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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-K (Mark One) þ
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2004   o
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________________ to ________________________ Commission File Number 0-23346 EMAK WORLDWIDE, INC.  Delaware
    
    13-3534145(State of or other jurisdiction of
    
    (I.R.S. employer identification No.)incorporation or organization)
 6330 SAN VICENTE BLVD.
LOS ANGELES, CALIFORNIA 90048
(Address of principal executive offices) (323) 932-4300
(Registrants telephone number, including area code) Securities registered pursuant to Section 12 (b) of the Act: Title of each Class
    
    Name of each exchange on which registeredNone
    
    None
 Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.001 par value
(Title of class) 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 period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes þ No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of registrants knowledge,
in definitive proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Act). Yes o No þ As of June 30, 2004, the aggregate market value of the voting and non-voting common equity
held by non-affiliates of the registrant was $41,928,684. Indicate the number of shares outstanding of each of the registrants classes of common stock,
as of the latest practicable date: Number of Sharesoutstanding onMarch 28, 2005Common Stock, $0.001 par value
    
    
    5,779,638
 Documents Incorporated by Reference: Certain portions of the Registrants definitive Proxy
Statement relating to registrants annual meeting of stockholders to be held on June 2, 2005
are incorporated by reference into Part III of this Form 10-K.




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EMAK WORLDWIDE, INC. INDEX TO ANNUAL REPORT ON FORM 10-K
FILED WITH THE SECURITIES AND EXCHANGE COMMISSIONYEAR ENDED DECEMBER 31, 2004 ITEMS IN FORM 10-K PagePart IItem 1. Business
    
    
    2Item 2. Properties
    
    
    8Item 3. Legal Proceedings
    
    
    8Item 4.Submission of Matters to a Vote of Security Holders
    
    
    8Part IIItem 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    
    
    8Item 6. Selected Financial Data
    
    
    10Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operation
    
    
    11Item 7A. Quantitative and Qualitative Disclosures About Market Risk
    
    
    30Item 8. Financial Statements and Supplementary Data
    
    
    31Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
    
    
    58Item 9A. Controls and Procedures
    
    
    58Item 9B. Other Information
    
    
    58Part IIIItem 10. Directors and Executive Officers of the Registrant
    
    
    59Item 11. Executive Compensation
    
    
    59Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
    
    
    59Item 13. Certain Relationships and Related Transactions
    
    
    59Item 14. Principal Accountant Fees and Services
    
    
    59Part IVItem 15. Exhibits, Financial Statement Schedules
    
    
    60EX-3.2EX-3.3EX-21EX-23EX-31.1EX-31.2EX-32.1EX-32.2
  FORWARD-LOOKING STATEMENTS Certain expectations and projections regarding the future performance of EMAK Worldwide, Inc.,
a Delaware corporation (the Company), discussed in this document 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 the Companys operating plans and are subject to future
events and uncertainties. Readers should not place undue reliance on any such forward-looking
statements, which speak only as of the date made. Actual results could vary materially from
those anticipated for a variety of reasons. The Company undertakes no obligation to publicly
release the results of any revisions to these forward-looking statements which may be made to
reflect events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events. Readers are advised to review Managements Discussion and Analysis of
Financial Condition and Results of Operation  Cautionary Statements and Risk Factors. 1




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PART I 
 ITEM 1. BUSINESS ($000s omitted, except share and per share amounts) Except as expressly indicated or unless the context otherwise requires, as used herein,
EMAK, the Company, we, our, or us, means EMAK Worldwide, Inc., a
Delaware corporation and its subsidiaries. Unless otherwise specifically indicated, all
dollar amounts herein are expressed in thousands. Overview EMAK is a leading global integrated marketing services company. We focus on the design and
execution of strategy-based marketing programs providing measurable results for our clients.
EMAK has expertise in the areas of: strategic planning and research, entertainment marketing,
design and manufacturing of custom promotional products, promotion, event marketing,
collaborative marketing, retail design and environmental branding. Our clients include Burger
King, Kelloggs, Frito Lay, Kohls, Macys, Kraft, Procter & Gamble, Miller Brewing Company
and Subway Restaurants, among others. EMAK is headquartered in Los Angeles, with operations
in Chicago, Minneapolis, New York, Ontario (California), Dublin, Frankfurt, London, Paris, The
Netherlands, Hong Kong and Shanghai. We believe our principal competitive advantages include:  
    our ability, as a full-service agency, to both design and implement strategy-based marketing programs;
    extensive brand-building and sales-building experience;
    extensive creative capabilities;
    our access to a broad range of intellectual properties from the worlds of entertainment, music and sports; and
    an infrastructure that can deliver unique, high-quality and cost-effective products
and services in a very tight time frame, with stringent quality control. EMAK is a market-driven and customer-driven global organization that serves as a strategic
marketing partner for its clients through recommending, executing and measuring a broad range
of fully integrated brand-building and sales-building programs that may or may not be
promotional product-based. We also develop and market consumer products, based on emerging and evergreen licensed
properties, which are sold through mass-market and specialty retailers. Historically, our
Consumer Products strategy was to support and complement our Marketing Services business by
leveraging our infrastructure, improving overall gross margins, strengthening our
relationships with licensors and retailers who may also be promotions clients, and feeding our
overall knowledge of trends in popular culture. As the economics of the toy industry have
become increasingly challenging for smaller participants, our core Marketing Services business
has gained additional breadth and complexity primarily as a result of the five acquisitions we
have completed since July 2001. Our Consumer Products business no longer provides benefit to
our overall gross margins, and our acquisitions have provided the leverage for our
infrastructure previously supplied by our Consumer Products business. We are not willing to
invest more resources into the Consumer Products business because it no longer complements our
core offerings as a family of integrated marketing services agencies. As a result, on
February 24, 2005, we finalized a decision to pursue the wind down of substantially all of our
consumer products business, Pop Rocket. We plan to significantly scale back this business
during 2005, while exiting the business permanently as soon as is feasible. In the near term,
this includes restructuring Pop Rocket and exiting certain licenses. We may keep other
licenses through the current term, depending on negotiations with our licensing partners, and
we are committed to the Crayola® brand for the long term. The Crayola®-branded bath line
carries modest inventory risk as it replenishes perpetually. It is also a brand that lends
itself well to promotional opportunities and is complementary to our retail-oriented marketing
agency, SCI Promotion. Our Growth and Vision Over the last five years we have focused on diversifying and growing our Marketing Services
skills and client base with the acquisition of businesses that leverage our infrastructure,
add new clients and complementary service offerings, and offer new channels of distribution or
territories.  
    In July 2001, EMAK acquired Logistix, gaining a presence in Europe with broad-based
strategic client relationships, including research, new concept development, licensing
guidance and the development of premium-based promotions.
    In July 2002, EMAK acquired Upshot, a strategic marketing agency with expertise in
promotional, event and collaborative marketing, retail design and environmental
branding, thereby providing us with a broader range of services and the ability to
develop a more diverse client base. 2




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
    In September 2003, EMAK acquired SCI Promotion, establishing us as a leading
provider of gift-with-purchase and purchase-with-purchase promotional programs to the
retail department store industry.
    In February 2004, EMAK acquired Johnson Grossfield, expanding our client base in
the Quick Service Restaurant category with the addition of the kids marketing program
of Subway Restaurants.
    In November 2004, EMAK acquired Megaprint Group, a pan-European market leader in
the design and production of innovative paper and board engineered (2-D) premiums,
providing EMAKs family of companies with an important complementary service offering
and expanding our client roster and geographic presence in Europe. Our focus for 2005 is the continued integration of our family of agencies in order to optimize
the sharing of intellectual assets and the leveraging of our infrastructure. EMAK Worldwide
companies will provide a variety of marketing services disciplines to affect consumer
behavior, founded on our historic strength in outstanding execution of below the line
marketing programs. We have added strong strategic planning capabilities, resident in our
Upshot, Equity Marketing and Logistix agencies. This combination of strengths is articulated
in our strategy combine unique strategic planning insights with tactical excellence to
measurably increase clients profitability. We have a strong global pipeline of new business
and we are competing for larger and higher-profile clients than ever before. We are managing
our business for growth, and we see evidence that our integrated marketing services strategy
is working despite the challenges of 2004. We continue to become more diversified and believe
we are building a franchise that will generate substantial value for our long-term
stakeholders. Our vision is to be the worlds largest and most respected independent provider
of strategically integrated marketing solutions Business Segments Our business is classified into two reportable business segments, namely Marketing Services
and Consumer Products. These business segments have been defined in a manner consistent with
EMAKs organizational structure, internal reporting, allocation of resources and operating
decision-making. Our Marketing Services revenues for the years ended December 31, 2002, 2003 and 2004 were
$175,372, $189,261 and $211,526, or 85%, 86% and 89% of total revenues, respectively. Our
Consumer Products revenues for the years ended December 31, 2002, 2003 and 2004 were $31,460,
$29,852 and $25,135, or 15%, 14% and 11% of total revenues, respectively. A single client, Burger King, accounted for approximately 65%, 58% and 51% of our total
revenues for the years ended December 31, 2002, 2003 and 2004, respectively. The business segment revenues for 2002 and 2003 set forth above have been reclassified to
conform to our management structure effective January 1, 2004; specifically, the results of
the USI division, which had been previously reported as part of, Consumer Products are now
being reported as part of Marketing Services. Marketing Services Our largest Marketing Services offering is the design and implementation of fully-integrated
promotional marketing programs which incorporate products used as free premiums or sold in
conjunction with the purchase of other products at retail. We also create non-premium based
integrated marketing programs that build brands and influence consumer behavior through
promotional, event and collaborative marketing, as well as retail and environmental design. Premium-based promotions are used by both the companies sponsoring the promotions, typically
our clients, and the licensors of the entertainment, music or sports properties on which the
promotional products are based. The use of promotional products based upon entertainment,
music or sports properties allows promotional sponsors to draw upon the popular identity
developed by the intellectual property through exposure in various media such as television
programs, motion pictures and publishing. Promotions are designed to benefit sponsors by
generating consumer interest, loyalty, building market share and enhancing the sponsors image
as a provider of value-added products and services. In addition, motion picture and television
studios and other licensors often incorporate such promotions into their own marketing plans
because of the substantial advertising expenditures made by sponsors of promotions and because
the broad exposure of the licensed property to consumers in the sponsors retail outlets
supplements the marketing of motion pictures, television programs and other intellectual
property such as sports leagues and music labels. Licenses for characters upon which our programs are based are generally obtained directly by
our clients (often with our assistance) from licensors, including Warner Bros., Universal
Studios, Nickelodeon, DreamWorks SKG, The Walt Disney Company, Sony Pictures Entertainment and Twentieth Century Fox. Such licenses are typically specific to the
promotional campaign and generally do not extend beyond the end of the promotional campaign. 3




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We perform a wide range of creative, design, development, production and fulfillment services
for our clients, including:  
    assisting clients in understanding the consumer through creative research and planning;
    assisting clients with promotional strategy, calendar planning, and concept development;
    evaluating intellectual properties for which licenses are available;
    advising clients as to which licenses are consistent with their marketing objectives;
    assisting clients in procuring licenses;
    proposing specific product and non-product based promotions often utilizing the properties secured by our clients;
    developing promotional concepts and designs based on the property;
    providing the development and engineering necessary to translate the property,
which often consists of two-dimensional artwork, into finished products;
    obtaining or coordinating licensor approval of product designs, prototypes and finished products;
    contracting for and supervising the manufacture of products;
    arranging for safety testing to customer and regulatory specifications by independent testing laboratories;
    arranging insurance, customs clearance and, in most instances, the shipping of finished products to the client;
    providing warehousing, fulfillment and billing services;
    providing creative services for packaging and point-of-sale advertising;
    developing experiential marketing campaigns to allow target
consumers to directly experience our clients brands;
    using the internet to complement promotional programs being conducted in the physical world;
    developing collaborative marketing programs between retailers and manufacturers; and
    creating three dimensional environments to influence consumers purchasing behavior
including environmental planning, store design, space planning and visual
merchandising. In some instances, customers obtain license rights or develop promotions concepts
independently and engage us only to design and produce specific products and services. More
often, we provide the full range of our services. EMAK pursues promotions opportunities worldwide. Our international promotions often include
unique products and promotional programs tailored to local markets as well as the use of
program elements from promotions originally run in the United States. A number of our clients
are now attempting to run promotions globallya trend we believe will accelerate in the
future. Consumer Products EMAKs Consumer Products business designs, contract manufactures and markets toys and other
consumer products for sale to major mass market retailers (such as Toys R Us, Wal-Mart and
Target), specialty market retailers and various international distributors. Our products are
primarily based upon trademarks, characters and other intellectual properties we license from
major entertainment companies. In some cases, our products are based on the same licensed
properties used by our Marketing Services division. As discussed above, on February 24, 2005 we finalized a decision to pursue the wind down of
substantially all of our Consumer Products business. We plan to significantly scale back this
business during 2005, while exiting the business permanently as soon as is feasible. In the
near term, this includes restructuring Pop Rocket and exiting certain licenses. We may keep
other licenses through the current term, depending on the outcome of ongoing discussions with
our licensors. We are committed to the Crayola® branded bath line for the long term, as it
carries modest inventory risk as it replenishes perpetually. It is also a brand that lends
itself well to promotional opportunities and is complementary to our retail-oriented marketing
agency, SCI Promotion. The acquisition of new licensed properties requires that we develop, design and engineer a
product line and packaging. This work is generally performed by a staff of designers,
artists, model makers and engineers. The initial development of a product line under a new
license typically takes from four to 10 months. As a result, the addition of new licensed
properties requires substantial investment in design and development well in advance of associated revenues. Such design and
development costs are expensed as incurred. In addition, existing products lines must be
regularly refreshed, redesigned and extended. Based upon the current economics of the toy
industry, we are not willing to make continued investments in the Consumer Products business
because of its unfavorable economics and because it no longer complements our core offerings
as a family of integrated marketing services agencies. 4




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The table below provides a summary of our current portfolio of licensed properties, including
the names of the licensed property and the licensor, the dates on which the license was
originally granted, when the first products were or will be marketed under the license, the
expiration date of the current license term, the product categories covered by the license and
the geographic territories in which the licensed product can be distributed. Property
    
    Licensor
    
    Grant Date
    
    Market Date
    
    Exp. Date
    
    Categories
    
    TerritoryScooby-Doo
    
    Warner Bros.
Consumer Products
    
    Jun 1998
    
    Sep 1998
    
    Dec 2007
    
    Toys based upon
television and
feature film
characters.
    
    Worldwide (except
Asia and Mexico)Robot Wars®
    
    BBC Worldwide
    
    Jul 2000
    
    Sep 2000
    
    Dec 2006
    
    Pullback, radio
control and die
cast toys and
playsets.
    
    United Kingdom and
IrelandAce Lightning
    
    BBC Worldwide
    
    Jan 2002
    
    Feb 2002
    
    Dec 2005
    
    Plastic toys and
playsets.
    
    United Kingdom and
IrelandUltimate Book of Spells
    
    BKN Consumer
Products
    
    Jan 2002
    
    Sep 2002
    
    Dec 2006
    
    Plastic figurines
and playsets.
    
    United Kingdom and
IrelandCrayola®
    
    Binney & Smith
    
    May 2002
    
    Aug 2002
    
    Dec 2005
    
    Bath toys,
activities and art
sets.
    
    North America and
EuropeKim Possible
    
    Disney Consumer
Products
    
    Sep 2002
    
    Aug 2003
    
    Dec 2005
    
    Toys and novelty
merchandise.
    
    United States and
CanadaJim
Hensons
Bear in the Big
Blue House
    
    Disney Enterprises,
Inc. 
(formerly, The
Jim Henson Company)
    
    Nov 2002
    
    Sep 2003
    
    Dec 2005
    
    Plush, figurines
and toy novelties.
    
    North America and
EuropeThe Powerpuff Girls
    
    Warner Bros.
Consumer Products
    
    Feb 2003
    
    Aug 2003
    
    Dec 2005
    
    Figures, plush and
playsets.
    
    United States and
CanadaSamurai Jack
    
    Warner Bros.
Consumer Products
    
    Feb 2003
    
    Aug 2003
    
    Dec 2005
    
    Figures, plush and
playsets.
    
    United States and
CanadaBaby Einstein
    
    The Baby Einstein
Company, LLC (a
Disney subsidiary)
    
    Feb 2003
    
    Jan 2004
    
    Dec 2005
    
    Puppets, plush,
activity and
infant/pre-school
toys.
    
    United States and
CanadaJoJos Circus
    
    Disney Consumer
Products
    
    Dec 2003
    
    Jan 2005
    
    Dec 2007
    
    Pre-school toys,
plush, playsets and
musical toys.
    
    United StatesCodename:
Kids 
Next
Door
    
    Warner Bros.
Consumer Products
    
    Mar 2004
    
    Jul 2005
    
    Dec 2006
    
    Activity sets,
roomguards/alarms.
    
    United States and
Canada
 Backlog Order backlog at March 26, 2004 and March 28, 2005 was approximately $156,000 and $150,000,
respectively. The Company expects the 2005 order backlog to be filled by December 31, 2005.
The 2005 and 2004 order backlog are not comparable, as 2004 order backlog included
approximately $14,000 in revenues related to low margin logistical services provided on behalf
of a significant client which the Company decided not to pursue in 2005. 5




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Manufacturing Our products are manufactured according to EMAK and customer specifications by unaffiliated
contract manufacturers, primarily in China. Our Hong Kong staff manages the production of our
products by our contract manufacturers and performs or procures product sourcing, product
engineering, quality control inspections, independent safety testing and export/import
documentation. We believe that the presence of a dedicated staff in Hong Kong results in
lower net costs, increased ability to respond rapidly to customer orders and maintenance of
more effective quality control standards. EMAK products are also manufactured by third
parties in the United States and Europe. We generally retain, either for our self or on behalf of our clients, ownership of the molds
and tooling required for the manufacture of our products. We are not a party to any long-term
contractual arrangements with any manufacturer. During 2004, approximately 93% of our products were manufactured in China. China currently
enjoys permanent normal trade relations (NTR) status under US tariff laws, which provides a
favorable category of US import duties. Chinas NTR status became permanent on January 1,
2002, following enactment of a bill authorizing such status upon Chinas accession to the
World Trade Organization (WTO), which occurred in December 2001. Membership in the WTO
substantially reduces the possibility of China losing its NTR status, which would result in
increased manufacturing costs for us and those of our competitors sourcing products in China. Virtually all of the raw materials used in our products are available from numerous suppliers.
Our contract manufacturers generally do not have long-term supply contracts in place with
their raw materials suppliers. Accordingly, we are subject to variations in the prices we pay
to manufacturers for products, depending on what they pay for raw materials. An increase in
the cost of raw materials, such as petroleum, could result in price increases which EMAK may
not be able to fully pass on to customers. Any such increase could negatively impact our
business, financial condition or results of operations. Trademarks and Copyrights We do not typically own trademarks or copyrights on properties on which most of our products
are based. These rights are owned or controlled by the creator of the property or by the
entity which licenses its intellectual property rights, such as a motion picture or television
producer. Competition Both our Marketing Services and Consumer Products businesses operate in highly competitive
domestic and international markets. In our core domestic Marketing Services business, EMAK competes with subsidiaries of The
Interpublic Group of Companies (including Draft Worldwide, The Zipatoni Company, Momentum and
Marketing Drive Worldwide), Arc Worldwide (a subsidiary of Publicis
Groupe), 141 Worldwide (a subsidiary WPP), Marketing Store Worldwide, Creata Promotion and
Wunderman (a subsidiary of WPP). Competition in the international promotions industry
includes the companies listed above as well as local companies in each market. We believe the principal competitive factors affecting our Marketing Services business are the
development of client marketing and promotional strategies, unique consumer insights, creative
execution, license selection, price, product and service quality and safety and speed of
production. Our Consumer Products competitors include companies which have far more extensive sales and
development staffs and significantly greater financial resources than EMAK. Our principal
competitors are mid-sized toy companies like Playmates Holdings Limited, Play Along, Inc. and
JAKKS Pacific, Inc. However, the toy industry includes major toy and game manufacturers such
as Hasbro, Inc. and Mattel, Inc. that compete in some of the same product categories as EMAK. We believe the principal competitive factors affecting our Consumer Products business are
license selection, price, product quality, distribution and play value. 6




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Government Regulation In the United States, our business is subject to the provisions of the Consumer Product Safety
Act and the Federal Hazardous Substances Act. These acts empower the Consumer Product Safety
Commission to protect the public against unreasonable risks of injury associated with
promotional and consumer products, including toys and other articles. The Consumer Product
Safety Commission has the authority to exclude from the market articles which are found to be
hazardous and can require a manufacturer to repair or repurchase such toys under certain
circumstances. Any such determination by the Consumer Product Safety Commission is subject to
court review. Violations of the Acts may also result in civil and criminal penalties.
Similar laws exist in some states and cities in the United States and in many jurisdictions
throughout the world. We perform quality control procedures (including the inspection of goods at factories and the
retention of independent testing laboratories) to ensure compliance with applicable product
safety requirements, both domestically and internationally. Notwithstanding the foregoing,
there can be no assurance that all of our products are or will be hazard-free. A product
recall could have a material adverse effect on our results of operations and financial
condition and could also negatively affect EMAKs reputation and the sales of our other
products. Employees As of December 31, 2004, EMAK employed a total of 410 individuals, including 267 individuals
located in the United States, 88 individuals located in Europe and 55 individuals in Asia. In
addition, we utilize freelance artists and other temporary staff on an ongoing basis in order
to serve our clients needs. We believe that our relations with our employees are good. Executive Officers of the Registrant The following persons are the executive officers of EMAK as of the date of this report. Such
executive officers are appointed annually by our board of directors and serve at the pleasure
of the board. The table below provides information with respect to our executive officers: Name
    
    Age
    
    PositionDonald A. Kurz
    
    
    49
    
    
    President and Chief Executive OfficerKim H. Thomsen
    
    
    52
    
    
    President and Chief Creative OfficerTeresa L. Tormey
    
    
    40
    
    
    Executive Vice President, General Counsel and SecretaryZohar Ziv
    
    
    52
    
    
    Senior Vice President and Chief Financial Officer
 Donald A. Kurzjoined EMAK in 1990 and is currently our President and Chief Executive Officer.
Mr. Kurz served as Chairman of our Board of Directors until February 2005, when our Board of
Directors split the roles of Chairman and Chief Executive Officer. Mr. Kurz served as
President and Co-CEO from 1991 through 1998 and has been a member of our Board of Directors
since 1990, when he joined EMAK as Executive Vice President. Mr. Kurz was previously a
management consultant with the general management consulting division of Towers Perrin, where
he was a vice president and senior partner and eventually headed the firms New York office.
Mr. Kurz earned a bachelors degree from Johns Hopkins University and a masters in business
administration from Columbia University Graduate School of Business. Kim H. Thomsenjoined EMAK in 1991 and is currently responsible for the creative direction for
all of our marketing services and consumer products. She was promoted to her current post in
early 2000. Prior to joining EMAK, she operated her own business as a creative consultant.
Ms. Thomsen earned her bachelors degree from Cornell University. Teresa L. Tormeyjoined EMAK in November 2002 and is responsible for our global legal and
business affairs, regulatory compliance, board administration and corporate governance
functions. She was promoted to her current position in early 2004. Ms. Tormey was previously
in private law practice as a partner in the corporate finance and transactions group of
Oppenheimer Wolff & Donnelly LLP. She holds a bachelor of arts degree in economics from the
University of California at Davis and a juris doctor from Pepperdine University School of Law. Zohar Zivjoined EMAK in February 2004 and is responsible for the Companys finance, treasury,
accounting and corporate development functions. Prior to joining EMAK, Mr. Ziv was the CFO of
Stravina Operating Company, LLC, a supplier of personalized novelty items, from June 2002 to
February 2004; the CFO of Joico Laboratories, Inc., a hair product supplier, from July 2001 to
June 2002; and the CFO of Intellisys Group, Inc., a multimedia system designer and integrator,
from June 1999 to February 2001. Mr. Ziv has a master of business administration in
international management from Thunderbird, The American Graduate School of International
Management, and a bachelor of science in accounting from California State University,
Northridge. He is a certified public accountant. 7




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Available Information Our website address is
www.emak.com. EMAK makes available, free of charge, on or through this
website our periodic and current reports filed or furnished pursuant to Section 13(a) or 15(d)
of the Securities Act of 1934 as soon as reasonably practicable after such material is filed
with or furnished to the SEC. Information contained on our website is not part of this
report. 
 ITEM 2. PROPERTIES Our corporate headquarters consists of approximately 57,000 square feet of space in Los
Angeles, California under a lease which expires December 31, 2009. SCI Promotion occupies
approximately 41,000 square feet of office and warehouse space in Ontario, California under a
lease which expires October 31, 2007. We also lease an approximately 40,000 square foot
warehouse in Indianapolis, Indiana under a lease which expires May 31, 2005. We recently
amended our Indianapolis lease to extend the term through July 31, 2010 and exchange our
current facility for an approximately 36,000 square foot facility commencing June 1, 2005. In
Hong Kong, we occupy approximately 10,000 square feet of space in Kowloon, under a lease which
expires August 31, 2005. Logistix and Megaprint Group occupy approximately 7,400 square feet
and 1,900 square feet of leased space in Gerrards Cross outside of London under leases that
expire September 20, 2014 and September 19, 2011, respectively, approximately 2,200 square
feet of leased space in Paris under a lease that expires January 31, 2013, and approximately
2,500 feet of space in Haarlem, The Netherlands under a lease which expires November 30, 2006.
Upshot occupies approximately 30,000 square feet of leased space in Chicago, Illinois under a
lease that expires March 31, 2009. In connection with a restructuring plan implemented in
2002, Upshot vacated approximately 30,000 square feet of leased space in Chicago and
approximately 12,000 square feet of leased space in Richmond, Virginia. The Richmond facility
and the vacated Chicago facility are currently occupied by subtenants. 
 ITEM 3. LEGAL PROCEEDINGS EMAK is involved in various legal proceedings generally incidental to our business. While the
result of any litigation contains an element of uncertainty, management presently believes
that the outcome of any known, pending or threatened legal proceeding or claim, individually
or combined, will not have a material adverse effect on our financial position, results of
operations or cash flows. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter of our
fiscal year ended December 31, 2004. 
 PART II 
  ITEM 5.
    MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Market for the Registrants Stock Our Common Stock is traded on The Nasdaq National Stock Market under the symbol EMAK. On
March 23, 2005 there were approximately 862 beneficial holders of our Common Stock. We currently have no plans to pay dividends on our Common Stock. We intend to retain all
earnings for use in our business. Under EMAKs current credit facility, we cannot pay
dividends on our Common Stock without the prior consent of the lender. (See Note 6 of the
accompanying Notes to Consolidated Financial Statements.) The high and low Common Stock prices per share were as follows: Price Range of Common Stock2003
    
    
    2004High
    
    
    Low
    
    
    High
    
    
    LowFirst Quarter
    
    
    15.09
    
    
    
    11.90
    
    
    
    16.05
    
    
    
    13.81Second Quarter
    
    
    15.50
    
    
    
    13.01
    
    
    
    15.45
    
    
    
    11.94Third Quarter
    
    
    16.29
    
    
    
