues for the three months ended March 31, 2004 increased $4,245, or 8.9%,
to $51,812 from $47,567 in the comparable period in 2003. Marketing Services
revenues increased $2,653, or 6.1%, to $46,488 primarily as a result of
increased revenues resulting from the acquisitions of SCI and JGI. 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 $1,400 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 4.9% for the three months
ended March 31, 2004 compared to the same period in 2003. 20




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Consumer Product revenues increased $1,592, or 42.7%, to $5,324. This is
attributable to our expanded line of products as compared to 2003. Our first
quarter 2003 revenues were primarily comprised of Scooby-Doo and Crayola®
product. While both of these product lines experienced significant growth in
2004, our Kim Possibleand Baby Einsteinproduct lines made significant
contributions this quarter. Our Kim Possible line was launched in the second
quarter of 2003 as a Wal-Mart exclusive; distribution expanded to other major
retailers beginning in January 2004. 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. Cost of sales and gross profit Cost of sales increased $3,285 to $38,572 (74.4% of revenues) for the three
months ended March 31, 2004 from $35,287 (74.2% of revenues) in the comparable
period in 2003 due to the higher sales volume in 2004. The gross margin percentage decreased to 25.6% for the three months ended March
31, 2004 from 25.8% 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 remained unchanged at 24.9% for the three
months ended March 31, 2003 and 2004. The gross profit percentage for Consumer
Products decreased to 30.9% for the three months ended March 31, 2004 from
36.7% in the comparable period in 2003. This decrease is primarily the result
of an increase in the relative mix of Consumer Products sold internationally as
well as an increase in the mix of hard-goods versus plush. 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. Hard-goods tend to carry lower gross margins than plush
because they require an investment in tooling. Salaries, wages and benefits Salaries, wages and benefits increased $1,416, or 24.2%, to $7,277 (14.0% of
revenues) for the three months ended March 31, 2004 from $5,861 (12.3% of
revenues) in the comparable period for 2003. This increase was primarily
attributable to the addition of approximately 55 employees from the
acquisitions of SCI and JGI. Salaries, wages and benefits increased as a percentage of revenues from 12.3%
to 14.0% as a result of revenues increasing at a lesser rate. The first
quarter 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 $871, or 17.3%, to
$5,896 (11.4% of revenues) for the three months ended March 31, 2004 from
$5,025 (10.6% of revenues) in the comparable period for 2003. The increase is
primarily the result of additional operating expenses resulting from the
acquisitions of SCI and JGI. Selling, general and administrative expenses increased as a percentage of
revenues from 10.6% to 11.4% as a result of revenues increasing at a lesser
rate. The first quarter 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 $43 (0.1% of revenues) for the three months
ended March 31, 2004. These are primarily travel costs directly related to the
integration of SCI and JGI. Other Income Net other income decreased $394 to $(292) for the three months ended March 31,
2004 from $102 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 quarter surpassed the currency hedges in place covering the
British pound against the Euro. 21




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Provision for taxes The effective tax rate for the three months ended March 31, 2004 was 38.1 %
compared to 34.6% 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 decreased $1,144 to a net loss of $166 ((0.3)% of revenues) in 2004
from $978 (2.0% 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. Financial Condition and Liquidity Our financial position remained strong in the first 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 March 31, 2004, we had
no debt and cash, cash equivalents and marketable securities were $14,152,
compared to $19,291 as of December 31, 2003. The decrease in cash, cash
equivalents and marketable securities was attributable to the acquisition of
JGI, purchases of fixed assets and the payment of current liabilities partially
offset by the collection of receivables. As of March 31, 2004, our net accounts receivable decreased $6,057 to $30,708
from $36,765 at December 31, 2003. This decrease is a result of the lower
level of sales volume in the first quarter compared to the fourth quarter of
2003. Historically, first 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 March 31, 2004, inventories decreased $1,898 to $13,201 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 second
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 63% and 71% of total
inventories as of March 31, 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 March 31, 2004, accounts payable decreased $2,820 to $26,045 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 March 31, 2004, accrued liabilities decreased $5,470 to $11,725 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 March 31, 2004, working capital was $24,834 compared to $29,447 at
December 31, 2003. Cash flows used in operations for the three months ended
March 31, 2004 were $204 compared to $7,802 in the prior year. Cash flows used
in operations in the first quarter 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 three months ended March 31, 2004 were $6,390 compared to $3,601 in the
prior year. This increase is the result of the acquisition of JGI and
increased purchases of fixed assets partially offset by reduced purchases of
marketable securities. Cash flows provided by financing activities for the
three months ended March 31, 2004 were $102 compared to cash used of $554 in
the prior year primarily as a result of a decrease in the repurchase of
treasury stock (we did not purchase any treasury stock during the three months
ended March 31, 2004) and an increase in proceeds from the exercise of stock
options. Our current strategy and business plan calls for the consummation of additional
mergers and 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. 22




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As of the date hereof, we believe that cash from operations, cash on hand at
March 31, 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 March 31, 2004 are as follows: 2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Thereafter
    
    TotalOperating Leases
    
    $
    3,082
    
    
    $
    4,038
    
    
    $
    4,009
    
    
    $
    3,978
    
    
    $
    3,614
    
    
    $
    6,183
    
    
    $
    24,904Guaranteed Royalties
    
    
    2,744
    
    
    