    14.00
    
    
    
    13.25
    
    
    
    9.60Fourth Quarter
    
    
    15.29
    
    
    
    12.88
    
    
    
    10.20
    
    
    
    9.07
 8




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##### Table of Contents



Issuer Purchases of Equity Securities In July 2002, EMAKs board of directors approved a share repurchase program of up to $10,000.
Through December 31, 2004, EMAK repurchased 267,650 shares at a cost of $3,505 pursuant to this
program. In 2004, EMAK repurchased 16,550 shares at a cost of $211 pursuant to this program.
EMAKs share repurchase program has no expiration date. During the fourth quarter of 2004, EMAK did not repurchase any of its Common Stock . The
following table sets forth all purchases made by us, as defined in Rule 10b-18(a)(3) of the
Securities Exchange Act of 1934, of the Companys Common Stock during 2004. Total Number of Shares
    
    
    Maximum Dollar ValuePurchased as Part of
    
    
    of Shares that May Yet BeTotal Number of
    
    
    Average Price Paid
    
    
    Publicly Announced
    
    
    Purchased Under the ProgramPeriod
    
    Shares Purchased
    
    
    per Share
    
    
    Program
    
    
    (in thousands)Jan 1  Mar. 31
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    6,706Apr. 1  June. 30
    
    
    16,550
    
    
    
    12.78
    
    
    
    16,550
    
    
    
    6,495July. 1  Sept. 30
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,495Oct. 1  Dec. 31
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,495Total
    
    
    16,550
    
    
    $
    12.78
    
    
    
    16,550
    
    
    $
    6,495
 9




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##### Table of Contents



ITEM 6. SELECTED FINANCIAL DATA The selected consolidated financial data presented below have been derived from EMAKs audited
consolidated financial statements and should be read in conjunction with the related notes
thereto and Item 7. Managements Discussion and Analysis of Financial Condition and Results
of Operation. Years Ended December 31,
    
    2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004Consolidated Statements
of Operations and Per Share Data: (in thousands, except share and per share data)Revenues
    
    $
    232,287
    
    
    $
    144,316
    
    
    $
    206,832
    
    
    $
    219,113
    
    
    $
    236,661Cost of sales
    
    
    172,270
    
    
    
    104,129
    
    
    
    151,307
    
    
    
    158,117
    
    
    
    180,487Forgiveness of note receivable
    
    
    
    
    
    
    
    
    
    
    1,685
    
    
    
    
    
    
    
    Minimum royalty guarantee shortfalls
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,722Gross profit
    
    
    60,017
    
    
    
    40,187
    
    
    
    53,840
    
    
    
    60,996
    
    
    
    48,452Operating expenses:Salaries, wages and benefits
    
    
    17,610
    
    
    
    15,924
    
    
    
    20,662
    
    
    
    24,523
    
    
    
    31,310Selling, general and administrative
    
    
    23,075
    
    
    
    18,323
    
    
    
    22,423
    
    
    
    24,576
    
    
    
    25,606AmeriServe bankruptcy bad debt expense
    
    
    482
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Impairment of assets
    
    
    8,504
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,312Integration costs
    
    
    
    
    
    
    192
    
    
    
    453
    
    
    
    
    
    
    
    174Restructuring loss (gain)
    
    
    (418
    )
    
    
    
    
    
    
    178
    
    
    
    234
    
    
    
    56Loss on Chicago lease
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    311Dispute resolution charge
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    237ERP reimplementation costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    59Total operating expenses
    
    
    49,253
    
    
    
    34,439
    
    
    
    43,716
    
    
    
    49,333
    
    
    
    64,065Income (loss) from operations
    
    
    10,764
    
    
    
    5,748
    
    
    
    10,124
    
    
    
    11,663
    
    
    
    (15,613
    )Other income (expense), net
    
    
    1,375
    
    
    
    1,370
    
    
    
    383
    
    
    
    389
    
    
    
    (787
    )Income (loss) before provision (benefit) for
income taxes and cumulative effect
of change in accounting principles
    
    
    12,139
    
    
    
    7,118
    
    
    
    10,507
    
    
    
    12,052
    
    
    
    (16,400
    )Provision (benefit) for income taxes
    
    
    6,797
    
    
    
    2,517
    
    
    
    3,786
    
    
    
    4,103
    
    
    
    (6,716
    )Income (loss) before cumulative effect
of change in accounting principles
    
    
    5,342
    
    
    
    4,601
    
    
    
    6,721
    
    
    
    7,949
    
    
    
    (9,684
    )Cumulative effect of change in accounting
principles, net of tax
    
    
    
    
    
    
    
    
    
    
    (2,496
    )
    
    
    
    
    
    
    Net income (loss)
    
    
    5,342
    
    
    
    4,601
    
    
    
    4,225
    
    
    
    7,949
    
    
    
    (9,684
    )Preferred stock dividends
    
    
    956
    
    
    
    1,500
    
    
    
    1,500
    
    
    
    1,500
    
    
    
    1,500Undistributed earnings allocated to participating
preferred stock
    
    
    933
    
    
    
    683
    
    
    
    623
    
    
    
    1,474
    
    
    
    Net income (loss) available to common
stockholders
    
    $
    3,453
    
    
    $
    2,418
    
    
    $
    2,102
    
    
    $
    4,975
    
    
    $
    (11,184
    )Basic income (loss) per share:Income (loss) per share
before cumulative effect of
change in accounting principles
    
    $
    0.55
    
    
    $
    0.40
    
    
    $
    0.81
    
    
    $
    0.87
    
    
    $
    (1.94
    )Cumulative effect of change in
accounting
principles, net of tax
    
    
    
    
    
    
    
    
    
    
    (0.44
    )
    
    
    
    
    
    
    Income (loss) per share
    
    $
    0.55
    
    
    $
    0.40
    
    
    $
    0.37
    
    
    $
    0.87
    
    
    $
    (1.94
    )Basic weighted average shares
outstanding
    
    
    6,275,590
    
    
    
    5,996,662
    
    
    
    5,721,790
    
    
    
    5,718,548
    
    
    
    5,753,978Diluted income (loss) per share:Income (loss) per share
before cumulative effect of
change in accounting principles
    
    $
    0.53
    
    
    $
    0.39
    
    
    $
    0.78
    
    
    $
    0.83
    
    
    $
    (1.94
    )Cumulative effect of change in
accounting
principles, net of tax
    
    
    
    
    
    
    
    
    
    
    (0.42
    )
    
    
    
    
    
    
    Income (loss) per share
    
    $
    0.53
    
    
    $
    0.39
    
    
    $
    0.36
    
    
    $
    0.83
    
    
    $
    (1.94
    )Diluted weighted average shares
outstanding
    
    
    6,460,557
    
    
    
    6,164,154
    
    
    
    5,895,103
    
    
    
    6,017,718
    
    
    
    5,753,978
 10




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##### Table of Contents



As of December 31,
    
    2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004Consolidated Balance Sheet Data:(in thousands)Working capital
    
    $
    52,140
    
    
    $
    36,620

    
    
    $
    29,157
    
    
    $
    29,447
    
    
    $
    17,934Total assets
    
    $
    110,542
    
    
    $
    99,487
    
    
    $
    133,254
    
    
    $
    128,330
    
    
    $
    133,313Long-term debt
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Mandatorily redeemable preferred stock
    
    $
    23,049
    
    
    $
    23,049
    
    
    $
    23,049
    
    
    $
    23,049
    
    
    $
    22,518Stockholders equity
    
    $
    45,241
    
    
    $
    42,473
    
    
    $
    45,946
    
    
    $
    53,666
    
    
    $
    46,293
 
  ITEM 7.
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION Overview Revenues for the year ended December 31, 2004 increased $17,548 to $236,661 as compared to $219,113
recorded in the prior year as a result of revenue contributions from our recent acquisitions as
well as revenue growth in our existing Marketing Services business. SCI Promotion, Johnson
Grossfield and Megaprint Group combined generated approximately $32,100 of revenue during the year.
SCI Promotion, which was acquired September 3, 2003, contributed approximately $10,000 of revenues
in 2003. Despite the revenue growth, our 2004 earnings were negatively impacted by losses in our
Consumer Products segment as well our SCI Promotion and Upshot businesses. In 2004, we recorded a net loss of $1.94 per diluted share compared to net income of $0.83 per
diluted share in the prior year. The net loss per share was primarily attributable to the
following factors:  
    Losses generated in our Consumer Products segment (which includes both Pop Rocket and
the consumer products business of Logistix) accounted for approximately 57% of our full
year loss. Sales in this segment decreased $4,717 from the prior year and gross profit
margins decreased to negative 8.2% of sales from 38.6% in the prior year. The negative
gross profit margins are attributable to a pre-tax charge of $7,722 relating to minimum
royalty guarantee shortfalls on several licenses. These shortfalls are the result of the
decision to wind down Pop Rocket. Approximately $3,000 of this pre-tax charge is non-cash
for write-offs of long-term royalty advances. Of the remaining $4,700, we are working with
our licensors to mitigate the cash impact of the shortfall.Despite sales growth in some product lines such as Crayola ® branded bath toys, the
overall revenues in this segment fell short of our expectations, as retailers were more
conservative than we anticipated with their inventory positions ahead of the 2004 holiday
season, and some of our product lines, particularly Scooby-Doo, did not perform as well as
expected. In addition to the minimum royalty guarantee shortfalls, the gross profit margin
deterioration for Consumer Products is attributable to a highly competitive retail pricing
environment, resulting in pricing and markdown concessions to retailers. Secondly, our raw
materials costs have risen significantly due to higher plastic resin costs resulting from
record-high oil prices. As a result, Consumer Product margins were pressured from both
revenues and cost of sales perspectives.
    Gross profit margins in our Marketing Services segment decreased to 23.9% in 2004, as
compared to 26.1% in the prior year. This reduction was due to the provision of lower
margin logistical services as well as a rapid rise in raw materials costs which could not
be recaptured from clients due to long lead times on programs.
    Our 2004 results were also impacted by weakness at our Upshot agency including the loss
of an important client in the fourth quarter. We recorded a pre-tax, non-cash goodwill
impairment charge of $6,312, or $0.65 per diluted share, related to Upshot. This charge
arose in connection with the annual impairment test required by Statement of Financial
Accounting Standards (SFAS) No. 142 Goodwill and Other Intangibles.
    Results for SCI Promotion for the year fell short of our expectations. The weakness at
SCI Promotion was attributable to deferrals of scheduled promotional programs into 2005,
cancellations of promotional programs due to specific business issues at client companies
and opportunity loss attributable to the integration process following the acquisition. As
a result, we did not achieve the sales volume necessary to absorb the largely fixed cost
structure of this business.
    In the fourth quarter of 2004, we recorded a pre-tax charge of $237, or $0.02 per
diluted share, related to a dispute settlement liability incurred by assisting the former
owner of SCI Promotion to settle a claim for a product sold prior to our acquisition in
September 2003. We chose to facilitate settlement of the claim in order to secure a
continued business relationship with SCI Promotions longtime client. We retain the right
to offset the amount paid toward the settlement against future earnout payments in
connection with the SCI Promotion acquisition. 11




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##### Table of Contents




    In the second quarter of 2004 we recorded a charge of $311, or $0.03 per diluted share
due to lower than estimated sublease income for vacated office space in the Upshot
business. The office space was subleased at rates modestly below our initial estimates, due
to softness in the current Chicago real estate market.
    Operating expenses in 2004 include approximately $550, or $0.06 per diluted share, in
non-cash expense related to grants of restricted stock units, compared with approximately
$180, or $0.02 per diluted share recognized in the same period of 2003. We began using
restricted stock units as our primary means of stock based compensation in the second
quarter of 2003 and made additional grants at the beginning of the second quarter of 2004. The economics of the toy industry have become increasingly challenging for smaller participants,
and we are not prepared to invest more resources into the consumer products business because it no
longer complements our core offerings as a family of integrated marketing services agencies. As a
result, on February 24, 2005, we finalized a decision to pursue the wind down of Pop Rocket. We
will significantly scale back this business during 2005 and exit the business permanently as soon
as is feasible. In the near term, this includes restructuring the Pop Rocket division and exiting
certain licenses. We may keep other licenses through the current term, depending on negotiations
with our licensing partners, and we are committed to the Crayola® brand for the long term. The
Crayola®-branded bath line carries modest inventory risk as it replenishes perpetually. It is also
a brand that lends itself well to promotional opportunities and is complementary to our
retail-oriented agency, SCI Promotion. Our Burger King business, Equity Marketing, performed in line with our expectations. During 2004
we implemented nine domestic premium programs and seven international. This is essentially the
same number of promotional programs that we have typically produced for Burger King. Sales for
this business were lower for the full year as a result of decreasing domestic unit volumes in the
first half of 2004. However, in the second half of 2004, unit volumes for the domestic programs
increased relative to the prior year. We are seeing the trend of lower domestic unit volumes in
recent years begin to turn around as a result of the recent improvements in Burger King system
sales of Kids Meals. In addition, in 2004, Equity Marketing expanded its role with Burger King and
is now the agency of record for promotional categories outside of the kids segment, including Adult
Promotions and Youth & Family Promotions. Upshot is aggressively pursuing new business to replace lost revenues due to the loss of an
important client in the fourth quarter of 2004. In March of 2005, Upshot was one of two agencies
of record selected for the promotional business of Miller Brewing Company. In its new role, Upshot
will engage in promotional work for Millers two trademark brands Miller Lite and Miller Genuine
Draft in the U.S., beginning in April. Although we expect Upshots financial results to improve
significantly in 2005, the recent award of new business does not impact the impairment charge
recorded at December 31, 2004 discussed above. In accordance with SFAS 142 the impairment testing
was done as of December 31, 2004 and is not impacted by subsequent events, such as the award of new
business which favorably impacts our anticipated cash flows. Our focus for 2005 is the continued integration of our family of agencies in order to optimize
the sharing of intellectual assets and the leveraging of our infrastructure. EMAK Worldwide
companies will provide a variety of marketing services disciplines to affect consumer
behavior, founded on our historic strength in outstanding execution of below the line
marketing programs. We have added strong strategic planning capabilities, resident in our
Upshot, Equity Marketing and Logistix agencies. This combination of strengths is articulated
in our strategycombine unique strategic planning insights with tactical excellence to
measurably increase clients profitability. We have a strong global pipeline of new business
and we are competing for larger and higher-profile clients than ever before. We are managing
our business for growth, and we see evidence that our integrated marketing services strategy
is working despite the challenges of 2004. We continue to become more diversified and believe
we are building a franchise that will generate substantial value for our long-term
stakeholders. Our vision is to be the worlds largest and most respected independent provider
of strategically integrated marketing solutions. 12




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##### Table of Contents



Results of Operation The following table sets forth for the periods indicated the Companys operating expenses as a
percentage of its total revenues: Years Ended December 31,
    
    2002
    
    
    2003
    
    
    2004Revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    73.2
    %
    
    
    72.2
    %
    
    
    76.3
    %Forgiveness of note receivable
    
    
    0.8
    %
    
    
    
    %
    
    
    
    %Minimum royalty guarantee shortfalls
    
    
    
    %
    
    
    
    %
    
    
    3.2
    %Gross profit
    
    
    26.0
    %
    
    
    27.8
    %
    
    
    20.5
    %Operating expenses:Salaries, wages and benefits
    
    
    10.0
    %
    
    
    11.2
    %
    
    
    13.2
    %Selling, general and administrative
    
    
    10.8
    %
    
    
    11.2
    %
    
    
    10.8
    %Impairment of assets
    
    
    
    %
    
    
    
    %
    
    
    2.7
    %Integration costs
    
    
    0.2
    %
    
    
    
    %
    
    
    0.1
    %Restructuring loss
    
    
    0.1
    %
    
    
    0.1
    %
    
    
    0.0
    %Loss on Chicago lease
    
    
    
    %
    
    
    
    %
    
    
    0.1
    %Dispute resolution charge
    
    
    
    %
    
    
    
    %
    
    
    0.1
    %ERP reimplementation costs
    
    
    
    %
    
    
    
    %
    
    
    0.1
    %Total operating expenses
    
    
    21.1
    %
    
    
    22.5
    %
    
    
    27.1
    %Income (loss) from operations
    
    
    4.9
    %
    
    
    5.3
    %
    
    
    (6.6
    )%Other income (expense), net
    
    
    0.2
    %
    
    
    0.2
    %
    
    
    (0.3
    )%Income (loss) before provision (benefit) for
income taxes and cumulative effect
of change in accounting principles
    
    
    5.1
    %
    
    
    5.5
    %
    
    
    (6.9
    )%Provision (benefit) for income taxes
    
    
    1.9
    %
    
    
    1.9
    %
    
    
    (2.8
    )%Income (loss) before cumulative effect of
change in accounting principles
    
    
    3.2
    %
    
    
    3.6
    %
    
    
    (4.1
    )%Cumulative effect of change in
accounting principles, net of tax
    
    
    (1.2
    )%
    
    
    
    %
    
    
    
    %Net income (loss)
    
    
    2.0
    %
    
    
    3.6
    %
    
    
    (4.1
    )%
 Year ended December 31, 2004 compared to year ended December 31, 2003 Revenues Our consolidated revenues in 2004 increased $17,548, or 8.0%, to $236,661 from $219,113 in
2003. Our Marketing Services revenues increased $22,265, or 11.8%, to $211,526 from $189,261
primarily as a result of the inclusion of revenues generated by Johnson Grossfield, SCI
Promotion and Megaprint Group as well as continued growth at Logistix. The results for 2003
include SCI Promotion from September 3, 2003 (acquired September 3, 2003) and exclude Johnson
Grossfield (acquired February 2, 2004) and Megaprint Group (acquired November 10, 2004).
Growth resulting from acquisitions and Logistix was partially offset by a decrease in Burger
King revenues. Revenues for the Burger King business decreased as the volume of units for
domestic programs in the first half of 2004 were lower as compared to previous years. Burger
King revenues represented 51% of total revenues in 2004 as compared to 58% in 2003. In 2004, our Logistix business based in the United Kingdom executed several successful promotional
programs for Kelloggs both domestically and internationally. In addition, net foreign
currency translation impact contributed approximately $4,553 to revenues for Logistix versus
the prior year period average exchange rates. Excluding the impact of the SCI Promotion, Johnson Grossfield and Megaprint Group
acquisitions, and excluding the impact of net foreign currency translation, Marketing Services
revenues decreased slightly for 2004 compared to 2003. Our Consumer Products revenues decreased $4,717 or 15.8%, to $25,135 from $29,852 in 2003.
The decrease is primarily attributable to a decline in domestic sales of Scooby-Doo product
and a significant one-time stocking of Kim Possible merchandise in 2003. Our Kim Possible
line was launched in 2003 as a Wal-Mart exclusive; distribution expanded to other major
retailers beginning in January 2004. The decrease was partially offset by increased
international sales of Scooby-Doo product, the continued growth of Crayola® branded bath
toys, and the addition of the Baby Einsteinproducts. Revenues for 2004 were primarily
comprised of Scooby-Doo, Crayola®, Baby Einstein and Kim Possible brands. In January 2004,
we began distributing the first toy products based upon Baby Einstein, the best selling brand
of videos specifically designed for infants and toddlers. We granted exclusive distribution
to Target and Babies R Us for 2004. The growth in our Crayola® line of bath toys, which was
launched in 2003, was attributable to an expanded product line and expanded distribution
channels. 13




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##### Table of Contents



The growth in Scooby-Doo international revenues for 2004 was attributable to the brand receiving more
exposure on television in Europe and Latin America. The growth in international sales of
Scooby-Doo was more than offset by a decline in domestic Scooby-Doo sales. Cost of sales and gross profit Cost of sales increased $22,370 to $180,487 (76.3% of revenues) from $158,117 (72.2% of
revenues) in 2003 due to the higher sales volume in 2004. The gross profit percentage
decreased to 20.5% from 27.8% in 2003. This decrease is primarily the result of a charge for
minimum royalty guarantee shortfalls of $7,722 on several licenses resulting from the decision
to wind down our consumer products business. The gross profit in our Marketing Services business decreased from 26.1% in 2003 to 23.9% in
2004. This decline is attributable to the provision of lower margin logistical services as
well as a rapid rise in raw materials costs which could not be recaptured from clients due to
long order lead times . Excluding the impact for the minimum royalty guarantee shortfalls, the gross profit percentage
in Consumer Products decreased to 22.5% from 38.6% in 2003. This decrease is primarily the
result of a highly competitive retail pricing environment resulting in pricing and markdown
concessions to retailers, increased costs for plastic resin resulting from higher oil prices
and a higher mix of international sales which carry lower margins. 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. The decrease in Consumer
Products margins is also partially attributable to a significant one-time stocking of high
margin Kim Possible merchandise in the second quarter of 2003. Salaries, wages and benefits Salaries, wages and benefits increased $6,787 in 2004, or 27.7%, to $31,310 (13.2% of
revenues) from $24,523 in 2003 (11.2% of revenues). This increase was primarily attributable
to the addition of approximately 75 employees from the SCI Promotion, Johnson Grossfield and
Megaprint Group acquisitions as well as annual employee merit pay increases and additional
compensation expense resulting from grants of restricted stock units. Salaries, wages and benefits increased as a percentage of revenues from 11.2% to 13.2% as a
result of revenues increasing at a lesser rate. Due to the weakness at SCI Promotion, which
was attributable to deferrals and cancellations of scheduled promotional programs, we did not
achieve the sales volume necessary to absorb the largely fixed cost structure of this
business. In addition, the reduction in Burger King unit volume in the first half of 2004,
which resulted in lower overall Burger King revenues for the year, 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 $1,030 in 2004, or 4.2%, to $25,606 (10.8%
of revenues) from $24,576 (11.2% of revenues) in 2003. The increase is primarily the result of
additional operating expenses resulting from the SCI Promotion, Johnson Grossfield and Megaprint
Group acquisitions partially offset by lower selling expenses such as freight out resulting from a
change in the terms of delivery for a significant Marketing Services client.. Selling, general and administrative expenses decreased as a percentage of revenues from 11.2%
to 10.8% as a result of lower selling expenses. Impairment of assets We recorded a charge for impairment of assets of $6,312 (2.7% of revenues) in 2004. This
charge is the result of the annual impairment test required by SFAS No. 142, due primarily to
Upshots loss of a significant client in the fourth quarter of 2004. The charge is for a
write-down of the goodwill resulting from the 2002 acquisition of Upshot. See Critical
Accounting Policies  Goodwill and Other Intangibles below. Integration costs We recorded integration costs of $174 (0.1% of revenues) in 2004. These are primarily travel,
training and consulting costs directly related to the integration of SCI Promotion, Johnson
Grossfield and Megaprint Group. 14




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Restructuring We recorded a net restructuring charge of $56 (0.0% of revenues) compared to $234 (0.1% of
revenues) in 2003. The charge is associated with the realignment of centralized resources in
our Marketing Services business, partially offset by a reversal of a portion of the 2003
restructuring charge related to severance for workforce reductions at Upshot. Loss on Chicago lease We recorded a charge for the loss on the Chicago office lease of $311 (0.1% of revenues) in
2004. This is due to lower than estimated sublease income for vacated office space in the
Upshot business. The office space was subleased at rates modestly below our initial estimates,
due to softness in the current Chicago real estate market. Dispute resolution charge We recorded a dispute resolution charge of $237 (0.1% of revenues) in 2004. This is related
to a dispute settlement liability incurred by assisting the former owner of SCI Promotion to
settle a claim for a product sold prior to our acquisition in September 2003. We chose to
facilitate the settlement of the claim in order to secure a continued business relationship
with SCI Promotions longtime client. We retained the right to offset the amount paid toward
the settlement against future earnout payments in connection with the SCI Promotion
acquisition. ERP reimplementation costs We recorded enterprise resource planning (ERP) reimplementation costs of $59 (0.1% of
revenues) in 2004. This represents consulting costs which were not capitalized into fixed
assets. The costs were incurred in connection with a significant upgrade and reimplementation
of the Companys ERP software which is designed to enhance management information, financial
reporting, inventory management, cost evaluation and controls while assisting in compliance
with the Sarbanes-Oxley Act of 2002. Other income (expense) Other income (expense) decreased $1,176 in 2004, to $(787) ((0.3)% of revenues) from $389
(0.2% of revenues) in 2003. Other expense is composed of a loss on foreign exchange of $628,
a loss on asset disposal of $8 and net interest expense of $151. Net interest expense
increased $82 to $151 in 2004 from $69 in 2003 due to reduced levels of cash and cash
equivalents and increased short-term debt in the fourth quarter of 2004. The foreign currency
transaction losses in 2004 were primarily a result of an effective hedge in the fourth quarter
of 2004. This loss was offset by a corresponding positive impact on cost of goods sold as a
result of the continuing weakening of the US dollar relative to the British Pound (GBP).
The Companys Logistix subsidiary purchases the bulk of its inventories from the Far East in
US dollars. Provision (benefit) for Income Taxes The effective tax rate changed in 2004 to 41.0% from 34.0% in 2003. The increase in the
effective tax rate is the result of a net loss being generated domestically in 2004 relative
to net income in 2003 which was primarily generated internationally in territories which have
more favorable tax rates. Net income (loss) Net income (loss) decreased $17,633, to $(9,684) in 2004 ((4.1)% of revenues) from $7,949 in
2003 (3.6% of revenues) primarily due to the impact of the minimum royalty guarantee
shortfalls and impairment of assets. In addition, the net loss in 2004 is due to lower gross
profit margins, increased salaries, wages and benefits and selling, general and administrative
expenses attributable to the acquisitions of SCI Promotion, Johnson Grossfield and Megaprint
Group, integration costs, restructuring loss, loss on Chicago lease, dispute resolution charge
and the ERP reimplementation costs. The decrease is also the result of foreign currency
transaction losses and higher interest expense. 15




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Year ended December 31, 2003 compared to year ended December 31, 2002 Revenues Our consolidated revenues in 2003 increased $12,281, or 5.9%, to $219,113 from $206,832 in 2002.
Our Marketing Services revenues increased $13,889, or 7.9%, to $189,261 from $175,372 primarily as
a result of the inclusion of revenues generated by Upshot and SCI Promotion, as well as continued
growth in our non-Burger King marketing services business. The results for 2002 include Upshot
from July 18, 2002 (acquired July 17, 2002) and exclude SCI Promotion(acquired September 3, 2003).
Excluding the impact of the Upshot and SCI Promotion acquisitions, Marketing Services revenues
decreased $6,072 or 3.5% for 2003 compared to 2002. This decrease was due to challenges in our
Burger King business. Although we still implemented a significant majority of the worldwide
programs for Burger King as we had previously, unit volumes in those programs were lower than in
previous years. The decreased volume levels in the Burger King business were partially offset by
continued growth at Logistix. Our Consumer Products revenues decreased $1,608, or 5.1%, to $29,852 from $31,460 in 2002. This
decrease was primarily as a result of decreased sales of Scooby-Doo, Robot Wars® and Tub Tints®
product partially offset by sales from the launch of a product line based on Disneys Kim Possible
and increased sales of Crayola® product. Revenues for Scooby-Doo product in 2002 were higher
primarily due to increased shipments attributable to the Scooby-Doo feature film, which was
released in the summer of 2002. Our Robot Wars® product line in the United Kingdom experienced
disappointing sales in 2003 as a result of reduced consumer interest in the brand. In 2003, we
successfully launched our new Kim Possible product line with an exclusive at Wal-Mart. Both
Wal-Mart and Disney provided significant marketing and advertising support to the launch of the
product line and we were pleased with the results. In 2003, we expanded our line of Crayola® bath
products to include a full line of bath activities and bath art sets. As a result, sales of our
retail bath products increased significantly in 2003. Cost of sales and gross profit Cost of sales increased $6,810 to $158,117 (72.2% of revenues) from $152,992 (74.0% of revenues) in
2002 due to the higher sales volume in 2003. The gross profit percentage increased to 27.8% from
26.0% in 2002. This increase was primarily the result of a charge for the forgiveness of a note
receivable of $1,685 (0.8% of revenues) in our Marketing Services business in 2002. Excluding the impact for the forgiveness of the note receivable, the gross profit in our Marketing
Services business decreased from 26.4% in 2002 to 26.1% in 2003 due to a decline in our Burger King
margins as compared to prior years. This decline was attributable to the provision of lower margin
logistical services, increased vendor costs and general pricing pressures. The gross profit percentage
in Consumer Products increased to 38.6% from 29.2% in 2002. This
improvement was attributable to higher margin new product introductions and to effective inventory
management both internally and in our distribution channels. Our overall gross profit percentage, excluding the impact of the charge for forgiveness of a note
receivable in 2002, improved slightly as a result of the improvement in Consumer Products. Salaries, wages and benefits Salaries, wages and benefits increased $3,861 in 2003, or 18.7%, to $24,523 (11.2% of revenues)
from $20,662 in 2002 (10.0% of revenues). This increase was primarily attributable to the addition
of employees from the acquisitions of Upshot and SCI Promotion, partially offset by a reduction in
performance bonuses for employees in 2003 (a decrease of approximately $700). Salaries, wages and benefits increased as a percentage of revenues from 10.0% to 11.2% as a result
of revenues increasing at a lesser rate. The reduction in Burger King unit volumes 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 $2,153 in 2003, or 9.6%, to $24,576 (11.2%
of revenues) from $22,423 (10.8% of revenues) in 2002. The increase was primarily the result of
additional operating expenses resulting from the acquisitions of Upshot and SCI Promotion. Selling, general and administrative expenses increased as a percentage of revenues from 10.8% to
11.2% as a result of revenues increasing at a lesser rate. The reduction in Burger King unit
volumes had a significant impact on this metric, as our cost structure required to service this
account is largely fixed. 16




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Integration costs

We recorded integration costs of $453 (0.2% of revenues) in 2002. These costs represent
expenses directly related to the integration of Upshot such as travel, training and
consulting. Restructuring In 2003, we recorded a net restructuring charge of $234 (0.1% of revenues) compared to $178
(0.1% of revenues) in 2002. In 2003, we recorded restructuring charge of $424 which
represents severance for workforce reductions at our Upshot division. Our Upshot business did
not achieve the level of contribution we were expecting this year which is primarily
attributable to reduced marketing expenditures by a couple of its larger clients. In order to
bring our cost structure in line with the current business volume, we eliminated eight
positions at Upshot. This charge was partially offset by a $190 reversal of a restructuring
reserve that we established in 1998 relating to former consumer products licenses. This
reversal is attributable to the expiration of certain contractual rights. The 2002
restructuring charge represents severance for workforce reductions made to combine and
streamline the operations of the Company subsequent to the acquisition of Upshot. Other income Other income increased $6 in 2003, or 1.6%, to $389 (0.2% of revenues) from $383 (0.2% of
revenues) in 2002. Other income was composed of a gain on foreign exchange of $439, a gain on
asset disposal of $19 and net interest expense of $69. Net interest income decreased $132 in
2003 from $63 in 2002. This decrease was attributable to a decline in interest rates as well
as to the reduced level of cash, cash equivalents and marketable securities as a result of
cash utilized for the acquisitions of Upshot and SCI Promotion and the stock buyback program.
The gain on foreign exchange is the result of the strengthening GBP and Euro relative to the
US Dollar. Provision for Income Taxes The effective tax rate changed in 2003 to 34.0% from 36.0% in 2002. The decrease in the
effective tax rate was primarily the result of revised estimates of state income tax
apportionment factors and an increase in the relative mix of earnings being generated
internationally in countries which have more favorable tax rates. Cumulative effect of change in accounting principles The cumulative effect of change in accounting principles in 2002 is due to the adoption of
SFAS No. 142 which requires that companies no longer amortize goodwill and indefinite life
intangible assets, such as trademarks. SFAS No. 142 also requires that companies evaluate
goodwill and indefinite life intangible assets for impairment. As a result of this
evaluation, we recorded a charge of $2,496, net of tax, in connection with the goodwill
resulting from the 1998 acquisition of Contract Marketing, Inc. and U.S. Import and Promotions
Co., collectively referred to as USI. The transition charge is reflected as a cumulative
effect of change in accounting principles effective January 1, 2002, and therefore results for
the quarter ended March 31, 2002 have been adjusted retroactively. See Critical Accounting
PoliciesGoodwill and Other Intangibles below. Net income Net income increased $3,724, or 88.1%, to $7,949 in 2003 (3.6% of revenues) from $4,225 in
2002 (2.0% of revenues). The increase was primarily due to the cumulative effect of change in
accounting principles in 2002 of $2,496, net of tax, a charge for the forgiveness of a note
receivable in 2002 of $1,045, net of tax, and the increase in gross profit earned on higher
revenues in 2003. The increase was partially offset by the increased salaries, wages and
benefits and selling, general and administrative expenses in 2003. 17




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Financial Condition and Liquidity Overview Over the past several years, our primary focus has been on diversifying and growing our
Marketing Services skills and infrastructure though acquisitions. From 2001 to 2004, EMAK
invested approximately $35,000 to acquire Logistix, Upshot, SCI Promotion, Johnson Grossfield
and Megaprint Group. Our acquisition strategy was successful in diversifying our revenue
mixour largest client, Burger King, accounted for 51% of our total revenues in 2004 as
compared to 80% of our revenues in 2000. Over this same period however, we experienced a
significant decrease in Burger King program unit volumes which offset the revenue contribution
from our newly acquired agencies. The largely fixed cost structure required to service the
Burger King account, combined with the operating expenses of our larger family of agencies,
has resulted in a trend of decreasing cash flows generated by operating activities from over
$22,000 in 2000 to less than $2,000 in 2003. As a result of the operating losses in 2004, we
used approximately $9,200 in cash from operating activities. We ended 2004 with $4,406 in
cash and cash equivalents and $6,025 in short-term debt (see discussion below). Despite the losses in 2004, we expect to generate positive cash flows from operations in 2005
and growth thereafter. As discussed above, in the second half of 2004 we began seeing the
trend of lower domestic Burger King unit volumes turn around as a result of recent
improvements in Burger King system sales of Kids Meals. In addition, we are in the process of
winding-down our Pop Rocket business. This business requires disproportionately large
investments in working capital relative to the revenues it generates and was responsible for
the bulk of our losses in 2004. Furthermore, as a result of our acquisitions, we continue to
become more diversified and we have a strong global pipeline of new business in our Marketing
Services segment. We are managing our business for growth, and we see evidence that our
integrated marketing services strategy is working despite the challenges of 2004. We believe that cash from operations, cash on hand at December 31, 2004 and our credit
facility will be sufficient to fund working capital needs for at least the next twelve months.
The statements set forth herein are forward-looking and actual results may differ materially.
See Credit Facilities below and Note 6 of the accompanying Notes to Consolidated Financial
Statements. 2004 Compared to 2003 At December 31, 2004, cash and cash equivalents decreased by $14,885 million to $4,406
compared to $19,291 at December 31, 2003, primarily due to the acquisition of Johnson
Grossfield and the net operating loss in 2004. As of December 31, 2004, net accounts receivable increased $10,415 to $47,180 from $36,765 in 2003.
This increase was primarily due to higher revenues at Logistix and additional receivables acquired
as a result of the Johnson Grossfield and Megaprint Group acquisitions. At December 31, 2004, inventories increased $3,664 to $18,763 from $15,099 in 2003. This was
primarily due to an increase in Consumer Products inventories for product scheduled for delivery in
the first quarter of 2005 as a result of the timing of the 2005 Easter Holiday. The increase is
also the result of additional inventories acquired as a result of the Johnson Grossfield and
Megaprint Group acquisitions. Marketing Services inventories represent 65% and 71% of total
inventories as of December 31, 2003 and 2004, respectively. Marketing Services inventories
generally have lower risk than Consumer Products inventories, as they usually represent product
made to order. At December 31, 2004, short-term debt increased $5,399 to $6,025 from $626 in 2003. This
increase is primarily attributable to short-term borrowings to finance the purchase of the
Megaprint Group, short-term debt assumed in the Megaprint Group acquisition and bank advances
at Logistix to finance inventory purchases. At December 31, 2004, accounts payable increased $2,757 to $30,996 from $28,239 in 2003. The
increase is primarily attributable to additional accounts payable acquired as a result of the
Johnson Grossfield and Megaprint Group acquisitions. At December 31, 2004, deferred revenue increased $1,445 to $3,607 from $2,162 in 2003. This
increase is primarily attributable to additional deferred revenue acquired as a result of the
Megaprint Group acquisition. Due to customer decreased $1,535 to $3,741 from $5,276 in 2003. This decrease in due to
customer was primarily due to the timing of the payment of royalty and administrative fees
collected from distribution companies on behalf of a significant Marketing Services client. At December 31, 2004, accrued liabilities, including accrued payroll and payroll related
costs, increased $3,755 to $13,512 from $9,757 in 2003. This increase in accrued liabilities
is primarily attributable to the accrual for the minimum royalty guarantee shortfalls and
accrued liabilities, accrued payroll and payroll related costs acquired as a result of the
Johnson Grossfield and Megaprint Group acquisitions. 18




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At December 31, 2004, working capital was $17,934 compared to $29,447 at December 31, 2003.
Cash flows used in operations for 2004 were $9,228 compared to cash flows provided by
operations of $1,335 in the prior year. This change is largely the result of the net loss.
Cash flows used in investing activities for 2004 increased $2,608 to $8,743 from $6,135 in the
prior year. This increase is primarily the result of the Johnson Grossfield and Megaprint
Group acquisitions in 2004 and increased purchases of fixed assets. Cash flows provided by
financing activities for 2004 were $2,982 compared to cash flows used in financing activities
of $1,891 in the prior year. This increase is primarily the result of an increase in
short-term borrowings to fund the Megaprint Group acquisition and to fund inventory purchases
at Logistix and a decrease in the repurchase of treasury stock partially offset by a decrease
in proceeds from the exercise of stock options. Commitments Future minimum annual commitments for guaranteed minimum royalty payments under license
agreements, non-cancelable operating leases and employment agreements as of December 31, 2004
are as follows: 2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    Thereafter
    
    
    TotalOperating Leases
    
    $
    4,911
    
    
    $
    4,347
    
    
    $
    4,047
    
    
    $
    3,641
    
    
    $
    3,664
    
    
    $
    2,625
    
    
    $
    23,235Guaranteed Royalties
    
    
    4,571
    
    
    
    2,613
    
    
    
    1,076
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,260Employment Agreements
    
    
    1,687
    
    
    
    751
    
    
    
    325
    
    
    
    200
    
    
    
    200
    
    
    
    1,600
    
    
    
    4,763Total
    
    $
    11,169
    
    
    $
    7,711
    
    
    $
    5,448
    
    
    $
    3,841
    
    
    $
    3,864
    
    
    $
    4,225
    
    
    $
    36,258
 We had no material commitments for capital expenditures at December 31, 2004. Letters of
credit outstanding as of December 31, 2003 and 2004 totaled $1,829 and $2,694, 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. On March 31, 2005 the
maturity date of the Facility was further extended through March 31, 2006. The credit facility is
secured by substantially all of our assets and provides for a line of credit of up to $35,000 with
borrowing availability determined by a formula based on qualified
assets. The March 31, 2005
amendment reduced the line of credit to $20,000. We sought a reduction in the size of the Facility
to better align the size and cost of the Facility with our borrowing needs. Interest on
outstanding borrowings will be based on either a fixed rate equivalent to LIBOR plus an applicable
spread of between 1.50 and 2.25 percent or a variable rate equivalent to the banks reference rate
plus an applicable spread of between zero and 0.50 percent. We are also required to pay an unused
line fee of between zero and 0.60 percent per annum and certain letter of credit fees. The
applicable spread is based on the achievement of certain financial ratios. The Facility also
requires us to comply with certain restrictions and covenants as amended from time to time. On
November 14, 2001, February 8, 2002, September 30, 2002, November 14, 2003, April 26, 2004, August
12, 2004, November 15, 2004 and March 31, 2005, certain covenants under the facility were amended.
As of December 31, 2004, we were in compliance with the amended restrictions and covenants. In
addition to amending certain covenants, the November 15, 2004 amendment imposed a temporary $12,000
cap on total outstanding borrowings and letters of credit. This amendment also increased the
maximum interest rate on outstanding borrowings by 0.25 percent.
The March 31, 2005 amendment
eliminated the temporary $12,000 cap. The Facility may be used for working capital and acquisition
financing purposes. As of December 31, 2004, $2,975 was outstanding under the Facility. In addition to the Facility, in October, 2003 our Logistix subsidiary established an import/letter of credit facility with Hong Kong Shanghai Bank Corp. (HSBC) to provide short-term financing of product purchases in Asia. The
total availability under this facility is 1,000 GBP. Under this facility HSBC may pay Logistixs vendors directly upon receipt of invoices and shipping documentation. Logistix in turn is obligated to repay HSBC within 120 days. As
of December 31, 2004, advances outstanding under this facility totaled approximately $1,797. In connection with the acquisition of the Megaprint Group, we assumed a mortgage loan secured
by a building in Holland. The mortgage loan has a 24 year term
and carries an interest rate
fixed at 5 percent per annum for three years from December 2002. The mortgage loan is
repayable in equal monthly installments of 4 Euros The outstanding balance on the mortgage
loan is 919 Euros (approximately US $1,253) as of December 31, 2004. Notwithstanding the
terms of the mortgage loan, it will be repaid in the second quarter of 2005. In the event
that the Megaprint Group is unable to sell the building by March 31, 2005, we will offset the
balance of the mortgage loan against monies owed to the sellers of the Megaprint Group (see
Acquisitions). This mortgage loan is recorded as short-term debt in the accompanying
balance sheet as of December 31, 2004. Megaprint Group has an overdraft facility of 750 Euros from ING Bank, Nederland. As of
December 31, 2004, there were no amounts outstanding under this facility. 19




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Acquisitions On July 17, 2002, we consummated the acquisition of UPSHOT, a marketing agency with expertise
in promotion, event marketing, collaborative marketing and environmental branding. We financed
the acquisition through our existing cash reserves. The acquisition was consummated pursuant
to an Asset Purchase Agreement, dated May 22, 2002, by and among EMAK, Promotional Marketing,
LLC (Promotional Marketing) and HA-LO Industries, Inc. (HA-LO) (the Upshot Purchase
Agreement). Under the terms of the Upshot Purchase Agreement, we acquired the principal
assets of Promotional Marketing (consisting of the principal assets used in connection with
the operation of the UPSHOT business) for $9,206 in cash plus related transaction costs of
$685. This purchase price is net of $106 received in the fourth quarter of 2002 for a closing
balance sheet working capital adjustment. We assumed the principal current liabilities of the
UPSHOT business in connection with the acquisition. HA-LO, which is the parent company of
Promotional Marketing, was in Chapter 11 bankruptcy proceedings as of the acquisition date,
and our acquisition of the UPSHOT business was approved by the United States bankruptcy court.
In 2004, we recorded a charge for impairment of assets of
$6,312 as a result of the annual impairment test required by SFAS No. 142. The charge was due
primarily to Upshots loss of a significant client in the fourth quarter of 2004. See
Critical Accounting Policies  Goodwill and Other Intangibles below. On September 3, 2003, we acquired substantially all of the assets of SCI Promotion, 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 Promotion and Joseph J.
Schmidt, III (the SCI Promotion Purchase Agreement). Under the terms of the SCI Promotion
Purchase Agreement, we acquired substantially all of the assets of SCI Promotion 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, 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. On February 2, 2004, we acquired certain assets of Johnson Grossfield, Inc. (JGI-MN) a privately
held promotional marketing services company based in Minneapolis, Minnesota (the Johnson
Grossfield Acquisition). We financed the Johnson Grossfield Acquisition through our existing cash
reserves. The Johnson Grossfield Acquisition was consummated pursuant to an Asset Purchase
Agreement dated January 16, 2004, by and among the Company, Johnson Grossfield, Inc., a Delaware
corporation wholly owned by us (Johnson Grossfield), JGI-MN, Marc Grossfield and Thom Johnson
(the Johnson Grossfield Purchase Agreement). Under the terms of the Johnson Grossfield Purchase
Agreement, we purchased the assets of JGI-MNs promotional agency business for approximately $4,600
in cash and 35,785 shares of our common stock (which, based upon the January 30, 2004 closing
market price of $14.80, had a value of $530), plus additional earnout consideration of up to $4,500
based upon future performance of the acquired business. We also assumed the operating liabilities
of the promotional agency business in connection with the acquisition. The earnout consideration
is based upon the acquired business achieving targeted levels of earnings before interest, taxes,
depreciation and amortization (EBITDA) over the period from 2004 through 2008. The earnout
payments, if required, are payable 50% in cash and 50% in shares of our common stock. The
additional consideration, if any, will be recorded as goodwill. On November 10, 2004, the Company acquired all of the outstanding capital stock of Megaprint Group
Limited (Megaprint Group), a privately held creative promotions agency headquartered in the
United Kingdom. The Company financed the Megaprint Group acquisition
through short-term debt. The
Company paid 1,824 GBP (approximately US $3,388) in cash (net of a hold back for working capital
adjustments of 180 GBP), plus related transaction costs of 283 GBP (approximately US $526). Under
the terms of the Stock Purchase Agreement, the Company is committed to pay, subject to offset for
any shortfall in the target level of net working capital at December 31, 2004, a minimum of 850 GBP
and up to a maximum of 1,300 GBP in 2005 based on the performance of Megaprint Group for the year
ended December 31, 2004. The Company has accrued a liability for the minimum payment of 850 GBP as
purchase price as of the acquisition date. The Company is also committed to pay additional
consideration up to a maximum of 2,450 GBP based on future performance through 2009. The
additional consideration is based upon the business achieving targeted levels of margin after
direct overhead (MADO) over the period from 2005 through 2009. The additional consideration, if
any, will be recorded as goodwill. 20




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##### Table of Contents



Preferred Stock On March 29, 2000, Crown EMAK Partners, LLC, a Delaware limited liability company (Crown),
invested $11,900 in EMAK in exchange for preferred stock and warrants to purchase additional
preferred stock. Under the terms of the investment, Crown acquired 11,900 shares of Series A
mandatorily redeemable senior cumulative participating convertible preferred stock, par value
$.001 per share, (the Series A Stock) with a conversion price of $14.75 per common share.
In connection with such purchase, we granted to Crown five year warrants (collectively, the
Warrants) to purchase 5,712 shares of Series B senior cumulative participating convertible
preferred stock, par value $.001 per share, (the Series B Stock) at an exercise price of
$1,000 per share, and 1,428 shares of Series C senior cumulative participating convertible
preferred stock, par value $.001 per share, (the Series C Stock) at an exercise price of
$1,000 per share. The Warrants were immediately exercisable. The conversion prices of the
Series B Stock and the Series C Stock were $16.00 and $18.00 per common share, respectively.
On June 20, 2000, Crown paid us an additional $13,100 in exchange for an additional 13,100
shares of Series A Stock with a conversion price of $14.75 per common share. In connection
with such purchase, we granted to Crown additional Warrants to purchase another 6,288 shares
of Series B Stock and another 1,572 shares of Series C Stock. Each share of Series A Stock is
convertible into 67.7966 shares of Common Stock, representing 1,694,915 shares of Common Stock
in aggregate. Each share of Series B Stock and Series C Stock is convertible into 62.5 and
55.5556 shares of Common Stock, respectively, representing 916,666 shares of Common Stock in
aggregate. Also in connection with such purchase, we agreed to pay Crown a commitment fee in
the aggregate amount of $1,250, paid in equal quarterly installments of $62.5 commencing on
June 30, 2000 and ending on March 31, 2005. We paid $250 in fees for the year ended December
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 also have been convertible into
916,666 shares of Common Stock). The New Warrants consist of warrants to purchase 750,000
shares and 166,666 shares of Common Stock at exercise prices of $16.00 and $18.00 per share,
respectively. Of each tranche, 47.6% expire on March 29, 2010 and 52.4% expire on June 20,
2010. As a result of the exchange transaction, Crown received an extension of time in which
to exercise its right to purchase additional equity in EMAK, and EMAK obtained an elimination
of the preferred rights and preferences as well as the preferred dividend associated with the
now eliminated Series B Stock and Series C Stock. On December 30, 2004, we entered into an Exchange Agreement with Crown whereby Crown received
25,000 shares of Series AA mandatorily redeemable senior cumulative preferred stock, par value
$0.001 per share, (the Series AA Stock) with a
conversion price of $14.75 per common share, in
exchange for 25,000 shares of Series A Stock. The Series AA Stock has substantially the same
rights and preferences as the Series A Stock, but does not participate in cash dividends paid
on Common Stock. The exchange was effected in response to the requirements of Emerging Issues
Task Force (EITF) Issue No. 03-6, Participating Securities and the Two-Class Method under
Financial Accounting Standards Board (FASB) No. 128, which requires companies having
participating securities to calculate earnings per share using the two-class method. (See 
Recent Accounting Pronouncements below.) Upon any voluntary or involuntary liquidation, dissolution or winding-up of our affairs,
Crown, as holder of the Series AA Stock, will be entitled to payment out of our assets
available for distribution of an amount equal to the greater of (a) the liquidation preference
of $1,000 per share (the Liquidation Preference) plus all accrued and unpaid dividends or
(b) the aggregate amount of payment that the outstanding preferred stock holder would have
received assuming conversion to Common Stock immediately prior to the date of liquidation of
capital stock, before any payment is made to other stockholders.
The Series AA Stock is subject to mandatorily redemption at the option of the holder at 101%
of the aggregate Liquidation Preference plus accrued and unpaid dividends if a change in
control occurs.
Crown has voting rights equivalent to the number of shares of Common Stock into which
their Series AA Stock is convertible on the relevant record date. Crown is also entitled to
receive a quarterly dividend equal to 6% of the Liquidation Preference per share outstanding,
payable in cash. Total dividend for the year ended December 31, 2004 amounted to $1,500, of
which $375 was paid in January 2005 and recorded in accounts payable in the accompanying
consolidated balance sheet as of December 31, 2004. The holders of the Series AA Stock, voting separately as a class, are entitled to elect two
directors of the Company, provided however, at ant time the Board of Directors is increased to
include more than eight members, the holders of the Series AA Stock are entitled to elect one
additional director. Crown currently holds 100% of the outstanding shares of Series AA Stock,
and has designated one individual to our Board of Directors. The Series AA Stock is recorded in the accompanying consolidated balance sheets at its
Liquidation Preference net of issuance costs. The issuance costs total approximately $1,951
and include an accrual of approximately $1,000 for the present value of the commitment fee
discussed above. 21




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Restructuring During 2002, we formulated and implemented a restructuring plan in connection with the Upshot
acquisition in order to combine and streamline EMAKs and Upshots operations. In connection with
this plan we recorded a restructuring charge of $178. This charge represents severance for a
workforce reduction of seven employees in our Los Angeles office, who were terminated, and is
reflected as a restructuring charge in the accompanying consolidated statement of operations. The
workforce reduction included employees from our Marketing Services segment as well as other support
services. In connection with the restructuring plan, we also decided to close Upshots Richmond, Virginia
office and eliminate certain positions at Upshots Chicago, Illinois office. Additionally, in 2003
we finalized the plan with respect to vacating half of the leased space (approximately 30,000
square feet) at Upshots Chicago, Illinois office. This resulted in an adjustment to the
liabilities recorded and an increase to goodwill of $1,900 for the present value of the remaining
lease payments for the vacated office space in excess of the estimated sub-lease income. The
liabilities assumed in connection with this restructuring plan totaled $3,535 and are included as
part of goodwill in accordance with Emerging Issues Task Force (EITF) Issue No. 95-3,
Recognition of Liabilities in Connection with a Purchase
Business Combination. $2,421 of these
liabilities were paid as of December 31, 2004. In 2003, we recorded a restructuring charge of $424 which represents severance for workforce
reductions at our Upshot division. Our Upshot business did not achieve the level of contribution
we were expecting that year which was primarily attributable to reduced marketing expenditures by a
couple of its larger clients. In order to bring our cost structure in line with the current
business volume, we eliminated eight positions at Upshot in December 2003. This charge was partially offset by a $190 reversal of a restructuring reserve that we
established in 1998 relating to former consumer products licenses. This reversal is attributable
to the expiration of certain contractual rights. In 2004, we implemented a restructuring plan in connection with the realignment of centralized
resources in our Marketing Services business in order to combine and streamline the operations. In
connection with this plan we recorded a restructuring charge of $81. This charge represents
severance for one employee in our Los Angeles office, who was terminated, and is reflected as a
restructuring charge in the accompanying condensed consolidated statement of operations. This
charge was partially offset by a restructuring gain of $25 that represents a reversal of a portion
of the 2003 restructuring charge related to the severance for workforce reductions at Upshot. On February 24, 2005, we finalized a decision to
pursue the wind down of substantially all of our consumer products business, Pop Rocket. Our
determination is to significantly scale back this business during 2005 while exiting the business
permanently as soon as is feasible. In the near term, this includes restructuring the Pop Rocket
division and exiting certain licenses. In connection with this decision, we expect to incur charges
for one-time employee termination benefits and other costs. The Company expects employee
termination costs to range from $700 to $900 in 2005. We are unable in good faith to make a
determination of an estimate as to other costs. Such costs are expected to result in future cash
expenditures. As a result of the wind down, in the fourth quarter of 2004, we recorded a pre-tax charge of $7,722
million relating to minimum royalty guarantee shortfalls on several of our consumer products
licenses. Approximately $3,000 of this pre-tax charge is non-cash for write-offs of long-term
royalty advances. Of the remaining $4,700, we are working with licensors to mitigate the future
cash impact of the shortfall. Stock Repurchase On July 24, 2001, 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 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 $10,000 for
the repurchase of our common stock. We spent $3,505 to repurchase 267,650 shares at an
average price of $13.10 per share including commissions under this authorization through
December 31, 2004. The duration of the current buyback program is indefinite; provided,
however, that our Board of Directors periodically reviews the program. 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. This repurchase program is
being funded through working capital. Inflation The effect of inflation on our operations during 2004 was insignificant. We will continue our
policy of controlling costs and adjusting prices to the extent permitted by competitive
factors. 22