    4,258
    
    
    
    2,458
    
    
    
    1,076
    
    
    
    
    
    
    
    
    
    
    
    10,536Employment Agreements
    
    
    1,711
    
    
    
    600
    
    
    
    325
    
    
    
    325
    
    
    
    200
    
    
    
    1,800
    
    
    
    4,961Total
    
    $
    7,537
    
    
    $
    8,896
    
    
    $
    6,792
    
    
    $
    5,379
    
    
    $
    3,814
    
    
    $
    7,983
    
    
    $
    40,401
 We had no material commitments for capital expenditures at March 31, 2004.
Letters of credit outstanding as of December 31, 2003 and March 31, 2004
totaled $823 and $1,001, 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 and April 26, 2004, certain covenants under the
facility were amended. As of March 31, 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 March 31, 2004, there were
no amounts outstanding under the Facility. In addition to the Facility, in October, 2003 our Logistix subsidiary
established an import/letter of credit facility with Hong Kong Shanghai Bank
Corp. (HSBC) to provide short-term financing of product purchases 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 March 31, 2004, there were no amounts outstanding under this facility. Acquisitions On September 3, 2003, we acquired substantially all of the assets of SCI, a
privately held promotional marketing services company based in Ontario,
California. We financed the acquisition through our existing cash reserves. The
acquisition was consummated pursuant to an Asset Purchase Agreement dated
September 3, 2003, by and among EMAK, SCI and Joseph J. Schmidt, III (the
Purchase Agreement). Under the terms of the Purchase Agreement, we acquired
substantially all of the assets of SCI 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 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. 23




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On February 2, 2004, we
acquired certain assets of JGI, a
privately held promotional marketing services company based in Minneapolis,
Minnesota. We financed the acquisition through our existing cash reserves. The
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, Marc Grossfield and Thom Johnson
(the Purchase Agreement). Under the terms of the Purchase Agreement, we
purchased the assets of JGI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 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 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. 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 was $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 is convertible into 62.5 and 55.5556 shares of Common Stock,
respectively, representing 916,666 shares of Common Stock in aggregate.
Also in connection with such purchase, we agreed to pay Crown a commitment
fee in the aggregate amount of $1,250, paid in equal quarterly installments
of $62.5 commencing on June 30, 2000 and ending on March 31, 2005. A
payment of $62.5 was made for the quarter ended March 31, 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 be 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 March 31, 2004 totaled $375 and were paid
in April 2004. These dividends were recorded in accounts payable in the
accompanying condensed consolidated balance sheets. 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. 24




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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. 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 $3,294 to repurchase 251,100 shares at an average
price of $13.12 per share including commissions under this authorization
through March 31, 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
$15,329 to purchase a total of 1,229,409 shares at an average price of
$12.47 per share including commissions through March 31, 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
information. 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. 25




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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 March 31, 2004 and earnings per share reported
in prior periods presented must be retroactively adjusted in order to comply
with EITF 03-6. We will be adopting EITF 03-6 for the quarter ended June 30,
2004. We are currently determining what impact the adoption of EITF 03-6 will have on our earnings per share calculation. Cautionary Statements and Risk Factors Marketplace Risks  
    
    Dependence on a single customer, Burger King, which may adversely affect the 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. 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 SCI and JGI
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 Syndrom (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. 
 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. 26




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ITEM 4. CONTROLS AND PROCEDURES The Company maintains disclosure controls and procedures, as defined in
Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934 (the
Exchange Act) , that are designed to ensure that information required to
be disclosed by the Company in the reports that it files or submits under
the Exchange Act is recorded, processed, summarized and reported within the
time periods specified in the Securities and Exchange Commissions rules
and forms and that such information is accumulated and communicated to the
Companys management, including its Chief Executive Officer and Chief
Financial Officer, as appropriate to allow timely decisions regarding
required disclosure. The Company carried out an evaluation, under the
supervision and with the participation of the Companys management,
including the Companys Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the Companys
disclosure controls and procedures as of March 31, 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 March 31, 2004, that have materially affected, or
are reasonably likely to materially affect, the Companys internal control
over financial reporting. 27




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PART II. OTHER INFORMATION 
 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On February 2, 2004, in
connection with the acquisition of the promotional marketing services business of Johnson Grossfield, Inc. 35,785 shares of
the Companys common stock were issued as part of the purchase
price (which, based
upon the January 30, 2004 closing price of $14.80, had a value of $530). 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K  (a)
    
    Exhibits: Exhibit 10.1
    
    Employment agreement dated as of January 1, 2004 between Equity Marketing, Inc. and Kim H. Thomsen.Exhibit 10.2
    
    Employment agreement dated as of January 1, 2004 between Equity Marketing, Inc. and Bret R. Hadley.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
January 22, 2004 (Items 5 and 7).Report on Form 8-K filed with the Securities and Exchange Commission on
February 11, 2004 (Items 5 and 7).Report on Form 8-K filed with the Securities and Exchange Commission on
March 1, 2004 (Items 7 and 12).Report on Form 8-K filed with the Securities and Exchange Commission on
March 29, 2004 (Items 5 and 7).
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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 May 17, 2004
    /s/ ZOHAR ZIVZohar ZivSenior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer) 29