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Related Party Transactions 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
served as an advisor to the Company with respect to potential mergers and acquisitions through
December 31, 2003 (the 2003 Agreement). On August 23, 2004, the Company entered into another
advisory agreement with USCI for services during calendar 2004 (the 2004 Agreement). Mr.
Deutschman currently serves on the Board of Directors of the Company as the representative of the
holder of the Companys Series AA Stock. The Companys agreements with USCI provided for the
payment of a discretionary success fee for completed acquisition transactions in an amount
determined by an independent committee of the Board. The 2003 Agreement set forth guidelines for
fees payable upon successful completion of an acquisition transaction of $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 had an
initial fee guideline of $275 for up to $10,000 of consideration. Notwithstanding the guidelines,
the independent committee had absolute discretion in determining the amount, if any, of the success
fee for any transaction. The 2004 Agreement does not include success fee guidelines. The USCI
agreements provide for the payment of a refundable advance against success fees in the aggregate
amount of $275 under the 2003 Agreement and $322 under the 2004 Agreement. The Company believes
that these agreements enhanced its ability to analyze and close merger and acquisition transactions
in a more cost effective manner than with traditional outside advisory firms. In connection with
the acquisition of SCI Promotion, USCI earned a success fee of $275. This success fee is recorded
as a transaction cost of the SCI Promotion acquisition. In connection with the February 2004
acquisition of Johnson Grossfield, USCI earned a success fee of $125. This success fee is recorded
as a transaction cost of the Johnson Grossfield acquisition. In connection with the acquisition of
Megaprint Group in November 2004, USCI earned a success fee of $322. This success fee is recorded
as a transaction cost of the Megaprint Group acquisition. The Company has not extended its
arrangement with USCI for 2005. Subsequent Event On March 31, 2005, the Companys credit facility with Bank of America was amended. This amendment
extended the maturity date of the Facility from June 30, 2005 to March 31, 2006, changed certain
covenants and restrictions to better suit the Companys business model, reduced the line of credit
from $35,000 to $20,000, and eliminated the temporary $12,000 cap on total outstanding borrowings
and letters of credit. The Company sought a reduction in the size of the Facility to better align
the size and cost of the Facility with its borrowing needs. Recent Accounting Pronouncements In November 2003 and March 2004, 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 adoption of EITF Issue No. 03-1 will not have
a material impact on our results of operations or financial position because we do not have any
investments in marketable securities as December 31, 2004. 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 adopted EITF 03-6 for the quarter ended June 30, 2004. EITF
03-6 had no impact on 2004 per share amounts because of the net loss. In addition EITF 03-6, will
not have an impact on earnings per share in future periods due to the exchange of our outstanding
participating securities for non-participating securities. In September 2004, the consensus of EITF Issue No. 04-10, Applying Paragraph 19 of FASB Statement
No. 131, Disclosures about Segments of an Enterprise and Related Information, in Determining
Whether to Aggregate Operating Segments That Do Not Meet the Quantitative Thresholds, was
published. EITF Issue No. 04-10 addresses how an enterprise should evaluate the aggregation
criteria of SFAS No. 131 when determining whether operating segments that do not meet the
quantitative thresholds may be aggregated in accordance with SFAS No. 131. The effective date of
the consensus in this Issue is for fiscal years ending after October 13, 2004. Adoption of the
EITF has not affected our segment classifications. In November 2004, the FASB issued SFAS No. 151, Inventory CostsAn Amendment of ARB No. 43,
Chapter 4. SFAS No. 151 amends the guidance in Chapter 4, Inventory Pricing, of Accounting
Research Bulletin (ARB) No. 43, Restatement and Revision of Accounting Research Bulletins, to
clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage). Among other provisions, the statement requires that items such as
idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as
current-period charges regardless of whether they meet the criterion of so
abnormal as stated in ARB No. 43. Additionally, SFAS No. 151 requires that the allocation of
fixed production overheads to the costs 23




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of conversion be based on the normal capacity of the
production facilities. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005.
We are currently evaluating the effect that the adoption of SFAS No. 151 will have on its results
of operations and financial position, but do not expect it to have a material impact. In December 2004, the FASB released FASB Staff Position No. FAS 109-1 (FSP 109-1). FASB Staff Position No. 109-1, Accounting of SFAS No. 109, Accounting for Income Taxes, for the Tax Deduction Provided to U.S.-Based
Manufacturers by the American Jobs Creation Act of 2004,
clarifies that the tax deduction for domestic manufacturers under the
American Jobs Creation Act of 2004 should be accounted for as a
special deduction in accordance with SFAS No. 109, Accounting for Income Taxes. The FSP went into effect upon being issued. FSP 109-1 had no impact on our consolidated financial statements. In December 2004, the FASB released FASB Staff Position No. FAS 109-2 (FSP 109-2). FASB
Staff Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings
Repatriation Provision within the American Jobs Creation Act of 2004, provides companies more
time (beyond the financial-reporting period during which the Act took effect) to evaluate the
Acts impact on our plan for reinvestment or repatriation of certain foreign earnings for
purposes of applying SFAS No. 109, Accounting for Income Taxes. The FSP went into effect
upon being issued. As of December 31, 2004, we had not determined whether, or to what extent, we
may repatriate foreign earnings under the Jobs Act. Therefore, our 2004 consolidated
financial statements do not include any provision for income taxes on the $5,705 cumulative
balance of unremitted foreign earnings as of year end 2004. Management expects to finalize
its assessment related to the Jobs Act in the first half of 2005. In December 2004, the FASB issued SFAS No. 123R (revised 2004), Share-Based Payment, which
replaced SFAS No. 123, Accounting for Stock-Based Compensation, and superceded APB Opinion
No. 25, Accounting for Stock Issued to Employees. SFAS No. 123R requires all share-based
payments to employees, including grants of employee stock options, to be recognized in the
financial statements based on their fair values in the first interim or annual period
beginning after June 15, 2005. The pro forma disclosures previously permitted under SFAS No.
123 will no longer be an alternative to financial statement recognition. We are required to
adopt SFAS No. 123R in the third quarter of fiscal year 2005, beginning July 1, 2005. Under
SFAS No. 123R, we must determine the appropriate fair value method to be used for valuing
share-based payments, the amortization method of compensation cost and the transition method
to be used at the date of adoption. The transition methods include prospective and retroactive
adoption options. Under the retroactive option, prior periods may be restated either as of the
beginning of the year of adoption or for all periods presented. The prospective method
requires that compensation cost be recorded for all unvested stock options and nonvested stock
at the beginning of the first quarter of adoption of SFAS No. 123R, whereas the retroactive
method requires recording compensation cost for all unvested stock options and nonvested stock
beginning with the first period restated. We are evaluating the requirements of SFAS No. 123R
and expect that the adoption of SFAS No. 123R will have a material impact on our results of
operations and earnings per share. We have not yet determined the method of adoption of SFAS
No. 123R, or whether the amounts recorded in the consolidated statements of income in future
periods will be similar to the current pro forma disclosures under SFAS No. 123. Critical Accounting Policies We make certain estimates and assumptions that affect the reported amounts of assets and
liabilities and the reported amounts of revenues and expenses. The accounting policies described
below are those we consider most critical in preparing our consolidated financial statements.
Management has discussed the development and selection of each of these critical accounting
policies with the audit committee of the board of directors and the audit committee has reviewed
each of the disclosures included below. These policies include significant judgment made by
management using information available at the time the estimates are made. As described below,
however, these estimates could change materially if different information or assumptions were used. Revenue Recognition For product related sales, we record revenues when title and risk of loss pass to the
customer. When a right of return exists, our practice is to estimate and provide for any
future returns at the time of sale, in accordance with SFAS No. 48, Revenue Recognition When
Right of Return Exists. Accruals for customer discounts and rebates and defective returns
are recorded as the related revenues are recognized. Service revenues include all amounts that are billable to clients under service contracts.
Service related revenues are recognized on a time and materials basis, or on a straight-line
basis, depending on the contract. In the case of fee and production arrangements, the
revenues are recognized as the services are performed, which is generally ratably over the
period of the client contract. Revenues from time and materials service contracts are
recognized as the services are rendered. Revenues from fixed price retainer contracts are
recognized on a straight-line basis over the contract term. Losses on contracts are
recognized during the period in which the loss first becomes probable and reasonably
estimable. Reimbursements, including those relating to travel and other out-of-pocket
expenses, and other similar third-party costs, such as printing costs, are included in
revenues, and an equivalent amount of reimbursable expenses are included in cost of sales.
Service revenues for the years ended December 31, 2002, 2003 and 2004
totaled $13,895, $22,129
and $24,692, respectively. Unbilled revenues represent revenues recognized in advance of
billings rendered based on work performed to date on certain service contracts. Unbilled revenues as
of December 31, 2003 and 2004 totaled $992 and $2,100, respectively. Unbilled revenues are
recorded in accounts receivable in the accompanying consolidated balance sheet. Unbilled
revenues are expected to be billed and collected within the next six months. 24




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In May 2003, the EITF issued Issue No. 00-21, Accounting for Revenue Arrangements with
Multiple Deliverables. EITF Issue No. 00-21 provides guidance on how to determine when an
arrangement that involves multiple revenue-generating activities or deliverables should be
divided into separate units of accounting for revenue recognition purposes, and if this
division is required, how the arrangement consideration should be allocated among the separate
units of accounting. The guidance in this Issue is effective for revenue arrangements entered
into in fiscal periods beginning after June 15, 2003. Under the contractual arrangements with
Burger King, creative services are a separate deliverable from manufacturing services. As a
result, we are required to record the creative revenues when the specification and engineering
package is delivered to and accepted by Burger King. Our revenue recognition policies are in compliance with the Securities and Exchange
Commissions Staff Accounting Bulletin (SAB) No. 101: Revenue Recognition in Financial
Statements and SAB No. 104 Revenue Recognition in Financial Statements. Allowance for Doubtful Accounts The allowances for doubtful accounts receivable and sales returns represent adjustments to
customer trade accounts receivable for amounts deemed partially or entirely uncollectible.
Management believes the accounting estimate related to such allowances is a critical
accounting estimate because significant changes in it could materially affect key financial
measures including revenues and selling, general and administrative expenses. In addition,
the allowances require a high degree of judgment since they involve the estimation of the
impact of both current and future economic factors as it relates to each of our customers
ability to pay amounts owed to us. In the case of our Consumer Products segment, we must
estimate the impact of retail sell through on customer discounts and returns. We regularly extend credit to distribution companies in connection with our business with
Burger King, which includes the Supply Chain Services, LLC (SCS), a subsidiary of Burger
Kings franchisee purchasing cooperative Restaurant Services, Inc. (RSI.) We began selling
product to SCS in October 2003. Receivables from SCS with terms in excess of net 30 (up to
net 60) are guaranteed by RSI as required under our credit policy. Because of RSIs
established credit history with us, as well as the payment history of SCS, we dont believe
that this increase in concentration of receivables has negatively impacted our overall credit
risk. Failure by SCS or one or more distribution companies to honor their payment obligations
to us could have a material adverse effect on our operations. The largest such distribution
company accounted for 20.5%, 17.9% and 80.2% of the products purchased from us by the Burger
King system for the years ended December 31, 2002, 2003 and 2004, respectively. The largest
such distribution company accounted for 23.9% and 19.2% of accounts receivable as of December
31, 2003 and 2004, respectively. We also extend credit to several retailers in the Consumer Products business. The mass market
retail channel has experienced significant shifts in market share among competitors in recent
years, causing some large retailers to experience liquidity problems. Failure by one or more
of these retailers to honor their payment obligations to us could have a material adverse
effect on our operations. We have procedures to mitigate the risk of exposure to losses from bad debts. Revenue is
recognized provided that: there are no uncertainties regarding customer acceptance; persuasive
evidence of an agreement exists documenting the specific terms of the transaction; the sales
price is fixed or determinable; and collectibility is reasonably assured. Our credit limits
and payment terms are established based on the underlying criteria that collectibility must be
reasonably assured at the levels set for each customer. Extensive evaluations are performed
on an on-going basis throughout the fiscal year of the financial performance, cash generation,
financing availability and liquidity status of each customer. Each customer is reviewed at
least annually, with more frequent reviews being performed if necessary based on the
customers financial condition and the level of credit being extended. For customers who are
experiencing financial difficulties, management performs additional financial analyses prior
to shipping to those customers on credit. Customer terms and credit limits are reviewed and
adjusted, if necessary, to reflect the results of the review. We use a variety of financial
transactions to ensure collectibility of accounts receivable of customers deemed to be a
credit risk, including requiring letters of credit and requiring cash on delivery. We record allowances for doubtful accounts receivable and sales returns at the time revenue is
recognized based on managements assessment of the business environment, customers financial
condition, historical collection experience, accounts receivable aging, retail sell through
and customer disputes. When a significant event occurs, such as a bankruptcy filing of a
customer, the allowance is reviewed for adequacy and adjusted to reflect the change in
estimated receivable impairment. We believe that our allowances for doubtful accounts
receivable and sales returns at December 31, 2004 are adequate and proper. 25




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Goodwill and Other Intangibles SFAS No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets
were approved by 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. The statement required us to perform a transitional goodwill
impairment test, using values as of January 1, 2002. We completed the goodwill transitional
impairment test in the second quarter of 2002. As a result, we determined that a non-cash
charge in the amount of $2,496, net of tax, was required relating to the goodwill resulting
from the 1998 acquisition of Contract Marketing, Inc. and U.S. Import and Promotions Co.,
collectively referred to as USI. The transition charge is reflected as a cumulative effect
of change in accounting principles effective January 1, 2002, and therefore, results for the
quarter ended March 31, 2002 have been adjusted retroactively. We have adopted the provisions
of these statements for the acquisition of Logistix effective July 1, 2001 and for all other
acquisitions effective January 1, 2002. Accordingly, beginning on January 1, 2002, we have
foregone all related goodwill amortization expense. Prior to implementing SFAS No. 142, we reviewed all goodwill assets for impairment under the
methodology of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for the
Long-Lived Assets to be Disposed of. The undiscounted cash flows associated with all
goodwill assets were in excess of the book value of the related goodwill assets, including USI
goodwill. Therefore, no goodwill assets, including USI goodwill, were considered impaired
under SFAS No. 121. Under the provisions of SFAS No. 142, the carrying value of assets acquired, including
goodwill, are reviewed annually. During such a review we 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. We will compare the discounted future 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 2004, we performed the annual impairment test required by SFAS No. 142 and
determined that the goodwill resulting from the acquisition of Upshot was impaired as of
December 31, 2004. As a result, we recorded a non-cash charge in the amount of $6,312 to
write-down the carrying value of the Upshot goodwill. Management believes the accounting estimate related to the valuation of its goodwill and other
intangibles is a critical accounting estimate because significant changes in assumptions
could materially affect key financial measures, including net income and goodwill. Our valuation method requires us to make projections of revenue, operating expenses and
working capital investment for the reporting unit over a multi-year period. Additionally,
management must make an estimate of its weighted average cost of capital to be used as a
discount rate. Changes in these projections or estimates could result in a reporting unit
either passing or failing the first step in the SFAS No. 142 impairment model, which could
significantly change the amount of impairment recorded. Royalties We enter 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. In the fourth quarter of 2004, we recorded a pre-tax
charge of $7,722 relating to minimum royalty guarantee shortfalls on several consumer products
licenses. These shortfalls are the result of our decision to wind down its consumer products
business, Pop Rocket which resulted in a decrease in expectations of future sales under
several licenses. Management believes the accounting estimate related to minimum guaranteed royalty commitments is a
critical accounting estimate because changes in sales projections could materially affect key
financial measures including, gross profit, net income and other assets. Inventories Inventories are stated at the lower of cost or market. Inventory obsolescence reserves are
recorded for damaged, obsolete, excess and slow-moving inventory. Management believes the
accounting estimate related to inventory allowance is a critical accounting estimate because
changes in it could materially affect key financial measures including, gross profit, net income
and inventories. In addition, the valuation requires a high degree of judgment since it involves
estimation of the impact resulting from both current and expected future events. As more fully
described below, valuation of our Consumer Product inventory could be impacted by changes in public
and consumer preferences, demand for product, or changes in the buying patterns and inventory
management of customers. 26




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Although the significant majority of our inventories are composed of made-to-order promotional
product, in the Consumer Products segment orders are subject to cancellation or change at any time
prior to shipment since actual shipments of products ordered and order cancellation rates are
affected by consumer acceptance of product lines, strength of competing products, marketing
strategies of retailers and overall economic conditions. Unexpected changes in these factors could
result in excess inventory in a particular product line, which would require management to make a
valuation estimate on such inventory. We base our production schedules for consumer products on customer orders, historical trends,
results of market research and current market information. We ship products in accordance with
delivery schedules specified by our customers, which usually request delivery within three months.
In anticipation of retail sales in the traditional holiday season in the fourth quarter, we
significantly increase our production in advance of the peak selling period, resulting in a
corresponding build-up of consumer product inventory levels in the second and third quarters of the
year. These seasonal purchasing patterns and requisite production lead times cause risk to our
consumer products business associated with the underproduction of popular products and the
overproduction of products that do not have significant consumer demand. Retailers are also
attempting to manage their inventories more tightly, requiring us to ship products closer to the
time the retailers expect to sell the products to consumers. These factors increase inventory
valuation risk since we may not be able to meet demand for certain products at peak demand times,
or that our own inventory levels may be adversely impacted by the need to pre-build products before
orders are placed. Additionally, current conditions in the domestic and global economies are extremely uncertain. As
a result, it is difficult to estimate the level of growth in various parts of the economy,
including the markets in which we participate. Economic changes may affect the sales of our
consumer products and its corresponding inventory levels, which would potentially impact the
valuation of our inventory. At the end of each quarter, management within the Consumer Products business segment performs a
detailed review of its inventory on an item by item basis and identifies which products are
believed to be obsolete or slow-moving. Management then applies an allowance for inventory
obsolescence to such inventory based on certain expectations, including customer and consumer
demand for product and the aging of the inventory, which are impacted by the factors discussed
above. Management believes that the allowance for inventory obsolescence at December 31, 2004 is adequate
and proper. However, the impact resulting from the aforementioned factors could cause actual
results to vary. Any incremental obsolescence charges would negatively affect the results of
operations of the Consumer Products business segment. The following table summarizes our obsolescence reserve at December 31: 2002
    
    
    2003
    
    
    2004Allowance for obsolescence
    
    $
    1,732
    
    
    $
    665
    
    
    $
    740As a percentage of total inventories
    
    
    9.6%
    
    
    
    4.2%
    
    
    
    3.8%
 The increase from 2003 to 2004 in the allowance for obsolescence was mainly due to the
specific identification of excess inventory that was impaired as of year end 2004. Sales of
excess Consumer Products inventories in 2003 were the primary cause of the decrease in
obsolescence reserve from 2002 to 2003. Management believes that its allowance for
obsolescence at year end 2004 is adequate and proper. However, the impact resulting from the
aforementioned factors could cause actual results to vary. Any incremental obsolescence
charges would negatively affect our results of operations. 27




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Cautionary Statements and Risk Factors Set forth below and elsewhere in this Form 10-K and in other documents we file with the
Securities and Exchange Commission are important risks and uncertainties that could cause our
actual results of operations, business and financial condition to differ materially from the
results contemplated by the forward looking statements contained in this Form 10-K. We Depend Significantly on One Key Customer Our success is partly dependent on a single customer, Burger King (including its franchise
purchasing cooperative RSI and various distribution companies), which accounted for
approximately 65%, 58% and 51% of our revenues for the years ended December 31, 2002, 2003 and
2004, respectively. The termination or a significant reduction by Burger King of its business
with us would adversely affect our business. We have domestic and international agreements
with Burger King and RSI which guarantee that we will retain our role as the primary creative
and manufacturing agency of record for both domestic and international Burger King premiums
programs awarded through September 2006 (shipping through approximately September 2007). Our
long-term agreements provide for bi-annual determinations of our guaranteed level of Burger
King premiums business. The Burger King business is subject to significant year-to-year
variability. For instance, our revenues generated by our business with Burger King decreased
from $133,987 in 2002 to $126,791 in 2003 and to $120,606 in 2004. We expect a modest
increase in sales to Burger King in 2005. The success of our business with Burger King is
also partially dependent on the overall success of the Burger King system, whose sales could
be negatively impacted by such factors as increased competition and product recalls. We Face Credit Risk We regularly extend credit to distribution companies in connection with our business with
Burger King, which includes SCS, which is a subsidiary of Burger Kings franchisee purchasing
cooperative RSI. We began selling product to SCS in October 2003. Sales to SCS represented
80.2% of our sales to the Burger King System in 2004. Failure by SCS to honor their payment
obligations to us could have a material adverse effect on our operations. Because of RSIs
established credit history with us, as well as the payment history of SCS, we dont believe
that this increase in concentration of receivables has negatively impacted our overall credit
risk. We occasionally provide SCS with extended payment terms of up to 60 days on the
condition that RSI provides a guaranty of payment. We also extend credit to several retailers
in connection with various promotional programs as well as with our Consumer Products
business. The mass market retail channel has experienced significant shifts in market share
among competitors in recent years, causing some large retailers to experience liquidity
problems. Failure by one or more of these retailers to honor their payment obligations to us
could have a material adverse effect on our business. We Rely on the Continued Development of New Promotional Programs A large portion of our revenues come from a relatively limited number of promotional programs
which are in effect for only a limited period of time and generally are not repeated. We must
continually develop and sell new products and services for utilization in new promotional
programs as part of our clients annual promotions calendars. There can be no assurance that
we or our customers will be able to secure licenses for additional entertainment properties on
which to base our promotional programs or that, if secured, such licenses will result in
successful products. The Success of Our Products Depends on the Popularity of Licensed Materials Our promotional products are typically based on entertainment properties, such as characters
from current motion pictures or television programs. The success of these products largely
depends on the popularity of the entertainment properties on which they are based. Each
motion picture and television program is an individual artistic work, and its commercial
success is dependent on unpredictable consumer preferences. Our results of operations may be
adversely affected if the entertainment properties upon which our products are based turn out
to be less popular than we anticipate. Also, delays in the release of motion pictures or
television programs could result in delays or cancellations of our promotions. Our Future Operating Results are Difficult to Predict We experience significant quarter-to-quarter variability in our revenues and net income. The
promotions business tends to include larger promotions in the summer and during the winter
holiday season. Major movie and television release schedules also vary year-to-year,
influencing the promotional schedules of our customers, as well as the particular promotions
for which we are retained. The motion picture or television characters on which the
promotions business is often based may only be popular for short periods of time or not at
all. There may not be comparable popular characters or similar promotional campaigns in the
future. Due to the foregoing factors, we believe that quarter-to-quarter comparisons of our
operating results are not a good indication of our future performance. It is likely that in
some future quarter our operating results may fall below the expectations of securities
analysts and investors. 28




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There Are Risks Associated with Acquisitions If we are presented with appropriate opportunities, we may make investments in complementary
companies. The anticipated benefits of any acquisitions or investment may not be realized.
If we buy a company, we could have difficulty in assimilating that companys personnel and
operations. In addition, the key personnel of the acquired company may decide not to work for
us. If we make other types of acquisitions, we could have difficulty in assimilating the
acquired technology or products into our operations. These difficulties could disrupt our
ongoing business, distract our management and employees and increase our expenses. Future
acquisitions could result in potentially dilutive issuances of equity securities, the
incurrence of debt, contingent liabilities and/or amortization expenses related to goodwill
and other intangible assets, which could adversely affect our results of operations and
financial condition. Our Current Licenses Require Us to Pay Minimum Royalties Sales of products under trademarks or trade or brand names licensed from others account for
substantially all of our Consumer Products revenues. Product licenses allow us to capitalize
on characters, designs, concepts and inventions owned by others or developed by toy inventors
and designers. Our license agreements generally require us to make specified minimum royalty
payments, even if we fail to sell a sufficient number of units to cover these amounts. In
connection with our decision to wind down our Pop Rocket consumer products business, we took a
pre-tax charge at December 31, 2004 of $7,722 related to minimum royalty guarantee shortfalls
on several licenses. Approximately $3,000 of this pre-tax charge is non-cash for write-offs of
long-term royalty advances. Of the remaining $4,700, we are working with our licenses to
mitigate the cash impact of the shortfall. Our Business is Subject to Extensive Government Regulation and to Potential Product Liability
Claims Our business is subject to the provisions of, among other laws, the Federal Consumer Products
Safety Act and the Federal Hazardous Substances Act, and rules and regulations promulgated
under these acts. These statutes are administered by the Consumer Product Safety Commission
(CPSC) which has the authority to remove from the market products that are found to be
defective and present a substantial hazard or risk of serious injury or death. The CPSC can
require a manufacturer to recall, repair, or replace these products under certain
circumstances. We cannot assure that defects in our products will not be alleged or found.
Products that we develop 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. Products that we develop or sell may also
expose us to liability for the costs related to product recalls. These costs can include
legal expenses, advertising, collection and destruction of product, and free goods. Our
product liability insurance coverage generally excludes such costs and damages resulting from
product recall. Our Markets Are Highly Competitive The markets in which our businesses operate are highly competitive. Our competitors, and in
many cases their parent companies, include companies which have far more extensive sales and
development staffs and significantly greater financial, marketing and other resources than we
do. There can be no assurance that we will be able to compete effectively against such
companies. We Rely on Foreign Manufacturers During 2004, approximately 93% of our products were manufactured in China. Foreign
manufacturing is subject to a number of risks, including transportation delays and
interruptions, political and economic disruptions, the imposition of tariffs, quotas and other
import or export controls, and changes in governmental policies. In addition, past outbreaks
of Severe Acute Respiratory Syndrome have been significantly concentrated in Asia,
particularly in Hong Kong and in the Guangdong province of China, where many of our contract
manufacturers are located. The development and manufacture of our products could suffer if a
significant number of our employees in Hong Kong or the employees of our contract
manufacturers in China contract SARS or other communicable diseases, or are otherwise unable
to fulfill their responsibilities. We do not have long-term contracts with our foreign manufacturers. Although we believe we
could secure other third-party manufacturers to produce our products, our operations could be
adversely affected if we lost our relationship with several of our current foreign
manufacturers. 29




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Virtually all of the raw materials used in our products are available to our contract manufacturers
from numerous suppliers. Our manufacturers do not have long-term supply contracts in place with
their raw materials suppliers. Accordingly, we are subject to variations in the prices we pay to
our manufacturers for products, depending on what they pay for their raw materials. An increase in
the cost of raw materials, such as petroleum, could result in price increases which we may not be
able to fully pass on to our customers. Any such increase could negatively impact our business,
financial condition or results of operations. We Face Foreign Currency Risk As part of our business, we enter into contracts for the purchase and sale of products with
entities in foreign countries. While the vast majority of our contracts are denominated in
U.S. dollars, significant fluctuations in the local currencies of the entities with which we
transact business may adversely affect these entities abilities to fulfill their obligations
under their contracts. Logistix enters into contracts denominated primarily in US dollars, GBP and Euros. Although
we attempt to reduce its exposure to changes in foreign currency exchange rates through the
use of certain hedging techniques, changes in such exchange rates may result in changes in the
value of our commitments and anticipated foreign currency cash flows. A Significant Portion of Our Common Stock is Controlled by Our Officers and Directors Donald A. Kurz and Stephen P. Robeck beneficially own approximately 26.4% and 14.2%,
respectively, of our outstanding Common Stock. Mr. Kurz is our President and Chief Executive
Officer and a member of the Board of Directors. Mr. Robeck is the Chairman of our Board of
Directors. Crown owns 100% of the outstanding shares of our Series AA senior cumulative
convertible preferred stock, which are convertible into 1,694,915 shares of Common Stock
(representing approximately 22.8% of the outstanding shares of Common Stock on an as converted
basis). These stockholders, either individually or acting together, significantly influence
all matters requiring approval by our stockholders, including the election of directors and
the approval of mergers or other business combination transactions. We May Issue Preferred Stock Our Board of Directors has authority to issue up to one million shares of preferred stock, and
to fix the rights, preferences, privileges and restrictions of those shares without any
further vote or action by our stockholders. The potential issuance of preferred stock may
have the effect of delaying, deferring or preventing a change in control and may discourage
bids for the Common Stock at a premium over the market price of the Common Stock and may
adversely affect the market price of, and the voting and other rights of, the holders of
Common Stock. The outstanding Series AA Stock is senior to any class of preferred stock which
might be authorized by the Board of Directors in the future. 
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Impact of Interest Rate Changes The amounts borrowed under
our Bank of America credit facility are at variable interest rates, and we are
subject to market risk resulting from interest rate fluctuations. As of December 31, 2004,
$2,975 was outstanding under our facility. As of December 31, 2004, the marginal interest
rate on available borrowings under our credit facility was 3.9%. Impact of Foreign Currency Fluctuation Approximately 15% of our revenues are denominated in foreign currencies, and we are subject to
market risks resulting from fluctuations in foreign currency exchange rates. In certain
instances, we enter into foreign currency exchange contracts in order to reduce exposure to
changes in foreign currency exchange rates that affect the value of our firm commitments and
certain anticipated foreign currency cash flows. We currently intend to continue to enter
into such contracts to hedge against future material foreign currency exchange rate risks. As of December 31, 2004, our Logistix and Megaprint Group subsidiaries entered into foreign
currency forward contracts aggregating 7,681 GBP to sell Euros in exchange for GBP and to sell
GBP in exchange for US dollars. The contracts will expire by August 2005. At December 31,
2004, these foreign currency forward contracts had an estimated fair
value of (256) GBP. In
addition, our Johnson Grossfield subsidiary entered into foreign currency forward contracts
aggregating $459 to sell Canadian dollars in exchange for US dollars. These contracts will
expire by May 2005. At December 31, 2004, these foreign currency forward contracts had an
estimated fair value of $(7). The fair value of the foreign currency forward contracts is
recorded in accrued liabilities in the consolidated balance sheet as of December 31, 2004.
The unrealized loss on the contracts is reflected in accumulated other comprehensive income. 30




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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 
 Report of Independent Registered Public Accounting Firm To the Board of Directors of
EMAK Worldwide, Inc. and Subsidiaries In our opinion, the accompanying consolidated balance sheets as of December 31, 2003 and 2004
and the related consolidated statements of operations, of shareholders equity and mandatorily
redeemable preferred stock, of comprehensive income (loss) and of cash flows present fairly,
in all material respects, the financial position of EMAK Worldwide, Inc. and its subsidiaries
(the Company) at December 31, 2003 and 2004, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 2004 in conformity
with accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Companys management; our responsibility is
to express an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards of the Public Company
Accounting Oversight Board (United States). These standards require that we plan and perform
the audits to obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements, assessing the accounting principles used
and significant estimates made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 1 to the consolidated financial statements, effective January 1, 2002,
the Company changed its method of accounting for goodwill in accordance with Statement of
Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. /s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP Los Angeles, California
March 31, 2005 31




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EMAK WORLDWIDE, INC. 
 CONSOLIDATED BALANCE SHEETS
 December 31,2003
    
    
    2004ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    19,291
    
    
    $
    4,406Accounts receivable (net of allowances of $2,143 and $1,733
as of December 31, 2003 and 2004, respectively)
    
    
    36,765
    
    
    
    47,180Inventories
    
    
    15,099
    
    
    
    18,763Deferred income taxes
    
    
    2,303
    
    
    
    2,557Prepaid expenses and other current assets
    
    
    2,049
    
    
    
    2,909Total current assets
    
    
    75,507
    
    
    
    75,815Fixed assets, net
    
    
    3,809
    
    
    
    5,029Goodwill
    
    
    41,893
    
    
    
    41,723Other intangibles, net
    
    
    1,252
    
    
    
    3,686Deferred income taxes
    
    
    2,833
    
    
    
    6,101Other assets
    
    
    3,036
    
    
    
    959Total assets
    
    $
    128,330
    
    
    $
    133,313LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS EQUITYCURRENT LIABILITIES:Short-term debt
    
    $
    626
    
    
    $
    6,025Accounts payable
    
    
    28,239
    
    
    
    30,996Deferred revenue
    
    
    2,162
    
    
    
    3,607Due to customer
    
    
    5,276
    
    
    
    3,741Accrued payroll and payroll related costs
    
    
    1,051
    
    
    
    1,074Accrued liabilities
    
    
    8,706
    
    
    
    12,438Total current liabilities
    
    
    46,060
    
    
    
    57,881Long-term liabilities
    
    
    5,555
    
    
    
    6,621Total liabilities
    
    
    51,615
    
    
    
    64,502COMMITMENTS AND CONTINGENCIES (Note 10)Mandatorily redeemable preferred stock, Series A senior cumulative participating
convertible as of December 31, 2003 and Series AA senior cumulative
convertible as of December 31, 2004, $.001 par value, 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 AA issued and outstanding
    
    
    
    
    
    
    Common stock, par value $.001 per share, 50,000,000 and 25,000,000
shares authorized as of December 31, 2003 and 2004, respectively,
5,684,953 and 5,759,263 shares
outstanding as of December 31, 2003 and
2004, respectively
    
    
    
    
    
    
    Additional paid-in capital
    
    
    23,886
    
    
    
    27,516Retained earnings
    
    
    45,138
    
    
    
    33,954Accumulated other comprehensive income
    
    
    3,334
    
    
    
    4,97272,358
    
    
    
    66,442LessTreasury stock, 3,150,708 and 3,167,258 shares at cost as of December 31, 2003
and 2004, respectively
    
    
    (17,458
    )
    
    
    (17,669
    )Unearned compensation
    
    
    (1,234
    )
    
    
    (2,480
    )Total stockholders equity
    
    
    53,666
    
    
    
    46,293Total liabilities, mandatorily redeemable preferred stock
and stockholders equity
    
    $
    128,330
    
    
    $
    133,313
 The accompanying notes are an integral part of these consolidated financial statements. 32




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EMAK WORLDWIDE, INC. 
 CONSOLIDATED STATEMENTS OF OPERATIONS
  Years Ended December 31,2002
    
    
    2003
    
    
    2004REVENUES
    
    $
    206,832
    
    
    $
    219,113
    
    
    $
    236,661Cost of sales
    
    
    151,307
    
    
    
    158,117
    
    
    
    180,487Forgiveness of note receivable
    
    
    1,685
    
    
    
    
    
    
    
    Minimum royalty guarantee shortfalls
    
    
    
    
    
    
    
    
    
    
    7,722Gross profit
    
    
    53,840
    
    
    
    60,996
    
    
    
    48,452OPERATING EXPENSES:Salaries, wages and benefits
    
    
    20,662
    
    
    
    24,523
    
    
    
    31,310Selling, general and administrative
    
    
    22,423
    
    
    
    24,576
    
    
    
    25,606Integration costs
    
    
    453
    
    
    
    
    
    
    
    174Loss on Chicago lease
    
    
    
    
    
    
    
    
    
    
    311Restructuring charge
    
    
    178
    
    
    
    234
    
    
    
    56Impairment of assets
    
    
    
    
    
    
    
    
    
    
    6,312Dispute resolution charge
    
    
    
    
    
    
    
    
    
    
    237ERP reimplementation costs
    
    
    
    
    
    
    
    
    
    
    59Total operating expenses
    
    
    43,716
    
    
    
    49,333
    
    
    
    64,065Income (loss) from operations
    
    
    10,124
    
    
    
    11,663
    
    
    
    (15,613
    )OTHER (EXPENSE) INCOME:Interest expense
    
    
    (258
    )
    
    
    (221
    )
    
    
    (253
    )Interest income
    
    
    321
    
    
    
    152
    
    
    
    102Other income (expense)
    
    
    320
    
    
    
    458
    
    
    
    (636
    )Income (loss) before provision (benefit) for income taxes and cumulative
effect of change in accounting principles
    
    
    10,507
    
    
    
    12,052
    
    
    
    (16,400
    )PROVISION (BENEFIT) FOR INCOME TAXES
    
    
    3,786
    
    
    
    4,103
    
    
    
    (6,716
    )Income (loss) before cumulative effect of change
in accounting principles
    
    
    6,721
    
    
    
    7,949
    
    
    
    (9,684
    )Cumulative effect of change in accounting principles, net of tax
    
    
    (2,496
    )
    
    
    
    
    
    
    Net income (loss)
    
    
    4,225
    
    
    
    7,949
    
    
    
    (9,684
    )PREFERRED STOCK DIVIDENDS
    
    
    1,500
    
    
    
    1,500
    
    
    
    1,500UNDISTRIBUTED EARNINGS ALLOCATED
TO PARTICIPATING PREFERRED STOCK
    
    
    623
    
    
    
    1,474
    
    
    
    NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS
    
    $
    2,102
    
    
    $
    4,975
    
    
    $
    (11,184
    )BASIC INCOME (LOSS) PER SHARE:Income (loss) per share before cumulative effect of change
in accounting principles
    
    $
    0.81
    
    
    $
    0.87
    
    
    $
    (1.94
    )Cumulative effect of change in accounting principles
    
    
    (0.44
    )
    
    
    
    
    
    
    BASIC INCOME (LOSS) PER SHARE
    
    $
    0.37
    
    
    $
    0.87
    
    
    $
    (1.94
    )BASIC WEIGHTED AVERAGE SHARES OUTSTANDING
    
    
    5,721,790
    
    
    
    5,718,548
    
    
    
    5,753,978DILUTED INCOME (LOSS) PER SHARE:Income (loss) per share before cumulative effect of change
in accounting principles
    
    $
    0.78
    
    
    $
    0.83
    
    
    $
    (1.94
    )Cumulative effect of change in accounting principles
    
    
    (0.42
    )
    
    
    
    
    
    
    DILUTED INCOME (LOSS) PER SHARE
    
    $
    0.36
    
    
    $
    0.83
    
    
    $
    (1.94
    )DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING
    
    
    5,895,103
    
    
    
    6,017,718
    
    
    
    5,753,978
 The accompanying notes are an integral part of these consolidated financial statements. 33




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EMAK WORLDWIDE, INC. 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND MANDATORILY REDEEMABLE PREFERRED STOCK
  Additional
    
    
    
    
    
    
    Accumulated OtherCommon Stock
    
    
    Preferred Stock
    
    
    Paid-in
    
    
    Retained
    
    
    Comprehensive
    
    
    Treasury
    
    
    UnearnedShares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Capital
    
    
    Earnings
    
    
    Income
    
    
    Stock
    
    
    Compensation
    
    
    TotalBalance, December 31, 2001
    
    
    5,715,293
    
    
    $
    
    
    
    
    25,000
    
    
    $
    23,049
    
    
    $
    20,050
    
    
    $
    35,964
    
    
    $
    242
    
    
    $
    (13,773
    )
    
    $
    (10
    )
    
    $
    65,522Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,225
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,225Issuance of shares pursuant to restricted
stock plan
    
    
    50,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    658
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (658
    )
    
    
    Amortization of restricted stock grants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    80
    
    
    
    80Exercise of stock options
    
    
    88,525
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    840
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    840Tax benefit from exercise of stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    93
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    93Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,500
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,500
    )Foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,523
    
    
    
    
    
    
    
    
    
    
    
    1,523Unrealized loss on foreign currency forward contract
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (55
    )
    
    
    
    
    
    
    
    
    
    
    (55
    )Purchase of treasury stock
    
    
    (137,315
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,733
    )
    
    
    
    
    
    
    (1,733
    )Balance, December 31, 2002
    
    
    5,716,503
    
    
    
    
    
    
    
    25,000
    
    
    
    23,049
    
    
    
    21,641
    
    
    
    38,689
    
    
    
    1,710
    
    
    
    (15,506
    )
    
    
    (588
    )
    
    
    68,995Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,949
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7.949Issuance of shares pursuant to restricted
stock plan
    
    
    1,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (13
    )
    
    
    Issuance of restricted stock units
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,022
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,022
    )
    
    
    Amortization of restricted stock units
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    186
    
    
    
    186Amortization of restricted stock grants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    177
    
    
    
    177Cancellation of restricted stock grants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (26
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26
    
    
    
    Exercise of stock options
    
    
    111,050
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    935
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    935Tax benefit from exercise of stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    301
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    301Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,500
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,500
    )Foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,784
    
    
    
    
    
    
    
    
    
    
    
    1,784Unrealized loss on foreign
currency forward contracts
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (160
    )
    
    
    
    
    
    
    
    
    
    
    (160
    )Purchase of treasury stock
    
    
    (143,600
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,952
    )
    
    
    
    
    
    
    (1,952
    )Balance, December 31, 2003
    
    
    5,684,953
    
    
    
    
    
    
    
    25,000
    
    
    
    23,049
    
    
    
    23,886
    
    
    
    45,138
    
    
    
    3,334
    
    
    
    (17,458
    )
    
    
    (1,234
    )
    
    
    76,715Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,684
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,684
    )Warrant exchange
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (531
    )
    
    
    487
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (44
    )Issuance of common stock
    
    
    35,785
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    530
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    530Issuance of restricted stock units
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,399
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,399
    )
    
    
    Issuance of shares pursuant to vesting
of restricted stock units
    
    
    375
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Amortization of restricted stock units
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    548
    
    
    
    548Cancellation of restricted stock units
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (440
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    440
    
    
    
    Amortization of restricted stock grants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    165
    
    
    
    165Exercise of stock options
    
    
    54,700
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    640
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    640Tax benefit from exercise of stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,500
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,500
    )Foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,805
    
    
    
    
    
    
    
    
    
    
    
    1,805Unrealized loss on foreign
currency forward contracts
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (167
    )
    
    
    
    
    
    
    
    
    
    
    (167
    )Purchase of treasury stock
    
    
    (16,550
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (211
    )
    
    
    
    
    
    
    (211
    )Balance, December 31, 2004
    
    
    5,759,263
    
    
    $
    
    
    
    
    25,000
    
    
    $
    22,518
    
    
    $
    27,516
    
    
    $
    33,954
    
    
    $
    4,972
    
    
    $
    (17,669
    )
    
    $
    (2,480
    )
    
    $
    68,811
 The accompanying notes are an integral part of these consolidated financial statements. 34




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##### Table of Contents



EMAK WORLDWIDE, INC. 
 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
  Years Ended December 31,2002
    
    
    2003
    
    
    2004NET INCOME (LOSS)
    
    $
    4,225
    
    
    $
    7,949
    
    
    $
    (9,684
    )OTHER COMPREHENSIVE INCOME:Foreign currency translation adjustments
    
    
    1,523
    
    
    
    1,784
    
    
    
    1,805Unrealized loss on foreign currency forward contract
    
    
    (55
    )
    
    
    (160
    )
    
    
    (167
    )COMPREHENSIVE INCOME (LOSS)
    
    $
    5,693
    
    
    $
    9,573
    
    
    $
    (8,046
    )
 The accompanying notes are an integral part of these consolidated financial statements. 35




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##### Table of Contents



EMAK WORLDWIDE, INC. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
  Years Ended December 31,2002
    
    
    2003
    
    
    2004CASH FLOWS FROM OPERATING ACTIVITIES:Net income (loss)
    
    $
    4,225
    
    
    $
    7,949
    
    
    $
    (9,684
    )Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:Cumulative effect of change in accounting principles, net of tax
    
    
    2,496
    
    
    
    
    
    
    
    Depreciation and amortization
    
    
    1,831
    
    
    
    1,946
    
    
    
    2,067Provision for bad debts
    
    
    484
    
    
    
    277
    
    
    
    48Gain on asset disposal
    
    
    (15
    )
    
    
    (19
    )
    
    
    (13
    )Tax benefit from exercise of stock options
    
    
    93
    
    
    
    301
    
    
    
    14Amortization of restricted stock
    
    
    80
    
    
    
    363
    
    
    
    714Impairment of assets
    
    
    
    
    
    
    
    
    
    
    6,312Minimum guarantee royalty shortfalls
    
    
    
    
    
    
    
    
    
    
    7,722Forgiveness of note receivable
    
    
    1,685
    
    
    
    
    
    
    
    Other
    
    
    (20
    )
    
    
    (1
    )
    
    
    Changes in assets and liabilities-Increase (decrease) in cash and cash equivalents:Accounts receivable
    
    
    (18,718
    )
    
    
    12,338
    
    
    
    (3,222
    )Note receivable
    
    
    498
    
    
    
    
    
    
    
    Inventories
    
    
    (5,073
    )
    
    
    2,294
    
    
    
    98Deferred income taxes
    
    
    (697
    )
    
    
    559
    
    
    
    (4,015
    )Prepaid expenses and other current assets
    
    
    4,207
    
    
    
    963
    
    
    
    (1,503
    )Other assets
    
    
    (542
    )
    
    
    (840
    )
    
    
    (908
    )Accounts payable
    
    
    14,645
    
    
    
    (14,518
    )
    
    
    82Accrued liabilities
    
    
    5,811
    
    
    
    (9,486
    )
    
    
    (6,006
    )Long-term liabilities
    
    
    (409
    )
    
    
    (791
    )
    
    
    (934
    )Net cash provided by (used in) operating activities
    
    
    10,581
    
    
    
    1,335
    
    
    
    (9,228
    )CASH FLOWS FROM INVESTING ACTIVITIES:Payment for purchase of Upshot
    
    
    (9,891
    )
    
    
    
    
    
    
    Payment for purchase of SCI Promotion, net of cash acquired of $162
    
    
    
    
    
    
    (6,059
    )
    
    
    --.Payment for purchase of Johnson Grossfield
    
    
    
    
    
    
    
    
    
    
    (4,614
    )Payment for purchase of Megaprint Group, net of cash acquired of $1,194
    
    
    
    
    
    
    
    
    
    
    (2,591
    )Proceeds from sales of fixed assets
    
    
    135
    
    
    
    74
    
    
    
    64Purchases of fixed assets
    
    
    (982
    )
    
    
    (1,150
    )
    
    
    (1,602
    )Proceeds from sale of marketable securities, net
    
    
    6,200
    
    
    
    1,000
    
    
    
    Net cash used in investing activities
    
    
    (4,538
    )
    
    
    (6,135
    )
    
    
    (8,743
    )CASH FLOWS FROM FINANCING ACTIVITIES:Preferred stock dividends paid
    
    
    (1,500
    )
    
    
    (1,500
    )
    
    
    (1,500
    )Purchase of treasury stock
    
    
    (1,733
    )
    
    
    (1,952
    )
    
    
    (211
    )Proceeds from exercise of stock options
    
    
    840
    
    
    
    935
    
    
    
    640Borrowings under line of credit
    
    
    
    
    
    
    626
    
    
    
    4,054Net cash provided by (used in) financing activities
    
    
    (2,393
    )
    
    
    (1,891
    )
    
    
    2,983Net increase (decrease) in cash and cash equivalents
    
    
    3,650
    
    
    
    (6,691
    )
    
    
    (14,988
    )Effects of exchange rate changes on cash and cash equivalents
    
    
    248
    
    
    
    149
    
    
    
    103CASH AND CASH EQUIVALENTS, beginning of year
    
    
    21,935
    
    
    
    25,833
    
    
    
    19,291CASH AND CASH EQUIVALENTS, end of year
    
    $
    25,833
    
    
    $
    19,291
    
    
    $
    4,406SUPPLEMENTAL CASH FLOW INFORMATION:Non-cash investing activities  Issuance of shares for purchase of Johnson Grossfield
    
    $
    
    
    
    $
    
    
    
    $
    530CASH PAYMENTS DURING YEAR FOR:Interest
    
    $
    286
    
    
    $
    214
    
    
    $
    236Taxes
    
    $
    218
    
    
    $
    4,166
    
    
    $
    1,210
 The accompanying notes are an integral part of these consolidated financial statements. 36




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##### Table of Contents



EMAK WORLDWIDE, INC. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES EMAK Worldwide, Inc., a Delaware corporation and subsidiaries (the Company), is a leading
global integrated marketing services company. We focus on the design and execution of
strategy-based marketing programs providing measurable results for our clients. EMAK has
expertise in the areas of: strategic planning and research, entertainment marketing, design
and manufacturing of custom promotional products, promotion, event marketing, collaborative
marketing, retail design and environmental branding. Our clients include Burger King,
Kelloggs, Frito Lay, Kohls, Macys, Kraft, Procter & Gamble, Miller Brewing Company and
Subway Restaurants, among others. EMAK is headquartered in Los Angeles, with operations in
Chicago, Minneapolis, New York, Ontario (California), Dublin, Frankfurt, London, Paris, The
Netherlands, Hong Kong and Shanghai. The Company primarily sells to customers in the United
States and Europe. The Companys functional currency is the US dollar. Principles of Consolidation  Use of Estimates  Cash and Cash Equivalents  Marketable Securities  The cost of debt securities is adjusted for amortization of premiums and accretion of
discounts to maturity. Such amortization, interest income, realized gains and losses and
declines in value judged to be other than temporary are included in interest income and
expense. The cost of securities sold is based on specific identification. Revenue Recognition  Service revenues include all amounts that are billable to clients under service contracts.
Service related revenues are recognized on a time and materials basis, or on a straight-line
basis, depending on the contract. In the case of fee and production arrangements, the
revenues are recognized as the services are performed, which is generally ratably over the
period of the client contract. Revenues from time and materials service contracts are
recognized as the services are rendered. Revenues from fixed price retainer contracts are
recognized on a straight-line basis over the contract term. Losses on contracts are
recognized during the period in which the loss first becomes probable and reasonably
estimable. Reimbursements, including those relating to travel and other out-of-pocket
expenses, and other similar third-party costs, such as printing costs, are included in
revenues, and an equivalent amount of reimbursable expenses are included in cost of sales.
Service revenues for the years ended December 31, 2002, 2003 and 2004 totaled $13,895, $22,129
and $24,692, respectively. Unbilled revenues represent revenues recognized in advance of
billings rendered based on work performed to date on certain service contracts. Unbilled
revenues as of December 31, 2003 and 2004 totaled $992 and $2,100, respectively. Unbilled revenues are recorded in accounts receivable
in the accompanying 37




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##### Table of Contents



consolidated balance sheet as of December 31, 2003 and 2004. Unbilled
revenues are expected to be billed and collected within the next six months. In May 2003, the Emerging Issues Task Force (EITF) issued Issue No. 00-21, Accounting for
Revenue Arrangements with Multiple Deliverables. EITF Issue No. 00-21 provides guidance on
how to determine when an arrangement that involves multiple revenue-generating activities or
deliverables should be divided into separate units of accounting for revenue recognition
purposes, and if this division is required, how the arrangement consideration should be
allocated among the separate units of accounting. The guidance in this Issue is effective for
revenue arrangements entered into in fiscal periods beginning after June 15, 2003. Under new
contractual arrangements with Burger King, creative services are a separate deliverable from
manufacturing services. As a result, the Company is required to record the creative revenues
when the specification and engineering package is delivered to and accepted by Burger King. The Companys revenue recognition policies are in compliance with the Securities and Exchange
Commissions Staff Accounting Bulletin (SAB)
No. 101, Revenue Recognition in Financial
Statements, and SAB No. 104, Revenue Recognition in Financial Statements. Inventories  December 31,2003
    
    
    2004Production-in-process
    
    $
    3,363
    
    
    $
    861Finished goods
    
    
    11,736
    
    
    
    17,902$
    15,099
    
    
    $
    18,763
 Fixed Assets  Leasehold improvements  lesser of lease term or life of related asset
Furniture, fixtures, equipment, hardware and software  3-7 years Betterments, which extend the life or add value to fixed assets are capitalized and
depreciated over their remaining useful life. Repairs and maintenance are expensed as
incurred. In October 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 requires that
long-lived assets be measured at the lower of the carrying amount or fair value less cost to
sell, whether reported in continuing operations or in discontinued operations. SFAS No. 144
is effective for 2002 and generally is to be applied prospectively. The Company adopted SFAS
No. 144 beginning January 1, 2002. The impact of such adoption did not have a material effect
on the Companys financial statements. Goodwill and Other Intangibles  38




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##### Table of Contents



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
future 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 2004, the Company performed the annual
impairment test required by SFAS No. 142 and determined that the goodwill resulting from the
acquisition of Upshot was impaired as of December 31, 2004. As a result, the Company recorded
a non-cash charge in the amount of $6,312 to write-down the carrying value of the Upshot
goodwill (see Note 3). The change in the carrying amount of goodwill from $41,893 as of December 31, 2003 to $41,723 as of
December 31, 2004 reflects: the Upshot goodwill impairment charge of $(6,312), the acquisition of
Megaprint Group (See Note 4) of $2,764, the acquisition of Johnson Grossfield (See Note 4) of
$1,192, an adjustment to reflect the net increase to goodwill for the SCI Promotion (See Note 4)
acquisition of $932, and a foreign currency translation adjustment of $1,254. All of the goodwill
balance relates to the Marketing Services segment. Identifiable intangibles of $1,252 and $3,686 as of December 31, 2003 and 2004, respectively, a
portion of which are subject to amortization, are included in other intangibles in the consolidated
balance sheets. Other intangibles are summarized as follows: As of December 31,2003
    
    
    2004Amortized Intangible AssetsEquity Marketing trademark
    
    $
    52
    
    
    $
    52Licensing, royalty and standstill agreements
    
    
    151
    
    
    
    163Customer contracts and related customer relationships
    
    
    869
    
    
    
    3,491Non-competition agreement
    
    
    
    
    
    
    113Sales order backlog
    
    
    343
    
    
    
    377Subtotal
    
    
    1,415
    
    
    
    4,196Less: Accumulated amortization
    
    
    (813
    )
    
    
    (1,214
    )602
    
    
    
    2,982Unamortized Intangible AssetsLogistix trademark
    
    
    650
    
    
    
    704Total Other Intangibles
    
    $
    1,252
    
    
    $
    3,686
 The Equity Marketing trademark is being amortized over an estimated useful life of 10 years.
The Logistix trademark is not subject to amortization under the provisions of SFAS No. 142 as
it has been determined that it has an indefinite life. The licensing, royalty and standstill
agreements along with the customer contracts and related customer relationships acquired in
the purchase of Logistix were amortized over the lives of the respective agreements which
ranged from 2 to 3 years and were fully amortized as of December 31, 2003. The sales order
backlog was also acquired in the purchase of Logistix and was fully amortized as of December
31, 2001. (See Note 4.) The customer contracts and related customer relationships acquired
in the purchase of Upshot are amortized over the lives of the respective agreements which
range from 6 to 12 months and were fully amortized as of December 31, 2003. Sales order
backlog was also acquired in the purchase of Upshot and was fully amortized as of December 31,
2002. The customer contracts and related customer relationships acquired in the purchase of
SCI Promotion are amortized over an estimated useful life of 5 years. Sales order backlog was
also acquired in the purchase of SCI Promotion and was fully amortized as of December 31,
2003. The customer relationship and non-competition agreement acquired in the purchase of
Johnson Grossfield are being amortized over estimated useful lives of 2 years to 12 years.
(See Note 4.) The customer relationships acquired in the purchase of Megaprint Group are
amortized over an estimated useful life of 15 years. Sales order backlog was also acquired in
the purchase of Megaprint Group and $5 was amortized as of December 31, 2004. (See Note 4.)
Useful lives for customer contracts and related customer relationships are determined based on
the average historical lives of customer relationships for each respective acquisition.
Useful lives for licensing, royalty and standstill agreements,
non-competition agreements and
sales order backlog are based on the terms of the underlying contractual agreements. For the
years ended December 31, 2002, 2003 and 2004, amortization expense related to other
intangibles amounted to $234, $309 and $363, respectively. The expected future amortization expense related to other intangibles for each of the
next five years is as follows: Year2005
    
    $
    4012006
    
    
    3452007
    
    
    3372008
    
    
    3042009
    
    
    211
 Due to Customer  39




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##### Table of Contents



Company  remits the fees to
the customer. As of December 31, 2003 and 2004, the amounts due to customer were $5,276 and
$3,741, respectively. Income
Taxes


The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income
Taxes, which requires recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been included in the financial statements or tax
returns, but not both. Under this method, deferred tax assets and liabilities are determined
based on the difference between the financial statements and tax basis of assets and
liabilities using the tax rates in effect for the years in which the differences are expected
to reverse. (See Note 9). 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. SFAS No. 148 is effective
for fiscal years beginning after December 15, 2002. At December 31, 2004, the Company currently has three stock based compensation plans that are
described in Note 8. In accordance with provisions of SFAS No. 123, the Company applies APB
Opinion 25 and related interpretations in accounting for its stock plans and, accordingly,
does not recognize compensation cost for grants whose exercise price equals the market price
of the stock on the date of grant. If the Company had elected to recognize compensation cost
based on the fair value of the options granted at grant date as prescribed by SFAS No. 123,
net income (loss) and earnings (loss) per share would have been reduced to the pro forma
amounts indicated in the table below: 2002
    
    
    2003
    
    
    2004Net income (loss) available to common stockholders  as reported
    
    $
    2,102
    
    
    $
    4,975
    
    
    $
    (11,184
    )Plus:Stock-based compensation expense included in reported
net income (loss) available to the common stockholder
    
    
    51
    
    
    
    239
    
    
    
    422Less:Compensation expense (a)
    
    
    1,555
    
    
    
    1,715
    
    
    
    1,065Net income (loss) available to common stockholders  pro forma
    
    $
    598
    
    
    $
    3,499
    
    
    $
    (11,827
    )Earnings (loss) per share:Basic earnings (loss) per share, as reported
    
    $
    0.37
    
    
    $
    0.87
    
    
    $
    (1.94
    )Pro forma basic (loss) earnings per share
    
    $
    0.10
    
    
    $
    0.61
    
    
    $
    (2.06
    )Diluted earnings (loss) per share, as reported
    
    $
    0.36
    
    
    $
    0.83
    
    
    $
    (1.94
    )Pro forma diluted earnings (loss) per share
    
    $
    0.10
    
    
    $
    0.58
    
    
    $
    (2.06
    )
   (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. The fair value of each stock option is estimated on the date of grant using the Black-Scholes
option pricing model with the following assumptions: Years Ended December 31,2002
    
    
    2003
    
    
    2004Expected dividend yield
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %Expected stock price volatility
    
    
    60.00
    %
    
    
    58.57
    %
    
    
    45.00
    %Risk free interest rate
    
    
    2.95
    %
    
    
    1.90
    %
    
    
    2.76
    %Expected life of options
    
    4 years
    
    4 years
    
    5 years
 The weighted average fair value of options granted during 2002, 2003 and 2004 is $6.08, $5.89
and $6.23, respectively. The Black-Scholes option valuation model was developed for use in estimating the fair value of
traded options that have no vesting restrictions and are fully transferable. In addition,
option valuation models require the input of highly subjective assumptions, including the
expected stock price volatility. Because the Companys stock options have characteristics
significantly different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, the existing models, in
managements opinion, do not necessarily provide a reliable single measure of the fair value
of its stock options. 40




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Net Income Per
Share


Basic net income (loss) per share (EPS) is computed by dividing net income (loss) available
to common stockholders by the weighted average number of common shares outstanding during each
period. Net income (loss) available to common stockholders represents reported net income
(loss) less preferred stock dividend requirements and undistributed earnings allocated to
participating preferred stock. Diluted EPS reflects the potential dilution that could occur if securities or other
contracts to issue shares of the Companys stock, $0.01 par value (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 assumed conversion of preferred
stock using the if-converted method. Options and warrants to purchase 2,075,066, 1,318,666
and 2,757,378 shares of the Companys Common Stock, for the years ended December 31, 2002,
2003 and 2004, respectively, were excluded from the computation of diluted EPS as they would
have been anti-dilutive. For the years ended December 31, 2002, 2003 and 2004, preferred
stock convertible into 1,694,915 shares of Common Stock was excluded in the computation of
diluted EPS. Earnings per share for the years ended December 31, 2002 and 2003, respectively, reflect a
restatement pursuant to Emerging Issues Task Force Issue No. 03-6, Participating Securities
and the Two-Class Method under SFAS No. 128, Earnings Per Share (EITF 03-6). EITF 03-6
requires that companies with participating securities calculate earnings per share using a
two-class method. The Companys Series A cumulative participating mandatorily redeemable
preferred stock (Series A Stock) qualifies as participating securities since it was
entitled to dividends declared on the Companys common stock; therefore, EITF 03-6 requires
the allocation of a portion of undistributed earnings to preferred stock. As a result,
earnings per basic common share, as reported in the prior years, were reduced by $0.11 and
$0.26 to $0.37 and $0.87 for the years ended December 31, 2002 and 2003, respectively. The
earnings per diluted common share, as reported in the prior years, were reduced by $0.20 and
$0.20 to $0.36 and $0.83 for the years ended December 31, 2002 and 2003, respectively. EITF
03-6 had no impact on 2004 per share amounts because of the net loss. The Series A Stock was
exchanged by the holder for an equivalent number of shares of non-participating preferred
stock on December 30, 2004 (See Note 8.) The following is a reconciliation of the numerators and denominators of the basic and diluted
EPS computation for income available to common shareholders and other disclosures required
by SFAS No. 128, Earnings per Share and EITF 03-6: For the years ended December 31,2002
    
    
    2003
    
    
    2004Income
    
    
    Shares
    
    
    Per Share
    
    
    Income
    
    
    Shares
    
    
    Per Share
    
    
    Loss
    
    
    Shares
    
    
    Per Share(Numerator)
    
    
    (Denominator)
    
    
    Amount
    
    
    (Numerator)
    
    
    (Denominator)
    
    
    Amount
    
    
    (Numerator)
    
    
    (Denominator)
    
    
    AmountBasic EPS:Net income (loss) available to common
stockholders
    
    $
    2,102
    
    
    
    5,721,790
    
    
    $
    0.37
    
    
    $
    4,975
    
    
    
    5,718,548
    
    
    $
    0.87
    
    
    $
    (11,184
    )
    
    
    5,753,978
    
    
    $
    (1.94
    )Effect of Dilutive Securities:Options and warrants
    
    
    
    
    
    
    173,313
    
    
    
    
    
    
    
    
    
    
    
    242,466
    
    
    
    
    
    
    
    
    
    
    
    Restricted stock units
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    56,704
    
    
    
    
    
    
    
    
    
    
    
    Dilutive EPS:Net income (loss) available to common
stockholders and assumed conversion
    
    $
    2,102
    
    
    
    5,895,103
    
    
    $
    0.36
    
    
    $
    4,975
    
    
    
    6,017,718
    
    
    $
    0.83
    
    
    $
    (11,184
    )
    
    
    5,753,978
    
    
    $
    (1.94
    )
 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. (See Note 2.) 41




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Concentration of
Risk
Burger King accounted for approximately 65%, 58% and 51% of the Companys total revenues for
the years ended December 31, 2002, 2003 and 2004, respectively. The Company regularly extends
credit to distribution companies in connection with its business with Burger King, which
includes Supply Chain Services, LLC (SCS), a subsidiary of Burger Kings franchisee
purchasing cooperative Restaurant Services, Inc (RSI). The Company began selling product to
SCS in October, 2003. Because of RSIs established credit history, as well as the payment
history of SCS, the Company does not believe that this increase in concentration of
receivables has negatively impacted the overall credit risk. Failure by SCS or one or more
distribution companies to honor their payment obligations could have a material adverse effect
on the Companys operations. The largest such distribution company accounted for 20.5%, 17.9%
and 80.2% of the products purchased from us by the Burger King system for the years ended
December 31, 2002, 2003 and 2004, respectively. The largest such distribution company
accounted for 23.9% and 19.2% of accounts receivable as of December 31, 2003 and 2004,
respectively. The Company purchases 93% of its manufactured products from suppliers located in China. China
currently enjoys normal trade relations (NTR) status under US tariff laws, which provides a
favorable category of US import duties. Chinas NTR status became permanent on January 1,
2002, following enactment of a bill authorizing such status upon Chinas accession to the
World Trade Organization, which occurred in December 2001. This substantially reduces the
possibility of China losing its NTR status, which would result in increased costs for the
Company. The impact of such an event on the Company could be somewhat mitigated by the
Companys ability to source product for the US market from countries other than China.
However, there can be no assurance that the Company would be able to obtain manufactured
products under acceptable terms. Supplemental Cash Flow
Information
During 2004, the Company sold a portion of its excess inventory to a
customer in exchange for credits toward future purchases of
advertising media. The credits were valued at $438 and can be used
over a period of five years. These credits are recorded in prepaid
expenses and other current assets in the accompanying consolidated
balance sheet. Comprehensive Income



The Company computes comprehensive income (loss) pursuant to SFAS No. 130, Reporting
Comprehensive Income. This statement establishes standards for the reporting and display of
comprehensive income (loss) and its components in financial statements and thereby reports a
measure of all changes in equity of an enterprise that result from transactions and other
economic events other than transactions with owners. Total comprehensive income (loss) for the
Company includes net income (loss) and other comprehensive income (loss) items, including
unrealized gains or losses on foreign exchange forward contracts and cumulative foreign
currency translation adjustments. Shipping and Handling Costs

In accordance with the Emerging Issues Task Force Issue 00-10, Accounting for Shipping and
Handling Fees and Costs, the Company classifies all amounts billed to customers related to
shipping and handling as revenues. Shipping and handling costs are recorded in selling,
general and administrative expenses. For the years ended December 31, 2002, 2003 and 2004
such costs totaled $2,584, $2,312, and $1,799, respectively. Foreign Currency Translation



Net foreign exchange gains or losses resulting from the translation of assets and liabilities
of foreign subsidiaries whose functional currency is not the US dollar are recognized as a
component of accumulated other comprehensive income in stockholders equity. 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. For the years
ended December 31, 2002, 2003 and 2004, respectively, the net transaction gain (loss) on
foreign exchange of $305, $438 and $(628) were recorded in other income (expense) in the
accompanying consolidated statements of operations. In accordance with the SFAS No. 52, Foreign Currency Translation, the financial statements
of Logistix and Megaprint Group are translated into U.S. dollars as follows: assets and
liabilities at year-end exchange rates; income and expenses at average exchange rates; and
shareholders equity at historical exchange rates. Since the functional currency of Logistix
and Megaprint Group is the British Pound (GBP), the resulting translation adjustment is
recorded as a component of accumulated other comprehensive income in the accompanying
consolidated balance sheet. Translation adjustments are not tax-effected since they relate to
investments which are permanent in nature. Derivative Instruments



The Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, which establishes accounting and reporting standards for derivative instruments
and for hedging activities. SFAS No. 133 requires that an entity recognize derivatives as
either assets or liabilities on the balance sheet and measure those instruments at fair value.
The accounting for changes in the fair value of a derivative depends on the intended use of
the derivative and the resulting designation. The Company designates its derivatives based upon criteria established by SFAS No. 133. For a
derivative designated as a fair value hedge, the gain or loss is recognized in earnings in the
period of change together with the offsetting loss or gain on the hedged item attributed to
the risk being hedged. For a derivative designated as a cash flow hedge, the effective portion
of the derivatives gain or loss is initially reported as a component of accumulated other
comprehensive income and subsequently 42




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##### Table of Contents



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 should be 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 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 three months in original
maturity. As of December 31, 2004, our Logistix and Megaprint Group subsidiaries entered into foreign
currency forward contracts aggregating 7,681 GBP to sell Euros in exchange for GBP and to sell
GBP in exchange for US dollars. The contracts will expire by August 2005. At December 31,
2004, these foreign currency forward contracts had an estimated fair
value of (256) GBP. In
addition, our Johnson Grossfield subsidiary entered into foreign currency forward contracts
aggregating $459 to sell Canadian dollars in exchange for US dollars. These contracts will
expire by May 2005. At December 31, 2004, these foreign currency forward contracts had an
estimated fair value of $(7). The fair value of the foreign currency forward contracts is
recorded in accrued liabilities in the consolidated balance sheet as of December 31, 2004.
The unrealized loss on the contracts is reflected in accumulated other comprehensive income. Advertising

Production costs of commercials and programming are charged to expense in the period during
which the production is first aired. The costs of other advertising, promotion and marketing
programs are charged to expense in the period incurred. Recent Accounting
Pronouncements



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 adoption of EITF Issue No. 03-1 will not have a material impact
on the Companys results of operations or financial position because it does not have any
investments in marketable securities as December 31, 2004. 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 has adopted EITF 03-6 for the quarter ended June 30,
2004. EITF 03-6 had no impact on 2004 per share amounts because of the net loss. In September 2004, the consensus of EITF Issue No. 04-10, Applying Paragraph 19 of FASB Statement
No. 131, Disclosures about Segments of an Enterprise and Related Information, in Determining
Whether to Aggregate Operating Segments That Do Not Meet the Quantitative Thresholds, was
published. EITF Issue No. 04-10 addresses how an enterprise should evaluate the aggregation
criteria of SFAS No. 131 when determining whether operating segments that do not meet the
quantitative thresholds may be aggregated in accordance with SFAS No. 131. The effective date of
the consensus in this Issue is for fiscal years ending after October 13, 2004. Adoption of the
EITF has not affected the Companys segment classifications. 43




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##### Table of Contents



In November 2004, the FASB issued SFAS No. 151, Inventory CostsAn Amendment of ARB No. 43,
Chapter 4. SFAS No. 151 amends the guidance in Chapter 4, Inventory Pricing, of Accounting
Research Bulletin (ARB) No. 43, Restatement and Revision of Accounting Research Bulletins, to
clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage). Among other provisions, the statement requires that items such as
idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as
current-period charges regardless of whether they meet the criterion of so abnormal as stated in
ARB No. 43. Additionally, SFAS No. 151 requires that the allocation of fixed production overheads
to the costs of conversion be based on the normal capacity of the production facilities. SFAS No.
151 is effective for fiscal years beginning after June 15, 2005. The Company is currently
evaluating the effect that the adoption of SFAS No. 151 will have on its results of operations and
financial position, but does not expect it to have a material impact. In December 2004, the FASB released FASB Staff Position No. FAS 109-1 (FSP 109-1). FASB Staff
Position No. 109-1, Accounting of SFAS No. 109, Accounting for Income Taxes, for the Tax
Deduction Provided to U.S.-Based Manufacturers by the American Jobs Creation Act of 2004,
clarifies that the tax deduction for domestic manufacturers under the American Jobs Creation Act of
2004 should be accounted for as a special deduction in accordance
with SFAS No. 109,
Accounting for Income Taxes. The FSP went into effect upon being issued. FSP 109-1
had no impact on the Companys consolidated financial statements. In December 2004, the FASB released FASB Staff Position No. FAS 109-2 (FSP 109-2). FASB
Staff Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings
Repatriation Provision within the American Jobs Creation Act of 2004, provides companies more
time (beyond the financial-reporting period during which the Act took effect) to evaluate the
Acts impact on the Companys plan for reinvestment or repatriation of certain foreign
earnings for purposes of applying SFAS No. 109, Accounting for Income Taxes. The FSP went
into effect upon being issued. As of December 31, 2004, management had not determined
whether, or to what extent, the Company may repatriate foreign earnings under the Jobs Act.
Therefore, the Companys 2004 consolidated financial statements do not include any provision
for income taxes on the $5,705 cumulative balance of unremitted foreign earnings as of year
end 2004. Management expects to finalize its assessment related to the Jobs Act in the first
half of 2005. In December 2004, the FASB issued SFAS No. 123R (revised 2004), Share-Based Payment, which
replaced SFAS No. 123, Accounting for Stock-Based Compensation, and superceded APB Opinion
No. 25, Accounting for Stock Issued to Employees. SFAS No. 123R requires all share-based
payments to employees, including grants of employee stock options, to be recognized in the
financial statements based on their fair values in the first interim or annual period
beginning after June 15, 2005. The pro forma disclosures previously permitted under SFAS No.
123 will no longer be an alternative to financial statement recognition. The Company is
required to adopt SFAS No. 123R in the third quarter of fiscal year 2005, beginning July 1,
2005. Under SFAS No. 123R, the Company must determine the appropriate fair value method to be
used for valuing share-based payments, the amortization method of compensation cost and the
transition method to be used at the date of adoption. The transition methods include
prospective and retroactive adoption options. Under the retroactive option, prior periods may
be restated either as of the beginning of the year of adoption or for all periods presented.
The prospective method requires that compensation cost be recorded for all unvested stock
options and nonvested stock at the beginning of the first quarter of adoption of SFAS No.
123R, whereas the retroactive method requires recording compensation cost for all unvested
stock options and nonvested stock beginning with the first period restated. The Company is
evaluating the requirements of SFAS No. 123R and expects that the adoption of SFAS No. 123R
will have a material impact on its results of operations and earnings per share. The Company
has not yet determined the method of adoption of SFAS No. 123R, or whether the amounts
recorded in the consolidated statements of income in future periods will be similar to the
current pro forma disclosures under SFAS No. 123. Reclassifications

Certain reclassifications have been made to the 2003 consolidated financial statements to
conform them with the 2004 presentation. Advances under an import/letter of credit facility
(see Note 6) which were previously recorded in accounts payable as of December 31, 2003 have
been reclassified to short-term debt on the accompanying consolidated balance sheets to
conform to current period presentation. 2. RESTRUCTURING CHARGE AND MINIMUM ROYALTY GUARANTEE SHORTFALLS During 2002, the Company formulated and implemented a restructuring plan in connection with the
Upshot acquisition in order to combine and streamline the operations of the Company and Upshot. In
connection with this plan the Company recorded a restructuring charge of $178. This charge
represents severance for a workforce reduction of seven employees in the Companys Los Angeles
office, who were terminated. The workforce reduction included employees from the Companys
marketing services division as well as other support services. 44




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In connection with the restructuring plan, the Company also decided to close Upshots Richmond,
Virginia office and eliminate certain positions at Upshots Chicago, Illinois office.
Additionally, in 2003 the Company finalized its exit plan with respect to vacating half of its
leased space (approximately 30,000 square feet) at Upshots Chicago, Illinois office. This
resulted in an adjustment to the liabilities recorded and an increase to goodwill of $1,900 for the
present value of the remaining lease payments for the vacated office space in excess of the
estimated sub-lease income. The liabilities assumed in connection with this restructuring plan
totaled $3,535 and are included as part of goodwill in accordance with EITF Issue No. 95-3,
Recognition of Liabilities in Connection with a Purchase
Business Combination. $2,421 of these
liabilities were paid as of December 31, 2004. In June 2004, the Company recorded expense of $311
due to lower than estimated sublease income for the vacated office space. The office space has
been subleased at rates modestly below the Companys initial estimates, due to softness in the
current Chicago real estate market. This expense is recorded as Loss on Chicago Lease in the
accompanying consolidated statement of operations for the year ended December 31, 2004. In 2003, the Company recorded a restructuring charge of $424 which represents severance for
workforce reductions at Upshot. The Upshot business did not achieve the expected level of
contribution in 2003 which is primarily attributable to reduced marketing expenditures by some of
its larger clients. In order to bring its cost structure in line with the current business volume,
the Company eliminated eight positions at Upshot in December 2003. All but $25 of this
restructuring charge was paid as of December 31, 2004 (a $25 restructuring gain was recorded in
2004see below). This charge was partially offset by a $190 reversal of a restructuring reserve
that the Company established in 1998 relating to former consumer products licenses. This reversal
is attributable to the expiration of certain contractual rights. In 2004, the Company formulated and implemented a restructuring plan in connection with the
realignment of centralized resources in its Marketing Services business in order to combine and
streamline the operations. In connection with this plan the Company recorded a restructuring charge
of $81. This charge represents severance for one employee in the Companys Los Angeles office,
whose position was eliminated, and is reflected as a restructuring charge in the accompanying
condensed consolidated statement of operations. All of this restructuring charge was paid as of
December 31, 2004. During the third quarter of 2004 there was a restructuring gain of $25 that
represents a reversal of a portion of the 2003 restructuring charge related to the severance for
workforce reductions at Upshot. On February 24, 2005, management finalized a decision to pursue the wind down of substantially all
of the Companys consumer products business, Pop Rocket. Managements plan is to significantly
scale back this business during 2005 while exiting the business permanently as soon as is feasible.
In the near term, this includes restructuring the Pop Rocket division and exiting certain licenses.
In connection with this decision, the Company expects to incur charges for one-time employee
termination benefits and other costs. The Company expects employee termination costs to range from
$700 to $900 in 2005. The Company is unable in good faith to make a determination of an estimate
as to other costs. Such costs are expected to result in future cash expenditures. As a result of the Pop Rocket wind down, in the fourth quarter of 2004, the Company recorded a
pre-tax charge of $7,722 million relating to minimum royalty guarantee shortfalls on several of its
consumer products licenses. This charge was determined based on contractual commitments as of
December 31, 2004 and reflects the Companys decision not to fully exploit these licenses.
Approximately $3,000 of this pre-tax charge is non-cash for write-offs of long-term royalty
advances. Of the remaining $4,700, the Company is working with licensors to mitigate the future
cash impact of the shortfall. The charge is recorded as minimum royalty guarantee shortfalls in
the accompanying consolidated statement of operations for the year ended December 31, 2004. 3. IMPAIRMENT OF ASSETS Refer to Note 1, Summary of Significant Accounting Policies  Goodwill and Other Intangibles
for discussion of goodwill impairment. During the fourth quarter of 2004, the Company performed its annual impairment review for
goodwill and other intangible assets and recorded a non-cash charge of $6,312. The charge was
required to reduce the carrying value of goodwill at Upshot. The Upshot impairment charge
reflects the reporting units lower than expected performance in 2004 and revised future
projections resulting from the loss of an important client in the fourth quarter of 2004.
This charge was calculated in accordance with the provisions of SFAS No. 142 utilizing a
present value based valuation technique based on the best available projections as of December
31, 2004 of Upshots future cash flows before interest. This impairment charge is recorded as
impairment of assets in the accompanying consolidated statement of operations for the year
ended December 31, 2004 and is reflected in the Marketing Services segment. 45




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4. ACQUISITIONS On July 17, 2002, the Company consummated the acquisition of Upshot, a marketing agency with
expertise in promotion, event, collaborative and environmental marketing. The Company
financed the acquisition through its existing cash reserves.
The acquisition was consummated pursuant to an Asset Upshot Purchase Agreement, dated May 22,
2002, by and among the Company, Promotional Marketing, LLC (Promotional Marketing) and HA-LO
Industries, Inc. (HA-LO) (the Upshot Purchase Agreement). Under the terms of
the Upshot Purchase Agreement, the Company acquired the principal assets of Promotional
Marketing (consisting of the principal assets used in connection with the operation of the
Upshot business) for $9,206 in cash plus related transaction costs of $685. The
Company assumed the principal current liabilities of the Upshot business in
connection with the acquisition. The Upshot acquisition has been accounted for under the purchase method of accounting. The
financial statements reflect the allocation of the purchase price to the acquired net assets
based on their estimated fair values as of the acquisition date. During 2003, the preliminary
allocation of the purchase price was adjusted to revise the estimated value of prepaid
expenses ($72 increase), deferred tax assets ($1,852 increase), accrued liabilities ($168
decrease) and non-current liabilities ($4,874 increase). These adjustments resulted in a net
increase to goodwill of $2,782. The adjustments to increase non-current liabilities are
attributable to a final determination of an unfavorable lease liability for Upshots Chicago,
Illinois office totaling $2,975 and to an adjustment totaling $1,900 due to the finalization
of an exit plan (see Note 2) both of which were contemplated as of the close of the
transaction. The unfavorable lease liability reflects the present value of the lease payments
in excess of market for the remaining term of the Chicago office lease. The increase in
deferred tax assets reflects the tax benefit associated with the increase in non-current
liabilities. Subsequent to these adjustments, the Companys allocation of purchase price for
the acquisition, based upon estimated fair values is as follows: Net current assets
    
    $
    7,029Property, plant and equipment
    
    
    700Other non-current assets
    
    
    1Net current liabilities
    
    
    (7,783
    )Non-current liabilities
    
    
    (4,874
    )Estimated fair value, net liabilities assumed
    
    
    (4,927
    )Goodwill
    
    
    14,631Other intangible assets
    
    
    187Total purchase price
    
    $
    9,891
 The intangible assets of $187 are comprised of customer contracts and related customer
relationships and sales order backlog, and are being amortized over estimated useful lives
ranging from 6 to 12 months. Intangible assets associated with the Upshot acquisition are
accounted for in accordance with SFAS No. 142, Goodwill and Other Intangible Assets.
Goodwill has an indefinite life and is not amortized. In connection with the Upshot acquisition, the Company formulated and implemented an
integration plan and incurred integration costs, including travel, training and consulting
costs. Such costs totaled $453 and were recorded as integration costs in the consolidated
statements of operations for the year ended December 31, 2002. In the fourth quarter of 2004, the Company performed the annual impairment test required by
SFAS No. 142 and determined that the goodwill resulting from the acquisition of Upshot was
impaired as of December 31, 2004. As a result, the Company recorded a non-cash charge in the
amount of $6,312 to write-down the carrying value of the Upshot goodwill. On September 3, 2003, the Company acquired substantially all of the assets of SCI Promotion, 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 (the SCI Promotion Purchase
Agreement.) Under the terms of the SCI Promotion Purchase Agreement, the Company acquired
substantially all of the assets of SCI Promotion 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 earning before interest, taxes,
depreciation and amortization (EBITDA) over the period from 2003 through 2006. The earnout
payments, if required, are payable 50% in cash and 50% in shares of the Companys common stock. The
additional consideration, if any, will be recorded as goodwill. The SCI Promotion acquisition has been accounted for under the purchase method of accounting.
The financial statements reflect the allocation of the purchase price to the acquired net
assets based on their estimated fair values as of the acquisition date. During 2004, the preliminary allocation of the purchase price was adjusted to revise the estimated
value of prepaid expenses ($64 46




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decrease), receivable from seller ($55 decrease) and accrued
liabilities ($13 increase). The allocation reflects a receivable from the seller resulting
from a closing balance sheet working capital adjustment of $800, accruing interest at the rate
of 5% per annum, that will offset additional earnout consideration based on the results for
2003. The additional earnout consideration was recorded as additional goodwill in 2004. The
Companys allocation of purchase price for the acquisition, based upon estimated fair values
is as follows: Net current assets
    
    $
    6,357Receivable from seller
    
    
    800Property, plant and equipment
    
    
    37Other non-current assets
    
    
    13Net current liabilities
    
    
    (5,755
    )Estimated fair value, net assets acquired
    
    
    1,452Goodwill
    
    
    4,041Other intangible assets
    
    
    728Total purchase price
    
    $
    6,221
 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. Intangible assets associated with the SCI Promotion acquisition are
accounted for in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. Goodwill has
an indefinite life and is not amortized. On February 2, 2004 (effective January 31, 2004), the Company acquired certain assets of Johnson
Grossfield, Inc. (JGI-MN), a privately held promotional marketing services company based in
Minneapolis, Minnesota. The Company financed the acquisition through its existing cash reserves.
The acquisition was consummated pursuant to an Asset Purchase Agreement dated January 16, 2004 (the
Johnson Grossfield Purchase Agreement). Under the terms of the Purchase Agreement, the Company
purchased the assets of JGI-MNs promotional agency business for approximately $4,325 in cash (net
of a holdback of $250) and 35,785 shares of the Companys Common Stock (which, based upon the
January 30, 2004 closing market price of $14.80, had a value of $530), plus related transaction
costs of $184 and a commitment to pay additional earnout consideration of up to $4,500 based upon
future performance of the acquired business. The Company also assumed the operating liabilities of
the promotional agency business in connection with the acquisition. The earnout consideration is
based upon the acquired business achieving targeted levels of EBITDA over the period from 2004
through 2008. The earnout payments, if required, are payable 50% in cash and 50% in shares of the
Companys Common Stock. The amount of earnout consideration attributable to 2004 performance will
be determined and paid in the second quarter of 2005. The additional consideration, if any, will
be recorded as goodwill. The Johnson Grossfield acquisition has been accounted for under the purchase method of accounting.
The financial statements reflect the allocation of the purchase price to the acquired
net assets based on their estimated fair values as of the acquisition date. During 2004, the preliminary allocation of the
purchase price was adjusted to revise the estimated value of accounts receivable ($31 decrease),
inventory ($68 decrease) and other intangible assets
($150 increase). During 2004, additional
consideration was paid in the amount of $105 as a working capital adjustment. The Companys
allocation of purchase price for the Johnson Grossfield acquisition, based upon
estimated fair values is as follows: Net current assets
    
    $
    2,758Property, plant and equipment
    
    
    8Other non-current assets
    
    
    7Net current liabilities
    
    
    (1,214
    )Estimated fair value, net assets acquired
    
    
    1,559Goodwill
    
    
    1,192Other intangible assets
    
    
    2,393Total purchase price
    
    $
    5,144
 The intangible assets of $2,393 are comprised of customer relationships and a non-competition
agreement, and are being amortized over estimated useful lives ranging from 2 years to 12 years. On November 10, 2004, the Company acquired all of the outstanding capital stock of Megaprint Group
Limited (Megaprint Group), a privately held creative promotions agency headquartered in the
United Kingdom. The Company financed the Megaprint Group acquisition through short-term debt. The
Company paid 1,824 GBP (approximately US $3,388) in cash (net of a hold back for working
capital adjustments of 180 GBP), plus related transaction costs of 283 GBP (approximately US $526).
Under the terms of the Stock 47




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Purchase Agreement, the Company is committed to pay, subject to
offset for any shortfall in the target level of net working capital at December 31, 2004, a minimum
of 850 GBP and up to a maximum of 1,300 GBP in 2005 based on the performance of Megaprint Group for
the year ended December 31, 2004 (2004 Earnout Payment). The Company has accrued a liability for
the minimum payment of 850 GBP as purchase price as of the acquisition date. The Company is also
committed to pay additional consideration up to a maximum of 2,450 GBP based on future performance
through 2009. The additional consideration is based upon the business achieving targeted levels of
margin after direct overhead (MADO) over the period from 2005 through 2009. The additional
consideration, if any, will be recorded as goodwill. The Companys preliminary allocation of
purchase price for the acquisition, based upon estimated fair values is as follows: Net current assets
    
    $
    8,512Property, plant and equipment
    
    
    1,265Net current liabilities
    
    
    (7,289
    )Estimated fair value, net assets acquired
    
    
    2,488Goodwill
    
    
    2,665Other intangible assets
    
    
    338Total purchase price
    
    $
    5,491
 Included in net current liabilities for the Megaprint Group is a mortgage loan for a building in
Holland (see Note 6). The balance of the mortgage loan as of the acquisition date totaled
approximately 900 Euros (approximately US $1,200). The building is
recorded under fixed assets and is recorded at the same value as the balance of the mortgage loan. The building
and mortgage loan are held in trust by the Megaprint Group on behalf of its former shareholders
(the Sellers). The building is currently held for sale. The proceeds of any sale would be used
to pay-off the mortgage loan and any excess proceeds would be remitted to the Sellers. In the
event that the Megaprint Group is unable to sell the building by March 31, 2005, the Company will
offset the balance of the mortgage loan against monies owed to the Sellers for the 2004 Earnout
Payment. The intangible assets of $338 are comprised of sales order backlog and customer relationships, and
are being amortized over estimated useful lives ranging from 7 months to 15 years. Pro Forma Financial
Data

SCI Promotion was formed in June 2002 when SCI Promotions management purchased the assets and
assumed certain liabilities of a predecessor business from Aspen Marketing, Inc. (a privately held
promotions company). In conjunction with this acquisition, SCI Promotions management implemented a
number of significant structural changes in the business and ascribed different underlying basis to
SCI Promotions assets and liabilities than previously ascribed by Aspen Marketing, Inc. As a
result of the acquisition and the changes in the business, the Companys management believes that
the financial information for SCI Promotion for the first half of 2002 is not meaningful or
relevant. The pro forma information shown below for 2002 excludes the impact of the SCI Promotion
acquisition. The following selected unaudited pro forma consolidated results of operations are
presented as if the Upshot, Johnson Grossfield and Megaprint Group acquisitions had occurred as of
the beginning of the period immediately preceding the period of acquisition and as if the SCI
Promotion acquisition had occurred at the beginning of 2003 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. Years Ended December 31,2002
    
    
    2003
    
    
    2004Pro forma revenues
    
    $
    220,509
    
    
    $
    264,044
    
    
    $
    249,920Pro forma net income (loss)
    
    $
    2,960
    
    
    $
    8,845
    
    
    $
    (9,669
    )Pro forma basic income (loss) per share
    
    $
    0.20
    
    
    $
    0.99
    
    
    $
    (1.94
    )Pro forma diluted income (loss) per share
    
    $
    0.19
    
    
    $
    0.94
    
    
    $
    (1.94
    )Pro forma basic weighted average
shares outstanding
    
    
    5,721,790
    
    
    
    5,718,548
    
    
    
    5,756,960Pro forma diluted weighted average
shares outstanding
    
    
    5,895,103
    
    
    
    6,053,503
    
    
    
    5,756,960
 Refer to Note 1 for further discussion of the method of computation of earnings per share. 48




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5. FIXED ASSETS, NET Fixed assets, net is summarized as follows: December 31,2003
    
    
    2004Furniture, fixtures and equipment
    
    $
    3,462
    
    
    $
    3,431Computer software
    
    
    3,979
    
    
    
    4,572Computer hardware
    
    
    4,546
    
    
    
    5,180Leasehold improvements
    
    
    1,744
    
    
    
    2,069Building
    
    
    
    
    
    
    1,239Fixed assets, at cost
    
    
    13,731
    
    
    
    16,491Accumulated depreciation and amortization
    
    
    (9,922
    )
    
    
    (11,462
    )Fixed assets, net
    
    $
    3,809
    
    
    $
    5,029
 For the years ended December 31, 2002, 2003 and 2004, depreciation expense related to fixed
assets was $1,597, $1,636 and $1,704, respectively. 6. 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. On March 31,
2005 the maturity date of the Facility was further extended through March 31, 2006. The credit
facility is secured by substantially all of the Companys assets and provides for a line of credit
of up to $35,000 with borrowing availability determined by a formula based on qualified assets.
The March 31, 2005 amendment reduced the line of credit to $20,000. The Company sought a reduction
in the size of the Facility to better align the size and cost of the Facility with its borrowing
needs. Interest on outstanding borrowings will be based on either a fixed rate equivalent to LIBOR
plus an applicable spread of between 1.50 and 2.25 percent or a variable rate equivalent to the
banks reference rate plus an applicable spread of between zero and 0.50 percent. The Company is
also required to pay an unused line fee of between zero and 0.60 percent per annum and certain
letter of credit fees. The applicable spread is based on the achievement of certain financial
ratios. The Facility also requires the Company to comply with certain restrictions and covenants
as amended from time to time. On November 14, 2001, February 8, 2002, September 30, 2002, November
14, 2003, April 26, 2004, August 12, 2004, November 15, 2004 and March 31, 2005, certain covenants
under the facility were amended. As of December 31, 2004, the Company was in compliance with the
amended restrictions and covenants. In addition to amending certain covenants, the November 15,
2004 amendment imposed a temporary $12,000 cap on total outstanding borrowings and letters of
credit. This amendment also increased the maximum interest rate on outstanding borrowings by 0.25
percent. The March 31, 2005 amendment eliminated the temporary $12,000 cap. The Facility may be
used for working capital and acquisition financing purposes. As of December 31, 2004, $2,975 was
outstanding under the Facility. In addition to the Facility, in October, 2003 Logistix established an import/letter of credit
facility with Hong Kong Shanghai Bank Corp. (The HSBC Facility) to provide short-term
financing of product purchases from Asia. The total availability under this facility is 1,000
GBP. Under The HSBC Facility Logistixs vendors are paid by the bank directly upon receipt of
invoices and shipping documentation. Logistix in turn is obligated to repay HSBC within 120
days. As of December 31, 2003 and 2004, advances outstanding under this facility totaled
approximately $626 and $1,797, respectively. As of December 31, 2003 and 2004, the marginal interest rate on available borrowings under the
Facility was 4.0% and 3.9%, respectively. As of December 31, 2003 and
2004, the marginal interest rate on available borrowings under the
HSBC Facility was 3.2% and 4.2%, respectively. Letters of credit outstanding
as of December 31, 2003 and 2004 totaled $1,829 and $2,694, respectively. In connection with the acquisition of the Megaprint Group, the Company assumed a mortgage loan
secured by a building in Holland (see Note 4). The mortgage loan has a 24 year term and
carrys an interest rate fixed at 5 percent per annum for three years from December 2002. The
mortgage loan is repayable in equal monthly installments of 4 Euros. The outstanding balance
on the mortgage loan is 919 Euros (approximately US $1,253) as of December 31, 2004.
Notwithstanding the terms of the mortgage loan, it will be repaid in the second quarter of
2005. In the event that the Megaprint Group is unable to sell the building by March 31, 2005,
the Company will offset the balance of the mortgage loan against monies owed to the Sellers
for the 2004 Earnout Payment. This mortgage loan is recorded as short-term debt in the
accompanying balance sheet as of December 31, 2004. Megaprint Group has an overdraft facility of 750 Euros from ING Bank, Nederland. As of
December 31, 2004, there were no amounts outstanding under this facility. 49




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7. DEFINED CONTRIBUTION PLAN The Company has a 401(k) Tax Deferred Savings Plan (the 401(k) Plan), which became effective
on January 1, 1992. The 401(k) Plan covers substantially all of its eligible employees, as
defined under the 401(k) Plan. The Company makes annual contributions to the 401(k) Plan
consisting of a discretionary matching contribution equal to a determined percentage of the
employees contribution. Costs related to contributions to the 401(k) Plan for the years ended
December 31, 2002, 2003, and 2004 were $303, $522 and $599, respectively. 8. EQUITY COMPENSATION PLANS The Company currently has three equity based compensation plans: the 2000 Stock Option Plan
(the 2000 Employee Plan), 2004 Non-Employee Director Stock Incentive Plan (the Non-Employee
Director Plan) and the 2004 Stock Incentive Plan (the Stock Incentive Plan and collectively
with 2000 Employee Plan and the Non-Employee Director Plan referred to as the Equity
Compensation Plans). A total of 2.1 million shares of Common Stock are reserved for issuance
pursuant to awards granted and to be granted under the Equity Compensation Plans. An
aggregate of 914,825 shares were available for grant under the Equity Compensation Plans as
of December 31, 2004. The 2000 Employee Plan expires in 2010. The Non-Employee Director Plan
and the Stock Incentive Plan expire in 2014. The Company previously had a 1996 Stock Option Plan, which expired in 2001, and a Non-Employee
Director Stock Option Plan, which expired in 2003 (collectively, the Expired Plans). An
aggregate of 1,112,078 shares are reserved for issuance pursuant to outstanding options
granted under these Expired Plans. The 2000 Employee Plan provides for option grants at exercise prices not less than the fair
market value on the date of grant in the case of qualified incentive stock options, and not
less than par value in the case of non-qualified options. Under the terms of the 2000
Employee Plan, the Company may issue awards of restricted stock and restricted stock units
upon such terms and conditions as it may deem appropriate. The Non-Employee Director Plan provides for the annual grant of incentive awards which may
consist of stock options, restricted stock grants or restricted stock units. The Non-Employee
Director Plan is administered by the Board of Directors or, if the Board so determines, by a
committee of the Board. The Stock Incentive Plan provides for the grant of incentive awards which may consist of stock
options, restricted stock grants, restricted stock units, stock bonuses, stock appreciation rights
or performance units. The Stock Incentive Plan is administered by the Board of Directors or, if the
Board so determines, by a committee of the Board. Transactions involving the Stock Compensation Plans and the Expired Plans are summarized as
follows: Exercisable at End of YearWeighted
    
    
    
    
    
    
    WeightedRestricted
    
    
    Average
    
    
    
    
    
    
    AverageOptions
    
    
    Stock
    
    
    Exercise Price
    
    
    Number
    
    
    Exercise PriceOutstanding
    
    
    Outstanding
    
    
    Per Share
    
    
    Exercisable
    
    
    SharesOutstanding at December 31, 2001
    
    
    1,958,778
    
    
    
    
    
    
    $
    11.96
    
    
    
    674,909
    
    
    $
    13.83Granted
    
    
    507,000
    
    
    
    
    
    
    
    12.92Exercised
    
    
    (88,525
    )
    
    
    
    
    
    
    9.48Canceled
    
    
    (142,875
    )
    
    
    
    
    
    
    11.14Outstanding at December 31, 2002
    
    
    2,234,378
    
    
    
    50,000
    
    
    
    12.34
    
    
    
    911,743
    
    
    $
    13.40Granted
    
    
    120,000
    
    
    
    78,750
    
    
    
    13.48Exercised
    
    
    (111,050
    )
    
    
    
    
    
    
    8.42Canceled
    
    
    (80,800
    )
    
    
    (4,300
    )
    
    
    13.48Outstanding at December 31, 2003
    
    
    2,162,528
    
    
    
    124,450
    
    
    
    12.74
    
    
    
    1,092,576
    
    
    $
    13.29Granted
    
    
    285,000
    
    
    
    167,050
    
    
    
    10.68Exercised
    
    
    (54,700
    )
    
    
    (13,075
    )
    
    
    9.44Canceled
    
    
    (436,100
    )
    
    
    (33,100
    )
    
    
    10.13Outstanding at December 31, 2004
    
    
    1,956,728
    
    
    
    245,325
    
    
    $
    12.01
    
    
    
    1,315,383
    
    
    $
    13.33
 50




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The following table summarizes information about the Companys equity awards outstanding and
exercisable as of December 31, 2004: WEIGHTEDAVERAGE
    
    
    WEIGHTED
    
    
    
    
    
    
    WEIGHTEDRANGE OF
    
    NUMBER
    
    
    REMAINING
    
    
    AVERAGE
    
    
    NUMBER
    
    
    AVERAGEEXERCISE PRICES
    
    OUTSTANDING
    
    
    CONTRACTUAL LIFE
    
    
    EXERCISE PRICE
    
    
    EXERCISABLE
    
    
    EXERCISE PRICE$  0.00
- $  9.94
    
    
    760,403
    
    
    
    4.64
    
    
    $
    9.63
    
    
    
    482,693
    
    
    $
    9.00$10.00 - $12.10
    
    
    525,150
    
    
    
    6.56
    
    
    $
    12.20
    
    
    
    377,890
    
    
    $
    12.20$12.25 - $13.39
    
    
    498,500
    
    
    
    7.82
    
    
    $
    14.27
    
    
    
    174,800
    
    
    $
    13.79$13.88 - $28.13
    
    
    418,000
    
    
    
    4.42
    
    
    $
    20.74
    
    
    
    280,000
    
    
    $
    22.022,202,053
    
    
    
    5.78
    
    
    $
    13.40
    
    
    
    1,315,383
    
    
    $
    13.33
 Warrants On March 29, 2000 and June 20, 2000, the Company granted Crown EMAK Partners, LLC (Crown)
15,000 warrants to purchase additional shares of preferred stock. On March 19, 2004, these
warrants were exchanged for warrants to purchase Common Stock. (See Preferred Stock below). Preferred Stock The Company has authorized 1,000,000 shares of preferred stock, par value $.001 per share
(Preferred Stock). The Board of Directors is empowered to issue Preferred Stock from time to
time in one or more series, without stockholder approval, and to determine the rights,
preferences and restrictions, including dividend, conversion, voting, redemption (including
sinking fund provisions), and other rights, liquidation preferences and the number of shares
constituting any series and the designations of such series. On March 29, 2000, Crown, invested $11,900 in the Company in exchange for Preferred Stock and
warrants to purchase additional Preferred Stock. Under the terms of the investment, Crown
acquired 11,900 shares of Series A mandatorily redeemable senior cumulative participating
convertible preferred stock, par value $.001 per share, (the Series A Stock) with a
conversion price of $14.75 per common share. In connection with such purchase, the Company
granted to Crown five year warrants (collectively, the Warrants) to purchase 5,712 shares of
Series B senior cumulative participating convertible preferred stock, par value $.001 per
share, (the Series B Stock) at an exercise price of $1,000 per share, and 1,428 shares of
Series C senior cumulative participating convertible preferred stock, par value $.001 per
share, (the Series C Stock) at an exercise price of $1,000 per share. The Warrants were
immediately exercisable. The conversion prices of the Series B Stock and the Series C Stock
were $16.00 and $18.00 per common share, respectively. On June 20, 2000, Crown paid an
additional $13,100 in exchange for an additional 13,100 shares of Series A Stock with a
conversion price of $14.75 per common share. In connection with such purchase, the Company
granted to Crown additional Warrants to purchase another 6,288 shares of Series B Stock and
another 1,572 shares of Series C Stock. Each share of Series A Stock is convertible into
67.7966 shares of Common Stock, representing 1,694,915 shares of Common Stock in aggregate.
Each share of Series B Stock and Series C Stock was convertible into 62.5 and 55.5556 shares
of Common Stock, respectively, representing 916,666 shares of Common Stock in aggregate. Also
in connection with such purchase, the Company agreed to pay Crown a commitment fee in the
aggregate amount of $1,250, paid in equal quarterly installments of $62.5 commencing on June
30, 2000 and ending on June 30, 2005. The Company paid $250 in fees for the year ended
December 31, 2004. On March 19, 2004, the Company entered into a Warrant Exchange Agreement with Crown whereby
Crown received new warrants to purchase an aggregate of 916,666 shares of Common Stock (New
Warrants) in exchange for cancellation of the existing Warrants to purchase shares of Series
B Stock and Series C Stock (which, upon issuance, would also have been convertible into
916,666 shares of Common Stock). The New Warrants consist of warrants to purchase 750,000
shares and 166,666 shares of Common Stock at exercise prices of $16.00 and $18.00 per common
share, respectively. Of each tranche, 47.6% expire on March 29, 2010 and 52.4% expire on June
20, 2010. As a result of the exchange transaction, Crown received an extension of time in
which to exercise its right to purchase additional equity in the Company, and the Company
obtained an elimination of the preferred rights and preferences as well as the preferred
dividend associated with the Series B Stock and Series C Stock. The exchange was recorded as a
reduction to preferred stock of $531 and an increase to additional paid-in-capital of $487,
net of transaction costs of $44. The exchange was approved by an independent committee of our
Board, which relied upon a fairness opinion provided by an outside advisory firm. On December 30, 2004, the Company entered into an Exchange Agreement with Crown whereby Crown
received 25,000 shares of Series AA mandatorily redeemable senior cumulative preferred stock,
par value $0.001 per share, (the Series AA Stock) with a conversion price of $14.75 per
common share, in exchange for 25,000 shares of Series A Stock. The Series AA Stock has
substantially the same rights and preferences as the Series A Stock, but does not participate
in cash dividends paid on Common Stock. The exchange was effected in response to the impact
of EITF 03-6 on reported earnings. (See Note 1) Upon any voluntary
or involuntary liquidation, dissolution or winding-up of the Companys affairs, Crown, as
holder of the Series AA Stock, will be 51




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entitled to payment out of assets of the Company
available for distribution of an amount equal to the greater of (a) the liquidation preference
of $1,000 per share (the Liquidation Preference) plus all accrued and unpaid dividends or
(b) the aggregate amount of payment that the outstanding preferred stock holder would have
received assuming conversion to Common Stock immediately prior to the date of liquidation of
capital stock, before any payment is made to other stockholders. The Series AA Stock is subject to mandatorily redemption at the option of the holder at 101% of the
aggregate Liquidation Preference plus accrued and unpaid dividends if a change in control occurs. Crown has voting rights equivalent to the number of shares of Common Stock into which their
Series AA Stock is convertible on the relevant record date. Crown is also entitled to receive
a quarterly dividend equal to 6% of the Liquidation Preference per share outstanding, payable
in cash. Total dividends for the year ended December 31, 2004 amounted to $1,500, of which
$375 was paid in January 2005 and recorded in accounts payable in the accompanying
consolidated balance sheet as of December 31, 2004. The holder of the Series AA Stock, voting separately as a class, are entitled to elect two
directors of the Company, provided however, at ant time the Board of Directors is increased to
include more than eight members, the holders of the Series AA Stock are entitled to elect one
additional director. Crown currently holds 100% of the outstanding shares of Series AA Stock and has designated one
individual to the Board of Directors of the Company. The Series AA Stock is recorded in the accompanying consolidated balance sheets at its
Liquidation Preference net of issuance costs. The issuance costs totaled approximately $1,951
and included an accrual of approximately $1,000 for the present value of the commitment fee
discussed above. Stock Repurchase On July 24, 2001, 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 August 2, 2001
through July 11, 2002, the Company spent $5,605 to purchase 454,715 shares at an average price
of $12.33 per share including commissions. On July 12, 2002, the Companys Board of Directors
authorized up to an additional $10,000 for the repurchase of the Companys common stock. The
Company spent $3,505 to repurchase 267,650 shares at an average price of $13.10 per share
including commissions under this authorization through December 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. This repurchase program is being
funded through working capital. 9. INCOME TAXES In accordance with SFAS No. 109, Accounting for Income Taxes, deferred income taxes reflect
the impact of temporary differences between values recorded for assets and liabilities for
financial reporting purposes and the values utilized for measurement in accordance with
current tax laws. Consolidated pre-tax income (loss) consists of the following: Years Ended December 31,2002
    
    2003
    
    2004US operations
    
    $
    5,854
    
    
    $
    7,430
    
    
    $
    (20,013
    )Foreign operations
    
    
    4,653
    
    
    
    4,622
    
    
    
    3,613$
    10,507
    
    
    $
    12,052
    
    
    $
    (16,400
    )
 The provision (benefit) for income taxes consist of: Years Ended December 31,2002
    
    
    2003
    
    
    2004CURRENT:Federal
    
    $
    2,163
    
    
    $
    2,202
    
    
    $
    (2,640
    )State and local
    
    
    342
    
    
    
    16
    
    
    
    16Foreign
    
    
    822
    
    
    
    1,166
    
    
    
    7173,327
    
    
    
    3,384
    
    
    
    (1,907
    )DEFERRED:Federal
    
    
    485
    
    
    
    980
    
    
    
    (2,970
    )State and Local
    
    
    73
    
    
    
    157
    
    
    
    (1,839
    )Foreign
    
    
    (99
    )
    
    
    (418
    )
    
    
    459
    
    
    
    719
    
    
    
    (4,809
    )$
    3,786
    
    
    $
    4,103
    
    
    $
    (6,716
    )
 52




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Income taxes recorded by the Company differ from the amounts computed by applying the
statutory United States Federal income tax rate to income before income taxes. The following
schedule reconciles income tax expense at the statutory rate and the actual income tax expense
as reflected in the accompanying consolidated statements of operations. Years Ended December 31,2002
    
    
    2003
    
    
    2004Tax at the Federal statutory rate
    
    $
    3,614
    
    
    $
    4,146
    
    
    $
    (5,641
    )State income taxes, net of the Federal tax benefit
    
    
    141
    
    
    
    (5
    )
    
    
    (1,052
    )Effect of
change in state rate on deferred tax assets
    
    
    
    
    
    
    
    
    
    
    (300
    )Valuation Allowance
    
    
    
    
    
    
    
    
    
    
    223Other
    
    
    31
    
    
    
    (38
    )
    
    
    54$
    3,786
    
    
    $
    4,103
    
    
    $
    (6,716
    )
 Other reflects the effects of permanent differences such as tax free municipal interest income
earned in 2002, 2003 and 2004, and the impact of foreign earnings which are taxed at different
rates. The effective rate increased in 2004 to 41.0% of pre-tax loss from 34.0% of pre-tax
income in 2003. This change in the effective rate is primarily the result of losses generated
in the United States. The losses recorded in the United States, which has higher tax rates,
generate a higher income tax benefit. Losses in the United States were partially offset by
income generated in international territories which have lower tax rates. The higher tax
benefit as a percentage of pre-tax loss in the U.S. combined with the lower tax provision as a
percentage of pre-tax income in international territories has resulted in a higher overall tax
benefit as a percentage of pre-tax loss. In addition, as a result of changes in business operations, the Companys current state income
tax rate has increased as compared to prior years. The Company expects the deferred tax assets to
reverse at the new state rate. As a result, the Companys deferred tax assets have been adjusted
accordingly. The tax effects of the significant temporary differences giving rise to the Companys deferred
tax assets (liabilities) for the years ended December 31, 2003 and 2004 are as follows: 2003
    
    
    2004Allowance for doubtful accounts
    
    $
    811
    
    
    $
    717Inventory reserve
    
    
    43
    
    
    
    80Accrued expenses
    
    
    663
    
    
    
    1,681Net operating loss carryforwards
    
    
    
    
    
    
    606Other
    
    
    786
    
    
    
    (304
    )Total current
    
    
    2,303
    
    
    
    2,780Goodwill and other intangibles
    
    
    518
    
    
    
    1,908Fixed assets
    
    
    69
    
    
    
    69Long term liabilities
    
    
    1,979
    
    
    
    3,836Other
    
    
    267
    
    
    
    288Total non-current
    
    
    2,833
    
    
    
    6,101Deferred income tax asset valuation allowance
    
    
    
    
    
    
    (223
    )Net deferred tax assets
    
    $
    5,136
    
    
    $
    8,658
 State net operating loss
(NOL) carryforwards totaled approximately $6,532 at December
31, 2004. Their use is limited to future taxable earnings of the Company. As the states do not
currently provide for a carryback provision, the state net operating losses will have a 10 year
carryforward period. The federal net operating losses will be carried back and utilized in prior
years. Management considered all available evidence and
determined that a valuation allowance of $223 was required as of December 31, 2004 for those
NOL carryforwards that are not expected to provide future tax benefits. Management believes
that it is more likely than not that the Company will generate sufficient taxable income in
the appropriate carryforward periods to realize the benefit of the remaining net deferred
income tax assets of $8,658. A deferred U.S. tax liability has not been provided on the unremitted earnings of Logistix
because it is the intent of the Company to permanently reinvest these earnings in the United
Kingdom. Undistributed pre-tax earnings of Logistix, which have been or are intended to be
permanently invested in accordance with APB No. 23, Accounting for Income Taxes  Special
Areas, aggregated $4,713 and $5,705 at December 31, 2003 and 2004, respectively. The
determination of the tax liability upon repatriation is not practicable. On October 22, 2004, the Jobs Act was signed into law. Among its various provisions, the Jobs
Act creates a temporary incentive for US corporations to repatriate accumulated income earned
abroad by providing an 85% dividends received deduction for certain qualifying dividends. On
December 21, 2004, the FASB issued FSP 109-2. FSP 109-2 allows companies additional time
beyond the financial reporting period in which the Jobs Act was enacted to evaluate the effect
of the Jobs Act on a companys plan for reinvestment or repatriation of unremitted foreign
earnings for the purposes of applying SFAS No. 109. As of December 31, 2004, management had
not determined whether, or to what extent, the Company may repatriate foreign earnings under
the Jobs Act. Therefore, the Companys 2004 consolidated financial statements do not include
any provision for income taxes on the $5,705
cumulative balance of unremitted foreign earnings as of year end 2004. Management expects to
finalize its assessment related to the Jobs Act in the first half of 2005. 53




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10. 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 are as follows: Year2005
    
    $
    4,9112006
    
    
    4,3472007
    
    
    4,0472008
    
    
    3,6412009
    
    
    3,664Thereafter
    
    
    2,625Total
    
    $
    23,235
 Aggregate rental expenses for operating leases were $2,832, $3,879 and $3,873 for the years
ended December 31, 2002, 2003 and 2004, respectively. Subsequent to December 31, 2004, the Company signed an amendment to the lease agreement for
the Indianapolis warehouse. The amendment extends the lease through July 31, 2010 and provides
for minimum annual payment of $127. Guaranteed Royalties For the years ended December 31, 2002, 2003, and 2004, the Company incurred $4,680, $4,278 and
$3,996, respectively, in royalty expense. In addition, the Company decided to wind down its
consumer products business. The result of the decision was a charge in 2004 for minimum
royalty guarantee shortfalls of $7,722. License agreements for certain copyrights and
trademarks require minimum guaranteed royalty payments over the respective terms of the
licenses. As of December 31, 2004, the Company has committed to pay total minimum guaranteed royalties
as follows: Year2005
    
    $
    4,5712006
    
    
    2,6132007
    
    
    1,076Total
    
    $
    8,260
 Employment Agreement The Company has employment agreements with key executives. Guaranteed compensation under
these agreements are as follows: Year2005
    
    $
    1,6872006
    
    
    7512007
    
    
    3252008
    
    
    2002009
    
    
    200Thereafter
    
    
    1,600Total
    
    $
    4,763
 Legal Proceedings The Company is involved in various legal proceedings generally incidental to its business.
While the result of any litigation contains an element of uncertainty, management presently
believes that the outcome of any other known, pending or threatened legal proceeding or claim,
individually or combined, will not have a material adverse effect on the Companys financial
position, results of operations or cash flows. Dispute Resolution Charge In the fourth quarter of 2004, the Company recorded a pre-tax charge of $237 related to a
dispute settlement liability incurred by assisting the former owner of SCI Promotion to settle
a claim for a product sold prior to its acquisition in September 2003. The Company chose to
facilitate settlement of the claim in order to secure a continued business relationship with
SCI Promotions 54




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##### Table of Contents



longtime client. The Company retained the right to offset the amount paid toward the
settlement against future earnout payments in connection with the SCI Promotion acquisition.
(See Note 4.) 11. INDUSTRY SEGMENTS, GEOGRAPHICAL INFORMATION AND MAJOR CUSTOMERS The Companys revenues are highly dependent on obtaining major contracts from a limited number
of customers. Approximately 65%, 58% and 51% of the Companys consolidated revenues for the
years ended December 31, 2002, 2003 and 2004, respectively, were from one customer in the
Marketing Services segment. 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 Marketing
Services segment is managed as an integrated business. The Marketing Services segment
provides a global offering of marketing services that draws upon the offerings of each of its
agencies. The Consumer Products segment designs and contracts for the manufacture of toys and
other consumer products for sale to major mass market and specialty retailers, who in turn
sell the products to consumers. Earnings of industry segments and geographic areas exclude interest income, interest expense,
depreciation expense, restructuring charges/gains, integration costs, and other unallocated
corporate expenses. Income taxes are allocated to segments on the basis of operating results.
Identified assets are those assets used in the operations of the segments and include
inventory, receivables, goodwill and other intangibles. Corporate assets consist of cash,
certain corporate receivables, fixed assets, and certain trademarks. 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. Industry Segments As of and For the Year Ended December 31, 2002ConsumerMarketing Services
    
    
    Products
    
    
    Corporate
    
    
    TotalTotal revenues
    
    $
    175,372
    
    
    $
    31,460
    
    
    $
    
    
    
    $
    206,832Income (loss) before provision
(benefit) for income taxes and
cumulative effect of change in
accounting principles
    
    $
    26,378
    
    
    $
    2,129
    
    
    $
    (18,000
    )
    
    $
    10,507Provision (benefit) for income taxes
    
    
    9,449
    
    
    
    695
    
    
    
    (6,358
    )
    
    
    3,786Income (loss) before cumulative effect
of change in accounting principles
    
    
    16,929
    
    
    
    1,434
    
    
    
    (11,642
    )
    
    
    6,721Cumulative effect of change in
accounting principles, net of tax
    
    
    2,496
    
    
    
    
    
    
    
    
    
    
    
    2,496Net income (loss)
    
    $
    14,433
    
    
    $
    1,434
    
    
    $
    (11,642
    )
    
    $
    4,225Fixed asset additions, net
    
    $
    
    
    
    $
    
    
    
    $
    982
    
    
    $
    982Depreciation and amortization
    
    $
    210
    
    
    $
    66
    
    
    $
    1,555
    
    
    $
    1,831Total assets
    
    $
    62,382
    
    
    $
    4,814
    
    
    $
    66,058
    
    
    $
    133,254
 55




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As of and For the Year Ended December 31, 2003ConsumerMarketing Services
    
    
    Products
    
    
    Corporate
    
    
    TotalTotal revenues
    
    
    189,261
    
    
    $
    29,852
    
    
    $
    
    
    
    $
    219,113Income (loss) before provision (benefit) for
income taxes
    
    $
    27,717
    
    
    $
    3,400
    
    
    $
    (19,065
    )
    
    $
    12,052Provision (benefit) for income taxes
    
    
    9,693
    
    
    
    1,182
    
    
    
    (6,772
    )
    
    
    4,103Net income (loss)
    
    $
    18,024
    
    
    $
    2,218
    
    
    $
    (12,293
    )
    
    $
    7,949Fixed asset additions
    
    $
    
    
    
    $
    
    
    
    $
    1,150
    
    
    $
    1,150Depreciation and amortization
    
    $
    174
    
    
    $
    128
    
    
    $
    1,644
    
    
    $
    1,946Total assets
    
    $
    86,218
    
    
    $
    8,767
    
    
    $
    33,345
    
    
    $
    128,330
 As of and For the Year Ended December 31, 2004ConsumerMarketing Services
    
    
    Products
    
    
    Corporate
    
    
    TotalTotal revenues
    
    $
    211,526
    
    
    $
    25,135
    
    
    $
    
    
    
    $
    236,661Income (loss) before provision (benefit) for
income taxes
    
    $
    12,362
    
    
    $

    (9,337
    )
    
    $
    (19,425
    )
    
    $
    (16,400
    )Provision (benefit) for income taxes
    
    
    5,063
    
    
    
    (3,824
    )
    
    
    (7,955
    )
    
    
    (6,716
    )Net income (loss)
    
    $
    7,299
    
    
    $
    (5,513
    )
    
    $
    (11,470
    )
    
    $
    (9,684
    )Fixed asset additions
    
    $
    
    
    
    $
    
    
    
    $
    1,602
    
    
    $
    1,602Depreciation and amortization
    
    $
    358
    
    
    $
    
    
    
    $
    1,709
    
    
    $
    2,067Total assets
    
    $
    98,866
    
    
    $
    11,570
    
    
    $
    22,877
    
    
    $
    133,313
 Information about the Companys operations by geographical area is as follows: As of and For the Years Ended December 31,2002
    
    
    2003
    
    
    2004Revenues:United States
    
    $
    160,364
    
    
    $
    171,819
    
    
    $
    177,125International
    
    
    46,468
    
    
    
    47,294
    
    
    
    59,536Total revenues
    
    $
    206,832
    
    
    $
    219,113
    
    
    $
    236,661Income from operations:United States
    
    $
    7,553
    
    
    $
    8,195
    
    
    $
    (14,893
    )International
    
    
    2,571
    
    
    
    3,468
    
    
    
    (720
    )Total income from operations
    
    $
    10,124
    
    
    $
    11,663
    
    
    $
    (15,613
    )Fixed assets, net:United States
    
    $
    3,747
    
    
    $
    3,244
    
    
    $
    2,916International
    
    
    438
    
    
    
    565
    
    
    
    2,113Total fixed assets
    
    $
    4,185
    
    
    $
    3,809
    
    
    $
    5,029
 12. Related Party Transactions 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 served as an advisor to the
Company with respect to potential mergers and acquisitions through December 31, 2003 (the 2003
Agreement). On August 23, 2004, the Company entered into another advisory agreement with USCI for
services during calendar 2004 (the 2004 Agreement). Mr. Deutschman currently serves on the Board
of Directors of the Company as the representative of the holder of the Companys Series AA Stock.
The Companys agreements with USCI provided for the payment of a discretionary success fee for
completed acquisition transactions in an amount determined by an independent committee of the
Board. The 2003 Agreement set forth guidelines for fees payable upon successful completion of an
acquisition transaction of $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 had an initial fee guideline of $275 for up to
$10,000 of consideration. Notwithstanding the guidelines, the independent committee had absolute
discretion in determining the amount, if any, of the success fee for any transaction. The 2004
Agreement does not include success fee guidelines. The USCI agreements provide for the payment of a
refundable advance against success fees in the aggregate amount of $275 under the 2003 Agreement
and $322 under the 2004 Agreement. The Company believes that these agreements enhanced its ability
to analyze and close merger and acquisition transactions in a more cost effective manner than with
traditional outside advisory firms. In connection with the acquisition of SCI Promotion, USCI
earned a success fee of $275. This success fee is recorded as a transaction cost of the SCI
Promotion acquisition. In connection with the February 2004 acquisition of Johnson Grossfield, USCI
earned a success fee of $125. This success fee is recorded as a transaction cost of the Johnson
Grossfield acquisition. In connection with the acquisition of Megaprint Group in November 2004,
USCI earned a success 56




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fee of $322. This success fee is recorded as a transaction cost of the Megaprint Group acquisition.  The Company has not extended its arrangement with USCI for 2005. 13. SUMMARIZED QUARTERLY FINANCIAL DATA (UNAUDITED) Three Months EndedMarch 31
    
    
    June 30
    
    
    September 30
    
    
    December 312003Revenues
    
    $
    47,567
    
    
    $
    56,953
    
    
    $
    48,948
    
    
    $
    65,645Income from operations
    
    $
    1,394
    
    
    $
    3,165
    
    
    $
    1,748
    
    
    $
    5,356Net income available to
common stockholders
    
    
    466
    
    
    $
    1,360
    
    
    $
    735
    
    
    $
    2,414Basic income per share:Income per share
    
    
    0.08
    
    
    $
    0.24
    
    
    $
    0.13
    
    
    $
    0.42Weighted average shares
outstanding
    
    
    5,708,279
    
    
    
    5,700,016
    
    
    
    5,750,736
    
    
    
    5,715,160Diluted income per share:Income per share
    
    
    0.08
    
    
    $
    0.22
    
    
    $
    0.12
    
    
    $
    0.40Weighted average shares
outstanding
    
    
    5,882,609
    
    
    
    6,057,801
    
    
    
    6,160,484
    
    
    
    6,018,604
 Three Months EndedMarch 31
    
    
    June 30
    
    
    September 30
    
    
    December 312004Revenues
    
    $
    51,812
    
    
    $
    51,778
    
    
    $
    58,055
    
    
    $
    75,016Income (loss) from operations
    
    $
    24
    
    
    $
    (806
    )
    
    $
    (1,638
    )
    
    $
    (13,193
    )Net income (loss) available to
common stockholders
    
    $
    (541
    )
    
    $

    (905
    )
    
    $
    (1,268
    )
    
    $
    (8,470
    )Basic income (loss) per share:Income (loss) per share
    
    $
    (0.09
    )
    
    $
    (0.16
    )
    
    $
    (0.22
    )
    
    $
    (1.47
    )Weighted average shares
outstanding
    
    
    5,739,603
    
    
    
    5,758,370
    
    
    
    5,758,888
    
    
    
    5,759,052Diluted income (loss) per share:Income (loss) per share
    
    $
    (0.09
    )
    
    $
    (0.16
    )
    
    $
    (0.22
    )
    
    $
    (1.47
    )Weighted average shares
outstanding
    
    
    5,739,603
    
    
    
    5,758,370
    
    
    
    5,758,888
    
    
    
    5,759,052
 14. SUBSEQUENT EVENT On
March 31, 2005, the Companys credit facility with Bank of America was amended. This amendment
extended the maturity date of the Facility from June 30, 2005 to March 31, 2006, changed certain
covenants and restrictions to better suit the Companys business model, reduced the line of credit
from $35,000 to $20,000, and eliminated the temporary $12,000 cap on total outstanding borrowings
and letters of credit. The Company sought a reduction in the size of the Facility to better align
the size and cost of the Facility with its borrowing needs. 57




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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE Inapplicable. 
 ITEM 9A. 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 December 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 December 31,
2004, that have materially affected, or are reasonably likely to materially affect, the
Companys internal control over financial reporting. 
 ITEM 9B. OTHER INFORMATION Inapplicable 58




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PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding our Executive Officers required by Item 10 of Part III is set forth in Item 1
of Part I BusinessExecutive Officers. Information required by Item 10 of Part III regarding our
Directors appears under the caption ELECTION OF DIRECTORS in our Proxy Statement relating to our
2005 Annual Meeting of Stockholders, and is incorporated herein by reference. Information relating
to our Policy on Business Conduct and to our compliance with Section 16(a) of the 1934 Act is also
set forth in our Proxy Statement relating to our 2005 Annual Meeting of Stockholders and is
incorporated herein by reference. 
 ITEM 11. EXECUTIVE COMPENSATION Information relating to this item appears under the captions ELECTION OF DIRECTORS,
EXECUTIVE COMPENSATION AND RELATED MATTERS and REPORT OF THE COMPENSATION COMMITTEE ON
EXECUTIVE COMPENSATION in our Proxy Statement relating to our 2005 Annual Meeting of
Stockholders, which are incorporated herein by reference. 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS Information relating to this item appears under the caption SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS in our Proxy Statement
relating to our 2005 Annual Meeting of Stockholders, which is incorporated herein by
reference. 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information relating to this item appears under the caption ELECTION OF DIRECTORS in our
Proxy Statement relating to our 2005 Annual Meeting of Stockholders, which is incorporated
herein by reference. 
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information relating to this item appears under the caption RATIFICATION OF SELECTION OF
INDEPENDENT AUDITORS in our Proxy Statement relating to our 2005 Annual Meeting of
Stockholders, which is incorporated herein by reference. 59




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PART IV 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES (a)List of documents filed as part of this Report. 1. Financial Statements:  
 PageReport of Independent Registered Public Accounting Firm
    
    
    31CONSOLIDATED FINANCIAL STATEMENTS:Balance Sheets as of December 31, 2003 and 2004
    
    
    32Statements of Operations for the Years Ended December 31, 2002, 2003 and 2004
    
    
    33Statements of Stockholders Equity and Mandatorily Redeemable Preferred Stock for the Years Ended
December 31, 2002, 2003 and 2004
    
    
    34Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2002, 2003 and 2004
    
    
    35Statements of Cash Flows for the Years Ended December 31, 2002, 2003 and 2004
    
    
    36Notes to Consolidated Financial Statements
    
    
    37
  2. Financial Statement Schedules:Report of Independent Registered Public Accounting Firm on Financial Statement Schedule
    
    
    64Schedule II Valuation and Qualifying Accounts
    
    
    65
   Note: All other supplementary schedules are omitted since
they are not applicable or the required information can be obtained from
the consolidated financial statements. 3. Exhibits: 3.1
    
    Certificate of Incorporation. (1)3.2
    
    Certificate of Amendment of
Certificate of Incorporation dated July 16, 2004. *3.3
    
    Certificate of Amendment of Certificate of Incorporation dated September 15, 2004. *3.4
    
    Amended and Restated Bylaws. (2)3.5
    
    Certificate of Designation of Series AA Senior Cumulative
Convertible Preferred Stock of the Company, dated March 19, 2004. (3)10.0
    
    Securities Purchase Agreement by and between Crown Acquisition
Partners, LLC and Equity Marketing, Inc., dated March 29, 2000. (4)10.1
    
    Registration Rights Agreement by and between Crown Acquisition
Partners, LLC and Equity Marketing, Inc., dated March 29, 2000. (4)10.2
    
    Agreement of Lease dated July 17, 1998 between Miracle Mile,
L.L.C. and Equity Marketing, Inc. (5)10.3
    
    Agreement of Lease, dated March 10, 2000, between Wide Harvest
Investment Ltd. and Equity Marketing Hong Kong, Ltd. (5)10.4
    
    Credit Agreement by and between Bank of America, N.A. and
Equity Marketing, Inc., dated April 24, 2001. (7)10.5
    
    First Amendment to Credit Agreement by and between Bank of
America, N.A. and Equity Marketing, Inc., dated September 30, 2001. (8)10.6
    
    Second Amendment to Credit Agreement by and between Bank of
America, N.A. and Equity Marketing, Inc., dated February 8, 2002. (9)10.7
    
    Third Amendment to Credit Agreement by and between Bank of
America, N.A. and Equity Marketing, Inc., dated September 30, 2002. (10)10.8
    
    Fourth Amendment to Credit Agreement by and between Bank of
America, N.A. and Equity Marketing, Inc., dated September 30, 2003. (14)
 60




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##### Table of Contents



Executive Compensation Plans and Arrangements of the Company 10.12
    
    Form of Directors and Officers Indemnification Agreement. (14)10.13
    
    Amended and Restated 1996 Stock Option Plan. (3)10.14
    
    Non-Employee Director Stock Option Plan. (2)10.15
    
    Employment Agreement dated January 1, 2003 between the Company and Donald A. Kurz. (11)10.16
    
    Amended and Restated 2000 Stock Option Plan. (12)10.17
    
    2004 Non-Employee Director Stock Incentive Plan. (15)10.18
    
    2004 Stock Incentive Plan. (15)10.19
    
    Employment Agreement dated
January 1, 2004 between the Company and Kim H. Thomsen. (16)21.
    
    Subsidiaries of the Registrant.*23.
    
    Consent of PricewaterhouseCoopers LLP.*31.1
    
    Certification of Principal Executive Officer dated March 31,
2005 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*31.2
    
    Certification of Principal Financial Officer dated March 31,
2005 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*32.1
    
    Certification of Principal Executive Officer dated March 31,
2005 pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.*32.2
    
    Certification of Principal Financial Officer dated March 31,
2005 pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.*
   (1)
    
    Previously filed as an exhibit to the Registrants Annual
Report on Form 10-K for the year ended December 31, 1995, and incorporated
herein by reference.(2)
    
    Previously filed as an exhibit to the Registrants Current
Report on Form 8-K dated March 17, 2005, and incorporated herein by
reference.(3)
    
    Previously filed as an exhibit to the Registrants Current
Report on Form 8-K dated January 5, 2005, and incorporated herein by
reference.(4)
    
    Previously filed as an exhibit to the Registrants Quarterly
Report on Form 10-Q for the quarter ended March 31, 2000, and incorporated
herein by reference.(5)
    
    Previously filed as an exhibit to the Registrants Current
Report on Form 8-K dated April 11, 2000, and incorporated herein by
reference.(6)
    
    Previously filed as an exhibit to the Registrants Quarterly
Report on Form 10-Q for the quarter ended March 31, 2001, and incorporated
herein by reference.(7)
    
    Previously filed as an exhibit to the Registrants Current
Report on Form 8-K dated November 16, 2001, and incorporated herein by
reference.(8)
    
    Previously filed as an exhibit to the Registrants Current
Report on Form 8-K dated March 18, 2002, and incorporated herein by
reference.(9)
    
    Previously filed as an exhibit to the Registrants Annual
Report on Form 10-K for the year ended December 31, 2002, and incorporated
herein by reference.(10)
    
    Previously filed as an exhibit to the Registrants Quarterly
Report on Form 10-Q for the quarter ended March 31, 2003, and incorporated
herein by reference.(11)
    
    Previously filed as an exhibit to the Registrants Quarterly
Report on Form 10-Q for the quarter ended June 30, 2003, and incorporated
herein by reference.(12)
    
    Previously filed as an exhibit to the Registrants Quarterly
Report on Form 10-Q for the quarter ended September 30, 2003, and
incorporated herein by reference.(13)
    
    Previously filed as an exhibit to the Registrants Annual
Report on Form 10-K for the year ended December 31, 2003, and incorporated
herein by reference.(14)
    
    Previously filed with the Registrants Proxy Statement for the
2004 Annual Meeting of Stockholders dated April 26, 2004 and incorporated
herein by reference. 61




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##### Table of Contents



(15)
    
    Previously filed as an exhibit to the Registrants Quarterly
Report on Form 10-Q for the quarter ended March 31, 2004, and incorporated
herein by reference.(*)
    
    Filed herewith (b) Exhibits Required by Item 601 of Regulation S-K See Item 3. above. (c) Financial Statement Schedule See Item 2. above. 62




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SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, on the 31st day of March, 2005 EMAK WORLDWIDE, INC.
 By:
    /s/ Donald A. KurzDonald A. KurzPresident and Chief Executive Officer POWER OF ATTORNEY We, the undersigned directors and officers of EMAK Worldwide, Inc. do hereby severally
constitute and appoint Donald A. Kurz, Teresa L. Tormey and Zohar Ziv , and each of them, our
true and lawful attorneys and agents, to do any and all acts and things in our name and behalf
in our capacities as directors and officers and to execute any and all instruments for us and
in our names in the capacities indicated below, which said attorneys and agents, or any of
them, may deem necessary or advisable to enable said corporation to comply with the Securities
Exchange Act of 1934, as amended, and any rules, regulations and requirements of the
Securities and Exchange Commission, in connection with this Annual Report on Form 10-K,
including specifically, but without limitation, power and authority to sign for us or any of
us, in our names in the capacities indicated below, any and all amendments hereto; and we do
each hereby ratify and confirm all said attorneys and agents, or any one of them, shall do or
cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacities and on
the dates indicated. /s/ Donald A. Kurz
    
    President and Chief
    
    March 31, 2005Donald A. Kurz
    
    Executive Officer, Director
(Principal Executive Officer)/s/ Zohar Ziv
    
    Senior Vice President and Chief Financial Officer
    
    March 31, 2005Zohar Ziv
    
    (Principal Financial and Accounting Officer)/s/ Stephen P. Robeck
    
    Chairman, Director
    
    March 31, 2005Stephen P. Robeck/s/ Barrie P. Berg
    
    Director
    
    March 31, 2005Barrie P. Berg/s/ Howard D. Bland
    
    Director
    
    March 31, 2005Howard D. BlandSanford R. Climan
    
    Director/s/ Jeffrey S. Deutschman
    
    Director
    
    March 31, 2005Jeffrey S. Deutschman/s/ Jonathan D. Kaufelt
    
    Director
    
    March 31, 2005Jonathan D. KaufeltDirectorAlfred E. Osborne, Jr.DirectorBruce I. Raben
 63




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##### Table of Contents



Report of Independent Registered Public Accounting Firm on
Financial Statement Schedule To the Board of Directors
of EMAK Worldwide, Inc.: Our audits of the
consolidated financial statements referred to in our report dated
March 31, 2005 appearing in the 2004 Annual Report to Shareholders of EMAK Worldwide, Inc. also included an
audit of the financial statement schedule listed in Item 15(a)(2) of this Form 10-K. In our
opinion, this financial statement schedule presents fairly, in all material respects, the
information set forth therein when read in conjunction with the related consolidated financial
statements. /s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Los Angeles, CA
March 31, 2005 64




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##### Table of Contents



EMAK WORLDWIDE, INC. 
 SCHEDULE IIVALUATION AND QUALIFYING ACCOUNTS (in thousands) Balance at
    
    
    Additions
    
    
    AdditionsBeginning of
    
    
    Charged to
    
    
    Charged to
    
    
    Net
    
    
    Balance atCLASSIFICATION
    
    of Year
    
    
    Expenses
    
    
    Revenues
    
    
    Deductions
    
    
    End of YearYear Ended December 31, 2002Allowances for doubtful
accounts receivable
and sales returns
    
    $
    2,336
    
    
    $
    484
    
    
    $
    1,212
    
    
    $
    (1,999
    )(A)
    
    $
    2,033Inventory reserve
    
    
    1,289
    
    
    
    664
    
    
    
    
    
    
    
    (221
    )
    
    
    1,732Restructuring reserves
    
    
    190
    
    
    
    178
    
    
    
    
    
    
    
    (139
    )
    
    
    229Year Ended December 31, 2003Allowances for doubtful
accounts receivable
and sales returns
    
    $
    2,033
    
    
    $
    277
    
    
    $
    605
    
    
    $
    (772
    )(A)
    
    $
    2,143Inventory reserve
    
    
    1,732
    
    
    
    487
    
    
    
    
    
    
    
    (1,554
    )
    
    
    665Restructuring reserves
    
    
    229
    
    
    
    366
    
    
    
    
    
    
    
    (228
    )
    
    
    367Year Ended December 31, 2004Allowances for doubtful
accounts receivable
and sales returns
    
    $
    2,143
    
    
    $
    48
    
    
    $
    1,410
    
    
    $
    (1,868
    )(A)
    
    $
    1,733Inventory reserve
    
    
    665
    
    
    
    499
    
    
    
    
    
    
    
    (424
    )
    
    
    740Restructuring reserves
    
    
    367
    
    
    
    56
    
    
    
    
    
    
    
    (423
    )
    
    
    Deferred tax
asset valuation allowance
    
    
    
    
    
    
    223
    
    
    
    
    
    
    
    
    
    
    
    223
    65